Edgar Filing: LYNCH INTERACTIVE CORP

SECURITIES & EXCHANGE COMMISSION
WASHINGTON, D.C. 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
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from to
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Commission File No. 1-15097
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LYNCH INTERACTIVE CORPORATION
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(Exact name of Registrant as specified in its charter)

Delaware 06-1458056
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State or other jurisdiction of I.R.S. Employer
incorporation or organization) Identification No.)

401 Theodore Fremd Avenue, Rye, New York 10580
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(Address of principal executive offices) (Zip Code)

(914) 921-8821
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Registrant's telephone number, including area code

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

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).Yes No X

Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock, as of the latest practical date.

Class Outstanding atJuly 31, 2004
----- ---------------------------
Common Stock, $.0001 par value 2,769,951

INDEX
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LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
----------------------------------------------

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets:
- June 30, 2004
- December 31, 2003
- June 30, 2003

Condensed Consolidated Statements of Operations:
- Three and six months ended June 30, 2004 and 2003

Condensed Consolidated Statements of Cash Flows:
- Three and six months ended June 30, 2004 and 2003

Notes to Condensed Consolidated Financial Statements

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

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Item 4. Controls and Procedures

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities

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

Item 6. Exhibits and Reports on Form 8-K

SIGNATURE
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CERTIFICATIONS
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PART I. FINANCIAL INFORMATION

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

LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)

June 30, December 31, June 30,
2004 2003 2003
--------------------------------------
(Unaudited) (Audited) (Unaudited)
ASSETS
Current Assets:

Cash and cash equivalents ............................... $ 25,932 $ 26,556 $ 25,526
Receivables, less allowances of $291,
$262 and $258, respectively ........................... 8,456 8,183 8,553
Material and supplies ................................... 3,240 2,597 3,300
Prepaid expenses and other current assets ............... 3,011 1,272 1,290
--------- --------- ---------
Total Current Assets ...................................... 40,639 38,608 38,669

Property, Plant And Equipment:
Land .................................................... 1,111 1,111 1,104
Buildings and improvements .............................. 17,555 17,549 17,538
Machinery and equipment ................................. 214,409 209,455 201,560
--------- --------- ---------
233,075 228,115 220,202
Less: Accumulated Depreciation .......................... (111,672) (102,556) (97,285)
--------- --------- ---------
121,403 125,559 122,917
Goodwill .................................................. 60,580 60,580 60,580
Other intangibles ......................................... 10,953 8,168 8,316
Investments in and advances to affiliated entities ........ 10,523 7,223 10,580
Other assets .............................................. 13,427 12,048 12,366
--------- --------- ---------
Total assets .............................................. $ 257,525 $ 252,186 $ 253,428
========= ========= =========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable to banks .................................. $ 6,450 $ 3,456 $ 11,623
Trade accounts payable .................................. 3,606 5,336 3,118
Accrued interest payable ................................ 757 697 372
Accrued liabilities ..................................... 9,952 8,732 15,086
Current maturities of long-term debt ..................... 13,959 13,162 18,619
--------- --------- ---------
Total current liabilities ................................. 34,724 31,383 48,818
Long-term debt ............................................ 160,721 162,621 160,720
Deferred income taxes ..................................... 15,930 15,517 6,659
Other liabilities ......................................... 2,962 3,015 2,941
--------- --------- ---------
Total liabilities ....................................... 214,337 212,536 219,138

Minority Interests ........................................ 10,784 9,763 9,246

Commitments and Contingencies

Shareholders' equity
Common stock, $0.0001 par value-10,000,000
shares authorized; 2,824,766 issued; 2,771,751
2,779,951 and 2,782,751 outstanding .................. -- -- --
Additional paid-in capital .............................. 21,406 21,406 21,406
Retained earnings ....................................... 11,256 9,269 4,448
Accumulated other comprehensive income .................. 1,453 686 599
Treasury stock, 53,015, 44,815 and 42,015 shares, at cost (1,711) (1,474) (1,409)
--------- --------- ---------
Total shareholder's equity ................................ 32,404 29,887 25,044
--------- --------- ---------
Total liabilities and shareholders' equity ................ $ 257,525 $ 252,186 $ 253,428
========= ========= =========

See accompanying Notes to Condensed Consolidated Financial Statements.

-1-

LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED) (In thousands,
except per share amounts)

Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------
2004 2003 2004 2003
-------------------------------------------

Revenues ........................................ $ 21,631 $ 21,343 $ 43,519 $ 42,646

Costs and expenses:
Cost of revenue ................................. 7,671 7,304 15,151 14,741
General and administrative costs at operations .. 3,533 3,335 6,859 6,742
Corporate office expenses ....................... 2,273 1,098 3,246 1,868
Depreciation and amortization ................... 4,927 4,913 10,148 9,828
-------- -------- ------- --------
Total Expense ............................... 18,404 16,650 35,404 33,179
-------- -------- -------- --------
Operating profit ................................ 3,227 4,693 8,115 9,467
Combined total

Other income (expense):
Investment income ............................ 82 98 810 656
Interest expense ............................. (2,851) (2,999) (5,670) (6,025)
Equity in earnings of affiliated companies ... 886 679 1,598 1,063
-------- ------- -------- --------
(1,883) (2,222) (3,262) (4,306)
-------- ------- -------- --------
Income before income taxes and minority interests 1,344 2,471 4,853 5,161
Provision for income taxes ...................... (473) (875) (1,922) (1,951)
Minority interests .............................. (487) (440) (944) (641)
-------- ------- -------- --------
Net income ...................................... $ 384 $ 1,156 $ 1,987 $ 2,569
======== ======== ======== ========

Basic and diluted weighted average shares outstanding 2,774 2,787 2,775 2,789

Basic and diluted earnings per share $ 0.14 $ 0.41 $ 0.72 $ 0.92

See accompanying Notes to Condensed Consolidated Financial Statements.

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LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED) (in thousands,
except share data)

Accumulated
Shares of Other
Common Additional Compre-hensive
Stock Common Paid-in Retained Income Treasury
Out-standing Stock Capital Earnings Stock Total
---------------------------------------------------------------------------------------

Balance as of December 31, 2,779,951 $ 0 $21,406 $9,269 $ 686 $(1,474) $29,887
2003
Net income for the period -- -- -- 1,987 -- -- 1,987
Unrealized losses on available
for sale securities, net -- -- -- -- 767 -- 767
----------
Comprehensive income -- -- -- -- -- -- 2,754
----------
Purchase of treasury stock (8,200) -- -- -- -- (237) (237)
---------- ---- ------- ------- ------ ------- ----------
Balance at June 30, 2004 2,771,751 $ 0 $21,406 $11,256 $1,453 $(1,711) $32,404
============ ========== ============= ============ ============== ============ ==========

See accompanying Note to Condensed Consolidated Financial Statements.

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LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (In thousands)

Six Months Ended
June 30,
----------------------
2004 2003
----------------------

Operating activities:
Net Income .......................................................... $ 1,987 $ 2,569
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization .................................... 10,148 9,828
Equity in earnings of affiliated companies ....................... (1,598) (1,063)
Minority interests ............................................... 944 641
Changes in operating assets and liabilities:
Receivables ................................................. (226) 363
Accounts payable and accrued liabilities .................... (368) (476)
Other ............................................................ (2,112) 212
-------- --------
Net cash provided by operating activities ........................... 8,775 12,074
-------- --------

Investing activities:
Capital expenditures ................................................ (6,307) (9,927)
Acquisition of business ............................................. (4,877) --
Acquisition of subscriber lists ..................................... (150) (369)
Investment in and advances to affiliated entities ................... (63) (546)
Distributions received from investments ............................. 879 409
Other ............................................................... (217) (463)
-------- --------
Net cash used in investing activities ............................... (10,735) (10,896)
-------- --------

Financing activities:
Issuance of long term debt .......................................... 5,599 8,748
Repayments of long term debt ........................................ (6,702) (6,030)
Net proceeds (repayments) on lines of credit ........................ 2,994 (1,259)
Purchase of treasury stock .......................................... (237) (222)
Other ............................................................... (318) (245)
-------- --------
Net cash provided by financing activities ........................... 1,336 992
-------- --------
Net increase (decrease) in cash and cash equivalents ................ (624) 2,170
Cash and cash equivalents at beginning of period .................... 26,556 23,356
-------- --------
Cash and cash equivalents at end of period .......................... $ 25,932 $ 25,526
======== ========

Cash paid for:
Interest expense .................................................. $ 5,509 $ 5,983
======== ========
Income taxes ...................................................... $ 1,703 $ 1,424
======== ========

See accompanying Notes to Condensed Consolidated Financial Statements.
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LYNCH INTERACTIVE CORPORATION & SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

A. Basis of Presentation

Lynch Interactive Corporation ("Interactive" or the "Company") consolidates the
operating results of its telephone and cable television subsidiaries (81%-100%
owned at June 30, 2004, December 31, 2003 and June 30, 2003). In addition,
certain less than 50% owned investments in limited liability companies which
were accounted for in accordance with the equity method of accounting as of
December 31, 2003 have been consolidated at June 30, 2004. See Note B. All
material intercompany transactions and balances have been eliminated.
Investments in affiliates in which the Company does not have a majority voting
control are accounted for in accordance with the equity method. The Company
accounts for the following affiliated companies on the equity basis of
accounting: Coronet Communications Company (20% owned at June 30, 2004, December
31, 2003 and June 30, 2003), Capital Communications Company, Inc. (49% owned at
June 30, 2004, December 31, 2003 and June 30, 2003; we note, however, that
Interactive owns a convertible preferred stock which, if converted, would
increase its ownership in Capital Communications to 50%) and the cellular
partnership operations in New Mexico (both 33% owned at June 30, 2004, December
31, 2003 and June 30, 2003).

The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Articles 10 and 11 of Regulation S-X. Accordingly,
they are not audited and do not include all of the information and footnotes
required for complete financial statements. The consolidated financial
statements and footnotes included in this Form 10-Q should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's annual report on Form 10-K for the year ended December
31, 2003. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three and six month periods ended June 30,
2004 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2004. The preparation of consolidated financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates. Certain prior year amounts in the
accompanying consolidated financial statements have been reclassified to conform
to current year presentation.

B. Recently Issued Accounting Pronouncements

The Financial Accounting Standards Board ("FASB") issued Financial
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46) in January 2003 and revised it in
December 2003 (FIN 46R). FIN 46 requires certain variable interest entities to
be consolidated by the primary beneficiary of the entity if the equity investors
in the entity do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
The provisions of FIN 46R must be applied for the first interim or annual period
ending after March 15, 2004 for both new and existing variable interest
entities. Certain less than 50% owned investments in limited liability
companies, which were considered to be variable interest entities, needed to be
consolidated as a result of the implementation of FIN 46. The effect of
consolidating such operations resulted in increasing intangible assets and
decreasing investments in and advances to affiliated companies by approximately
$2 million and had no other significant effect on the Company's consolidated
financial statements.

-5-

C. Acquisitions and Dispositions

In March 2004, the Company signed an agreement to acquire California-Oregon
Telecommunications Company ("Cal-Ore") located in Dorris, California. Cal-Ore's
subsidiary Cal-Ore Telephone Company is the incumbent service provider for a
rural area of about 850 square miles along the Northern California border with
Oregon with approximately 2,500 access lines. Cal-Ore's other businesses include
an Internet service provider, a CLEC that is planning to provide services in the
surrounding area and interests in certain cellular partnerships. The acquisition
price is $21.2 million, subject to certain closing adjustments. The acquisition
will close subject to meeting certain conditions, including approval by the
California Public Utilities Commission and other regulatory authorities.
Therefore, the Company's consolidated financial statements for the three and six
months ended June 30, 2004 do not include the results of Cal-Ore.

In February 2004, Central Telecom Services, LLC, a 100% owned subsidiary of the
Company completed the acquisition of cable television assets at a cost of $0.4
million. The allocation of the purchase price to the assets acquired and
liabilities assumed was based on estimates of fair value, including $50,000
allocated to other intangibles for the subscriber list.

On April 30, 2004, the Company acquired a 37% interest in an entity (KMG) whose
principal asset consist of a $6.0 million subordinated note and a 17% equity
interest in Lynch Telephone Corporation, a 83% owned subsidiary of the Company.
The remaining 63% ownership of KMG is held by the members or management of
Western New Mexico Telephone Company, Inc. The Company issued a $4.5 million,
8.5% five-year amortizing subordinated note to acquire such interest. In
addition to the above mentioned assets, KMG owns a lumber yard in Andrews,
Texas, and other investments.

D. Investments in Affiliated Companies

Interactive has equity investments in both broadcasting and telecommunications
companies.

Summarized financial information for companies accounted for by the equity
method as of and for the three and six months ended June 30, 2004 and 2003 and
as of December 31, 2003 is as follows (in thousands):

Broadcasting Combined Information
June 30, December 31, June 30,
2004 2003 2003
--------------------------------

Current assets ................................. $ 5,163 $ 5,330 $ 5,404
Property, plant & equipment, intangibles & other 8,749 9,615 10,103
-------- -------- --------
Total assets ................................... $ 13,912 $ 14,945 $ 15,507
======== ======== ========

Current liabilities ............................ $ 2,400 $ 3,182 $ 3,127
Long term liabilities .......................... 15,756 16,483 17,020
Equity ......................................... (4,244) (4,720) (4,640)
-------- -------- --------
Total liabilities & equity ..................... $ 13,912 $ 14,945 $ 15,507
======== ======== ========

Three months ended
Revenues ....................................... $ 3,204 $ 3,115
Gross profit ................................... 1,062 771
Net (Loss) Profit .............................. 328 12

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Six months ended
Revenues ....................................... $ 6,694 $ 5,738
Gross profit ................................... 2,318 1,455
Net (Loss) Profit............................... 682 (212)

Telecommunications Combined Information
June 30, December 31, June 30,
2004 2003 2003
---------------------------------

Current assets ................................. $31,064 $30,340 $11,694
Property, plant & equipment, intangibles & other 26,350 27,114 27,291
------- ------- -------
Total assets ................................... $57,414 $57,454 38,985
======= ======= =======

Current liabilities ............................ $22,107 $23,073 $ 5,397
Long term liabilities .......................... 8,223 9,056 10,913
Equity ......................................... 27,084 25,325 22,675
------- ------- -------
Total liabilities & equity ..................... $57,414 $57,454 $38,985
======= ======= =======

Three months ended
Revenues ....................................... $14,443 $11,476
Gross profit ................................... 6,567 4,151
Net income ..................................... 4,357 3,161

Six months ended
Revenues ....................................... $26,749 $21,981
Gross profit ................................... 12,042 7,580
Net income ..................................... 7,652 5,679

At June 30, 2004, December 31, 2003, and June 30, 2003 the Company's investment
in Coronet Communications Company ("Coronet") was carried at a negative
$688,000, a negative $810,000, and a negative $793,000 respectively, due to the
Company's guarantee of $3.8 million of Coronet's third party debt. Long-term
debt of Coronet, at June 30, 2004, totaled $9.8 million due to a third party
lender, which is due in quarterly payments through December 31, 2005. The
Company's investment in Capital Communications Company, Inc. was carried at $0
for all periods.

In March 2004, a wholly owned subsidiary of Brighton Communications invested
$250,000 for a 7% interest in an entity which provides wireline
telecommunication transport services in New York State.

On April 30, 2004, the Company acquired a 37% interest in KMG whose principal
assets consist of a $6.0 million subordinated note and a 17% equity interest in
Lynch Telephone Corporation, which is an 83% owned subsidiary of the Company.

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E. Indebtedness

Interactive maintains a short-term line of credit facility totaling $10.0
million. This facility was renewed during the third quarter of 2003 and
currently expires on August 31, 2004. The Company expects to refinance this line
of credit at current or somewhat lower borrowing levels. Borrowings under this
facility were $2.6 million, zero and $8.3 million at June 30, 2004, December 31,
2003 and June 30, 2003, respectively. Long-term debt consists of (all interest
rates are at June 30, 2004) (in thousands):

June 30, December 31, June 30,
2004 2003 2003
--------------------------------------------------

Rural Electrification Administration ("REA") and Rural Telephone Bank (`RTB")
notes payable due from 2006 to 2027 at fixed interest rates ranging from 2% to
7.5%. (5% weighted average, secured by assets of the telephone
companies with a net book value of $150 million) ............................... $ 58,787 $ 59,917 $ 58,878

Bank Credit facilities utilized by certain telephone and telephone holding
companies due from 2005 to 2016, $25.9 million at fixed interest rates averaging
7.8 % and $48.6
million at variable interest rates averaging 3.7% ............................. 74,548 78,646 82,681

Unsecured notes issued in connection with acquisitions
through 2006, at fixed interest rates of 8.0% to 10.0% ......................... 38,889 34,389 34,634

Other .......................................................................... 2,456 2,831 3,146
--------- --------- ---------
174,680 175,783 179,339
Current maturities ............................................................. (13,959) (13,162) (18,619)
--------- --------- ---------
$ 160,721 $ 162,621 $ 160,720
========= ========= =========

On April 30, 2004 a subsidiary of the Company issued a $4.5 million, 8.5%
five-year amortizing subordinated note in connection with the acquisition of
KMG, which is classified as unsecured notes in the above table.

F. Comprehensive Income

Other comprehensive income, net of tax, which consists of unrealized gains
(losses) on available for sale securities, for the three and six month periods
ended June 30, 2004 and 2003 are as follows (in thousands):

Three Months Ended Six Months Ended
June 30, June 30,
------------------- --------------------
2004 2003 2004 2003
------------------- --------------------

Net income ..................... $ 384 $ 1,156 $ 1,987 $ 2,569
Unrealized gains ............... 305 218 1,166 104
Tax effect ..................... (104) (87) (399) (39)
------- ------- ------- -------
Net other comprehensive income 201 131 767 65
------- ------- ------- -------
Comprehensive income ........... $ 585 $ 1,287 $ 2,754 $ 2,634
======= ======= ======= =======

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G. Treasury Stock Purchases

During the six months ended June 30 2004, the Company purchased 8,200 shares of
its common stock for treasury at an average investment of $28.89 per share.

H. Litigation

Interactive and several other parties, including Interactive's CEO, and Fortunet
Communications, L.P., which was Sunshine PCS Corporation's
predecessor-in-interest, have been named as defendants in a lawsuit brought
under the so-called "qui tam" provisions of the federal False Claims Act in the
United States District Court for the District of Columbia. The complaint was
filed under seal with the court on February 14, 2001. At the initiative of one
of the defendants, the seal was lifted on January 11, 2002. Under the False
Claims Act, a private plaintiff, termed a "relator," may file a civil action on
the U.S. government's behalf against another party for violation of the statute.
In return, the relator receives a statutory bounty from the government's
litigation proceeds if he is successful.

The main allegation in the case is that the defendants participated in the
creation of "sham" bidding entities that allegedly defrauded the federal
Treasury by improperly participating in certain Federal Communications
Commission (FCC) spectrum auctions restricted to small businesses, as well as
obtaining bidding credits in other spectrum auctions allocated to "small" and
"very small" businesses. While the complaint seeks to recover an unspecified
amount of damages, which would be subject to mandatory trebling under the
statute, a document filed by the relator with the Court on February 24, 2004
discloses an initial computation of damages of not less than $88 million
resulting from bidding credits awarded to the defendants in FCC auctions and
$120 million of unjust enrichment through the sale or assignment of licenses
obtained by the defendants in FCC auctions, in each case prior to trebling.
Although as discussed below, the bidding credits the defendants received were
considerably less than the $88 million amount reported.

Interactive strongly believes that this lawsuit is completely without merit and
that relator's initial damage computation is without basis, and intends to
defend the suit vigorously. The U.S. Department of Justice has notified the
court that it has declined to intervene in the case. Nevertheless, we cannot
predict the ultimate outcome of the litigation, nor can we predict the effect
that the lawsuit or its outcome will have on our business or plan of operation.
Interactive does not have any insurance to cover its cost of defending this
lawsuit, which costs will be material. Interactive does have a directors and
officers liability policy but the insurer has reserved its rights under the
policy and, as a result, any coverage to be provided to any director or officer
of Interactive in connection with a judgment rendered in this action is unclear
at this time.

Interactive was formally served with the complaint on July 10, 2002. On
September 19, 2002, the defendants filed two motions with the United States
District Court for the District of Columbia: a motion to dismiss the lawsuit and
a motion to transfer the action to the Southern District of New York. On
November 25, 2002, the relator filed an opposition reply to our motion to
dismiss and on December 5, 2002; the defendants filed a reply in support of its
motion to dismiss. On September 30, 2003, the Court granted our motion to
transfer the action to the Southern District of New York. A scheduling
conference was held on February 10, 2004, at which time, the judge approved a
scheduling order and discovery commenced.

On June 7, 2004, the defendants filed a motion to relator to refer the issues in
this litigation to the Federal Communications Commission, which motion has been
opposed by the relator. Discovery continues while the motion is under
consideration by the Courts.

On July 28, 2004, the judge issued a ruling on the motion to dismiss, which in
large part, denied the motion and allowed the discovery to continue (See the
Company's website www.lynchinteractivecorp.com). Defendant bidding entities that
did not win licenses were dismissed. Interactive and its subsidiaries remain

-9-

parties to the litigation.

In addition to the litigation described above, Interactive is a party to routine
litigation incidental to its business. Based on information currently available,
Interactive believes that none of this ordinary routine litigation, either
individually or in the aggregate, will have a material effect on its financial
condition and results of operations.

History of Lynch's "C" Block Activities
---------------------------------------

As part of the Omnibus Budget Resolution of 1993, Congress authorized its
Federal Communications Commission to employ competitive bidding procedures to
select among mutually exclusive applicants for certain spectrum bidding.
Initially the FCC had an initiative to include, among others, qualified African
Americans, Native Americans, Asian Americans and women. As a result of this, the
FCC conducted auctions beginning in 1995 to allocate spectrum in a competitive
manner. Lynch Interactive was a participating investor and/or service provider
to various entities in the auction. In 2001, Interactive was named in a False
Claim Act litigation with regard to its auction activities. Below is a history
of our C-Block activities, the first auction Lynch Interactive was involved with
as an investor and as a service provider.

On December 18, 1995, Lynch Interactive Corporation (through its predecessor
Lynch Corporation) had investments in five entities that participated in the
Federal Communications Commission Auction for Broadband PCS "C" Block Spectrum
(Auction 5). When the auction closed, on May 6, 1996, these five entities, on a
combined basis, were the higher bidders for thirty-one 30 MHz licenses at a
gross cost of $288.2 million. These entities were initially put together under
the FCC's initiative to include, among others, qualified women, African
Americans, Native Americans and Asian Americans. As a result of changes in these
initiatives, these same individuals were qualified as small businesses and
remained eligible as bidders. These entities received $72 million of bidding
credits, and accordingly the net cost was $216.2 million. The federal government
provided financing for 90% of the cost of these licenses, or $194.6 million.
Lynch's investments in these entities totaled $21 million.

Events during and subsequent to Auction 5, made financing these licenses through
the capital markets much more difficult than originally anticipated. On April
18, 1997, among other reasons, in order to obtain some economies of scale, such
as financing, the five entities merged into Fortunet Communications, Inc. The
FCC, in partial response to actions by Nextwave and others, promoted a plan of
refinancing of "C" block. In 1997, many of the license holders from Auction 5,
including Fortunet, petitioned the FCC for relief in order to afford these small
businesses the opportunity to more realistically restructure and build out their
systems. The President of Fortunet, Karen Johnson, participated in an FCC
sponsored forum on this issue on June 30, 1997 - see our website
www.lynchinteractivecorp.com for an excerpt of this testimony. The response from
the FCC, which was announced on September 26, 1997 and modified on March 24,
1998, afforded license holders four options. One of these options was the
resumption of current debt payments, which had been suspended earlier in 1997
for all such license holders. Another option, amnesty, was to return all
licenses and forgo any amounts deposited in exchange for forgiveness of the FCC
debt. Other options include: disaggregation, splitting a 30 MHz license into two
15 MHz licenses and forgoing 50% of the amount deposited, or prepayment, return
of certain licenses and utilize 70% of the amount deposited to acquire other
licenses, 30% of the deposits would be forfeited.

-10-

Fortunet also lost $6.0 million of its down payment. A lawyer for many
applications for FCC licenses, Mr. Taylor is aware of the details of these FCC
initiated alternatives to the "C" Block, as was and should be his law firm. As a
result of this decision, during 1997, Interactive recorded a $7.0 million write
down of its investment in Fortunet.

On April 15, 1999, the FCC completed a reauction of all the C-Block licenses
that were surrendered, including the 15 MHz of spectrum that Fortunet returned
to the FCC on June 8, 1998 in respect of the Tallahassee, Panama City and Ocala,
Florida markets. In that reauction, the successful bidders paid a total of $2.7
million for those three 15 MHz licenses returned by Fortunet versus the $15.8
million paid by Fortunet. As a result of this auction, Interactive recorded a
further write down of its investment of $15.4 million, including capitalized
costs, to reflect the amount bid for the similar licenses in the reauction.

In February 2000, Fortunet merged with Sunshine PCS Corporation, which by way of
a spin-off from Lynch Interactive became a public company. It traded under the
symbol SUNPA.

On December 31, 2003, Sunshine, after undergoing appropriate corporate and
regulatory processes, sold its three 15 MHz licenses to Cingular Wireless for
$13.75 million. Interactive received $7.6 million as part of the sale
transaction versus its cash investment of $21 million initially invested in the
original five entities in 1992.

I. Subsequent Events

Interactive was the high bidder on two licenses in Block 31, Buffalo, NY and
Davenport, IA, for a total cost of $49,000 in the Federal Communications
Communication conducted auction for 24 GHz spectrum which was held on July 27,
2004.

In addition, Interactive acted as the administrative bidding agent for Napoleon
Communications, which was the high bidder in Phoenix, AZ, Las Vegas, NV, Reno,
NV and Albuquerque, NM (Block 39) in that auction. Napoleon qualified as a very
small business and received a bidding credit of 35%.

-11-

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

Forward Looking Information
---------------------------

Included in this Management Discussion and Analysis of Financial Condition and
Results of Operations are certain forward looking financial and other
information, including without limitation, the Company's effort to monetize
certain assets, Liquidity and Capital Resources and Market Risk. It should be
recognized that such information are estimates or forecasts based upon various
assumptions, including the matters, risks, and cautionary statements referred to
therein, as well as meeting the Company's internal assumptions regarding
expected operating performance and the expected performance of the economy and
financial markets as they impact Registrant's businesses. As a result, such
information is subject to uncertainties, risks and inaccuracies, which could be
material.

Overview
--------

Interactive has grown primarily through the selective acquisition of rural local
exchange carriers ("RLECs") and by offering additional services such as Internet
service, alarm services, long distance service and competitive local exchange
carrier ("CLEC") service. From 1989 through the current period, Interactive
acquired fourteen telephone companies, four of which have indirect minority
ownership of 2% to 19%, whose operations range in size from approximately 800 to
over 10,000 access lines. The Company's telephone operations are located in
Iowa, Kansas, Michigan, New Hampshire, New Mexico, New York, North Dakota, Utah
and Wisconsin.

The telecommunications industry in general and the RLECs that comprise
Interactive's business face a number of economic or industry-wide issues and
challenges.

o Regulatory- The Telecommunications Act of 1996 and other federal and state
legislation and regulations have a significant impact on the industry and
on rural carriers in particular. Interactive's telephone companies are all
RLECs serving very high cost areas with a significant portion of their
revenues being derived from federal or state support mechanisms, which are
referred to as Universal Service Funds ("USF"). The revenues and margins of
our RLEC subsidiaries are largely dependent on the continuation of such
support mechanisms.

o Competition- The effects of competition from CLECs, wireless service, high
speed cable, Voice Over Internet Protocol ("VoIP") and other internet
providers is an industry-wide issue that is felt to varying degrees by our
rural telephone companies.

o The economy- Unemployment, building starts, business bankruptcies and the
overall health of the economy have a significant effect on demand for our
services.

o Telecommunication bankruptcies- Interactive's telephone companies have
significant, normal course of business receivables from interexchange
carriers, such as MCI or Global Crossings who filed for bankruptcy and, as
a result, have been written-off. Additional bankruptcies could have a
significant effect on our financial condition.

o Market challenges- Our phone companies are required to comply with
industry-wide initiatives such as local number portability and the
requirements of the Communications Assistance for Law Enforcement Acto
("CALEA") that are expensive to implement and that in some cases have
limited demand in our markets.

-12-

Interactive generates cash and earns telecommunications revenues primarily from
local network access, intrastate and interstate access revenue and from state
and federal USF support mechanisms. Due to the nature of the Company's regulated
telephone operations, revenues and operating expenses are relatively stable
period to period.

o Local Revenues - The number of access lines is the primary driver of local
network access revenues. In addition, the ratio of business lines to
residential, as well as the number of features subscribed to by customers
are secondary drivers.

o Intrastate access revenues - Customer usage, primarily based on minutes of
use, and the number of access lines are the primary drivers of intrastate
access revenues since the Company's RLECs are on a "bill-and-keep" basis.

o Interstate access revenues depend upon whether the RLEC has elected to be
"cost-based" or has remained an "average schedule" carrier. The revenues of
our ten cost-based carriers directly correlate to their approved rate of
return on regulated net investment plus the amount of regulated operating
expenses including taxes. The revenues of the Company's four average
schedule subsidiaries correlate to usage based measurements such as access
lines, interstate minutes-of-use, and the number and mileage of different
types of circuits. The average schedule method is intended to be a proxy
for cost-based recovery.

o USF subsidies are primarily driven by investments in specific types of
infrastructure, as well as the operating expenses and taxes of the Company.
Interstate and intrastate USF subsidies are included in the respective
interstate and intrastate access revenue captions in the breakdown of
revenue and operating expenses which follows.

o Other business revenue: Interactive's companies also provide non-regulated
telecommunications related services, including Internet access service,
wireless and long distance resale service, in certain of its telephone
service and adjacent areas. Interactive also provides and intends to
provide more local telephone and other telecommunications service outside
certain of its franchise areas by establishing CLEC operations in selected
nearby areas. In addition, certain of Interactive's companies have expanded
into cable and security businesses in the areas in which they operate.

o Long Distance revenues are only retained by the Company if it is providing
the long distance service to the end user customer as the toll provider.
For unaffiliated IXCs, we provide a billing service and receive an
administrative handling fee.

The following are material opportunities, challenges and risks that
Interactive's executives are currently focused on and what actions are being
taken to address the concerns:

o Universal Service Reform: There are two separate but associated proceedings
related to universal service currently underway at the FCC. In June 2004,
the FCC asked the Federal-State Joint Board on Universal Service ("Joint
Board") to review the rules relating to the high-cost universal service
support mechanisms for rural carriers and to determine the appropriate
rural mechanism to succeed the five-year plan adopted in the Rural Task
Force Order. In particular, the FCC asked the Joint Board to make
recommendations on a long-term universal service plan that ensures that
support is specific, predictable, and sufficient to preserve and advance
universal service. The FCC asked the Joint Board to ensure that its
recommendations are consistent with the goal of ensuring that consumers in
rural, insular, and high-cost areas have access to telecommunications and
information services at rates that are affordable and reasonably comparable
to rates charged for similar services in urban areas. The FCC

-13-

also asked the Joint Board to consider how support can be effectively
targeted to rural telephone companies serving the highest cost areas, while
protecting against excessive fund growth. In conducting its review, the
Joint Board is supposed to take into account the significant distinctions
among rural carriers, and between rural and non-rural carriers and consider
all options for determining appropriate universal service support.

o In June 2004, the FCC also issued a Notice of Proposed Rulemaking seeking
comment on whether the Joint Board's Recommended Decision should be
adopted, in whole or in part, including the process for designation of
eligible telecommunications carriers (ETCs) and the FCC's rules regarding
high cost universal service support. In its Recommended Decision, the Joint
Board recommended that the Commission adopt permissive federal guidelines
for states to consider in ETC designation proceedings and that the FCC
limit the scope of high-cost support to a single connection that provides a
subscriber access to the public telephone network. The Company participated
with the RLEC industry in comments to the FCC regarding the potential
impact to customers and RLECs in rural America. Total USF support payments
are material to the Company's financial results.

o Intercarrier Compensation and Access Charge Reform: The Company is actively
participating in the RLEC industry's efforts to determine how intercarrier
compensation and access charges should be modified without sustaining
revenue losses for RLECs.

o Loss of Access Revenues from VoIP and wireless usage: The Company is
experiencing revenue losses as usage transfers from landline service
provided by the Company's subsidiaries to either VoIP or wireless services.
The Company is trying to install more broadband service to offset revenue
losses from traditional voice services.

Three months ended June 30, 2004 compared to June 30, 2003
----------------------------------------------------------

The following is a breakdown of revenues and operating costs and expenses for
the second quarter ended June 30, 2004 and 2003 (in thousands):

Second Quarter ended June 30,
----------------------------- Increase
2004 2003 (Decrease)
-------------------------------------
(Unaudited)
Revenues:

Local access ...................... $ 3,176 $ 3,103 $ 73
Interstate access ................. 9,351 9,151 200
Intrastate access ................. 3,858 3,693 165
Other telephone ................... 555 835 (280)
Other business .................... 4,691 4,561 130
------- ------- -------
Total ........................... 21,631 21,343 288
------- ------- -------

Operating Cost and Expense:
Cost of revenue ................... 7,671 7,304 367
General and administrative costs at
operations ...................... 3,533 3,335 198
Corporate office expenses ......... 2,273 1,098 1,175
Depreciation and amortization ..... 4,927 4,913 14
------- ------- -------
Total ........................... 18,404 16,650 1,754
------- ------- -------
Operating profit ................ $ 3,227 $ 4,693 $(1,466)
======= ======= =======

Total revenues for the three months ended June 30, 2004 increased by $0.3
million, or 1.3%, to $21.6 million

-14-

compared to the second quarter of 2003. Local access revenue increased by
$73,000 in the second quarter of 2004 resulting from the sale of additional
features and rate increases, partially offset by a 1.0% decrease in access
lines. Interstate access revenue increased $0.2 million in the second quarter of
2004 primarily due to infrastructure development undertaken in 2002 and 2003,
which entitled the company to increased USF support primarily at the Haviland
Telephone Company in Kansas. Such USF increase was partially offset by the loss
of a telecommunications transport contract in Utah. The $0.3 million reduction
in other telephone revenues resulted primarily from a one-time NECA adjustment
to our previously reported rate base, which effects the amount of revenue that
we were entitled to in prior periods. The Company's acquisition in February 2004
of a small cable company in Utah resulted in $0.1 million increase in other
business revenue. Other business revenue also benefited from revenue growth at a
competitive local exchange carrier in Kansas.

Total costs and expenses increased by $1.8 million to $18.4 million in the
second quarter of 2004. Costs of revenue increased $0.4 million, or 5%, due to
additional operating costs related to the additional infrastructure development
in Haviland and to the February 2004 acquisition of a small cable television
operation in Central Utah. General and administrative costs incurred at the
operations were relatively flat. Corporate office expenses increased $1.2
million resulting from $0.8 million of legal costs incurred defending the "qui
tam" litigation in the second quarter of 2004, $0.7 million of increased audit
and consulting costs resulting from Sarbanes-Oxley implementation, offset by the
absence in 2004 of a $0.3 million management incentive accrual recorded in the
second quarter of 2003. Depreciation and amortization remained flat.

As a result of the above, operating profit for the three months ended June 30,
2004, decreased by $1.5 million to $3.2 million compared to the second quarter
of 2003.

EBITDA
------

EBITDA represents the Company's earnings before interest, taxes, depreciation
and amortization. EBITDA is not intended to represent cash flows from operating
activities and should not be considered as an alternative to net income or loss
(as determined in conformity with generally accepted accounting principles), as
an indicator of the Company's operating performance or to cash flows as a
measure of liquidity. EBITDA from operations is presented herein because the
Company's chief operating decision maker evaluates and measures each business
unit's performance based on its EBITDA results. The Company believes that EBITDA
from operations is the most accurate indicator of the Company's results, because
it focuses on revenue and operating cost items driven by operating managers'
performance, and excludes non-recurring items and items largely outside of
operating managers' control. In addition, Interactive utilizes EBITDA as one of
its metrics for valuing potential acquisitions. The following table reconciles
EBITDA to Operating profit and to Income before income taxes and minority
interests (in thousands).

Second Quarter ended June 30,
----------------------------- Increase
2004 2003 (Decrease)
-----------------------------------------
(Unaudited)

EBITDA from operations ......... $ 10,427 $ 10,704 $ (277)
Corporate office expenses ...... (2,273) (1,098) (1,175)
-------- -------- --------
Total EBITDA ................. 8,154 9,606 (1,452)
Depreciation ................... 4,550 4,758 (208)
Amortization ................... 377 155 222
-------- -------- --------
Operating profit ............. 3,227 4,693 (1,466)
Investment income .............. 82 98 (16)
Interest expenses .............. (2,851) (2,999) 148
Equity in earnings of affiliates 886 679 207
-------- -------- --------
Income before income taxes and
minority interest $ 1,344 $ 2,471 $ (1,127)
======== ======== ========

-15-

Other Income (Expense)
----------------------

For the three months ended June 30, 2004, investment income decreased slightly
due to lower yields on investable funds.

Interest expense decreased by $0.1 million in the second quarter of 2004 from
the same period in the prior year due primarily to lower outstanding borrowings.

Equity in earnings of affiliates for the three-month ending June 30, 2004
increased from the same period in the previous year due to higher earnings at
the Company's New Mexico cellular investments (RSA 3 and 5).

Income Tax Provision
--------------------

The income tax provision includes federal, as well as state and local taxes. The
tax provision for the three months ended June 30, 2004 and 2003, represent
effective tax rates of 35.2% and 35.4%, respectively. The difference between
these effective rates and the federal statutory rate is principally due to state
income taxes, including the effect of earnings attributable to different state
jurisdictions.

Minority Interests
------------------

Minority interests decreased earnings by $0.5 million for the three months ended
June 30, 2004, as compared to $0.4 million for the three months ended June 30,
2003

Net Income
----------

Net income for the three months ended June 30, 2004, was $0.4 million, or $0.14
per share (basic and diluted), compared to a net income for the same period last
year of $1.2 million, or $0.41 per share (basic and diluted). The Company has no
dilutive instruments outstanding.

Six months ended June 30, 2004 compared to June 30, 2003
--------------------------------------------------------

The following is a breakdown of revenues and operating costs and expenses for
the six months ended June 30, 2004 and 2003 (in thousands):

Six Months ended June 30,
----------------- Increase
2004 2003 (Decrease)
------------------------------
(Unaudited)

Revenues:
Local access ...................... $ 6,178 $ 6,134 $ 44
Interstate access ................. 18,891 18,209 682
Intrastate access ................. 7,852 7,616 236
Other telephone ................... 1,278 1,568 (290)
Other business .................... 9,320 9,119 201
------- ------- -------
Total ........................... 43,519 42,646 873
------- ------- -------

Operating Cost and Expense:
Cost of revenue ................... 15,151 14,741 410
General and administrative costs at
operations ...................... 6,859 6,742 117
Corporate office expenses ......... 3,246 1,868 1,378
Depreciation and amortization ..... 10,148 9,828 320
------- ------- -------
Total ........................... 35,404 33,179 2,225
------- ------- -------
Operating profit ................ $ 8,115 $ 9,467 $(1,352)
======= ======= =======

-16-

Total revenues for the six months ended June 30, 2004 increased $0.9 million, or
2.0%, to $43.5 million compared to the first half of 2003. Local access revenue
increased by $44,000 in the six months of 2004 resulting from the sale of
additional features and rate increases, partially offset by a 1.0% decrease in
access lines. Interstate access revenue increased $0.7 million in the second
quarter of 2004 primarily due to infrastructure development undertaken in 2002
and 2003, which entitled the company to increased USF support primarily at the
Haviland Telephone Company in Kansas. Such USF increase was partially offset by
the loss of a telecommunications transport contract in Utah. The $0.3 million
reduction in other telephone revenues resulted primarily from a one-time NECA
adjustment to our previously reported rate base, which effects the amount of
revenue that we were entitled to in prior periods. The Company's acquisition in
February 2004 of a small cable company in Utah resulted in $0.1 million increase
in other business revenue. Other business revenue also benefited from revenue
growth at a competitive local exchange carrier in Kansas.

Total costs and expenses increased by $2.2 million to $35.4 million in the six
months of 2004. Costs of revenue increased $0.4 million, or 2.8%, due to
additional operating costs related to the additional infrastructure development
in Haviland and the February 2004 acquisition of a small cable television
operation in Central Utah. General and administrative costs incurred at the
operations were relatively flat. Corporate office expenses increased $1.4
million resulting from $1.1 million of legal costs incurred defending the "qui
tam" litigation in the first six months of 2004, increased audit and consulting
costs resulting from Sarbanes-Oxley implementation, and partially offset by the
absence in 2004 of a $0.3 million management incentive accrual recorded in the
2003 period. Depreciation and amortization increased $0.3 million primarily as a
result of a revision to depreciable lines, which resulted in increased
depreciation expense at our Michigan telephone company.

As a result of the above, operating profit for the six months ended June 30,
2004, decreased by $1.4 million to $8.1 million compared to the six months of
2003.

EBITDA
------

The following table reconciles EBITDA to Operating profit and to Income before
income taxes and minority interests (in thousands).

Six Months ended June 30,
---------------------- Increase
2004 2003 (Decrease)
--------------------------------
(Unaudited)

EBITDA from operations ......... $ 21,509 $ 21,163 $ 346
Corporate office expenses ...... (3,246) (1,868) (1,378)
-------- -------- --------
Total EBITDA ................. 18,263 19,295 (1,032)
Depreciation ................... 9,619 9,526 93
Amortization ................... 529 302 227
-------- -------- --------
Operating profit ............. 8,115 9,467 (1,352)
Investment income .............. 810 656 154
Interest expenses .............. (5,670) (6,025) 355
Equity in earnings of affiliates 1,598 1,063 535
-------- -------- --------
Income before income taxes and $ 4,853 $ 5,161 $ (308)
minority interest ======== ======== ========

-17-

Other Income (Expense)
----------------------

For the six months ended June 30, 2004, investment income increased by $0.2
million due to a cash distribution from Sunshine PCS Corporation in the first
quarter of 2004.

Interest expense decreased by $0.4 million in the six months of 2004 from the
same period in the prior year due primarily to lower outstanding borrowings.

Equity in earnings of affiliates for the six-month ending June 30, 2004
increased from the same period in the previous year due to higher earnings at
the Company's New Mexico cellular investments (RSA 3 and 5).

Income Tax Provision
--------------------

The income tax provision includes federal, as well as state and local taxes. The
tax provision for the six months ended June 30, 2004 and 2003, represent
effective tax rates of 39.6% and 37.8%, respectively. The difference between
these effective rates and the federal statutory rate is principally due to state
income taxes, including the effect of earnings attributable to different state
jurisdictions.

Minority Interests
------------------

Minority interests decreased earnings by $0.9 million for the six months ended
June 30, 2004, as compared to $0.6 million for the six months ended June 30,
2003. The change was due to higher earnings from the Company's New Mexico
cellular investments.

Net Income
----------

Net income for the six months ended June 30, 2004, was $2.0 million, or $0.72
per share (basic and diluted), compared to a net income for the same period last
year of $2.6 million, or $0.92 per share (basic and diluted). The Company has no
dilutive instruments outstanding.

Cash Requirements
-----------------

The debt at each of Interactive's subsidiary companies contains restrictions on
the amount of funds that can be transferred to their respective parent
companies. The Interactive parent company ("Parent Company") needs cash
primarily to pay corporate expenses, federal income taxes and to invest in new
opportunities, including spectrum licenses. The Parent Company receives cash to
meet its obligations primarily through management fees charged to its
subsidiaries, a tax sharing agreement with its subsidiaries, a $10 million line
of credit facility, and has obtained additional liquidity by refinancing certain
subsidiary debt. In addition, the Parent Company considers various alternative
long-term financing sources: debt, equity, or sale of investments and other
assets.

The Company's RLECs and other businesses need cash to fund their current
operations, as well as future long-term growth initiatives. Each RLEC and other
business finances its cash needs with cash generated from operations, by
utilizing existing borrowing capacity or by entering into new long-term debt
agreements. New business acquisitions are generally financed with a combination
of new long-term debt, secured by the acquired assets, as well as cash from the
Parent. While management expects that both Parent and its operating subsidiaries
will be able to obtain adequate financing resources to enable the Company to
meet its obligations, there is no assurance that such can be readily obtained or
at reasonable costs. The Company is obligated under long-term debt provisions
and lease agreements to make certain cash payments over the term of the
agreements. The following table summarizes, as of June 30, 2004 for the periods
shown, these contractual obligations and certain other financing commitments
from banks and other financial institutions that provide liquidity:

-18-

Payments Due by Period
(In thousands)
Less than
Total 1 year 2 - 3 years 4 - 5 years After 5 years
--------------------------------------------------------------

Long-term debt (a) ................... $174,680 $ 13,959 $ 53,616 $ 47,450 $ 59,655
Operating leases ..................... 1,703 419 725 242 317
Notes payable to banks ............... 6,450 6,450 -- -- --
Guarantees ........................... 3,750 -- 3,750 -- --
-------- -------- -------- -------- --------
Total contractual cash obligations and
commitments ........................ $186,583 $ 20,828 $ 58,091 $ 47,692 $ 59,972
======== ======== ======== ======== ========

(a) Does not include interest payments on debt.

A subsidiary of the Company has guaranteed $3.8 million of an equity investees'
total debt of $9.9 million. The guarantee is in effect for the duration of the
loan which expires on December 31, 2005 and would be payable if the equity
investee fails to make such payment in accordance with the terms of the loan.

The Parent Company has a short-term line of credit facility, which expires
August 31, 2004, with maximum availability totaling $10.0 million, of which $7.4
million was available at June 30, 2004 and all of which was available at
December 31, 2003. The Company is pursuing various financing alternatives
including renewal of the line of credit, refinancing substantially all or
individual pieces of its currently outstanding debt, and sale of certain
investments. The Company expects that this line of credit facility will be
renewed in August 2004 at current or somewhat lower borrowing levels. While it
is management's belief that the Company will have adequate resources to fund
operations over the next twelve months, there can be no assurance that the
Company will obtain financing on terms acceptable to management. The renewal of
the line of credit is a critical element of the Company's financing strategy.

At June 30, 2004, total debt (including notes payable to banks) was $181.1
million, an increase of $1.9 million from December 31, 2003. At June 30, 2004,
there was $124.4 million of fixed interest rate debt outstanding averaging 7.0%
and $56.7 million of variable interest rate debt averaging 4.4%. The debt at
fixed interest rates includes $38.9 million of subordinated notes at interest
rates averaging 9.5% issued to sellers as part of acquisitions. The long-term
debt facilities at certain subsidiaries are secured either by substantially all
of such subsidiaries assets, or by the common stock of such subsidiaries. At
June 30, 2004 and December 31, 2003, substantially all of the subsidiaries' net
assets are restricted. In addition, the debt facilities contain certain
covenants restricting distribution to Lynch Interactive. As of June 30, 2004,
the Company is in compliance with all debt covenants.

Interactive has a high degree of financial leverage. The ratio of total debt to
equity was 5.6 to 1 as of June 30, 2004 and 6.0 to 1 as of December 31, 2003.
Certain subsidiaries also have high debt to equity ratios. Management believes
that it is currently more beneficial to hold excess cash at certain of our
subsidiaries rather than utilizing the cash to pay-down existing credit
facilities.

As of June 30, 2004, Interactive had current assets of $40.6 million and current
liabilities of $34.7 million resulting in a working capital surplus of $5.9
million compared to a surplus of $7.2 million at December 31, 2003.

Sources and Uses of Cash
------------------------

Cash at June 30, 2004, was $25.9 million, a decrease of $0.6 million compared to
December 31, 2003. During the first quarter of 2004, net cash provided by
operations of $8.4 million were primarily used to invest in plant and equipment,
acquire businesses and repay debt.

-19-

Capital expenditures which are predominantly spent at the RLECs and will be
included in their rate bases for rate setting purposes were $6.3 million in the
six months of 2004 compared to $9.9 million in 2003. Capital expenditures in
2004 are expected to be approximately $19 million, most of which will be added
to the RLEC rate bases. External financing is currently in place for
approximately $3 million of these expenditures. The remainder will be financed
from internal sources.

The Company completed two acquisitions in the six months ended June 30, 2004. In
February 2004, a 100% owned subsidiary of the Company acquired cable television
assets at a cost of $0.4 million. On April 30, 2004, the Company acquired a 37%
interest in KMG by issuing a $4.5 million, 8.5% five-year amortizing
subordinated note.

The Company has initiated an effort to monetize certain of its assets, including
selling a portion or all of its investment in certain of its operating entities
and equity investments. These initiatives may include the sale of certain
telephone operations where growth opportunities are not readily apparent. There
is no assurance that all or any part of this program can be effectuated on
acceptable terms.

Subsequent to the spin-off by Lynch Corporation, the Board of Directors of
Interactive authorized the purchase of up to 100,000 shares of common stock.
Through June 30, 2004, 53,200 shares had been purchased at an average cost of
$32.32.

Lynch Corporation, the Company's predecessor, has not paid any cash dividends on
its common stock since 1989. The Company has not paid any cash dividends since
its inception in 1999. The Company may consider paying dividends in the future
depending upon the needs of its businesses. Further financing may limit or
prohibit the payment of dividends.

Contingencies
-------------

-20-

its rights under the policy and, as a result, any coverage to be provided to any
director or officer of Interactive in connection with a judgment rendered in
this action is unclear at this time.

Critical Accounting Policies and Estimates
------------------------------------------

The preparation of consolidated financial statements requires Interactive's
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an ongoing basis, Interactive evaluates its
estimates, including those related to revenue recognition, carrying value of its
investments in spectrum entities and long-lived assets, purchase price
allocations, and contingencies and litigation. Interactive bases its estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. Interactive believes the
following critical accounting policies affect its more significant judgments and
estimates used in the preparation of its consolidated financial statements.

We believe that revenue from interstate access is based on critical accounting
estimates and judgment. Such revenue is derived from settlements with the
National Exchange Carrier Association ("NECA"). NECA was created by the FCC to
administer interstate access rates and revenue pooling on behalf of small local
exchange carriers who elect to participate in a pooling environment. Interstate
settlements are determined based on the various subsidiaries' cost of providing
interstate telecommunications service. Interactive recognizes interstate access
revenue as services are provided based on an estimate of the current year cost
of providing service. Estimated revenue is adjusted to actual upon the
completion of cost studies in the subsequent period.

Interactive's current business development strategy is to expand its existing
operations through internal growth and acquisition. From 1989 through 2001, the
Company has acquired twelve telephone companies. Significant judgments and
estimates are required to allocate the purchase price of acquisitions to the
fair value of tangible assets acquired and identifiable intangible assets and
liabilities assumed. Any excess purchase price over the above fair values is
allocated to goodwill. Additional judgments and estimates are required to
determine if identified intangible assets have finite or indefinite lives.

Annually, the Company tests goodwill and other intangible assets with indefinite
lives for impairment. The Company screens for potential impairment by
determining fair value for each reporting unit. We estimate the fair value of
each reporting unit based on a number of subjective factors, including: (a)
appropriate weighting

-21-

of valuation approaches (income approach, market approach and comparable public
company approach), (b) estimates of our future cost structure, (c) discount
rates for our estimated cash flows, (d) selection of peer group companies for
the public company approach, (e) required level of working capital, (f) assumed
terminal value and (g) time horizon of cash flow forecasts.

We consider the estimate of fair value to be a critical accounting estimate
because (a) a potential goodwill impairment could have a material impact on our
financial position and results of operations and (b) the estimate is based on a
number of highly subjective judgments and assumptions, the most critical of
which is that the regulatory environment will continue in its current form.

Interactive tests its investments and other long-term non-regulated assets
annually whenever events or changes in circumstances indicate that the carrying
value of such assets may not be recoverable. Significant judgment is required to
determine if an impairment has occurred and whether such impairment is "other
than temporary."

The calculation of depreciation and amortization expense is based on the
estimated economic useful lives of the underlying property, plant and equipment
and intangible assets. Although Interactive believes it is unlikely that any
significant changes to the useful lives of its tangible or intangible assets
will occur in the near term, rapid changes in technology, the discontinuance of
accounting under SFAS No. 71 by the Company's wireline subsidiaries, or changes
in market conditions could result in revisions to such estimates that could
materially affect the carrying value of these assets and the Company's future
consolidated operating results.

Recently Issued Accounting Pronouncements
-----------------------------------------

The Financial Accounting Standards Board (FASB" issued Financial Interpretation
No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB
No. 51" (FIN 46) in January 2003 and revised it in December 2003 (FIN 46R). FIN
46 requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The provisions of FIN 46R
must be applied for the first interim or annual period ending after March 15,
2004 for both new and existing variable interest entities. Certain less than 50%
owned investments in limited liability companies, which were considered to be
variable interest entities, needed to be consolidated as a result of the
implementation of FIN 46. The effect of consolidating such operations resulted
in increasing intangible assets and decreasing investments in and advances to
affiliated companies by approximately $2 million and had no other significant
effect on the Company's consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosure about Market Risk
---------------------------------------------------------

The Company is exposed to market risks relating to changes in the general level
of U.S. interest rates. Changes in interest rates affect the amount of interest
earned on the Company's cash equivalents and short-term investments
(approximately $25.9 million at June 30, 2004 and $26.6 million at December 31,
2003). The majority of the Company's debt is fixed rate and the Company
generally finances the acquisition of long-term assets by borrowing on a fixed
long-term basis. The Company does not use derivative financial instruments for
trading or speculative purposes. Management does not currently foresee any
significant changes in the strategies used to manage interest rate risk in the
near future, although the strategies may be reevaluated as market conditions
dictate. As of June 30, 2004, the fair value of debt was approximately equal to
its carrying value.

At June 30, 2004 and December 31, 2003, approximately $56.7 million and $56.4
million, respectively, or 31% and 34% of Interactive's long-term debt and notes
payable bears interest at variable rates. Accordingly, the Company's earnings
and cash flows are affected by changes in interest rates. Assuming the current
level of borrowings for variable rate debt and assuming a one percentage point
change in the 2004 average interest rate

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under these borrowings, it is estimated that Interactive's interest expense for
the six months ended June 30, 2004 would have changed by approximately $0.3
million. In the event of an adverse change in interest rates, management would
likely take actions to further mitigate its exposure. However, due to the
uncertainty of the actions that would be taken and their possible effects, no
such actions are assumed. As of June 30, 2004, if the Company were to convert a
significant portion of its variable interest rate debt into fixed interest
rates, such conversion could increase interest expense for the six months ended
June 30, 2004 by $0.8 million assuming that variable rates remain constant.
Further, such analysis does not consider the effects of the change in the level
of overall economic activity that could exist in such an environment.

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

Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the
"Act")) as of the end of the period covered by this report. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that the Company's disclosure controls and procedures as of the end of
the period covered by this report were designed and were functioning effectively
to provide reasonable assurance that the information required to be disclosed by
the Company in reports filed under the Act is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms. The
Company believes that a controls system, no matter how well designed and
operated, cannot provide absolute assurance that the objectives of the controls
system are met, and no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within a company have
been detected.

During the period covered by this report, there have been no changes in our
internal control over financial reporting that have materially affected, or is
reasonably likely to materially affect, our financial statements.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings
-----------------

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notified the court that it has declined to intervene in the case. Nevertheless,
we cannot predict the ultimate outcome of the litigation, nor can we predict the
effect that the lawsuit or its outcome will have on our business or plan of
operation. Interactive does not have any insurance to cover its cost of
defending this lawsuit, which costs will be material. Interactive does have a
directors and officers liability policy but the insurer has reserved its rights
under the policy and, as a result, any coverage to be provided to any director
or officer of Interactive in connection with a judgment rendered in this action
is unclear at this time.

History of Lynch's "C" Block Activities
---------------------------------------

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On June 8, 1998, Fortunet elected to apply its eligible credits relating to its
original down payment to the purchase of three licenses for 15 MHz of PCS
spectrum in Tallahassee, Panama City and Ocala, Florida. Consistent with an FCC
promulgated disaggregation alternative, Fortunet surrendered all the remaining
licenses and forfeited 30% of its original down payment in full satisfaction of
the government debt and the forgiveness of all accrued interest. Accordingly,
Fortunet retained 15 MHz of spectrum in the three Florida markets covering a
population of approximately 962,000 at a net auction cost of $15.8 million. As a
result of following this FCC process, disaggregation resulted in a reduction of
the bidding credits to $5.3 million. Fortunet also lost $6.0 million of its down
payment. A lawyer for many applications for FCC licenses, Mr. Taylor is aware of
the details of these FCC initiated alternatives to the "C" Block, as was and
should be his law firm. As a result of this decision, during 1997, Interactive
recorded a $7.0 million write down of its investment in Fortunet.

In February 2000, Fortunet merged with Sunshine PCS Corporation, which by way of
a spin-off from Lynch Interactive became a public company. It traded under the
symbol SUNPA.

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Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
-----------------------------------------------------------------------
Securities
----------

Total Number of Maximum Number of
Shares Purchased as Shares that May Yet
Part of Publicly Be Purchased Under
Total Number of Average Price Paid Announced Plans or the Plans or Programs
Period Shares Purchased per Share Programs
------------------ ---------------------- ----------------------- ----------------------- -----------------------

April 2004 200 $ 31.07 200 49,500
May 2004 500 33.08 500 49,000
June 2004 2,200 34.44 2,200 46,800
----------------------------------------------------------------------------------------------
Total 2,900 $33,97 2,900 --

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

At the Annual Meeting of Stockholders of the Company held on May 13, 2004, the
following persons were elected as Directors of with the following votes:

Name Votes For Votes Withheld
--------------------------------------------

Morris Berkowitz 2,306,892 51,643
Paul J. Evanson 2,352,305 6,230
John C. Ferrara 2,352,495 6,040
Mario J. Gabelli 2,352,295 6,246
Daniel R. Lee 2,352,283 6,252
Salvatore Muoio 2,352,495 6,040

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit 31.1 - Chief Executive Officer Section 302 Certification.
Exhibit 31.2 - Chief Financial Officer Section 302 Certification.
Exhibit 32.1 - Chief Executive Officer Section 906 Certification.
Exhibit 32.2 - Chief Financial Officer Section 906 Certification.

(b) Reports on Form 8-K during the quarter reported on:

- Current Report on Form 8-K filed May 14, 2004, under Items 7 and 12
reporting the issuance of a press release regarding the Company's
first quarter operating results.
- Current Report on Form 8-K filed April 15, 2004, under Items 7 and 12
reporting the issuance of a press release regarding the Company's
fourth quarter of 2003 operating results.

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SIGNATURE

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.

LYNCH INTERACTIVE CORPORATION
(Registrant)

/s/ Robert E. Dolan__
--------------------
Robert E. Dolan
Chief Financial Officer
August 16, 2004

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