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 March 31, 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 Number)
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 April 23, 2004
----- -----------------------------
Common Stock, No Par Value 7,604,715 Shares
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARY COMPANIES
INDEX
Page
Numbers
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets
March 31, 2004 and December 31, 2003 3-4
Unaudited Condensed Consolidated Statements of Income for the
Three Months Ended March 31, 2004 and 2003 5
Unaudited Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2004 and 2003 6
Unaudited Condensed Consolidated Statements of
Shareholders' Equity and Comprehensive Income
for the Three Months Ended March 31, 2004 and the
Year Ended December 31, 2003 7
Notes to Unaudited Condensed Consolidated
Financial Statements 8-11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12-25
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
Item 4. Controls and Procedures 27-28
PART II. OTHER INFORMATION
Item 5. Other Information 28
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
Exhibit Index 30
Exhibit 31 31-32
Exhibit 32 33
2
Item 1. FINANCIAL STATEMENTS
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
Assets March 31, 2004 December 31, 2003
-------------- -----------------
Current Assets
Cash and cash equivalents $ 33,138 $ 28,696
Accounts receivable, net 6,974 6,488
Income tax receivable 576 1,526
Materials and supplies 1,859 2,062
Prepaid expenses and other (Note 10) 7,175 1,669
Deferred income taxes 400 522
-------- --------
Total current assets 50,122 40,963
Securities and investments
Available-for-sale securities 201 199
Other investments 7,263 7,268
-------- --------
Total securities and investments 7,464 7,467
Property, plant and equipment, net 124,879 127,686
Other Assets
Cost in excess of net assets of business
acquired 5,105 5,105
Deferred charges and other assets, net 1,048 999
Escrow account (Note 10) -- 5,000
-------- --------
6,153 11,104
Accumulated amortization 1,860 1,856
-------- --------
Net other assets 4,293 9,248
-------- --------
Total Assets $186,758 $185,364
======== ========
(continued)
3
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
(in thousands)
Liabilities and Shareholders' Equity March 31, 2004 December 31, 2003
-------------- -----------------
Current Liabilities
Current maturities of long-term debt $ 4,257 $ 4,230
Accounts payable 5,004 4,729
Advance billings and deposits 3,332 3,326
Other current liabilities 2,953 3,511
------------ ------------
Total current liabilities 15,546 15,796
Long-term debt, less current maturities 38,044 39,116
Other Liabilities
Deferred income taxes 20,719 20,819
Pension and other 3,777 3,425
------------ ------------
Total other liabilities 24,496 24,244
Shareholders' Equity
Common stock 5,882 5,733
Retained earnings 102,762 100,449
Accumulated other comprehensive income 28 26
------------ ------------
Total shareholders' equity 108,672 106,208
------------ ------------
Total Liabilities and Shareholders' Equity $ 186,758 $ 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
(in thousands, except per share data) March 31,
2004 2003
-------------------------------
Operating Revenues
Wireless $ 18,953 $ 15,634
Wireline 7,149 7,639
Other revenues 1,707 1,674
-------------------------------
Total revenues 27,809 24,947
Operating Expenses
Cost of goods and services 2,987 2,328
Network operating costs 8,314 8,007
Depreciation and amortization 4,337 4,021
Selling, general and administrative 7,887 6,441
-------------------------------
Total operating expense 23,525 20,797
-------------------------------
Operating Income 4,284 4,150
Other Income (expense):
Non-operating income, net 224 204
Loss on investments, net (18) (328)
Interest expense (797) (954)
-------------------------------
Income before income taxes, discontinued
operations and cumulative effect of change in accounting 3,693 3,072
Income tax provision (1,380) (1,141)
-------------------------------
Income from continuing operations 2,313 1,931
Income from discontinued operations, net of
income taxes -- 22,628
Cumulative effect of a change in accounting,
net of income taxes -- (76)
-------------------------------
Net income $ 2,313 $ 24,483
===============================
Net income per share, basic
Continuing operations $ 0.30 $ 0.26
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 $ 0.30 $ 3.24
===============================
Net income per share, diluted
Continuing operations $ 0.30 $ 0.26
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 $ 0.30 $ 3.23
===============================
Weighted average shares outstanding, basic 7,600 7,565
===============================
Weighted average shares, diluted 7,646 7,577
===============================
See accompanying notes to unaudited condensed consolidated financial statements.
5
SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three months ended
March 31,
2004 2003
-------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Income from continuing operations $ 2,313 $ 1,931
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 4,334 4,019
Amortization 3 2
Deferred income taxes 22 1,554
Gain on investments -- (83)
(Income) loss from patronage and equity investments (34) 292
Loss on disposal of equipment 79 20
Other 303 99
Changes in current assets and liabilities:
(Increase) decrease in:
Accounts receivable (486) 1,453
Materials and supplies 203 65
Increase (decrease) in:
Accounts payable 275 231
Other prepaids, deferrals and accruals (108) 138
-------------------------------
Net cash provided by operating activities 6,904 9,721
Cash Flows from Investing Activities
Purchases of property, plant and equipment (1,621) (2,027)
Purchases of other investments (56) (177)
Proceeds from investment activities 96 151
Proceeds from disposal of assets 15 --
-------------------------------
Net cash used in investing activities (1,566) (2,053)
Cash Flows from Financing Activities
Payments on long-term debt and revolving loan (1,045) (8,337)
Proceeds from issuance of common stock upon
exercise of stock options 149 226
-------------------------------
Net cash used in financing activities (896) (8,111)
-------------------------------
Net cash provided by (used in) continuing operations 4,442 (443)
Net cash provided by discontinued operations -- 34,522
-------------------------------
Net increase in cash and cash equivalents 4,442 34,079
Cash and Cash Equivalents
Beginning 28,696 2,209
-------------------------------
Ending $ 33,138 $ 36,288
===============================
Cash paid for:
Interest paid $ 799 $ 962
Income taxes (net of refunds) $ 410 $ 121
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 -- -- 2,313 2,313
Net unrealized change in securities
available-for-sale, net of tax -- -- 2 2
--------
Total comprehensive income 2,315
Common stock issued through the
exercise of stock options 11 149 -- 149
-----------------------------------------------------------------
Balance, March 31, 2004 7,604 $ 5,882 $102,762 $ 28 $108,672
=================================================================
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 the APB Opinion No.
25 and related interpretations. Accordingly, no compensation expense has been
recognized under the Plan. Had compensation expense been recorded 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 months ended March 31:
--------------------------
(in thousands, except Three months ended
per share amounts) March 31,
--------------------------
Net Income 2004 2003
As reported $ 2,313 $ 24,483
Pro forma 2,294 24,427
Earnings per share, basic and diluted
As reported, basic $ 0.30 $ 3.24
As reported, diluted 0.30 3.23
Pro forma, basic 0.30 3.23
Pro forma, diluted 0.29 3.22
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 provide. 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), income (loss) from
continuing operations, income from discontinued operations, cumulative effect of
accounting change, and net income (loss) of each segment is as follows for the
three months ended March 31, 2004 and March 31, 2003.
For the three months ended March 31, 2004
--------------------------------------------------------------------------------------------------
Net Income Income
(loss) from (loss) from
In thousands External Internal Operating continuing discontinued Cum. Net income
(unaudited) Revenues Revenues Income (loss) operations operations effect (loss)
--------------------------------------------------------------------------------------------------
Holding $ -- $ -- $ (528) $ (300) $ -- $ -- $ (300)
PCS 18,221 -- 1,161 484 -- -- 484
Telephone 5,546 932 2,608 1,589 -- -- 1,589
ShenTel Service 1,688 77 218 105 -- -- 105
Cable TV 1,104 6 182 70 -- -- 70
Mobile 732 320 462 250 -- -- 250
Long Distance 338 332 49 32 -- -- 32
Network 161 38 129 80 -- -- 80
ShenTel
Communications 17 -- 4 3 -- -- 3
Leasing 2 -- (1) -- -- -- --
--------------------------------------------------------------------------------------------------
Combined totals 27,809 1,705 4,284 2,313 -- -- 2,313
Inter-segment
eliminations -- (1,705) -- -- -- -- --
--------------------------------------------------------------------------------------------------
Consolidated totals $ 27,809 -- $ 4,284 $ 2,313 -- -- $ 2,313
==================================================================================================
For the three months ended March 31, 2003
--------------------------------------------------------------------------------------------------
Net Income Income
(loss) from (loss) from
In thousands External Internal Operating continuing discontinued Cum. Net income
(unaudited) Revenues Revenues Income (loss) operations operations effect (loss)
--------------------------------------------------------------------------------------------------
Holding $ -- $ -- $ (140) $ (47) $ -- $ -- $ (47)
PCS 14,976 -- (305) (684) -- -- (684)
Telephone 6,003 734 3,573 2,162 12 -- 2,174
ShenTel Service 1,659 80 370 209 -- -- 209
Cable TV 1,097 1 246 73 -- -- 73
Mobile 658 300 258 (6) 22,628 (76) 22,546
Long Distance 341 127 206 131 -- -- 131
Network 198 31 155 96 -- -- 96
ShenTel
Communications 11 -- (8) (4) -- -- (4)
Leasing 4 -- 1 1 -- -- 1
--------------------------------------------------------------------------------------------------
Combined totals 24,947 1,273 4,356 1,931 22,640 (76) 24,495
Inter-segment
eliminations -- (1,273) (206) -- (12) -- (12)
--------------------------------------------------------------------------------------------------
Consolidated totals $ 24,947 -- $ 4,150 $ 1,931 $ 22,628 $ (76) $ 24,483
==================================================================================================
9
The Company's assets by segment as of March 31, 2004, December 31, 2003, and
March 31, 2003 are as follows:
In thousands March 31, December 31, March 31,
(unaudited) 2004 2003 2003
Holding $ 143,198 $ 141,658 $ 143,631
PCS 68,864 68,773 68,104
Telephone 59,891 57,533 57,173
ShenTel Service 6,679 6,721 6,115
Cable TV 10,271 10,340 10,776
Mobile 18,580 18,396 16,854
Long Distance 866 808 552
Network 1,721 1,557 1,232
ShenTel Communications 69 78 111
Leasing 188 188 183
-----------------------------------------
Combined totals 310,327 $ 306,052 $ 304,731
Inter-segment eliminations (123,569) (120,688) (110,980)
-----------------------------------------
Consolidated totals $ 186,758 $ 185,364 $ 193,751
=========================================
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
In thousands (unaudited) March 31,
2004 2003
----------------------------
Net income $ 2,313 $ 24,483
Net unrealized income 2 (8)
----------------------------
Comprehensive income $ 2,315 $ 24,475
============================
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.
10
9. The following table presents pension and other post-retirement benefits
information for the periods presented.
Three Months Ended March 31,
In thousands (unaudited) 2004 2003
- --------------------------------------------------------------------------------------
Net periodic benefit cost recognized:
Service cost $ 166 $ 122
Interest cost 189 154
Expected return (135) (135)
Amortization of unrecognized transition asset (2) (7)
Recognized gains or losses 16 8
Prior service cost recognized 17 8
-----------------------
Total $ 251 $ 150
=======================
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 sale proceeds
as discontinued operations in the 2003 first quarter results. $5.0 million of
the sales price has been held in escrow and is now reflected as an other current
asset as of March 31, 2004.
11
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 over fifty thousand 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, 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 during 2002. In addition, the
Company sells and leases equipment, mainly related to services it provides, and
also 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.
12
The Company participates in the telecommunications industry, which requires
substantial investment in fixed assets or plant. For new initiatives, this
significant capital requirement may preclude profitability during the early
years of operation. The strategy of the Company is to expand and diversify its
business by adding services and geographic areas that can leverage the existing
plant, but to do so within the opportunities and constraints presented by the
industry. For many years the Company focused on reducing reliance on the
regulated telephone operation, which up until 1981 was the primary business
within the Company. This initial diversification was concentrated in other
wireline businesses, such as the cable television and regional fiber facility
businesses, but in 1990 the Company made its first significant investment in the
wireless sector through its former investment in the Virginia 10 RSA Limited
partnership. By 1998, revenues of the regulated telephone operation had
decreased to 59.2% of total revenues. In that same year more than 76.6% of the
Company's total revenue was generated by wireline operations, and initiatives
were already underway to make wireless a more significant contributor to total
revenues.
During the 1990's significant investments were made in the cellular and PCS
(wireless) businesses. The VA 10 RSA cellular operation, in which the Company
held a 66% interest and was the general partner, experienced rapid revenue
growth and excellent margins in the late 1990's. The cellular operation covered
only six counties, and became increasingly dependent on roaming revenues.
Management believed the roaming revenues and associated margins would be
unsustainable as other wireless providers increasingly offered
nationally-branded services with significantly reduced usage charges. To
position it to participate in the newer, more advanced, digital wireless
services, in 1995 the Company entered the PCS business through an affiliation
with American Personal Communications (APC), initiating service along the
Interstate 81 corridor from Harrisonburg, Virginia to Chambersburg,
Pennsylvania. This territory was a very close match to the Company's fiber
network, thereby providing economic integration that might not be available to
other wireless carriers. In 1999, the Company entered a new affiliation
arrangement with Sprint, the successor to APC (which introduced the Company to a
nationally-branded wireless service), and expanded the PCS footprint further
into Central Pennsylvania.
The wireless industry in the late 1990's became increasingly competitive and the
Company was not immune to industry issues. The Clear Pay(SM) program, introduced
by Sprint as a no-deposit offering in 2001, attracted high credit risk customers
in the Company's markets. As the results began to materialize, the Company
implemented deposits on this program (mid-April 2002), and experienced high
levels of customer turnover (churn) and uncollectable accounts. The write-offs
of uncollectable accounts peaked in the third quarter of 2002. During the fourth
quarter of 2002 there was some evidence that the strengthened credit policy was
having a favorable impact. Nonetheless, the 2002 net loss in the PCS operation
was $5.4 million, as compared to $5.5 million in 2001. Despite the disappointing
financial results for 2002, the PCS customer base grew by over 40%. While the
PCS operation was adding customers, the cellular operation continued to lose its
local customer base.
The growing belief that national branding was critical to our wireless
operations, the expectation that roaming revenues from our analog cellular
operation would not continue to grow, and the increase in the number of wireless
competitors in our markets, prompted the Company to exit the cellular business
in order to focus on our PCS operations. The Company entered into an agreement
on November 21, 2002 to sell its 66% ownership interest in the Virginia 10 RSA
cellular operation, which was then classified as a discontinued operation. The
sale closing occurred February 28, 2003.
13
The Company received $37.0 million in proceeds, including $5.0 million in escrow
for two years and $1.7 million for working capital.
On January 30, 2004, the Company signed an addendum to its management and
services agreements with Sprint, which is expected to lead to cost savings and
greater certainty in fees paid to Sprint. However, the consolidation predicted
for the wireless industry in recent years, including the recently announced sale
of the AT&T Wireless operations to Cingular and anticipated improvements in the
overall economics of wireless services, has not yet materialized. Future Sprint
marketing efforts, designed to meet the competition, could potentially have an
unfavorable impact on the Company and lead to additional losses. The risks
associated with the Sprint PCS affiliation are described elsewhere in this
report. The Company is now reviewing alternatives for other businesses to
further diversify our revenue mix based on services provided and geographic
areas served.
14
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 Month Period Ended
----------------------------------------------------------
(Unaudited) Mar. 31, Dec. 31, Sept. 30, Jun. 30, Mar. 31,
2004 2003 2003 2003 2003
----------------------------------------------------------
Telephone Access Lines 24,901 24,877 24,951 24,972 24,903
Cable Television Subscribers 8,701 8,696 8,796 8,750 8,704
Dial-up Internet Subscribers 17,063 17,420 17,616 17,798 18,174
DSL Subscribers 1,637 1,298 1,163 1,080 852
Retail PCS Subscribers 89,632 85,139 81,015 77,398 72,480
Wholesale PCS Users (1) 16,349 12,858 7,531 4,690 3,280
Paging Subscribers 1,862 1,989 2,107 2,315 2,805
Long Distance Subscribers 9,542 9,526 9,517 9,520 9,312
Fiber Route Miles 552 552 552 552 552
Total Fiber Miles 28,743 28,740 28,740 28,739 28,729
Wholesale PCS Minutes (000) 8,492 4,974 3,207 2,303 1,562
Long Distance Calls (000) (2) 5,821 5,851 6,078 5,001 5,074
Total Switched Access Minutes (000) 58,090 55,932 54,349 51,124 48,380
Originating Switched Access MOU (000) 18,252 17,829 18,285 18,343 18,685
Employees (full time equivalents) 272 268 264 266 267
CDMA Base Stations (sites) 257 253 248 246 240
Towers (100 foot and over) 78 77 76 73 72
Towers (under 100 foot) 11 11 10 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) 1,585 1,581 1,581 1,574 1,574
PCS Average Revenue Per User (ARPU) (ex. Travel) $ 50.38 $ 52.05 $ 55.09 $ 52.84 $ 52.22
PCS Travel Revenue per subscriber (4) $ 18.20 $ 20.84 $ 16.50 $ 17.18 $ 17.39
PCS Ave. Management Fee per subscriber $ 4.07 $ 4.02 $ 4.62 $ 4.58 $ 4.40
PCS Ave. Monthly Churn % 2.2% 2.3% 2.4% 2.1% 2.6%
PCS Cost Per Gross Addition (CPGA) $371.49 $387.47 $418.22 $376.98 $276.97
PCS Cash Cost Per User (CCPU) (4) $ 38.57 $ 36.31 $ 40.05 $ 44.23 $ 45.87
(1) - Wholesale Digital PCS Users are private label subscribers homed 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 roamer revenue and is divided by
average subscribers. PCS Average management fee per subscriber is 8% of
revenue paid to Sprint, excluding travel 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 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.
15
Significant Transactions
On January 30, 2004, the Company entered into an amendment to the Management
Agreement with Sprint as previously disclosed in the Company's Annual Report on
Form 10-K filed with the SEC on March 9, 2004. The agreement was filed as an
exhibit to that report.
During the first quarter 2004, the Company was notified by two of its
Interexchange carriers of a dispute they each filed in relation to how the
Company billed for 800 calls originating in the Company's service area. The
dispute covers the period of April 1, 2003 through February 28, 2004. As a
result, management recorded a $0.3 million reduction in access revenue.
Management reviewed the issue and effective in the second quarter of 2004, the
Company modified its bills for originating 800 call services.
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 business includes the Company's Internet operation, the
Interstate 81 corridor Travel 511 project, and the sales and service of
telecommunications systems.
From the mid 1990's, the principal source of the Company's revenues had shifted
from traditional wireline revenues to wireless and other revenues. For the three
months ended March 31, 2004, wireless revenue accounted for 68.2% of total
revenue, wireline revenue accounted for 25.7% of total revenue, and other
revenue accounted for 6.1% of total revenue. These results compare to 62.7% for
wireless, 30.6% for wireline and 6.7% for other, for the three months ended
March 31, 2003.
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, using 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 March 31, 2004. The Company
had 257 PCS CDMA base stations in service at March 31, 2004, compared to 240
base stations in service at March 31, 2003. This increase in base stations is
primarily the result of supplementing the 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 those subscribers using the Company's
network when they travel. The Company relies on
16
Sprint to provide timely, accurate and complete information for the Company to
record the appropriate revenue and expenses for the periods reflected.
The Company's PCS business has operated in a positive net travel revenue
position for several years. The Company received $6.0 million in net travel in
2003, compared to $5.8 million in 2002, and $4.0 million in 2001. In the first
quarter of 2004, the positive net travel revenue was $1.4 million compared to
$1.4 million in first quarter of 2003. This relationship could change due to
service plan changes, subscriber travel habit changes and other changes beyond
the control of the Company.
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.
In August 2002, the Company entered into a resale agreement for its PCS wireless
network through Sprint with Virgin Mobile USA, LLC, a joint venture of Sprint
and the Virgin global family of companies. The agreement allows the Company to
receive wholesale revenue for usage of the network by Virgin Mobile subscribers
traveling in or based in the Company's network coverage area. The Company also
agreed to sell Virgin Mobile handsets and plans in its retail stores. The plans
offered by Virgin Mobile are pre-paid plans, a type not currently offered by
Sprint. Prior to 2003, the Company did not experience significant revenue from
or usage by wholesale users. During the first quarter of 2004, the network
minutes generated by wholesale users, primarily from Virgin Mobile subscribers
active on the Company's PCS network, were nearly 8.5 million minutes compared to
1.6 million minutes generated in the first quarter of 2003.
As previously reported, the Company entered into an amendment to the management
agreement between the Company and Sprint on January 30, 2004. This amendment
extends the travel rate paid by the Company and received by the Company at the
$0.058 per minute through 2006. The Company's net travel and wholesale roaming
position increased to a $1.8 million receivable for the current quarter,
compared to a $1.2 million receivable for the same quarter last year, including
the long distance and 3G data portion of that traffic. The Company's travel
receivable minutes increased 40% to 62.0 million while the travel payable
minutes increased by 49% to 43.3 million compared to the first 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 165 minutes in the first quarter of 2004, which represented an increase of 25
minutes from first 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 first quarter of 2004, the Company's average PCS churn rate decreased to
2.2%, compared to 2.6% in the first quarter of 2003. To date, the impact of
Wireless Local Number Portability, which began November 24, 2003 in part of the
Company's service area, has not had a significant impact on churn. There is no
certainty this trend will continue. Bad debt expense has declined for the last
four quarters due to the implementation of deposits in the Clear Pay program
suspended nearly two years ago. Bad debt expense for the PCS operation, as a
percentage of service revenues, declined from 8.5% in the first quarter of 2003
to 3.6% in the first quarter of 2004. There is no certainty that
17
the improving bad debt trend will continue in the future, although management is
monitoring receivables and looking for signs of a deterioration of collection
efforts.
The wireline business is made up of traditional telephony, cable TV, fiber
network operations and the Company's 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 inhabitants, 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 subscriber count declined in the third and fourth
quarters of 2003 but increased by a net 24 subscribers in first quarter of 2004.
The Company believes the decline is attributable to the migration of customers
to wireless and DSL services. Based on industry experience, the Company
anticipates the trend of limited subscriber additions and, possibly, further
declines may continue for the foreseeable future.
Other revenues are primarily Internet services, which are provided through both
dial-up and DSL high-speed service. The Company has experienced a decline in
dial up subscriptions 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.
The Company is facing competition for revenues it generates in the other lines
of business, which will 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.
First Quarter 2004 vs. First Quarter 2003
General
Total revenue for the first quarter of 2004 was $27.8 million, which represented
an increase of $2.9 million, or 11.5% compared to $24.9 million for the first
quarter of 2003. Total revenues include wireless revenue of $19.0 million, which
increased by $3.3 million or 21.2%; wireline revenues of $7.1 million, which
decreased by $0.5 million, or 6.4%; and other revenues of $1.7 million, which
remained at the same level achieved in the first quarter of 2003. Operating
income increased $0.2 million, to $4.3 million, compared to $4.1 million for the
same period in 2003. Income per share from continuing operations, diluted was
$0.30 cents per share for the 2004 first quarter, compared to $0.26 per share
for the 2003 first quarter.
The 2003 first quarter results included $0.4 million of favorable adjustments to
prior period estimates, in addition to bad debt recoveries of $0.4 million.
Additionally, a reduction in revenue of $0.3 million was recorded in the first
quarter of 2004 against telephone access revenue related to revenue recorded in
prior periods disputed by interexchange carriers.
18
Revenues
Wireless revenues are primarily derived from the PCS business. As of March 31,
2004, the Company had 89,632 retail PCS subscribers. The PCS operation added
17,152 net subscribers since March 31, 2003, and 4,493 since December 31, 2003.
Wireless service revenues were $12.0 million for the first quarter of 2004,
which represented an increase of $2.1 million or 20.9% compared to $9.9 million
for first quarter of 2003. The Company's Average Revenue Per User (ARPU)
exclusive of travel revenue, decreased 3.5% to $50.38 for the first quarter of
2004, from $52.22 for the first quarter of 2003. The first quarter 2004 ARPU
also decreased 3.2% from the fourth quarter 2003 ARPU of $52.05. These decreases
were primarily attributable to subscribers generating less revenue from minutes
over plan usage.
PCS travel and roaming revenue combined for the first quarter 2004 were $5.4
million, which represented a $0.8 million or 16.7% increase compared to the
travel and roaming revenue for the first quarter of 2003. The travel and roamer
revenue increase resulted from an increase in travel usage, the effect of which
was offset in part by a decline in roaming usage for the same period.
Wireline revenues were $7.1 million in the 2004 first quarter, which represented
a decrease of $0.5 million or 6.4% from the 2003 first quarter. Access revenue
in the telephone business decreased $0.4 million, due primarily to a recorded
reduction in revenue of $0.3 million related to a dispute with interexchange
carriers in the rating of originating 800 traffic between interstate and
intrastate. Total switched minutes of use increased 20.1% compared to the first
quarter of 2003. The mix of wireless traffic to total traffic shifted from 32.8%
for the first quarter of 2003 to 42.8% for the first quarter of 2004. This
increase is primarily terminating traffic coming into the Company's network and
being delivered to wireless users.
Other revenues of $1.7 million remained at the same level achieved in the first
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 18,700
as of March 31, 2004 compared to 19,026 as of March 31, 2003. Total dial-up and
DSL Internet subscribers decreased 326 or 1.7% compared to March 31, 2003. While
DSL subscribers increased 785 or 92% compared to the March 31, 2003 subscriber
base, there was a decline of 1,111 subscribers or 6.1% decrease in dial-up
subscribers from the level at March 31, 2003. In those areas where the Company
does not offer a high speed access alternative, the Company has experienced
increased subscriber deactivations due to migration to competing high-speed
Internet services.
Operating Expenses
Total operating expense for the first quarter of 2004 was $23.5 million, which
represented an increase of $2.7 million or 13.1%, compared to the first quarter
of 2003. The principal factors reflected in the higher operating expense were an
increase in the number of PCS subscribers, the expanded PCS network operation,
and an increase in selling, general and administrative expenses, offset in part
by a significant decline in bad debt expenses.
Costs of goods and services were $3.0 million, which represented an increase of
$0.7 million or 29.3% from the first quarter of 2003. This increase was due
primarily to an increase in current PCS customers upgrading their handsets.
During the first quarter of 2004, the Company added 10,343 gross new PCS
subscribers compared to 10,362 gross new subscribers added in the first quarter
19
2003. Existing subscribers are purchasing Company subsidized new handsets to
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 first quarter of 2004 was $0.4 million. Management anticipates the
upgrade trend will continue, and may increase significantly in the future as
subsidized handsets are offered by wireless carriers as enticement for a
subscriber to extend their service agreement.
The Company's cost per gross add (CPGA) in the PCS business for the first
quarter of 2004 increased to $371.49 or 34.1% from the first quarter of 2003,
due to handset upgrade costs included in the CPGA measure. Cost of goods sold on
a per gross addition basis contributed $59.18 or 62.6% of the increase in the
CPGA measure. Currently, the Company classifies 100% of the handset cost as a
cost per gross addition, including the costs of existing subscribers electing to
up-grade their handsets.
Network operating costs for the first quarter of 2004 were $8.3 million, which
represented an increase of $0.3 million, or 3.7% compared to first quarter 2003.
Increased rental costs for towers and buildings of $0.1 million and increased
travel costs of $0.7 million were offset in part by lower network costs in the
PCS operation. The travel costs increased in part due to an increase in the
average minutes of use for travel by the Company's subscribers. This increase
was approximately 25 minutes per month per subscriber.
Depreciation and amortization expense for the 2004 first quarter was $4.3
million, which represented an increase of $0.3 million or 7.9% compared to $4.0
million for the first 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 $7.9 million, an increase of $1.4
million or 22.5%. Billing and customer care costs incurred in the PCS operation,
primarily charges from Sprint, increased $0.2 million as a result of the
increase in the total number of PCS subscribers, net of cost reductions obtained
as part of the amendment signed with Sprint on January 30, 2004. Increased
administrative staff and increases in wages and benefits for existing employees
contributed $0.5 million in added costs compared to the first quarter of 2003.
Costs incurred to prepare for Sarbanes-Oxley compliance were $0.3 million in the
first quarter of 2004. Selling and marketing expenses increased $0.5 million due
to added internal sales staff and expanded advertising efforts on the new
Shentel Pages phone book introduced in early 2004. Bad debt expenses decreased
$0.2 million primarily due to reduced PCS subscriber terminations for
non-payment compared to the first quarter of 2003, and bad debt recoveries of
$0.4 million recorded in the first quarter of 2003. Bad debt expense, net of
recoveries, was 1.6% of total revenue in the first quarter of 2004 compared to
2.5% of total revenue in the first quarter of 2003.
In the Company's PCS operation, cash cost per user (CCPU) for the first quarter
of 2004 declined to $38.57, which represented a 15.9% decrease from the first
quarter of 2003. The change was primarily the result of economies of scale due
to an increase in the average number of customers of 24.9% compared to the first
quarter of 2003.
Other Income (Expense)
Losses on external investments totaled $18 thousand in the first quarter of
2004, compared to a $0.3 million loss in the first quarter of 2003. First
quarter 2004 interest expense decreased by $0.2
20
million, or 16.5%, a result of decreased borrowing levels compared to the first
quarter of 2003. The Company's total debt as of March 31, 2004 was $42.3
million, compared to $47.2 million as of March 31, 2003 and $43.3 million as of
December 31, 2003.
Income before income taxes, discontinued operations and cumulative effect of
accounting changes was $3.7 million, which represented an increase of $0.7
million from the $3.0 million reported for the first quarter of 2003.
Income from continuing operations was $2.3 million for first quarter 2004,
compared to $1.9 million for the first quarter 2003, which represented an
increase of $0.4 million.
The results of discontinued operations in 2003 were from the sale of the VA 10
RSA limited partnership in February 2003. Income from discontinued operations
was $22.6 million in the first quarter of 2003, which is net of the tax effect
on the transaction. There were no discontinued operations in 2004.
The Company adopted FAS 143 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 first quarter of 2003.
The Company's first quarter net income was $2.3 million compared to $24.5
million in 2003.
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 traded, the Company evaluates
whether to hold or sell parts or all of each investment on an individual basis.
As of March 31, 2004, the Company held shares in two companies that are publicly
traded, with the following market values: $52 thousand in Net IQ (NTIQ) with
3,744 shares held, and $148 thousand in Deutsche Telekom, AG (DT) with 8,219
shares held.
Liquidity And Capital Resources
The Company generated $6.9 million in cash from operations in the first quarter
of 2004, compared to $9.7 million in the first quarter of 2003. The higher cash
flow in the 2003 first quarter was primarily attributable to a one-time payment
by Sprint PCS of $1.0 million for the true-up of cash payments due to a
calculation error in the distribution of cash between Sprint and the affiliates,
and the impact of the growth of deferred tax liabilities on cash flows.
The Company expects that operations will continue to generate positive cash
flows as PCS operations continue to improve and the Company further monitors its
current assets and current liabilities.
21
As of March 31, 2004, the Company's total debt was $42.3 million, with an
annualized overall weighted average interest rate of approximately 7.5%. As of
March 31, 2004, the Company was in compliance with the covenants in its credit
agreements.
The Company is obligated to make future payments under various contracts it has
entered into, 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 $33 million,
including approximately $23 million for additional PCS base stations, additional
towers, and switch upgrades to enhance the PCS network. Improvements and
replacements of approximately $5 million are planned for the telephone
operation. The remaining $5 million covers building renovations, vehicles,
office equipment, and other miscellaneous capital needs including the final
renovation to the Shentel Center in Edinburg, Virginia for the housing of its
corporate offices.
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 to fund potential dividend payments from cash on hand,
operating cash flow, and amounts expected to be available under the Company's
existing financing facilities and its anticipated financing facilities discussed
above. The Company may, at its election, liquidate some of its investments to
generate additional cash for its capital needs as market conditions allow.
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
as new developments and requirements are added.
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 respective periods. Corrections, if any, are made no earlier
than the period in which the parties agree to the corrections and as noted in
this report, there are several dispute settlements, true-ups of estimates and
corrections which are recorded in the period the issue has been resolved. The
Company is at risk for reporting errors that may be made by Sprint.
The net balance of PCS travel revenue and expense 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 impact the ability of the Company 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 will be
effective in all areas of the United States on May 24, 2004.
22
Although the initial impact of WLNP on the Company's operations appears to be
immaterial, there may be a significant future impact to 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.
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. As a result, the plans and promotions
offered may have a material 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, 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 material 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 will impact the Company. These distribution and
reseller programs may have an adverse effect on the results of the Company.
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 will 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 to the Company's regulated telephone network. An unfavorable
finding 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. Although the Company has not seen a material reduction
in its number of access lines to date, it experienced line decreases in the
third and fourth quarters of 2003. There is a significant risk that this trend
could have a material adverse effect on the Company's telephone operations in
the future.
On May 24, 2004, Local Number Portability (LNP) will be required in the
Company's local wireline service area. The Company's customers will be able to
retain their existing wireline phone
23
number and use it to obtain service from a competing wireline or wireless
provider in the service area. At this time, the Company cannot estimate the
potential impact on its telephone operations. If a significant number of
customers disconnect the Company's service, such disconnections will have an
adverse impact on the Company's telephone operating results.
The Company's revenue from fiber leases may be adversely impacted 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 minimize the risk
related to this business.
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 the procurement of
programming. The continued success of the satellite television providers may
have an adverse impact on the Company's cable television results.
The Company currently has a 12-month, $1.2 million contract with the Virginia
Department of Transportation (VDOT) to provide 511 Travel services in the I-81
corridor of Virginia. This contract expires in February 2005. The Department has
recently requested a proposal for a three-year contract with two two-year
extensions to extend 511 services to the entire state. The Company submitted a
proposal for the new VDOT contract, but there is no certainty that the Company
will be selected to provide these services after the end of its current
contract.
The Company may not be able to utilize all of its net operating loss carry
forwards for taxes in certain states before they expire, resulting in the
Company writing off some of its deferred tax assets and impacting its cash
position.
Recent Accounting Pronouncements
In December 2003, 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 SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Liabilities and Equity," which was effective
at the beginning of the first interim
24
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 132(R). SFAS 132(R) is a revision of SFAS
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits."
SFAS 132(R) is effective for financial statements with fiscal years ending after
December 15, 2003. SFAS 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
postretirement 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.
25
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. Our 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 March
31, 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 Banks. The
Company's remaining debt has fixed rates through its maturity. A 10.0% decline
in interest rates would increase the fair value of the fixed rate debt by
approximately $1.2 million, while the estimated current fair value of the fixed
rate debt is approximately $41.1 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 $23.6
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 impact 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
impacted 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, currently there is limited risk related to
the Company's available for sale securities. General economic conditions
impacted by regulatory changes, competition or other external influences may
play a higher risk to the Company's overall results.
As of March 31, 2004, the Company has $7.5 million invested in privately held
companies directly or through investments with portfolio managers. Most of the
companies are early stage 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 $1.7 million committed under contracts the Company has signed with
portfolio managers.
26
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 Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Commission's rules and forms, 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 March
31, 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 Shentel, 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 first fiscal quarter of 2004, there have been 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. As a
result, Sprint remits to the Company approximately 62% of the Company's total
revenues based on this quarter's results and approximately 39% 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 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. This report did not indicate
there were issues which would adversely impact the information used to support
the recording of the revenues and expenses provided by Sprint related to our
relationship with them.
27
We believe the processes we have put into place have steadily improved our
ability to identify material errors in Sprint financial information on a timely
basis.
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 and documenting our internal control processes.
PART II. OTHER INFORMATION
ITEM 5. Other Information
At the Company's Annual Meeting of Shareholders, which was held on April 20,
2004, Dale S. Lam was elected to a three-year term of the Board of Directors.
Mr. Lam currently serves as Chief Financial Officer and member of the Board of
Directors of ComSonics, Inc., a cable television equipment manufacturer and
repair operation located in Harrisonburg, Virginia. He is also a certified
public accountant and previously served in a variety of positions with WLR
Foods, Inc., including Controller, Chief Financial Officer, and Vice President
of Finance. Subsequent to the Annual Meeting, the Board of Directors appointed
Mr. Lam to its Audit Committee. The Board of Directors has determined that Mr.
Lam qualifies as an audit committee financial expert and is independent of
management under SEC rules.
Mr. Lam fills the vacancy created by the retirement of Dick D. Bowman. Mr.
Bowman's term of office expired at the 2004 Annual Meeting, and he was not
eligible to stand for re-election as a director due to the Board's mandatory
retirement policy.
ITEM 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are attached to this Quarterly Report on Form
10-Q:
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
--------------------- -------------
February 3, 2004 Item 9 (press release announcing
amendment to the Management
Agreement with Sprint)
February 13, 2004 Item 9 (press release announcing
Fourth Quarter and Full Year
2003 Financial Results)
28
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)
May 7, 2004 /S/ Earle A. MacKenzie
---------------------------------------------------------
Earle A. MacKenzie
Executive Vice President and
Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)
29
EXHIBIT INDEX
Exhibit No. Exhibit
----------- -------
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.
30
Exhibit 31
CERTIFICATION
I, Christopher E. French, President and Chief Executive Officer of Shenandoah
Telecommunications Company certify that:
1. I have reviewed this quarterly report on Form 10-Q of Shenandoah
Telecommunications Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter (the registrant's
fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons
performing the equivalent function(s)):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: May 7, 2004 /S/ Christopher E. French
-------------------------
Christopher E. French
President and
Chief Executive Officer
31
CERTIFICATION
I, Earle A. MacKenzie, Executive Vice President and Chief Financial Officer of
Shenandoah Telecommunications Company certify that:
1. I have reviewed this quarterly report on Form 10-Q of Shenandoah
Telecommunications Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter (the registrant's
fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons
performing the equivalent function(s)):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: May 7, 2004 /S/ Earle A. MacKenzie
----------------------------------
Earle A. MacKenzie
Executive Vice President and
Chief Financial Officer
32
Exhibit 32
Written Statement of Chief Executive Officer and Chief Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Each of the undersigned, the President and Chief Executive Officer and the
Executive Vice President and Chief Financial Officer, of Shenandoah
Telecommunications Company (the "Company"), hereby certifies that, on the date
hereof:
(1) the quarterly report on Form 10-Q of the Company for the three months
ended March 31, 2004 filed on the date hereof with the Securities and Exchange
Commission (the "Report") fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/S/ Christopher E. French
-------------------------------------
Christopher E. French
President and Chief Executive Officer
May 7, 2004
/S/ Earle A. MacKenzie
-------------------------------------
Earle A. MacKenzie
Executive Vice President and
Chief Financial Officer
May 7, 2004
The foregoing certification is being furnished solely pursuant to Rule 13a-14(b)
under the Securities Exchange Act of 1934 (the "Exchange Act") and 18 U.S.C.
Section 1350 and is not being filed as part of the Report or as a separate
disclosure document. This certification shall not be deemed "filed" for purposes
of Section 18 of the Exchange Act or otherwise subject to liability under that
section. This certification shall not be deemed to be incorporated by reference
into any filing under the Securities Act of 1933 or the Exchange Act except to
the extent this Exhibit 32 is expressly and specifically incorporated by
reference in any such filing.
33