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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
|_| 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)
VIRGINIA 54-1162807
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
124 South Main Street, Edinburg, VA 22824
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (540) 984-4141
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
----------
Securities registered pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK (NO PAR VALUE)
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports, and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registration is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes |X| NO |_|
1
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of June 27, 2003, based on the closing sale price of such stock on
the NASDAQ National Market on such date, was approximately $157 million (In
determining this figure, the registrant has assumed that all of its officers and
directors are affiliates. Such assumption shall not be deemed to be conclusive
for any other purpose.)
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 FEBRUARY 24, 2004
Common Stock, No Par Value 7,602,838
----------
Information in Part III is incorporated by reference to the Company's
definitive proxy statement for its 2004 Annual Meeting of Shareholders.
2
SHENANDOAH TELECOMMUNICATIONS COMPANY
Item Page
Number Number
PART I
1. Business 4-16
2. Properties 16-17
3. Legal Proceedings 17
4. Submission of Matters to a Vote of Security Holders 17
PART II
5. Market for the Registrant's Common Equity and Related
Shareholder Matters 18
6. Selected Financial Data 18-19
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19-39
7A. Quantitative and Qualitative Disclosures about Market Risk 40
8. Financial Statements and Supplementary Data 41
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 41
9A. Controls and Procedures 41
PART III
10. Directors and Executive Officers of the Registrant 42
11. Executive Compensation 42
12. Security Ownership of Certain Beneficial Owners and Management 43
13. Certain Relationships and Related Transactions 43
14. Principal Accountant Fees and Services 43
PART IV
15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 44-48
Index to the Consolidated 2003 Financial Statements F-1
Certifications
Exhibits Index
3
PART I
This Annual Report contains forward-looking statements. These
statements are subject to certain risks and uncertainties that could
cause actual results to differ materially from those anticipated in
the forward-looking statements. Factors that might cause such a
difference include, but are not limited to changes in the interest
rate environment; management's business strategy; national,
regional, and local market conditions; and legislative and
regulatory conditions. The Company undertakes no obligation to
publicly revise these forward-looking statements to reflect
subsequent events or circumstances, except as required by law.
ITEM 1. BUSINESS
Shenandoah Telecommunications Company is a diversified
telecommunications holding company providing both regulated and
unregulated telecommunications services through its nine
wholly-owned subsidiaries. The Company's business strategy is to
provide integrated, full service telecommunications products and
services in the Northern Shenandoah Valley and surrounding areas.
This geographic area includes the four-state region from
Harrisonburg, Virginia to the Harrisburg and Altoona, Pennsylvania
markets, and on a limited basis into Northern Virginia. Our fiber
network is a state-of-the-art electronic backbone utilized for many
of our services with the main lines of this network following the
Interstate-81 corridor and the Interstate-66 corridor in the
northwestern part of Virginia. Secondary routes providing redundant
capacity are built to provide alternate routing in the event of an
outage. The Company is certified to offer competitive local exchange
services in Virginia outside of the present telephone service area.
The Company has 268 employees and operates ten reporting segments
based on the products and services provided by the holding company
and the operating subsidiaries. There are minimal seasonal
variations in the Company's operations, with the exception of the
traditional seasonality in the retail sale of wireless handsets and
services in November and December. The Company provides personal
communications service (PCS) and is licensed to use the Sprint brand
name in the territory from Harrisonburg, Virginia to Harrisburg,
York and Altoona, Pennsylvania. The Company operates its PCS network
under the Sprint radio spectrum license. The Company also holds a
paging radio telecommunications license.
In November 2002, the Company entered into an agreement to sell its
66% general partner interest in the Virginia 10 RSA Limited
Partnership (cellular operation) to Verizon Wireless for $37.0
million. The partnership interest was owned by the Mobile company
subsidiary. The closing of the sale took place at the close of
business on February 28, 2003. The total proceeds received were
$38.7 million, including $5.0 million held in escrow, and a $1.7
million adjustment for estimated working capital at the time of
closing. There was a post closing adjustment based on the actual
working capital balance as of the closing date, which amounted to a
charge to the Company of $39 thousand. The $5.0 million escrow was
established for any contingencies and indemnification issues that
may arise during the two-year post-closing period. To date, there
have been no claims filed against the escrowed funds. The Company's
net after tax gain on the total transaction was approximately $22.4
million, which is reflected in the 2003 financial statements. As set
forth in the Company's consolidated financial statements appearing
in the Company's 2003 Annual Report to security holders, the
operating results of the partnership are reflected in discontinued
operations for all periods presented.
4
Shenandoah Telecommunications Company
The Holding Company invests in both affiliated and non-affiliated
companies. The Company's investments in non-affiliated companies are
The Burton Partnership, LP (Burton), CoBank, Dolphin Communications
Parallel Fund, LP (Dolphin), Dolphin Communications Fund II, LP
(Dolphin II), NECA Services, Inc., NTC Communications, L.L.C.,
(NTC), South Atlantic Private Equity IV LP (SAPE IV), and South
Atlantic Venture Fund III (SAVF III). Burton invests in a
combination of small capitalization public companies and privately
owned emerging growth companies. CoBank is a cooperative bank, and
is the Company's primary lender. As a term of the loan agreement,
the Company is required to own a specified amount of CoBank's stock.
The growth of this investment is the result of distributions
declared by CoBank and recorded by the Company that will be received
by the Company in the future. Dolphin, Dolphin II, SAVF III, and
SAPE IV are venture capital funds that invest in startup companies,
a large number of which are telecommunications firms. NECA Services,
Inc. provides services to telecommunications providers. NTC is a
limited liability company that provides bundled telecommunication
services primarily to privately owned multi-unit housing properties
that target students near college and university campuses.
Shenandoah Telephone Company
This subsidiary provides both regulated and non-regulated telephone
services to approximately 24,900 customers as of December 31, 2003,
primarily in Shenandoah County and small service areas in
Rockingham, Frederick, and Warren counties in Virginia. This
subsidiary provides access for inter-exchange carriers to the local
exchange network. The telephone subsidiary has a 20 percent
ownership in Valley Network Partnership (ValleyNet), which is a
partnership offering fiber network facility capacity in western,
central, and northern Virginia, as well as the Interstate 81
corridor from Johnson City, Tennessee to Carlisle, Pennsylvania.
Shenandoah Cable Television Company
This subsidiary provides coaxial cable based television service to
approximately 8,700 customers in Shenandoah County. The system is a
state-of-the art hybrid fiber coaxial network, upgraded to 750
megahertz which provides better signal quality, expands the number
of channels, and provides the infrastructure for future offerings of
broadband services. Digital program offerings along with pay per
view options are value added features available to customers.
ShenTel Service Company (ShenTel)
ShenTel Service Company sells and services telecommunications
equipment and provides information services and Internet access to
customers in the Northern Shenandoah Valley and surrounding areas.
The Internet service has approximately 17,400 dial-up customers and
nearly 1,300 DSL customers as of December 31, 2003. This subsidiary
offers broadband Internet access via ADSL technology.
5
Shenandoah Valley Leasing Company
This subsidiary finances purchases of telecommunications equipment
by customers of the other subsidiaries, particularly ShenTel Service
Company.
Shenandoah Mobile Company
Shenandoah Mobile Company owns and leases tower space in the PCS
service territory mentioned below in Virginia, West Virginia,
Maryland and Pennsylvania to Shenandoah Personal Communications
Company and other wireless communications providers. Additionally,
this subsidiary provides paging service throughout the Virginia
portion of the Northern Shenandoah Valley. Shenandoah Mobile Company
was the managing partner and 66% owner of the Virginia 10 RSA
Limited Partnership prior to its sale February 28, 2003.
Shenandoah Long Distance Company
This subsidiary principally offers resale of long distance service
for calls placed to locations outside the regulated telephone
service area. This operation purchases switching and billing and
collection services from the telephone subsidiary similar to other
long distance providers. In addition, this subsidiary offers
facility leases of fiber optic capacity in surrounding counties, and
into Herndon, Virginia. This subsidiary has approximately 9,500
customers at December 31, 2003.
Shenandoah Network Company
This subsidiary owns and operates the Maryland and West Virginia
portions of a fiber optic network in the Interstate-81 corridor. In
conjunction with the telephone subsidiary, Shenandoah Network
Company is associated with the ValleyNet fiber network.
ShenTel Communications Company
This subsidiary began offering DSL service marketing Front Royal,
VA. in early 2002, is outside the Company's regulated service area.
The Company is operating this subsidiary as a Competitive Local
Exchange Carrier (CLEC). Currently there are minimal subscribers
receiving service from this subsidiary.
Shenandoah Personal Communications Company (PCS)
PCS began offering personal communications services through a
digital wireless telephone and data network in 1995. The service was
originally offered from Chambersburg, Pennsylvania to Harrisonburg,
Virginia under an agreement with American Personal Communications
(APC), using the GSM air interface technology. Upon the sale of APC
to Sprint, during the fourth quarter of 1999, PCS executed a
management agreement with Sprint, finished constructing and
activating a CDMA network where our GSM network existed, and
converted our PCS customer base from GSM to CDMA service. The Sprint
agreement expanded the Company's existing PCS territory to include
the adjacent Basic Trading Areas of Altoona, Harrisburg, and
York-Hanover, Pennsylvania increasing the population served by PCS
from of 679,000 to one of 2,048,000. During 2000, PCS completed the
initial network build-out of the Harrisburg/York, PA. market,
placing 74 sites in service in February 2001. This portion of the
network includes Harrisburg, York, Hanover, Gettysburg, and
Carlisle, Pennsylvania. In December 2001, the Altoona, Pennsylvania
market was activated bringing the total covered population to
approximately 1,600,000. The network covers
6
233 miles of Interstates 81 and 83, and provides coverage on a
126-mile section of the Pennsylvania Turnpike between Pittsburgh and
Philadelphia. The Company had approximately 85,100 PCS customers at
December 31, 2003.
Additional information regarding the details of the agreements with
Sprint is set forth in Note 7 of the Company's consolidated
financial statements and related notes thereto appearing elsewhere
in this report.
Additional detail on the operating segments is set forth in Note 14
of the Company's consolidated financial statements appearing
elsewhere in this report.
The registrant does not engage in operations in foreign countries.
Working capital practices and competitive conditions are discussed
in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the consolidated financial statements and
related notes thereto appearing elsewhere in this report.
The Company has no research and development expenses.
Websites and Additional Information
The SEC maintains a website at www.sec.gov that contains reports,
proxy and information statements, and other information regarding
the Company. In addition, we maintain a corporate website at
www.shentel.com. We make available free of charge through our
website our annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and all amendments to those
reports, as soon as reasonably practicable after we electronically
file or furnish such material with or to the SEC. The contents of
our website are not a part of this report.
We also make available on our website and in print to any
shareholder who requests them copies of the charters of each
standing committee of our board of directors and our code of
business conduct and ethics. Requests for copies of these documents
may be directed to our Secretary at Shenandoah Telecommunications
Company, 124 South Main Street, P.O. Box 459, Edinburg, Virginia
22824. To the extent required by SEC rules, we intend to disclose
any amendments to our code of conduct and ethics, and any waiver of
a provision of the code with respect to the Company's directors,
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions, on our website referred to above within five business
days following any such amendment or waiver, or within any other
period that may be required under SEC rules from time to time.
RISK FACTORS
The Company is subject to many risks. The following items are
representative of the risks, uncertainties and assumptions that
could affect the Company, future performance, liquidity and the
outcome of the forward-looking statements. In addition, the
business, future performance, and liquidity could be affected by
general industry and market conditions and growth rates, general
economic and political conditions, including the global economy and
other future events, including those described below and elsewhere
in this annual report on Form 10-K.
7
Risks Related to the PCS Business
Shenandoah Personal Communications Company (PCS) is the largest of
our operating subsidiaries in terms of revenues and assets.
PCS faces many risks associated with this substantial and growing
business. The Company relies on Sprint's ongoing operations as the
basis for its ability to continue to offer its PCS subscribers
seamless national services that are currently provided. Given the
magnitude of the relationship, any interruption in Sprint's business
could adversely impact the Company's results of operations,
liquidity and financial condition.
Competition is intense in the wireless communications industry.
Competition has caused, and the Company anticipates that competition
will continue to cause, the market prices for two-way wireless
products and services to decline in the future. The ability to
compete will depend, in part, on the ability to anticipate and
respond to various competitive factors affecting the
telecommunications industry as a whole, and the wireless industry
specifically.
Revenues may be less than anticipated, which could materially
adversely affect liquidity, financial condition and results of
operations.
Revenue growth is primarily dependent on the growth of the
subscriber base, average monthly revenues per user, travel and
roaming revenue. The Company has seen a continuation of competitive
pressures in the wireless telecommunications market causing some
major carriers to offer plans with increasingly larger bundles of
minutes of use at lower prices that may compete with the Sprint
wireless calling plans sold by the Company. Increased price
competition may lead to lower average monthly revenues per user than
anticipated. In addition, the lower reciprocal travel rate that
Sprint instituted in 2003 reduced our travel revenue yield, although
the Company's overall travel revenue increased due to significantly
increased travel traffic. The Company's travel expense may not
follow the same trend in the future, depending on our subscribers'
travel usage outside our network area. If revenues are less than
anticipated, it could impact liquidity, financial condition and
results of operations.
Operating costs may be higher than anticipated which could
materially adversely affect liquidity, financial condition and
results of operations.
Increased competition may lead to higher promotional costs, losses
on sales of handsets and other costs to acquire subscribers.
Further, as described below under "Risks Related to Our Relationship
With Sprint," a substantial portion of costs of service and roaming
are attributable to fees and charges paid to Sprint for billing and
collection, customer care and other back-office support. The ability
to manage costs charged by Sprint is limited. If these costs are
more than anticipated, the actual amount of funds to implement the
Company's strategy and business plan may fall short of our
estimates, which could have a material adverse affect on liquidity,
financial condition and results of operations.
The dynamic nature of the wireless market may limit management's
ability to quickly discern causes of volatility in key operating
metrics.
The Company's dependence on Sprint to develop competitive products
and services in the PCS segment may limit the ability to keep pace
with competitors on the introduction of new products, services and
equipment.
8
The business plan and estimated future operating results are based
on estimates of key operating metrics, including subscriber growth,
subscriber turnover (commonly known as churn), average monthly
revenue per subscriber, losses on sales of handsets and other
subscriber acquisition costs and other operating costs. The dynamic
nature of the wireless market, economic conditions, increased
competition in the wireless telecommunications industry, Sprint's
or any competitor's new service offerings of increasingly larger
bundles of minutes of use at lower prices, and other issues facing
the wireless telecommunications industry in general created a level
of uncertainty that may adversely affect our ability to predict
these key operating metrics.
The Company may continue to experience a high rate of subscriber
turnover, which could adversely affect financial performance in the
future.
The 2004 business plan assumes that churn will remain fairly stable
under existing operating conditions. Due to significant competition
in the industry and general economic conditions, among other things,
this stability may not occur and the future rate of subscriber
turnover may be higher than the Company's recent experience. Factors
that may contribute to higher churn include:
o inability or unwillingness of subscribers to pay,
which results in involuntary deactivations;
o subscriber mix and credit class, particularly
sub-prime credit subscribers;
o competition of products, services and pricing of
other providers;
o inadequate network performance and coverage
relative to competitors in the Company's service
area;
o inadequate customer service;
o increased prices; and,
o any future changes by Sprint and/or the Company in
the products and services offered, especially as
it relates to sub-prime credit customers.
A high rate of subscriber turnover could adversely affect the
competitive position, liquidity, financial position, results of
operations and the costs of, or losses incurred in, obtaining new
subscribers, especially because as is the norm in the industry, the
Company subsidizes some of the costs related to the purchases of
handsets by subscribers.
The allowance for doubtful accounts is an estimate and may not be
sufficient to cover uncollectable accounts.
On an ongoing basis, the Company estimates the amount of subscriber
receivables that will not be collected based on historical results
and actual write-offs reported by Sprint. The allowance for doubtful
accounts may underestimate actual unpaid receivables for various
reasons, including:
9
o the churn rate may exceed estimates;
o bad debt as a percentage of service revenues may
increase rather than remain consistent with
historical trends ;
o adverse changes in the economy; or,
o unanticipated changes in Sprint's wireless
products and services.
If the allowance for doubtful accounts is insufficient to cover
losses on receivables, it could adversely affect liquidity,
financial condition and results of operations.
Travel revenue, which is the fee paid to the Company by Sprint and
the other Sprint Affiliates when their customers use the Company's
network, could be less than anticipated, which could adversely
affect the liquidity, financial condition and results of operations.
The Company may incur significantly higher wireless handset subsidy
costs than anticipated for existing subscribers who upgrade to a new
handset.
As the Company's subscriber base matures, and technological
innovations occur, the Company anticipates existing subscribers will
continue to upgrade to new wireless handsets. The Company subsidizes
a portion of the price of wireless handsets and in some cases incurs
sales commissions, for handset upgrades, to discourage customer
defections to competitors. If more subscribers upgrade to new
wireless handsets than the Company projects, the results of
operations would be adversely affected. If the Company does not
continue to subsidize the cost of the handsets for handset
up-grades, subscribers could choose to deactivate and move to other
carriers.
If the Company is unable to secure additional tower sites or leases
to install equipment to expand the wireless coverage or is unable to
renew expiring leases, the level of service and ultimately the
financial condition and results of operations could be adversely
impacted.
Many of the Company's cell sites are co-located on leased tower
facilities shared with one or more wireless providers. A large
portion of these leased tower sites are owned by a limited number of
companies. If economic conditions affect the leasing company, the
Company's lease may be impacted and the ability to remain on the
tower could be jeopardized, which could leave areas of the Company's
service area without service, and therefore the financial condition
and results of operations could be materially and adversely
affected.
Media reports have suggested that certain radio frequency emissions
from wireless handsets may be linked to various health problems,
including cancer, and may interfere with various electronic medical
devices, including hearing aids and pacemakers. Concerns over radio
frequency emissions may discourage use of wireless handsets or
expose the Company to potential litigation. Any resulting decrease
in demand for wireless services, costs of litigation or damage
awards could impair the ability to sustain profitability.
Regulation by government or potential litigation relating to the use
of wireless phones while driving could adversely affect our results
of operations, liquidity and financial condition. Some studies have
indicated that some aspects of using wireless phones
10
while driving may impair drivers' attention in certain
circumstances, making accidents more likely. These concerns could
lead to litigation relating to accidents, deaths or serious bodily
injuries, or to new restrictions or regulations on wireless phone
use, any of which also could have an adverse effect on the results
of operations. A number of U.S. states and local governments are
considering or have recently enacted legislation that would restrict
or prohibit the use of a wireless handset while driving a vehicle
or, alternatively, require the use of a hands-free telephone.
Legislation of this nature, if enacted, could require wireless
service providers to supply to its subscribers hands-free enhanced
services, such as voice activated dialing and hands-free speaker
phones and headsets, in order to continue generating revenue from
their subscribers who use wireless phones while driving. If the
Company is unable to provide hands-free services and products to
subscribers in a timely and adequate fashion, the volume of wireless
phone usage would likely decrease, and the ability to generate
revenues would suffer in the wireless line of our business.
Risks Related to the Telecommunications Industry
With the enactment of the Telecommunications Act of 1996,
competition in all segments of the business has intensified.
As new technologies are developed and deployed by competitors in the
Company's service area, there is the potential that subscribers will
elect other providers' offerings, based on price, capabilities and
personal preferences. If significant numbers of the Company's
subscribers elect to move to other competing providers, it could
prevent the Company from operating profitably.
Most of the Company's competitors are larger, possess greater
resources, have more extensive coverage areas, and offer more
services than the Company. There has been a recent trend in the
industry towards consolidation through joint ventures,
reorganizations and acquisitions. The Company expects this
consolidation to lead to larger competitors over time, and as a
result, the Company may be unable to compete successfully with
larger companies that have substantially greater resources or that
offer more services to larger geographic areas.
Market saturation could limit or decrease the rate of new subscriber
additions.
Alternative technologies, changes in the regulatory environment and
current uncertainties in the marketplace may reduce future demand
for existing telecommunication services.
The telecommunications industry is experiencing significant
technological change, evolving industry standards, ongoing
improvements in the capacity and quality of digital technology,
shorter development cycles for new products and enhancements and
changes in end-user requirements and preferences. Technological
advances and industry changes could cause the technology used by the
Company to become obsolete. The Company and its vendors may not be
able to respond to such changes and implement new technology on a
timely basis, or at an acceptable cost.
If the Company and other companies that support the Company's
operations are unable to keep pace with these technological changes,
the Company may lose revenues, subscribers or both. This could be
the result of changes in the telecommunications market based on the
effects of the Telecommunications Act of 1996, from the uncertainty
of future government regulation and changes in customers' technology
demands.
11
A recession in the United States involving significantly reduced
consumer spending could have a negative impact on the results of
operations.
The Company customers are individual consumers and businesses that
provide goods and services to consumers. The Company's customers are
located in a relatively concentrated geographic area and our
accounts receivable represent unsecured credit. An economic downturn
could have an adverse affect on the Company's operations. In the
event that the economic downturn occurs, and spending by consumers
drops significantly, the Company may be negatively affected.
Regulation by government and taxing agencies may increase the costs
of providing service or require changes in services, either of which
could impair the Company's financial performance.
The Company's operations is subject to varying degrees of regulation
by the Federal Communications Commission, the Federal Trade
Commission, the Federal Aviation Administration, the Environmental
Protection Agency, the Occupational Safety and Health Administration
along with state and local regulatory agencies and legislative
bodies. Adverse decisions or regulation of these regulatory bodies
could negatively impact the operations and the costs of doing
business. For example, changes in tax laws or the interpretation of
existing tax laws by state and local authorities could increase
income, sales or other tax costs.
Risks Related to the Company's Relationship with Sprint
The termination of the Company's affiliation with Sprint would
severely restrict the ability to conduct the wireless business.
The Company does not own the licenses to operate its wireless
network. The ability of the Company to offer Sprint wireless
products and services and operate a PCS network is dependent on the
Sprint agreements remaining in effect and not being terminated. The
Company's Management Agreement with Sprint automatically renews at
the expiration of the 20-year initial term which ends in 2019, for
an additional 10-year period and two subsequent 10-year periods
unless the Company is in material default. Sprint can choose not to
renew the Management Agreement at the expiration of any the renewal
term. In any event, the Management Agreement terminates in 50 years.
In addition, each of the Sprint Agreements can be terminated for
breach of any material term, including, among others, marketing,
build-out and network operational requirements. Many of these
requirements are extremely technical and detailed in nature. In
addition, many of these requirements can be changed by Sprint with
little notice. As a result, the Company may not always be in
compliance with all requirements of the Sprint agreements. At
December 31, 2003, the Company believes it was in compliance with
all material terms and conditions of the Sprint Management
Agreement.
The Company is dependent on Sprint's ability to perform its
obligations under the Sprint agreements. The non-renewal or
termination of any of the Sprint agreements or the failure of Sprint
to perform its obligations under the Sprint agreements would
severely restrict the ability to conduct business.
Sprint may make business decisions that are not in the Company's
best interests, which may adversely affect the relationships with
subscribers in our territory, increase expenses and/or decrease
revenues.
12
Sprint, under the Sprint Agreements, has a substantial amount of
control over the conduct of the Company's PCS business. Accordingly,
Sprint may make decisions that adversely affect our PCS business,
such as the following:
o Sprint could price its national plans based on its own
objectives and could set price levels or other terms
that may not be economically sufficient for the Company;
o Sprint could develop products and services, or establish
credit policies, which could adversely impact the
results of operations;
o Sprint cost to provide and maintain support services
could increase;
o Sprint can reduce the reciprocal travel rate charged
when Sprint's or its PCS Affiliates' subscribers use the
Company's network after 2006;
o Sprint could, subject to limitations under our Sprint
Agreements, alter its network and technical requirements
or request the Company build out additional areas within
its territories, which could result in increased
equipment and build-out costs; or
o Sprint could make decisions that could adversely affect
the Sprint brand names; products or services; or no
longer perform its obligations, any of which would
severely restrict the Company's ability to conduct
business in its PCS segment.
The occurrence of any of the foregoing could adversely affect the
relationship with wireless subscribers in the Company's territories,
increase expenses and/or decrease revenues and have a material
adverse affect on liquidity, financial condition and results of
operation not only in our PCS business, but could damage the
reputation of the Company and have a similar impact on the other
business segments.
The dependence on Sprint for services may limit the ability to
reduce costs, which could adversely affect the financial condition
and results of operations or may adversely affect the ability to
predict the results of operations.
The dependence on Sprint injects a greater degree of uncertainty to
the Company's business and financial planning. Unanticipated future
expenses and reductions in revenue will have a negative impact on
liquidity and make it more difficult to reliably predict future
performance.
It is the Company's policy to 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.
Inaccuracies in data provided by Sprint could overstate or
understate expenses or revenues and result in out-of-period
adjustments that may materially adversely impact financial results.
13
Because Sprint provides billing and collection services for the
Company, Sprint remits a significant portion of total revenues to
the Company. The Company relies on Sprint to provide accurate,
timely and sufficient data and information to properly record
revenues, expenses and accounts receivable, which underlie a
substantial portion of the financial statements and other financial
disclosures.
The Company and Sprint have previously discovered billing and other
errors or inaccuracies, which, while not material to Sprint, could
be material to the Company. If the Company is required in the future
to make additional adjustments or charges as a result of errors or
inaccuracies in data provided by Sprint, such adjustments or charges
may have a material adverse affect on the financial results in the
period that the adjustments or charges are made. Such adjustments,
may lead to a qualified opinion by the external auditors, or require
restatement of the Company's financial statements.
The Company is subject to risks relating to Sprint's provision of
back office services, changes in products, services, plans and
programs.
The inability of Sprint to provide high quality back office services
could lead to subscriber dissatisfaction, increased churn or
otherwise increased costs. The Company relies on Sprint's internal
support systems, including customer care, billing and back office
support. The Company's operations could be disrupted if Sprint is
unable to provide and expand its internal support systems in a high
quality manner, or to efficiently outsource those services and
systems through third-party vendors.
Sprint recently notified the Company that the customer care function
was being outsourced to IBM. This move could impact the level of
service the customers receive and could adversely impact the
Company's ability to retain subscribers in its markets.
Changes in Sprint's PCS products and services may reduce subscriber
additions, increase subscriber turnover and decrease subscriber
credit quality. The competitiveness of Sprint's PCS products and
services is a key factor in the ability to attract and retain
subscribers.
Sprint's roaming arrangements to provide service outside of the
Sprint National Network may not be competitive with other wireless
service providers, which may restrict the ability to attract and
retain subscribers and may increase the costs of doing business.
The Company relies on Sprint's roaming arrangements with other
wireless service providers for coverage in some areas where Sprint
service is not yet available. The risks related to these
arrangements include:
o the quality of the service provided by another provider
during a roaming call may not approximate the quality of
the service provided by the Sprint PCS network;
o the price of a roaming call off network may not be
competitive with prices of other wireless companies for
roaming calls;
o subscribers must end a call in progress and initiate a
new call when leaving the Sprint PCS network and
entering another wireless network;
14
o customers may not be able to use Sprint's advanced
features, such as voicemail notification, while roaming;
and
o Sprint or the carriers providing the service may not be
able to provide accurate billing information on a timely
basis.
If customers are not able to roam quickly or efficiently onto other
wireless networks, the Company may lose current subscribers and
Sprint wireless services will be less attractive to new subscribers.
Certain provisions of the Sprint Agreements may diminish the value
of the Company's common stock and restrict or diminish the value of
the business.
Under limited contractual circumstances, Sprint may purchase the
operating assets of the Company's PCS operation at a discount. In
addition, Sprint must approve any assignment of the Sprint
agreements. Sprint also has a right of first refusal if the Company
decides to sell its PCS operating assets to a third-party. These
restrictions and other restrictions contained in the Sprint
agreements could adversely affect the value of the Company's common
stock, may limit the ability to sell the business, may reduce the
value a buyer would be willing to pay and may reduce the "entire
business value," as described in the Sprint agreements.
The Company may have difficulty in obtaining an adequate supply of
certain handsets from Sprint, which could adversely affect the
results of operations.
PCS depends on our relationship with Sprint to obtain handsets.
Sprint orders handsets from various manufacturers. The Company could
have difficulty obtaining specific types of handsets in a timely
manner if:
o Sprint does not adequately project the need for handsets
for itself, its PCS Affiliates and its other third-party
distribution channels, particularly in transition to new
technologies;
o Sprint gives preference to other distribution channels;
o The Company does not adequately project its need for
handsets;
o Sprint modifies its handset logistics and delivery plan
in a manner that restricts or delays access to handsets;
or
o there is an adverse development in the relationship
between Sprint and its suppliers or vendors.
o Sprint and the Company rely on manufacturers for new
product introductions and meeting delivery commitments.
The occurrence of any of the foregoing could disrupt subscribers'
service and/or result in a decrease in subscribers, which could
adversely affect the results of operations.
If Sprint does not continue to enhance its nationwide digital
wireless network, the Company may not be able to attract and retain
subscribers.
Sprint currently intends to cover a significant portion of the
population of the United States, Puerto Rico and the U.S. Virgin
Islands by creating a nationwide network through its own
construction efforts and those of its PCS Affiliates. Sprint and the
Affiliates are still constructing its nationwide network and does
not offer PCS services, either on its own network or through its
roaming agreements, in every part of the United States. Sprint
15
has entered into management agreements similar to the Company's with
companies in other markets under its nationwide digital wireless
build-out strategy. The results of operations are dependent on
Sprint's national network and on the networks of Sprint's other
Affiliates. Sprint's digital wireless network may not provide
nationwide coverage to the same extent as its competitors, which
could adversely affect the ability to attract and retain
subscribers.
If other PCS Affiliates of Sprint have financial difficulties or
cease operating, the Affiliate's network could be disrupted.
Sprint's national digital wireless network is a combination of
networks. The large metropolitan areas are owned and operated by
Sprint, and the areas in between them are generally owned and
operated by Sprint PCS Affiliates, all of which are independent
companies.
If other PCS Affiliates experience financial difficulties, Sprint's
digital wireless network could be disrupted. While Sprint may have
the right to step in and operate the network in the affected
territory, there can be no assurance that the transition would occur
in a timely and seamless manner. In addition, the Company does not
have the ability to require other PCS Affiliates to pay amounts due
for travel in the Company's market areas by such other PCS
Affiliates subscribers. The Company relies on Sprint to enforce the
payment obligations of such PCS Affiliates.
Non-renewal or revocation by the Federal Communications Commission
(FCC) of Sprint's PCS licenses would significantly harm to the
Company. Wireless spectrum licenses are subject to renewal and
revocation by the FCC. There may be opposition to renewal of
Sprint's PCS licenses upon their expiration, and Sprint's PCS
licenses may not be renewed. The FCC has adopted specific standards
to apply to PCS license renewals. Any failure by Sprint to comply
with these standards could cause revocation or forfeiture of
Sprint's PCS licenses. If Sprint loses any of its licenses, it would
severely restrict the Company's ability to conduct business.
If Sprint does not maintain control over its licensed spectrum, the
Sprint agreements may be terminated, which would result in the
inability to provide service to the Company's subscribers.
ITEM 2. PROPERTIES
The Company owns a 24,000 square foot building in Edinburg, Virginia
that houses the corporate headquarters and the Company's main
switching center. A separate 10,000 square foot building in
Edinburg, is used for customer services and retail sales. In late
1999, the Company purchased a 60,000 square foot building in
Edinburg, which was initially used for storage and limited office
space. Renovations are currently underway to convert a portion of
the building into additional office space and meeting facilities.
The Company also owns eight telephone exchange buildings that are
located in the major towns and some of the rural communities and
that serve the regulated service area. These buildings contain
switching and fiber optic equipment and associated local exchange
telecommunications equipment. The Company owns a 6,000 square foot
service building outside of the town limits of Edinburg, Virginia.
The Company owns a 10,000 square foot building in Winchester,
Virginia used for retail sales and office space. The Company has
fiber optic hubs or points of presence in Hagerstown, Maryland;
Ashburn, Berryville, Front Royal, Harrisonburg, Herndon, Leesburg,
Stephens City, Warrenton and Winchester, Virginia; and Martinsburg,
West Virginia.
16
The buildings are a mixture of owned on leased land, leased space,
and leasehold improvements. The majority of the identified
properties are of masonry construction, are suitable to their
existing use, and are in adequate condition to meet the foreseeable
future needs of the organization. The Company is leasing a
warehouse, office space and an operations area in Pennsylvania, to
support the network and sales efforts in the Central Penn market.
The Company also leases retail space in Harrisonburg and Front
Royal, Virginia, Hagerstown, Maryland, and Harrisburg,
Mechanicsburg, and York, Pennsylvania. The Company plans to lease
additional land, equipment space, and retail space in support of the
ongoing PCS expansion.
ITEM 3. LEGAL PROCEEDINGS
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders for the
three months ended December 31, 2003.
17
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Company's stock is traded on the NASDAQ National Market under the
symbol "SHEN." Information on the high and low closing prices per share of
common stock as reported by the NASDAQ National Market for the last two years is
set forth below:
2003 High price Low price
---- ---------- ---------
First Quarter $24.31 $13.64
Second Quarter 24.98 14.33
Third Quarter 25.48 19.25
Fourth Quarter 27.50 19.74
2002 High price Low price
---- ---------- ---------
First Quarter $20.06 $16.50
Second Quarter 27.25 19.69
Third Quarter 27.25 22.75
Fourth Quarter 25.95 21.61
All share and per share figures are restated to reflect the 2 for 1 stock split
effected February 23, 2004.
As of February 15, 2004, there were approximately 3,930 holders of record of the
Company's common stock.
The Company historically has paid an annual cash dividend on or about December
1st of each year. The cash dividend was $0.39 per share in 2003 and $0.37 per
share in 2002. The terms of a mortgage agreement require the maintenance of
defined amounts of the Telephone subsidiary's equity and working capital after
payment of dividends. Approximately $2,812,000 of the Telephone subsidiary's
retained earnings was available for payment of dividends at December 31, 2003.
The loan agreement is not expected to limit dividends in amounts that the
Company historically has paid.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data as of December 31, 1999,
2000, 2001, 2002 and 2003 and for each of the five years ended December 31,
2003.
The selected financial data as of December 31, 2001, 2002 and 2003 and for each
of the years in the three-year period ended December 31, 2003 are derived from
the Company's audited consolidated financial statements appearing elsewhere in
this report.
The selected financial data as of December 31, 1999 and 2000 and for the years
ended December 31, 1999 and 2000 are derived from the Company's financial
statements which have been audited.
The selected financial data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our consolidated financial statements and related notes thereto appearing
elsewhere in this report.
(Dollar figures in thousands, except per share data.)
2003 2002 2001 2000 1999
----------- ----------- ---------- ---------- ----------
Operating Revenues $ 105,861 $ 92,974 $ 68,722 $ 44,445 $ 29,701
Operating Expenses 87,233 83,636 62,298 39,065 24,624
Income Taxes (Benefit) 5,304 (2,109) 5,811 2,975 1,729
Interest Expense 3,510 4,195 4,127 2,936 1,951
Income (Loss) from Continuing
Operations $ 9,761 $ (2,893) $ 9,694 $ 5,091 $ 2,927
Discontinued Operations, net of tax 22,389 7,412 6,678 4,764 3,501
Cumulative effect of a change in
accounting, net of tax (76) -- -- -- --
Net Income 32,074 4,519 16,372 9,855 6,428
Total Assets 185,364 164,004 167,372 152,585 133,644
Long-term Obligations 43,346 52,043 56,436 55,487 33,030
Shareholder Information
Number of Shareholders 3,930 3,954 3,752 3,726 3,683
Shares Outstanding 7,592,768 7,551,818 7,530,956 7,518,462 7,511,520
Income (Loss) per share from
Continuing Operations-diluted $ 1.28 $ (0.38) $ 1.28 $ 0.68 $ 0.39
Income per share from
Discontinued Operations-diluted 2.94 0.98 0.88 0.63 0.47
Loss per share from cumulative effect of
a change in accounting-diluted (0.01) -- -- -- --
Net Income per share-diluted 4.22 0.60 2.17 1.31 0.86
Cash dividends per share $ 0.39 $ 0.37 $ 0.35 $ 0.33 $ 0.28
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This annual report contains 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, including statements regarding our expectations, hopes,
intentions, or strategies regarding the future. These statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those anticipated in the forward-looking statements. Factors
that might cause such a difference include, but are not limited to, changes in
the interest rate environment, management's business strategy, national,
regional and local market conditions, and legislative and regulatory conditions.
The Company undertakes no obligation to publicly revise these forward-looking
statements to reflect subsequent events or circumstances, except as required by
law.
General
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 made up of
the Personal Communications Company (a PCS Affiliate of Sprint), and the Mobile
Company. Wireline revenues include the following subsidiary revenues in the
financial results: Telephone Company, Network Company, Cable Television Company,
and the Long Distance Company. Other revenues are comprised of the revenues of
ShenTel Service Company, the Leasing Company, ShenTel Communications Company and
the Holding Company. For additional information on the Company's business
segments, see Note 14 to audited consolidated financial statements appearing
elsewhere in this report.
19
The Company participates in the telecommunications industry, which requires
substantial investment in fixed assets or plant. This significant capital
requirement may preclude profitability during the initial years of operation.
The strategy of the Company is to grow and diversify the 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 Company's combined capital investment in 2000 and 2001
in the PCS operation was $45.1 million.
The wireless industry in the late 1990's became increasingly competitive and the
Company was not immune to these industry issues. The Clear PaySM 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 classified as a discontinued operation. The closing
occurred February 28, 2003. The Company received $37.0 million in proceeds,
including $5.0 million in escrow for two years and $1.7 million for working
capital.
In many respects, 2003 was a successful year. Churn and levels of uncollectable
accounts in the PCS operation returned to more acceptable levels. PCS revenues
reached $67.0 million, and total revenues reached $105.9 million. The PCS
operation recognized a small profit for the year, including favorable
adjustments associated with settlement of disputed items with Sprint. Excluding
the favorable adjustments, the PCS operation recognized a profit in the fourth
quarter. With improved operating cash flow and reduced capital spending in 2003,
the Company prepaid $4.6 million in debt, selecting those notes with nominal
prepayment penalties. Additionally, after receiving the cash and paying taxes on
the gain of the sale of the Virginia 10 partnership interest, the Company
invested the remaining proceeds in liquid financial instruments, available for
future deployment. Additionally, the Company has been successful at decreasing
its dependency on wireline revenues. Wireline revenues, at $29.0 million in 2003
compared to $18.6 million in 1998, were 27.4% of total revenues in 2003 compared
to 76.6% in 1998.
Entering 2004, the Company is pleased with the milestone of a profitable quarter
in the PCS operation, but recognizes that much work remains to ultimately earn a
reasonable return on this investment. The recently announced signing of an
addendum to the management and services agreements with Sprint is expected to
lead to cost savings and greater
20
certainty in fees paid to Sprint. However, the consolidation predicted for the
wireless industry in recent years, including the recently announced Cingular/ATT
deal 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 in further detail elsewhere in this document. The Company is now
reviewing alternatives for other businesses to further diversify our revenue
base, from either a services platform or a geographic concentration.
21
Additional Information About the Company's Business
(unaudited)
Three Month Period Ended Dec. 31, Sept. 30, Jun. 30, Mar. 31, Dec. 31,
2003 2003 2003 2003 2002
-----------------------------------------------------------------
Telephone Access Lines 24,877 24,951 24,972 24,903 24,879
CATV Subscribers 8,696 8,796 8,750 8,704 8,677
Dial-up Internet Subscribers 17,420 17,616 17,798 18,174 18,050
DSL Subscribers 1,298 1,163 1,080 852 646
Retail PCS Subscribers 85,139 81,015 77,398 72,480 67,842
Wholesale PCS Users (1) 12,858 7,531 4,690 3,280 1,672
Paging Subscribers 1,989 2,107 2,315 2,805 2,940
Long Distance Subscribers 9,526 9,517 9,520 9,312 9,310
Fiber Route Miles 552 552 552 552 549
Total Fiber Miles 28,740 28,740 28,739 28,729 28,403
Wholesale PCS Minutes (000) 4,974 3,207 2,303 1,562 530
Long Distance Calls (000) (2) 5,851 6,078 5,001 5,074 5,969
Total Switched Access Minutes (000) 55,932 54,349 51,124 48,380 46,627
Originating Switched Access MOU (000) 17,829 18,285 18,343 18,685 18,476
Employees (full time equivalents) 268 264 266 267 268
CDMA Base Stations (sites) 253 248 246 240 237
Towers (100 foot and over) 77 76 73 72 72
Towers (under 100 foot) 11 10 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) 1,581 1,581 1,574 1,574 1,555
PCS Average Revenue Per User (ex. Travel) $ 52.05 $ 55.09 $ 52.84 $ 52.22 $ 51.38
PCS Travel Revenue per sub. (4) $ 20.84 $ 16.50 $ 17.18 $ 17.39 $ 31.21
PCS Ave. Management Fee per sub $ 4.02 $ 4.62 $ 4.58 $ 4.40 $ 4.64
PCS Ave. Monthly Churn % 2.00% 2.20% 1.90% 2.30% 3.40%
PCS Cost Per Gross Addition (CPGA) $387.47 $418.22 $376.98 $276.97 $390.66
PCS Cash Cost Per User (CCPU) (4) $ 36.31 $ 40.05 $ 44.23 $ 45.87 $ 53.52
--------------------
PLANT FACILITIES Telephone CATV
--------------------
Route Miles 2,133.6 550.5
Customers Per Route Mile 11.7 15.8
Miles of Distribution Wire 579.3 157.8
Telephone Poles 7,675 36
Miles of Aerial Copper Cable 337.2 162.0
Miles of Buried Copper Cable 1,314.4 352.7
Miles of Underground Copper Cable 39.2 2.0
Fiber Optic Cable-Fiber Miles 256.9 --
Inter-toll Circuits to Interexchange Carriers 1,622 --
Special Service Circuits to Interexchange Carriers 313 --
(1) - Wholesale PCS Users are private label subscribers homed in the Company's
wireless network service area and primarily include Virgin Mobile
subscribers.
(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 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 collected revenue, excluding travel
revenue, retained by Sprint. 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.
22
(4) - On a normalized basis, the 4th quarter PCS travel revenue per subscriber
would be $19.25 and PCS CCPU would be approximately $38.66 taking into
account the adjustments and true-ups recorded in December 2003.
Significant Transactions
The Company had several significant transactions during 2003. The largest was
the sale of its 66% interest in the Virginia 10 RSA cellular operation, as
described above. The Company originally entered into the agreement with Verizon
Wireless in November 2002. The Company was the general partner of the limited
partnership which operated an analog cellular network in the six-county area of
Northwestern Virginia, including Clarke, Frederick, Page, Rappahannock,
Shenandoah, and Warren counties, and the city of Winchester. The sales price was
$37.0 million plus the Company's 66% share of the partnership's working capital,
which was approximately $1.7 million. The Company was required to do a working
capital true up following the closing, from which the Company recorded a charge
for $23 thousand after taxes. In the fourth quarter the Company recorded an
additional charge for taxes of $0.2 million to reflect the consolidated
effective tax rate based on the final operating results for the year.
The sale of this business is reflected in the discontinued operations section of
the income statement along with the results of operations for the two months of
2003 that the operation remained a part of the Company.
Reflected in the 2003 results are several unusual items, which should be noted
in understanding the financial results of the Company for 2003.
1. Certain access revenue rate elements billed by the Company to
interexchange carriers were disputed and subsequently refunded to
the carriers. During 2003, the Company recorded a reduction in
access revenue of $1.2 million from interexchange customers related
to the disputed access revenue the Company previously billed for
switching facilities and the local exchange network. The disputes
cover a two-year period beginning in 2001 through and including the
second quarter of 2003. The total amount of the reduction related to
2003 was $0.7 million.
2. The Company changed its employee vacation policy so that employees
now earn and use their vacation benefits in the same year.
Previously, vacation benefits were earned in the year prior to the
year the benefits were available to the employee. As a result of
this change in employee benefit policy, the Company did not accrue
employee vacation expense for 2004 in 2003, thereby reducing its
benefit expenses by $0.5 million for the 2003 year.
3. The Company adjusted its estimate of deferred revenue for the PCS
operation in the fourth quarter of 2003. The adjustment decreased
deferred revenue by $0.6 million and increased revenue in 2003 by
the same amount.
4. The Company received a reimbursement from Sprint of $0.2 million
related to 2002 for its portion of the E911 surcharge collected from
PCS subscribers. The reimbursement is to offset the Company's
portion of handset costs incurred to make the customers' phones E911
compliant. This entry decreased cost of goods expenses.
On January 30, 2004, the Company, a PCS Affiliate of Sprint, signed agreements
with Sprint that resolved disputed items and documented changes in the
management and operating agreements between the two companies related to the
operations of the nationwide Sprint PCS network. The agreements provide the
Company with the ability to better estimate the future costs of certain
operating expenses and in the Company's opinion improve the contract between
Sprint and itself. Under the agreements:
1. Sprint agreed to compensate the Company for lost travel revenue
related to usage by Sprint customers in the Company's territory for
the period prior to 2003, and change the method of allocating
certain software maintenance fees between Sprint and its Affiliates
for fees recorded in 2002 and 2003. These items had the effect of
increasing operating income by $0.7 million in the 4th quarter of
2003.
23
2. The method used to price certain services performed by Sprint on
behalf of the Company was simplified. The CCPU (cash cost per user)
rate for the periods 2004 through 2006 was set at $7.70 per user per
month. This fee covers customer service, billing, collections,
network operations and other costs to support the customer. However,
Sprint may discontinue such services if Sprint is discontinuing such
services to all other Sprint PCS affiliates and Sprint's own
end-users. It is estimated that this rate will decrease the amount
the Company will pay Sprint compared to payments under the previous
method by approximately $120,000 per month in 2004.
3. There will be a maximum until the year 2007, on the non-direct Costs
per Gross Additions (CPGA) at the greater of 6.3% of the Sprint
published CPGA rate or $25. With the volatility of CPGA, the Company
cannot determine the amount of potential savings, but the change
does provide more certainty in estimating future costs.
4. For the period 2004 through 2006, the travel and reseller rates
between the Company and Sprint were set at $0.058 per minute for
voice and $0.002 per kilobyte for data. Without this agreement the
voice travel rate for 2004 would have decreased to $0.041. Since the
Company is in a net receivable position related to travel with
Sprint, the impact on net travel and reseller revenue would have
been a reduction of $1.5 million had the $0.041 rate been in effect
in 2003. Beginning in 2007, the Sprint travel and reseller rate will
be changed annually to equal 90% of Sprint's retail yield from the
prior year. Sprint's retail yield will be determined based on
Sprint's average revenue per PCS user for voice services divided by
the average minutes of use per user.
5. Sprint and the Company will agree on a service level agreement
related to the provision of customer services by December 1, 2006.
If Sprint does not reach the stated goals, the Company will have
the opportunity to either provide the services itself or contract
with a third party, beginning in 2008.
6. Through 2006, a methodology is provided to determine if the Company
is required to make certain capital expenditures and participate in
Sprint national marketing programs.
7. Effective January 1, 2004, the method of cash settlement provided
for under the Agreement changed from Sprint distributing cash from
customers based on collected revenue to billed revenue. The absolute
amount of cash received by the Company should remain the same, but
the Company should receive cash on a more timely basis.
8. The Company is entitled to a Most Favored Nations clause.
During the period through 2006, the Company will have the
opportunity to adopt any addendum to the Management and/or Service
Agreements that Sprint signs with another PCS Affiliate.
In May 2003, the Board of Directors of the Company adopted a nonqualified
supplemental executive retirement plan (SERP) benefit for named executives. The
plan was established to provide benefits beyond the pension plan that covers all
employees. See Note 9 of the Consolidated Financial Statements for additional
information.
In November 2003, the Company commenced a management reorganization that will be
ongoing into 2004. The reorganization was in recognition of the Company's growth
and changes in the telecom industry. The Company shifted from an organization
structure that was focused on lines of business to a plan that organizes on
function. The Company plans to expand the senior staff and corresponding
departments as needed to better position itself for future opportunities. This
reorganization did not require a charge to the operation, as there were no
positions lost or values impaired as a result of the reorganization.
On November 24, 2003, federal regulations went into effect whereby customers in
the 100 largest metropolitan areas were able to change wireless carriers and
keep their phone numbers. This is referred to as Wireless Local Number
Portability (WLNP). On the same date in those markets, wireline customers could
transfer their wireline number to a wireless phone. On May 24, 2004, Local
Number Portability (LNP) will be available to wireless and wireline subscribers
throughout the United States. To date, the impact of LNP/ WLNP on the Company
has been insignificant.
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
24
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.
The PCS operation must be understood within the context of the Company's
relationship with Sprint and its PCS Affiliates. The Company operates its PCS
wireless network as an 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 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 net travel receivable 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. 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.
The Company faces vigorous competition in the wireless business as numerous
national carriers are aggressively marketing their services in the Company's
markets. The competitive landscape could change significantly depending on the
marketing initiatives of our competitors, or in the event of consolidation in
the wireless industry.
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 quarter and again
in the fourth quarter of 2003. Migration to wireless and DSL services are
believed to be driving this change. Based on industry experience, the Company
anticipates this trend may continue for the foreseeable future.
Other revenues include Internet services, both dial-up and DSL high-speed
service. The Company has seen a decline in dial up subscriptions over the last
year. The DSL service has grown over 100% in the last year driven by customer
desire for faster Internet connections.
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.
CRITICAL ACCOUNTING POLICIES
The Company relies on the use of estimates and makes assumptions that impact its
financial condition and results. These estimates and assumptions are based on
historical results and trends as well as the Company's forecasts as to how these
might change in the future. Several of the most critical accounting policies
that materially impact the Company's results of operations include:
Allowance for Doubtful Accounts
Estimates are used in determining the allowance for doubtful accounts and are
based on historical collection and write-off experience, current trends, credit
policies, and the analysis of the accounts receivable by aging category. In
determining these estimates, the Company compares historical write-offs in
relation to the estimated period in which the subscriber was originally billed.
The Company also looks at the historical average length of time that elapses
between the original billing date and the date of write-off and the financial
position of its larger customers in determining the adequacy of the allowance
for doubtful accounts. From this information, the Company assigns specific
amounts to the aging categories. The Company provides an allowance for
substantially all receivables over 90 days old.
25
The allowance for doubtful accounts balance as of December 31, 2003, 2002 and
2001 was $0.5 million, $0.9 million and $0.7 million, respectively. If the
allowance for doubtful accounts is not adequate, it could have a material
adverse effect on our liquidity, financial position and results of operations.
The Company also reviews current trends in the credit quality of the subscriber
bases in its various businesses and periodically changes its credit policies. As
of December 31, 2003, the Sprint PCS subscriber base in the Company's market
area consisted of 17.9% sub-prime credit quality subscribers compared to 25.3%
at December 31, 2002. Sprint manages the accounts receivable function related to
all of the Company's Sprint PCS wireless customers, therefore limiting the
amount of control the Company has in setting credit policy parameters.
The remainder of the Company's receivables are associated with services provided
on a more localized basis, where the Company exercises total control in setting
credit policy parameters. Historically there have been limited losses generated
from the non-PCS revenue streams. Prior to 2002, the Company had not faced
significant write-offs of inter-carrier accounts, but due to the
telecommunication industry down-turn of the last few years, the Company
experienced write-offs in this area of the business totaling $0.5 million in
2002, due to bankruptcy filings of several significant telecommunications
companies. In 2003, the inter-carrier segment of the business improved and the
Company recovered $240 thousand of bad debt from the sale of certain accounts
that were previously written-off.
Bad Debt expense summary, net of recoveries for the three years ended December
31, 2003:
In thousands
2003 2002 2001
----------------------------------
PCS subscribers $1,716 $3,744 $1,241
Interexchange carriers 48 488 --
Other subscribers and entities 71 170 82
----------------------------------
Total bad debt expense $1,835 $4,402 $1,323
==================================
Revenue Recognition
The Company recognizes revenues when persuasive evidence of an arrangement
exists, services have been rendered or products have been delivered, the price
to the buyer is fixed and determinable, and collectibility is reasonably
assured. The Company's revenue recognition polices are consistent with the
guidance in Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in
Financial Statements promulgated by the Securities and Exchange Commission, and
the Emerging Issues Task Force ("EITF") 00-21, "Revenue Arrangements with
Multiple Deliverables" ("EITF 00-21"). Effective July 1, 2003 the Company
adopted EITF 00-21. The EITF guidance addresses how to account for arrangements
that may involve multiple revenue-generating activities, i.e., the delivery or
performance of multiple products, services, and/or rights to use assets. In
applying this guidance, separate contracts with the same party, entered into at
or near the same time, will be presumed to be a bundled transaction, and the
consideration will be measured and allocated to the separate units based on
their relative fair values. The consensus guidance was applicable to new PCS
service agreements entered into for quarters beginning July 1, 2003. The
adoption of EITF 00-21 required evaluation of each arrangement entered into by
the Company for each sales channel. The Company will continue to monitor
arrangements with its sales channels to determine if any changes in revenue
recognition will need to be made in the future. The adoption of EITF 00-21 has
resulted in substantially all of the PCS activation fee revenue generated
through Company-owned retail stores and associated direct costs being recognized
at the time the related wireless handset is sold and it is classified as
equipment revenue and cost of equipment, respectively. Upon adoption of EITF
00-21, previously deferred PCS revenue and costs will continue to be amortized
over the remaining estimated life of a subscriber, not to exceed 30 months. PCS
revenue and costs for activations at other retail locations and through other
sales channels will continue to be deferred and amortized over their estimated
lives as prescribed by SAB 101. The adoption of EITF 00-21 had the effect of
increasing equipment revenue by $68 thousand and increasing costs of equipment
by $23 thousand, which otherwise would have been deferred and amortized.
The Company records equipment revenue from the sale of handsets and accessories
to subscribers in its retail stores and to local distributors in its territories
upon delivery. The Company does not record equipment revenue on handsets and
accessories purchased from national third-party retailers, those purchased
though the Company's business-to-business sales force, or directly from Sprint
by subscribers in its territories. The Company believes the equipment revenue
and related cost of equipment associated with the sale of wireless handsets and
accessories is a separate earnings process from the sale of wireless services to
subscribers. For competitive marketing reasons, the Company
26
sells wireless handsets at prices lower than the cost. In certain instances the
Company may offer larger handset discounts as an incentive for the customer to
agree to a multi-year service contract. The Company also sells wireless handsets
to existing customers at a loss in handset sales and the corresponding cost in
cost of goods, and accounts for these transactions separately from agreements to
provide customers wireless service. These transactions are viewed as a cost to
retain the existing customers and deter churn.
For the Company's wireless customers that purchase and activate their service
through a channel not covered by EITF 00-21, the wireless customers generally
pay an activation fee to the Company when they initiate service. The Company
defers the activation fee revenue (except when a special promotion reduces or
waives the fee) over the average life of its subscribers, which is estimated to
be 30 months. The Company recognizes service revenue from its subscribers as
they use the service. The Company provides a reduction of recorded revenue for
billing adjustments and the portion of revenue (8%) that is retained by Sprint.
The Company also reduces recorded revenue for rebates and discounts given to
subscribers on wireless handset sales in accordance with ("EITF") Issue No. 01-9
"Accounting for Consideration Given by a Vendor to a Subscriber (Including a
Reseller of the Vendor's Products)." The Company participates in the Sprint
national and regional distribution programs in which national retailers sell
Sprint wireless products and services. In order to facilitate the sale of Sprint
wireless products and services, national retailers purchase wireless handsets
from Sprint for resale and receive compensation from Sprint for Sprint wireless
products and services sold. For industry competitive reasons, Sprint subsidizes
the price of these handsets by selling the handsets at a price below cost. Under
the Company's agreements with Sprint, when a national retailer sells a handset
purchased from Sprint to a subscriber in the Company's territories, the Company
is obligated to reimburse Sprint for the handset subsidy. The Company does not
receive any revenues from the sale of handsets and accessories by national
retailers. The Company classifies these handset subsidy charges as a cost of
goods expense.
Through December 31, 2003, the Agreement provided that Sprint retains 8% of
collected service revenues from subscribers based in the Company's markets and
from non-Sprint wholesale subscribers who roam onto the Company's network. The
amount of revenue retained by Sprint is recorded as an offset to the revenues
recorded. All revenue derived from the sale of handsets and accessories by the
Company and from certain roaming services (outbound roaming and travel revenues
from Sprint and its PCS Affiliate subscribers) are retained by the Company.
The Company defers direct subscriber activation costs on subscribers whose
activation falls within the SAB 101 guidelines. The activation costs are
deferred when incurred, and then amortized using the straight-line method over
30 months, which is the estimated average life of a subscriber. Direct
subscriber activation costs also include the activation charge from Sprint, and
credit check fees. These fees are charged to the Company by Sprint at
approximate $12.50 per subscriber.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. The Company evaluates the recoverability of tax assets generated
on a state-by-state basis from net operating losses apportioned to that state.
Management uses a more likely than not threshold to make that determination and
has established a valuation allowance against the tax assets, in case they are
not recoverable. For 2003, the Company added an additional reserve of $0.2
million to its valuation allowance due to the uncertainty of the recoverability
of the net operating loss carry-forwards in certain states. The valuation
allowance now stands at $0.9 million as of December 31, 2003. Management will
evaluate the effective rate of taxes based on apportionment factors, the
Company's operating results, and the various state income tax rates. Currently,
management anticipates the normalized effective income tax rate to be
approximately 39%.
Other
The Company does not have any unrecorded off-balance sheet transactions or
arrangements, however, the Company has commitments under operating leases and is
subject to certain capital calls under one of its investments.
27
Results of Continuing Operations
2003 compared to 2002
Total revenue was $105.9 million in 2003, an increase of $12.9 million or 13.9%.
Total revenues included $69.9 million of wireless revenues, an increase of $12.0
million or 20.7%; wireline revenues of $29.0 million, an increase of $0.3
million or 0.9%; and other revenues of $7.0 million, an increase of $0.6 million
or 9.7%.
Within wireless revenues, the PCS operation contributed $67.0 million, an
increase of $11.6 million, or 20.8%. PCS service revenues were $44.4 million, an
increase of $10.9 million or 32.4%. Service revenue growth was driven by the
increase in subscribers, totaling 85,139 at December 31, 2003, an increase of
17,297 or 25.5%, compared to 67,842 subscribers at year-end 2002. The company
had churn of 2.1% in 2003 compared to 2.8% in 2002. The decline in the churn
rate is the result of tightening the credit screening for new subscribers as
well as continued efforts to improve the after sales support. Competition in the
wireless industry continues to have a significant impact on the results of the
Company's PCS operation.
PCS travel revenue, including reseller revenue, which is compensation between
Sprint and its PCS Affiliates for use of the other party's network, was $16.8
million, an increase of $0.3 million or 1.8%. Travel revenue is impacted by the
geographic size of the Company's network service area, the overall number of
Sprint wireless customers, their travel patterns and the travel exchange rate.
The rate received on travel was $0.058 per minute in 2003, compared to $0.10 per
minute in 2002. As a part of the amended management agreement signed on January
30, 2004, Sprint and the Company agreed to maintain the travel rate at $0.058
per minute through December 31, 2006.
PCS equipment sales were $2.1 million, an increase of $0.4 million or 26.6%. The
equipment sales are net of $1.7 million of rebates and discounts given at the
time of sale. Rebates and discounts continue to be required to meet significant
industry competition for subscriber additions and subscriber retention. These
discounts and rebates are primarily transacted in the form of instant rebates,
providing a second phone free when a customer purchases one, or providing free
phones if the subscriber signs up for a specific contract term and a specific
service plan.
In accordance with Sprint's requirements, the Company launched third generation
(3G 1X) wireless service in August 2002. 3G 1X is the first of a four-stage
migration path that will enable additional voice capacity and increased data
speeds for subscribers. The network upgrades completed in 2002 were software
changes, channel card upgrades, and some new network elements required for
packet data. The Company's base stations were outfitted with network card
enhancements, thereby allowing the Company to provide 3G 1X service without
wholesale change-outs of base stations. 3G 1X is backwards compatible with the
existing 2G network, thereby allowing continued use of current customer
handsets. The impact of 3G 1X-network enhancements on revenues became more
pronounced in 2003, as use of new 3G services and features generated
approximately $1.0 million for the year, compared to $0.2 million in 2002. The
growth in 3G revenue is the result of more subscribers on 3G plans and the
increase in popularity of camera phones during 2003.
Wireless revenues included tower leases of $2.6 million, an increase of $0.5
million or 24.8%. The increase was the result of other wireless carriers
executing additional leases to use space on the Company's portfolio of towers.
Of the 88 towers and poles owned by the Company as of December 31, 2003, 52
towers have one or more external tenants, compared to 46 towers with external
tenants at the end of 2002.
Wireless revenues from the Company's paging operation were $0.2 million, a
decrease of $0.1 million as the customer base increasingly chose alternative
wireless services. Paging service subscribers declined by 32.3% in 2003 from
2,940 subscribers to 1,989 subscribers. The paging operation continues to
decline as more areas are covered by wireless voice services, which have
features that surpass those of paging technologies. The Company anticipates that
its paging customer base will continue to decline in the future.
Within wireline revenues, the Telephone operation contributed $22.7 million, an
increase of $0.3 million, or 1.2%. Telephone access revenues were $11.6 million,
an increase of $0.7 million or 6.7%. During 2003, the Company recorded a $1.2
million reduction to access revenue, of which $0.7 million was related to 2002,
resolving disputes with interexchange carriers on the rating of long distance
calls transiting the Telephone switching network for termination on wireless
networks.
Originating access revenue increased in 2003 due in part to a shift from
interstate to intrastate traffic. On similar traffic volume in both years, the
Company generated an additional $0.4 million due to a favorable rate
differential of $0.03 per minute on the increase in the mix of intrastate
traffic. The Company's increased access revenue was also a result of the benefit
gained through terminating more minutes through the switch, which increased 36.0
million minutes or
28
35.7% over 2002. The rates for terminating traffic were similar in both years,
although the percentage of terminating traffic to total traffic increased from
58% in 2002 to 65% in 2003.
The shift in originating traffic is the result of implementing software capable
of identifying actual interstate and intrastate traffic specifically delivered
to the wireline switch, where previously usage was allocated between interstate
and intrastate traffic types by the interexchange carriers.
The following table shows the access traffic minutes of use for the two years of
2003 and 2002.
Minutes of use (in thousands) 2003 2002
-------------------------------------------------------------
(net of intercompany usage)
Originating Terminating Originating Terminating
-------------------------------------------------------------
Interstate 29,373 87,539 42,929 63,959
Intrastate 37,190 49,103 22,684 36,712
-------------------------------------------------------------
Total 66,563 136,642 65,613 100,671
=============================================================
Access revenue (in thousands) 2003 2002
-------------------------------------------------------------
(net of intercompany usage) As reported Pro forma As reported Pro forma
-------------------------------------------------------------
Traffic sensitive (1) $ 4,274 $ 4,974 $ 4,676 $ 3,976
Special access revenues 1,606 1,606 1,247 1,247
Carrier common line settlement 5,750 5,750 4,978 4,978
-------------------------------------------------------------
Total $11,630 $ 12,330 $10,901 $ 10,201
=============================================================
(1) Traffic sensitive revenue has been normalized in the proforma column to
remove the impact of the access billing dispute adjustment and the impact
of the NECA settlement adjustments.
Facility lease revenue contributed $5.5 million to wireline revenues, a decrease
of $0.2 million or 3.5%. The decrease was primarily the result of the prolonged
decline of lease rates associated with competitive pricing pressures and the
economic downturn in the telecommunications industry. During 2002 the Company
completed a second, diverse fiber route to its existing interconnection point in
the Dulles airport area of Northern Virginia. This fiber route provides
increased reliability for customers in the event of fiber cuts or breaks, and
extends the availability of the Company's fiber network to additional market
locations but to date has not added additional revenue to the Company's
operation.
Billing and collection services and other revenues contributed $0.4 million to
wireline revenues, which was the same as 2002 results. Revenues from this
service had declined in recent years, with interexchange carriers now issuing a
greater proportion of their bills directly to their customers.
Wireline revenues from cable television services were $4.4 million, an increase
of $0.1 million or 1.7%. The number of subscribers and service plan prices
remained relatively constant during 2003.
Other revenues, primarily consisting of Internet and 511Virginia service
revenues were $5.8 million in 2003, an increase of $0.7 million or 13.5%. The
Company had 17,420 dial-up Internet subscribers at December 31, 2003, compared
to 18,050 at the end of the previous year. During 2003, the Company's DSL
high-speed Internet access subscriber count increased to 1,298 from 646. Total
Internet service revenue was $4.5 million, an increase of $0.3 million or 10.7%.
The 511Virginia contract with the Virginia Department of Transportation
contributed $1.3 million to other revenues, an increase of $0.4 million or
41.3%. Telecommunications equipment sales, services and lease revenues were $1.1
million, which reflects a $0.1 million decrease from 2002 results.
Total operating expenses were $87.2 million, an increase of $3.6 million or
4.3%. The primary driver in the increase in operating expenses is continued
growth in the PCS operation somewhat offset by a significant decline in bad debt
expense compared to 2002.
Late in 2003, the Company made an employee benefits policy change, which
eliminated the requirement for the Company to accrue a vacation liability in
advance of the year in which the benefit was used. The result of this change was
a reduction of benefit expense of $0.5 million for the year compared to 2002.
Benefit expenses impact all operating departments based on the amount of direct
labor charged to the department. The change has a one-time impact on the
financial statements of the Company. The benefits policy now provides that
employees earn and use their paid time off in the same period. In the future,
under this policy, unused hours can be banked but only used for extended
illness, not carried over for use as vacation.
29
Cost of goods and services was $10.9 million, an increase of $0.4 million or
4.2%. The PCS cost of goods sold was $8.5 million, an increase of $0.2 million
or 2.3%. This change is due primarily to higher volumes of handsets sold through
Company owned stores and PCS handset subsidies paid to third-party retailers. In
2003, the Company recorded approximately $1.8 million in handset costs related
to existing subscribers upgrading their handsets. Prior to 2003, the Company did
not track the specific costs related to subsidizing new handsets to existing
customers. The cost of handset up-grades sold to existing customers is expected
to increase as the customer base matures and handset manufacturers introduce new
technologies in new handsets. The cable television programming (cost of service)
expense was $1.6 million, an increase of $0.2 million or 16.3%. The Company has
seen continuing upward pressure on the cost of cable TV programming by cable TV
program providers.
Network operating costs were $33.6 million, an increase of $1.1 million or 3.4%.
The largest item in network operating costs is travel expense. These costs made
up 31.8% and 32.9% of the total network and other costs in 2003 and 2002,
respectively. Travel expense is the cost of minutes used by the Company's PCS
subscribers on Sprint or other Sprint Affiliates' networks. Travel expense in
2003 was $10.8 million, an increase of $0.1 million due to a significant
increase in travel minutes in 2003 which was offset by the impact of the rate
decline. The travel rate declined from $0.10 per minute in 2002 to $0.058 per
minute in 2003. Our PCS customers increased their average monthly travel minutes
by 22% compared to 2002. In 2002, the average customer's travel usage was 130
minutes per month and in 2003 that average travel usage increased to 159 minutes
per month.
Network infrastructure maintenance costs were $4.9 million or 14.6% of total
network operating costs, a decrease of $0.2 million from 2002. Rent for towers,
tower sites, and buildings increased $0.9 million or 27.3% to $4.2 million.
Lease escalators plus the increase in the number of sites leased contributed to
the increase. Line costs in 2003 were $9.8 million or 29.1% of the network
operating costs, an increase of $0.1 million.
Depreciation and amortization expense was $16.6 million, an increase of $2.1
million or 14.8%. The PCS operation had depreciation expense of $10.2 million,
an increase of $1.6 million or 18.9%. The 16 additional PCS base stations placed
in service during 2003 resulted in higher depreciation expense for the year. In
the telephone operation, depreciation increased $0.5 million or 12.7%, due to
new assets deployed in the operation. There was no amortization of goodwill in
2003 or 2002, compared to goodwill amortization of $360 thousand expensed in
2001, due to the required accounting change.
Selling, general and administrative expenses were $26.0 million, down $0.1
million or 0.4%. Customer support costs were $8.7 million, an increase of $0.9
million or 11.4%. The growth in Sprint wireless subscribers is primarily
responsible for this change. Advertising expense was $4.6 million, an increase
of $0.3 million or 6.4%. The change is primarily due to increased marketing
efforts in support of the PCS operations in both the Quad State and Central Penn
markets. PCS sales staff expenses were $2.8 million, an increase of $0.1 million
or 1.5% compared to 2002. Other sales staff expenses increased $0.3 million to
$1.3 million as the Company worked to expand its other services in areas outside
its historically defined service area. Bad debt expense decreased $2.6 million
or 58.3%.
Administrative expenses increased $1.0 million or 17.1%. This increase is a
result of increased professional fees, insurance and pension costs. During 2003,
the Company added several positions to expand the management team to support the
Company's growing operations.
Bad debt expense decreased $2.6 million to $1.8 million or 58.3%. This decrease
was due to more restrictive credit terms for new PCS subscribers (limiting the
high credit risk customers who obtained service), lower churn in the PCS
operation and improvement in the interexchange carrier segment of the business.
This expense is net of normal recoveries and includes a recovery of $0.2 million
for an interexchange carrier settlement the Company received in 2003 which was
written off in 2002.
Operating income grew to $18.6 million, an increase of $9.3 million or 100%.
Revenue growth, primarily in the PCS operation in addition to the reduced bad
debt expenses, adjustments of management estimates, and the settlement of
disputed items with Sprint, all contributed to the operating income
improvements. The Company's operating margin was 17.6%, compared to 10.0% in
2002.
Other income (expense) is comprised of non-operating income and expenses,
interest expense and gain or loss on investments. Collectively, the net impact
of these items to pre-tax income was an expense of $3.6 million for 2003,
compared to expense of $14.3 million from 2002. The 2002 results were primarily
the results of the previously disclosed $9.0 million loss recorded on the sale
of the VeriSign stock.
30
Interest expense was $3.5 million, a decrease of $0.7 million or 16.3%. The
Company's average debt outstanding decreased approximately $4.8 million.
Long-term debt (inclusive of current maturities), was $43.3 million at year-end
2003, versus $52.0 million at year-end 2002. The Company did not borrow any
money on its revolving facilities in 2003.
Net losses on investments were $0.4 million, compared to a loss of $10.1 million
fr