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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



FORM 10-Q



(Mark One)



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



For the quarterly period ended June 30, 2004



OR



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



For the transition period from
 to



Commission File Number 0-13716



NORTH PITTSBURGH SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Pennsylvania                                                   |  | 25-1485389                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



4008 Gibsonia Road,
Gibsonia, Pennsylvania 15044-9311

(Address of principal executive offices)

(Zip Code)



724.443.9600

(Registrants telephone number, including area code)



No Change

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



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.



YES  x    NO ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).



YES  x    NO ̈



The number
of shares of the registrants Common Stock (par value $.15625 per share) outstanding as of July 30, 2004 was 15,005,000.



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##### Table of Contents

TABLE OF CONTENTS



|           |  |                                                                                                      |  |   
|---------- |  | ---------------------------------------------------------------------------------------------------- |  | --
|           |  |                                                                                                     
|PART I     |  | Financial Information                                                                                |  |   
|           |  |                                                                                                     
|           |  | Report of Independent Registered Public Accounting Firm                                              |  |   
|           |  |                                                                                                     
|Item 1.    |  | Financial Statements                                                                                 |  |   
|           |  |                                                                                                     
|           |  | Condensed Consolidated Statements of IncomeFor the three and six months ended June 30, 2004 and 2003 |  | 1 
|           |  |                                                                                                     
|           |  | Condensed Consolidated Balance SheetsJune 30, 2004 and December 31, 2003                             |  | 2 
|           |  |                                                                                                     
|           |  | Condensed Consolidated Statements of Cash FlowsFor the six months ended June 30, 2004 and 2003       |  | 4 
|           |  |                                                                                                     
|           |  | Notes to Condensed Consolidated Financial Statements                                                 |  | 5 
|           |  |                                                                                                     
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                |  | 8 
|           |  |                                                                                                     
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                                           |  | 21
|           |  |                                                                                                     
|Item 4.    |  | Controls and Procedures                                                                              |  | 21
|           |  |                                                                                                     
|PART II    |  | Other Information                                                                                    |  |   
|           |  |                                                                                                     
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                  |  | 22
|           |  |                                                                                                     
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                                     |  | 22
|           | 
|SIGNATURES |  | 24                                                                                                  





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##### Table of Contents

PART 1



FINANCIAL INFORMATION



Report of Independent Registered Public Accounting Firm



The Board of Directors

North Pittsburgh Systems, Inc.:



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



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



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



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



Pittsburgh, Pennsylvania

July 22, 2004





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##### Table of Contents

PART I



FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------



NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES



Condensed Consolidated Statements of Income (Unaudited)

(Amounts in Thousands  Except Per Share Data)



|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|-------------------------------------------------------------------------------------------------------- |  | ---------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                         |  | For the Three Months Ended June 30 |        |   | For the Six Months EndedJune 30 |  
|                                                                                                         |  | 2004                               |        |   | 2003                            |   |        | 2004 |  |   | 2003   |  
|Operating revenues:                                                                                      |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Local network services                                                                                   |  | $                                  | 6,793  |   |                                 | $ | 6,326  |      |  | $ | 13,517 |   |  | $ | 12,299 |  
|Long distance and access services                                                                        |  |                                    | 16,573 |   |                                 |   | 16,401 |      |  |   | 33,215 |   |  |   | 32,168 |  
|Directory advertising, billing & other services                                                          |  |                                    | 353    |   |                                 |   | 356    |      |  |   | 711    |   |  |   | 588    |  
|Telecommunication equipment sales                                                                        |  |                                    | 501    |   |                                 |   | 514    |      |  |   | 1,116  |   |  |   | 1,044  |  
|Other operating revenues                                                                                 |  |                                    | 2,846  |   |                                 |   | 2,604  |      |  |   | 5,637  |   |  |   | 5,222  |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total operating revenues                                                                                 |  |                                    | 27,066 |   |                                 |   | 26,201 |      |  |   | 54,196 |   |  |   | 51,321 |  
|Operating expenses:                                                                                      |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Network and other operating expenses (exclusive of depreciation and amortization shown separately below) |  |                                    | 14,126 |   |                                 |   | 16,217 |      |  |   | 27,966 |   |  |   | 29,657 |  
|Depreciation and amortization                                                                            |  |                                    | 4,705  |   |                                 |   | 4,729  |      |  |   | 9,335  |   |  |   | 9,413  |  
|State and local taxes                                                                                    |  |                                    | 851    |   |                                 |   | 956    |      |  |   | 1,969  |   |  |   | 2,035  |  
|Telecommunication equipment expenses                                                                     |  |                                    | 367    |   |                                 |   | 382    |      |  |   | 787    |   |  |   | 748    |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                                                                 |  |                                    | 20,049 |   |                                 |   | 22,284 |      |  |   | 40,057 |   |  |   | 41,853 |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net operating income                                                                                     |  |                                    | 7,017  |   |                                 |   | 3,917  |      |  |   | 14,139 |   |  |   | 9,468  |  
|Other expense (income), net:                                                                             |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Interest expense                                                                                         |  |                                    | 477    |   |                                 |   | 538    |      |  |   | 970    |   |  |   | 1,086  |  
|Interest income                                                                                          |  |                                    | (64    | ) |                                 |   | (47    | )    |  |   | (126   | ) |  |   | (105   | )
|Equity income of affiliated companies                                                                    |  |                                    | (1,366 | ) |                                 |   | (823   | )    |  |   | (2,170 | ) |  |   | (1,713 | )
|Sundry expense, net                                                                                      |  |                                    | 58     |   |                                 |   | 58     |      |  |   | 73     |   |  |   | 83     |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total other expense (income), net                                                                        |  |                                    | (895   | ) |                                 |   | (274   | )    |  |   | (1,253 | ) |  |   | (649   | )
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Income before income taxes                                                                               |  |                                    | 7,912  |   |                                 |   | 4,191  |      |  |   | 15,392 |   |  |   | 10,117 |  
|Provision for income taxes                                                                               |  |                                    | 3,264  |   |                                 |   | 1,726  |      |  |   | 6,347  |   |  |   | 4,174  |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net income                                                                                               |  | $                                  | 4,648  |   |                                 | $ | 2,465  |      |  | $ | 9,045  |   |  | $ | 5,943  |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Weighted average common shares outstanding                                                               |  |                                    | 15,005 |   |                                 |   | 15,005 |      |  |   | 15,005 |   |  |   | 15,005 |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted earnings per share                                                                     |  | $                                  | .31    |   |                                 | $ | .16    |      |  | $ | .60    |   |  | $ | .40    |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Dividends per share                                                                                      |  | $                                  | .18    |   |                                 | $ | .17    |      |  | $ | .36    |   |  | $ | .34    |  
|                                                                                                         |  |                                    |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  



See accompanying notes
to condensed consolidated financial statements.



1



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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES



Condensed Consolidated Balance Sheets

(Amounts in Thousands)



|                                                                                 |  |                          |         |              |   |        
|-------------------------------------------------------------------------------- |  | ------------------------ | ------- | ------------ | - | -------
|                                                                                 |  | (Unaudited) June 30 2004 |         | Dec. 31 2003
|ASSETS                                                                           |  |                          |         |              |   |        
|Current assets:                                                                  |  |                          |         |              |   |        
|Cash and temporary investments                                                   |  | $                        | 33,511  |              | $ | 32,026 
|Marketable securities available for sale                                         |  |                          | 489     |              |   | 473    
|Accounts receivable:                                                             |  |                          |         |              |   |        
|Customers, net of allowance for doubtful accounts of $669 and $686, respectively |  |                          | 6,140   |              |   | 6,015  
|Access service settlements and other                                             |  |                          | 6,724   |              |   | 7,455  
|Prepaid expenses                                                                 |  |                          | 589     |              |   | 886    
|Inventories                                                                      |  |                          | 1,525   |              |   | 1,535  
|Prepaid taxes other than income taxes                                            |  |                          | 688     |              |   |       
|Deferred income taxes                                                            |  |                          | 1,599   |              |   | 1,545  
|                                                                                 |  |                          |         |              |   |        
|Total current assets                                                             |  |                          | 51,265  |              |   | 49,935 
|                                                                                 |  |                          |         |              |   |        
|Property, plant and equipment:                                                   |  |                          |         |              |   |        
|Land                                                                             |  |                          | 475     |              |   | 475    
|Buildings                                                                        |  |                          | 13,428  |              |   | 13,772 
|Equipment                                                                        |  |                          | 195,336 |              |   | 191,135
|Assets held under capital lease                                                  |  |                          | 10,363  |              |   | 10,363 
|                                                                                 |  |                          |         |              |   |        
|                                                                                 |  |                          | 219,602 |              |   | 215,745
|Less accumulated depreciation and amortization                                   |  |                          | 140,181 |              |   | 132,133
|                                                                                 |  |                          |         |              |   |        
|                                                                                 |  |                          | 79,421  |              |   | 83,612 
|Construction in progress                                                         |  |                          | 2,809   |              |   | 2,174  
|                                                                                 |  |                          |         |              |   |        
|Total property, plant and equipment, net                                         |  |                          | 82,230  |              |   | 85,786 
|                                                                                 |  |                          |         |              |   |        
|Investments                                                                      |  |                          | 13,245  |              |   | 12,858 
|Intangible asset                                                                 |  |                          | 758     |              |   | 758    
|Other assets                                                                     |  |                          | 1,306   |              |   | 1,288  
|                                                                                 |  |                          |         |              |   |        
|Total assets                                                                     |  | $                        | 148,804 |              | $ | 150,625
|                                                                                 |  |                          |         |              |   |        



(Continued)



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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES



Condensed Consolidated Balance Sheets

(Amounts in Thousands)



|                                                                                    |  |                          |         |   |              |   |         |  
|----------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ------------ | - | ------- | -
|                                                                                    |  | (Unaudited) June 30 2004 |         |   | Dec. 31 2003 |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                |  |                          |         |   |              |   |         |  
|Current liabilities:                                                                |  |                          |         |   |              |   |         |  
|Current portion of long-term debt                                                   |  | $                        | 3,085   |   |              | $ | 3,085   |  
|Obligation under capital lease                                                      |  |                          | 1,112   |   |              |   | 1,072   |  
|Accounts payable                                                                    |  |                          | 4,927   |   |              |   | 5,436   |  
|Dividend payable                                                                    |  |                          | 2,701   |   |              |   | 2,551   |  
|Other accrued liabilities                                                           |  |                          | 4,404   |   |              |   | 4,656   |  
|Federal and state income taxes                                                      |  |                          | 312     |   |              |   | 1,638   |  
|                                                                                    |  |                          |         |   |              |   |         |  
|Total current liabilities                                                           |  |                          | 16,541  |   |              |   | 18,438  |  
|                                                                                    |  |                          |         |   |              |   |         |  
|Long-term debt                                                                      |  |                          | 23,140  |   |              |   | 24,682  |  
|Obligation under capital lease                                                      |  |                          | 4,972   |   |              |   | 5,539   |  
|Deferred income taxes                                                               |  |                          | 9,839   |   |              |   | 10,028  |  
|Accrued pension and postretirement benefits                                         |  |                          | 10,965  |   |              |   | 12,207  |  
|Other liabilities                                                                   |  |                          | 556     |   |              |   | 579     |  
|                                                                                    |  |                          |         |   |              |   |         |  
|Total liabilities                                                                   |  |                          | 66,013  |   |              |   | 71,473  |  
|                                                                                    |  |                          |         |   |              |   |         |  
|Shareholders equity:                                                               |  |                          |         |   |              |   |         |  
|Capital stock: authorized 50,000 shares:                                            |  |                          |         |   |              |   |         |  
|Common stock, par value $.15625; issued 15,040 shares and outstanding 15,005 shares |  |                          | 2,350   |   |              |   | 2,350   |  
|Preferred stock, par value $1.00; none issued                                       |  |                          |        |   |              |   |        |  
|Capital in excess of par value                                                      |  |                          | 2,215   |   |              |   | 2,215   |  
|Retained earnings                                                                   |  |                          | 80,314  |   |              |   | 76,671  |  
|Less cost of treasury stock (35 shares)                                             |  |                          | (508    | ) |              |   | (508    | )
|Accumulated other comprehensive loss                                                |  |                          | (1,580  | ) |              |   | (1,576  | )
|                                                                                    |  |                          |         |   |              |   |         |  
|Total shareholders equity                                                          |  |                          | 82,791  |   |              |   | 79,152  |  
|                                                                                    |  |                          |         |   |              |   |         |  
|Total liabilities and shareholders equity                                          |  | $                        | 148,804 |   |              | $ | 150,625 |  
|                                                                                    |  |                          |         |   |              |   |         |  



See accompanying notes
to condensed consolidated financial statements.



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##### Table of Contents

NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES



Condensed Consolidated Statements of Cash Flows (Unaudited)

(Amounts in Thousands)



|                                                                           |  |                                  |        |   |      |   |        |  
|-------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                           |  | For the Six Months Ended June 30 |       
|                                                                           |  | 2004                             |        |   | 2003 |  
|Cash from operating activities:                                            |  |                                  |        |   |      |   |        |  
|Net income                                                                 |  | $                                | 9,045  |   |      | $ | 5,943  |  
|Adjustments to reconcile net income to net cash from operating activities: |  |                                  |        |   |      |   |        |  
|Depreciation and amortization                                              |  |                                  | 9,335  |   |      |   | 9,413  |  
|Equity income of affiliated companies                                      |  |                                  | (2,170 | ) |      |   | (1,713 | )
|Changes in assets and liabilities:                                         |  |                                  |        |   |      |   |        |  
|Accounts receivable                                                        |  |                                  | 606    |   |      |   | (439   | )
|Inventories                                                                |  |                                  | 10     |   |      |   | 50     |  
|Prepaid expenses and other assets                                          |  |                                  | 279    |   |      |   | (241   | )
|Prepaid taxes                                                              |  |                                  | (688   | ) |      |   | (598   | )
|Accounts payable                                                           |  |                                  | (509   | ) |      |   | (15    | )
|Other accrued liabilities                                                  |  |                                  | (275   | ) |      |   | (1,873 | )
|Accrued pension and postretirement benefits                                |  |                                  | (1,242 | ) |      |   | (160   | )
|Federal and state income taxes                                             |  |                                  | (1,326 | ) |      |   | (3,370 | )
|Deferred income taxes                                                      |  |                                  | (240   | ) |      |   | 671    |  
|Other, net                                                                 |  |                                  | 201    |   |      |   | 93     |  
|                                                                           |  |                                  |        |   |      |   |        |  
|Total adjustments                                                          |  |                                  | 3,981  |   |      |   | 1,818  |  
|                                                                           |  |                                  |        |   |      |   |        |  
|Net cash from operating activities                                         |  |                                  | 13,026 |   |      |   | 7,761  |  
|                                                                           |  |                                  |        |   |      |   |        |  
|Cash used for investing activities:                                        |  |                                  |        |   |      |   |        |  
|Expenditures for property and equipment                                    |  |                                  | (5,978 | ) |      |   | (5,215 | )
|Purchase of marketable securities available for sale                       |  |                                  | (25    | ) |      |   |       |  
|Investments in affiliated companies                                        |  |                                  |       |   |      |   | (937   | )
|Distributions from affiliated companies                                    |  |                                  | 1,783  |   |      |   | 2,524  |  
|                                                                           |  |                                  |        |   |      |   |        |  
|Net cash used for investing activities                                     |  |                                  | (4,220 | ) |      |   | (3,628 | )
|                                                                           |  |                                  |        |   |      |   |        |  
|Cash used for financing activities:                                        |  |                                  |        |   |      |   |        |  
|Cash dividends                                                             |  |                                  | (5,252 | ) |      |   | (5,102 | )
|Payments of capital lease obligation                                       |  |                                  | (527   | ) |      |   | (488   | )
|Retirement of debt                                                         |  |                                  | (1,542 | ) |      |   | (1,542 | )
|                                                                           |  |                                  |        |   |      |   |        |  
|Net cash used for financing activities                                     |  |                                  | (7,321 | ) |      |   | (7,132 | )
|                                                                           |  |                                  |        |   |      |   |        |  
|Net increase (decrease) in cash and temporary investments                  |  |                                  | 1,485  |   |      |   | (2,999 | )
|Cash and temporary investments at beginning of period                      |  |                                  | 32,026 |   |      |   | 22,244 |  
|                                                                           |  |                                  |        |   |      |   |        |  
|Cash and temporary investments at end of period                            |  | $                                | 33,511 |   |      | $ | 19,245 |  
|                                                                           |  |                                  |        |   |      |   |        |  
|Supplemental disclosure of cash flow information:                          |  |                                  |        |   |      |   |        |  
|Interest paid                                                              |  | $                                | 979    |   |      | $ | 1,095  |  
|Income taxes paid                                                          |  | $                                | 7,916  |   |      | $ | 6,880  |  



See accompanying notes
to condensed consolidated financial statements.



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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES



Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in Thousands)



|(1) | Basis of Presentation and Consolidation
|--- | ---------------------------------------



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



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



|(2) | Comprehensive Income
|--- | --------------------



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



|                                                                                                   |  |                                    |       |   |                                  |   |        |      |  |   |       |   |  |   |        |  
|-------------------------------------------------------------------------------------------------- |  | ---------------------------------- | ----- | - | -------------------------------- | - | ------ | ---- |  | - | ----- | - |  | - | ------ | -
|                                                                                                   |  | For the Three Months Ended June 30 |       |   | For the Six Months Ended June 30 |  
|                                                                                                   |  | 2004                               |       |   | 2003                             |   |        | 2004 |  |   | 2003  |  
|Net income                                                                                         |  | $                                  | 4,648 |   |                                  | $ | 2,465  |      |  | $ | 9,045 |   |  | $ | 5,943  |  
|Unrealized gain (loss) on marketable securities including reclassification adjustments, net of tax |  |                                    | (7    | ) |                                  |   | 36     |      |  |   | (4    | ) |  |   | 30     |  
|Minimum pension liability adjustment, net of tax                                                   |  |                                    |      |   |                                  |   | (1,374 | )    |  |   |      |   |  |   | (1,374 | )
|                                                                                                   |  |                                    |       |   |                                  |   |        |      |  |   |       |   |  |   |        |  
|Comprehensive income                                                                               |  | $                                  | 4,641 |   |                                  | $ | 1,127  |      |  | $ | 9,041 |   |  | $ | 4,599  |  
|                                                                                                   |  |                                    |       |   |                                  |   |        |      |  |   |       |   |  |   |        |  



|(3) | Postretirement Benefits
|--- | -----------------------



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



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



Components of Net Periodic Benefit Cost:



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



|                                   |  |                            |      |   |                          |   |      |      |  |   |        |   |  |   |        |  
|---------------------------------- |  | -------------------------- | ---- | - | ------------------------ | - | ---- | ---- |  | - | ------ | - |  | - | ------ | -
|                                   |  | Pension Benefits           |     
|                                   |  | Three Months Ended June 30 |      |   | Six Months Ended June 30 |  
|                                   |  | 2004                       |      |   | 2003                     |   |      | 2004 |  |   | 2003   |  
|Service cost                       |  | $                          | 331  |   |                          | $ | 321  |      |  | $ | 663    |   |  | $ | 642    |  
|Interest cost                      |  |                            | 690  |   |                          |   | 669  |      |  |   | 1,380  |   |  |   | 1,338  |  
|Expected return on plan assets     |  |                            | (716 | ) |                          |   | (618 | )    |  |   | (1,433 | ) |  |   | (1,237 | )
|Amortization of prior service cost |  |                            | 31   |   |                          |   | 35   |      |  |   | 63     |   |  |   | 71     |  
|Amortization of transition asset   |  |                            | (38  | ) |                          |   | (38  | )    |  |   | (77    | ) |  |   | (77    | )
|Recognized actuarial loss          |  |                            | 116  |   |                          |   | 139  |      |  |   | 232    |   |  |   | 279    |  
|                                   |  |                            |      |   |                          |   |      |      |  |   |        |   |  |   |        |  
|Net periodic benefit cost          |  | $                          | 414  |   |                          | $ | 508  |      |  | $ | 828    |   |  | $ | 1,016  |  
|                                   |  |                            |      |   |                          |   |      |      |  |   |        |   |  |   |        |  
|Additional loss due to curtailment |  | $                          |     |   |                          | $ | 788  |      |  | $ |       |   |  | $ | 788    |  
|                                   |  |                            |      |   |                          |   |      |      |  |   |        |   |  |   |        |  



|                                   |  |                               |     |   |                          |   |     |      |  |   |      |   |  |   |     |  
|---------------------------------- |  | ----------------------------- | --- | - | ------------------------ | - | --- | ---- |  | - | ---- | - |  | - | --- | -
|                                   |  | Other Postretirement Benefits |    
|                                   |  | Three Months Ended June 30    |     |   | Six Months Ended June 30 |  
|                                   |  | 2004                          |     |   | 2003                     |   |     | 2004 |  |   | 2003 |  
|Service cost                       |  | $                             | 88  |   |                          | $ | 75  |      |  | $ | 177  |   |  | $ | 150 |  
|Interest cost                      |  |                               | 171 |   |                          |   | 143 |      |  |   | 341  |   |  |   | 287 |  
|Amortization of prior service cost |  |                               | (1  | ) |                          |   | (1  | )    |  |   | (3   | ) |  |   | (3  | )
|Recognized actuarial loss          |  |                               | 59  |   |                          |   | 34  |      |  |   | 119  |   |  |   | 68  |  
|                                   |  |                               |     |   |                          |   |     |      |  |   |      |   |  |   |     |  
|Net periodic benefit cost          |  | $                             | 317 |   |                          | $ | 251 |      |  | $ | 634  |   |  | $ | 502 |  
|                                   |  |                               |     |   |                          |   |     |      |  |   |      |   |  |   |     |  
|Additional loss due to curtailment |  | $                             |    |   |                          | $ | 795 |      |  | $ |     |   |  | $ | 795 |  
|                                   |  |                               |     |   |                          |   |     |      |  |   |      |   |  |   |     |  



North Pittsburgh also
has a nonqualified supplemental pension plan covering former and current employees, which provides for incremental pension payments to the extent that income tax regulations limit the amount payable from North Pittsburghs qualified defined
benefit plan. Pension expense for the supplemental plan for the three-month periods ended June 30, 2004 and 2003 was $55 and $41, respectively, and pension expense for the six-month periods ended June 30, 2004 and 2003 was $110 and $81,
respectively.



Employer Contributions:



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



Contributions for the other postretirement benefit plans are made on a
pay-as-you-go basis, with total contributions of $321 having been made during the six-month period ended June 30, 2004. The $321 of contributions for the first half of 2004 were in line with the expected annual contributions of $641 disclosed in the
Companys 2003 Form 10-K.



|(4) | Transactions with Related Parties
|--- | ---------------------------------



Since 1998, we have had an agreement to obtain certain data processing functions from a third party processor (Processor), which is a member of the
Armstrong Group of Companies (the Armstrong Group). We are related to the Armstrong Group by a common shareholder and director. Payments to the Processor under this agreement were $1,421 and $1,857 for the six-month periods ended June 30, 2004 and
2003, respectively. Also, we paid $107 and $39, respectively, in those same periods to the law firm of a member of the Board of Directors for various legal services. As of June 30, 2004, we had amounts outstanding of $173 and $56 to the Processor
and law firm, respectively.



In addition, in the ordinary
course of business, we both provide and receive telecommunication transport services from Boulevard Communications, LLP (Boulevard), a competitive access provider jointly owned by us and a company in the Armstrong Group. Total revenues recognized
from providing services to Boulevard were approximately $13 for both



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six-month periods, and total expenses incurred from receiving services from Boulevard were approximately $99 and $128, for the six-month periods ended June
30, 2004 and 2003, respectively. We also provide, in the ordinary course of business, telecommunication and transport services to other member companies of the Armstrong Group, with total revenues recognized of approximately $79 and $118, for those
same periods, respectively. The amounts outstanding from and/or due to Boulevard and the companies in the Armstrong Group were negligible as of June 30, 2004.



|(5) | Workforce Reduction
|--- | -------------------



During the second quarter of 2003, the Company instituted a workforce reduction program at its North Pittsburgh subsidiary. That program consisted of both
layoffs and early retirement incentives. The Company recorded $1,076 in severance charges related to the workforce reduction program during the second quarter of 2003, all of which was paid prior to June 30, 2003.



Because of the workforce reduction program, the Company also recorded
curtailment charges and completed a re-measurement of its obligations under its defined benefit pension plan and postretirement healthcare plan. Curtailment charges totaling $1,583 were recorded in the second quarter of 2003. Both the $1,076 in
severance charges and $1,583 in curtailment charges were recorded in the Network and other operating expenses line item on the Companys Condensed Consolidated Statements of Income.



|(6) | Recent Accounting Pronouncements
|--- | --------------------------------



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



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



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PART I



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

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



Cautionary Language Concerning Forward-Looking Statements



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



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



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



| |  | a change in economic conditions in the markets in which we operate;
| | - | -------------------------------------------------------------------



| |  | government and regulatory policies at both the federal and state levels;
| | - | ------------------------------------------------------------------------



| |  | unanticipated higher capital spending for, or delays in, the deployment of new technologies;
| | - | --------------------------------------------------------------------------------------------



| |  | the pricing and availability of equipment, materials and inventories;
| | - | ---------------------------------------------------------------------



| |  | changes in the competitive environment in which we operate, including the intensity of competitive activity, pricing pressures and new and/or alternative product offerings;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our ability to continue to successfully penetrate our edge-out markets.
| | - | -----------------------------------------------------------------------



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



Overview



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



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



In addition to our core businesses described above, we also
derive a portion of our net income and cash flow from our limited partner interests in three wireless partnerships, all of which are majority owned and operated by Verizon Wireless. These partnerships, which have their origin



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in the 1980s with the allocation by the Federal Communications Commission (FCC) of B licenses, cover territories which overlap the majority of our ILEC and
edge-out markets.



General Description of Our Company and Business



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



North Pittsburgh
Telephone Company



North Pittsburgh, our ILEC, was founded
in 1906 and operates in an approximate 285 square mile territory in Western Pennsylvania, which includes portions of Allegheny, Armstrong, Butler and Westmoreland Counties. We provide service to approximately 73,400 business and residential access
lines in our ILEC territory. Over the past decade, our ILEC territory has experienced very robust population growth due to the continued expansion of suburban communities into the southern portions of our serving area, with the southernmost point of
our territory being only 12 miles from the City of Pittsburgh. According to the census covering the past decade, the population in our ILEC service territory grew 14.3% from 1990 to 2000. Although no formal census has been published since 2000,
business and new home growth has remained robust in our territory over the last several years and census estimates, which are published on a yearly basis, continue to show population growth.



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



Penn Telecom



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



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



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



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CLECs. As of June 30, 2004, Penn Telecom served 31,677 dial tone access lines and 21,723 access line equivalents1, for a grand total of 53,400 equivalent access lines2.



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



Pinnatech



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



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



Industry Dynamics



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



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



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



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



Regulation and Competition



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

---

|1 | Access line equivalents represent a conversion of data circuits to an access line basis and are presented for comparability purposes. Equivalents are calculated by
converting data circuits (basic rate interface (BRI), PRI, DSL, DS-1 and DS-3) and SONET-based (optical) services (OC-3 and OC-48) to the equivalent of an access line. While the revenues generated by access line equivalents have a directional
relationship with these counts, growth rates cannot be compared on an equivalent basis.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|2 | Equivalent access lines include dial tone access lines and access line equivalents.
|- | -----------------------------------------------------------------------------------



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##### Table of Contents

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



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



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



Highlights and Outlook



Revenues for the six-month period ended June 30, 2004 increased $2,875, or
5.6%, over the prior year comparable period. The majority of this growth was attributable to our ability to continue to effectively penetrate our edge-out markets as well as expand our broadband service offerings. Total operating expenses for the
six-month period ended June 30, 2004 decreased $1,796 from the prior year comparable period, which included a $2,659 charge associated with a workforce reduction program. Excluding that charge, other operating expenses increased $863, or 2.2%, in
the first six months of 2004. The lower percentage growth in operating expenses in contrast to operating revenues reflects our continued efforts to contain costs. The first six months of 2004 were impacted positively by decreases in the cost of
contracted operational support system (OSS) services pursuant to a new agreement executed in the third quarter of 2003 as well as by our ability to greatly moderate the annual growth rate in overall labor costs (inclusive of current and
postretirement benefits). Labor costs increased at an approximate 3% rate for the six-month period ended June 30, 2004 over the prior year comparable period in contrast to double digit percentage increases in these costs experienced in the past
several years.



For 2004, we expect that competition for all of
our service offerings will continue to intensify, resulting in further pressures on operating margins. We expect that revenue growth will continue to be driven by the addition of new customers in our edge-out markets and further broadband
penetration. We have also started to focus to an even greater extent on bundled product offerings, which we anticipate will drive value to our customers and serve as a retention tool for our existing customer base.



Our cost structure is heavily weighted towards labor and depreciation. As
such, there is not a great deal of direct correlation between our revenues and our largest operating expenses. Percentage increases in our labor costs have outpaced our revenue growth over the past several years, primarily driven by increases in
healthcare costs and postretirement benefit expenses. We have taken steps to address some of these issues, including the workforce reduction program implemented in 2003 and using our excess cash reserves to make additional contributions into the
defined benefit pension plan. The benefits of taking these steps were evident in the results of operations for the first six months of 2004. Our ability to contain the growth in overall labor costs to 3% in comparison to the first six months of 2003
allowed for the majority of the increase in revenues to flow through into operating margin.



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



Our financial condition and balance sheet have continually improved over the last several years through prudent investment
strategies and strong cash flows generated from operating activities. Unlike many telecommunication companies that have substantially leveraged their businesses, we have a greater amount of cash on hand ($33,511) than our total debt outstanding
($26,225). Our financial condition gives us the ability to invest in new products and/or opportunities



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and the flexibility to continue to evaluate ways to create greater shareholder value, whether through our dividend policy, stock repurchases or other
investment opportunities.



Results of Operations



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



Results of Operations for the Six Months Ended June 30,
2004 and 2003



Net income for the six-month period ended
June 30, 2004 was $9,045, or $.60 per share, compared to net income of $5,943, or $.40 per share, for the comparable prior year period. The increase in net income was attributable to the following factors:



Operating Revenues



Total operating revenues increased $2,875, or 5.6%, in the six-month period
ended June 30, 2004 over the comparable period in 2003. This increase was the result of increases in local network services revenues of $1,218 (9.9%), long distance and access services revenues of $1,047 (3.3%), directory advertising, billing and
other services revenues of $123 (20.9%), telecommunication equipment sales of $72 (6.9%) and other operating revenues of $415 (7.9%).



Increases in local network services revenues of $1,218, or 9.9%, were primarily attributable to the following factors:



| |  | Local dial tone revenues increased $1,006, partially as a result of total access lines (including CLEC) growing by 7,833 lines, or 8.1%, from 97,266 access lines as of June 30, 2003
to 105,099 access lines as of June 30, 2004. More specifically, the total growth was a result of a 10,362 access line increase in our edge-out markets offset partially by a 2,529 access line decrease in our ILEC market. Also contributing to the
increase was an approximate $630 increase in local dial tone revenues due to revenue neutral rate re-balancings at North Pittsburgh during April and December of 2003, which increased local residential rates and decreased intrastate access rates.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Revenues earned from PRIs increased $105, mostly as a result of an increase in the average number of circuits in our edge-out markets during the course of 2004. However, as of June
30, 2004, our PRI circuit count was the same as June 30, 2003, primarily due to the consolidation of our customer base and the elimination of redundant facilities. As communicated in our 2003 Form 10-K, we expected our 2004 PRI growth rate to
decrease from previous rates ($747 annual increase in 2003). The majority of our circuit growth in our edge-out markets was the result of winning ISPs away from the incumbent. ISPs use PRIs as a component of their network for dial-up traffic. The
continued penetration of broadband services has led to customers migrating from dial-up connections to broadband access, thereby decreasing the overall markets need for dial-up infrastructure. The Western Pennsylvania market is also
experiencing consolidation in the dial-up business, and we have recently experienced consolidation among our customers which has led to the elimination of redundant facilities. Although we expect to continue to win ISP business from the incumbent,
we already have a relatively high penetration rate in the ISP markets in which we currently operate. As such, we expect the growth rate in revenues from PRI circuits to greatly decrease, or perhaps turn negative, during the remainder of 2004.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The increase in long distance and access
services revenues of $1,047, or 3.3%, was primarily attributable to the following factors:



| |  | Access revenues increased $199 due primarily to an increase in end user interstate access charges generated by the growth in access lines and switched circuits and
as a result of changes in the National Exchange Carrier Association (NECA) average schedule settlement formulas in which North Pittsburgh participates. The growth rate in access revenues, however, was approximately 1% for the first six months of
2004 over the prior period as compared to a 12% growth rate experienced for full year 2003. One factor contributing to the lower growth rate was that the prior year second quarter was favorably impacted by $427 in final inter-carrier settlement
adjustments covering a two-year period. In addition, as communicated in our 2003 Form 10-K, we did not expect to achieve the same growth rate in access revenues for 2004 as we experienced in 2003 due to several other factors, the most significant of
which was a revision made between Verizon and Penn Telecom in September of 2003 in the percent local use (PLU) factor used to settle traffic between the companies. At that time, the PLU factor change resulted in an approximate $250 per month
decrease in intrastate access revenues recognized. As the impact of the PLU adjustment affected
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | only four months in 2003, year over year comparisons for full year 2004 will be negatively impacted by an entire twelve months of the adjustment. Secondly,
in conjunction with the FCCs Access Charge Reform Order, Penn Telecoms interstate access rates have been phased down over a three-year period, which began in 2001. The final decrease, which adjusted Penn Telecoms rates to mirror
the incumbents rates, was effective June 20, 2004. We expect that the impact of the interstate rate change will be an approximate $40 per month decrease in access revenues. Thirdly, based on reviews of the NECA average schedule settlement
formulas, which became effective July 1, 2004, we anticipate an approximate $50 per month decrease in North Pittsburghs interstate revenues. Finally, as previously described in the local network services section above, North Pittsburghs
intrastate access rates were reduced through revenue neutral rate re-balancings that increased local dial tone charges.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Special access revenues increased $586, mostly as a result of increases in the number of DS-1 and DS-3 circuits sold.
| | - | ---------------------------------------------------------------------------------------------------------------------



| |  | Overall toll revenues (the combination of metro area, intraLATA and interLATA toll) increased $262. We have continued to be successful in bundling toll in our edge-out markets (in
which the number of access lines grew by 10,362), with nearly a 77% subscription rate. Our ability to increase our customer base has been partially offset by continuing pricing pressures from the introduction of aggressively priced flat rate toll
packages from VoIP providers and intense pricing competition in the wireless market.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The increase in directory advertising, billing and other services revenues of $123 was mostly attributable to the prior year first quarter including an
approximate $120 reduction in revenues recorded in anticipation of a lower settlement for the 2002 directory book than originally estimated.



The increase in telecommunication equipment sales of $72 was due to an increase in post sale support revenues. Correspondingly, telecommunication
equipment expenses increased by $39.



The increase in other
operating revenues of $415, or 7.9%, was primarily due to growth in DSL revenues of approximately $585 as combined DSL lines (both wholesale and retail) sold increased from 8,670 as of June 30, 2003 to 11,028 as of June 30, 2004.



Operating Expenses and Net Operating Income



Total operating expenses decreased $1,796, or 4.3%, in the six-month
period ended June 30, 2004 over the comparable period in 2003. The change was the result of decreases in network and other operating expenses of $1,691 (5.7%), depreciation and amortization expenses of $78 (0.8%) and state and local taxes of $66
(3.2%), offset partially by an increase in telecommunications equipment expenses of $39 (5.2%),



The decrease in network and other operating expenses of $1,691, or 5.7%, was primarily due to the prior year second quarter including a $2,659
charge recorded in association with a workforce reduction program at our North Pittsburgh subsidiary. Excluding that charge, other operating expenses in this category increased $968, or 3.6%, for the first six months of 2004 over the comparable year
period, mostly due to increases in direct costs associated with the growth in access lines and access line equivalents. Such direct costs include the fees paid for leasing unbundled network elements (UNEs) in the portions of our edge-out markets
that we do not provision over our own facilities and fees paid to terminate the increased local, toll and Internet traffic generated by our growing customer base. The 3.6% increase in costs, though, was historically low in comparison to the growth
rates experienced in the past several years, due to the impact of the following items:



| |  | Combined labor and benefit expenses for the first six months of 2004 increased at an approximate 3% rate in comparison to the prior year period (excluding the
$2,659 in one-time workforce reduction charges in 2003 discussed above), reversing the trend of double digit percentage increases in these costs experienced in the past several years. The majority of the increase was due to the continued rise in
current benefit expenses (mostly as a result of increases in medical insurance premiums). Payroll expense remained relatively flat, as an approximate 5% decrease in the overall workforce offset the effects of the normal year over year wage
increases. Aggregate postretirement benefit expenses, as outlined in more detail in Note 3 to the Condensed Consolidated Financial Statements included in this Form 10-Q, also remained relatively constant for the first six months of 2004 over the
prior year period (excluding the $1,583 in one-time curtailment charges included in the workforce reduction charges in 2003 discussed above). This contrasts with double digit percentage increases in postretirement benefit expenses experienced over
the past several years. We have been able to curtail the growth in these expenses due to a decrease in the number of plan eligible participants as a result of the workforce reduction and by making additional contributions, above the minimum required
level,
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | into the defined benefit pension plan in both 2003 and the early part of 2004. In addition, we have benefited from the strong performance of the assets in
the pension plan during 2003.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We realized an approximate $700 decrease in the costs of contracted OSS services for the six-month period ended June 30, 2004 over the comparable prior year period pursuant to a
newly negotiated agreement in the third quarter of 2003.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The decrease in consolidated depreciation and amortization expenses of $78, or 0.8%, was the result of the capitalized costs and license fees, which were incurred with the conversion to a Year 2000 compliant OSS approximately five years
ago, becoming fully depreciated in December of 2003. This resulted in an approximate $540 decrease in depreciation for that set of assets. Otherwise, depreciation expense for all other assets increased approximately $462 as the depreciable asset
base (gross property, plant and equipment) grew 4.5% over the twelve-month period ended June 30, 2004.



The decrease in state and local taxes of $66, or 3.2%, was attributable mostly to nominal decreases in payroll taxes and gross receipts tax expense.



Overall, the increase in total operating revenues of $2,875
coupled with the decrease in total operating expenses of $1,796, resulted in a $4,671, or 49.3%, increase in net operating income for the six-month period ended June 30, 2004 over the comparable prior year period.



Other Items



Interest expense decreased for the six-month period ended June 30, 2004 by
$116 due to the continued scheduled pay-down of our Federal Financing Bank (FFB) notes and capital lease obligation.



Equity income of affiliated companies increased $457 in the six-month period ended June 30, 2004 over the comparable prior year period due mainly to a
$460 increase in the amount of income generated from the Companys limited partner interest in three wireless partnerships. These partnerships, all of which are majority owned and operated by Verizon Wireless, have continued to show strong
growth in the number of customers and operating results. In addition, we are benefiting from a reduction in switching cost which became effective in 2004.



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



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



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



Directory advertising, billing and other services revenues decreased $3, or 0.8%, for the three-month period ended June 30,
2004 as compared to the same quarterly period in 2003, in contrast to a six-month year to date increase of $123, or 20.9%. As previously discussed, the year to date increase was mostly a result of the prior year first quarter including an
approximate $120 reduction in revenues recorded in anticipation of a lower settlement for the 2002 directory book than originally estimated. Absent that item, which was unique to the first quarter comparisons, year over year revenues have remained
relatively flat.



Telecommunication equipment sales decreased
$13, or 2.5%, for the three-month period ended June 30, 2004 as compared to the same quarterly period in 2003, in contrast to a six-month year to date increase of $72, or 6.9%. As the majority of our revenue from this category is non-recurring in
nature, quarter over quarter comparisons can be impacted by the timing of when some of our larger installations occur. Correspondingly, telecommunication equipment expenses decreased $15 in the second quarter of 2004 over the prior year second
quarter, in contrast to a six-month year to date increase of $39.



Network and other operating expenses decreased $2,091, or 12.9%, for the three-month period ended June 30, 2004 as compared to the same quarterly period in 2003, in contrast to a six-month year to date decrease of $1,691, or 5.7%. The
larger percentage decrease for the second quarterly period of 2004 as compared to the year to date period was due to the fact that all of the $2,659 in workforce reduction charges occurred in the second quarter of 2003.



Equity income of affiliated companies increased $543, or 66.0%, for the
three-month period ended June 30, 2004 as compared to the same quarterly period in 2003, in contrast to a six-month year to date increase of $457, or 26.7%. The larger percentage increase for the second quarterly period of 2004 as compared to the
year to date period was partially due to the fact that the favorable reduction in switching expense, as previously described, became effective with the partnership results that we reported for the second quarter of 2004. In addition, the prior year
first quarter



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results for the Pennsylvania RSA 6 (II) partnership were positively impacted by several non-recurring items.



Liquidity and Capital Resources



|                                              |  |              |        |                  |   |       
|--------------------------------------------- |  | ------------ | ------ | ---------------- | - | ------
|                                              |  | June 30,2004 |        | December 31,2003
|Cash and temporary investments                |  | $            | 33,511 |                  | $ | 32,026
|Working capital                               |  | $            | 34,724 |                  | $ | 31,497
|Long-term debt (including current maturities) |  | $            | 26,225 |                  | $ | 27,767



Cash and temporary
investments were $33,511 at June 30, 2004 as compared to $32,026 at December 31, 2003. The increase was a result of operating cash flows exceeding investment and financing requirements. Cash flows from operations were $13,026 for the six-month
period ended June 30, 2004, a $5,265 increase from the comparable prior year period. Cash flows from operations were positively impacted by net income increasing $3,102 over the prior year period. A portion of that increase in net income was due to
the fact that the prior year period included $1,076 in cash severance and early retirement incentives. Cash flows from operations for the first half of 2004 were also positively impacted by improvements in accounts receivable collection, with an
approximate $421 previously disputed receivable paid by a carrier in January of 2004. Furthermore, contributions into the Companys defined benefit pension plan were $491 lower in the first six months of 2004 than the prior year period. The
remainder of the difference was mostly a result of the timing of the payment of liabilities, most notably income taxes, as the charges generated from the workforce reduction program in the second quarter of 2003 did not yield cash tax benefits until
the third quarter of 2003. We do not expect the magnitude of the increase (68%) in cash flows from operations for the first six months of 2004 to continue throughout the rest of the year, because the timing benefits experienced on working capital
accounts are not recurring in nature and may reverse throughout the year.



Cash flows used for investing activities were $4,220 for the six-month period ended June 30, 2004, a $592 increase from the comparable prior year period. The increase was primarily the result of a $763 increase in
capital additions as the first six months of 2004 included investments in equipment for our next generation of DSL products (including a 3 Megabit offering) as well as an increase in purchases for fleet vehicles. This was partially offset by a $196
increase in net proceeds received from our wireless partnerships.



We expended $7,321 during the six-month period ended June 30, 2004 for financing activities, which included cash dividends and the scheduled repayments of debt and capital lease obligations. The amount is $189 higher than the prior year
period, mostly as a result of a $150 increase in dividends paid pursuant to the Company raising by $.01 per share the dividend it declared payable during the second quarter of 2004.



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



Working capital levels at June 30, 2004 increased $3,227 from December 31,
2003, mostly due to the continued generation of cash flows from operations, which contributed to a $1,485 increase in cash and temporary investments (as discussed above) and the pay-down of current liabilities (decreases in accrued federal and state
income taxes and accounts payable of $1,326 and $509, respectively).



The decrease in long-term debt was a result of scheduled principal repayments of $1,542 during the six-month period ended June 30, 2004. We funded 100% of our year-to-date 2004 expenditures for property and equipment from operations cash
flows and cash reserves. Therefore, no additional advances were requested from our available debt facilities. In 1996, North Pittsburgh was granted approval for a loan from the FFB guaranteed by the Rural Utilities Service (RUS) in the maximum
principal amount of $75,000. The total amount outstanding at June 30, 2004 to the FFB under this loan was $26,225, with all advances having a maturity date of December 31, 2012. The unadvanced amount of this facility as of June 30, 2004 was $34,764.
North Pittsburgh can draw against this facility through June 30, 2012 for qualified capital expenditure projects, as defined in the loan agreement, to furnish and improve telephone service in rural areas. As of June 30, 2004, North Pittsburgh had
approximately $3,510 of qualified capital expenditures that were eligible to be drawn against this facility.



The notes payable to the FFB are secured by a supplemental Mortgage Agreement executed by North Pittsburgh, which provides that substantially all of the
assets of North Pittsburgh, which approximate a net book value of $96,588, are subject to a lien or a security interest. Such agreement contains restrictions regarding dividends and other distributions by North Pittsburgh. Under these restrictions,
unless certain working capital levels, net worth levels and interest expense ratios are maintained, North Pittsburgh is not permitted to pay dividends on its capital stock (other than in shares of capital stock), or make any other distributions to
its



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shareholder or purchase, redeem or retire any of its capital stock or make any investment in affiliated companies. As a result of these restrictions,
approximately $7,207 of North Pittsburghs retained earnings was available for dividends and other distributions to the Registrant as of June 30, 2004. Taking into consideration the North Pittsburgh restrictions, approximately $47,546 of our
consolidated retained earnings was available for dividends and other distributions to our shareholders as of June 30, 2004.



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



Consolidated capital expenditure commitments for the purchase and installation of new equipment at June 30, 2004 amounted to approximately $1,578, with such amount being part of our 2004 construction program, which is projected to aggregate
in the range of $12,000 to $13,000. The Company had made expenditures of $5,978 in association with this construction program through June 30, 2004.



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



We refer you to our Managements Discussion and Analysis of Financial Condition and Results of Operations section of
our 2003 Form 10-K for a disclosure and discussion of our aggregate contractual obligations and purchase commitments as of December 31, 2003. There were no material changes in the specified contractual obligations and purchase commitments during the
six-month period ended June 30, 2004. Scheduled payments of $1,542, $796 and approximately $143 were made to reduce the outstanding long-term debt, capital lease and operating lease obligations, respectively, during the first six months of 2004.



Critical Accounting Policies



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



Revenue Recognition



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



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



Impairment of Long-Lived
Assets



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



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Valuation of Accounts Receivable



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



Income Taxes



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



Pension and Other Postretirement Benefits



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



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



Regulatory Matters



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



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



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



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Pittsburgh became subject to implementing Local Number Portability (LNP) within six months of receipt of a bona fide request from a CLEC.



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



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



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



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



Prior to the FCCs issuance of the
NPRM regarding VoIP, several companies had petitioned the FCC for declaratory rulings that their specific service offerings, which utilize some component of Internet Protocol (IP), were exempt from access charges. One of these filings was made by
AT&T and one was made by pulver.com.



The AT&T Petition
asked the FCC for a declaratory ruling that AT&Ts Phone-to-Phone IP telephony service, which utilizes IP in the transport portion of the service, is exempt from access charges. On April 21, 2004, the FCC released an Order denying the
AT&T Petition and affirming that access charges do apply to toll calls that originate or terminate on the Public Switched Telephone Network (PSTN) even if some portion of the call is transported utilizing IP.



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



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



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



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proceeding is unknown at this time, we are unable to determine the effect such action may have on our operations and revenues.



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



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



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



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



On June 30, 2004, a group of CLECs including AT&T and several state regulatory parties filed petitions at the US Supreme Court seeking to reverse the federal appeals court decision. It is uncertain whether their
appeals will be successful, as both the US solicitor general and the FCC have not sought a review of the appeals court decision.



The FCC has stated that it plans to issue interim rules shortly that will be in place while it works on drafting final rules that will comply with the
Court decision. Until such time as the US Supreme Court acts on the petition for review and the FCC issues final rules in compliance with the Courts rulings, we are unable to determine the effect their rulings may have on our operations and
revenues.



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



With regard to UNE-P, we had approximately 2,500, or 7%, of
our CLEC dial tone access lines served utilizing UNE-P as of June 30, 2004. Should changes occur in the current UNE-P environment, either in terms of restricting availability or revising pricing methodologies to allow for



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price increases, our margins realized for these lines may decrease and/or our future effectiveness in geographically expanding our customer base may be
partially hampered.



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



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



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



Recent Accounting
Pronouncements



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



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



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##### Table of Contents

PART I



|Item 3. | Quantitative And Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------



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



|Item 4. | Controls and Procedures
|------- | -----------------------



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



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



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##### Table of Contents

PART II



OTHER INFORMATION



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



The 2004 Annual Meeting of Shareholders of the Company was held on May 21, 2004. The only matter voted upon at the Annual Meeting was the election of Directors. The vote tabulation in respect to each nominee to serve
as Director until the 2005 Annual Meeting of Shareholders is shown in the following table:



|                       |  |                                 |  |                          
|---------------------- |  | ------------------------------- |  | -------------------------
|Name                   |  | Number of Shares Voted in Favor |  | Number of Shares Withheld
|Nominees Elected:      |  |                                 |  |                          
|Harry R. Brown         |  | 12,279,051                      |  | 971,273                  
|Dr. Charles E. Cole    |  | 12,898,619                      |  | 351,705                  
|Frederick J. Crowley   |  | 12,917,519                      |  | 332,805                  
|Allen P. Kimble        |  | 12,351,492                      |  | 898,832                  
|Stephen G. Kraskin     |  | 11,875,539                      |  | 1,374,785                
|David E. Nelsen        |  | 12,939,228                      |  | 311,096                  
|Jay L. Sedwick         |  | 12,647,381                      |  | 602,943                  
|Charles E. Thomas, Jr. |  | 12,354,069                      |  | 896,255                  



|Item 6. | Exhibits and Reports on Form 8-K
|------- | --------------------------------



|(a) | Exhibits Index for Quarterly Reports on Form 10-Q.
|--- | --------------------------------------------------



|            |  |                                                                             |  |                                                                                                                                                     
|----------- |  | --------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Subject                                                                     |  | Applicability                                                                                                                                       
|            |  |                                                                            
|(2)         |  | Plan of acquisition, reorganization, arrangement, liquidation or succession |  | Not Applicable                                                                                                                                      
|            |  |                                                                            
|(3)(i)      |  | Articles of Incorporation                                                   |  | Provided in Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 and Incorporated Herein by Reference                             
|            |  |                                                                            
|(3)(ii)     |  | Amended and Restated By-Laws                                                |  | Provided in Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 and Incorporated Herein by Reference                                 
|            |  |                                                                            
|(4)         |  | Instruments defining the rights of security holders, including indentures   |  |                                                                                                                                                     
|            |  |                                                                            
|            |  | (a)     Agreement of Reorganization and Plan of Merger                      |  | Provided in Registration of Securities of Certain Successor Issuers on Form 8-B filed on June 25, 1985 and Incorporated Herein by Reference         
|            |  |                                                                            
|            |  | (b)     Rights Agreement dated as of September 25, 2003                     |  | Provided as Exhibit 1 to the Registration of Certain Classes of Securities on Form 8-A filed on October 3, 2003 and Incorporated Herein by Reference
|            |  |                                                                            
|(10)        |  | Material contracts                                                          |  |                                                                                                                                                     
|            |  |                                                                            
|            |  | (a)     Amended and Restated Executive Employment Agreement                 |  | Provided in Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 and Incorporated Herein by Reference.                                
|            |  |                                                                            
|            |  | (b)     Executive Retention Payment Program Agreement                       |  | Provided in Annual Report on Form 10-K for the year ended December 31, 2003 and Incorporated Herein by Reference.                                   



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##### Table of Contents

|            |  |                                                                                                                                                                                                |  |                                                                                                                  
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Subject                                                                                                                                                                                        |  | Applicability                                                                                                    
|            |  |                                                                                                                                                                                               
|            |  | (c)     Extension of Amended and Restated Executive Employment Agreement and Retention Payment
Program                                                                                         |  | Provided in Annual Report on Form 10-K for the year ended December 31, 2003 and Incorporated Herein by Reference.
|            |  |                                                                                                                                                                                               
|(11)        |  | Statement re computation of per share earnings                                                                                                                                                 |  | Attached Hereto                                                                                                  
|            |  |                                                                                                                                                                                               
|(15)        |  | Letter re unaudited financial information                                                                                                                                                      |  | Not Applicable                                                                                                   
|            |  |                                                                                                                                                                                               
|(18)        |  | Letter re change in accounting principles                                                                                                                                                      |  | Not Applicable                                                                                                   
|            |  |                                                                                                                                                                                               
|(19)        |  | Report furnished to securities holders                                                                                                                                                         |  | Not Applicable                                                                                                   
|            |  |                                                                                                                                                                                               
|(22)        |  | Published report regarding matters submitted to vote of security holders                                                                                                                       |  | Not Applicable                                                                                                   
|            |  |                                                                                                                                                                                               
|(23)        |  | Consents of experts and counsel                                                                                                                                                                |  | Not Applicable                                                                                                   
|            |  |                                                                                                                                                                                               
|(24)        |  | Power of attorney                                                                                                                                                                              |  | Not Applicable                                                                                                   
|            |  |                                                                                                                                                                                               
|(31.1)      |  | Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                               |  | Attached Hereto                                                                                                  
|            |  |                                                                                                                                                                                               
|(31.2)      |  | Certification of Vice President, Treasurer and Chief Financial and Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                |  | Attached Hereto                                                                                                  
|            |  |                                                                                                                                                                                               
|(32.1)      |  | Certification of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                |  | Attached Hereto                                                                                                  
|            |  |                                                                                                                                                                                               
|(32.2)      |  | Certification of Vice President, Treasurer and Chief Financial and Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 |  | Attached Hereto                                                                                                  



|(b) | Reports on Form 8-K
|--- | -------------------



During the quarter ended June 30, 2004, we furnished one Report on Form 8-K. That Report, dated April 27, 2004, reported under Item 12, Results of
Operations and Financial Condition, the Companys press release announcing first quarter 2004 earnings.



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##### Table of Contents

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.



|                     |  |  |  |                                                   
|-------------------- |  |  |  | --------------------------------------------------
|                     |  |  |  | NORTH PITTSBURGH SYSTEMS, INC. (Registrant)       
|                     |  | 
|Date: August 9, 2004 |  |  |  | /s/ H.R. Brown                                    
|                     |  |  |  | H. R. Brown, President and Chief Executive Officer



|                     |  |  |  |                                                                                   
|-------------------- |  |  |  | ----------------------------------------------------------------------------------
|                     |  | 
|Date: August 9, 2004 |  |  |  | /s/ A.P. Kimble                                                                   
|                     |  |  |  | A. P. Kimble, Vice President, Treasurer and Chief Financial and Accounting Officer



24