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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended June 30, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
1934
For the transition period from _______________________________
to ______________________________
Commission File Number: 0-9881
SHENANDOAH TELECOMMUNICATIONS COMPANY
(Exact name of registrant as specified in its charter)
Virginia 54-1162807
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
124 South Main Street, Edinburg, Virginia 22824
(Address of principal executive offices) (Zip Code)
(540) 984-4141
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. |X| YES |_| NO
Indicate by check mark whether the registration is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). |X| YES |_| NO
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 July 28, 2004
- -------------------------- ----------------------------
Common Stock, No Par Value 7,612,785 Shares
SHENANDOAH TELECOMMUNICATIONS COMPANY
INDEX
Page
Numbers
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets
June 30, 2004 and December 31, 2003 3-4
Unaudited Condensed Consolidated Statements of Income for the
Three and Six Months Ended June 30, 2004 and 2003 5
Unaudited Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2004 and 2003 6
Unaudited Condensed Consolidated Statements of
Shareholders' Equity and Comprehensive Income
for the Six Months Ended June 30, 2004 and the
Year Ended December 31, 2003 7
Notes to Unaudited Condensed Consolidated
Financial Statements 8-12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13-28
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
Item 4. Controls and Procedures 29-30
PART II. OTHER INFORMATION
Item 4. Submissions of Matters to a Vote of Security Holders 31
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 32
Signatures 33
Exhibit Index 34
2
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
Assets June 30, December 31,
2004 2003
-------- ------------
Current Assets
Cash and cash equivalents $ 34,931 $ 28,696
Accounts receivable, net 7,639 6,488
Income tax receivable 2,077 1,526
Materials and supplies 2,324 2,062
Prepaid expenses and other (Note 10) 7,021 1,669
Deferred income taxes 411 522
-------- --------
Total current assets 54,403 40,963
Securities and investments
Available-for-sale securities 195 199
Other investments 7,705 7,268
-------- --------
Total securities and investments 7,900 7,467
Property, plant and equipment, net 127,396 127,686
Other Assets
Cost in excess of net assets of business
acquired 5,105 5,105
Deferred charges and other assets, net 1,146 999
Escrow account (Note 10) -- 5,000
-------- --------
6,251 11,104
Accumulated amortization 1,862 1,856
-------- --------
Net other assets 4,389 9,248
-------- --------
Total Assets $194,088 $185,364
======== ========
(continued)
3
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
(in thousands)
June 30, December 31,
Liabilities and Shareholders' Equity 2004 2003
-------- ------------
Current Liabilities
Current maturities of long-term debt $ 4,285 $ 4,230
Accounts payable 8,331 4,729
Advance billings and deposits 3,183 3,326
Other current liabilities 3,920 3,511
-------- --------
Total current liabilities 19,719 15,796
Long-term debt, less current maturities 36,961 39,116
Other Liabilities
Deferred income taxes 23,522 20,819
Pension and other 2,203 3,425
-------- --------
Total other liabilities 25,725 24,244
Shareholders' Equity
Common stock 6,016 5,733
Retained earnings 105,642 100,449
Accumulated other comprehensive income 24 26
-------- --------
Total shareholders' equity 111,682 106,208
-------- --------
Total Liabilities and Shareholders' Equity $194,088 $185,364
======== ========
See accompanying notes to unaudited condensed consolidated financial statements.
4
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
(in thousands, except per share data) June 30, June 30,
2004 2003 2004 2003
-----------------------------------------------------
Operating Revenues
Wireless $ 20,679 $ 16,769 $ 39,632 $ 32,403
Wireline 7,608 6,309 14,757 13,948
Other revenues 1,676 1,766 3,383 3,440
-----------------------------------------------------
Total revenues 29,963 24,844 57,772 49,791
Operating Expenses
Cost of goods and services 3,037 2,661 6,024 4,989
Network operating costs 9,127 8,647 17,441 16,532
Depreciation and amortization 4,395 4,127 8,732 8,148
Selling, general and administrative 8,379 7,011 16,264 13,452
-----------------------------------------------------
Total operating expense 24,938 22,446 48,461 43,121
-----------------------------------------------------
Operating Income 5,025 2,398 9,311 6,670
Other Income (expense):
Non-operating income, net 191 142 415 223
Gain (loss) on investments, net 146 9 128 (319)
Interest expense (773) (893) (1,571) (1,847)
-----------------------------------------------------
Income before income taxes, discontinued
operations and cumulative effect of change in accounting 4,589 1,655 8,282 4,727
Income tax provision (1,709) (611) (3,090) (1,752)
-----------------------------------------------------
Income from continuing operations 2,880 1,044 5,193 2,975
Income from discontinued operations, net of
income taxes -- -- -- 22,628
Cumulative effect of a change in accounting,
net of income taxes -- -- -- (76)
-----------------------------------------------------
Net income $ 2,880 $ 1,044 $ 5,193 $ 25,527
=====================================================
Net income per share, basic
Continuing operations $ 0.38 $ 0.14 $ 0.68 $ 0.39
Discontinued operations, net of income taxes -- -- -- 2.99
Cumulative effect of a change in accounting,
net of income taxes -- -- -- (0.01)
-----------------------------------------------------
Total net income per share, basic $ 0.38 $ 0.14 $ 0.68 $ 3.37
=====================================================
Net income per share, diluted
Continuing operations $ 0.38 $ 0.14 $ 0.68 $ 0.39
Discontinued operations, net of income taxes -- -- -- 2.98
Cumulative effect of a change in accounting,
net of income taxes -- -- -- (0.01)
-----------------------------------------------------
Total net income per share, diluted $ 0.38 $ 0.14 $ 0.68 $ 3.36
=====================================================
Weighted average shares outstanding, basic 7,609 7,575 7,608 7,570
=====================================================
Weighted average shares, diluted 7,658 7,606 7,656 7,594
=====================================================
See accompanying notes to unaudited condensed consolidated financial statements.
5
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Six Months Ended
June 30,
2004 2003
-----------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Income from continuing operations $ 5,193 $ 2,975
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 8,726 8,145
Amortization 6 3
Deferred income taxes 2,815 1,683
Gain on investments -- (161)
(Income) loss from patronage and equity investments (236) 288
Loss on disposal of equipment 133 29
Other (75) (20)
Changes in current assets and liabilities:
(Increase) decrease in:
Accounts receivable (1,151) 2,195
Materials and supplies (262) 54
Increase (decrease) in:
Accounts payable 494 (460)
Other prepaids, deferrals and accruals (1,930) 986
-----------------------
Net cash provided by operating activities 13,713 15,717
Cash Flows from Investing Activities
Purchases of property, plant and equipment (5,489) (4,284)
Purchases of other investments (479) (384)
Proceeds from investment activities 278 513
Proceeds from disposal of assets 29 33
-----------------------
Net cash used in investing activities (5,661) (4,122)
Cash Flows from Financing Activities
Payments on long-term debt and revolving loan (2,100) (10,136)
Proceeds from issuance of common stock upon
exercise of stock options 283 317
-----------------------
Net cash used in financing activities (1,817) (9,819)
-----------------------
Net cash provided by continuing operations 6,235 1,776
Net cash provided by discontinued operations -- 27,750
-----------------------
Net increase in cash and cash equivalents 6,235 29,526
Cash and Cash Equivalents
Beginning 28,696 2,209
-----------------------
Ending $ 34,931 $ 31,735
=======================
Cash paid for:
Interest paid $ 1,585 $ 1,911
Income taxes (net of refunds) $ 491 $ 7,085
Other non-cash transactions:
The Company received but has not paid for equipment with a cost of $3.1 million
and $0.1 million as of June 30, 2004and 2003 repectively.
See accompanying notes to unaudited condensed consolidated financial statements.
6
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND
COMPREHENSIVE INCOME
(in thousands)
Accumulated
Other
Common Retained Comprehensive
Shares Stock Earnings Income (Loss) Total
--------------------------------------------------------------------
Balance, December 31, 2002 7,552 $5,246 $ 71,335 $ (4) $ 76,577
Comprehensive income:
Net income -- -- 32,074 -- 32,074
Net unrealized change in
securities available-for-sale,
net of tax of $ (18) -- -- -- 30 30
---------
Total comprehensive income 32,104
Dividends declared ($ 0.39 per share) -- -- (2,960) -- (2,960)
Common stock issued through the
exercise of stock options
and stock grants 41 487 -- -- 487
--------------------------------------------------------------------
Balance, December 31, 2003 7,593 $5,733 $ 100,449 $ 26 $ 106,208
(unaudited) Comprehensive income:
Net income -- -- 5,193 -- 5,193
Net unrealized change in securities
available-for-sale, net of tax $1 -- -- -- (2) (2)
----------------------
Total comprehensive income 5,191
Common stock issued through the
exercise of stock options 19 283 -- -- 283
--------------------------------------------------------------------
Balance, June 30, 2004 7,612 $6,016 $ 105,642 $ 24 $ 111,682
====================================================================
See accompanying notes to unaudited condensed consolidated financial statements.
7
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The interim condensed consolidated financial statements of Shenandoah
Telecommunications Company and Subsidiaries (collectively, the "Company") are
unaudited. In the opinion of management, all adjustments necessary for a fair
presentation of the interim results have been reflected therein. All such
adjustments were of a normal and recurring nature. These statements should be
read in conjunction with the consolidated financial statements and related notes
in the Company's Annual Report on Form 10-K for the year ended December 31,
2003. The balance sheet information at December 31, 2003 was derived from the
audited December 31, 2003 consolidated balance sheet.
2. Operating revenues and income from continuing operations and discontinued
operations for any interim period are not necessarily indicative of results that
may be expected for the entire year.
3. To account for its stock options granted under the Company Stock Incentive
Plan (the "Plan"), the Company applies the intrinsic value-based method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations, including
Financial Accounting Standards Board ("FASB") Interpretation No. 44, Accounting
for Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25 issued in March 2000. Under this method, compensation expense is
recorded on the date of the grant only if the current market price of the
underlying stock exceeded the exercise price. SFAS No. 123, Accounting for
Stock-Based Compensation, established accounting and disclosure requirements
using a fair value-based method of accounting for stock-based employee
compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic value-based method of accounting described
above, and has adopted the disclosure requirements of SFAS No. 123, as amended
by SFAS No. 148, Accounting for Stock-Based Compensation--Transition and
Disclosure--an amendment of FASB Statement No. 123.
Grants of options under the Plan are accounted for following APB Opinion No. 25
and related interpretations. Accordingly, no compensation expense has been
recognized under the Plan for years prior to the 2004 grants. In 2004, the
Company issued tandem awards of stock options and stock appreciation rights. As
a result of the tandem awards, the Company recognized compensation expense for
the vested portion of the awards, which totaled $26 thousand for the second
quarter of 2004. Had compensation expense been recorded for the options based on
fair values of the awards at the grant date (the method prescribed in SFAS No.
123), reported net income and earnings per share would have been reduced to the
pro forma amounts shown in the following table for the three and six months
ended June 30:
(in thousands, except Three Months Ended Six Months Ended
per share amounts) June 30, June 30,
-------------------------------------------------------------
Net Income 2004 2003 2004 2003
As reported $ 2,880 $ 1,044 $ 5,193 $ 25,527
Pro forma 2,846 989 5,128 25,419
Earnings per share, basic and diluted
As reported, basic $ 0.38 $ 0.14 $ 0.68 $ 3.37
As reported, diluted 0.38 0.14 0.68 3.36
Pro forma, basic 0.37 0.13 0.67 3.36
Pro forma, diluted $ 0.37 $ 0.13 $ 0.67 $ 3.36
8
4. Basic net income per share was computed on the weighted average number of
shares outstanding. Diluted net income per share was computed under the treasury
stock method, assuming the conversion as of the beginning of the period, for all
dilutive stock options. There were no adjustments to net income in the
computation of dilutive net income per share for any period.
5. The Company has identified ten reporting segments based on the products and
services each provides. Each segment is managed and evaluated separately because
of diverse technologies and marketing strategies. A summary of unaudited
external operating revenues (revenues generated from outside customers or
subscribers), internal operating revenues (revenues generated between the
Company's operating segments), operating income (loss), and net income (loss) of
each segment is as follows for the three months ended June 30, 2004 and June 30,
2003.
Three Months Ended June 30, 2004
Operating
In thousands (unaudited) External Internal Income Net Income
Revenues Revenues (loss) (loss)
--------------------------------------------------------
Holding $ -- $ -- $ (421) $ (152)
PCS 19,913 -- 1,832 896
Telephone 5,986 883 2,717 1,713
ShenTel Service 1,657 76 176 80
Cable TV 1,103 9 90 7
Mobile 766 325 494 250
Long Distance 349 336 79 50
Network 170 29 127 80
ShenTel Communications 17 -- (68) (43)
Leasing 2 -- (1) (1)
------------------------------------------------------
Combined totals 29,963 1, 658 5,025 2,880
Inter-segment eliminations -- (1,658) -- --
------------------------------------------------------
Consolidated totals $29,963 $ -- $ 5,025 $ 2,880
======================================================
Three Months Ended June 30, 2003
Operating
In thousands (unaudited) External Internal Income Net Income
Revenues Revenues (loss) (loss)
--------------------------------------------------------
Holding $ -- $ -- $ (173) $ 110
PCS 16,056 1 (426) (788)
Telephone 4,685 764 1,911 1,135
ShenTel Service 1,747 75 284 150
Cable TV 1,109 1 215 45
Mobile 713 305 364 252
Long Distance 330 -- 80 51
Network 185 39 149 92
ShenTel Communications 15 -- (6) (4)
Leasing 4 -- 1 1
------------------------------------------------------
Combined totals 24,844 1,185 2,399 1,044
Inter-segment eliminations -- (1,185) (1) --
------------------------------------------------------
Consolidated totals $24,844 $ -- $ 2,398 $ 1,044
======================================================
9
A summary of unaudited external operating revenues (revenues generated from
outside customers or subscribers), internal operating revenues (revenues
generated between the Company's operating segments), operating income (loss),
income (loss) from continuing operations, income (loss) from discontinued
operations, cumulative effect of accounting change, and net income (loss) of
each segment is as follows for the six months ended June 30, 2004 and June 30,
2003.
Six Months Ended June 30, 2004
-------------------------------------------------------------------------------------------
Net Income Income
Operating (loss) from (loss) from
In thousands External Internal Income continuing discontinued Cum. Net Income
(unaudited) Revenues Revenues (loss) operations operations effect (loss)
- -------------------------------------------------------------------------------------------------------------------
Holding $ -- $ -- $ (949) $ (452) -- -- $ (452)
PCS 38,134 1 2,995 1,380 -- -- 1,380
Telephone 11,532 1,815 5,325 3,302 -- -- 3,302
ShenTel Service 3,345 153 394 185 -- -- 185
Cable TV 2,207 15 272 77 -- -- 77
Mobile 1,498 645 956 500 -- -- 500
Long Distance 687 668 128 82 -- -- 82
Network 331 67 256 160 -- -- 160
ShenTel --
Communications 34 (64) (40) -- -- (40)
Leasing 4 -- (2) (1) -- -- (1)
-----------------------------------------------------------------------------------------
Combined totals 57,772 3,364 9,311 5,193 -- -- 5,193
Inter-segment
eliminations -- (3,364) -- -- -- -- --
-----------------------------------------------------------------------------------------
Consolidated totals $57,772 $ -- $ 9,311 $ 5,193 -- -- $ 5,193
=========================================================================================
Six Months Ended June 30, 2003
-------------------------------------------------------------------------------------------
Net Income Income
Operating (loss) from (loss) from
In thousands External Internal Income continuing discontinued Cum. Net Income
(unaudited) Revenues Revenues (loss) operations operations Effect (loss)
- -------------------------------------------------------------------------------------------------------------------
Holding $ -- $ -- $ (313) $ 63 $ -- $ -- $ 63
PCS 31,032 -- (731) (1,472) -- -- (1,472)
Telephone 10,688 1,498 5,484 3,297 12 -- 3,309
ShenTel Service 3,406 155 654 359 -- -- 359
Cable TV 2,206 2 461 118 -- -- 118
Mobile 1,371 605 744 246 22,628 (76) 22,798
Long Distance 671 127 286 182 -- -- 182
Network 383 70 304 188 -- -- 188
ShenTel
Communications 26 1 (14) (8) -- -- (8)
Leasing 8 -- 2 2 -- -- 2
-----------------------------------------------------------------------------------------
Combined totals 49,791 2,458 6,877 2,975 22,640 (76) 25,539
Inter-segment
eliminations -- (2,458) (207) -- (12) -- (12)
-----------------------------------------------------------------------------------------
Consolidated totals $49,791 $ -- $ 6,670 $ 2,975 $ 22,628 $ 76 $ 25,527
=========================================================================================
10
The Company's assets by segment as of June 30, 2004, December 31, 2003, and June
30, 2003 are as follows:
In thousands June 30, December 31, June 30,
(unaudited) 2004 2003 2003
-----------------------------------------
Holding $ 143,813 $ 141,658 $ 142,828
PCS 74,430 68,773 67,811
Telephone 61,747 57,533 57,903
ShenTel Service 6,957 6,721 6,365
Cable TV 10,230 10,340 10,782
Mobile 18,813 18,396 16,826
Long Distance 934 808 570
Network 1,807 1,557 1,284
ShenTel Communications 43 78 110
Leasing 187 188 187
-----------------------------------------
Combined totals 318,961 306,052 304,666
Inter-segment eliminations (124,873) (120,688) (117,418)
-----------------------------------------
Consolidated totals $ 194,088 $ 185,364 $ 187,248
=========================================
6. Comprehensive income includes net income along with net unrealized gains and
losses on the Company's available-for-sale investments. Following is a summary
of comprehensive income for the periods indicated:
Three Months Ended Six Months Ended
In thousands (unaudited) June 30, June 30,
---------------------------------------------
2004 2003 2004 2003
---------------------------------------------
Net income $2,880 $1,044 $ 5,193 $25,527
Net unrealized income (loss) -- 33 (2) 21
---------------------------------------------
Comprehensive income $2,880 $1,077 $ 5,191 $25,548
=============================================
7. Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation. These reclassifications
had no effect on previously reported results of operations or retained earnings.
8. On February 20, 2004, the Company effected a 2-for-1 stock split with a
record date of January 30, 2004. Shareholders received one additional share of
common stock for each share of common stock held on the record date. All share
and per share amounts have been retroactively adjusted to reflect the impact of
the split.
11
9. The following table presents pension and other post-retirement benefits
information for the periods presented.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------
In thousands (unaudited) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------
Net periodic benefit cost recognized:
Service cost $ 166 $ 133 $ 332 $ 255
Interest cost 189 163 378 317
Expected return (135) (135) (270) (270)
Amortization of unrecognized transition asset (2) (12) (4) (19)
Recognized gains or losses 16 8 32 16
Prior service cost recognized 17 15 34 23
-----------------------------------------
Total $ 251 $ 172 $ 502 $ 322
=========================================
The Company's contribution to the pension plan for 2004 was $2.0 million, which
was contributed on April 30, 2004, of which $0.1 million was a required
contribution.
10. As a result of the previously reported February 2003 sale of the Company's
cellular operation, the Company reflected those operations and the sales
proceeds as discontinued operations in the 2003 first quarter results. Of the
sales price, $5.0 million has been held in escrow and is now reflected as a
current asset under "Prepaid expenses and other" line on the accompanying
balance sheet, as of June 30, 2004. The Company expects to receive the entire
$5.0 million on or about February 28, 2005.
12
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This management's discussion and analysis includes "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. When used in this report,
the words "anticipate," "believe," "estimate," "expect," "intend," "plan" and
similar expressions as they relate to Shenandoah Telecommunications Company or
its management are intended to identify these forward-looking statements. All
statements regarding Shenandoah Telecommunications Company's expected future
financial position and operating results, business strategy, financing plans,
forecasted trends relating to the markets in which Shenandoah Telecommunications
Company operates and similar matters are forward-looking statements. We cannot
assure you that the Company's expectations expressed or implied in these
forward-looking statements will turn out to be correct. The Company's actual
results could be materially different from its expectations because of various
factors, including those discussed below and under the caption "Business--Risk
Factors" in the Company's Annual Report on Form 10-K for its fiscal year ended
December 31, 2003. The following management's discussion and analysis should be
read in conjunction with the Company's Annual Report on Form 10-K for its fiscal
year ended December 31, 2003, including the financial statements and related
notes included therein.
Unless indicated otherwise, dollar amounts fifty thousand and over have
been rounded to the nearest hundred thousand dollars and dollar amounts of less
than fifty thousand have been rounded to the nearest thousand dollars.
Overview
Shenandoah Telecommunications Company is a diversified telecommunications
company providing both regulated and unregulated telecommunications services
through its nine wholly owned subsidiaries. These subsidiaries provide local
exchange telephone services, and wireless personal communications services
("PCS"), as well as cable television, paging, Internet access, long distance,
fiber optics facilities, and leased tower facilities. The Company is the
exclusive provider of wireless mobility communications network products and
services under the Sprint brand from Harrisonburg, Virginia to Harrisburg, York
and Altoona, Pennsylvania. The Company refers to the Hagerstown, Maryland;
Martinsburg, West Virginia; and Harrisonburg and Winchester, Virginia markets as
its Quad State markets. The Company refers to the Altoona, Harrisburg, and York,
Pennsylvania markets as its Central Penn markets. Competitive local exchange
carrier ("CLEC") services were established on a limited basis in Virginia,
during 2002. In addition, the Company sells and leases equipment, mainly related
to services it provides, and participates in emerging services and technologies
by direct investment in non-affiliated companies.
The Company reports revenues as wireless, wireline and other revenues. These
revenue classifications are defined as follows: Wireless revenues are generated
by operations of the Personal Communications Company (a PCS Affiliate of Sprint)
and the Mobile Company. Wireline revenues are generated by operations of the
Telephone Company, Network Company, Cable Television Company, and Long Distance
Company. Other revenues are generated by operations of ShenTel Service Company,
the Leasing Company, ShenTel Communications Company and the Holding Company.
13
Selected Operating Statistics
The following table shows selected operating statistics of the Company for the
most recent five quarters. This information is unaudited, and is provided as a
supplement to the financial statements.
Three Months Ended
------------------------------------------------------------
(Unaudited) Jun. 30, Mar. 31, Dec. 31, Sept. 30, Jun. 30,
2004 2004 2003 2003 2003
------------------------------------------------------------
Telephone Access Lines 24,867 24,901 24,877 24,951 24,972
Cable Television Subscribers 8,709 8,701 8,696 8,796 8,750
Dial-up Internet Subscribers 16,422 17,063 17,420 17,616 17,798
DSL Subscribers 1,856 1,637 1,298 1,163 1,080
Retail PCS Subscribers 94,475 89,632 85,139 81,015 77,398
Wholesale PCS Users (1) 18,059 16,349 12,858 7,531 4,690
Paging Subscribers 1,782 1,862 1,989 2,107 2,315
Long Distance Subscribers 9,559 9,542 9,526 9,517 9,520
Fiber Route Miles 554 552 552 552 552
Total Fiber Miles 28,770 28,743 28,740 28,740 28,739
Wholesale PCS Minutes (000) 10,373 8,492 4,974 3,207 2,303
Long Distance Calls (000) (2) 6,228 5,821 5,851 6,078 5,001
Total Switched Access Minutes (000) 60,874 58,099 55,932 54,349 51,124
Originating Switched Access MOU (000) 18,280 18,252 17,829 18,285 18,343
Employees (full time equivalents) 284 272 268 264 266
CDMA Base Stations (sites) 257 257 253 248 246
Towers (100 foot and over) 78 78 77 76 73
Towers (under 100 foot) 10 11 11 10 10
(See note (3) for definitions of terms)
PCS Market POPS (000) 2,048 2,048 2,048 2,048 2,048
PCS Covered POPS (000) 1,610 1,585 1,581 1,581 1,574
PCS Average Revenue Per User (ARPU) (ex. Travel) $ 50.63 $ 50.38 $ 52.05 $ 55.09 $ 52.84
PCS Travel Revenue per subscriber (4) $ 20.12 $ 18.20 $ 20.84 $ 16.50 $ 17.18
PCS Ave. Management Fee per subscriber $ 4.06 $ 4.07 $ 4.02 $ 4.62 $ 4.58
PCS Ave. Monthly Churn % 1.9% 2.2% 2.3% 2.4% 2.1%
PCS Cost Per Gross Addition (CPGA) $428.19 $371.49 $387.47 $418.22 $376.98
PCS Cash Cost Per User (CCPU) (4) $ 37.78 $ 38.57 $ 36.31 $ 40.05 $ 44.23
(1) - Wholesale Digital PCS Users are private label subscribers based in the
Company's wireless network service area.
(2) - Originated by customers of the Company's Telephone subsidiary
(3) - POPS refers to the estimated population of a given geographic area. Market
POPS are those within a market area, and Covered POPS are those covered by
the network's service area. ARPU is revenue before travel, roaming
revenue, and management fee, net of adjustments divided by average
subscribers. PCS Travel revenue includes travel, roaming and wholesale
revenue and is divided by the average number of subscribers. PCS Average
management fee per subscriber is 8% of revenue retained by Sprint,
excluding travel and wholesale revenue. PCS Ave. Monthly Churn is the
average of three monthly calculations of deactivations (excluding returns
less than 30 days) divided by beginning of period subscribers. CPGA
14
includes selling costs, product costs, and advertising costs. CCPU
includes network, customer care and other costs.
(4) - On a normalized basis, PCS travel revenue per subscriber in the fourth
quarter of 2003 would have been $19.25 and PCS CCPU would have been
approximately $38.66 taking into account the adjustments and true-ups
recorded in December 2003.
Significant Transactions
As previously disclosed in a Form 8-K report filed with the SEC on May 26, 2004,
the Company entered into an amendment to the Management Agreement with Sprint on
May 24, 2004. The agreement is filed as an exhibit to this report. Under the
terms of the agreement, the Company has agreed to participate in all new and
renewed reseller agreements signed through December 31, 2006. Additionally, the
Company signed a letter of agreement to participate in all existing Sprint
reseller arrangements applicable to the Company's service area. In consideration
for this participation, the Company received a reduction in the monthly fee per
subscriber paid to Sprint for back office services and certain network services.
The reduction per subscriber per month is $0.45 in 2004, $0.70 in 2005 and $0.95
in 2006, from the amounts agreed upon in the management agreement amendment
dated January 2004.
As previously disclosed in a Form 8-K report filed with the SEC on May 26, 2004,
the Company signed a contract with Lucent Technologies on May 21, 2004. The
contract with Lucent provides for the Company to purchase up to $20 million of
third generation (3G) CDMA2000 mobile network equipment in 2004. As part of the
agreement, the Company has committed to use Lucent as its vendor of choice for
all switching and base station requirements for its existing CDMA2000 mobile
network through 2007.
On May 18, 2004, AT&T announced a five-year non-exclusive agreement with Sprint
that will allow AT&T to sell wireless service that will be provided over
Sprint's wireless network. AT&T announced that it intends to begin selling
wireless service using the Sprint network later this year. The Company believes
it should benefit from this relationship as a result of the amendment it signed
with Sprint on May 24, 2004, discussed above, but is unable at this date to
determine the extent of the potential benefit.
On June 1, 2004, the Company was informed by the Virginia Department of
Transportation ("VDOT") that it was not the winning bidder for the new statewide
511 Travel contract effective February 2005. The Company is the current provider
of 511 Travel to the Interstate 81 corridor under contract with VDOT through
January 2005. The Company recorded $0.6 million in revenue for the six months
ended June 30, 2004 from this contract.
On June 22, 2004, Sprint announced plans to deploy EV-DO (Evolution Data
Optimized) technology across its PCS network to provide its customers average
user speeds of 300-500 kilobits per second and peak rates of up to 2.4 Megabits
per second for downloads. Sprint announced that it expects to deploy EV-DO in
select markets in the second half of 2004 and the majority of the top U.S.
metropolitan markets in 2005. The Company, as a PCS Affiliate of Sprint, is
evaluating the impact of deploying EV-DO into its network, but has not yet
determined the timing, cost or the extent of this deployment.
15
Results of Operations
Summary
The Company's three major lines of business are wireless, wireline and other
businesses. Each of the three areas has unique issues and challenges that are
critical to the understanding of the operations of the Company. The wireless
business is made up of two different operations, the PCS operation and the tower
business. The wireline business is made up of traditional telephone operations,
a cable TV operation, fiber network leasing and a company that resells
long-distance. Other businesses include the Company's Internet operation, the
Interstate 81 corridor Travel 511 project, and the sales and service of
telecommunications systems.
Since the mid 1990's, the principal source of the Company's revenues has shifted
from traditional wireline revenues to wireless and other revenues. For the three
months ended June 30, 2004, wireless revenues accounted for 69.0% of total
revenues, wireline revenues accounted for 25.4% of total revenues, and other
revenues accounted for 5.6% of total revenues. For the three months ended June
30, 2003, wireless revenues accounted for 67.5%, wireline revenues for 25.4% and
other revenues for 7.1% of total revenues.
The Company's strategy is to expand its services and the geographic areas
served. This strategy has been implemented primarily through enhancing the PCS
network, through Call Division Multiple Access ("CDMA") technology, under the
national brand of Sprint. The Company's efforts to market its services in the
expanded PCS network area contributed to new subscribers purchasing phones and
services, which continued to increase revenues during the three months ended
June 30, 2004. The Company had 257 PCS CDMA base stations in service at June 30,
2004, compared to 246 base stations in service at June 30, 2003. This increase
in base stations is primarily the result of supplementing network capacity and
gradually extending coverage along highly traveled secondary roads in the
Company's market areas.
The Company operates its wireless network as a PCS affiliate of Sprint. The
Company receives revenues from Sprint for subscribers that obtain service in the
Company's network coverage area and subscribers that use the Company's network
when they travel. The Company relies on Sprint to provide timely, accurate and
complete information for the Company to record the appropriate revenue and
expenses for each financial period.
Through Sprint, the Company began receiving revenue from wholesale resellers of
wireless PCS service in late 2002. These resellers pay a flat rate per minute of
use for all traffic their subscribers generate on the Company's network. The
Company's cost to handle this traffic is the incremental cost to provide the
necessary network capacity.
The Sprint five-year non-exclusive wholesale agreement with AT&T, discussed
above, may facilitate a significant increase in the wholesale minutes of use on
the Company's wireless network. This potential for increased traffic, however,
could require additional investment by the Company in expansion of its wireless
network capacity.
For the third consecutive quarter, the Company's PCS operation recorded
profitable operations, largely as a result of attainment by the PCS operation of
a break-even level in the number of customers in the Company's service area.
Achievement of the break-even level has enabled the Company to cover all fixed
costs of operation in addition to the coverage of all variable costs . The
16
PCS operation achieved this level due to more favorable pricing from Sprint on
customer care services, reduced bad debt expense, and a continued favorable net
travel position.
The Company's net travel and wholesale roaming, including the long distance and
3G data portions of that traffic, increased to a $2.7 million receivable for the
current quarter, compared to a $2.3 million receivable for the same quarter last
year. The Company's travel receivable minutes increased 43.7% to 71.8 million
and the travel payable minutes increased by 35.8% to 49.8 million, compared to
the second quarter of 2003. The increases in travel minutes receivable and
payable are primarily the result of an increase in usage of the Company's
network facilities by subscribers based in other markets and growth in
subscribers in the Company's markets.
On a per-subscriber basis, the Company's average of travel payable minutes
increased to 176 minutes in the second quarter of 2004, which represented an
increase of 28 minutes from second quarter of 2003. A continuation of this trend
could negatively affect the results of the PCS operation and overall results of
the Company absent any changes in the Company's arrangements with Sprint.
In the second quarter of 2004, the Company's average PCS customer turnover, or
churn, rate decreased to 1.9%, compared to 2.1% in the second quarter of 2003.
To date, Wireless Local Number Portability has not had a significant effect on
the churn rate, although there is no certainty that the rate will not be
affected in future periods. Bad debt expense has declined for the last five
quarters due to the implementation of deposits and more restrictive credit
policies. Bad debt expense for the PCS operation, as a percentage of service
revenues, declined from 4.8% in the second quarter of 2003 to 1.4% in the second
quarter of 2004. Although management continues to monitor receivables,
collection efforts and new subscriber credit ratings, there is no certainty that
the improving bad debt trend will continue in the future.
The Company has experienced a decline in ARPU, which it believes is the result
of a lower rate plan mix in the first six months of 2004. If this trend
continues, the Company expects a negative impact on ARPU, but a favorable impact
on churn and bad debt expense.
The wireline business is made up of the Company's traditional telephony, cable
TV, fiber network operations, yellow page directory and long-distance resale
business. These businesses operate in a defined geographic area. The Company's
primary service area for the telephone, cable TV and long-distance business is
Shenandoah County, Virginia. The county is a rural area in northwestern
Virginia, with a population of approximately 37,300 residents, which has
increased by approximately 6,000 since 1990. The potential for significant
numbers of additional customers in the current operating area is limited.
The Company's telephone access line count declined in the third and fourth
quarters of 2003, increased by a net 24 lines in first quarter of 2004, and
declined by 34 lines in the second quarter of 2004. The Company believes that
the declines are attributable to the migration of traditional telephone lines to
wireless and DSL services. Based on industry experience, the Company anticipates
the trend of further access line declines may continue for the foreseeable
future.
Other revenues are derived primarily from Internet services, which are provided
through both dial-up and DSL high-speed service. The Company has experienced a
decline in dial up subscriptions
17
over the last year. Over the same period, customer desire for faster Internet
connections has contributed to growth of almost 100% in revenues from the DSL
service.
In the third quarter of 2004, the Company will begin offering compression
technology to its dial-up Internet customers as part of its basic service. The
compression technology offers download speeds of up to five times faster than
traditional service for certain applications. This offering is intended to
enhance the Internet experience of the dial-up subscriber base, particularly in
areas where the Company cannot offer high-speed broadband access.
The Company is facing competition for revenues it generates in all lines of
business, which may require the Company to differentiate itself from other
providers through its service levels and evolving technologies that are more
reliable and cost effective for the customer.
The Company continues to devote significant resources to comply with the various
requirements of the Sarbanes-Oxley Act.
Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003
General
Total revenues for the second quarter of 2004 were $30.0 million, which
represented an increase of $5.1 million, or 20.6%, compared to $24.8 million for
the second quarter of 2003. Total revenues include wireless revenue of $20.7
million, which increased by $3.9 million, or 23.3%; wireline revenues of $7.6
million, which increased by $1.3 million, or 20.6%; and other revenues of $1.7
million, which decreased $0.1 million from the second quarter of 2003. Operating
income increased $2.6 million, to $5.0 million, compared to $2.4 million for the
same period in 2003. Income per share from continuing operations, diluted was
$0.38 cents per share for the 2004 second quarter, compared to $0.14 per share
for the 2003 second quarter.
Revenues in the 2004 and 2003 quarters were affected by revenue adjustments
occurring in other fiscal periods. The first adjustment resulted from the
resolution of a $0.3 million revenue dispute, reported in the first quarter of
2004, which involved issuing several of the Company's inter-exchange carrier
customers credit for $154 thousand and adjusting the remaining reserve of $146
thousand, through access revenues in second quarter of 2004. The results in the
2003 second quarter were affected by an adjustment of $1.5 million to reduce
access revenues for disputed charges from two previous years involving
inter-exchange carrier customers.
Revenues
Wireless revenues are primarily derived from the PCS business. As of June 30,
2004, the Company had 94,975 retail PCS subscribers. The PCS operation added
17,577 net retail subscribers since June 30, 2003, and 4,843 since March 31,
2004. Wireless service revenues were $12.7 million for the second quarter of
2004, which represented an increase of $2.0 million, or 15.8%, compared to $10.7
million for the second quarter of 2003. The Company's ARPU, exclusive of travel
revenue, decreased 4.2% to $50.63 for the second quarter of 2004, from $52.84
for the second quarter of 2003. These changes in ARPU were primarily
attributable to subscribers generating fewer minutes over plan usage and the
popularity of additional Add-a-Phone SM plans, which dilute the per subscriber
revenue.
18
PCS travel, wholesale and roaming revenues combined for the second quarter 2004
were $6.3 million, which represented a $1.4 million, or 28.5%, increase compared
to the travel, wholesale and roaming revenue for the second quarter of 2003. The
travel, wholesale and roaming revenue increase, which resulted from an increase
in travel usage and growth in wholesale minutes, was offset in part by a decline
in roaming usage for the same period.
PCS equipment sales increased $0.5 million, or 52.0%, to $0.9 million for the
second quarter of 2004. The increase was primarily due to more subscribers
upgrading their handsets to access new features provided with the service.
Wireline revenues were $7.6 million in the 2004 second quarter, which
represented an increase of $1.3 million, or 20.6%, from the second quarter of
2003. Access revenue in the telephone business increased $1.3 million, due
primarily to a reduction of $1.5 million for access revenue disputes recorded in
revenue in the second quarter of 2003. Total switched minutes of use increased
by 20.1% compared to the first quarter of 2003, but reflected the decrease in
access rates and settlements from the National Exchange Carrier Association
("NECA") pools. The mix of wireless traffic to total traffic shifted from 31.0%
for the second quarter of 2003 to 40.8% for the second quarter of 2004. This
increase was primarily attributable to terminating traffic that comes into the
Company's telephone network and is delivered to wireless users.
Other revenues of $1.7 million decreased $0.1 million compared to other revenues
for the second quarter of 2003. Internet revenues increased $0.1 million, or
5.0%. The total subscriber base for the Company's dial-up and DSL Internet
services was 18,278 as of June 30, 2004, compared to 18,878 as of June 30, 2003,
a decrease of 3.2%. While DSL subscribers increased 776, or 71.9%, compared to
the June 30, 2003 subscriber base, there was a decline of 1,376 dial-up
subscribers, or 7.7%, from the level at June 30, 2003. The Company has
experienced increased subscriber deactivations due to migration to competing
high-speed Internet services in those areas where the Company does not offer a
high-speed Internet access alternative.
The revenue from the Travel 511 contract with the Virginia Department of
Transportation, which expires January 31, 2005, decreased by $0.1 million due to
a lower price negotiated for the final year of the contract period.
Operating Expenses
Total operating expense for the second quarter of 2004 was $24.9 million, which
represented an increase of $2.5 million, or 11.4%, compared to the second
quarter of 2003. The higher operating expense was primarily attributable to an
increase in the number of PCS subscribers, the expanded PCS network operation,
and an increase in selling, general and administrative expenses. The effect of
these factors was offset in part by a significant decline in bad debt expense.
Costs of goods and services were $3.0 million, which represented an increase of
$0.4 million, or 14.1%, from the second quarter of 2003. This increase was due
primarily to an increase in gross additions in the quarter, an increase of
approximately $51 in the cost per gross additions, from $377 for the second
quarter of 2003, to $428 for the second quarter of 2004, including action by
current PCS customers to upgrade their handsets. During the second quarter of
2004, the Company added 10,201 gross new PCS subscribers compared to the 9,742
gross new subscribers it added in the second quarter of 2003. Existing
subscribers are purchasing Company subsidized new handsets to
19
replace their current handsets as new features become available, and new
services are offered that are not available on earlier model handsets. The
upgrade cost for the second quarter of 2004 was $0.5 million. Management
anticipates the upgrade trend may continue, and may increase significantly, in
future periods as wireless carriers offer subsidized handsets as an inducement
for subscribers to extend the term of their service agreements.
The Company's cost per gross addition ("CPGA") in the PCS business for the
second quarter of 2004 increased to $428.19, or 13.6%, from the second quarter
of 2003, due to handset upgrade costs included in the CPGA measure. Cost of
goods sold per gross addition basis contributed $21.39, or 5.7%, to the increase
in the CPGA measure. Currently, the Company classifies 100% of the handset cost,
including the costs of existing subscribers electing to up-grade their handsets,
as a cost per gross addition.
Network operating costs for the second quarter of 2004 were $9.1 million, which
represented an increase of $0.5 million, or 5.6%, compared to the second quarter
of 2003. Increased travel costs of $1.0 million were offset in part by lower
network costs of $0.3 million in the PCS operation and lower rental costs of
$0.2 million for buildings and towers. The travel costs increased due to an
increase in subscribers and an increase in the average travel minutes used by
the Company's subscribers in the Sprint or Sprint affiliate markets not operated
by the Company, to 176 minutes per month in the 2004-second quarter, from 148
minutes per month in the 2003-second quarter.
Depreciation and amortization expense for the 2004 second quarter was $4.4
million, which represented an increase of $0.3 million, or 6.5%, compared to
$4.1 million for the second quarter of 2003, as new assets, primarily in the PCS
and telephone operation, have been added to the networks.
Selling, general and administrative costs were $8.4 million, which represented
an increase of $1.4 million, or 19.5%. Billing and customer care costs incurred
in the PCS operation, primarily charges from Sprint, increased $0.4 million as a
result of the increase in the total number of PCS subscribers, net of cost
reductions obtained as part of amendments signed with Sprint on January 30, 2004
and May 24, 2004. Increased administrative staff and increases in wages and
benefits for existing employees contributed $0.5 million in added costs compared
to the second quarter of 2003. The Company has previously announced plans to
increase staff to manage existing and future growth and for expanded reporting
requirements. Additional costs incurred in connection with Sarbanes-Oxley
compliance were $0.2 million in the second quarter of 2004. Selling and
marketing expenses increased $0.3 million due to added internal sales staff,
additional third party sales agents and expanded advertising efforts related to
the new Shentel Pages phone book, which began selling advertising for its 2005
book in the later part of the second quarter. Bad debt expense decreased $0.4
million compared to the second quarter of 2003 primarily due to reduced PCS
subscriber terminations for non-payment. PCS bad debt expense, net of
recoveries, was 1.4% of total PCS service revenues in the second quarter of
2004; compared to 4.8% of total PCS service revenues in the second quarter of
2003.
In the Company's PCS operation, cash cost per user ("CCPU") for the second
quarter of 2004 declined to $37.78, which represented a 14.6% decrease from the
second quarter of 2003. The change was primarily the result of the amendments to
the Company management contract with Sprint that were signed on January 30, 2004
and May 24, 2004, and economies of scale due to an increase of 22.4% in the
average number of customers over the second quarter of 2003.
20
Other Income (Expense)
Gains on external investments totaled $146 thousand in the second quarter of
2004, compared to a nominal gain in the second quarter of 2003. Second quarter
2004 interest expense decreased by $0.1 million, or 16.5%, a result of decreased
borrowing levels compared to the second quarter of 2003. The Company's total
debt as of June 30, 2004 was $41.2 million, compared to $45.4 million as of June
30, 2003 and $43.3 million as of December 31, 2003.
Income before income taxes, discontinued operations and cumulative effect of
accounting changes was $4.6 million, which represented an increase of $2.9
million from the $1.7 million reported for the second quarter of 2003.
Income from continuing operations was $2.8 million for the second quarter of
2004, compared to $1.0 million for the second quarter 2003, which represented an
increase of $1.8 million.
The results of discontinued operations in 2003 were from the VA 10 RSA limited
partnership, which was sold in February 2003. There were no discontinued
operations in the second quarter of 2004 or 2003. The Company's 2004 second
quarter net income was $2.8 million compared to $1.0 million in 2003.
Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003
General
Total revenues for the six months ended June 30, 2004 (the "2004 six-month
period") was $57.8 million, which represented an increase of $8.0 million, or
16.0%, compared to $49.8 million for the six months ended June 30, 2003 (the
"2003 six-month period"). Total revenues for the 2004 six-month period include
wireless revenue of $39.6 million, which increased by $7.2 million, or 22.3%;
wireline revenues of $14.8 million, which increased by $0.8 million, or 5.8%;
and other revenues of $3.4 million, which were essentially unchanged for the
2003 six month period. Operating income increased $2.6 million, to $9.3 million,
compared to $6.7 million for the same period in 2003. Income per share from
continuing operations, diluted was $0.68 cents per share for the 2004 six-month
period, compared to $0.39 per share for the same period of 2003.
The 2003 six-month period includes a reduction in wireline revenue of $1.5
million, which related to access revenue recorded in prior periods that was
disputed by interexchange carrier customers.
Revenues
Wireless service revenues were $24.7 million for the 2004 six-month period,
which represented an increase of $4.1 million, or 19.8%, compared to $20.6
million for same period of 2003. The Company's average customer base increased
by 24.4% in 2004, compared to the same period of 2003. The ARPU exclusive of
travel revenue has decreased as a result of the implementation of a significant
number of Add-a-Phone SM customer plans, which generate significantly lower
revenues than the normal customer base. Management is monitoring the add-a-phone
sales, which have negatively affected the ARPU of the PCS operation.
21
PCS travel, wholesale and roaming revenue combined for the 2004 six-month period
were $11.7 million, which represented a $2.2 million, or 22.8%, increase
compared to the travel, wholesale and roaming revenue for the 2003 six-month
period. The travel, wholesale and roaming revenue increase resulted from an
increase in travel usage and the growth of wholesale minutes, the effect of
which was offset in part by a decline in roaming usage for the same period.
PCS equipment sales increased $0.8 million, or 103.0% to $1.7 million for 2004
six-month period. The increase was primarily due to an increase in gross
additions and in the number of subscribers replacing phones and upgrading their
handsets to access added features provided with the service.
Wireline revenues were $14.8 million in the 2004 six-month period, which
represented an increase of $0.8 million, or 5.8%, from the 2003 six-month
period. Access revenue in the telephone business increased $1.1 million, due
primarily to a recorded reduction in revenue of $1.5 million in 2003 related to
a dispute with inter-exchange carriers. Total switched minutes of use increased
20.1% in the 2004 six-month period, compared to the 2003 six-month period. The
increased traffic, which is primarily due to wireless traffic over the Company's
telephone subsidiary's network, is billed at a lower rate.
Other revenues of $3.4 million decreased $0.1 million compared to the 2003
six-month period other revenues. Internet revenues increased $0.1 million, or
4.0%, while 511 Travel revenue and other equipment sales and service revenues
decreased $0.2 million from the 2003 six-month period. The Company was informed
by the Virginia Department of Transportation in the second quarter of 2004 that
the Company's contract for the 511 Virginia travel business would not be renewed
beyond the term of the existing contract, which extends through January 2005.
Operating Expenses
Total operating expense for the 2004 six-month period was $48.5 million, which
represented an increase of $5.4 million, or 12.4%, compared to the 2003
six-month period. The higher operating expense was primarily attributable to an
increase in the number of PCS subscribers; the expanded PCS network operation,
and an increase in selling, general and administrative expenses. The effect of
these factors was offset in part by a significant decline in bad debt expense.
Costs of goods and services were $6.0 million for the 2004 six-month period,
which represented an increase of $1.0 million, or 20.7%, from the 2003 six-month
period. This increase was due primarily to an increase in the number of PCS
gross subscriber additions, higher cost per gross additions and action by
current PCS customers to upgrade their handsets.
Network operating costs for the 2004 six-month period were $17.4 million, which
represented an increase of $0.9 million, or 5.5%, compared to the same period of
2003. Increased travel costs of $1.7 million were offset in part by lower other
network costs of $0.7 million in the PCS operation. The travel costs increased
due to an increase in PCS subscribers and an increase in the average minutes of
use for travel by the Company's subscribers.
Depreciation and amortization expense for the 2004 six-month period was $8.7
million, which represented an increase of $0.6 million, or 7.2%, compared to
$8.1 million for the 2003 six-month period, as new assets, primarily in the PCS
and telephone operation, have been added to the networks.
22
Selling, general and administrative costs were $16.3 million, which represented
an increase of $2.8 million, or 20.9%. Billing and customer care costs incurred
in the PCS operation, primarily charges from Sprint, increased $0.6 million as a
result of the increase in the total number of PCS subscribers, net of cost
reductions obtained as part of the amendments signed with Sprint on January 30,
2004 and May 24, 2004. Increased administrative staff and increases in wages and
benefits for existing employees contributed $0.5 million in added costs compared
to the first six months of 2003. Additional costs incurred in connection with
Sarbanes-Oxley compliance were $0.7 million for the 2004 six-month period.
Selling and marketing expenses increased $0.9 million due to added internal
sales staff and expanded advertising efforts on the new Shentel Pages phone book
introduced in early 2004. Bad debt expense decreased $0.6 million as a result of
reduced PCS subscriber terminations for non-payment, which were attributable to
an improved credit profile of the subscriber base in the Company's operating
area.
Other Income (Expense)
Gains on external investments totaled $128 thousand in the 2004 six-month
period, compared to a $0.3 million loss for the 2003 six-month period. Interest
expense decreased $0.3 million, or 15.0%, in the 2004 six-month period compared
to the 2003 six-month period, a result of decreased borrowing levels.
Income before income taxes, discontinued operations and cumulative effect of
accounting changes was $8.3 million in the 2004 six-month period, which
represented an increase of $3.6 million from the $4.7 million reported for the
2003 six-month period.
Income from continuing operations increased $2.2 million, or 74.6%, to $5.2
million for the 2004 six-month period from $3.0 million for the 2003 six-month
period.
The results of discontinued operations in 2003 were from the VA 10 RSA limited
partnership, which was sold in February 2003. Income from discontinued
operations, net of the tax effect of the transaction, was $22.6 million in the
2003 six-month period. There were no discontinued operations in the 2004
six-month period.
The Company adopted Statement of Financial Accounting Standards No. 143,
"Accounting of Asset Retirement Obligations," effective January 1, 2003, and as
a result, recorded a charge to earnings for the cumulative effect of this change
in accounting of $76 thousand after taxes in the 2003 six-month period.
The Company's net income for the 2004 six-month period was $5.2 million compared
to $25.5 million for the 2003 six-month period.
Investments In Non-Affiliated Companies
The Company participates in emerging technologies by investing in entities that
invest in start-up companies. This includes indirect participation through
capital venture funds of South Atlantic Venture Fund III, South Atlantic Private
Equity IV, Dolphin Communications Parallel Fund, Dolphin Communications Fund II
and Burton Partnership. The Company also participates by direct investment in
privately held companies. Currently the Company's only direct investment is in
NTC Communications, a provider of voice, video and data connections to
off-campus student housing properties at universities and colleges. For those
investments that eventually become publicly-
23
traded, the Company evaluates whether to hold or sell parts or all of each
investment on an individual basis.
As of June 30, 2004, the Company held shares in two companies that are
publicly-traded, with the following market values: $49 thousand in Net IQ
(NTIQ), with 3,744 shares held, and $146 thousand in Deutsche Telekom, AG (DT),
with 8,219 shares held.
Liquidity And Capital Resources
The Company generated $16.8 million in cash from operations in the 2004
six-month period, compared to $15.8 million in the 2003 six-month period. During
the second quarter of 2004, the Company contributed $2.0 million in cash to the
Company's defined benefit pension plan, of which $0.1 million was a mandatory
contribution. This disbursement is reflected as a component of the "other
prepaids, deferrals and accruals" line of the cash flows from operating
activities, appearing elsewhere in this report.
The Company expects that operations may continue to generate positive cash flows
as PCS operations continue to improve and the number of subscribers continues to
increase. The Company may liquidate some of its short-term investments, to pay
for new equipment purchased from Lucent during the current year, under the $20
million equipment purchase contract signed in the second quarter of 2004.
As of June 30, 2004, the Company's total debt was $41.2 million, with an
annualized overall weighted average interest rate of approximately 7.5%. As of
June 30, 2004, the Company was in compliance with the covenants in its credit
agreements.
The Company is obligated to make future payments under various contracts,
including amounts pursuant to its various long-term debt facilities, and
non-cancelable operating lease agreements for retail space, tower space and cell
sites.
Capital expenditures budgeted for 2004 total approximately $34 million,
including approximately $24.3 million for additional PCS base stations,
additional towers, additional sites, and switch upgrades to enhance the PCS
network, and approximately $5 million to the telephone operation. An additional
$5 million will be expended for building renovations, vehicles, office
equipment, and other miscellaneous capital needs including the renovation to the
Shentel Center in Edinburg, Virginia, which will house the Company's corporate
offices. The Company has increased its capital budget for 2004 by $1.3 million
to provide funds for new site acquisitions in preparation to improve and expand
the coverage of the PCS network. This funding will cover the initial site
identification costs.
For the 2004 six-month period, the Company spent $5.5 million in capital
projects. Management anticipates its spending will accelerate during the third
quarter of 2004, as a significant number of the base station replacements occur
during that period
The Company expects to generate adequate cash to meet its short-term and
long-term cash needs, including working capital requirements, capital projects
and debt payments, and dividend payments, from cash on hand, operating cash
flow, and amounts expected to be available under the Company's existing
financing facility. The Company may, at its election, liquidate some of its
investments to generate additional cash for its capital needs.
24
Risks
The Company is one of eleven PCS Affiliates of Sprint, and accordingly, is
affected by decisions and requirements adopted by Sprint in regard to its
wireless operation. Management continually reviews its relationship with Sprint
in light of new developments and requirements.
The Company is dependent on Sprint for the reporting of a significant majority
of PCS revenues, particularly travel and service revenue. Controls and processes
are continually refined, so the Company can monitor, review, test, and validate
information being reported to the Company by Sprint. It is the Company's policy
to estimate and reflect the information supplied by Sprint in the financial
statements in the applicable fiscal periods. Corrections, if any, are made no
earlier than the period in which the parties agree to the corrections. The
Company is at risk for reporting errors that may be made by Sprint.
The net balance of PCS travel revenue and expense, which is currently favorable
to the Company, could change significantly due to changes in service plan
offerings, changes in the travel settlement rate, changes in travel habits by
the subscribers in the Company's market areas or other Sprint subscribers, and
numerous other factors beyond the Company's control. The Company is continuing
to monitor the financial strength of the other PCS Affiliates of Sprint, as
their ability to maintain their segment of the Sprint network may affect the
Company's ability to add new subscribers.
Wireless Local Number Portability ("WLNP") permits a subscriber to change
wireless service providers in the same market area while retaining the
subscriber's existing telephone number. This Federal Communications Commission
mandate was effective November 24, 2003 in the 100 largest metropolitan areas
and became effective in all areas of the United States on May 24, 2004. Although
the initial impact of WLNP on the Company's operations appears to be immaterial,
WLNP may have a significant future effect on the Company's operations. As a
result of WLNP, portions of the PCS subscriber base may migrate to other
wireless providers, thereby contributing to increased churn. Alternatively, the
implementation of WLNP may allow the Company to attract additional subscribers
from other wireless providers. To date, the impact of WLNP has been marginally
favorable to the Company.
The Company has limited control over the service plans and marketing promotions
offered by Sprint in the competitive wireless telecommunications industry.
Sprint controls the marketing plans, advertising message and market promotions
offered in the Company's market area. The plans and promotions offered may have
a materially adverse effect on the Company's results of operations.
The Company relies on Sprint for the development of new products and services to
remain competitive in the wireless industry. These services include text
messaging, video, data transfer, and push-to-talk walkie-talkie features. If
these services do not operate properly or if Sprint should not continue to
develop new competitive products, the results could have a materially adverse
impact on the results of the Company.
The Company is required to participate in national and regional third party
distribution programs formulated and negotiated by Sprint. Sprint has entered
into reseller agreements, which may affect
25
the Company. These distribution and reseller programs may have an adverse impact
on the Company's results.
The Company's PCS network is part of Sprint's nationwide wireless network. The
network is owned and operated by Sprint and its Affiliates. The financial
viability of Sprint and its Affiliates is critical to the success of operating
and marketing Sprint PCS. If financial difficulties are experienced by Sprint or
any Affiliate, those difficulties could have an adverse impact on the Company's
results.
The current competitive nature of the wireless industry may prompt major
wireless providers to strive for financial improvements through industry
consolidation. Such consolidation could include Sprint. It is not clear to what
extent consolidation may occur or which companies may be involved, but certain
consolidation transactions may have an adverse impact on the operating results
and valuation of the Company's wireless operations.
The Company's telephone access revenue may be adversely impacted by legislative
or regulatory actions that decrease access rates or exempt certain traffic from
paying access or by industry trends that shift minutes from the Company's
regulated telephone network. An unfavorable finding, trend or ruling may have an
adverse effect on the Company's telephone operations.
There has been a trend for incumbent local exchange carriers to see a decrease
in access lines due to the effect of wireless and wireline competition and the
elimination of a second line dedicated to dial-up Internet as customers migrate
to broadband connections. The Company has not seen a material reduction in its
number of access lines to date. An acceleration of this trend could have a
materially adverse effect on the Company's telephone operations in the future.
On May 24, 2004, Local Number Portability ("LNP") was implemented in the
Company's local wireline service area. The Company's customers are able to
retain their existing wireline phone number and use it to obtain service from a
competing wireline or wireless provider in the service area. To date, there has
been insignificant activity, but the Company cannot estimate the future impact
of LNP on its telephone operations. If a significant number of customers
disconnect the Company's service, such disconnections may have an adverse impact
on the Company's telephone operating results.
The Company's revenue from fiber leases may be adversely affected by further
erosion in demand or in price competition for these facilities. There is also
the potential for additional bankruptcies of the Company's customers. The
Company monitors each of its fiber lease customers closely to manage this risk.
The Company operates the cable television system in Shenandoah County, Virginia.
The Company has seen increased competition from satellite providers that are
larger and have cost advantages over the Company in programming procurement. The
continued success of the satellite television providers may have an adverse
impact on the Company's cable television results.
The Company may not be able to utilize all of its net operating loss carry
forwards for taxes in certain states before they expire. As a result, the
Company may have to write off some of its deferred tax assets, which could
adversely affect its future cash position.
26
Recent Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board, (the "FASB") issued
FASB Interpretation No. 46 (revised December 2003),"Consolidation of Variable
Interest Entities," which addresses how a business enterprise should evaluate
whether it has a controlling financial interest in an entity through means other
than voting rights and accordingly should consolidate the entity. FIN 46R
replaces FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities," which was issued in January 2003. The Company is required to apply
FIN 46R to variable interests in Variable Interest Entities created after
December 31, 2003. For variable interests in Variable Interest Entities created
before January 1, 2004, the Interpretation was applied beginning on January 1,
2004, except that the interpretation was required to be applied in the fourth
quarter of 2003 for any Variable Interest Entities that were considered to be
special purpose entities. For any Variable Interest Entities that must be
consolidated under FIN 46R that were created before January 1, 2004, the assets,
liabilities and non-controlling interests of the Variable Interest Entities
initially would be measured at their carrying amounts, with any difference
between the net amount added to the balance sheet and any previously recognized
interest being recognized as the cumulative effect of an accounting change. If
determining the carrying amounts is not practicable, fair value at the date FIN
46R first applies may be used to measure the assets, liabilities and
non-controlling interest of the VIE. The Company has determined the application
of FIN 46R to Variable Interest Entities in which the Company has variable
interests has no impact on the Company's consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Financial Instruments with
Characteristics of Liabilities and Equity," which was effective at the beginning
of the first interim period beginning after June 15, 2003. This Statement
establishes standards for the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity. The
Statement also includes required disclosures for financial instruments within
its scope. For the Company, the Statement was effective for instruments entered
into or modified after May 31, 2003 and otherwise became effective as of January
1, 2004, except for mandatorily redeemable financial instruments. For certain
mandatorily redeemable financial instruments, the Statement will be effective
for the Company on January 1, 2005. The effective date has been deferred
indefinitely for certain other types of mandatorily redeemable financial
instruments. The Company currently does not have any financial instruments that
are within the scope of this Statement.
In December 2003, the FASB issued SFAS No.132(R). SFAS No.132(R) is a revision
of SFAS No.132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits." SFAS No.132(R) is effective for financial statements with fiscal
years ending after December 15, 2003. SFAS No.132(R) requires additional
disclosures including information describing the types of plan assets,
investment strategy, measurement date(s), plan obligations, cash flows, and
components of net periodic benefit cost recognized during interim periods. The
objectives of the revisions are to provide qualitative information about the
items in the financial statements, quantitative information about items
recognized or disclosed in the financial statements, information that enables
users of financial statements to assess the effect that pension plans and other
post-retirement benefit plans have on entities' results of operations, and
information to facilitate assessments of future earnings and cash flows. The
Company has adopted this statement effective December 31, 2003. See note 9 to
the financial statements appearing elsewhere in this report for the disclosures
required by this pronouncement.
27
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's market risks relate primarily to changes in interest rates on
instruments held for other than trading purposes. The Company's interest rate
risk involves three components, although only one is of any significance at this
time. The first component is outstanding debt with variable rates. As of June
30, 2004, the Company's variable rate debt balance was zero. The Company has a
variable rate line of credit totaling $0.5 million with SunTrust Bank. The
Company's remaining debt has fixed rates through its maturity. A 10.0% decline
in market interest rates would increase the fair value of the fixed rate debt by
approximately $1.3 million, while the estimated current fair value of the fixed
rate debt is approximately $39.9 million.
The second component of interest rate risk is temporary excess cash, primarily
invested in overnight repurchase agreements and short-term certificates of
deposit and money market funds. The Company currently has approximately $23.7
million of cash equivalents in money market funds, which are accruing interest
at rates of approximately 1% per year. The cash is currently in short-term
investment vehicles that have limited interest rate risk. Management continues
to evaluate the most beneficial use of these funds.
The third component of interest rate risk is marked increases in interest rates,
which may adversely affect the rate at which the Company may borrow funds for
growth in the future. Although this risk is real, it is not significant at this
time as the Company has adequate cash for operations, payment of debt and
near-term capital projects.
Management does not view market risk as having a significant impact on the
Company's results of operations, although future results could be adversely
affected if interest rates were to escalate markedly and the Company required
external financing. Since the Company does not currently have significant
investments in publicly traded stock, there is limited risk related to the
Company's available-for-sale securities. General economic conditions affected by
regulatory changes, competition or other external influences may play a higher
risk to the Company's overall results.
As of June 30, 2004, the Company had $7.9 million invested in privately-held
companies directly or through investments with portfolio managers. Most of the
companies are at an early stage of development, and significant increases in
interest rates could have an adverse impact on their results, ability to raise
capital and viability. The Company's market risk is limited to the funds
previously invested and an additional $1.3 million committed under contracts the
Company has signed with portfolio managers.
28
ITEM 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in reports under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the rules and forms of the Securities and Exchange
Commission, and that such information is accumulated and communicated to
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosure.
The Company's management, with the participation of its Chief Executive Officer,
who is the Company's principal executive officer, and its Chief Financial
Officer, who is the Company's principal financial officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures as of June 30,
2004. Based upon that evaluation, the Chief Executive Officer and the Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures are effective in alerting them in a timely manner to material
information relating to Shenandoah Telecommunications Company, including its
consolidated subsidiaries, required to be included in this report and the other
reports that the Company files or submits under the Securities Exchange Act of
1934.
During the second fiscal quarter of 2004, there were no changes in the Company's
internal control over financial reporting that have materially affected, or that
are reasonably likely to materially affect, its internal control over financial
reporting.
Under our agreements with Sprint, Sprint provides us with billing, collections,
customer care, certain network operations and other back office services for the
PCS operation. As a result, Sprint remits to the Company approximately 63% of
the Company's total revenues based on the results of the 2004 second quarter,
while approximately 44% of the expenses reflected in the Company's consolidated
financial statements relate to charges by or through Sprint for expenses such as
billing, collections and customer care, roaming expense, long-distance, and
travel. Due to this relationship, the Company necessarily relies on Sprint to
provide accurate, timely and sufficient data and information to properly record
our revenues, expenses and accounts receivable, which underlie a substantial
portion of our periodic financial statements and other financial disclosures.
Information provided by Sprint includes reports regarding the subscriber
accounts receivable in our markets. Sprint provides us monthly accounts
receivable, billing and cash receipts information on a market level, rather than
a subscriber level. We review these various reports to identify discrepancies or
errors. However, under our agreements with Sprint, we are entitled to only a
portion of the receipts, net of items such as taxes, government surcharges,
certain allocable write-offs and the 8% of revenue retained by Sprint. Because
of our reliance on Sprint for financial information, we must depend on Sprint to
design adequate internal controls with respect to the processes established to
provide this data and information to the Company and Sprint's other PCS
affiliate network partners. To address this issue, Sprint engages its
independent auditors to perform a periodic evaluation of these controls and to
provide a "Report on Controls Placed in Operation and Tests of Operating
Effectiveness for Affiliates" under guidance provided in Statement of Auditing
Standards No. 70 ("SAS 70 reports"). The report is provided to us annually and
covers a twelve-month period from October to September. The most recent report
indicated there were no issues which would adversely affect the information used
to support the recording of the revenues and expenses provided by Sprint related
to our relationship with them.
29
In connection with the requirements imposed under Section 404 of the
Sarbanes-Oxley Act of 2002, we have retained an outside consulting firm to
assist us in reviewing, documenting, and improving our internal control
processes and intend to engage a regional accounting firm to assist in the
testing of these controls.
The Company dedicated significant resources during the second quarter of 2004 in
preparing for the conversion of its PCS point of sale system. The conversion
will involve a change from a stand-alone, Company-hosted system, to a system
hosted by Sprint that is integrated into the Sprint PCS billing system. Through
this integration, the Company has eliminated several points of multiple data
entry, thereby reducing the risk of error, and enhancing internal control, while
improving the sales process. The new system was placed in service during
mid-July 2004.
As part of the preparation for meeting the requirements of Section 404 of the
Sarbanes-Oxley Act, the Company has spent time formalizing and further
documenting existing internal controls. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Because of the inherent
limitations in all control systems no evaluation of controls can provide
absolute assurance that all control issues, if any, within a company have been
detected.
30
PART II. OTHER INFORMATION
ITEM 4. Submissions of Matters to a Vote of Security Holders set forth below:
(a) The Company held its 2004 annual meeting of shareholders on April 20,
2004.
(c) The following sets forth information regarding the election of
Directors at the 2004 annual meeting, which was the only matter voted upon
at the 2004 annual meeting. There were 7,604,257 shares of common stock
outstanding as of the record date for, and entitled to vote at, the 2004
annual meeting, of which 5,666,479 shares were present in person or by
proxy, and constituted a quorum.
The shareholders approved a proposal to elect each of the three nominees
to the board of directors for a three-year term, which will expire at the
annual meeting of shareholders in 2007. The tabulation of votes on this
proposal is as follows:
NOMINEE FOR WITHHELD
Christopher E. French 5,642,403 24,076
Dale S. Lam 5,627,289 39,190
James E. Zerkel II 5,631,071 35,408
31
ITEM 5. Other Information
Amendment to Sprint Management Agreement executed
May 24, 2004.
Attached
ITEM 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed with this Quarterly Report on Form
10-Q:
10.15 Addendum VI dated May 24, 2004 to Sprint PCS Management Agreement by
and among Sprint Spectrum L.P., WirelessCo, L.P., APC PCS, LLC,
PhillieCo, L.P., and Shenandoah Personal Communications Company.
31 Certifications pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934.
32 Certifications pursuant to Rule 13a-14(b) under the Securities
Exchange Act of 1934 and 18 U.S.C. 1350.
(b) The following Current Reports on Form 8-K were furnished during the
period covered by this report:
Filing Date of Report Item Reported
--------------------- -------------
April 15, 2004 Item 9 (press release announcing first
quarter 2004 financial results)
May 26, 2004 Item 5 (press release announcing the
signing of a $20 Million Agreement with
Lucent Technologies for 3G Network
Equipment)
May 26, 2004 Item 5 (press release announcing the
signing of an amendment to the
management agreement with Sprint)
32
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.
SHENANDOAH TELECOMMUNICATIONS COMPANY
(Registrant)
August 4, 2004 /S/ Earle A. MacKenzie
------------------------------------------------
Earle A. MacKenzie
Executive Vice President and
Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)
33
EXHIBIT INDEX
Exhibit No. Exhibit
----------- -------
10.15 Addendum VI dated May 24, 2004 to Sprint PCS Management
Agreement by and among Sprint Spectrum L.P., WirelessCo,
L.P., APC PCS, LLC, PhillieCo, L.P., and Shenandoah
Personal Communications Company.
31 Certifications pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934.
32 Certifications pursuant to Rule 13a-14(b) under the
Securities Exchange Act of 1934 and 18 U.S.C. 1350.
34