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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 1996 Commission file number 000-20709
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D & E Communications, Inc.
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(exact name of registrant as specified in its charter)
Pennsylvania 23-2837108
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
124 East Main Street; P.O. Box 458
Ephrata, Pennsylvania 17522-0458
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(Address of principal executive offices) (zip code)
Registrant's Telephone Number, including area code (717) 733-4101
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.16 per share
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(Title of class)
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 if the disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
The aggregate market value of the Registrant's Common Stock held by
non-affiliates on March 6, 1997 (based upon the closing price of such stock as
of such date) was $55,681,670.
The number of shares outstanding of the Registrant's common stock, $.16 par
value, was 5,764,619 at March 6, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------
(1) Portions of the Proxy Statement relative to the Registrant's 1997 Annual
Meeting of the Shareholders to be held on April 29, 1997, are incorporated by
reference in Part III hereof.
Total number of pages including cover page is 85.
The index to exhibits is found on sequentially numbered page 20.
TABLE OF CONTENTS
Page
PART I
Item 1. Business.............................................................1
Item 2. Properties...........................................................7
Item 3. Legal Proceedings....................................................8
Item 4. Submission of Matters to a Vote of Security Holders..................8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters..............................................................9
Item 6. Selected Financial Data.............................................10
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......................11
Item 8. Financial Statements and Supplementary Data.........................17
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................................17
PART III
Item 10. Directors and Executive Officers of the Registrant..................18
Item 11. Executive Compensation..............................................18
Item 12. Security Ownership of Certain Beneficial Owners and Management......18
Item 13. Certain Relationships and Related Transactions......................18
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....19
i
PART I
Item 1. Business.
(a) General Development of Business.
D & E Communications, Inc. is a telecommunications holding company
formed in June 1996, when it became the successor parent company to its
telephone operating subsidiary, Denver and Ephrata Telephone and Telegraph
Company ("Telco"). On February 28, 1996, Telco applied to the Pennsylvania
Public Utility Commission ("PUC") for approval to form a holding company
corporate structure ("Restructuring"). The general purpose of the Restructuring
was to establish a more appropriate corporate structure for continued growth and
financial strength in a competitive environment. A majority of the shareholders
entitled to vote at the Annual Meeting of Shareholders held on May 9, 1996
approved the Agreement and Plan of Exchange ("Plan of Exchange"). Under the
terms of the Plan of Exchange, each of the outstanding Telco common shares
($0.50 par value) was exchanged for three D & E Communications, Inc. common
shares ($0.16 par value). In effect, the exchange was similar to a three-for-one
split of Telco common shares. In addition, Telco declared a dividend to D & E
Communications, Inc. of all of the capital stock of its subsidiaries Red Rose
Communications, Inc. ("Red Rose"), (f/k/a Red Rose Systems, Inc,) and D & E
Marketing Corp. ("Marketing"). D & E Communications, Inc. and its subsidiaries
(hereinafter collectively referred to as "D&E") provide telecommunications
services for local exchange and long distance markets and sell related systems
equipment to customers in the southcentral Pennsylvania area. D&E also provides
network access services for switching and transporting telephone calls. Other
communication services include computer network design and installation,
directory advertising, and billing and collection services.
(b) Financial Information About Industry Segments.
Financial information about D&E and its subsidiaries is contained
in the consolidated Financial Statements filed herewith. D&E presently engages
in operations in only one industry segment, telecommunications services and
equipment.
(c) Narrative Description of Business.
(1) Overview. Telco, furnishes telephone service through 51,289
access lines to an estimated population of 100,000 in an area of approximately
227 square miles covering parts of Berks, Lancaster and Lebanon Counties in the
Commonwealth of Pennsylvania. National and international communications services
are also furnished through interconnection with the facilities of other
companies.
The area served by Telco is mostly rural and suburban in nature, with
an agricultural and farming economic base. In addition, the business elements
include manufacturing, distribution, retail, and service establishments. Of the
51,289 access lines serviced by D&E as of December 31, 1996, service is provided
to 37,870 residential customer lines (74%) and to 13,419 business customer lines
(26%).
The principal categories of service rendered by Telco are:
(i) Local Network Services -- consist primarily of local exchange
(dial tone), local private line and public telephone services
furnished to residential and business customers in Telco's
franchised serving area. Revenues from this category of service
contributed the following amounts and percentages of consolidated
operating revenues for each of the last three fiscal years:
1996 - $8,655,000 (19.5%); 1995 - $8,321,000 (20.4%); and
1994 - $7,886,000 (21.4%).
1
(ii) Network Access Services -- provide local exchange carriers and
interexchange carriers and other regional telephone companies
with the use of Telco's local network facilities that are needed
for the completion of long distance calls and from settlement
pools administered by the National Exchange Carrier Association,
Inc. ("NECA"). Revenues from this category of service contributed
the following amounts and percentages of consolidated operating
revenues for each of the last three fiscal years: 1996 -
$15,843,000 (35.7%); (1995 - $15,309,000 (37.4%); and 1994 -
$14,666,000 (39.9%).
(iii) Long Distance Network Services -- consist of long distance calls
made by residential and business customers within the Capital
(southcentral) Region of Pennsylvania.
Telco participates in cellular joint ventures with 360(degree)
Communications Company, formerly known as Sprint Cellular Company ("360CC"), and
Conestoga Enterprises, Inc. through its 50% interest in Lancaster Area Cellular
Enterprises ("LACE") and its 15% interest in Berks and Reading Area Cellular
Enterprises ("BRACE"). LACE and BRACE, in conjunction with other
telecommunications companies, provide cellular telephone service in the Reading,
Lancaster, York and Harrisburg metropolitan areas. Through its 33.3% interest,
Telco participates with 360CC in a joint venture, the Pennsylvania RSA 12
Limited Partnership ("PA RSA 12"), which provides cellular telephone service in
the Lebanon metropolitan area.
D&E is positioning itself to participate in a new generation of
wireless services known as Personal Communications Services ("PCS"). PCS is a
cellular-like, digital, wireless communication system with opportunities to
provide truly mobile, portable communications to an untapped business and
residential market. In 1995, Red Rose became managing partner in The D and E
Group, a partnership formed for the purpose of participating in PCS spectrum
auctions conducted by the Federal Communications Commission ("FCC"). Red Rose
made an initial capital contribution of $2,000,000 to The D and E Group, which
in turn, became a minority equity investor in PCS One, Inc. ("PCS One").
In 1994, Telco constructed and installed, and now maintains, an
enhanced 911 system in Lancaster County pursuant to an Agreement, which was
modified on February 23, 1995, for Telco to furnish the County's 911 system with
an Automatic Location Identification ("ALI") Network. The enhanced 911system is
operational since loading of the information was completed during 1996. The 911
backup system, required by the Public Safety Emergency Act of 1990, is located
at Telco's Ephrata Central Office. Under the enhanced 911 system, a dispatcher
will be provided with the phone number and address of the caller by
sophisticated computer equipment. Telco estimates that this Agreement, as
modified, will generate an estimated $9,500,000 of revenue over the 10 year term
of the Agreement.
D&E's subsidiary, Red Rose, sells, installs and maintains
telecommunications equipment. In this capacity, Red Rose provides service for
approximately 2,400 business customers in central and eastern Pennsylvania. In
addition, it operates a retail store that specializes in communications
equipment such as telephones and accessories. Red Rose doing business as D and E
Long Distance ("DELD") also provides long distance telephone services on an
equal access basis within the Telco service area. Revenues from this category of
service contributed the following amounts and percentages of consolidated
operating revenues for each of the last three fiscal years: 1996 - $10,935,000
(24.6%) 1995 - $8,666,000 (21.2%); and 1994 - $5,876,000 (16.0%).
On February 20, 1997, the shareholders of PCS One approved the
Agreement and Plan of Merger ("the Merger") as of December 12, 1996, by and
between PCS One and D&E whereby PCS One merged with and into D&E. Additionally,
on January 31, 1997, the Federal Communication Commission ("FCC") approved the
transfer of the Lancaster C Block PCS License from PCS One to D&E pending the
outcome of any reconsideration petitions that may be filed with the FCC by March
12, 1997. The Merger was completed on March 21, 1997.
2
On January 15, 1997, D&E was awarded two PCS licenses in the FCC
spectrum auction for the Harrisburg D Block License and the York/Hanover E Block
License. D&E anticipates forming a new subsidiary in 1997 to design, construct
and provide PCS services in the three markets of Lancaster, Harrisburg and York.
D&E filed applications with the FCC on February 19, 1997 to purchase the two PCS
licenses for a total price of $1.5 million.
In 1995, Marketing invested in Red Rose SuperNet(TM), a partnership
which offers Internet access service and related equipment to customers in
southcentral Pennsylvania. Marketing owns 50% of Red Rose SuperNet(TM).
(2) Regulatory Matters. A substantial portion of D&E's operations
are subject to regulation at both the federal and state levels. The
Telecommunications Act of 1996 (the "Telecommunications Act"), signed into law
by President Clinton on February 8, 1996, has enormous ramifications throughout
both state and federal jurisdictions and, therefore, affects the strategic
direction of D&E. While the Telecommunications Act encourages development of
advanced technology in the telecommunications industry and entrance of D&E into
new markets, it may also provide these same opportunities to a new set of
competitors and other entrepreneurs, who have not previously been permitted to
compete in Telco's markets. Development of advanced technology is expected to
accelerate as competitors vie for new products and services to attract
customers, thus spurring equipment manufacturers and technology vendors to
explore innovative ways of bringing such products and services to market.
In conjunction with the Telecommunications Act, state regulatory laws
are also being revised. For example, local exchange carriers operating in a
competitive market are now permitted to package dial tone and toll services, a
product mixture formerly prohibited. The lifting of such marketing restrictions
will enable D&E to compete within and beyond its existing franchise territory on
equal footing with new market entrants and with more regulatory freedom than
traditional local exchange carriers currently possess.
The Telecommunications Act also removes entry barriers such as
cross-ownership rules, into other industry segments. The immediate absence of
cross-ownership rules, which formerly prohibited a cable television company and
telephone company owned by the same entity from offering services in the
franchise territory, could encourage mergers and marketing opportunities
throughout the nation. Therefore, the competitive profile of incumbent local
exchange carriers may change. D&E continues to analyze the merits of entering
such new markets, while focusing on continuing to strengthen its franchise
territory.
The Telecommunications Act may also provide long distance carriers,
such as AT&T Communications ("AT&T"), MCI, Sprint and Regional Bell Operating
Companies ("RBOCs"), such as Bell Atlantic and NYNEX, the opportunity to compete
in Telco's traditional service area. The foregoing competitors may have
substantially more resources than D&E. However, Telco is initially afforded some
protection through the Telecommunications Act's rural exemption clauses which
specifically prohibit competitive local exchange carriers from offering service
to Telco's customers until the state public utility commission determines that a
bona fide request from a competitor would not be unduly economically burdensome,
technically infeasible and is not inconsistent with universal service
principles.
(i) Federal. Telco's furnishing of interstate network access services
and certain related matters are subject to regulation by the FCC, Washington,
D.C. Interstate network access services are transmission and switching services
provided by local telephone companies at each end of a long distance telephone
call. These services provide connections from end-users (telephone subscribers)
to the long distance networks of companies such as AT&T, MCI, Sprint and others.
Interstate network access revenues have contributed the following percentages of
consolidated operating revenues for each of the three prior years, 21.2% in
1996, 22.6% in 1995, and 23.6% in 1994.
3
Telco earns its interstate revenues based upon its own traffic
sensitive tariffed rates and the carrier common line settlement pools
administered by the National Exchange Carrier Association Inc. ("NECA"),
Whippany, NJ. NECA comprises approximately 1,252 local telephone companies in
the United States -- both large and small. Established at the direction of the
FCC, NECA prepares and files uniform interstate access charge tariffs on behalf
of NECA member companies and collects data from member companies upon which it
bases its redistribution of revenues to the member companies. Telco bills access
charges to both interexchange carriers and end user customers at uniform rates
specified in NECA tariffs, reports the demand unit data to NECA, and receives
compensation from NECA based upon FCC approved settlement formulas. NECA
settlements represent Telco's portion of pooled revenues designed to recover the
costs of providing interstate access services, plus an authorized return on
investment. Telco received approval from the FCC to withdraw from the NECA
Traffic Sensitive Pool and apply its own tariff rates effective July 1, 1994.
The total compensation received from NECA amounted to $1,087,000 in 1996,
$1,142,000 in 1995, and $467,000 in 1994. A major reason for the increase in
1995 and 1996 as compared to 1994 is Telco's withdrawal from the NECA Traffic
Sensitive Pool. Telco's tariff was filed for the period July 1, 1994 to June 30,
1995. Upon the expiration of this tariff on June 30, 1995, Telco applied for new
tariff rates which were approved by the FCC and are effective for the period
July 1, 1995 through June 30, 1997. Telco elected to rejoin NECA's Traffic
Sensitive Pool and effective July 1, 1997, will revise its traffic-sensitive
access rates and apply the rates from the NECA Interstate Access Tariff. Telco
anticipates a decline of approximately $900,000 during 1997 in interstate access
revenue derived from interstate pool settlements. The interstate revenues that
will be generated through participating in NECA access rates and settlements are
more favorable than if Telco established rates based on its costs.
Pursuant to recently adopted rules, the FCC prescribes the rate of
return on the interstate access services furnished by NECA member companies,
including Telco. Through such rules, the FCC permits Telco to earn up to 11.25%
return on its investment in property, plant and equipment used to furnish
interstate access service. This rate of return serves as a benchmark for
regulation of the interstate access services provided by NECA member companies.
The FCC has also adopted rate of return enforcement rules, which require
telephone companies to target their rates to produce the prescribed return and
to refund, to NECA, earnings in excess of their allowable return.
In June 1994, D&E, through its subsidiary, Red Rose, was granted FCC
approval for its long distance toll reseller, D and E Long Distance. Other
aspects of D&E's interstate operations are also generally subject to the
jurisdiction of the FCC. This federal agency has established and currently
enforces regulations governing the operations of, and services furnished by,
telecommunications companies.
(ii) State. D&E's furnishing of local and intrastate services is
subject to regulation by the Public Utility Commission, Harrisburg, Pennsylvania
("PUC"). The majority of services provided by D&E are considered to be local or
intrastate in nature, and are therefore subject to PUC regulation. These
services include local network services, intrastate network access services,
regional and long distance toll services, and other miscellaneous services.
Local and intrastate regulated operations have contributed between 55.4% and
59.9% of D&E's consolidated operating revenues during each of the last three
fiscal years.
The rates which Telco charges for toll and access are contained in the
tariffs issued by the Pennsylvania Telephone Association ("PTA") -- a trade
association of the state's approximately 37 telephone companies. Telco uses the
PTA toll and access tariffs for rates and rules governing the provision of
intrastate access services furnished to interexchange carriers and for regional
long distance (including WATS/800) services provided to end-users.
4
The PUC also has established rules pertaining to all jurisdictional
public utilities generally, and to telephone companies specifically, which are
applicable to D&E. The following list provides examples of the primary areas in
which the PUC has established rules which affect D&E:
- Certificates of public convenience.
- Rates and rate making.
- Standards of service and facilities; service outages.
- Billing practices for residential customers.
- Accounting and budgetary matters.
- Registration of securities and obligations.
- Relations with affiliated interests.
- Tariffs for fixed service utilities.
- Confidentiality of customer information.
- Violations and penalties.
66 Pa. C.S. (sections) 3001 - 3009 (also known as Chapter 30),
enacted on July 8, 1993, allows local exchange carriers to petition the PUC for
an alternative form of regulation other than traditional rate base/rate of
return. In its petition, the local exchange carrier must define and commit to a
network modernization plan promising 100% conversion of its interoffice and
distribution telecommunications network to broadband capability by December 31,
2015. The petition also allows the local exchange carrier to propose services
that are deemed competitive for deregulation. Local exchange carriers who do not
file a petition and network plan by July 8, 1998, will be subject to a Show
Cause order, which is an order requiring the local exchange carrier to show good
reason why it should not be required to file a petition. D&E is currently
formulating its strategy in this area.
(3) Significant Customers. There are no significant end-users
(telephone subscribers), the loss of whom would have a material adverse effect
on D&E. AT&T, however, is D&E's most significant customer in terms of total
revenue received from a single entity. During each of the last three fiscal
years, AT&T purchased network access services, billing and collection services,
and marketing and sales-referral services from D&E which, in 1996, 1995 and
1994, produced $5,193,000, $5,412,000 and $6,325,000, respectively, in annual
revenues, or approximately 11.7%, 13.2% and 17.2%, respectively, of total
consolidated operating revenues.
Although D&E's revenue stream relies heavily upon services furnished to
AT&T, it is not likely that a significant portion of AT&T revenues is in
jeopardy of being lost for the following reasons:
D&E provides network access services within its franchised
service area to interexchange carriers such as AT&T, MCI,
Sprint and others who use D&E's switching and transmission
facilities for the completion of long distance calls. Certain
long distance carriers have occasionally (I) limited the use
of D&E's facilities by converting the use of service from
switched access service to special access service ("Service
Bypass"), or (ii) bypassed the use of D&E's facilities
entirely ("Facility Bypass"), both of which result in less
revenue. D&E does not expect its business to be significantly
affected by either Service Bypass or Facility Bypass within
the immediate future. Such bypass normally occurs in
metropolitan areas in which a significant customer represents
a large portion of business. D&E's serving area is
predominantly rural and suburban in nature and constitutes a
diverse customer mix.
To the extent that AT&T loses market share to other long
distance companies, D&E should receive approximately the
same revenue from any other long distance carrier competing
with AT&T.
5
Although AT&T has previously objected to D&E's network access service
rates, D&E and AT&T have negotiated such rates, which have been approved by the
PUC and the FCC. D&E believes that its relations with AT&T are good, and fully
expects to continue doing business with AT&T, even though the volume of services
furnished to AT&T is declining. D&E does not expect its business to be
significantly affected by either Service Bypass or Facility Bypass within the
immediate future. Based on two year data in the period from 1994 to 1996, access
lines are growing at an average annual rate of 4.2%, while AT&T minutes of use
are declining at an average annual rate of 2.7%. A portion of AT&T's decline in
D&E's franchised area since 1994 can be attributed to DELD which began its
operations as a long distance toll reseller in June 1994.
(4) Competition. On December 15, 1995, the PUC ordered an
implementation schedule for intraLATA toll presubscription which takes affect
for Telco on December 31, 1997. Regional, or "intraLATA" toll, presubscription
enables consumers to designate a carrier of their choice for all direct-dialed
toll calls made within the same Local Access Transport Area ("LATA"). Currently
, all direct-dialed intraLATA toll calls are handled by the local exchange
carrier. IntraLATA presubscription will require Telco to open its exclusive
direct-dial regional market to long distance competitors, i.e., interexchange
carriers and toll resellers, in the same manner interLATA and interstate toll
calls are offered by a variety of long distance companies today. To the extent
that these competitors are able to gain a significant market share of Telco's
intraLATA toll or a significant portion of service of Telco's franchise
territory, such loss would have a material adverse effect on the Company's
operations and financial condition. However, some portion of this loss may be
recouped from the increased volume of access required by the long distance
companies.
Another form of emerging competition will affect the local exchange
market via competitive local exchange carriers ("CLECs") who provide consumers
an alternative to the local telephone company for any and all telecommunications
services. In order to compete with local exchange carriers, CLECs must receive
PUC approval. D&E realizes the potential threat to its own rural and suburban
franchise territory could occur within the next several years as CLECs extend
their applications into territories currently protected under the rural
exemption clauses of the Telecommunications Act. At present, however, Telco is
protected under such rural exemption clauses and, therefore, does not have any
such competition.
Another significant service provided by Telco, which had traditionally
been non-competitive, is network access services provided to long distance
companies and other telephone companies within the local region. Competitive
access service providers, which are capable of originating and/or terminating
calls without the use of the local telephone company's plant, are beginning to
compete with telephone companies in providing network access service in major
metropolitan areas. However, D&E does not expect its business to be
significantly affected by competitive access service providers because D&E has a
diverse customer mix which D&E services with competitive pricing.
Various other services had been historically provided exclusively
by Telco, but in recent years such markets were opened to the forces of
competition by other suppliers. Examples include directory publishing and
billing and collection services. In furnishing such services, the federal and
state regulatory agencies exercise a lessened form of regulation, i.e., tariffs
showing rates and rules governing the furnishing of some of these services are
no longer required. However, the revenues, expenses and investments associated
with these operations are still a part of the PUC's rate making formula in the
determination of basic local service rates and are reflected as such in Telco's
operations. To compete in open markets, D&E utilizes a combination of media,
such as local newspaper, radio and television advertising, to highlight D&E's
competitive service and pricing differences in order to attract customers to
D&E's products and services.
D&E participates in cellular joint ventures with Conestoga Enterprises,
Inc. and 360CC, which is licensed by the FCC. These carriers compete with
wireless cellular service providers in the respective metropolitan areas in
which they are licensed to serve. Personal Communication Services ("PCS") also
constitutes a potential source of competition. PCS consists of wireless portable
telephone services which allow customers to place and receive calls, as well as
send data transmissions, from any location thereby competing with pay phone and
cellular phone services. Red Rose also faces competition in its DELD long
distance telephone
6
service which competes against other long distance carriers such as AT&T,
Sprint, MCI and others.
(d) Financial Information About Foreign and Domestic Operations and
Export Sales. On February 28, 1994, the government of Hungary awarded a
concession to the Monor Telephone Company ("MTT"), a Hungarian corporation, to
provide local exchange telecommunications service for a period of twenty-five
years in the Monor Region of Hungary. The Monor Communications Group, Inc.
("MCG"), a Nebraska corporation, presently owns 88.7% of MTT. Marketing has
invested $6,662,000 in MCG since December 1993, resulting in 16.5% ownership of
MCG. The Hungarian concession provides that MTT will have the exclusive right to
design, construct and operate this telecommunications network beginning in 1994
for an eight-year period. The Monor Region is a 750 square mile area with a
population of 240,000 people and is adjacent to the southeast side of Budapest.
MTT provides over 55,000 lines of telephone service and additionally, provides
service to over 14,000 cable television customers.
Item 2. Properties.
(a) Land and Buildings. D&E's corporate headquarters is in a
multi-purpose six-story building, the Brossman Business Complex ("BBC"), located
at 124 East Main Street, Ephrata, Pennsylvania. It consists of approximately
85,900 square feet of floor space. The first and second floors are occupied by a
movie/live theater and a restaurant. The third and fourth floors are leased as
office space and conference rooms. The fifth and sixth floors are currently
occupied by D&E employees and executive officers.
D&E's main central office switch is located at 130 East Main Street,
Ephrata, Pennsylvania. This building consists of approximately 19,600 square
feet and contains administrative offices and central office switching equipment
serving customers in the Adamstown, Denver, Akron and Ephrata exchanges.
In addition, D&E owns eighteen (18) other building facilities,
containing a total floor space area of 121,200 square feet, located in various
communities throughout D&E's service area. These buildings serve a variety of
functions including: exchange central offices, remote switching units, plant
operations center, materials storage, engineering and planning, vehicle
maintenance, retail store, a parking garage and a communications tower site.
(b) Network Plant Facilities. D&E owns and operates a network of
switching and transmission facilities which are used to provide local,
nationwide and international telecommunications services to its customers. This
network also provides for advanced custom calling services and customer local
area signaling services ("CLASS") and is positioned to provide broadband
services in the future.
The switching facilities consist primarily of digital electronic
switching equipment housed in D&E-owned buildings situated at various locations
within the service area. The 100% fully digital switching technology used by D&E
is manufactured by Northern Telecom, Inc. Two host DMS-100 switches are located
in Ephrata and Lititz; ten remote switching centers or remote line modules are
located in buildings or controlled environmental vaults at Adamstown, Akron,
Brickerville, Denver, Durlach, Elstonville, Lincoln, Manheim, Reinholds, and
Turnpike 21. Other smaller remote dial tone units, such as access nodes and
digital loop carrier equipment, are contained in weather-proof housings
scattered throughout the territory. D&E has also invested in Signaling System 7
("SS7") Signaling Transfer Point equipment, SS7 Signaling Control Point
equipment and an Advanced Intelligent Network ("AIN") Service BuilderTM software
which are used to provide AIN services. In addition, this equipment permits D&E
to be a node in the Illuminet telephone network through which other
telecommunications companies can obtain access to the national SS7 network.
7
Transmission facilities, sometimes referred to as "outside plant,"
consist of cables, wires, terminals and the necessary supporting structures
(poles, conduits, manholes, etc.). The cable plant in service contains mostly
metallic copper conductors and is installed in one of the following methods:
aerial construction on poles, underground in conduit, or directly buried in the
earth. The "outside plant," or "local loop" facilities, connect each end user
(telephone subscriber) with one of D&E's switching units, which in turn are
interconnected with other exchange central offices or the facilities of long
distance companies such as AT&T, MCI, Sprint and others.
In 1994, D&E completed a four-year fiber optic ring project.
Approximately 431,000 feet of fiber optic cable was installed in order to create
three "self healing" fiber optic rings. This self healing ring technology
provides an uninterruptable communications link to each of D&E's switching
centers and larger digital remote units, thus protecting D&E's customers from
any service outage caused by a break in any major fiber optic cable.
Item 3. Legal Proceedings.
D&E is involved in various legal proceedings arising in the ordinary
course of its business. In the opinion of management, the ultimate resolution of
these matters will not have a material adverse effect on D&E's consolidated
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of the shareholders during
the fourth quarter of 1996.
8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The common stock of D & E Communications, Inc, has traded on the NASDAQ
National Market tier of the NASDAQ Stock Market under the symbol DECC since
October 1, 1996. Previously it was traded on the over-the-counter market. The
table below sets forth the high and low bid prices of D&E's common stock during
each of the periods indicated, as reported and summarized in the "Pink Sheets,"
published by the National Quotation Bureau prior to October 1, 1996. Such
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions. After October
1, 1996, the bid prices were available daily on the NASDAQ National Market.
1995 Low Bid High Bid
1st Quarter $23.67 $24.83
2nd Quarter $24.00 $24.83
3rd Quarter $24.33 $24.75
4th Quarter $23.67 $25.17
1996 Low Bid High Bid
1st Quarter $17.83 $23.92
2nd Quarter $19.67 $19.83
3rd Quarter $20.00 $24.75
4th Quarter $23.50 $24.75
The amounts shown above reflect the three-for-one share exchange which
occurred when D&E became the holding company of the Denver and Ephrata Telephone
and Telegraph Company. The approximate number of holders of common stock of D&E,
based upon the records maintained by D&E, as of December 31, 1996, was 910.
Cash dividends have been declared quarterly on D&E's common stock
during the two most recent fiscal years in the annual amount of $0.39 and $0.36
per share, respectively. Dividends are paid as and when declared by D&E's Board
of Directors and in accordance with restrictions set forth in covenants
contained in Telco's debt agreements. For further discussion of such
restrictions, see Note 7 to the financial statements.
For further discussion of D&E's intended use of any cash reserves
available to it, see Management's Discussion and Analysis of Financial Condition
and Results of Operations.
9
Item 6. Selected Financial Data.
The following table sets forth selected consolidated summary financial
information as of December 31, and for each of the last five fiscal years ended
December 31, 1996. Certain amounts have been reclassified for comparative
purposes.
FIVE-YEAR COMPARISON OF SELECTED FINANCIAL DATA
(dollars in thousands, except per-share amounts) (1)
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
Income Statement Data
Operating Revenues ........... $44,396 $40,907 $36,777 $32,626 $29,421
Net Income ................... $ 3,910 $ 3,343 $ 3,244 $ 3,374 $ 2,296
Balance Sheet Data
Total Assets ................. $91,556 $88,521 $85,175 $78,246 $66,337
Long-Term Debt ............... $24,888 $26,137 $26,512 $26,269 $21,064
Redeemable Preferred Stock (2) $ -- $ -- $ 129 $ -- $ --
Per-Share Information
Earnings Per Common
Share (3) .................. $0.68 $0.59 $0.57 $0.59 $0.40
Cash Dividends Declared
Per Common Share (3) ....... $0.39 $0.36 $0.35 $0.33 $0.30
(1) The selected financial data for fiscal years 1995 through 1992 are for
Denver and Ephrata Telephone and Telegraph Company ("Telco"), which is now a
subsidiary of D & E Communications, Inc. D & E Communications, Inc., and its
subsidiaries are referred to as ("D&E").
(2) The 1,289 outstanding shares of Telco's Series B 5 1/2% Preferred Stock were
redeemed on February 1, 1995, at $100 par value per share plus accrued
dividends.
(3) The per-share data is based upon the weighted average common shares out-
standing and reflects the ten-for-one stock split effective June 30, 1992,
and a three-for-one share exchange effective June 7, 1996.
10
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation.
Fiscal Years 1996, 1995 and 1994
On June 7, 1996, D & E Communications, Inc. became the parent company of Denver
and Ephrata Telephone and Telegraph Company pursuant to the terms of the
Agreement and Plan of Exchange (the Plan of Exchange), whereby each of the
outstanding Telco common shares, par value $.50, was exchanged for three D&E
common shares, par value $.16 (the D&E Share Exchange). In its effect, the D&E
Share Exchange was similar to a three-for-one split of Telco common shares. For
comparative purposes, all information related to D&E common shares and per-share
amounts for all periods presented have been restated to reflect the D&E Share
Exchange. Monetary amounts presented in the following discussion are rounded to
the nearest thousand dollars. The following should be read in conjunction with
D&E's financial statements.
RESULTS OF OPERATIONS
Net Income
Net income for 1996 was $3,910,000, 17.0% more than 1995 net income of
$3,343,000. The 1995 net income represented a 3.1% increase from the net income
of $3,244,000 for 1994. The 1996 increase in net income was primarily due to an
increase in the equity in net income from affiliates of $1,196,000 associated
with D&E's Hungarian investment. The 1995 increase in net income was primarily
due to an increase in operating income offset by a decrease of $1,077,000 in
equity in net income of affiliates associated with D&E's Hungarian investment.
Operating Revenues
Total consolidated operating revenues for 1996 were $44,396,000, an
increase of $3,489,000, or 8.5%, over 1995. Total operating revenues for 1995
were $40,907,000, an increase of 4,130,000, or 11.2%, over 1994 operating
revenues of $36,777,000. Approximately two-thirds of the revenue growth in 1996
and 1995 was derived from non-regulated sources, while revenues from regulated
telephone activities also increased.
Local network services revenues are generated by Telco providing local
exchange, local private line, and public telephone services. Local network
services revenues increased $334,000, or 4.0%, in 1996 and $435,000, or 5.5%, in
1995. The 1996 increase was primarily due to an increase in the number of access
lines, local private line revenues and custom calling features implemented in
mid-1995. These increases were offset by a decline in revenue related to the
one-time revenues recorded in 1995 to load customer records in the Automatic
Location Identification (ALI) network used by Lancaster County's 911 Center. The
1995 increase was primarily due to growth in the number of access lines, an
increase in revenue from local private line and custom calling features, and
revenue from the loading of customer records into the ALI network. Access lines
in service at December 31, 1996, increased 5.0% compared to December 31, 1995.
This gain in access lines accounted for approximately $266,000 of the increase
in local network revenues. The increase of $66,000 in local private line
revenues was primarily due to one-time revenues recorded to set up several new
local private line customers. In 1996, revenue increased $119,000 from custom
calling features, primarily Caller ID Deluxe, implemented in 1995. The loading
of customer records into the ALI network accounted for $100,000 of the increase
in 1995 over 1994. There was also a $105,000 increase in revenue in 1995 over
1994 from new custom calling features.
Network access services revenues are received from Telco's subscribers,
from local exchange carriers (LECs) and interexchange carriers (IXCs) for their
use of local exchange facilities in providing long distance
11
services to their customers, and from settlement pools administered by the
National Exchange Carrier Association, Inc. (NECA). Revenues in this category
increased $533,000, or 3.5%, in 1996 and $643,000, or 4.4%, in 1995. The
increase in 1996 was primarily due to an increase of $406,000 from the
intrastate minutes of use and increases in the number of access lines and
special access circuits. The increase in 1995 was primarily due to a growth in
access lines, the exit from the NECA Traffic Sensitive Pool, an increase in the
NECA Carrier Common Line Pool rates, increased trunk installations for IXCs and
Telco's share of settlements from NECA for the 1991-1992 monitoring period. The
increases amounted to approximately $1,257,000 and were partially offset by
lower interstate traffic-sensitive rates. These rates, which were filed with the
Federal Communications Commission (FCC), independent of the NECA Traffic
Sensitive Pool rates, accounted for a decline in revenues of approximately
$735,000.
During the third quarter of 1996, Telco exceeded 50,000 access lines.
Therefore, on July 1, 1997, when the current traffic-sensitive access rates
expire under the FCC Small Company Incentive regulation, Telco will be required
to follow another method of determining these rates. Accordingly, in December
1996, Telco elected to rejoin NECA's Traffic Sensitive Pool and effective July
1, 1997, will revise its traffic-sensitive access rates and apply the rates from
the NECA Interstate Access Tariff. Telco anticipates a decline of approximately
$900,000 during 1997 in interstate access revenue derived from interstate pool
settlements. The interstate revenues that will be generated through
participating in NECA access rates and settlements are more favorable than if
Telco established rates based on its costs.
Long distance network services revenues are received from long distance
calls made by residential and business customers within the Capital
(southcentral) Region of Pennsylvania. Long distance network services revenues
increased by $158,000, or 3.9%, in 1996 and decreased by $225,000, or 5.3%, in
1995. The 1996 increase was related to an increase of 4.0%, in the long distance
minutes of use. The 1995 decline was primarily due to a 1994 adjustment to
accrue unbilled long distance revenues.
Directory advertising revenues in 1996 increased $269,000, or 10.1%,
compared to a $523,000, or 24.4%, increase in 1995. The 1996 increase was
primarily due to a rate increase in local billings of 6.0% and a 12.7% increase
in other Donnelley billings. The increase in 1995 was primarily due to a $229,00
settlement adjustment of 1993 revenues made in 1994. Also, in 1995 there was a
4.0% increase in advertising rates and a 3.5% increase in the number of local
and regional advertisers.
Sales & services revenues include revenues from Red Rose
Communications, Inc. (Red Rose), which are generated primarily by the following
services: sales and service of business telephone systems and communications
products; revenues from premise work; and revenues from the long distance
calling service, D and E Long Distance (DELD), which began in 1994. Revenues
from Red Rose grew $1,778,000, or 20.9%, in 1996 and $2,345,000, or 38.0%, in
1995. The increase in both years was primarily due to increases in business
telephone system sales and revenues from DELD. Additionally, both years
experienced an increase from the prior year in revenue related to the
construction of a fiber optic facility that was completed in 1996.
Miscellaneous revenues include amounts earned from billing and
collection services (B&C) provided to IXCs, pole attachment rentals, the rental
of real estate facilities, services provided to Lancaster County in implementing
and maintaining the 911 Center at Telco's Manheim Central Office and other
miscellaneous services. Miscellaneous revenues decreased $75,000, or 3.9%, in
1996 and decreased $35,000, or 1.8%, in 1995. The 1996 decrease was primarily
due to the decrease in the 911 implementation revenues, which was partially
offset by 911 ongoing maintenance revenues. The 1995 decrease was related to a
decrease in 911 implementation revenues and a decrease in B&C revenue. The 1995
decrease was partially offset by an increase in revenues received from the
rental of real estate facilities.
Operating Expenses
Total consolidated operating expenses for 1996 were $35,998,000, an
increase of $3,542,000, or 10.9%, over 1995. Total operating expenses for 1995
were $32,456,000, an increase of $2,902,000, or 9.8%, over 1994
12
operating expenses of $29,554,000.
Network operations expenses are incurred in maintaining Telco's
switching and transmission facilities, including digital central office
switching equipment and outside plant cable and trunk facilities. Network
operations include related employee costs, engineering expense, maintenance of
land and buildings, testing, general purpose computers, office equipment,
videoconferencing and other materials and supplies. Expenses in this category
increased $168,000, or 2.9%, in 1996 and decreased $325,000, or 5.3%, in 1995.
The 1996 increase was primarily due to increased wages and benefits. The 1995
decrease was primarily due to a decline in maintenance costs of land and
buildings, as well as engineering expenses.
Depreciation expense increased $490,000, or 7.2%, in 1996 and $444,000,
or 7.0%, in 1995. The increase in both years was primarily attributable to an
increase in telephone plant in service and, based on a depreciation analysis,
new depreciation rates which became effective early in the year.
Customer services expense in 1996 increased $11,000, or 0.7%, primarily
due to increased wages and benefits offset by decreases in certain mailing
costs. Customer service expenses in 1995 increased $131,000, or 8.4% primarily
due to an increase in postage and supplies expense combined with an increase in
wages and benefits.
Financial and administrative services expense increased $736,000, or
15.8%, in 1996 and $565,000, or 13.8%, in 1995. The 1996 increase was primarily
due to an increase in wages and benefits, a one-time charge of $354,000 for an
early retirement program implemented during the fourth quarter and the costs to
list D&E's stock on the NASDAQ National Market. The 1995 increase was primarily
due to an increase in wages and benefits, along with technical support costs
associated with new database software purchased in 1995.
Directory advertising increased $153,000, or 9.1%, in 1996 and
increased $276,000, or 19.6%, in 1995. Increases in both years were related to
increased size and costs to publish the telephone directory. The increase in
1995 was primarily due to a $144,000 settlement adjustment of 1993 expenses made
in 1994.
Operating taxes, other than income taxes, primarily consists of real
estate taxes, gross receipts tax, public utility realty tax (PURTA), and capital
stock tax. Operating taxes increased $43,000, or 3.0%, in 1996 over 1995 and
$70,000, or 5.1%, in 1995 over 1994.
Costs of products sold consist primarily of the material costs of
equipment sales. These costs increased $1,329,000, or 36.2%, in 1996 and
$995,000, or 37.3%, in 1995. The increase in both years was principally due to
an increase in material purchased for resale related to higher telephone system
sales volumes and expenses associated with the construction of a fiber optic
facility.
Other expenses include all operating expenses incurred by Red Rose and
D & E Marketing Corp. (Marketing) in the course of their business activities,
excluding material costs, and operating taxes other than income taxes. These
expenses increased $646,000, or 13.5%, in 1996 and $803,000, or 20.1%, in 1995.
The 1996 increase was principally attributable to the following: increased
Personal Communications Services (PCS) development expense (PCS is a new
generation of wireless services), wages and commissions resulting from higher
sales, and costs associated with the acquisition of Com Tech Technical Services
late in 1996. The 1995 increase was principally attributable to an increase in
the direct costs associated with providing the long distance calling service,
DELD, which began in June 1994, and an increase in sales commissions resulting
from an increase in sales. Also contributing to the 1995 increase were expenses
associated with the start-up of Internet access services.
Operating Income
Operating income for 1996 was $8,399,000, or $53,000 lower than 1995.
Operating income in 1995 was $8,452,000, an increase of $1,228,000 over 1994
operating income of $7,224,000.
13
Other Income (Expense)
Other income (expense) for 1996 was $1,826,000 in net expenses, a
decrease of $1,050,000 from 1995. This decrease was primarily related to a
decline of $590,000 in the equity in net loss of Monor Communications Group
(MCG) and an increase in equity in net income of three cellular partnerships of
$468,000. The 1995 increase was related to an increase in the equity in net loss
of affiliates of $1,077,000, primarily due to the equity in net loss of
$1,460,000 of MCG. MCG owns 88.7% of Monor Telephone Company (MTT), which
operates a telephone company in Hungary. Marketing owns 16.5% of MCG. The net
loss reported by MCG is directly related to the losses of MTT. These result
mainly from interest expense and foreign currency translation and exchange
losses. The foreign currency losses relate to the use by MTT of the Hungarian
forint (HUF) as the functional currency for accounting purposes. The predominant
portion of the debt of MTT is a $30 million U.S. dollar-denominated loan from
the Overseas Private Investment Corporation (OPIC). Translation losses of
$4,972,000 in 1996 and $4,950,000 in 1995 were taken to reflect the devaluation
of the HUF relative to the U.S. dollar, which was approximately 18% in 1996 and
24% in 1995. Marketing's portion of this expense was approximately $724,000 and
$650,000, respectively. See Note 5 to the Financial Statements. The MTT business
plan reflects ongoing HUF/U.S. dollar-devaluation. These losses are expected to
be countered by MTT's ability to raise rates to customers in order to repay the
OPIC loan with devalued HUFs. The telecommunications rate regulation in Hungary
permits MTT to make certain inflation adjustments based upon the Producer Price
Index (PPI) and, in fact, MTT raised rates approximately 10% in July of 1995,
25% in January of 1996, and 23% in January 1997. Therefore, management believes
the cost of foreign currency hedging is not currently warranted. The Hungarian
government has been increasingly receptive to the conversion of HUFs to U.S.
dollars, and MTT has not experienced, and does not expect to experience, any
difficulties in making the necessary currency conversions.
In 1996, compared with 1995, interest expense increased primarily as a
result of increased short-term borrowings. Management anticipates that this
trend will continue in 1997, with increased borrowing for capital expansion.
Minority Interest
The 20% minority partner's interest in The D and E Group was recorded
for the first time in 1996. See "Majority-Owned Subsidiary" in Note 5 to the
Financial Statements.
Income Taxes
The federal and state income taxes increased $501,000, or 23.1%, in
1996 and decreased $37,000, or 1.7%, in 1995. The increase in 1996 was primarily
due to the increase in pre-tax income. The decrease in 1995 was primarily due to
a decrease in the state tax rate from 11.99% in 1994 to 9.99% in 1995. The
effective tax rates were 40.1%, 38.9% and 39.9% for 1996, 1995 and 1994,
respectively.
Effects of Inflation
It is the opinion of management that the effects of inflation on
operating expenses over the past three years have been immaterial and have been
partially offset by growth in operating and other revenues. Management
anticipates that this trend will continue in 1997.
FINANCIAL CONDITION
Liquidity and Capital Resources
D&E believes that it has adequate internal and external resources
available to meet ongoing operating requirements, including network expansion
and modernization and business development. Telco implemented
14
an Employee Stock Purchase Plan in the second quarter of 1994 and a Dividend
Reinvestment Plan in the fourth quarter of 1994 to raise additional capital to
support operating requirements. D&E expects that presently foreseeable capital
requirements for its existing business will be financed primarily through
internally-generated funds and additional long-term debt. Additional short- or
long-term debt or equity financing may be needed to fund new business
development activities and to enhance D&E's capital structure within
management's guidelines. See Note 15 to the Financial Statements.
D&E's primary source of funds in 1996 and 1995 was cash generated from
operating activities. Net cash provided by operating activities was $8,061,000
in 1996 and $13,466,000 in 1995. The change resulted from a reduction of
accounts payable to Northern Telecom of $1,889,000 for equipment purchases and
an increase in receivables in the form of a short-term note from PCS One, Inc.
(PCS One) for $1,559,000 related to its merger into D&E. See Note 14 to the
Financial Statements.
As of December 31, 1996, D&E had unsecured lines of credit totaling
$13,000,000 with two domestic banks. The outstanding amounts borrowed under
these agreements at the end of the year totaled $7,140,000. D&E borrowed a net
of $1,610,000 on these lines of credit in 1996 and repaid a net of $1,270,000 in
1995. A portion of these funds, in both years, was used to invest in and provide
working capital to telephone operations in Hungary, as well as to provide
additional working capital for D&E. For example, in 1996 D&E deposited
$1,300,000 with the FCC to participate in the FCC's Auction of the D, E, and F
blocks of the PCS spectrum, the bands on which a new generation of wireless
communication service will be offered. Previously, in 1995, $2,000,000 was
invested in The D and E Group, a partnership formed for the purpose of
participating in the FCC's auction of the C Block of broadband PCS spectrum.
Maturities of long-term debt over the next five years are $1,220,000
for 1997, $1,063,000 annually 1998 through 2000, and $973,000 in 2001. D&E
believes it will have adequate resources to meet these obligations as they
become payable.
As a result of the restructuring associated with the D&E Share
Exchange, Telco negotiated amendments, effective June 7, 1996, to the financial
covenants stipulated in each of its three Senior Note Agreements. Prior to such
restructuring, the covenants contained in these notes were calculated based upon
consolidated Telco financial data, which included Red Rose and Marketing. In
connection with such restructuring, Telco transferred all capital stock of these
subsidiaries to D&E. The amendments changed the limit on accumulated
distributions and restricted investments from $9,000,000 plus 75% of accumulated
consolidated net income of Telco, to $5,000,000 plus 75% of accumulated
consolidated net income of Telco. The distributions, restricted investments and
consolidated net income are cumulative since June 30, 1991. These Senior Note
agreements of Telco are guaranteed by D&E.
D&E's most significant investing activities were additions to property,
plant and equipment. D&E invested $6,349,000 in 1996, compared to $7,864,000 in
1995, for additions to property, plant and equipment. Capital investment
decreased $1,516,000, or 19.3%, in 1996 and increased $387,000, or 5.2%, in
1995. During 1996, D&E invested $2,309,000 in digital electronic switching
equipment, $2,054,000 in poles and cable, $887,000 in general purpose computers
and software, and $286,000 in remote digital circuit equipment. Management
anticipates there will be approximately $15 million of capital expenditures in
1997 with the increase primarily related to the implementation of a PCS network.
Funds for these expenditures will come from internally-generated sources, from
D&E's revolving lines of credit and, for PCS development, from additional debt
financing negotiated subsequent to December 31, 1996. Under the anticipated
additional debt financing, two local banks together will lend up to a total of
$10,000,000 at the prime interest rate or at alternative LIBOR rates. See Note
15 to the Financial Statements.
Another of D&E's significant investing activities includes Marketing's
advances to MCG and MTT, net of receipts on those advances. Marketing received
$1,606,000 from MTT in 1996 for advances to MTT. Marketing invested $1,507,000
in MCG in 1996. Marketing anticipates that the amount it costs to provide MTT
with technical expertise will be repaid by MTT on a regular basis.
15
In March 1995, Marketing acquired common stock of MCG by forgiving
$633,000 of its accounts receivable from MCG.
D&E's ratio of total debt to total debt plus capital declined to 46.3%
at December 31, 1996, compared to 47.0% at December 31, 1995.
For further information regarding the interest rates on the unsecured
lines of credit and the long-term debt, and for current maturities of long-term
debt during the next five years, see Note 7 to the Financial Statements.
OTHER
On February 2, 1995, Telco and the other investors in MCG entered into
a Project Completion Agreement with OPIC as a condition to OPIC's Finance
Agreement with MTT. The Finance Agreement provides a credit facility to MTT in
an amount up to $30,000,000. The Project Completion Agreement provides that
Telco will guarantee payments to MTT or MCG in an amount determined by OPIC, not
to exceed $3,333,000, if, in the opinion of OPIC, MTT has insufficient funds to
achieve project completion or to meet its obligations as they become due and
payable. Progress is continuing to be made toward Project Completion which is
defined to include certain physical completion tests and legal conditions of the
facilities that MTT procures, constructs and installs and certain operational
completion tests. The operations completion tests include MTT reaching a
stipulated number of subscribers and reaching a certain dollar level of
revenues.
On November 4, 1996, D&E acquired substantially all of the assets and
liabilities of Com Tech Technical Services, a computer hardware and software
reseller specializing in Local Area Network installation and maintenance, for
$580,000, consisting of 22,536 D&E common shares. On November 4, 1996, 1,128 of
such D&E common shares were delivered, and the remaining 21,408 were delivered
on January 6, 1997. All such shares are unregistered, although certain
registration rights were granted to the holders thereof.
During December 1996, D&E recorded an expense of $354,000 for the costs
of an early retirement program. Annual labor savings of $366,000 are anticipated
as a result of implementing this program.
During 1997, D&E entered into commitments with an equipment
manufacturer to purchase up to $8 million of equipment for the PCS switch and
network facilities.
D&E is negotiating a $10 million financing arrangement with two local
banks to obtain additional funds for the development and construction of the PCS
network. Terms of the agreements are being negotiated and final approval is
expected by April 1997.
D&E expects to establish a $3 million line of credit with a local bank.
D&E anticipates that this line of credit will be available for additional
general business use.
In March 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share."
This Statement establishes standards for computing and presenting earnings per
share (EPS) and applies to entities with publicly held common stock or potential
common stock. This Statement is effective for financial statements issued for
periods ending after December 15, 1997. Earlier application is not permitted.
This Statement requires restatement of all prior-period EPS data presented. D&E
is currently evaluating the impact, if any, adoption of SFAS No. 128 will have
on its financial statements.
16
FORWARD-LOOKING STATEMENTS
This annual report contains certain forward-looking statements as to
the future performance of D&E and its various domestic and international
investments, the effects of inflation and long-term contracts, including the
Lancaster County 911 system, MCG, MTT, The D and E Group, and PCS One, Inc.
Actual results may differ as a result of factors over which D&E has no control,
including, but not limited to regulatory changes and factors, uncertainties and
economic fluctuations in the domestic and foreign markets in which the companies
compete, foreign currency risks and increased competition in domestic markets
due in large part to continued deregulation of the telecommunications industry.
Item 8. Financial Statements and Supplementary Data.
Information called for by this Item is set forth on pages F-1 through
F-14. See Index to Financial Statements.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
There were no changes in or disagreements with accountants on
accounting and financial disclosure.
17
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required under this Item is incorporated by reference
from the material captioned "Management and Directors" in D&E's definitive proxy
statement to be filed.
Item 11. Executive Compensation.
The information required under this Item is incorporated by reference
from the material captioned "Executive Compensation" in D&E's definitive proxy
statement to be filed.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required under this Item is incorporated by reference
from the material captioned "Security Ownership of Certain Beneficial Owners and
Management" in D&E's definitive proxy statement to be filed.
Item 13. Certain Relationships and Related Transactions.
The information required under this Item is incorporated by reference
from the material captioned "Certain Relationships and Related Transactions" in
D&E's definitive proxy statement to be filed.
18
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are filed as a part of this Annual Report
on Form 10-K in the following manner:
(1) The consolidated financial statements of the Company and its
subsidiaries filed as part of this report are listed in the attached Index to
Financial Statements.
(2) All schedules are omitted since the required information is
not present or is not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements.
(3) The exhibits filed as part of this Report are listed in the
Index to Exhibits.
(b) There have been no current reports on Form 8-K filed by the
Registrant during the last quarter of 1996.
(c) Exhibits. See Index to Exhibits.
(d) Financial statement schedules of subsidiaries not consolidated and
50% or less owned. The information called for by this Item 14 (d) is set forth
on pages F - 15 through F - 29. See Index to Financial Statements.
19
INDEX TO EXHIBITS
Exhibit Identification
No. of Exhibit Reference
- ------- -------------- ---------
2. Plan of acquisition, reorganization, arrangement,
liquidation or succession:
2.1 Agreement and Plan of Exchange Incorporated herein by reference from
Between Denver and Ephrata Telephone and Exhibit 2.1 to Amendment No. 2 to the
Telegraph Company (a Pennsylvania Registration Statement on Form S-4
corporation) and D & E Communications, Inc. Registration No. 333-2960) filed by
(a Pennsylvania corporation). D&E on April 23, 1996.
2.2 Agreement and Plan of Merger, as amended, Incorporated herein by reference from
between D & E Communications, Inc. Exhibit B to Amendment No. 1 to the
(a Pennsylvania corporation) and PCS One, Inc. Registration Statement on Form S-4
(a New Jersey corporation). (Registration No. 333-18659) filed by
D&E on January 21, 1997.
2.3 Amendment No. 1 to the Agreement and Plan of Incorporated herein by reference from
Merger between D & E Communications, Inc, Exhibit C to Amendment No. 1 to the
(a Pennsylvania corporation) and PCS One, Inc. Registration Statement on Form S-4
(a New Jersey corporation). (Registration No. 333-18659) filed by
D&E on January 21, 1997.
3. Articles of Incorporation and By-laws:
3.1 Amended and Restated Articles of Incorporated herein by reference from
Incorporation Exhibit A to D&E's definitive proxy
statement for its 1997 Annual Meeting
of Shareholders to be filed.
3.2 By-Laws Incorporated herein by reference from
Exhibit 3.2 to D&E's Registration
Statement on Form 10.
4. Instruments defining the rights of security holders,
including debentures:
4.1 Form of D&E Common Stock Certificate, Filed herewith.
par value $0.16 per share.
4.2 Note Agreement between Allstate Life Incorporated herein by reference from
Company, Allstate Life Insurance Company Exhibit 4.1 to D&E's Registration
of New York, and Denver and Ephrata Telephone and Statement on Form 10.
Telegraph Company, dated as of November 15, 1991,
Re: $10,000,000 9.18% Senior Notes due November
15, 2021.
4.3 First Amendment to Note Agreement dated as of Incorporated herein by reference from
November 15,1991 between Allstate Life Insurance Exhibit 4.2 to D&E's 1993 Annual
Company, Allstate Life Insurance Company of Report on Form 10-K.
20
Exhibit Identification
No. of Exhibit Reference
- ------- -------------- ---------
New York, and Denver and Ephrata Telephone and
Telegraph Company, dated as of January 14, 1994,
due November 15, 2021, Re: $10,000,000 9.18%
Senior Notes due November 15, 2021.
4.4 Note Agreement between Allstate Life Insurance Incorporated herein by reference from
Company and Denver and Ephrata Telephone and Exhibit 4.3 to D&E's 1993 Annual
Telegraph Company, dated as of January 14, 1994, Report on Form 10-K.
Re: $10,000,000 6.49% Senior Notes due
January 14, 2004.
4.5 Second Amendment to Note Agreement dated Incorporated herein by reference from
as of November 15,1991 between Allstate Life Exhibit 4.3 to D&E's Registration
Insurance Company, Allstate Life Insurance Statement on Form S-3.
Company of New York, and Denver and Ephrata
Telephone and Telegraph Company, dated as of
September 27, 1994, Re: $10,000,000 9.18%
Senior Notes due November 15, 2021.
4.6 First Amendment to Note Agreement dated as of Incorporated herein by reference from
January 14, 1994 between Allstate Life Insurance Exhibit 4.5 to D&E's Registration
Company and Denver and Ephrata Telephone and Statement on Form S-3.
Telegraph Company, dated as of September 27, 1994,
Re: $10,000,000 6.49% Senior Notes due
January 14, 2004.
4.7 Second Amendment to Note Agreement dated as of Incorporated herein by reference from
January 14, 1994 between Allstate Life Insurance Exhibit 4.6 to D&E's 1995 Annual
Company and Denver and Ephrata Telephone and Report on Form 10-K.
Telegraph Company, dated as of September 1, 1995,
Re: $10,000,000 6.49% Senior Notes due
January 14, 2004.
4.8 Third Amendment to Note Agreement dated Incorporated herein by reference from
as of November 15,1991 between Allstate Life Exhibit 4.7 to D&E's 1995 Annual
Insurance Company, Allstate Life Insurance Report on Form 10-K.
Company of New York, and Denver and Ephrata
Telephone and Telegraph Company, dated as of
September 1, 1995, Re: $10,000,000 9.18%
Senior Notes due November 15, 2021.
4.9 Fourth Amendment, Consent and Waiver of Note Incorporated herein by reference from
Agreement dated as of November 15, 1991 between Exhibit 4.1 to D&E's Quarterly
Allstate Life Insurance Company, Allstate Life Report on Form 10-Q for the quarterly
Insurance Company of New York and Denver and period ended June 30, 1996.
Ephrata Telephone and Telegraph Company dated as
of June 7, 1996, RE: $10,000,000 9.18% Senior
Notes due November 15, 2021.
21
Exhibit Identification
No. of Exhibit Reference
- ------- -------------- ---------
4.10 Third Amendment, Consent and Waiver to Note Incorporated herein by reference from
Agreement dated as of January 14, 1994 between Exhibit 4.2 to D&E's Quarterly
Allstate Life Insurance Company and Denver and Report on Form 10-Q for the quarterly
Ephrata Telephone and Telegraph Company dated as period ended June 30, 1996.
of June 7, 1996, RE: $10,000,000 6.49% Senior
Notes due January 14, 2004.
None of the other long-term debt of D&E and its
consolidated subsidiaries exceeds 10 percent of the
total assets of D&E and its subsidiaries on a
consolidated basis. The Company will furnish a copy
of the instrument relating to any such long-term debt
to the Commission upon request.
9. Voting Trust Agreement.
9.1 Voting Trust Agreement Among Shareholders Incorporated herein by reference from
of Denver and Ephrata Telephone and Telegraph Exhibit 9.1 to D&E's 1995 Report
Company and Kay William Shober, Anne Brossman on Form 10-K.
Sweigart, W. Garth Sprecher, Ronald E. Frisbie and
John Amos as Voting Trustees, dated as of
November 19, 1992. ("Voting Trust Agreement")
9.2 Amendment to the Voting Trust Agreement Incorporated herein by reference from
dated as of December 31, 1995. Exhibit 9.2 to D&E's 1995 Annual
Report on Form 10-K.
10. Material Contracts
10.1 Denver and Ephrata Telephone and Telegraph Company Filed herewith.
Executive Incentive Plan as revised January 1997.
10.2 AT&T Communications Standard Agreement for Incorporated herein by reference from
the Provision of Telecommunications Services and Exhibit 10.2 to D&E's Registration
Facilities between AT&T Communications of Statement on Form 10.
Pennsylvania, Inc. and Denver and Ephrata Telephone
and Telegraph Company;
Article 1 General Provisions, effective
May 25, 1984;
Article 8-2 Billing and Collection Services
effective April 1, 1992;
10.3 Telecommunications Services and Facilities Incorporated herein by reference from
Agreement between the Bell Telephone Company of Exhibit 10.3 to D&E's Registration
Pennsylvania and Denver and Ephrata Telephone and Statement on Form 10.
Telegraph Company, effective January 1, 1986; and
Amendment to Telecommunications Services and
22
Exhibit Identification
No. of Exhibit Reference
- ------- -------------- ---------
Facilities Agreement and the IntraLATA Compensation
Agreement, dated May 7, 1992;
Appendix 1 IntraLATA Telecommunications
Services, effective January 1, 1986;
Appendix 2 Ancillary Services, effective
January 1, 1986;
Appendix 5 Jointly Provided Feature Group A
Compensation effective July 24, 1986;
and
Appendix 7 Extended Area Service, effective
October 1, 1988.
10.4 IntraLATA Compensation Agreement between Incorporated herein by reference from
the Pennsylvania Non-Bell Telephone Companies and Exhibit 10.4 to D&E's Registration
Denver and Ephrata Telephone and Telegraph Statement on Form 10.
Company, effective January 1, 1986; and Amendment to
Telecommunications Services and Facilities Agreement
and the IntraLATA Compensation Agreement,
dated May 7, 1992.
10.5 Agreement between Donnelley Directory, Incorporated herein by reference from
a division of The Reuben H. Donnelley Corporation Exhibit 10.5 to D&E's Registration
Statement and Denver and Ephrata Telephone and Telegraph Statement on Form 10.
Company, dated April 19, 1991. Portions of this
exhibit have been omitted pursuant to a request
for confidential treatment and have been separately
filed with the Commission.
10.6 Agreement for the Distribution of Interstate Incorporated herein by reference from
Access Revenues between the National Exchange Exhibit 10.6 to D&E's Registration
Carrier Association, Inc. and Denver and Ephrata Statement on Form 10.
Telephone and Telegraph Company,
effective May 25, 1984.
10.7 Agreement for the Provision of Enhanced Incorporated herein by reference from
9-1-1 Services between the County of Exhibit 10.1 to D&E's Quarterly
Lancaster and Denver and Ephrata Report on Form 10-Q for the
Telephone and Telegraph Company, quarterly period ended June 30, 1994.
effective upon approval of the
Pennsylvania Public Utility Commission
which occurred May 18, 1994
Attachment #1 Request for Proposal
as Amended;
Attachment #2 Best and Final Offer,
April 28, 1994;
Attachment #3 Clarifications to RFP;
Attachment #4 Lancaster County
Resolution #74, September 22, 1993;
Attachment #5 Lancaster County
Resolution #32, May 5, 1994;
23
Exhibit Identification
No. of Exhibit Reference
- ------- -------------- ---------
Attachment #6 Addenda, Errata,
Bulletins to Contract Documents;
Attachment #7 Facility Lease; and
Attachment #8 Tariffed Local Exchange
Carrier Services.
10.8 Amendment 1 to Exhibit A of Appendix Incorporated herein by reference from
1 of the Telecommunications Services Exhibit 10.2 to D&E 's Quarterly
and Facilities Agreement signed Report on Form 10-Q for the quarterly
June 23, 1994. period ended September 30, 1994.
10.9 Modification to the Agreement for the Provision Incorporated herein by reference from
of Enhanced 9-1-1 Services between the County of Exhibit 10.9 to D&E's 1994 Annual
Lancaster and Denver and Ephrata Telephone and Report on Form 10-K.
Telegraph Company, February 23, 1995.
10.10 Affiliated Interest Agreement between Denver Incorporated herein by reference from
and Ephrata Telephone and Telegraph Company Exhibit 10.10 to D&E's 1995 Annual
and D & E Marketing Corp. Report on Form 10-K.
10.11 Affiliated Interest Agreement between Denver Incorporated herein by reference from
and Ephrata Telephone and Telegraph Company Exhibit 10.11 to D&E's 1995 Annual
and Red Rose Systems, Inc. Report on Form 10-K.
10.12 Joint Venture Agreement for Lancaster Area Incorporated herein by reference from
Cellular Enterprises (LACE). Exhibit 10.12 to D&E's 1995 Annual
Report on Form 10-K.*
10.13 Sales Agreement between Denver and Incorporated herein by reference from
Ephrata Telephone and Telegraph Exhibit 10.13 to D&E's 1995 Annual
Company and Northern Telecom Inc. Report on Form 10-K.*
10.14 Project Completion Agreement among Incorporated herein by reference from
Monor Communications Group Inc., Exhibit 10.14 to D&E's 1995 Annual
Denver and Ephrata Telephone Report on Form 10-K.*
and Telegraph Company,
Consolidated Companies, Inc.,
United International Holdings, Inc.,
Huntel Systems, Inc., and
Overseas Private Investment Corporation
10.15 Stock Pledge Agreement among Incorporated herein by reference from
D&E Marketing Corp., Exhibit 10.15 to D&E's 1995 Annual
Huntel Systems, Inc., Report on Form 10-K.
Consolidated Companies, Inc.,
UIH Hungary, Inc., and
Overseas Private Investment Corporation
24
Exhibit Identification
No. of Exhibit Reference
- ------- -------------- ---------
10.16 First Amendment to Stock Pledge Agreement Among Incorporated herein by reference from
D&E Marketing Corp., Exhibit 10.16 to D&E's 1995 Annual
Huntel Systems, Inc., Report on Form 10-K.
Consolidated Companies, Inc.,
UIH Hungary, Inc., and
Overseas Private Investment Corporation
10.17 Subordination Agreement Among Incorporated herein by reference from
Monor Telefon Tarsasag, Rt., Exhibit 10.17 to D&E's 1995 Annual
Monor Communications Group Inc., Report on Form 10-K.
MCG Management Inc.,
Denver and Ephrata Telephone
and Telegraph Company,
D&E Marketing Corp.,
Consolidated Companies, Inc.,
United International Holdings, Inc.,
UIH Hungary, Inc.,
Huntel Systems, Inc., and
Overseas Private Investment Corporation
10.18 First Amendment to Subordination Agreement Incorporated herein by reference from
among Exhibit 10.18 to D&E's 1995 Annual
Monor Telefon Tarsasag, Rt., Report on Form 10-K.
Monor Communications Group Inc.,
MCG Management Inc.,
Denver and Ephrata Telephone
and Telegraph Company,
D&E Marketing Corp.,
Consolidated Companies, Inc.,
United International Holdings, Inc.,
UIH Hungary, Inc.,
Huntel Systems, Inc., and
Overseas Private Investment Corporation
10.19 Joint Venture Agreement for Lancaster Area Incorporated herein by reference from
Cellular Enterprises, dated October 12, 1984. Exhibit 10.19 to D&E's Amendment
No. 2 to the Registration Statement on
Form S-4 (Registration No. 333-2960)
of D & E Communications, Inc.*
10.20 Network Production Purchase Agreement Incorporated herein by reference from
between Northern Telecom, Inc. and Denver Exhibit 10.1 to D&E's Quarterly
and Ephrata Telephone and Telegraph Company Report on Form 10-Q for the quarterly
dated May 3, 1996. period ended March 31, 1996.*
10.21 Affiliated Interest Agreement between D & E Filed herewith.
Communications, Inc. and Denver and Ephrata
Telephone and Telegraph Company and Red
Rose Communications, Inc.
25
Exhibit Identification
No. of Exhibit Reference
- ------- -------------- ---------
10.22 D & E Shareholder Agreement, Exhibit D to the Incorporated herein by reference from
Agreement and Plan of Merger by and between Exhibit B to Amendment No. 1 to the
D & E Communications, Inc. and PCS One, Inc. Registration Statement on Form S-4
(Registration No. 333-18659) filed by
D&E on January 21, 1997.
10.23 D & E Communications, Inc. Filed herewith.
Officer Incentive Plan
21. Subsidiaries of the Registrant
21.1 List of all subsidiaries of D&E. Filed herewith.
27. Financial Data Schedule.
27.1 Financial Data Schedule. Filed herewith.
- -------------------------
*Confidential treatment received with respect to portions thereof.
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned in the capacities designated and on the dates
indicated, thereunto duly authorized.
D & E Communications, Inc.
Date March 31, 1997 By /s/ Anne B. Sweigart
-------------- ------------------------
Anne B. Sweigart
President, Chairman of the Board, and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date March 31, 1997 By /s/ Anne B. Sweigart
-------------- ------------------------
Anne B. Sweigart
President, Chairman of the Board, and Chief
Executive Officer
Date March 31, 1997 By /s/ Robert M. Lauman
-------------- ------------------------
Robert M. Lauman
Executive Vice President and
Chief Operating Officer
Member of the Board of Directors
Date March 31, 1997 By /s/ Thomas E. Morell
-------------- ------------------------
Thomas E. Morell
Vice President, Chief Financial Officer
and Treasurer
Date March 31, 1997 By /s/ Linda L. Hall
-------------- ---------------------
Linda L. Hall
Controller
Date March 31, 1997 By /s/ Paul W. Brubaker
-------------- ------------------------
Paul W. Brubaker
Member of the Board of Directors
Date March 31, 1997 By /s/ G. William Ruhl
-------------- -----------------------
G. William Ruhl
Senior Vice President, Member of
the Board of Directors
Date March 31, 1997 By /s/ W. Garth Sprecher
-------------- -------------------------
W. Garth Sprecher
Vice President and Secretary,
Member of the Board of Directors
INDEX TO FINANCIAL STATEMENTS
Page
Item 8 D & E Communications, Inc.
and Subsidiaries.
Report of Independent Accountants. F - 1
Consolidated Statements of
Income for the years ended
December 31, 1996, 1995 and 1994. F - 2
Consolidated Balance Sheets
as of December 31, 1996 and 1995. F - 3
Consolidated Statements of
Cash Flows for the years ended
December 31, 1996, 1995 and 1994. F - 4
Consolidated Statements of
Shareholders' Equity for the years ended
December 31, 1996, 1995 and 1994. F - 5
Notes to Consolidated Financial Statements. F - 6
Item 14 (d) Monor Communications Group, Inc
and Subsidiaries.
Report of Independent Accountants F - 15
Consolidated Balance Sheets
as of December 31, 1996 and 1995. F - 16
Consolidated Statements of Loss for the years
ended December 31, 1996 and 1995. F - 18
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 1996 and 199 F - 19
Consolidated Statements of Cash Flows
for the years ended December 31, 1996 and 1995. F - 20
Notes to Consolidated Financial Statements. F - 21
Report of Independent Accountants
To the Board of Directors and Shareholders
D & E Communications, Inc.
Ephrata, Pennsylvania
We have audited the accompanying consolidated balance sheets of D & E
Communications, Inc. as of December 31, 1996 and 1995, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of D & E
Communications, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 7, 1997
F-1
D & E Communications, Inc. and Subsidiaries
Consolidated Statements of Income
For the years ended December 31, 1996, 1995 and 1994
OPERATING REVENUES 1996 1995 1994
---- ---- ----
Local network services............................................ $ 8,654,554 $ 8,320,747 $ 7,886,123
Network access services........................................... 15,842,753 15,309,336 14,666,061
Long distance network services.................................... 4,182,000 4,024,374 4,249,355
Directory advertising............................................. 2,939,846 2,670,357 2,147,376
Sales & services.................................................. 10,934,642 8,665,579 5,876,124
Other............................................................. 1,842,581 1,917,095 1,952,092
------------ ------------ -----------
Total operating revenues...................................... 44,396,376 40,907,488 36,777,131
------------ ------------ -----------
OPERATING EXPENSES
Network operations................................................ 6,034,923 5,866,851 6,192,068
Network access.................................................... 1,830,638 1,865,086 1,921,560
Depreciation...................................................... 7,258,260 6,768,751 6,325,056
Customer services................................................. 1,707,967 1,696,501 1,565,516
Financial and administrative services............................. 5,397,382 4,661,522 4,096,232
Directory advertising............................................. 1,837,574 1,684,751 1,408,934
Operating taxes, other than income................................ 1,486,918 1,443,491 1,373,302
Costs of products sold............................................ 4,995,773 3,667,082 2,671,590
Other............................................................. 5,448,153 4,801,868 3,999,255
------------ ------------ -----------
Total operating expenses...................................... 35,997,588 32,455,903 29,553,513
------------ ------------ -----------
Operating income......................................... 8,398,788 8,451,585 7,223,618
------------ ------------ -----------
OTHER INCOME (EXPENSE)
Allowance for funds used during construction...................... 75,696 26,882 --
Equity in net income (loss) of affiliates......................... 754,505 ( 441,088) 636,197
Interest expense.................................................. ( 2,590,564) ( 2,451,325) ( 2,421,084)
Other, net........................................................ ( 65,235) ( 9,903) 81,009
------------ ------------ -----------
Total other income (expense).................................. ( 1,825,598) ( 2,875,434) ( 1,703,878)
------------ ------------ -----------
Income before minority interest, income taxes
and dividends on utility series preferred stock......... 6,573,190 5,576,151 5,519,740
MINORITY INTEREST ..................................................... 74,586 -- --
------------ ------------ -----------
Income before income taxes and dividends
on utility series preferred stock...................... 6,647,776 5,576,151 5,519,740
INCOME TAXES AND DIVIDENDS ON
UTILITY SERIES PREFERRED STOCK
Income taxes ..................................................... 2,667,337 2,166,447 2,203,194
Dividends on utility series preferred stock....................... 70,473 66,264 72,142
------------ ------------ -----------
Total income taxes and dividends on
utility series preferred stock.............................. 2,737,810 2,232,711 2,275,336
------------ ------------ -----------
NET INCOME ......................................................... $ 3,909,966 $ 3,343,440 $ 3,244,404
============ ============ ============
Average common shares outstanding................................. 5,728,067 5,708,292 5,689,293
Earnings per common share......................................... $ 0.68 $ 0.59 $ 0.57
============ ============ ============
Dividends per common share........................................ $ 0.39 $ 0.36 $ 0.35
============ ============ ============
See notes to consolidated financial statements.
F-2
D & E Communications, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 1996 and 1995
ASSETS 1996 1995
---- ----
CURRENT ASSETS
Cash and cash equivalents.................................................... $ 312,125 $ 50,911
Accounts receivable and notes receivable..................................... 8,454,775 6,151,686
Accounts receivable and note receivable-- affiliated companies............... 1,028,780 833,064
Inventories, lower of cost or market, at average cost........................ 1,009,904 778,330
Prepaid expenses............................................................. 2,406,465 2,226,614
Other........................................................................ 1,393,336 266,964
------------- --------------
TOTAL CURRENT ASSETS..................................................... 14,605,385 10,307,569
------------- --------------
INVESTMENTS
Investments in affiliated companies.......................................... 9,580,320 8,193,201
Other........................................................................ 327,403 2,920,721
------------- --------------
9,907,723 11,113,922
------------- --------------
PROPERTY, PLANT AND EQUIPMENT
Telephone plant in service................................................... 110,961,586 106,214,967
Under construction........................................................... 1,233,340 1,460,604
------------- --------------
112,194,926 107,675,571
Less accumulated depreciation................................................ 47,207,238 41,410,562
------------- --------------
64,987,688 66,265,009
------------- --------------
OTHER ASSETS
Unamortized software costs................................................... 126,825 253,653
Accounts receivable-- affiliated company..................................... 101,342 119,664
Other........................................................................ 1,826,978 461,464
------------- --------------
2,055,145 834,781
------------- --------------
TOTAL ASSETS ....................................................................... $ 91,555,941 $ 88,521,281
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable................................................................ $ 7,140,000 $ 5,530,000
Long-term debt maturing within one year...................................... 1,220,158 365,612
Accounts payable............................................................. 6,499,496 6,990,399
Accounts payable-- affiliated companies...................................... 196,941 7,233
Accrued taxes................................................................ 493,546 264,034
Accrued interest and dividends............................................... 468,780 464,385
Advance billings, customer deposits and other................................ 2,842,432 3,429,718
------------- --------------
TOTAL CURRENT LIABILITIES................................................ 18,861,353 17,051,381
------------- --------------
LONG-TERM DEBT ..................................................................... 24,888,193 26,137,463
------------- --------------
OTHER LIABILITIES
Deferred income taxes........................................................ 6,545,013 6,673,234
Regulatory liability, net.................................................... 778,783 915,671
Accrued retirement benefits.................................................. 1,565,438 878,794
Other........................................................................ 108,835 267,702
------------- --------------
8,998,069 8,735,401
------------- --------------
MINORITY INTEREST .................................................................. 229,973 500,000
------------- --------------
PREFERRED STOCK OF UTILITY SUBSIDIARY par value $100, cumulative, callable at
par, at the option of the Company,
authorized 20,000 shares, outstanding:
Series A 4 1/2%, 14,456 shares ................................... 1,445,600 1,445,600
------------- --------------
COMMITMENTS
SHAREHOLDERS' EQUITY
Common stock, par value $.16, authorized shares, 30,000,000.................. 918,508 914,812
Outstanding shares, 5,740,674 at December 31, 1996
5,717,577 at December 31, 1995
Additional paid-in capital................................................... 2,020,656 1,505,688
Unearned ESOP compensation................................................... ( 950,740) ( 1,196,774)
Retained earnings............................................................ 35,144,329 33,427,710
------------- --------------
37,132,753 34,651,436
------------- --------------
TOTAL LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY ...................... $ 91,555,941 $ 88,521,281
============= ==============
See notes to consolidated financial statements.
F-3
D & E Communications, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the years ended December 31, 1996, 1995 and 1994
1996 1995 1994
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income........................................................ $ 3,909,966 $ 3,343,440 $ 3,244,404
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................................. 7,743,264 7,295,742 6,746,811
Deferred income taxes......................................... ( 265,109) ( 349,555) 1,057,255
Undistributed (earnings) losses of affiliates................. ( 754,505) 441,088 ( 636,197)
Distribution from affiliates.................................. 1,051,650 460,000 222,820
Tax benefits applicable to ESOP............................... 21,678 24,359 27,767
Loss on retirement of property, plant and equipment........... 36,837 23,750 46,228
Allowance for funds used during construction.................. ( 75,696) ( 26,882) --
Losses applicable to minority interest........................ ( 74,586) -- --
Changes in operating assets and liabilities:
Accounts receivable and notes receivable...................... ( 2,206,225) ( 266,148) ( 1,578,245)
Inventories................................................... ( 141,490) ( 149,271) ( 194,831)
Prepaid expenses.............................................. ( 179,851) ( 48,094) 305,582
Accounts payable.............................................. ( 1,013,406) 1,928,909 ( 2,148,707)
Accrued taxes and accrued interest............................ 233,907 119,528 315,346
Advance billings, customer deposits and other................. ( 608,883) 838,966 398,843
Other, net.................................................... 383,595 ( 169,671) 269,406
------------ ------------ ------------
Net Cash Provided by Operating Activities................ 8,061,146 13,466,161 8,076,482
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures.............................................. ( 6,348,853) ( 7,864,489) ( 7,477,686)
Allowance for funds used during construction...................... 75,696 26,882 --
Proceeds from sale of assets...................................... 98,188 232,511 1,026,893
Cost of removal of plant retired.................................. ( 98,779) ( 93,821) ( 108,565)
Acquisition of other assets....................................... ( 676,057) -- --
Increase in investments and advances to affiliates................ ( 5,143,931) ( 6,869,833) ( 5,783,715)
Decrease in investments and repayments from affiliates............ 4,569,868 3,652,573 15,982
------------ ------------ ------------
Net Cash Used in Investing Activities.................... ( 7,523,868) ( 10,916,177) ( 12,327,091)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends on common stock......................................... ( 2,092,669) ( 1,977,627) ( 1,949,373)
Proceeds from long-term debt...................................... -- -- 10,000,000
Payments of long-term debt........................................ ( 162,203) ( 162,203) ( 9,562,202)
Net proceeds from (payments on)
revolving lines of credit..................................... 1,610,000 ( 1,270,000) 5,300,000
Net contributions from minority interest.......................... 1,500 500,000 --
Proceeds from issuance of common stock............................ 367,308 400,099 214,942
Redemption of Series B 5 1/2% Preferred Stock..................... -- ( 128,900) --
------------ ------------ ------------
Net Cash Provided by (Used in) Financing Activities...... ( 276,064) ( 2,638,631) 4,003,367
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS ................................................. 261,214 ( 88,647) ( 247,242)
CASH AND CASH EQUIVALENTS
BEGINNING OF YEAR ................................................ 50,911 139,558 386,800
------------ ------------ ------------
END OF YEAR ...................................................... $ 312,125 $ 50,911 $ 139,558
============ ============ ============
See notes to consolidated financial statements.
F-4
D & E Communications, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
For the years ended December 31, 1996, 1995 and 1994
Common Additional ESOP Retained
Stock Paid-in Capital Compensation Earnings
---------- --------------- ------------ -----------
Balance, January 1, 1994......................... $ 909,882 $ 776,318 ($ 1,656,195) $30,833,999
Net Income....................................... 3,244,404
Reduction of ESOP trust loan..................... 224,899
Tax benefits from dividends paid to ESOP......... 27,767
Dividends
Common stock-- $0.35 per share................ ( 1,972,182)
Common stock issued for Employee
Stock Purchase Plan and Dividend
Reinvestment Plan......................... 1,631 236,120
---------- ----------- ------------ -----------
Balance, December 31, 1994....................... 911,513 1,012,438 ( 1,431,296) 32,133,988
---------- ----------- ------------ -----------
Net Income....................................... 3,343,440
Reduction of ESOP trust loan..................... 234,522
Tax benefits from dividends paid to ESOP......... 24,359
Dividends
Common stock-- $0.36 per share................ ( 2,074,077)
Common stock issued for Employee
Stock Purchase Plan and Dividend
Reinvestment Plan......................... 3,299 493,250
---------- ----------- ------------ -----------
Balance, December 31, 1995....................... 914,812 1,505,688 ( 1,196,774) 33,427,710
---------- ----------- ------------ -----------
Net Income....................................... 3,909,966
Reduction of ESOP trust loan..................... 246,034
Tax benefits from dividends paid to ESOP......... 21,678
Dividends
Common stock-- $0.39 per share................ ( 2,215,025)
Common stock issued for acquisition.............. 180 28,854
Common stock issued for Employee
Stock Purchase Plan and Dividend
Reinvestment Plan......................... 3,516 486,114
---------- ----------- ------------ -----------
Balance, December 31, 1996....................... $ 918,508 $ 2,020,656 ($ 950,740) $35,144,329
========== =========== ============ ===========
See notes to consolidated financial statements.
F-5
Notes to Consolidated Financial Statements
1. Nature of Business:
Description:
D & E Communications, Inc. is a telecommunications holding company which
became the successor parent company to its telephone operating subsidiary,
Denver and Ephrata Telephone and Telegraph Company (Telco) in June 1996. The
accompanying consolidated financial statements include the accounts of D & E
Communications, Inc., its subsidiary companies and its majority-owned
partnership (D&E). D&E operates in one principal business segment:
Communications Services and Equipment. Through its subsidiaries, D&E provides
telecommunications services for local exchange and long distance markets and
sells related communications equipment to customers in the southcentral
Pennsylvania area. D&E also provides network access services for switching and
transporting telephone calls. Other services include computer network design,
installation and support, directory advertising, and billing and collection
services.
Regulatory Environment and Competition:
A substantial portion of D&E's operations are subject to regulation at both
the federal and state levels. On February 8, 1996, the Federal Communications
Commission (FCC) adopted The Telecommunications Act of 1996 (the 1996 Act) which
mandates significant changes to encourage competition in the local exchange
market. On August 8, 1996, the FCC issued the Interconnection Order (the Order)
establishing specific new requirements for local exchange companies to provide
interconnection as set forth in the 1996 Act. The U.S. Court of Appeals for the
Eighth Circuit has issued a temporary stay regarding certain provisions of the
Order. Hearings with respect to the issues on appeal were held in January 1997.
No rulings have been issued regarding the outcome of those hearings.
The 1996 Act and the Order provide the most comprehensive and significant
revisions to federal regulations governing telecommunications in over 60 years.
The Order allows the Pennsylvania Public Utility Commission (PUC) to enforce
compliance with the 1996 Act and the Order through state-arbitrated decisions,
if necessary. Telco qualifies as a rural telephone company and is presently
exempt from certain provisions of the 1996 Act.
With the new regulations designed to foster competition in the local
subscriber market, D&E expects to be subject to increasing competitive
pressures, while at the same time being presented with opportunities in new
markets. No estimate can be made of the financial impacts of these changes.
Concentrations of Credit Risk:
Financial instruments that subject D&E to concentrations of credit risk
consist primarily of trade receivables and notes receivable. Concentrations of
credit risk with respect to trade receivables other than AT&T are limited due to
the large number of customers in D&E's customer base. For the years ended
December 31, 1996, 1995 and 1994, revenues generated from services provided to
AT&T, primarily network access and billing and collection, were $5,192,892,
$5,412,494 and $6,325,232, respectively. At December 31, 1996 and 1995, accounts
receivable from AT&T totaled $859,142 and $873,099, respectively.
D&E believes the risk of incurring significant losses related to credit
risk is remote and any losses would not be material to the results of operations
or financial condition.
2. Significant Accounting Policies:
Principles of Consolidation:
The subsidiary companies included in the consolidated financial statements
are Denver and Ephrata Telephone and Telegraph Company (Telco); Red Rose
Communications, Inc. (Red Rose); Red Rose's majority-owned subsidiary, The D & E
Group; and D&E Marketing Corp. (Marketing). The accounts of Telco are reported
using
F-6
generally accepted accounting principles applicable to regulated entities. The
long-term debt and preferred stock represent the accounts of Telco. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Investments in partnership joint ventures and a domestic corporation are
accounted for under the equity method of accounting, due to D&E's ability to
exercise significant influence over the operating and financial policies of
these entities. Investments in other entities are accounted for under the cost
method.
Basis of Presentation:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of revenues, expenses, assets,
liabilities and the disclosure of contingencies at the date of the financial
statements and during the reporting period. Actual results could differ from
those estimates. For comparative purposes, certain amounts have been
reclassified to conform to the current-year presentation.
Revenue Recognition:
Revenues are generally recognized when services are rendered or as products
are sold to customers. Accounting for long-term contracts is determined using
the percentage-of-completion method, with revenues recognized in the proportion
that costs incurred bear to the estimated total costs at completion.
D&E receives a portion of its interstate access revenues from settlement
pools in which it participates with other telephone companies through the
National Exchange Carrier Association, Inc. (NECA). These pools were established
at the direction of the FCC and are funded by access service charges which the
FCC regulates. Revenues earned through this pooling process are initially
recognized based on estimates. D&E has settled substantially all pool
settlements through 1994. In July 1994, D&E withdrew from the traffic-sensitive
pool and now earns its interstate traffic-sensitive revenues based on its own
tariff filed with the FCC. In December 1996, D&E elected to rejoin the
traffic-sensitive pool and effective July 1, 1997, will revise its
traffic-sensitive access rates and apply the rates from the NECA interstate
access tariff.
Prepaid Directory:
Directory advertising costs are deferred and amortized to expense, and the
related advertising revenue is amortized over the twelve month period related to
the directory publication.
Depreciation:
Depreciation on property, plant and equipment is computed using the
straight-line method of depreciation over the estimated useful lives of 28 years
for buildings, 3 to 32 years for equipment, and 12 to 45 years for outside plant
facilities. Depreciation as a percentage of average depreciable plant in service
amounted to 7.1% in 1996 and 7.0% for 1995 and 1994.
When depreciable telephone property is retired, the original cost of the
asset, net of salvage, is charged to accumulated depreciation. Any gains or
losses on disposition are amortized over the service lives of the remaining
assets. When other depreciable property is retired, the gain or loss is
recognized as an element of other income. Extra-ordinary property retirements
were amortized over a ten-year period ending in 1994. The cost of maintenance
and repairs is charged to operating expense.
Cost in Excess of Net Assets Acquired:
The cost in excess of the fair value of the net assets from a business
acquisition is recorded as goodwill. Amortization expense for goodwill,
organization costs and other intangibles is recorded on a straight-line basis
over a period of 5 to 10 years.
In January 1996, D&E adopted Statement of Financial Accounting Standards
No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of." D&E reviews assets and certain intangibles
for impairment whenever events or changes in circumstances indicate that the
carrying value of the asset may not be recoverable. A determination of
impairment (if any) is made based on estimates of undiscounted future cash
flows. No costs related to asset impairment were recorded in 1996.
Capitalized Interest:
The cost of funds used to finance construction projects is capitalized as a
part of the construction costs. Additionally, capitalized interest on regulated
telephone construction projects is recorded as Allowance for Funds Used During
Construction (AFUDC), a non-cash element of
F-7
other income. Interest costs related to non-regulated construction projects are
reflected as a cost of plant and a reduction of interest expense.
Income Taxes:
D&E files a consolidated federal income tax return. Income taxes are
accounted for under the provisions of Statement of Financial Accounting Standard
No. 109, "Accounting for Income Taxes," which requires the use of the asset and
liability method of accounting for income taxes. Deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax basis of assets and liabilities and are measured using the enacted tax
rates that will be in effect when those differences are expected to reverse. A
valuation allowance is established for any deferred tax asset for which
realization is not likely.
Earnings per Common Share:
Earnings per common share (EPS) are calculated by dividing net income by
the weighted average number of common shares outstanding. Common shares
outstanding were restated for prior years to present the effects of the share
exchange, which was similar to a three-for-one stock split (see Note 10). For
comparative purposes, the historical share and per-share data have been
restated.
3. Cash Flow Information:
D&E considers all highly liquid investments purchased with a maturity of
three months or less to be cash equivalents.
Cash paid for income taxes and interest expense was:
1996 1995 1994
---- ---- ----
Interest expense......... $ 2,514,801 $ 2,424,218 $ 2,072,517
Income taxes............. 2,716,494 2,197,579 1,042,641
D&E had non-cash investing activities in November 1996 related to the
issuance of common stock for $580,000 in connection with an acquisition (see
Note 6). In March 1995, D&E acquired additional shares of Monor Communications
Group, Inc. (MCG) by forgiving $633,333 of its accounts receivable from MCG.
4. Property, Plant and Equipment:
Property, plant and equipment, which is stated at cost, is summarized as
follows at December 31:
1996 1995
---- ----
Land and buildings................ $ 29,249,284 $ 29,046,005
Digital switching equipment....... 32,716,270 30,407,658
Outside plant facilities.......... 36,974,963 35,237,978
Telecommunications equipment
for rental..................... 3,123,141 3,045,342
Computers and office equipment.... 5,599,823 5,316,737
Other equipment................... 3,298,105 3,161,247
Telephone plant under construction 1,233,340 1,460,604
------------ ------------
Total property, plant and equipment 112,194,926 107,675,571
Less: Accumulated depreciation.... 47,207,238 41,410,562
------------ ------------
Property, plant and equipment, net $ 64,987,688 $ 66,265,009
============ ============
5. Investments in Affiliated Companies:
Equity Investees:
In February 1994, the government of Hungary awarded a concession to Monor
Telephone Company (MTT), a Hungarian corporation, to provide local exchange
telecommunications services for a period of twenty-five years in the Monor
Region of Hungary. The Hungarian concession provides that MTT will have the
exclusive right to design, construct and operate this telecommunications network
for an eight-year period.
Monor Communications Group (MCG) is a domestic corporation which owns 88.7%
of MTT. D&E has a 16.5% ownership interest in MCG. The equity investment in MCG
is subject to the risks of foreign currency translation changes, which may be
included in the earnings results of MTT.
Amounts owed for services performed for MCG and MTT at December 31, 1996
and 1995, were $656,801 and $655,161, respectively. These amounts are recognized
as short-term and long-term accounts receivable. On December 31, 1996 and 1995,
short-term receivables were $555,459 and $535,497, respectively; long-term
receivables were $101,342 and $119,664, respectively.
D&E has investments in three domestic partnership joint ventures which
directly or indirectly offer cellular telecommunications services in
southcentral Pennsylvania. D&E owns 50% of Lancaster Area Cellular Enterprises
(LACE). LACE is an 18.4% limited partner in Susquehanna Cellular Communications
Limited Partnership, which provides cellular services in the Harrisburg,
Lancaster and York market areas. D&E is a 33.3% limited partner in the
Pennsylvania RSA 12 Limited Partnership,
F-8
which provides cellular services in the Lebanon market area. D&E also owns 15%
of Berks and Reading Area Cellular Enterprises (BRACE). BRACE is a 39% limited
partner in the Reading SMSA Limited Partnership, which provides cellular
services in the Reading market area.
D&E has a 50% equity investment in Red Rose SuperNet, a partnership joint
venture that offers Internet access services and related equipment.
Summarized financial information for MCG and other affiliates is presented
as follows:
MCG
1996 1995 1994
---- ---- ----
At December 31:
Current assets...... $ 5,105,912 $ 3,629,026 $10,275,970
Noncurrent assets... 60,450,620 59,672,669 39,521,130
Current liabilities 7,139,502 5,836,056 22,940,596
Noncurrent liabilities 39,014,565 37,847,796 5,639,931
Minority interest... 1,639,220 1,706,489 2,687,756
Years ended December 31:
Net sales .......... $11,731,995 $ 5,508,446 $ 346,870
Loss on foreign currency
translation...... ( 4,971,532) (4,949,528) ( 149,090)
Net loss ........... ( 5,340,495) (9,302,097) ( 1,713,648)
Other Affiliates
1996 1995 1994
---- ---- ----
At December 31:
Current assets...... $ 1,070,987 $ 639,574 $ 466,481
Noncurrent assets... 14,602,305 12,060,624 9,788,512
Current liabilities 802,258 461,436 277,926
Years ended December 31:
Net sales........... $ 5,235,810 $ 4,281,646 $ 3,205,933
Income from
joint venture.... 3,856,357 2,556,322 1,705,962
Net income ......... 4,692,108 3,256,114 2,260,959
The change in D&E's investments in MCG and in other affiliates is
summarized as follows:
MCG
1996 1995 1994
---- ---- ----
Loss................ ($ 870,481) ($ 1,460,000) ( $ 264,472)
Investments......... 1,506,667 2,343,333 2,635,417
------------ ------------- -----------
Total activity...... $ 636,186 $ 883,333 $2,370,945
============ ============= ===========
Other Affiliates
1996 1995 1994
---- ---- ----
Income.............. $ 1,624,986 $ 1,018,912 $ 900,669
Investments......... 183,320 160,409 409,793
Distributions....... ( 1,051,650) ( 460,000) ( 222,820)
------------ ------------- -----------
Total activity...... $ 756,656 $ 719,321 $ 1,087,642
============ ============= ===========
Under the terms of the Red Rose SuperNet partnership agreement, D&E will
advance funds up to a maximum amount of $550,000 to provide the partnership with
additional working capital. On December 31, 1996 and 1995, amounts advanced
under this note agreement amounted to $420,000 and $240,000, respectively.
Majority-Owned Subsidiary:
In November 1995, D&E invested $2 million for an 80% controlling
partnership interest and along with a minority interest partner established The
D and E Group partnership. The D and E Group invested $2.5 million to acquire
9.17% of PCS One, Inc. (PCS One). Formed in October 1994, PCS One is a domestic
development-stage enterprise which owns a license to provide digital wireless
communications services called Personal Communications Services (PCS) in the
Lancaster, PA, market area. In June 1996, $1.1 million of the initial investment
was returned to The D and E Group by PCS One (see Note 14). The D and E Group is
a consolidated subsidiary of D&E.
6. Acquisition:
On November 4, 1996, D&E acquired Com Tech Technical Services (Com Tech), a
domestic partnership. Com Tech specializes in computer network engineering, and
installation and maintenance services for Local and Wide Area Networks serving
customers in the Lancaster area. The acquisition was financed by 22,536 shares
of D&E common stock, payable in two installments during November 1996 and
January 1997. All of such shares are unregistered but have certain registration
rights. The
F-9
acquisition is accounted for under the purchase method of accounting. The
proforma results of Com Tech operations are not significant to the consolidated
results of operations or financial condition.
7. Notes Payable and Long-Term Debt:
Notes payable consist of amounts borrowed under lines of credit that D&E
has established with local lending institutions. D&E had lines of credit
totaling $13 million at December 31, 1996. These lines of credit are payable on
demand and provide D&E with the option to borrow at various prevailing interest
rates. At December 31, 1996 and 1995, notes payable outstanding under the lines
of credit totaled $7,140,000, with an average weighted interest rate of 6.3%,
and $5,530,000, with an average weighted interest rate of 7.0%, respectively.
Long-term debt at December 31 consisted of the following:
1996 1995
---- ----
8.95% ESOP Note due 2001......... $ 950,740 $ 1,196,774
6.49% Senior Notes due 2004...... 10,000,000 10,000,000
7.55% Senior Notes due 2007...... 5,000,000 5,000,000
9.18% Senior Notes due 2021...... 10,000,000 10,000,000
Other............................ 157,611 306,301
------------ ------------
26,108,351 26,503,075
Less current maturities.......... 1,220,158 365,612
------------ ------------
Total long-term debt............. $ 24,888,193 $ 26,137,463
============ ============
In July 1992, D&E borrowed $2,080,000 from a local bank to finance the
purchase of 240,000 shares of D&E's common stock for the Employee Stock
Ownership Plan (the ESOP Note). The loan is guaranteed by D&E as to principal
and interest. Interest is payable quarterly and principal payments of $208,000
are due annually through December 15, 2001.
In January 1994, D&E issued $10 million of 6.49% Senior Notes to an
insurance company, due on January 14, 2004. Interest is payable semi-annually
with the total principal balance due at maturity.
In February 1993, D&E issued $5 million of 7.55% Senior Notes to an
insurance company, due on November 15, 2007. Interest is payable semi-annually,
with annual principal payments of $454,545 commencing on November 15, 1997, and
continuing for eleven years.
In November 1991, D&E issued $10 million of 9.18% Senior Notes to an
insurance company, due on November 15, 2021. Interest is payable semi-annually,
with annual principal payments of $400,000 commencing on November 15, 1997, and
continuing for twenty-five years.
Under covenants contained in D&E's Senior Note Agreements, D&E must
maintain a minimum tangible net worth of at least $29.7 million. Additionally,
the covenants stipulate that the maximum amount of the consolidated funded debt
balance should not exceed 55% of the sum of consolidated funded debt plus
consolidated tangible net worth through April 1, 1997. On and after April 1,
1997, the maximum allowed percentage will decline to 50% and the definition of
consolidated funded debt will include D&E's $3.3 million guarantee of the
Overseas Private Investment Corporation (OPIC) Loan (see Note 8).
D&E is also restricted from paying dividends and making certain investments
in excess of the aggregate of $5 million plus 75% of accumulated consolidated
net income (or minus 100% of a net loss). The distributions, restricted
investments and consolidated net income are cumulative since June 30, 1991. In
addition, the debt agreements contain restrictions relating to, among other
things, mortgages and liens, sales of capital assets, and investments in fixed
assets. At December 31, 1996, and 1995, D&E was in compliance with the debt
covenants.
Based on the borrowing rate currently available to D&E for bank loans, the
fair market value of long-term debt is $30,319,932.
Maturities of long-term debt for each year ending December 31, 1997 through
2001, are as follows:
Year Aggregate Amount
---- ----------------
1997 $ 1,220,158
1998 1,062,545
1999 1,062,545
2000 1,062,545
2001 973,285
8. Commitments:
D&E had various purchase commitments at December 31, 1996, related to its
1997 construction and operating budgets.
In November 1996, D&E entered into a promissory note agreement to advance
funds to PCS One up to the maximum principal amount of $14 million, payable on
demand with an interest rate of 2% above the prime rate.
F-10
The proceeds of the loan are to be used for the purchase of the Lancaster C
Block broadband PCS license and for costs of the design, construction and
operation of the PCS network. As of December 31, 1996, the total amount advanced
under this promissory note was $1.6 million.
In November 1995, D&E entered into an agreement with a local college for
the sale and installation of telecommunications equipment and fiber optic cable
facilities for a campus-wide voice and data network. Completion of the project
is expected by the end of the third quarter of 1997.
In February 1995, D&E, along with other investors in MCG, entered into a
Project Completion Agreement with OPIC as a condition to OPIC's Finance
Agreement with MTT. The Finance Agreement provides a credit facility to MTT in
an amount up to $30 million. The Project Completion Agreement provides that D&E
will guarantee payments to MTT or MCG in an amount determined by OPIC, not to
exceed $3.3 million, if in the opinion of OPIC, MTT has insufficient funds to
achieve project completion requirements or to meet its obligations as they
become due. D&E has not made any payments pursuant to the terms of the OPIC
guarantee.
In May 1994, D&E entered into an agreement to construct, install and
maintain an enhanced 911 system for Lancaster County, PA. The ten-year agreement
was approved by the PUC and will expire in July 2004. In addition, D&E serves as
the administrator of the Automatic Location Identification (ALI) information
network, a database of Lancaster County telephone numbers, names and addresses
which help to further identify the location of a 911 caller.
9. Income Taxes:
The provision for income taxes consists of the following:
1996 1995 1994
---- ---- ----
Current:
Federal.......... $ 2,153,634 $ 1,931,681 $ 883,196
State............ 778,813 584,319 377,446
----------- ------------ -----------
2,932,447 2,516,000 1,260,642
Deferred:
Federal.......... ( 187,793) ( 248,798) 721,582
State............ ( 77,317) ( 100,755) 335,672
----------- ------------ -----------
( 265,110) ( 349,553) 1,057,254
Investment tax credits,
net.............. -- -- ( 114,702)
Total income taxes.. $ 2,667,337 $ 2,166,447 $ 2,203,194
=========== ============ ===========
The effective income tax rate on consolidated pre-tax earnings differs from
the federal income tax statutory rate for the following reasons:
1996 1995 1994
---- ---- ----
Federal statutory rate................ 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
State income taxes, net
of federal tax benefits........... 6.7 6.0 8.8
Investment tax credits............. -- -- (2.1)
Benefit of rate differential
applied totemporary differences... (1.2) (1.4) (1.4)
Accelerated depreciation........... (0.2) (0.2)
Other, net......................... 0.6 0.5 0.8
---- ---- ----
Effective income tax rate............. 40.1% 38.9% 39.9%
==== ==== ====
Approximately $1,976,000 of state net operating loss carryforwards remained
at December 31, 1996. These carryforwards are due to the operations of D&E's
subsidiaries and will expire in the years 1997 through 1999. The benefit of
these carryforwards is dependent on the taxable income of these subsidiaries
during the carryforward period. A valuation allowance has been provided because
realization is not likely. The amount of the deferred tax asset could change in
the near term if estimates of future taxable income during the carryforward
period are revised. The valuation allowance at December 31, 1996 and 1995, is
$64,382 and $95,811, respectively. During 1996, D&E's subsidiaries applied
$350,029 of net operating loss carryforwards to offset their state income tax
liability.
For D&E's regulated operations, the net regulatory liability of $778,783 at
December 31, 1996, is comprised of $1,740,153 in regulatory liabilities and
$961,370 in regulatory assets.
The significant components of the net deferred income tax liability were as
follows at December 31:
1996 1995
---- ----
Deferred tax liabilities:
Depreciation.................. $ 7,845,906 $ 7,391,628
Other, net.................... 621,235 548,357
----------- ------------
8,467,141 7,939,985
Deferred tax assets:
Employee benefits............. ( 802,814) ( 517,280)
Net operating loss carryforward ( 130,316) ( 141,769)
Equity in net loss of affiliates ( 1,053,380) ( 703,513)
------------ ------------
( 1,986,510) ( 1,362,562)
Valuation allowance.............. 64,382 95,811
----------- ------------
Deferred income taxes............ $ 6,545,013 $ 6,673,234
=========== ============
F-11
10. D&E Share Exchange and
Restructuring:
On June 7, 1996, D&E became the parent company of Denver and Ephrata
Telephone and Telegraph Company pursuant to the terms of the Agreement and Plan
of Exchange (the Plan of Exchange), whereby each of the outstanding Telco common
shares, par value $.50, was exchanged for three D&E common shares, par value
$.16, (the D&E Share Exchange). In its effect, the D&E Share Exchange was
similar to a three-for-one split of Telco common shares. As an additional aspect
of forming the new holding company structure (the Restructuring), Telco issued
D&E a dividend for all of the capital stock of Red Rose and Marketing. The
preferred stock of Telco was not exchanged in the Restructuring.
The general purpose of the Restructuring was to establish a corporate
structure more appropriate for conducting non-regulated business activities.
D&E became the successor to the agreements of Telco relating to capital
stock as a result of the D&E Share Exchange. For comparative purposes, all
information related to D&E common shares and per-share amounts for all periods
presented have been restated.
11. Shareholders' Equity:
Preferred Stock:
In September 1994, Telco's Board of Directors approved the redemption of
the 1,289 outstanding shares of Telco's Series B 5 1/2% Preferred Stock. The
redemption occurred on February 1, 1995. Each share was redeemed at its $100 par
value plus accrued dividends.
Common Stock:
D&E established the Employee Stock Purchase Plan (ESPP), effective June
1994. The ESPP provides eligible employees of D&E the opportunity to purchase
shares of D&E's common stock through payroll deductions. There are 300,000
shares of common stock reserved for issuance pursuant to the ESPP. The total
number of shares purchased pursuant to the ESPP during 1996 and 1995 was 6,523
and 6,993, respectively.
In November 1994, D&E established the Dividend Reinvestment and Stock
Purchase Plan (DRP). The DRP provides all shareholders of D&E's common stock the
opportunity to purchase additional shares of common stock by: 1) reinvesting all
cash dividends paid on their shares of common stock, 2) making optional cash
purchases of not less than $100, up to a maximum of $5,000, per quarter while
continuing to receive cash dividends, or 3) both reinvesting all cash dividends
and making such optional cash purchases. There are 300,000 shares of common
stock reserved for issuance pursuant to the DRP. The total number of shares
purchased through the DRP during 1996 and 1995 was 15,446 and 12,798,
respectively.
Shares for the ESPP and DRP may be purchased by participants at fair market
value, which is defined as the average of the high and low per-share sale price
as reported by the NASDAQ National Market on the day of the purchase. If no
shares were traded on the day of purchase, then the prices on the previous day
are used to compute the per-share price. D&E listed its stock on the NASDAQ
National Market on October 1, 1996.
At December 31, 1996 and 1995, the outstanding shares of common stock
include 3,158,106 and 3,155,961 shares, respectively, held in a voting trust,
certain trustees of which are officers of D&E.
12. Employee Benefit Plans:
Employees' Retirement Plan:
D&E's pension plan is a noncontributory defined benefit plan computed on an
actuarial basis covering all eligible employees. Pension benefits are based upon
length of service and the employee's compensation as the average of the highest
three years for the ten-year period prior to retirement. Accrued benefits are
vested after five years of participation in the plan. Assets of the pension plan
consist primarily of stocks and bonds.
Net pension expense for 1996, 1995 and 1994 included the following
components:
1996 1995 1994
---- ---- ----
Service cost - benefits earned
during the period..... $ 562,808 $ 361,312 $ 395,063
Interest cost on projected
benefit obligation.... 1,078,395 1,023,591 965,737
Actual return on assets.. (1,211,813) (2,331,128) 223,122
Net amortization and
deferral.............. 384,060 1,385,199 (1,095,512)
---------- ---------- ----------
Net periodic pension
expense............... $ 813,450 $ 438,974 $ 488,410
========== ========== ==========
F-12
The following assumptions were used for determining net periodic pension
expense:
1996 1995 1994
---- ---- ----
Discount rate.......................... 7.0% 8.5% 7.5%
Rates of increase in
compensation levels................. 4.5% 4.5% 4.5%
Expected long-term rate of
return on assets.................... 9.75% 9.75% 9.75%
The following table summarizes the pension plan's funded status and the
related amounts recognized in the Consolidated Balance Sheets at December 31:
1996 1995
---- ----
Actuarial present value of
benefit obligations:
Vested benefit obligation........ ($12,800,000) ($11,800,000)
============ ============
Accumulated benefit obligation... ($14,400,000) ($13,200,000)
============ ============
Plan assets at fair value........ $12,909,615 $11,939,913
Projected benefit obligation..... ( 16,697,922) (15,561,455)
------------ -----------
Plan assets less than projected
benefit obligation............ ( 3,788,307) ( 3,621,542)
Unrecognized net loss............ 1,781,598 2,278,294
Prior service cost............... 387,415 256,433
Unrecognized net asset........... ( 127,714) ( 191,447)
------------ -----------
Pension liability recognized in the
consolidated balance sheets... ($ 1,747,008) ($1,278,262)
============ ============
The discount rate used in determining the projected benefit obligation was
7.5% at December 31, 1996, and 7.0% at December 31, 1995.
The accrued pension liability at December 31, 1996, amounted to $1,747,008.
The current portion of the liability, $181,570, is included in Accounts Payable.
The long-term portion, $1,565,438, is reflected in Other Liabilities, recorded
as Accrued retirement benefits.
Voluntary Retirement Program:
In October 1996, D&E offered a supplemental early retirement plan to
certain eligible salaried and hourly employees. Ten employees elected to
participate in this offer effective December 31, 1996. As a result, D&E recorded
additional operating expense of $354,365, with a per-share effect of $.06,
related to the additional pension plan expense.
Employees' 401(k) Savings Plan:
D&E also has an employee savings plan available to all eligible employees
(Savings Plan). Participating employees may contribute a portion of their
compensation to the Savings Plan and D&E makes matching contributions up to a
specified level. D&E may also make discretionary profit-sharing contributions.
D&E's contribution, made in cash, amounted to $164,596 in 1996, $154,857 in 1995
and $142,856 in 1994.
Employee Stock Ownership Plan:
In July 1992, D&E established the Employee Stock Ownership Plan (ESOP)
covering all eligible employees. Unallocated shares are held in a "suspense
account" in the ESOP's trust fund until allocated to participants' accounts. D&E
makes quarterly contributions to the ESOP, which, along with the dividends on
unallocated shares, are used to repay the ESOP Note. As principal payments on
the ESOP Note are made, unallocated shares held in the suspense account are
released and allocated among the accounts of participants. Participants have a
legal right to their allocated accounts upon vesting. Dividends on shares
allocated to participants' accounts are allocated to such accounts in the form
of stock released from the suspense account.
Both unallocated and allocated shares of the ESOP are considered
outstanding for purposes of calculating the EPS. The ESOP Note is reflected as
long-term debt with a corresponding reduction in shareholders' equity for the
unearned ESOP compensation, which represents D&E's payment of future
compensation expenses. D&E's principal and interest payments on the ESOP Note,
offset by unallocated dividends, are reported as compensation and interest
expense. The common shares allocated are measured based upon the fair value of
the shares committed to be released. Dividends on the unallocated shares held by
the ESOP are charged to retained earnings.
Information related to the ESOP is summarized as follows:
1996 1995 1994
---- ---- ----
Compensation expense..... $172,667 $170,756 $169,216
Interest expense......... 88,309 104,361 119,827
Dividends on
unallocated shares..... ( 53,404) ( 60,007) ( 66,249)
D&E shares held by the ESOP are summarized as follows at December 31:
1996 1995
---- ----
Unallocated...................... 109,729 138,096
Allocated........................ 124,790 98,580
F-13
13. Postretirement Health Care Benefits:
D&E provides certain basic health care benefits to eligible individuals who
retired between the period of December 31, 1972 and July 1, 1992. Those benefits
are provided by the Employee Benefit Plan Trust, a self-insured plan, and by
individual policies from an insurance company. Additionally, an insurance
company provides specific and aggregate stop-loss coverage, the costs of which
are based on benefits paid during the year.
Effective July 1992, retiree health care benefits were discontinued for
active employees in conjunction with the establishment of the ESOP benefit plan.
As a result, the annual accruals represent the estimated cost of health care
benefits for certain eligible retired employees determined on an actuarial
basis. Those costs amounted to $93,605 in 1996, $112,174 in 1995 and $107,633 in
1994.
14. Merger:
On February 20, 1997, the shareholders of PCS One approved the Agreement
and Plan of Merger (the Merger) dated December 12, 1996, by and between the
companies, whereby PCS One will merge with and into D&E. Additionally, on
January 31, 1997, the FCC approved the transfer of the C Block broadband PCS
license for the Lancaster, PA, Basic Trading Area (the Lancaster License) from
PCS One to D&E. D&E anticipates that the Merger will occur by the end of March
1997.
Pursuant to the terms of the Merger, shares of D&E common stock will be
exchanged for all of the outstanding shares of PCS One common stock (the Share
Exchange). To consummate the Merger, D&E will issue approximately 320,000 common
shares in the Share Exchange (or $8 million before deducting PCS One's costs,
including its share of the registration costs for the D&E common stock to be
issued in connection with the Merger). The Merger will be accounted for under
the purchase method of accounting. The purchase price in excess of the
underlying fair value of the net assets acquired will be amortized over a period
of forty years.
In September 1996, PCS One was granted the Lancaster License as a result of
bidding in the FCC radio spectrum auctions. The Lancaster License is the
principal asset of PCS One. PCS One purchased the Lancaster License for $13.2
million (net after the 25% entrepreneurs' discount) and issued a ten-year note
payable to the FCC in the amount of $11.9 million. Interest of 7% is payable on
the note for the first six years; interest and principal will be made over the
remaining four years of the term of the loan. Additionally, the Lancaster
License serves as collateral for the note payable to the FCC.
15. Subsequent Events:
On January 15, 1997, D&E was the successful bidder in the FCC radio
spectrum auction for the D Block broadband PCS license for the Harrisburg, PA,
Basic Trading Area and the E Block broadband PCS license for the York, PA, Basic
Trading Area. D&E filed applications with the FCC on February 19, 1997, to
purchase the two PCS licenses for a total price of $1.5 million. In 1996, D&E
had deposited $1.3 million with the FCC, and in January 1997, the FCC returned
$992,800 of this deposit to D&E. Pending a period of reconsideration, D&E
expects to be awarded the two PCS licenses by April 1997.
D&E anticipates forming a new subsidiary in 1997 to design, construct and
provide PCS services in the three markets of Lancaster, Harrisburg and York.
During 1997, D&E entered into commitments with an equipment manufacturer to
purchase up to $8 million of equipment for the PCS switch and network
facilities.
D&E is negotiating a $10 million financing arrangement with two local banks
to obtain additional funds for the development and construction of the PCS
network. Terms of the agreements are being negotiated and final approval is
expected by April 1997. D&E also expects to establish an additional $3 million
line of credit with a local bank.
F-14
Report of Independent Accountants
To the Stockholders and Board of Directors of
Monor Communications Group, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Monor
Communications Group, Inc. and Subsidiaries as of December 31, 1995, and the
related consolidated statement of loss, shareholders' equity, and cash flows
for the year then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Monor
Communications Group, Inc. and Subsidiaries as of December 31, 1995, and the
consolidated results of their operations and their cash flows for the year then
ended in conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
- ------------------------------
Lincoln, Nebraska
March 15, 1996
F-15
MONOR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
ASSETS 1996 1995
(Unaudited)
Current assets:
Cash and cash equivalents $ 1,020,793 $ 430,955
Receivables 2,480,521 2,665,867
Inventories 57,280 323,934
Prepaid expenses 47,317 208,270
------------ ------------
Total current assets 3,605,911 3,629,026
------------ ------------
Property, plant and equipment, at cost:
Property, buildings and central plant 38,754,875 13,918,608
Office equipment 1,338,358 1,331,490
Operations equipment 11,299,655 8,327,976
Leased vehicles 731,874 851,536
Construction in progress 10,082,949 32,152,566
------------ ------------
62,207,711 56,582,176
Accumulated depreciation and amortization (4,222,161) (2,050,090)
------------ ------------
Net property, plant and equipment 57,985,550 54,532,086
------------ ------------
Other assets:
Intangible assets, net of accumulated amortization 2,465,070 3,619,015
Marketable securities 1,500,000 1,521,568
------------ ------------
Total other assets 3,965,070 5,140,583
------------ ------------
$ 65,556,531 $ 63,301,695
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-16
MONOR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, Continued
December 31, 1996 and 1995
LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995
(Unaudited)
Current liabilities:
Notes payable to bank $ 987,898 $ 655,881
Bridge loans payable to related parties 60,000 60,000
Accounts payable 1,946,343 1,443,157
Accrued liabilities 2,179,571 2,984,444
Accounts payable to related parties 1,735,032 573,410
Current installments of capital lease obligations 230,656 233,085
------------ ------------
Total current liabilities 7,139,500 5,949,977
------------ ------------
Long-term debt 30,000,000 30,000,000
Preferred notes payable to shareholders 3,850,010 3,850,010
Accrued interest payable on preferred notes 1,506,079 782,506
Capital lease obligations, less current installments 68,721 335,591
Deferred revenue 2,669,222 2,685,768
Other liabilities 920,531 80,000
------------ ------------
Total other liabilities 39,014,563 37,733,875
------------ ------------
Minority interest 1,634,274 1,706,489
------------ ------------
Commitments and contingencies (Notes 11 and 16)
Shareholders' equity:
Common stock, $.10 par value
Authorized 5,000,000 shares; Issued and outstanding:
Series A (91, 979 in 1995 and 1994) 9,198 9,198
Series B (3,338,670 in 1996 and 2,853,333 in 1995) 333,867 285,333
Additional paid-in capital 43,238,096 34,186,629
Foreign current translation adjustment (9,414,966) (5,506,410)
Unrealized gain on marketable securities, net of tax 2,716 1,772
Retained deficit (16,400,717) (11,065,168)
------------ ------------
Total shareholders' equity 17,768,194 17,911,354
------------ ------------
$ 65,556,531 $ 63,301,695
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-17
MONOR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF LOSS
for the years ended December 31, 1996 and 1995
1996 1995
(Unaudited)
Operating revenue:
Telephone service $ 10,722,115 $ 5,125,844
Other 1,009,880 382,602
------------ ------------
Total operating revenue 11,731,995 5,508,446
Operating expenses and costs:
Operating expenses 4,712,005 3,921,352
Management services - related parties 2,194,300 2,257,254
Depreciation and amortization 3,381,834 2,850,915
------------ ------------
Total operating expenses and costs 10,288,139 9,029,521
Operating income (loss) 1,443,856 (3,521,075)
Other income (expenses):
Interest income 147,739 283,704
Interest expense (1,923,263) (1,068,057)
Interest expense - related parties 0 (51,327)
Other (182,685) (518,024)
Foreign currency gain (loss) (408,726) (458,242)
Loss on foreign currency translation (4,971,532) (4,949,528)
------------ ------------
Total other expenses (7,338,467) (6,761,474)
------------ ------------
Loss before minority interest in loss of subsidiary (5,894,611) (10,282,549)
Minority interest in loss of subsidiary
Minority interest in loss of subsidiary 559,062 980,452
------------ ------------
Net loss $ (5,335,549) $ (9,302,097)
============ ============
Net loss per share $ (1.65) $ (3.71)
Weighted average shares outstanding 3,231,694 2,510,690
The accompanying notes are an integral part of the consolidated financial
statements.
F-18
MONOR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1996 and 1995
Foreign
Additional Currency Unrealized
Common Paid-In Translation Gain on
Stock Capital Adjustment Securities
-------- ------------ ------------- -----------
Balances, December 31, 1994 $ 198,198 $20,287,962 $ (189,272) $ 0
Sale of common stock Series B
at $12.50 share 80,000 9,920,000 0 0
Sale of common stock Series B
at $18.75 share 21,333 3,978,667 0 0
Change in unrealized gain on
securities, net of tax 0 0 0 1,772
Foreign currency translation
adjustment 0 0 (5,317,138) 0
Net loss 0 0 0 0
----------- ----------- ----------- -----------
Balance, December 31, 1995 294,531 34,186,629 (5,506,410) 1,772
Sale of common stock Series B
at $12.50 share 0 0 0 0
Sale of common stock Series B
at $18.75 share 48,534 9,051,467 0 0
Change in unrealized gain on
securities, net of tax 0 0 0 944
Foreign currency translation
adjustment 0 0 (3,908,556) 0
Net loss 0 0 0 0
----------- ----------- ----------- -----------
Balances, December 31, 1996 (unaudited) $ 343,065 $43,238,096 $(9,414,966) $ 2,716
=========== =========== =========== ===========
Total
Retained Shareholders
Deficit Equity
------------ -------------
Balances, December 31, 1994 $ (1,763,071) $ 18,528,817
Sale of common stock Series B
at $12.50 share 0 10,000,000
Sale of common stock Series B
at $18.75 share 0 4,000,000
Change in unrealized gain on
securities, net of tax 0 1,772
Foreign currency translation
adjustment 0 (5,317,138)
Net loss (9,302,097) (9,302,097)
------------ ------------
Balance, December 31, 1995 (11,065,168) 17,911,354
Sale of common stock Series B
at $12.50 share 0 0
Sale of common stock Series B
at $18.75 share 0 9,001,001
Change in unrealized gain on
securities, net of tax 0 944
Foreign currency translation
adjustment 0 (3,908,556)
Net loss (5,335,549) (5,335,549)
------------ ------------
Balances, December 31, 1996 (unaudited) $(16,400,717) $ 17,768,194
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-19
MONOR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1996 and 1995
1996 1995
(Unaudited)
Cash flows from operating activities:
Cash received from customers $ 17,577,200 $ 4,007,801
Cash paid to suppliers and employees (9,465,714) (4,040,200)
Miscellaneous receipts (payments) 129,581 3,938,806
Interest received 164,484 497,820
Interest paid (1,194,921) (433,907)
------------ ------------
Net cash provided by operating activities 7,210,630 3,970,320
Cash flows from investing activities:
Proceeds from sale of fixed assets 230,705 0
Capital expenditures (18,191,374) (45,488,824)
Decrease (increase) in restricted cash 0 1,147,176
(Purchase) maturities of marketable securities 23,000 (1,497,775)
Acquisition of intangible assets (27,744) (216,932)
------------ ------------
Net cash used in investing activities (17,965,413) (46,056,355)
Cash flows from financing activities:
Proceeds from issuance of long-term debt 0 30,000,000
Debt issuance costs 0 (1,075,905)
Proceeds from sale of common stock 9,100,000 14,000,000
Operating advances from (paid) with related parties 0 (4,606,091)
Sale of subsidiary stock to minority interests 244,966 0
Increase in other long-term liabilities 1,850,086 1,518,860
Payment of capital lease obligations (215,011) (163,966)
Increase (decrease) in notes payable 468,886 (437,693)
------------ ------------
Net cash provided by financing activities 11,448,927 39,235,205
Effect of exchange rate movements of cash (104,306) (442,736)
------------ ------------
Net increase in cash and cash equivalents 589,133 (3,293,566)
Cash and cash equivalents at beginning of period 430,955 3,724,521
------------ ------------
Cash and cash equivalents at end of period $ 1,020,088 $ 430,955
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-20
MONOR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
for the years ended December 31, 1996 and 1995
1996 1995
(Unaudited)
Reconciliation of net loss to net cash provided by (used in) operating
activities:
Net loss $ (5,335,549) $ (9,302,097)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization 3,461,866 2,859,915
Accretion (487) (21,021)
Unrealized loss for currency translation 4,971,532 4,949,528
Loss on sale of fixed assets 47,661 0
Allowance for doubtful accounts 22,807 180,575
Minority interest (559,062) (980,452)
Change in assets and liabilities:
Receivables (120,852) 3,025,004
Inventory 2,600,251 (251,117)
Prepaid expenses 0 (71,621)
Accounts payable and accrued liabilities 477,517 3,174,805
Deferred revenue 1,644,946 415,801
------------ ------------
Total adjustments 12,546,179 13,272,417
------------ ------------
Net cash provided by (used in) operating activities $ 7,210,630 $ 3,907,320
============ ============
Supplemental disclosure of noncash investing and financing activities:
Equipment acquired under capital leases $ 25,778 $ 303,894
The accompanying notes are an integral part of the consolidated financial
statements.
F-21
MONOR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization:
Monor Communications Group, Inc. (the Company) was organized in December 1993 as
a Limited Liability Company to act in association with two privately-held
Hungarian companies to acquire the concession to provide telecommunication
services to the Monor Region of Hungary through a Hungarian company, Monor
Telefon Tarsasag Rt. (MTT). The Company's founding members are comprised of
three companies: Consolidated Companies, Inc.; D&E Marketing Corp., a
wholly-owned subsidiary of Denver & Ephrata Telephone and Telegraph Company; and
HunTel Systems, Inc. (the founders).
In April 1994, the Company reorganized into a "C" Corporation incorporated in
Delaware. This was followed by a stock offering which broadened the ownership
base of the Company. In June 1996 the Company reincorporated as a Nebraska
corporation and reduced the number of authorized shares from 25,000,000 to
5,000,000. The principal shareholder is now United International Holdings, Inc.
(UIH) which owns 50% of the Series B Voting shares while the three founding
members own the remaining 50% in equal proportions. The Series A shareholders
have no voting rights.
MTT was founded in December 1993 and commenced small scale investment in a
telecommunications network pending decision by the Hungarian Government on a
concession. Telephone service operations began in 1994 after successfully
winning the concession to provide telecommunication services to the Monor
primary region. In 1996, MTT has begun construction of a cable television
network and is offering cable television services along with telephone service.
The Company has previously been reported on as a development stage enterprise as
there had been no significant revenue generated from the planned principal
operations prior to 1996.
Certain 1995 amounts have been reclassified to conform with the 1996
presentation.
2. Summary of Significant Accounting Policies:
Principles of Consolidation
The consolidated financial statements include the accounts of Monor
Communications Group, Inc., its wholly-owned subsidiary, MCG Management, Inc.,
and its 88.69% owned subsidiary, MTT. The minority ownership of MTT consists of
the municipalities which constitute the Monor primary area of Hungary. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
F-22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Summary of Significant Accounting Policies, Continued:
Principles of Consolidation, Continued
During 1995, the Company received permission from the Hungarian Ministry of
Telecommunications and Transportation to increase its ownership stake in MTT
from 74.25% to a maximum of 90%. The Company has a 10-year agreement allowing
them to maintain this ownership ratio, after which the Hungarian national
capital ownership must return to 25%.
MTT comprises substantially all of the assets and operations of the Company.
Foreign Currency Translation
The financial position and results of operations of MTT are measured using the
local currency, the Hungarian Forint, as the functional currency. Assets and
liabilities of this subsidiary are translated at the exchange rate in effect at
year-end. Income statement accounts are translated at the average rate of
exchange prevailing during the year. Translation adjustments arising from
differences in exchange rates from period to period are included in the
accumulated foreign currency translation adjustments account in shareholders'
equity. Foreign currency transaction gains and losses, as well as translation
adjustments for monetary assets and liabilities of MTT that are denominated in
currencies other than the Forint are recognized in the statement of net loss.
Cash and Cash Equivalents
Cash and cash equivalents include cash and highly liquid debt instruments with
an original maturity of three months or less and are carried at cost which
approximates fair value due to the short maturities.
Inventory
Inventory includes telephone merchandise held for sale. Inventories are stated
at the lower of cost or market with cost determined using average costs.
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation,
except for land which is not depreciated. Cost includes all materials and
attributable direct labor and overhead associated with preparing the asset for
use. Depreciation of plant and equipment is computed for financial reporting
purposes using the straight line method over the estimated useful lives of the
assets. Useful lives range from up to 50 years for buildings, up to 25 years for
network, up to 7 years for office furniture and equipment and up to 3 years for
leased vehicles.
F-23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Summary of Significant Accounting Policies, Continued:
Property, Plant and Equipment, Continued
Costs incurred in developing new networks, including network design, negotiation
of rights-of-way and obtaining legal/regulatory authorization costs consisting
of substantially all nondevelopment costs incurred during the preoperating phase
of a newly-constructed network for a specified region are capitalized and
depreciated over their respective useful life beginning with the start of
operations.
Maintenance, repair and rearrangement costs are expensed as incurred. All
betterments and renewals which increase the productive capacity or the economic
lives of assets are capitalized, as are costs associated with the engineering
and design of new facilities. The cost and related accumulated depreciation are
relieved from the respective accounts when assets are retired. Gain or loss
resulting from the disposal of assets is included in the statements of loss.
Intangible Assets and Amortization
Intangible assets are stated at cost less accumulated amortization and consist
principally of the concession fee, organizational and development costs,
deferred debt expenses, and software. These items are being amortized over their
expected useful lives which range from 8 years for the concession to 5 years for
the organizational costs and 3 years for the software. Deferred debt expenses
are amortized over the life of the related debt.
Income Taxes
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" which
requires the use of the liability method of computing income taxes. Deferred tax
assets have not been recognized because it is uncertain to what extent the
Company may benefit from utilization of net operating losses. The Company has
federal and state operating loss carryforwards of approximately $1,960,000 which
expire in 2009 through 2011.
MTT is currently operating under a tax holiday in Hungary which grants 100%
relief from taxes in the first 5 years to be followed by 60% relief for the
following 5 years. Therefore, no deferred taxes have been provided.
Revenue Recognition
The Company recognizes revenue in the month telecommunication services are
provided.
F-24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Summary of Significant Accounting Policies, Continued:
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the period. Actual results
could differ from those estimates.
3. Cash and Restricted Cash:
Cash includes cash on hand and cash on deposit with financial institutions of
high credit quality.
4. Marketable Securities:
Marketable securities available for sale at December 31, 1995 consisted of a
U.S. Treasury Note purchased in 1995 for $1,497,775 with a February 1996
maturity, amortized carrying cost of $1,518,796, and gross unrealized gains of
$2,772. The marketable securities are held in an escrow account at a local bank
and are designated as funds to be used in capitalizing MTT per the terms of a
long-term debt agreement with the Overseas Private Investment Corporation. In
1996, the Treasury Note matured and the funds transferred into a U.S. federated
money market fund.
5. Receivables:
Receivables consist of the following at December 31, 1996 and 1995:
1996 1995
(Unaudited)
Trade receivables $1,946,311 $1,399,403
Value added tax recoverable 0 394,656
Short-term advance 89,645 101,322
Other 616,196 948,248
---------- ----------
2,652,152 2,843,629
Allowance for doubtful accounts 171,631 177,762
---------- ----------
$2,480,521 $2,665,867
========== ==========
6. Property, Plant and Equipment:
Depreciation and amortization expense for leased assets was $233,323 and
$272,349 and for other assets $2,251,907 and $1,811,415 for the years ended
December 31, 1996 and 1995, respectively. Interest expense of $2,297,734 and
$2,513,625 was capitalized for the year ended December 31, 1996 and 1995,
respectively.
F-25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
7. Intangible Assets:
Intangible assets consisted of the following at December 31, 1996 and 1995:
1996 1995
(Unaudited)
Concession rights $ 1,234,873 $ 1,457,513
Organizational and development costs 1,535,914 1,812,831
Deferred debt expense 813,902 960,644
Property rights 1,111 1,312
Software 266,159 283,961
----------- -----------
Total intangible assets 3,851,959 4,516,261
Accumulated amortization (1,386,889) (897,246)
----------- -----------
$ 2,465,070 $ 3,619,015
=========== ===========
Amortization expense for the years ended December 31, 1996 and 1995 was $71,264
and $86,984 for software and $418,379 and $680,167 for other intangible assets,
respectively.
8. Note Payable to Bank:
Note payable to bank consists of an uncollateralized short-term line of credit
with Credit Lyonnais Bank in Hungary with an interest rate of 25.75%.
9. Bridge Loans Payable to Related Parties:
The Company had 7% bridge loans due on demand with the founders amounting to
$60,000 at December 31, 1996 and 1995.
10. Deferred Revenue:
Prior to July 20, 1995, MTT collected moneys from customers which are termed
"construction contributions". These contributions were designed to partly assist
the Company in covering its construction costs. The contributions are refundable
to the customer on a pro rata basis over five years if service is discontinued.
The contributions are being recognized consistent with the amortization policy
for the concession over eight years.
Due to a change in the Hungarian Telecommunication law effective July 20, 1995,
the subscription deposit is no longer broken into installation and construction
contributions. The Company policy is to recognize one third of the deposit as
installation revenue and defer the remainder over eight years which is
consistent with the previous accounting treatment.
F-26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
11. Capital Lease Obligations:
MTT has entered into financing leases for vehicles. These leases have three year
terms with a bargain purchase option at the end of the lease. The payment
schedule for the remaining years is as follows. The exchange rate at December
31, 1995, was used in translating the future payments.
1996 $ 303,604
1997 75,131
1998 10,740
---------
Total minimum obligations 389,475
Less amount representing interest (90,098)
---------
299,377
Current installments (230,656)
---------
Long-term portion $ 68,721
=========
12. Long-Term Debt:
In February 1995, MTT entered into an agreement with the Overseas Private
Investment Corporation for a U.S. dollar denominated $30 million loan. $22
million of the loan was received during the first quarter of 1995 and $8 million
was received during the third quarter of 1995. The loan carries an interest rate
equal to that charged by the U.S. Treasury on a security of equal maturity plus
285 basis points. At December 31, 1996, this rate approximated 10.36%. The loan
is scheduled to be repaid in 14 equal semiannual installments beginning in June
1998.
Future maturities for the next five years are as follows:
1997 $ 0
1998 4,285,714
1999 4,285,714
2000 4,285,714
2001 3,993,000
The loan may be prepaid with a prepayment premium ranging from 3% to 1% over the
first three years of the loan. The loan carries various covenants which require
MTT to maintain certain financial ratios such as working capital and debt to
equity at specified levels, restricts the payment of dividends, and limits the
amounts of management fees payable to the Company and the amount of annual rents
under leases. The loan is collateralized by all of the Series B common stock of
the Company and the stock of MTT owned by the Company.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
13. Preferred Notes Payable to Shareholders:
In conjunction with the offering of common stock in 1994, the Company issued 15%
preferred promissory notes to the purchasers. Principal and interest become due
and payable in a lump sum at the earlier of a change in control of the Company,
sale of substantially all the assets of the Company, or the closing of an
underwritten primary offering of any of the Company's securities under a Federal
Securities Act of 1933 filing. These notes otherwise shall be of perpetual
duration without right of repayment. The Company cannot prepay the notes without
the consent of the holders. The notes are senior to the Company's equity
securities but are subordinate to other indebtedness of the Company. Total
interest incurred in 1996 and 1995 was $723,573 and $604,293, respectively.
14. Capital Stock:
The Series A common stock does not have voting rights. The holders of Series A
common stock are entitled to a preference over Series B holders in the event a
liquidation occurs, and will automatically convert into Series B common stock
under certain circumstances such as an initial public offering or a sale of all
or substantially all of the Company or its assets.
The Company issued 57,960 warrants in 1994 to the underwriter of its private
placement memorandum (PPM) to purchase Series A common stock at an option price
of $12.50 per share, which is the same as the price of the PPM amount as set by
the Board of Directors. The warrants expire in 1999.
15. Related Party Transactions:
Accounts payable to related parties represents operating costs paid on behalf of
the Company by the founders. Interest expense incurred by the Company in 1995
was $51,327 for bridge loans (Note 9) and advances made by the founders.
The Company has entered into a technical assistance agreement with the founders
and UIH to provide technical and management services for both the telephone and
cable television business of MTT. MTT will pay 5% of its gross revenues to the
providers as a management fee. The total amount of management fees recognized in
1996 was $574,301 and in 1995 was $259,273.
MTT obtained management services provided by one of the founders. The total
dollar amount of these services was $ 1,619,999 and $ 1,997,981 for 1996 and
1995, respectively.
MTT purchased $180,713 in 1995 of software and computer services from a
subsidiary of one of the founders.
MTT granted a loan of $74,957 to a village, which is a minority shareholder of
MTT, in order for the village to make its equity contribution. The loan will be
repaid in 1997 and carries an interest rate equal to that of the Hungarian
National Bank.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
16. Contingencies and Commitments:
At December 31, 1996, MTT had commitments for equipment purchases and
construction contracts which amounted to approximately $1,500,000.
MTT has operating leases for offices and office equipment. Future payments under
these operating leases amount to $203,458 in 1997 and $81,278 in 1998.
As a Hungarian company, MTT must comply with local legislation regarding the
distribution of earnings. Hungarian statutory accounts prevail in the
determination of the amount of profit available for distribution to
shareholders.
In July 1995, the city of Monor filed a lawsuit against MTT over the final
payment associated with the purchase of the Monor city assets which took place
in 1994. The Company is subject to various other legal actions arising out of
the conduct of its business. Total amounts included in accrued liabilities were
approximately $154,000 at December 31, 1995. In the opinion of management of the
Company, amounts accrued in connection with these matters are adequate and
ultimate resolution of these matters will not have a material effect on the
Company's consolidated financial position, results of operations, or cash flows.
F-29