UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 000-20709
D & E Communications, Inc.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA
(State or other jurisdiction of
incorporation or organization)
I.R.S. Employer Identification Number: 23-2837108
Brossman Business Complex
124 East Main Street
Ephrata, Pennsylvania 17522
(Address of principal executive offices)
Registrant's Telephone Number: (717) 733-4101
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
(D & E Communications, Inc. is the successor registrant to Denver and Ephrata
Telephone and Telegraph Company by virtue of a share exchange effective
June 7, 1996.)
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 4, 1996
----- -------------------------------
Common Stock, par value $.16 per share 5,737,291 Shares
<PAGE>
Form 10-Q
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Item No. Page
- -------- ----
PART I. FINANCIAL INFORMATION
1. Financial Statements
Consolidated Statements of Income --
For the three months and nine months ended
September 30, 1996 and 1995 ........................ 1
Consolidated Balance Sheets --
September 30, 1996 and December 31, 1995 ........... 2
Consolidated Statements of Cash Flows --
For the three months and nine months ended
September 30, 1996 and 1995 .................. 3
Notes to Consolidated Financial Statements ........... 4-6
2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................. 7-14
PART II. OTHER INFORMATION
6. Exhibits and Reports on Form 8-K ..................... 15
SIGNATURES ........................................... 16
i
<PAGE>
Form 10-Q Part I - Financial Information
Item 1. Financial Statements
D & E Communications, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
<TABLE>
<CAPTION>
Three months Ended Nine months Ended
September 30 September 30
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
OPERATING REVENUE
Local network services ................................ $ 2,189,990 $ 2,065,747 $ 6,461,892 $ 6,131,328
Network access ........................................ 3,881,491 3,824,641 11,779,710 11,363,321
Long distance network services ........................ 1,017,651 1,021,761 3,140,650 3,004,387
Directory advertising ................................. 730,380 657,708 2,204,421 1,985,182
Other sales and services .............................. 2,587,012 2,147,718 8,474,764 5,957,744
Miscellaneous ......................................... 460,632 530,418 1,316,450 1,379,370
------------ ------------ ------------ ------------
Total Operating Revenue ............................ 10,867,156 10,247,993 33,377,887 29,821,332
------------ ------------ ------------ ------------
OPERATING EXPENSE
Network operations .................................... 1,420,467 1,542,922 4,452,206 4,462,701
Network access ........................................ 438,372 489,996 1,374,388 1,415,598
Depreciation .......................................... 1,836,981 1,701,636 5,400,192 5,041,924
Customer services ..................................... 434,829 432,071 1,289,564 1,274,640
Financial and administrative services ................. 1,289,266 1,075,193 3,777,213 3,391,606
Directory ............................................. 473,208 432,999 1,373,289 1,241,363
Operating taxes, other than income .................... 359,827 373,401 1,102,230 1,108,354
Costs of products sold ................................ 1,201,149 903,761 3,961,098 2,436,515
Other expenses ........................................ 1,343,797 1,234,859 3,879,788 3,621,243
------------ ------------ ------------ ------------
Total Operating Expense ............................ 8,797,896 8,186,838 26,609,968 23,993,944
------------ ------------ ------------ ------------
Operating Income .............................. 2,069,260 2,061,155 6,767,919 5,827,388
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE)
Allowance for funds used during construction ......... 9,517 2,663 63,595 2,663
Equity in net income (loss) of affiliates ............ 391,782 (54,818) 646,564 (70,166)
Interest expense ..................................... (660,042) (615,431) (1,946,688) (1,851,001)
Other, net ........................................... 55,703 (4,617) 54,472 13,974
------------ ------------ ------------ ------------
Total Other Income (Expense) ...................... (203,040) (672,203) (1,182,057) (1,904,530)
------------ ------------ ------------ ------------
Income before minority interest, income taxes
and dividends on utility
series preferred stock......................... 1,866,220 1,388,952 5,585,862 3,922,858
MINORITY INTEREST ....................................... 26,046 -- 33,662 --
------------ ------------ ------------ ------------
Income before income taxes and
dividends on utility series preferred stock ... 1,892,266 1,388,952 5,619,524 3,922,858
INCOME TAXES AND DIVIDENDS ON
UTILITY SERIES PREFERRED STOCK
Income taxes .......................................... 762,770 575,273 2,278,605 1,591,653
Dividends on utility series preferred stock ........... 16,263 16,263 48,789 50,001
------------ ------------ ------------ ------------
Total Income taxes and dividends
on utility series preferred stock ............... 779,033 591,536 2,327,394 1,641,654
------------ ------------ ------------ ------------
NET INCOME .............................................. $ 1,113,233 $ 797,416 $ 3,292,130 $ 2,281,204
============ ============ ============ ============
Average common shares outstanding .................... 5,730,736 5,710,887 5,724,994 5,705,937
Earnings per common share ............................ $ .19 $ .14 $ .58 $ .40
============ ============ ============ ============
Dividends per common share ........................... $ .10 $ .09 $ .29 $ .27
============ ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
1
<PAGE>
Form 10-Q Part 1 - Financial Information
Item 1. Financial Statements
D & E Communications, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1996 1995
------------- ------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents ............................................... $ 243,383 $ 50,911
Accounts receivable ..................................................... 7,332,426 6,151,686
Accounts receivable and note receivable - affiliated companies .......... 1,041,854 833,064
Inventories, lower of cost or market, at average cost ................... 888,277 778,330
Prepaid expenses ........................................................ 854,375 2,226,614
Other current assets .................................................... 1,563,581 266,964
------------ ------------
TOTAL CURRENT ASSETS ............................................. 11,923,896 10,307,569
------------ ------------
INVESTMENTS
Investments in affiliated companies ..................................... 9,806,694 8,193,201
Other ................................................................... 1,747,244 2,920,721
------------ ------------
11,553,938 11,113,922
------------ ------------
PROPERTY, PLANT AND EQUIPMENT
Telephone plant in service .............................................. 109,814,679 106,214,967
Under construction ...................................................... 444,016 1,460,604
------------ ------------
110,258,695 107,675,571
Less accumulated depreciation ........................................... 45,517,370 41,410,562
------------ ------------
64,741,325 66,265,009
------------ ------------
OTHER ASSETS
Unamortized software costs .............................................. 158,532 253,653
Accounts receivable - affiliated company ................................ 97,688 119,664
Other ................................................................... 1,042,516 461,464
------------ ------------
1,298,736 834,781
------------ ------------
TOTAL ASSETS ................................................................. $ 89,517,895 $ 88,521,281
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable ........................................................... $ 7,830,000 $ 5,530,000
Long-term debt maturing within one year ................................. 363,316 365,612
Accounts payable ........................................................ 5,407,503 6,990,399
Accounts payable - affiliated companies ................................. 255,756 7,233
Accrued taxes ........................................................... 264,152 264,034
Accrued interest and dividends .......................................... 667,774 480,648
Advance billings, customer deposits and other ........................... 1,525,803 3,429,718
------------ ------------
TOTAL CURRENT LIABILITIES ....................................... 16,314,304 17,067,644
------------ ------------
LONG-TERM DEBT ............................................................... 25,988,774 26,137,463
------------ ------------
OTHER LIABILITIES
Deferred income taxes ................................................... 6,792,230 6,673,234
Regulatory liability, net ............................................... 822,386 915,671
Accrued retirement benefits ............................................. 1,010,323 878,794
Other ................................................................... 258,616 267,702
------------ ------------
8,883,555 8,735,401
------------ ------------
MINORITY INTEREST ............................................................ 238,397 500,000
------------ ------------
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 .............. 917,406 914,812
Outstanding shares, 5,733,787 at September 30, 1996
5,717,577 at December 31, 1995
Additional paid-in capital .............................................. 1,850,893 1,505,688
Unearned ESOP compensation .............................................. (1,196,774) (1,196,774)
Retained earnings ....................................................... 35,075,740 33,411,447
------------ ------------
36,647,265 34,635,173
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................................... $ 89,517,895 $ 88,521,281
============ ============
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
Form 10-Q Part 1 - Financial Information
Item 1. Financial Statements
D & E Communications, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the nine months ended September 30, 1996 and 1995
(Unaudited)
<TABLE>
<CAPTION>
September 30, September 30,
1996 1995
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ................................................ $ 3,292,130 $ 2,281,204
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ........................... 5,752,791 5,450,956
Deferred income taxes ................................... 25,711 (215,364)
Undistributed (earnings) losses of affiliates ........... (646,564) 70,166
Distribution from affiliates ............................ 718,650 460,000
Tax benefits applicable to ESOP ......................... 16,258 18,102
Loss on retirement of property, plant and equipment ..... 14,245 38,525
Allowance for funds used during construction ............ (63,595) (2,663)
Losses applicable to minority interest .................. (33,662) --
Changes in operating assets and liabilities:
Accounts receivable ..................................... (1,180,740) 169,278
Inventories ............................................. (109,947) (137,889)
Prepaid expenses ........................................ 1,372,239 1,461,593
Accounts payable ........................................ (1,584,406) (484,417)
Accrued taxes, interest and dividends ................... 203,507 131,356
Advance billings, customer deposits and other ........... (1,903,915) (1,078,775)
Other, net .............................................. 107,498 (161,165)
----------- -----------
Net Cash Provided by Operating Activities ............. 5,980,200 8,000,907
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures ...................................... (4,185,922) (4,400,279)
Allowance for funds used during construction .............. 63,595 2,663
Proceeds from sale of assets .............................. 69,446 215,674
Cost of removal of plant retired .......................... (70,102) (85,361)
Acquisition of other assets ............................... (513,158) --
Increase in investments and advances to affiliates ........ (4,673,447) (3,943,767)
Decrease in investments and repayments from affiliates .... 2,695,122 4,220,729
----------- -----------
Net Cash Used in Investing Activities ................... (6,614,466) (3,990,341)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends on common stock ................................. (1,570,865) (1,469,640)
Payments on long-term debt ................................ (162,202) (162,203)
Net proceeds from (payments on) revolving lines of credit . 2,300,000 (2,710,000)
Contributions from minority interest ...................... 1,500 --
Proceeds from issuance of common stock .................... 258,305 328,331
Redemption of Utility Series B 5 1/2% Preferred Stock ..... -- (128,900)
----------- -----------
Net Cash Provided By (Used in) Financing Activities ..... 826,738 (4,142,412)
----------- -----------
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS .................................... 192,472 (131,846)
CASH AND CASH EQUIVALENTS
BEGINNING OF PERIOD ..................................... 50,911 139,558
----------- -----------
END OF PERIOD ........................................... $ 243,383 $ 7,712
=========== ===========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
Form 10-Q
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 1. Notes to Consolidated Financial Statements
(Unaudited)
(1) RESTRUCTURING AND SHARE EXCHANGE
On June 7, 1996, D & E Communications, Inc. (and with its subsidiaries,
"D & E") became the parent company of Denver and Ephrata Telephone and
Telegraph Company ("Telco") pursuant to the terms of that certain Agreement
and Plan of Exchange (the "Plan of Exchange"), whereby each outstanding
Common Share, $0.50 par value, of Telco (the "Telco Common Shares") was
exchanged (the "Share Exchange") for three Common Shares, $0.16 par value,
of D & E (the "D & E Common Shares"). In its effect, the Share Exchange was
similar to a three-for-one split of Telco Common Shares. As an additional
aspect of the reorganizing of Telco into a holding company structure (the
"Restructuring"), Telco dividended to D & E all of the capital stock of its
subsidiaries, Red Rose Communications, Inc. (f/k/a Red Rose Systems, Inc.,
"Red Rose") and D & E Marketing Corp. ("Marketing"). The preferred stock of
Telco was not exchanged in the Restructuring.
The general purpose of the Restructuring was to establish a more
appropriate corporate structure for the conduct of unregulated business
activities. D & E believes that the Restructuring will better enable D & E
to establish a broader base of income generation which will enhance the
overall financial strength of the enterprise.
(2) BASIS OF PRESENTATION
The accompanying financial statements are unaudited and have been
prepared by D & E pursuant to the rules and regulations of the Securities
and Exchange Commission ("SEC"). In the opinion of management, the
financial statements include all adjustments (consisting of normal
recurring adjustments and all adjustments necessary as a result of the
Restructuring) necessary to present fairly the results of operations,
financial position and cash flows of D & E for the periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such SEC rules and
regulations. The use of generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amount
of revenues and expenses during the reporting period. Actual results could
differ from those estimates. Certain items in the financial statements for
the three months and nine months ended September 30, 1995 have been
reclassified for comparative purposes and to reflect the three-for-one
stock-split effect of the Plan of Exchange. D & E believes that the
disclosures made are adequate to make the information presented not
misleading. It is suggested that these financial statements be read in
conjunction with the financial statements and notes thereto included in the
Telco Annual Report on Form 10-K/A for the fiscal year ended December 31,
1995.
4
<PAGE>
Form 10-Q
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 1. Notes to Consolidated Financial Statements
(Unaudited)
(3) INVESTMENTS IN AFFILIATED COMPANIES
D & E is positioning itself to participate in a new generation of
wireless services known as Personal Communications Services ("PCS"). In
1995, Red Rose invested $2,000,000 to acquire an 80% controlling ownership
interest and along with another partner, who invested $500,000 for a 20%
minority interest, formed The D and E Group, a new partnership. The D and E
Group owns 9.17% of PCS One, Inc., a corporation which participated in the
Federal Communications Commission auction for the C Block of PCS licenses.
PCS One, Inc. was the high bidder for the license to operate in the
Lancaster, Pennsylvania market having submitted a bid of approximately
$17,600,000 ($13,200,000 net after the 25% entrepreneurs' discount). A 10%
down payment was made with the remaining 90% of the net auction price for
the license to be paid in installments, with payments of interest only at
7.0% for the first 6 years and payments of interest at 7% and principal
amortized over the remaining 4 years of the 10-year license term. In June
of 1996, PCS One, Inc. returned $1,180,000 of the D and E Group's initial
investment.
Telco is pursuing its opportunities in the FCC Auctions of the
remaining D, E and F Blocks of the PCS Spectrum, and, in July, filed a
short form application with the FCC. The FCC reviewed applications from
Telco and others and established a list of qualified bidders. Telco made a
refundable deposit of $1,300,000 on August 12, 1996 to qualify for bidding.
This deposit can be applied to the down payment for any licenses Telco
wins. Auction bidding commenced on August 26, 1996 and management
anticipates it will be completed by December 31, 1996.
(4) SUBSEQUENT EVENTS
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 22,536 D & E Common Shares and certain ancillary
agreements. On November 4, 1996, 1,128 of such D & E Common Shares were
delivered and the remaining 21,408 will be delivered between January 1 and
January 6, 1997. All of such shares are unregistered although certain
registration rights were granted to the holders thereof.
(5) NOTES PAYABLE AND LONG-TERM DEBT
As a result of the Restructuring, Telco has negotiated amendments,
effective June 7, 1996, to the financial covenants stipulated in each of
the following Senior Note Agreements: 9.18% Senior Note, 7.55% Senior Note
and 6.49% Senior Note. Prior to the Restructuring, the covenants contained
in these note agreements were calculated based upon consolidated Telco
financial data, which included Red Rose and Marketing. One aspect of the
Restructuring was that Telco dividended to D & E all the capital stock of
these subsidiaries, leaving Telco with no subsidiaries to consolidate. The
amendments changed the limit on accumulated distributions and restricted
investments from $9,000,000 plus 75% of accumulated consolidated net income
5
<PAGE>
Form 10-Q
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 1. Notes to Consolidated Financial Statements
(Unaudited)
of Telco, to $5,000,000 plus 75% of accumulated net income of Telco.
The distributions, restricted investments and net income are cumulative
since June 30, 1991. These Senior Note Agreements of Telco are guaranteed
by D & E.
6
<PAGE>
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Monetary amounts presented in the following discussion are rounded to the
nearest thousand dollars. Certain items in the financial statements for the
three months and nine months ended September 30, 1995 have been reclassified for
comparative purposes and to reflect the three-for-one stock-split effect of the
Share Exchange.
RESULTS OF OPERATIONS
Net Income. Net income for the three months ended September 30, 1996 was
$1,113,000, 39.6% more than the net income of $797,000 recorded in the
corresponding period in 1995. The increase occurred primarily due to an increase
in operating revenue of $619,000 and an increase in equity in net income of
affiliates of $447,000. Increases were offset primarily by corresponding
increases in operating expense of $611,000 and income taxes of $187,000.
Earnings per common share totaled $.19, as compared with earnings per common
share of $.14 in the third quarter of last year.
Net income for the nine months ended September 30, 1996 was $3,292,000,
44.3% more than the corresponding period in 1995, which had net income of
$2,281,000. Earnings per common share totaled $.58 for the nine months ended
September 30, 1996, as compared with earnings of $.40 per common share for the
nine months ended September 30, 1995. Net income increased due to an increase in
operating revenue of $3,557,000 and an increase in equity in net income of
affiliates of $717,000 offset by corresponding increases in operating expense of
$2,616,000 and income taxes of $687,000.
Operating Revenue. Total operating revenue for the third quarter of 1996
was $10,867,000, an increase of $619,000 or 6.0%, while year-to-date operating
revenue totaled $33,378,000, an increase of $3,557,000 or 11.9% from the
corresponding period last year.
Local network services revenue is generated from providing local exchange
and local private line services. Local network revenues for the three months
ended September 30, 1996 increased $124,000 or 6.0% as compared to the same
period in 1995. The increase for the first three quarters of 1996, relative to
the same period in 1995, was $331,000 or 5.4%. Revenue for the first nine months
of 1996, as well as for the third quarter, increased primarily as a result of
growth in access lines and local private lines and an increase in revenue from
custom calling features. The number of access lines in service at September 30,
1996 increased 4.4% compared to September 30, 1995. The increase in access lines
plus other one-time charges for several local private lines, accounts for
approximately $94,000 and $251,000 of the increase in local network service
revenue for the three and nine months ended September 30, 1996 over September
30, 1995, respectively. The increase in revenue from custom calling features for
the three and nine months ended September 30, 1996 over September 30, 1995 of
$30,000 and $93,000, respectively, was primarily due to the newly offered Caller
Identification ("Caller ID") Deluxe. This service was initiated in June 1995.
7
<PAGE>
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Network access services revenue is received from Telco's subscribers, from
local exchange carriers, interexchange carriers ("IXCs") and cellular companies
for their use of local exchange facilities in providing interstate and
intrastate long distance services to their customers and from settlement pools
administered by the National Exchange Carrier Association, Inc. ("NECA").
Revenue in this category for the third quarter of 1996 amounted to $3,881,000,
an increase of $57,000 or 1.5% over the corresponding period in 1995. Revenue in
this category for the first nine months of 1996 amounted to $11,780,000, an
increase of $416,000 or 3.7% over the corresponding period in the previous year.
The increase in the third quarter was primarily due to an increase in access
lines for $123,000 offset by the effect of a decline in cellular traffic revenue
of approximately $76,000. The year-to-date increase was primarily due to an
increase in intrastate minutes of use for approximately $223,000 of revenue and
an increase in access lines for approximately $222,000. Currently, Telco is
under FCC Regulation 61.39, the Small Company Incentive regulation, for its
interstate traffic sensitive access rates. One of the requirements under this
regulation is that companies must have fewer than 50,000 access lines. In the
third quarter of 1996, Telco exceeded 50,000 access lines, therefore; when the
current rates expire under this regulation on July 1, 1997, Telco will be
required to follow another method of determining these rates. Thereafter,
management anticipates a significant revenue decline in network access services
revenue. Management believes the most favorable method of determining these
rates will be through electing to use NECA average schedule settlement formulas.
Long distance network services revenue is received from long distance calls
made by residential and business customers within the Capital (southcentral)
Region of Pennsylvania. Revenue in this category decreased $4,000 or 0.4% in the
third quarter and increased $136,000 or 4.5% year-to-date in 1996 compared with
the corresponding periods in 1995, respectively. These changes were primarily
due to fluctuations in minutes of use.
Directory advertising revenue increased $73,000 or 11.0% and $219,000 or
11.0% for the third quarter of 1996 and year-to-date 1996 over the corresponding
periods in 1995. Revenue in this category increased primarily due to a rate
increase of approximately 4.8% combined with an increase in the number of local
and regional advertisers of approximately 3.2%.
Other sales and services revenue consists primarily of the following
services furnished by Red Rose: sales and service of business telephone systems
and communications products, revenue from work at customers' sites and revenue
from the long distance calling service, D and E Long Distance ("DELD"). Also
included in this category is revenue from the sale of fiber optic facilities.
Revenue in this category grew $439,000 or 20.5% for the third quarter of 1996
over the third quarter of 1995 and year-to-date grew $2,517,000 or 42.2% over
1995 year-to-date. These increases were both generated primarily by a large
system sales contract for York College of Pennsylvania (the "large system sale")
which began in January 1996.
8
<PAGE>
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Operating Expense. Total operating expense for the three and nine month
periods ended September 30, 1996 was $8,798,000 and $26,610,000, respectively.
These amounts represent increases of $611,000 or 7.5% and $2,616,000 or 10.9%,
respectively, over the same periods in 1995.
Network operations expenses are incurred in maintaining D and E'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
decreased $122,000 or 7.9% for the third quarter and $10,000 or 0.2% for the
nine months of 1996 compared with the corresponding periods in 1995. The third
quarter and year-to-date reductions were primarily due to purchases in the prior
year third quarter of Caller ID Deluxe and ALI Database software.
Depreciation expense increased $135,000 or 8.0% and $358,000 or 7.1% in the
third quarter and first nine months of 1996, respectively, over the
corresponding periods in 1995. The majority of these increases were attributable
to an increase in plant in service in 1996 and new depreciation rates that were
effective January 1, 1996.
Financial and administrative services expense increased $214,000 and
$386,000 or 19.9% and 11.4% for the three and nine month periods ended September
30, 1996, over the corresponding periods in the previous year. The increases
were primarily due to an increase in wages and benefits.
Directory expense increased $40,000 or 9.3% and $132,000 or 10.6% for the
three months and nine months ended September 30, 1996 over the comparable
periods in 1995. The increase is primarily related to increased fees which are
calculated on phone directory revenue.
Costs of products sold consists primarily of the material costs of
equipment sales. The increases of $297,000 and $1,525,000 in the costs of
products sold during the three and nine month periods ended September 30, 1996
compared to 1995, were principally due to the large system sale, as discussed in
revenue from "Other sales and services."
Other expenses primarily include all operating expenses incurred by Red
Rose and Marketing in the course of their business activities, excluding
material costs and operating taxes other than income taxes. These expenses
increased $109,000 and $259,000 for the three and nine month periods ended
September 30, 1996, over the comparable periods last year. This increase is
primarily attributable to 1996 PCS expenses, an increase in sales commissions
and expenses associated with Marketing's investment in Monor Communications
Group ("MCG").
Other Income (Expense). Other income (expense) for the three and nine
months ended September 30, 1996 was $203,000 and $1,182,000, respectively, in
net expenses, a decrease of $469,000 and $722,000 over the net expense of the
9
<PAGE>
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
same periods in 1995. These decreases in the third quarter and first nine months
primarily related to increases in equity in net income of affiliates of $466,000
and $717,000, respectively. Equity in net income of affiliates increased
primarily due to a $351,000 decrease in the third quarter and a $334,000
decrease year-to-date in the losses of MCG, resulting primarily from an
increased number of access lines installed, and increased income from cellular
joint ventures of $26,000 and $365,000 for the third quarter and year-to-date
1996 over the corresponding periods in 1995, respectively.
MCG is a domestic corporate joint venture which owns 89.62% of Monor
Telephone Company ("MTT"), which operates a telephone company in Hungary.
Marketing owns 16.5% of MCG at September 30, 1996. The net losses reported by
MCG are directly related to the losses of MTT. These result primarily from the
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 MTT business plan reflects ongoing
HUF/U.S. Dollar-devaluation based on Hungarian government estimates which are
currently 15%, 12% and 7%, respectively for the years 1997 through 1999. These
losses are expected to be countered by MTT's ability to raise rates to customers
in order to repay the Overseas Private Investment Corporation ("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 expects to raise rates in January 1997 and up to two times per
year subsequent to that increase. Therefore, management has decided 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.
Income Taxes. The federal and state income taxes increased by $187,000 or
32.6% for the third quarter of 1996 and $687,000 or 43.2% for the nine months
ended September 30, 1996 over the corresponding periods in 1995. These increases
in income taxes were primarily due to an increase in pre-tax accounting income.
The effective income tax rates for the three and nine months ended September 30,
1996 were 40.3% and 40.5%, respectively, compared to 41.4% and 40.6%,
respectively, for the corresponding periods last year.
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. D & E,
as successor to Telco, implemented 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. These plans have
provided $118,000 and $116,000 of additional funds in the third quarter of 1996
and 1995, respectively, and $348,000 and
10
<PAGE>
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
$399,000 during the nine month periods ended September 30, 1996 and 1995,
respectively. D & E expects that presently foreseeable capital requirements will
be financed primarily through internally-generated funds, although additional
short- or long-term debt or equity financing may be needed to fund development
activities and to maintain D & E's capital structure within management's
guidelines and, management believes D & E has the ability to obtain this
financing as necessary.
D & E's primary source of funds for the first nine months of 1996 and 1995
was cash generated from operating activities. Net cash provided by operating
activities was $5,980,000 in 1996, compared with $8,001,000 in 1995. This
decline was due to an accounts receivable increase primarily related to the
large system sale, an accounts payable decrease resulting from payments for AIN
software and to a reduction of advanced billing related to recording directory
revenue deferred as unearned at December 31, 1995.
D & E's most significant investing activity in the first nine months of
1996 was its numerous additions to property, plant and equipment. The most
significant property, plant and equipment purchases, during the first nine
months of 1996, were as follows: $730,000 in digital electronic switching
equipment, $1,125,000 in general purpose computers, $1,327,000 in cable, and
$236,000 in buildings.
Another of D & E's significant investing activities includes Marketing's
investments in MCG, advances to MTT and receipts from MTT on those advances.
Marketing invested $1,517,000 in MCG in the first nine months of 1996. Marketing
advanced MTT an additional $1,277,000, and received $1,257,000 from MTT in the
first nine months of 1996 for its advances to MTT.
In the third quarter of 1996, $1,300,000 was deposited with the FCC to
qualify Telco as a bidder in the PCS Auctions for the D, E and F Blocks of PCS
Spectrum. Also contributing to the fluctuation in the investing activities was a
return of investment of $1,180,000 from PCS One, Inc. to The D and E Group
(owned 80% by Red Rose).
In March 1995, Marketing acquired common stock of MCG by forgiving
$633,000, of its accounts receivable from MCG.
As of September 30, 1996, D & E had unsecured lines of credit ("LOCs")
totaling $13,000,000 with two domestic banks. D & E borrowed an aggregate of
$9,242,000 on these lines of credit in the first nine months of 1996 and repaid
an aggregate of $6,942,000. The net proceeds of $2,300,000 were used in
operations and for making a refundable deposit to participate in the auction of
the D, E and F Blocks of PCS Spectrum. The outstanding amounts borrowed under
these agreements at September 30, 1996 totaled $7,830,000.
As a result of the Restructuring, Telco has negotiated amendments,
effective June 7, 1996, to the financial covenants stipulated in each of the
following Senior Note Agreements: 9.18% Senior Note, 7.55% Senior Note and
6.49% Senior Note. Prior to the Restructuring, the covenants contained in
11
<PAGE>
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
these note agreements were calculated based upon consolidated Telco financial
data, which included Red Rose and Marketing. One aspect of the Restructuring was
that Telco dividended to D & E all the capital stock of these subsidiaries,
leaving Telco with no subsidiaries to consolidate. 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 ratio of total debt to total debt plus equity including preferred
stock was 47.3% at September 30, 1996 compared with 47.0% at December 31, 1995.
OTHER
In 1994, D & E 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 D & E to furnish the County's 911 system with an
Automatic Location Identification ("ALI") network. D & E estimates that this
Agreement as modified will generate an estimated $9,500,000 of revenue over its
ten-year term. The ALI system is operational and the customer data information
is being loaded into the system. Most of the initial information was loaded
during the third quarter of 1996. Additional information will be loaded as it
becomes available. Revenues recorded on this contract since its inception have
been approximately $2,452,000 of which approximately $660,000 is included in the
1996 year-to-date financial statements.
On February 1, 1995, Telco redeemed 1,289 outstanding shares of its Series
B 5 1/2% Preferred Stock at its $100 par value per share, plus accrued dividends
thereon.
On February 2, 1995, Telco and the other participating companies of 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.
12
<PAGE>
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION (continued)
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
D & E is positioning itself to participate in a new generation of wireless
services known as Personal Communications Services ("PCS"). In 1995, Red Rose
invested $2,000,000 to acquire an 80% controlling ownership interest and along
with another partner, who invested $500,000 for a 20% minority interest, formed
The D and E Group, a new partnership. The D and E Group owns 9.17% of PCS One,
Inc., a corporation which participated in the Federal Communications Commission
auction for the C Block of PCS licenses. PCS One, Inc. was the high bidder for
the license to operate in the Lancaster, Pennsylvania market having submitted a
bid of approximately $17,600,000 ($13,200,000 net after the 25% entrepreneurs'
discount). A 10% down payment was made with the remaining 90% of the net auction
price for the license to be paid in installments, with payments of interest only
at 7.0% for the first 6 years and payments of interest at 7% and principal
amortized over the remaining 4 years of the 10-year license term. In June of
1996, PCS One, Inc. returned $1,180,000 of the D and E Group's initial
investment.
Telco is also pursuing its opportunities in the remaining D, E and F Block
Auctions of the PCS Spectrum and, in July, filed a short-form application with
the FCC. The FCC reviewed applications from Telco and others and established a
list of qualified bidders. Telco made a refundable deposit of $1,300,000 on
August 12, 1996 to qualify for bidding. This deposit can be applied to the down
payment for any licenses Telco wins. Auction bidding commenced on August 26,
1996 and management anticipates it will be completed by December 31, 1996.
On June 7, 1996, D & E became the parent company of Telco pursuant to the
terms of the Plan of Exchange, whereby each of the Telco Common Shares was
exchanged through the Share Exchange for three D & E Common Shares. In its
effect, the Share Exchange was similar to a three-for-one split of Telco Common
Shares. As an additional aspect of the Restructuring, Telco dividended to D & E
all of the capital stock of its subsidiaries, 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 more
appropriate corporate structure for the conduct of unregulated business
activities. D & E believes that the Restructuring will better enable D & E to
establish a broader base of income generation which will enhance the overall
financial strength of the enterprise.
On August 1, 1996 the FCC adopted an order to implement the local
competition provisions of the Telecommunications Act of 1996 ("the 1996 Act").
On September 27, 1996, the U.S. Court of Appeals for the Eighth Circuit issued a
temporary stay regarding certain provisions in the August 1996 FCC Order to
implement the local competition provision of the Act of 1996. Hearings with
respect to the issues on appeal will not take place until early 1997. Since
competition in its traditional service area is anticipated at some future
juncture, D & E is taking steps to improve customer service through enhanced
technology, such as AIN (Advanced Intelligent Network). D & E is also actively
investigating markets beyond its traditional service area where its talents and
community leadership will prove advantageous.
13
<PAGE>
During September 1996, the Company announced a supplemental early
retirement program to salaried and hourly employees. The maximum cost of the
program, estimated to be approximately $500,000, will be determined upon the
election of employees' eligible to participate in the program and will be
recorded during the quarter ended December 31, 1996.
On October 1, 1996 D & E Communcations, Inc. was listed on the National
Association of Security Dealers, Inc., Automated Quotations ("NASDAQ") National
Market System. The stock is listed under the symbol DECC.
FORWARD-LOOKING STATEMENTS
This quarterly report contains certain forward-looking statements as to the
future performance of D & E and its various domestic and international
investments 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 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.
14
<PAGE>
Form 10-Q
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Identification
No. of Exhibit Reference
--- ---------- ---------
27 Financial Data Schedule. Filed herewith.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed in the quarter ended September 30,
1996.
15
<PAGE>
Form 10-Q
D & E COMMUNICATIONS, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
D & E COMMUNICATIONS, INC.
(Registrant)
Date: November 12, 1996 By: /s/ Thomas E. Morell
-------------------------
Thomas E. Morell
Chief Financial Officer and Treasurer
(On Behalf of the Registrant and
as Principal Financial Officer)
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF NOVEMBER 12, 1996.
16
<PAGE>
INDEX TO EXHIBITS
Exhibit Identification
No. of Exhibit Reference
--- ---------- ---------
27 Financial Data Schedule. Filed herewith.
17
<PAGE>
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