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UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from__________ to __________

Commission File No.: 000-09881

SHENANDOAH TELECOMMUNICATIONS COMPANY

(Exact name of registrant as specified in its charter)

500 Shentel Way, Edinburg, Virginia    22824

(Address of principal executive offices)  (Zip Code)

(540) 984-4141

(Registrant's telephone number, including area code)

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ☑   No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐

Accelerated filer ☑

Non-accelerated filer ☐

Smaller reporting company ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No  ☑

The number of shares of the registrant’s common stock outstanding on July 23, 2015 was 24,198,020.

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY

INDEX

 

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

See accompanying notes to unaudited consolidated financial statements.

(Continued)

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

See accompanying notes to unaudited consolidated financial statements.

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME AND

COMPREHENSIVE INCOME

(in thousands, except per share amounts)

 

See accompanying notes to unaudited consolidated financial statements.

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(in thousands, except per share amounts)

See accompanying notes to unaudited consolidated financial statements.

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

(Continued)

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

At June 30, 2015, accounts payable included approximately $1.2 million associated with capital expenditures. Cash flows for accounts payable and acquisition of property, plant and equipment exclude this activity.

See accompanying notes to unaudited consolidated financial statements.

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.	Basis of Presentation

The interim 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 audited consolidated financial statements and related notes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.  The balance sheet information at December 31, 2014 was derived from the audited December 31, 2014 consolidated balance sheet. Operating revenues and income from operations for any interim period are not necessarily indicative of results that may be expected for the entire year.

2.	Property, Plant and Equipment

Property, plant and equipment consisted of the following (in thousands):

3.	Earnings per share

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.  Of the 696 thousand and 694 thousand shares and options outstanding at June 30, 2015 and 2014, respectively, 79 thousand and zero were anti-dilutive, respectively.  These shares and options have been excluded from the computations of diluted earnings per share for their respective period.  There were no adjustments to net income for either period.

4.	Investments Carried at Fair Value

Investments include $2.8 million and $2.7 million of investments carried at fair value as of June 30, 2015 and December 31, 2014, respectively, consisting of equity, bond and money market mutual funds.  These investments were acquired under a rabbi trust arrangement related to the Company’s nonqualified Supplemental Executive Retirement Plan (the “SERP”). The Company purchases investments in the trust to mirror the investment elections of participants in the SERP; gains and losses on the investments in the trust are reflected as increases or decreases in the liability owed to the participants. During the six months ended June 30, 2015, the Company recognized $37 thousand in dividend and interest income from investments, and recorded net unrealized gains of $54 thousand on these investments. Fair values for these investments held under the rabbi trust were determined by Level 1 quoted market prices for the underlying mutual funds.

5.	Financial Instruments

Financial instruments on the consolidated balance sheets that approximate fair value include:  cash and cash equivalents, receivables, investments carried at fair value, payables, accrued liabilities, interest rate swaps and variable rate long-term debt.

 

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The Company’s objectives in using interest rate derivatives are to add stability to cash flows and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps (both those designated as cash flow hedges as well as those not designated as cash flow hedges) involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The Company entered into a pay-fixed, receive-variable interest rate swap of $174.6 million of notional principal in September 2012.  This interest rate swap was designated as a cash flow hedge.  The total outstanding notional amount of the cash flow hedge was $161.5 million as of June 30, 2015.  The outstanding notional amount decreases as the Company makes scheduled principal payments on the debt.

The effective portion of changes in the fair value of interest rate swaps designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The Company uses its derivatives to hedge the variable cash flows associated with existing variable-rate debt. The ineffective portion of the change in fair value of the derivative is recognized directly in earnings through interest expense. No hedge ineffectiveness was recognized during any of the periods presented.

Amounts reported in accumulated other comprehensive income related to the interest rate swap designated and that qualifies as a cash flow hedge are reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. As of June 30, 2015, the Company estimates that $1.2 million will be reclassified as an increase to interest expense during the next twelve months due to the interest rate swap since the hedge interest rate exceeds the variable interest rate on the debt.

The table below presents the fair value of the Company’s derivative financial instrument as well as its classification on the consolidated balance sheet as of June 30, 2015 and December 31, 2014 (in thousands):

The fair value of interest rate swaps is determined using a pricing model with inputs that are observable in the market (level 2 fair value inputs).

 

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The table below presents change in accumulated other comprehensive income by component for the six months ended June 30, 2015 (in thousands):

 

7.	Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision makers.  The Company has three reportable segments, which the Company operates and manages as strategic business units organized by lines of business: (1) Wireless, (2) Cable, and (3) Wireline.   A fourth segment, Other, primarily includes Shenandoah Telecommunications Company, the parent holding company.

The Wireless segment provides digital wireless service to a portion of a four-state area covering the region from Harrisburg, York and Altoona, Pennsylvania, to Harrisonburg, Virginia, as a Sprint PCS Affiliate.  This segment also owns cell site towers built on leased land, and leases space on these towers to both affiliates and non-affiliated service providers.

The Cable segment provides video, internet and voice services in Virginia, West Virginia and Maryland, and leases fiber optic facilities throughout southern Virginia and West Virginia. It does not include video, internet and voice services provided to customers in Shenandoah County, Virginia.

The Wireline segment provides regulated and unregulated voice services, DSL internet access, and long distance access services throughout Shenandoah County and portions of Rockingham, Frederick, Warren and Augusta counties, Virginia. The segment also provides video services in portions of Shenandoah County, and leases fiber optic facilities throughout the northern Shenandoah Valley of Virginia, northern Virginia and adjacent areas along the Interstate 81 corridor through West Virginia, Maryland and portions of Pennsylvania.

Three months ended June 30, 2015

(in thousands)

 

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Three months ended June 30, 2014

(in thousands)

 

 

(1)

Prior year service and other revenue amounts have been recast to conform to the current year presentation of video and internet equipment revenues being included in service revenue rather than other revenue.

 

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A reconciliation of the total of the reportable segments’ operating income to consolidated income before taxes is as follows:

The Company’s assets by segment are as follows:

8.	Income Taxes

The Company files U.S. federal income tax returns and various state and local income tax returns.  Years prior to 2011 are no longer subject to examination. The Company is not subject to any state or federal income tax audits as of June 30, 2015.

 

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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 “Risk Factors” in the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2014.  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, 2014, including the financial statements and related notes included therein.

General

Overview. Shenandoah Telecommunications Company is a diversified telecommunications company providing both regulated and unregulated telecommunications services through its wholly-owned subsidiaries.  These subsidiaries provide wireless personal communications services (as a Sprint PCS Affiliate), local exchange telephone services, video, internet and data services, long distance services, fiber optics facilities, and leased tower facilities. The Company has three reportable segments, which it operates and manages as strategic business units organized by lines of business:

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The Wireless segment provides digital wireless service as a Sprint PCS Affiliate to a portion of a four-state area covering the region from Harrisburg, York and Altoona, Pennsylvania, to Harrisonburg, Virginia.  In this area, the Company is the exclusive provider of wireless mobility communications network products and services on the 800 and 1900 MHz bands under the Sprint brand.  This segment also owns cell site towers built on leased land, and leases space on these towers to both affiliates and non-affiliated service providers.

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The Cable segment provides video, internet and voice services in franchise areas in portions of Virginia, West Virginia and western Maryland, and leases fiber optic facilities throughout its service area. It does not include video, internet and voice services provided to customers in Shenandoah County, Virginia.

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The Wireline segment provides regulated and unregulated voice services, DSL internet access, and long distance access services throughout Shenandoah County and portions of Rockingham, Frederick, Warren and Augusta counties, Virginia. The segment also provides video services in portions of Shenandoah County, and leases fiber optic facilities throughout the northern Shenandoah Valley of Virginia, northern Virginia and adjacent areas along the Interstate 81 corridor through West Virginia, Maryland and portions of Pennsylvania.

A fourth segment, Other, primarily includes Shenandoah Telecommunications Company, the parent holding company.

 

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Results of Operations

Three Months Ended June 30, 2015 Compared with the Three Months Ended June 30, 2014

The Company’s consolidated results for the second quarter of 2015 and 2014 are summarized as follows:

Operating revenues

For the three months ended June 30, 2015, operating revenues increased $4.3 million, or 5.3%. Cable segment revenue grew $3.3 million on higher internet and voice subscribers, a video price increase in January 2015, and internet customers upgrading to higher-priced plans. Wireless segment revenues increased $0.9 million compared to the second quarter of 2014. Net prepaid service revenue increased $1.2 million, driven by 6.3% subscriber growth, but was partially offset by a $0.4 million decline in net postpaid service revenues that resulted from lower revenue service plans associated with handset financing and leasing plans. Wireline segment revenue increased $0.8 million, primarily due to growth in fiber contracts.

Operating expenses

Total operating expenses were $67.0 million in the second quarter of 2015 compared to $65.6 million in the prior year period.  Cost of goods and services sold decreased $2.1 million, primarily due to a $3.1 million decrease in PCS postpaid handset costs, partially offset by a $1.0 million increase in cable programming costs. Selling, general and administrative expenses increased $2.4 million, including increases of $0.6 million to support the wireless prepaid business, $0.6 million to support marketing and selling functions in other areas of the business, $0.6 million for professional services, and $0.4 million related to growth in customer service and bad debt expenses. Depreciation and amortization expense increased $1.1 million, primarily due to ongoing projects to expand and upgrade the wireless, cable and fiber networks.

Income tax expense

The Company’s effective tax rate decreased from 39.8% for the three months ended June 30, 2014 to 39.6% for the three months ended June 30, 2015.  For the remainder of 2015, the Company expects that its effective tax rate, without unanticipated adjustments, will be approximately 40.0%.

Net income

For the three months ended June 30, 2015, net income increased $1.9 million, or 21.6%, primarily reflecting growth in Cable and Wireless segment operating results, offset by higher income tax expenses.

 

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Six Months Ended June 30, 2015 Compared with the Six Months Ended June 30, 2014

Consolidated Results

The Company’s consolidated results for the first six months of 2015 and 2014 are summarized as follows:

Operating revenues

For the six months ended June 30, 2015, operating revenues increased $8.1 million, or 5.0%. Cable segment service revenue grew $5.7 million as a result of a 6.4% growth in average subscriber counts and an increase in revenue per subscriber. Wireless segment revenues increased $2.3 million compared to the first six months of 2014 primarily due to growth in net prepaid service revenue. Wireline segment revenues increased by $0.6 million due to growth of internet service revenue and fiber revenues.

Operating expenses

Total operating expenses were $132.7 million in the six months ended June 30, 2015 compared to $130.4 million in the prior year period.  Cost of goods and services sold decreased $3.7 million, primarily due to a $5.8 million decrease in PCS postpaid handset costs, partially offset by a $2.3 million increase in cable programming costs. Selling, general and administrative expenses increased $4.0 million, including increases of $1.5 million to support the wireless prepaid business, $1.1 million for professional services, $0.6 million of property and other operating taxes, and $0.4 million related to growth in bad debt expenses. Depreciation and amortization expense increased $2.0 million, primarily due to ongoing projects to expand and upgrade the wireless, cable and fiber networks.

Income tax expense

The Company’s effective tax rate increased from 39.6% for the six months ended June 30, 2014 to 39.8% for the six months ended June 30, 2015.  For the remainder of 2015, the Company expects that its effective tax rate, without unanticipated adjustments, will be approximately 40.0%.

Net income

For the six months ended June 30, 2015, net income increased $3.5 million, or 20.5%, primarily reflecting growth in subscriber counts in the Wireless and Cable segments, offset by higher depreciation expense and costs associated with prepaid wireless programs.

Wireless

The Company’s Wireless segment provides digital wireless service to a portion of a four-state area covering the region from Harrisburg, York and Altoona, Pennsylvania, to Harrisonburg, Virginia, through Shenandoah Personal Communications, LLC (“PCS”), a Sprint PCS Affiliate.  This segment also leases land on which it builds Company-owned cell towers, which it leases to affiliated and non-affiliated wireless service providers, throughout the same four-state area described above, through Shenandoah Mobile, LLC (“Mobile”).

 

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PCS receives revenues from Sprint for subscribers that obtain service in PCS’s network coverage area.  PCS relies on Sprint to provide timely, accurate and complete information to record the appropriate revenue for each financial period.  Postpaid revenues received from Sprint are recorded net of certain fees retained by Sprint.  These fees total 22% of net postpaid billed revenue, as defined in the Sprint PCS affiliate agreement.

The Company offers prepaid wireless products and services in its PCS network coverage area.  Sprint retains a 6% Management Fee on prepaid revenues.  Prepaid revenues received from Sprint are reported net of the cost of this fee.  Other fees charged on a per unit basis are separately recorded as expenses according to the nature of the expense.  The Company pays handset subsidies to Sprint for the difference between the selling price of prepaid handsets and their cost, in aggregate and as a net cost included in cost of goods sold.  The revenue and expense components reported to us by Sprint are based on Sprint’s national averages for prepaid services, rather than being specifically determined by customers assigned to our geographic service areas.

In April 2014, the Company’s PCS stores began participating in Sprint’s postpaid handset financing programs, whereby Sprint enters into a financing agreement with the subscriber and the subscriber receives a handset from Sprint.  The equipment revenue from the subscriber and the handset expense are Sprint’s responsibility and are not recorded by the Company. In the second quarter of 2015, approximately 65% of postpaid handset transactions through Company channels involved a financing plan. All else being equal, the service plans for these subscribers generate less monthly service revenue compared to plans with a subsidized handset.

The following tables show selected operating statistics of the Wireless segment as of the dates shown:

1)

POPS refers to the estimated population of a given geographic area and is based on information purchased from third party sources.  Market POPS are those within a market area which the Company is authorized to serve under its Sprint PCS affiliate agreements, and Covered POPS are those covered by the Company’s network. Covered POPS increased in 2014 primarily as a result of the Company’s deployment of the 800 megahertz spectrum at existing cell sites.

2)

The decreases during 2014 are primarily a result of termination of Sprint iDEN leases associated with the former Nextel network.

3)

PCS Average Monthly Retail Churn is the average of the monthly subscriber turnover, or churn, calculations for the period.

 

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Three Months Ended June 30, 2015 Compared with the Three Months Ended June 30, 2014

 

Operating revenues

Wireless service revenue increased $0.9 million, or 1.8%, for the three months ended June 30, 2015, compared to the comparable 2014 period.  Net prepaid service revenues grew $1.2 million, or 11.1%, due to 6.3% growth in average prepaid subscribers over 2014 and improved product mix. Net postpaid service revenues decreased $0.4 million. Average postpaid subscribers increased 6.4% in 2015 over the 2014 period, but was more than offset by a switch to lower revenue service plans associated with handset financing plans.  Under these programs, the Company receives less service revenue from the subscriber, while the equipment revenue from the subscriber and the handset expense become Sprint’s responsibility and are not recorded by the Company.  The decreases in service revenues are currently more than offset by a decrease in handset expense within cost of goods and services.

Cost of goods and services

Cost of goods and services decreased $2.6 million, or 13.9%, in 2015 from the second quarter of 2014. Postpaid handset costs decreased $3.1 million, as handset expenses associated with financing and leasing plans are Sprint’s responsibility and are not recorded by the Company. Prepaid handset costs increased $0.3 million due to an increase in gross prepaid subscriber additions.  Network costs increased $0.2 million, driven by increases in rent and power expenses.

Selling, general and administrative

Selling, general and administrative costs increased $1.3 million, or 16.5%, in the second quarter of 2015 from the comparable 2014 period.  Advertising expenses grew $0.4 million. Costs to support the prepaid subscriber base grew $0.3 million, driven by subscriber growth, product mix, and higher expense rates. Costs associated with the addition of prepaid subscribers increased $0.3 million, driven by a 30.6% increase in prepaid gross additions over the prior year quarter. Personnel costs and other retail store expenses increased $0.3 million due to the addition of new stores.

Depreciation and amortization

Depreciation and amortization increased $0.5 million, or 6.7%, in the second quarter of 2015 over the comparable 2014 period. Depreciation expense grew $0.7 million due to ongoing investments in wireless network coverage and capacity. The increase was partially offset by a $0.2 million decline in amortization expense.

 

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Six Months Ended June 30, 2015 Compared with the Six Months Ended June 30, 2014

Operating revenues

Wireless service revenue increased $2.0 million, or 2.1%, for the six months ended June 30, 2015, compared to the comparable 2014 period.  Net prepaid service revenues grew $2.2 million, or 9.9%, due primarily to 6.3% growth in average prepaid subscribers over 2014. Net postpaid service revenues decreased $0.1 million.  Average postpaid subscribers increased 5.9% in 2015 over the 2014 period, but was largely offset by a switch to lower revenue service plans associated with handset financing plans.  Under these programs, the Company receives less service revenue from the subscriber, while the equipment revenue from the subscriber and the handset expense become Sprint’s responsibility and are not recorded by the Company.  The decreases in service revenues are currently more than offset by a decrease in handset expense within cost of goods and services.

Equipment revenue increased due primarily to lower discounts on subsidized handset sales.

Cost of goods and services

Cost of goods and services decreased $5.0 million, or 13.6%, in 2015 from the first half of 2014. Postpaid handset costs decreased $5.8 million, as handset expenses associated with financing and leasing plans are Sprint’s responsibility and are not recorded by the Company. Prepaid handset costs increased $0.3 million due to an increase in gross prepaid subscriber additions. The prior year period included a one-time $0.4 million gain on disposal of 3G equipment.

Selling, general and administrative

Selling, general and administrative costs increased $1.9 million, or 11.7%, in the first six months of 2015 from the comparable 2014 period.  Costs to support the prepaid subscriber base grew $1.5 million, driven by subscriber growth, product mix, and higher expense rates. Advertising expenses increased $0.6 million. Personnel costs increased $0.3 million due to the addition of new retail stores.  The increases were partially offset by a $0.8 million decline in third party commissions expense due to lower volume of commissionable handsets activated through dealer channels.

Depreciation and amortization

Depreciation and amortization increased $1.2 million, or 7.7%, in the first six months of 2015 over the comparable 2014 period. Depreciation expense grew $1.6 million due to ongoing investments in wireless network coverage and capacity. The increase was partially offset by a $0.4 million decline in amortization expense.

 

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Cable

The Cable segment provides video, internet and voice services in franchise areas in portions of Virginia, West Virginia and western Maryland, and leases fiber optic facilities throughout its service area. It does not include video, internet and voice services provided to customers in Shenandoah County, Virginia.