Attached files

file filename
EX-32 - EXHIBIT 32 - SHENANDOAH TELECOMMUNICATIONS CO/VA/ex32.htm
EX-31.2 - EXHIBIT 31.2 - SHENANDOAH TELECOMMUNICATIONS CO/VA/ex31_2.htm
EX-31.1 - EXHIBIT 31.1 - SHENANDOAH TELECOMMUNICATIONS CO/VA/ex31_1.htm


UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended September 30, 2010
 
o
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 incorporation or organization)
(I.R.S. Employer Identification No.)

500 Shentel Way, Edinburg, Virginia    22824
(Address of principal executive offices)  (Zip Code)

(540) 984-4141
(Registrant's telephone number, including area code)
 



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

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

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

Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o

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

The number of shares of the registrant’s common stock outstanding on October 29, 2010 was 23,737,973.
 


 
1

 

SHENANDOAH TELECOMMUNICATIONS COMPANY
INDEX

   
Page
   
Numbers
       
PART I.
FINANCIAL INFORMATION
   
       
Item 1.
Financial Statements
   
       
   
3-4
       
   
5
       
   
6
       
   
7-8
       
   
9-15
 
 
 
 
Item 2.
 
16-33
       
Item 3.
 
34
       
Item 4.
 
35
       
PART II.
OTHER INFORMATION
   
       
Item 1A.
 
36-37
       
Item 2.
 
37
       
Item 6.
 
38
       
   
39
       
   
40

 
2


SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)


ASSETS
 
September 30,
2010
   
December 31,
2009
 
             
Current Assets
           
Cash and cash equivalents
  $ 43,144     $ 12,054  
Accounts receivable, net
    22,149       15,058  
Income taxes receivable
    -       5,531  
Materials and supplies
    5,355       6,062  
Prepaid expenses and other
    3,488       2,504  
Assets held for sale
    10,850       10,810  
Deferred income taxes
    -       616  
Total current assets
    84,986       52,635  
                 
Investments, including $2,163 and $1,990 carried at fair value
    9,021       8,705  
                 
Property, Plant and Equipment
               
Plant in service
    448,581       373,111  
Plant under construction
    19,232       9,116  
      467,813       382,227  
Less accumulated amortization and depreciation
    202,584       179,925  
Net property, plant and equipment
    265,229       202,302  
                 
Other Assets
               
Intangible assets, net
    91,868       2,417  
Cost in excess of net assets of businesses acquired
    10,885       4,418  
Deferred charges and other assets, net
    5,084       1,248  
Net other assets
    107,837       8,083  
Total assets
  $ 467,073     $ 271,725  


See accompanying notes to unaudited condensed consolidated financial statements.

(Continued)

 
3


SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
September 30,
2010
   
December 31,
2009
 
             
Current Liabilities
           
Current maturities of long-term debt
  $ 12,508     $ 4,561  
Accounts payable
    7,821       8,804  
Advanced billings and customer deposits
    9,505       6,349  
Accrued compensation
    2,938       1,003  
Income taxes payable
    512       -  
Liabilities held for sale
    1,328       858  
Deferred income taxes
    674       -  
Accrued liabilities and other
    6,876       3,053  
Total current liabilities
    42,162       24,628  
                 
Long-term debt, less current maturities
    185,629       28,399  
                 
Other Long-Term Liabilities
               
Deferred income taxes
    30,048       29,649  
Deferred lease payable
    3,592       3,351  
Asset retirement obligations
    6,166       5,966  
Other liabilities
    4,829       4,060  
Total other liabilities
    44,635       43,026  
                 
Commitments and Contingencies
               
                 
Shareholders’ Equity
               
Common stock
    19,056       17,890  
Retained earnings
    175,591       160,230  
Accumulated other comprehensive loss, net of tax
    -       (2,448 )
Total shareholders’ equity
    194,647       175,672  
                 
Total liabilities and shareholders’ equity
  $ 467,073     $ 271,725  


See accompanying notes to unaudited condensed consolidated financial statements.

 
4


SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)


   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
                         
Operating revenues
  $ 53,155     $ 40,115     $ 136,954     $ 120,356  
                                 
Operating expenses:
                               
Cost of goods and services, exclusive of depreciation and  amortization shown separately below
    21,220       13,703       50,450       39,452  
Selling, general and administrative, exclusive of depreciation and amortization shown separately below
    14,170       7,692       32,746       22,569  
Depreciation and amortization
    12,202       8,151       28,927       24,116  
Total operating expenses
    47,592       29,546       112,123       86,137  
Gain on sale of directory
    4,000       -       4,000       -  
Operating income
    9,563       10,569       28,831       34,219  
                                 
Other income (expense):
                               
Interest expense
    (2,416 )     (193 )     (2,992 )     (1,128 )
Gain (loss) on investments, net
    (11 )     201       (153 )     (203 )
Non-operating income, net
    274       95       543       449  
Income from continuing operations before income taxes
    7,410       10,672       26,229       33,337  
                                 
Income tax expense
    3,220       4,326       10,969       14,019  
Net income from continuing operations
    4,190       6,346       15,260       19,318  
Earnings (loss) from discontinued operations, net of tax  (expense) benefit of $100, $24, $(66) and $6,415, respectively
    (156 )     (39 )     101       (10,484 )
Net income
  $ 4,034     $ 6,307     $ 15,361     $ 8,834  
                                 
Basic and diluted income (loss) per share:
                               
                                 
Net income from continuing operations
  $ 0.18     $ 0.27     $ 0.64     $ 0.81  
Net earnings (loss) from discontinued operations
    (0.01 )     -       0.01       (0.44 )
Net income
  $ 0.17     $ 0.27     $ 0.65     $ 0.37  
                                 
Weighted average shares outstanding, basic
    23,738       23,640       23,724       23,633  
                                 
Weighted average shares, diluted
    23,883       23,706       23,799       23,696  


See accompanying notes to unaudited condensed consolidated financial statements.

 
5


SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(in thousands, except per share amounts)
 

   
Shares
   
Common Stock
   
Retained Earnings
   
Accumulated
Other Comprehensive Income (Loss)
   
Total
 
                               
Balance, December 31, 2008
    23,605     $ 16,139     $ 152,706     $ (2,533 )   $ 166,312  
Comprehensive income:
                                       
Net income
    -       -       15,092       -       15,092  
Reclassification adjustment for unrealized loss from pension plans included in net income, net of tax
    -       -       -       55       55  
Net unrealized loss from pension plans, net of tax
    -       -       -       30       30  
Total comprehensive income
                                    15,177  
Dividends declared ($0.32 per share)
    -       -       (7,568 )     -       (7,568 )
Dividends reinvested in common stock
    32       560       -       -       560  
Stock-based compensation
    -       676       -       -       676  
Conversion of liability classified awards to equity classified awards
    -       85       -       -       85  
Common stock issued through  exercise of incentive stock  options
    44       367       -       -       367  
Net excess tax benefit from stock options exercised
    -       63       -       -       63  
                                         
Balance, December 31, 2009
    23,681     $ 17,890     $ 160,230     $ (2,448 )   $ 175,672  
Comprehensive income:
                                       
Net income
    -       -       15,361       -       15,361  
Reclassification adjustment for  unrealized loss from pension plans included in net income, net of tax
    -       -       -       2,596       2,596  
Net unrealized loss from pension plan, net of tax
    -       -       -       (148 )     (148 )
Total comprehensive income
                                    17,809  
Stock-based compensation
    -       539       -       -       539  
Common stock issued through exercise of incentive stock  options
    57       557       -       -       557  
Net excess tax benefit from stock options exercised
    -       70       -       -       70  
                                         
Balance, September 30, 2010
    23,738     $ 19,056     $ 175,591     $ -     $ 194,647  


See accompanying notes to unaudited condensed consolidated financial statements.

 
6


SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

   
Nine Months Ended
September 30,
 
   
2010
   
2009
 
             
Cash Flows From Operating Activities
           
Net income
  $ 15,361     $ 8,834  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Impairment on assets held for sale
    -       17,545  
Depreciation
    26,040       23,666  
Amortization
    2,887       450  
Provision for bad debt
    844       845  
Stock based compensation expense
    539       475  
Pension settlement and curtailment expenses
    3,964       -  
Excess tax benefits on stock option exercises
    (70 )     (63 )
Deferred income taxes
    152       (7,463 )
Net loss on disposal of equipment
    316       734  
Realized (gain) on sale of directory
    (4,000 )     -  
Realized loss (gain) on disposal of investments
    147       188  
Unrealized (gains) losses on investments
    (229 )     (515 )
Net (gain) loss from patronage and equity investments
    67       395  
Other
    575       2,300  
Changes in assets and liabilities:
               
(Increase) decrease in:
               
Accounts receivable
    (4,031 )     (160 )
Materials and supplies
    707       1,694  
Income taxes receivable
    5,531       7,366  
Increase (decrease) in:
               
Accounts payable
    (841 )     (915 )
Income taxes payable
    512       6,209  
Deferred lease payable
    237       114  
Other prepaids, deferrals and accruals
    4,989       (2,191 )
                 
Net cash provided by operating activities
  $ 53,697     $ 59,508  
                 
Cash Flows From Investing Activities
               
Purchase and construction of property, plant and equipment
  $ (33,940 )   $ (37,648 )
Cash paid for acquisition of business
    (147,613 )     -  
Cash received on sale of directory
    4,000       -  
Cash paid to acquire prepaid subscriber rights
    (6,884 )     -  
Proceeds from sale of equipment
    503       75  
Purchase of investment securities
    (114 )     (360 )
Proceeds from sale of investment securities
    54       14  
                 
Net cash used in investing activities
  $ (183,994 )   $ (37,919 )


(Continued)

 
7


SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

   
Nine Months Ended
September 30,
 
   
2010
   
2009
 
             
Cash Flows From Financing Activities
           
Principal payments on long-term debt
  $ (25,595 )   $ (14,284 )
Amounts borrowed under debt agreements
    189,800       2,000  
Cash paid for debt issuance costs
    (3,445 )     -  
Excess tax benefits on stock option exercises
    70       63  
Proceeds from exercise of incentive stock options
    557       310  
                 
                 
Net cash provided by (used in) financing activities
  $ 161,387     $ (11,911 )
                 
Net increase in cash and cash equivalents
  $ 31,090     $ 9,678  
                 
Cash and cash equivalents:
               
Beginning
    12,054       5,240  
Ending
  $ 43,144     $ 14,918  
                 
Supplemental Disclosures of Cash Flow Information
               
Cash payments for:
               
                 
Interest
  $ 2,392     $ 1,437  
                 
Income taxes
  $ 5,225     $ 1,596  
 
During the nine months ended September 30, 2010, the Company assumed other debt of $972  in connection with the JetBroadBand acquisition.

During the nine months ended September 30, 2010 and 2009, the Company utilized $75 and $5,054, respectively, of vendor credits receivable to reduce cash paid for acquisitions of property, plant and equipment.

See accompanying notes to unaudited condensed consolidated financial statements.

 
8


SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.  The interim condensed consolidated financial statements of Shenandoah Telecommunications Company and Subsidiaries (collectively, the “Company”) are unaudited.  In the opinion of management, all adjustments necessary for a fair presentation of the interim results have been reflected therein.  All such adjustments were of a normal and recurring nature.  These statements should be read in conjunction with the consolidated financial statements and related notes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.  The balance sheet information at December 31, 2009 was derived from the audited December 31, 2009 consolidated balance sheet.

2.  Operating revenues and income from operations for any interim period are not necessarily indicative of results that may be expected for the entire year.
 
3.  In September 2008, the Company announced its intention to sell its Converged Services operation, and the related assets and liabilities were reclassified as held for sale in the consolidated balance sheet and the historical operating results were reclassified as discontinued operations.  Depreciation and amortization on long-lived assets was also discontinued.

In connection with the preparation of the Company’s first quarter 2009 financial statements, the Company determined that the fair value of Converged Services had declined from earlier estimates.  Accordingly, the Company recorded an impairment loss of $17.5 million ($10.7 million, net of taxes) to reduce the carrying value of these assets to their estimated fair value less cost to sell as of March 31, 2009.  At September 30, 2010, negotiations to complete the sale continue, and there has been no change in the estimated fair value of the assets.

Assets and liabilities held for sale consisted of the following:

   
September 30, 2010
   
December 31, 2009
 
Assets held for sale:
           
Property, plant and equipment, net
  $ 7,764     $ 7,484  
Intangible assets, net
    868       868  
Deferred charges
    1,610       1,628  
Other assets
    608       830  
    $ 10,850     $ 10,810  
Liabilities:
               
Other liabilities
  $ 1,328     $ 858  

 
Discontinued operations included the following amounts of operating revenue and income (loss) before income taxes:

   
Three Months Ended
September 30,
 
   
2010
   
2009
 
Operating revenues
  $ 2,895     $ 3,123  
Earnings (loss) before income taxes
  $ (256 )   $ (63 )
                 

   
Nine Months Ended
September 30,
 
   
2010
   
2009
 
Operating revenues
  $ 9,597     $ 10,033  
Earnings (loss) before income taxes
  $ 167     $ (16,899 )


4.  Basic net income (loss) per share was computed on the weighted average number of shares outstanding.  Diluted net income (loss) per share was computed under the treasury stock method, assuming the conversion as of the beginning of the period for all dilutive stock options.  Of 383 thousand and 351 thousand outstanding options and shares at September 30, 2010 and 2009, respectively, 213 thousand and 222 thousand were anti-dilutive, respectively.  There were no adjustments to net income for any period.

 
9


5.  Investments include $2.2 million and $2.0 million of investments carried at fair value as of September 30, 2010 and December 31, 2009, respectively, consisting of equity, bond and money market mutual funds.  These investments are held under a rabbi trust arrangement related to a non-qualified supplemental retirement plan maintained by the Company.  During the three months ended September 30, 2010, the Company made no contributions to the trust, recognized $15 thousand in dividend and interest income from investments, and recognized net unrealized gains of $135 thousand on these investments.  During the nine months ended September 30, 2010, the Company contributed $63 thousand to the trust, recognized $8 thousand in net losses on dispositions of investments, recognized $23 thousand in dividend and interest income from investments, and recognized net unrealized gains of $91 thousand on these investments.  Fair values for these investments held under the rabbi trust were determined by Level 1 quoted market prices for the underlying mutual funds.

6.  During the second quarter of 2010, the Company completed the settlement of its defined benefit pension plan following the receipt of a favorable tax determination letter from the Internal Revenue Service in February, 2010.  The Company purchased non-participating annuities to provide benefits to retirees, and distributed vested balances (in the form of lump sum cash outs and rollovers to qualified retirement accounts, including Individual Retirement Accounts and the Company’s 401(k) plan) to active employees and other participants.  In order to complete the settlement, the Company contributed $977 thousand during June 2010 to fully fund the pension obligations, and recognized $3.6 million of pension expense.  There are no remaining assets or liabilities of the Company’s qualified pension plan.

During the second quarter of 2010, the Company curtailed future participation in the Company’s Supplemental Executive Retirement Plan (“SERP”).  Current participants may remain in the SERP and will continue to vest and earn returns on invested balances, but the Company will make no further contributions to the SERP and no new participants will be eligible to join the SERP.  The Company recognized a curtailment loss of $666 thousand consisting of actuarial losses previously recorded in other comprehensive income.

7.  Financial instruments on the consolidated balance sheets that approximate fair value include:  cash and cash equivalents, receivables, investments carried at fair value, payables, accrued liabilities, and long-term debt.  Due to the relatively short time frame to maturity of the Company’s fixed rate debt, fair value approximates its carrying value.

The Company measures its interest rate swap at fair value based on information provided by the counterparty and recognizes it as a liability on the Company’s condensed consolidated balance sheet.  Changes in the fair value of the swap are recognized in interest expense, as the Company did not designate the swap agreement as a cash flow hedge for accounting purposes.

The July 2010 credit agreement (see note 12) provided that the Company enter into a hedge agreement for a minimum notional value of approximately $63 million, and for a minimum term of 3 years, to manage a portion of its exposure to interest rate movements by converting a portion of its long-term debt from variable to fixed rates.

8.  Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision makers.  The Company has three reportable segments, which the Company operates and manages as strategic business units organized by lines of business: (1) Wireless, (2) Wireline, and (3) Cable TV.   A fourth segment, Other, primarily includes Shenandoah Telecommunications Company, the parent holding company, as well as certain general and administrative costs historically charged to Converged Services that cannot be allocated to discontinued operations.

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

The Wireline segment provides regulated and unregulated voice services, dial-up and DSL internet access, and long distance access services throughout Shenandoah County and portions of northwestern Augusta County, Virginia, and leases fiber optic facilities throughout the northern Shenandoah Valley of Virginia, northern Virginia and adjacent areas along the Interstate 81 corridor, including portions of West Virginia and Maryland.

The Cable TV segment provides video, internet and voice services in Virginia and West Virginia.  It includes the operations acquired from JetBroadBand, LLC, since July 30, 2010.

 
10


During the third quarter of 2010, the Company revised the financial reporting provided to senior management and the Board of Directors to exclude non-operating income and expenses.  The following disclosures present our reportable segments based on segment operating income, consistent with the information provided to the chief operating decision maker to assess segment performance.  Prior period reports have been revised to conform to the current presentation.
Selected financial data for each segment is as follows:


Three months ended September 30, 2010

(In thousands)
   
Wireless
   
Wireline
   
Cable TV
   
Other
   
Eliminations
   
ConsolidatedTotals
 
External revenues
                                   
Service revenues
  $ 28,624     $ 3,596     $ 10,585     $ -     $ -     $ 42,805  
Other
    4,342       4,715       1,293       -       -       10,350  
Total external revenues
    32,966       8,311       11,878       -       -       53,155  
Internal revenues
    762       3,375       14       -       (4,151 )     -  
Total operating revenues
    33,728       11,686       11,892       -       (4,151 )     53,155  
                                                 
Operating expenses
                                               
Costs of goods and services, exclusive of depreciation and amortization shown separately below
    12,237       4,318       8,272       56       (3,663 )     21,220  
Selling, general and administrative, exclusive of depreciation and amortization shown separately below
    5,885       1,828       6,195       750       (488 )     14,170  
Depreciation and amortization
    6,401       2,000       3,746       55       -       12,202  
Total operating expenses
    24,523       8,146       18,213       861       (4,151 )     47,592  
Gain on sale of directory
    -       4,000       -       -       -       4,000  
Operating income (loss)
  $ 9,205     $ 7,540     $ (6,321 )   $ (861 )   $ -     $ 9,563  


Three months ended September 30, 2009

(In thousands)

   
Wireless
   
Wireline
   
Cable TV
   
Other
   
Eliminations
   
ConsolidatedTotals
 
External revenues
                                   
Service revenues
  $ 25,287     $ 3,340     $ 3,526     $ -     $ -     $ 32,153  
Other
    2,724       4,907       331       -       -       7,962  
Total external revenues
    28,011       8,247       3,857       -       -       40,115  
Internal revenues
    679       3,440       8       -       (4,127 )     -  
Total operating revenues
    28,690       11,687       3,865       -       (4,127 )     40,115  
                                                 
Operating expenses
                                               
Costs of goods and services, exclusive of depreciation and amortization shown separately below
    9,594       4,346       3,285       84       (3,606 )     13,703  
Selling, general and administrative, exclusive of depreciation and amortization shown separately below
    4,123       1,934       1,309       847       (521 )     7,692  
Depreciation and amortization
    5,178       1,999       895       79       -       8,151  
Total operating expenses
    18,895       8,279       5,489       1,010       (4,127 )     29,546  
Operating income (loss)
  $ 9,795     $ 3,408     $ (1,624 )   $ (1,010 )   $ -     $ 10,569  

 
11


Nine months ended September 30, 2010

(In thousands)
 
 
 
Wireless
   
Wireline
   
Cable TV
   
Other
   
Eliminations
   
ConsolidatedTotals
 
External revenues
                                   
Service revenues
  $ 81,415     $ 10,595     $ 17,722     $ -     $ -     $ 109,732  
Other
    10,309       14,852       2,061       -       -       27,222  
Total external revenues
    91,724       25,447       19,783       -       -       136,954  
Internal revenues
    2,268       10,076       37       -       (12,381 )     -  
Total operating revenues
    93,992       35,523       19,820       -       (12,381 )     136,954  
                                                 
Operating expenses
                                               
Costs of goods and services, exclusive of depreciation and amortization shown separately below
    32,108       13,075       16,001       188       (10,922 )     50,450  
Selling, general and administrative, exclusive of depreciation and amortization shown separately below
    14,808       6,993       9,939       2,465       (1,459 )     32,746  
Depreciation and amortization
    16,927       5,860       5,944       196       -       28,927  
Total operating expenses (1)
    63,843       25,928       31,884       2,849       (12,381 )     112,123  
Gain on sale of directory
    -       4,000       -       -       -       4,000  
Operating income (loss)
  $ 30,149     $ 13,595     $ (12,064 )   $ (2,849 )   $ -     $ 28,831  


Nine months ended September 30, 2009

(In thousands)

   
Wireless
   
Wireline
   
Cable TV
   
Other
   
Eliminations
   
ConsolidatedTotals
 
External revenues
                                   
Service revenues
  $ 76,348     $ 9,928     $ 10,682     $ -     $ -     $ 96,958  
Other
    8,258       14,316       824       -       -       23,398  
Total external revenues
    84,606       24,244       11,506       -       -       120,356  
Internal revenues
    1,948       9,568       24       -       (11,540 )     -  
Total operating revenues
    86,554       33,812       11,530       -       (11,540 )     120,356  
                                                 
Operating expenses
                                               
Costs of goods and services, exclusive of depreciation and amortization shown separately below
    27,534       12,563       9,211       235       (10,091 )     39,452  
Selling, general and administrative, exclusive of depreciation and amortization shown separately below
    12,237       5,374       3,766       2,641       (1,449 )     22,569  
Depreciation and amortization
    15,021       6,334       2,513       248       -       24,116  
Total operating expenses
    54,792       24,271       15,490       3,124       (11,540 )     86,137  
Operating income (loss)
  $ 31,762     $ 9,541     $ (3,960 )   $ (3,124 )   $ -     $ 34,219  

 
(1)
Total operating expenses for the nine months ended September 30, 2010 includes $3.8 million of expense, pre-tax, resulting from the settlement of the qualified pension plan and curtailment of the SERP during the second quarter of 2010.

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

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Total consolidated operating income
  $ 9,563     $ 10,569     $ 28,831     $ 34,219  
Interest expense
    (2,416 )     (193 )     (2,992 )     (1,128 )
Non-operating income (expense), net
    263       296       390       246  
Income from continuing operations before income taxes
  $ 7,410     $ 10,672     $ 26,229     $ 33,337  

 
12


The Company’s assets by segment are as follows:

(In thousands)

   
September 30, 2010
   
December 31, 2009
 
             
Wireless
  $ 122,800     $ 146,228  
Wireline
    77,216       80,668  
Cable TV
    198,720       20,240  
Other (includes assets held for sale)
    399,790       172,069  
Combined totals
    798,526       419,205  
Inter-segment eliminations
    (331,453 )     (147,480 )
Consolidated totals
  $ 467,073     $ 271,725  


9. The Company files U.S. federal income tax returns and various state and local income tax returns.  With few exceptions, years prior to 2006 are no longer subject to examination.  No state or federal income tax audits were in process as of September 30, 2010.

10.  On July 8, 2010, the Company announced that it had amended its Management Agreement with Sprint Nextel Corporation to allow the Company to begin selling Sprint Nextel’s Boost and Virgin Mobile prepaid wireless plans in its territory.  The Company also purchased from Sprint Nextel the right to receive a share of revenues from approximately 50,000 Virgin Mobile prepaid wireless subscribers currently receiving service in its territory for $138 per subscriber.  The purchase price of approximately $6.9 million has been recorded in intangible assets and is being amortized using an accelerated basis over four years, determined based upon the historical and expected churn rate of the underlying customer base.

11.  On July 30, 2010, the Company completed its previously announced acquisition of the cable operations of JetBroadBand Holdings, LLC (“JetBroadBand”) for $148 million in cash less working capital adjustments.  The purchase price was financed by a credit facility arranged by CoBank, ACB (see Note 12).  The Company has included these operations for financial reporting purposes for periods subsequent to the acquisition.

The total purchase price of $147.2 million has been preliminarily allocated to the assets of JetBroadBand as follows (in thousands):


Accounts receivable
  $ 3,417  
Other current assets
    930  
Cable plant
    44,924  
Converter boxes
    2,875  
Headend equipment
    4,708  
Land and buildings
    1,700  
All other plant and equipment
    1,828  
Acquired subscriber base
    22,112  
Franchise operating rights (indefinite lived)
    62,930  
Cost in excess of net assets of business acquired
    6,467  
Total assets
  $ 151,891  
         
Current liabilities
  $ 4,683  
         
Net assets acquired
  $ 147,208  

Finalization of the allocations is dependent on verification of proposed adjustments to the initial working capital adjustment and final review and acceptance of the independent appraiser’s valuation report, which we expect to complete by the end of 2010.

 
13


Following are the unaudited pro forma results of the Company for the three and nine months ended September 30, 2010 and 2009 as if the acquisition of JetBroadBand had occurred at the beginning of each of the periods presented, in millions:

   
Three Months Ended
September 30,
 
   
2010
   
2009
 
Operating revenues
  $ 57.0     $ 51.3  
Earnings before income taxes
  $ 12.3     $ 14.4  

   
Nine Months Ended
September 30,
 
   
2010
   
2009
 
Operating revenues
  $ 163.9     $ 153.5  
Earnings before income taxes
  $ 26.0     $ 41.8  

The pro forma disclosures shown above are based upon estimated preliminary valuations of the assets acquired and liabilities assumed as well as preliminary estimates of depreciation and amortization charges thereon, that may differ from the final fair values of the acquired assets and assumed liabilities and the resulting depreciation and amortization charges thereon.  They should not be construed as representative of actual results that might have been reported had the acquisition actually occurred at the beginning of each of the periods presented.

Operating revenues reported in the condensed consolidated statements of income for the three and nine months ended September 30, 2010 included revenues of $7.4 million related to the former JetBroadBand entity.  The amount of earnings before income taxes related to the former JetBroadBand entity is not readily determinable due to intercompany transactions and allocations that have occurred in connection with the operations of the combined company.

12.  Total debt consists of the following:

(In thousands)

   
September 30,
2010
   
December 31,
2009
 
             
Fixed term loans
  $ 7,572     $ 13,060  
Term loan A
    189,800       -  
Delayed draw term loan
    -       19,700  
Other
    765       200  
      198,137       32,960  
Current maturities
    12,508       4,561  
Total long-term debt
  $ 185,629     $ 28,399  


On July 30, 2010, the Company executed a syndicated Credit Agreement for the purpose of refinancing the Company’s existing outstanding debt, funding the purchase price of the JetBroadBand acquisition described above, funding planned capital expenditures to upgrade the acquired cable networks, and other corporate needs.

As of September 30, 2010, the Company’s indebtedness totaled $198.1 million, with an annualized overall weighted average interest rate of approximately 4.13%.  The balance included $7.6 million fixed at 7.37% (the Fixed Term Loan Facility, described further below), and $189.8 million of the Term Loan A Facility at a variable rate (of 3.77%  as of September 30, 2010) that resets monthly based on one month LIBOR plus a base rate of 3.50% currently.  These loans are more fully described below.

The Credit Agreement provides for three facilities, a Term Loan Facility, a Revolver Facility, and an Incremental Term Loan Facility.  The Term Loan Facility totals $198 million and was fully drawn for the purposes described above.  The Term Loan Facility has two parts, the Fixed Term Loan Facility of initially approximately $8 million in aggregate principal amount, and the Term Loan A Facility of $189.8 million in aggregate principal amount.  The Fixed Term Loan Facility is required to be repaid in monthly installments of approximately $200 thousand of principal, plus interest at 7.37%, from August 2010 through August 2013.  The Term Loan A Facility requires quarterly principal repayments of $2.4 million beginning on December 31, 2010 through September 30, 2011, increasing to $4.7 million quarterly thereafter through September 30, 2015, with the remaining expected balance of approximately $104 million due December 31, 2015.  The Term Loan A Facility is expected to bear interest at a base rate based upon one month LIBOR plus a spread determined by the Company’s Total Leverage Ratio, initially 3.50%; the Company may elect to use other rates as the base, but does not currently expect to do so.

 
14


The Revolver Facility provides for $30 million in immediate availability for future capital expenditures and general corporate needs, and an additional $20 million of availability once certain conditions have been met, for total availability of $50 million.  In addition, the Credit Agreement permits the Company to enter into one or more Incremental Term Loan Facilities in the aggregate principal amount not to exceed $100 million subject to compliance with certain covenants.  No draw has been made or is currently contemplated under either of these facilities.  When and if a draw is made, the maturity date and interest rate options would be substantially identical to the Term Loan A Facility.  Repayment provisions would be agreed to at the time of each draw under the Incremental Term Loan Facility.

The Credit Agreement also required the Company to enter into a hedge agreement to manage its exposure to interest rate movements.  The Company elected to hedge the minimum required under the Credit Agreement, and entered into a pay fixed, receive variable swap on $63 million notional principal for three years.  The Company will receive one month LIBOR and pay a fixed rate of 1.00% in addition to the 3.50% initial spread on the Term Loan A Facility.

The Credit Agreement contains affirmative and negative covenants customary to secured credit facilities, including covenants restricting the ability of the Company and its subsidiaries, subject to negotiated exceptions, to incur additional indebtedness and additional liens on their assets, engage in mergers or acquisitions or dispose of assets, pay dividends or make other distributions, voluntarily prepay other indebtedness, enter into transactions with affiliated persons, make investments, and change the nature of the Company’s and its subsidiaries’ businesses.

Indebtedness outstanding under any of the facilities may be accelerated by an Event of Default, as defined in the Credit Agreement.

The Facilities are secured by a pledge by the Company of its stock in its subsidiaries, a guarantee by the Company’s subsidiaries other than Shenandoah Telephone Company or Shentel Converged Services, Inc., and a security interest in all of the assets of the guarantors.

The Company is subject to certain financial covenants to be measured on a trailing twelve month basis each calendar quarter unless otherwise specified.  These covenants include:

 
·
a limitation on the Company’s total leverage ratio, defined as indebtedness divided by earnings before interest, taxes, depreciation and amortization, or EBITDA, of less than or equal to 3.00 to 1.00 from the closing date through March 31, 2011, then 2.50 to 1.00 December 31, 2012, and 2.00 to 1.00 thereafter;
 
·
a minimum debt service coverage ratio, defined as EBITDA divided by the sum of all scheduled principal payments on the Term Loans and regularly scheduled principal payments on other indebtedness plus cash interest expense, greater than 2.25 to 1.00 from the closing date through December 31, 2012, then 2.50 to 1.00 thereafter;
 
·
a minimum equity to assets ratio, defined as consolidated total assets minus consolidated total liabilities, divided by consolidated total assets, of at least 0.35 to 1.00 at all times, measured at each fiscal quarter end;
 
·
a minimum fixed charge coverage ratio, defined as EBITDA divided by fixed charges (defined as cash interest expense plus scheduled principal payments to be made on indebtedness plus capital expenditures other than capital expenditures acquired pursuant to a capital lease through the reinvestment of net proceeds of permitted asset dispositions or the sale of Shentel Converged Services, Inc. plus cash income taxes plus cash dividends and distributions), greater than 0.80 to 1.00 from the closing date through December 31, 2012, then 0.90 to 1.00 through December 31, 2013, and 1.00 to 1.00 thereafter; and,
 
·
the Company must maintain a minimum liquidity balance, defined as availability under the Revolver Facility plus unrestricted cash and cash equivalents other than cash and cash equivalents held in the name of an Excluded Subsidiary, of greater than $15 million at all times.

These ratios are generally more restrictive than the covenant ratios the Company had been required to comply with under its previously existing debt arrangements.  As of September 30, 2010, the Company was in compliance with the covenants in its credit agreements.

 
15

 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This management’s discussion and analysis includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  When used in this report, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan” and similar expressions as they relate to Shenandoah Telecommunications Company or its management are intended to identify these forward-looking statements.  All statements regarding Shenandoah Telecommunications Company’s expected future financial position and operating results, business strategy, financing plans, forecasted trends relating to the markets in which Shenandoah Telecommunications Company operates and similar matters are forward-looking statements.  We cannot assure you that the Company’s expectations expressed or implied in these forward-looking statements will turn out to be correct.  The Company’s actual results could be materially different from its expectations because of various factors, including those discussed below and under the caption “Risk Factors” in the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2009.  The following management’s discussion and analysis should be read in conjunction with the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2009, including the financial statements and related notes included therein.

General

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

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

 
*
The Wireline segment provides regulated and unregulated voice services, dial-up and DSL internet access, and long-distance access services throughout Shenandoah County and portions of northwestern Augusta County, Virginia, and leases fiber optic facilities, throughout the northern Shenandoah Valley of Virginia, northern Virginia and adjacent areas along the Interstate 81 corridor, including portions of West Virginia and Maryland.

 
*
The Cable Television segment provides video, internet and voice services in Virginia and West Virginia.

A fourth segment, Other, primarily includes Shenandoah Telecommunications Company, the parent holding company, as well as certain general and administrative costs historically charged to Converged Services that cannot be allocated to discontinued operations.

In September 2008, the Company announced its intention to sell its Converged Services operation, and the related assets and liabilities were reclassified as held for sale in the consolidated balance sheet and the historical operating results were reclassified as discontinued operations.  Depreciation and amortization on long-lived assets was discontinued.

In connection with the preparation of the Company’s first quarter 2009 financial statements, the Company determined that the fair value of Converged Services had declined from earlier estimates.  Accordingly, the Company recorded an impairment loss of $17.5 million ($10.7 million, net of taxes) to reduce the carrying value of these assets to their estimated fair value less cost to sell as of March 31, 2009.    At September 30, 2010, efforts to complete the sale continue, and there has been no change in the estimated fair value of the assets.

 
16


During the second quarter of 2010, the Company completed the settlement of its defined benefit pension plan following the receipt of a favorable tax determination letter in February, 2010.  In order to complete the settlement, the Company contributed $977 thousand during June 2010 to fully fund the pension obligations, and recognized $3.6 million of pension expense from other comprehensive income.  During the second quarter of 2010, the Company also curtailed future participation in the Company’s SERP.  Current participants may remain in the SERP and will continue to earn returns on invested balances, but the Company will make no further contributions to the SERP and no new participants will be eligible to join the SERP.  As a result of the curtailment, the Company recognized a curtailment loss of $666 thousand, consisting of actuarial losses previously recorded in other comprehensive income.

Acquisition of Virgin Mobile Customers and Initiation of Prepaid Wireless Sales

On July 8, 2010, the Company acquired the right to receive a share of revenues from approximately 50,000 Virgin Mobile customers in our service area, and effective July 11, 2010, the Company began selling Virgin Mobile and Boost prepaid products and services.  Based upon the initial subscriber base acquired, the Company expects to recognize approximately $0.9 million in monthly revenue and approximately $0.3 million in monthly expenses related to prepaid customers.  The Company will also recognize amortization on the $6.9 million capitalized purchase price of the acquired contract for the 50,000 acquired Virgin Mobile subscribers.  The amortization of the contract costs will approximate the life of the customers acquired, gradually decreasing over the expected four year life of this asset.  In future periods, the Company expects to incur significant costs of acquisition (including handset subsidies, commissions, and other sales and marketing costs) in the month of a new customer activation.   New customers are expected to generate net income over the course of their service.  Due to expensing all costs of acquisition in the month of acquisition, the Company expects that the sale of prepaid products and services will have a net negative impact on operating results until the base of customers is sufficient such that the aggregate monthly revenue less recurring expenses exceeds the up-front costs for new activations.

Acquisition of JetBroadBand

On April 16, 2010, the Company announced that it had signed an asset purchase agreement to purchase the cable operations of JetBroadBand for $148 million in cash, subject to certain adjustments.  On July 30, 2010, the Company completed this acquisition.  The acquired cable operations offer video, high speed Internet and voice services representing approximately 66,000 revenue generating units in southern Virginia and southern West Virginia.  The acquired networks pass approximately 115,000 homes.  The acquired cable operations’ operating results are now included in the Company’s Cable Television segment significantly impacting that segment’s operating revenues and expenses in subsequent periods.  Various fees and other expenses associated with the acquisition impacted the Company’s operating expenses.

The acquisition of JetBroadBand is consistent with the Company’s business strategy which focuses on meeting the growing demand for broadband services, and the advantages of cable systems in providing broadband services.  The fiber/coax network of a cable system is technically superior and more cost effective at delivering voice, video and data, than is the fiber/twisted pair network of a telephone company.  Our primary competitors in the areas JetBroadBand serves will be the incumbent telephone companies.  With our focus on providing quality service, we are confident that we will be able to effectively compete for market share.

JetBroadBand operates in southern Virginia and southern West Virginia, a close geographic fit with our existing markets and only a few hours away from our executive offices in Edinburg, Virginia.  The integration of the Rapid Communications acquisition has gone very well and we are now meeting and exceeding our growth expectations.  By combining our management team’s experience in upgrading the Rapid Communications markets with the financial resources we’ve obtained on attractive terms, we believe we can accelerate growth in the JetBroadBand markets.

This acquisition provides further diversification of our revenues and provides scale to our cable operations.  We are optimistic about the growth opportunities in cable, but our existing cable operations were not of an adequate size, and did not enjoy the margins benefitting larger operators. The acquisition will help improve the economies of scale of our cable business, and will allow us to leverage our management team, back office systems and assets, helping to maximize the investment return.  The current JetBroadBand penetration levels of services per homes passed are lower than industry norms.  Reaching industry average penetration levels alone presents a significant opportunity for growth.  The acquisition of JetBroadBand is expected to cause a downward trend in net income in the next few years, with the biggest negative impact most likely occurring in 2011, the first full year of operation.  We expect to begin to realize the long term positive impact of the JetBroadBand acquisition on our results of operations in 2012 and beyond.

 
17


Results of Operations

Consolidated Results for the Three Months Ended September 30, 2010

The Company’s consolidated results from continuing operations for the third quarter of 2010 and 2009 are summarized as follows:

(in thousands)
 
Three Months Ended
September 30,
   
Change
 
   
2010
   
2009
    $       %  
                           
Operating revenues
  $ 53,155     $ 40,115     $ 13,040       32.5  
Operating expenses
    47,592       29,546       18,046       61.1  
Gain on sale of directory
    4,000       -       4,000       n/m  
Operating income
    9,563       10,569       (1,006 )     (9.5 )
                                 
Other income (expense)
    (2,153 )     103       (2,256 )     n/m  
Income tax expense
    3,220       4,326       (1,106 )     (25.6 )
Net income from continuing operations
  $ 4,190     $ 6,346     $ (2,156 )     (34.0 )

Operating revenues

For the three months ended September 30, 2010, operating revenues increased $13.0 million, or 32.5%, primarily due to $7.4 million of revenue associated with the JetBroadBand acquisition, $2.4 million of pre-paid wireless revenue, $2.6 million of additional on-going Wireless revenue and an incremental $0.6 million of revenue in the Cable segment.  The increase in Wireless revenues included a one-time adjustment of $0.8 million related to re-calculated straight-line rent amounts adjusted during the third quarter of 2010.  The remaining increases in Wireless and Cable revenues resulted primarily from increases in customers and services provided.

Operating expenses

For the three months ended September 30, 2010, operating expenses increased $18.0 million, or 61.1%, compared to the 2009 period.  The Cable Segment accounted for $12.7 million of this increase; the acquired JetBroadBand operations added approximately $10.3 million of incremental costs, while the existing Shentel Cable operations accounted for $3.6 million of the quarter over quarter increase.   Included in the $10.3 million of incremental JetBroadBand-related operating expenses were approximately $3.0 million of one-time costs related to the acquisition.  In the Wireless Segment, the new prepaid activities generated $4.1 million of incremental expenses, including approximately $1.5 million in handset subsidies, $1.1 million in amortization of the purchase price of the existing subscribers, and $1.4 million in pass-through costs from Sprint Nextel.

Gain on sale of directory

The Company sold its telephone directory for $4 million in cash during the third quarter of 2010.

Other income (expense)

 Other income (expense) decreased $2.3 million in the third quarter of 2010 from the comparable 2009 period as interest expense increased $2.2 million as a result of the increase in borrowings in support of the JetBroadBand acquisition.

 
18


Income tax expense

The Company’s effective tax rate on income from continuing operations increased from 40.5% in the third quarter of 2009 to 43.5% in the third quarter of 2010 principally due to expanded operations in higher tax states.

Net income from continuing operations

For the three months ended September 30, 2010, net income from continuing operations decreased $2.2 million due to the various factors discussed above.
 
Consolidated Results for the Nine Months Ended September 30, 2010

The Company’s consolidated results from continuing operations for the first nine months of 2010 and 2009 are summarized as follows:

(in thousands)
 
Nine Months Ended
September 30,
   
Change
 
   
2010
   
2009
    $       %  
                           
Operating revenues
  $ 136,954     $ 120,356     $ 16,598       13.8  
Operating expenses
    112,123       86,137       25,986       30.2  
Gain on sale of directory
    4,000       -       4,000       n/m  
Operating income
    28,831       34,219       (5,388 )     (15.7 )
                                 
Other income (expense)
    (2,602 )     (882 )     (1,720 )     n/m  
Income tax expense
    10,969       14,019       (3,050 )     (21.8 )
Net income from continuing operations
  $ 15,260     $ 19,318     $ (4,058 )     (21.0 )

Operating revenues

For the nine months ended September 30, 2010, operating revenues increased $16.6 million, or 13.8%, primarily due Cable Segment revenues associated with the acquired JetBroadBand operations, totaling $7.4 million in 2010, and to $2.4 million in Wireless Segment revenues associated with prepaid subscribers beginning July 1, 2010.  Other Cable Segment revenues increased $0.9 million in 2010 over 2009, while other Wireless segment revenues increased $5.0 million. This increase in Wireless Segment revenues included a one-time adjustment of $0.8 million to straight-line rent computations for a small number of co-location leases.  Wireline revenues included an adjustment of $1.0 million related to re-calculated settlements due from NECA recorded in the second quarter of 2010, including $0.7 million related to 2008 and 2009.

Operating expenses

For the nine months ended September 30, 2010, operating expenses increased $26.0 million, or 30.2%, compared to the 2009 period.  Expenses recognized in connection with the final settlement of the Company’s defined benefit pension plan, and the curtailment loss associated with the Company’s SERP plan, totaled $3.8 million during the second quarter of 2010.  The incremental costs of the acquired JetBroadBand operations included within the Company’s Cable segment totaled $10.9 million, including approximately $3.1 million of expenses associated with closing the transaction.  Existing Shentel Cable operations accounted for $5.5 million of the year over year increase.  Operating costs associated with prepaid wireless subscribers totaled $4.1 million as noted previously.  All other operating expenses increased $1.7 million, net, in the first nine months of 2010, compared to the comparable 2009 period.

Gain on sale of directory

The Company sold its telephone directory for $4 million in cash during the third quarter of 2010.

 
19


Other income (expense)

The change in other income (expense) resulted primarily from an increase in interest expense of $1.9 million due to the increase in indebtedness during the third quarter of 2010 due to the JetBroadBand acquisition.

Income tax expense

The Company’s effective tax rate on income from continuing operations decreased from 42.1% in the first nine months of 2009 to 41.8% in the first nine months of 2010 due primarily to non-recurring adjustments recognized during the early months of the 2009 period.

Net income from continuing operations

For the nine months ended September 30, 2010, net income from continuing operations decreased $4.1 million, due to the various factors described above.
 
Wireless

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

PCS receives revenues from Sprint Nextel for subscribers that obtain service in PCS’s network coverage area.  PCS relies on Sprint Nextel to provide timely, accurate and complete information to record the appropriate revenue for each financial period.  Postpaid revenues received from Sprint Nextel are recorded net of fees, as defined, retained by Sprint Nextel.  Through May 31, 2010, such fees totaled 16.8% of net billed revenue; effective June 1, 2010, the net service fee component increased from 8.8% to 12.0%, bringing the total fee retained by Sprint Nextel to 20%.  The fee increase will result in Sprint Nextel retaining an additional $0.3 million of revenue per month at current levels of revenue.

Beginning in July 2010, the Company began offering prepaid wireless products and services in its PCS network coverage area.  Prepaid revenues received from Sprint Nextel are reported gross of expenses passed through from Sprint Nextel.  The Company pays handset subsidies to Sprint Nextel for the difference between the selling price of handsets and their cost, in the aggregate and as a net cost.  Many of the revenue and expense components reported to us by Sprint Nextel are based on Sprint Nextel’s national averages for prepaid services, rather than being specifically determined by customers homed in our geographic service areas.

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

   
As of
   
As of
 
   
Sept. 30,
   
Dec. 31,
   
Sept. 30,
   
Dec. 31,
 
   
2010
   
2009
   
2009
   
2008
 
                         
Retail PCS Subscribers - Postpaid
    230,612       222,818       219,353       211,462  
Retail PCS Subscribers - Prepaid
    56,203       -       -       -  
PCS Market POPS (000) (1)
    2,339       2,327       2,324       2,310  
PCS Covered POPS (000) (1)
    2,052       2,033       1,988       1,931  
CDMA Base Stations (sites)
    484       476       448       411  
EVDO-enabled sites
    346       334       306       211  
EVDO Covered POPS (000) (1)
    1,960       1,940       1,874       1,663  
Towers
    142       140       132       118  
Non-affiliate cell site leases
    211       196       191       183  

 
20

 
   
Three Months Ended
   
Nine Months Ended
 
   
Sept. 30,
   
Sept. 30,
   
June 30,
   
Sept. 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net PCS Subscriber Additions - Postpaid
    3,175       3,286       7,794       7,891  
Net PCS Subscriber Additions – Prepaid (2)
    6,296       -       6,296       -  
PCS Average Monthly Retail Churn % - Postpaid (3)
    1.88 %     2.17 %     1.82 %     2.13 %
PCS Average Monthly Retail Churn %  - Prepaid (3)
    5.02 %     n/a       n/a       n/a  

1)
POPS refers to the estimated population of a given geographic area and is based on information purchased from third party sources.  Market POPS are those within a market area which the Company is authorized to serve under its Sprint PCS affiliate agreements, and Covered POPS are those covered by the network’s service area.
2)
Excludes prepaid subscribers purchased.
3)
PCS Average Monthly Retail Churn is the average of the monthly subscriber turnover, or churn, calculations for the period.


Operating Results for the Three Months Ended September 30, 2010

 
 (in thousands)
 
Three Months Ended
September 30,
   
Change
 
   
2010
   
2009
    $       %  
                           
Segment operating revenues
 
 
         
 
         
Wireless service revenue
  $ 28,624     $ 25,287     $ 3,337       13.2  
Tower lease revenue
    2,078       1,813       265       14.6  
Equipment revenue
    1,712       1,046       666       63.7  
Other revenue
    1,314       544       770       141.5  
Total segment operating revenues
    33,728       28,690       5,038       17.6  
Segment operating expenses
                               
Cost of goods and services, exclusive of depreciation and amortization shown separately below
    12,237       9,594       2,643       27.5  
Selling, general and administrative, exclusive of depreciation and amortization shown separately below
    5,885       4,123       1,762       42.7  
Depreciation and amortization
    6,401       5,178       1,223       23.6  
Total segment operating expenses
    24,523       18,895       5,628       29.8  
Segment operating income
  $ 9,205     $ 9,795     $ (590 )     (6.0 )


Operating revenues

Wireless service revenue increased $3.3 million, or 13.2%, for the three months ended September 30, 2010, compared to the comparable 2009 period.  Net service revenue from prepaid subscribers accounted for $2.5 million of the increase in revenue.  The Company purchased approximately 50,000 prepaid subscribers in July 2010, and began offering prepaid plans under the Boost and Virgin Mobile brands.  Postpaid wireless service revenue increased $1.7 million, or 4.8%, in the third quarter of 2010 over 2009.  Average postpaid subscribers increased 5.2% in the current quarter compared to the 2009 third quarter.  Billed revenue per user has declined 0.8% due to an increase in all-inclusive plans, which reduce revenue from higher usage customers, and to increased additions of second phones, such as to a family plan, at lower revenue than the primary phone.  Total credits against gross billed revenue, including fees retained by Sprint Nextel and bad debt write-offs, increased $0.8 million from the third quarter of 2009.   Fees retained by Sprint Nextel increased by $1.4 million, or 27.1%, while bad debt write-offs declined by $0.5 million, or 26.1%.  The increase in fees retained by Sprint Nextel was primarily due to the increase in the net service fee to 12% from 8.8% effective June 1, 2010, as described more fully below.

 
21


In March 2007, the Company and Sprint Nextel amended the Management Agreement to simplify the method that the companies used to settle certain revenues and expenses between them.  The revenues and expenses for 2006 were used as the basis for the calculation.  For 2006, the ratio of net expense due Sprint Nextel for each net revenue dollar (net of credits and bad debt) generated by the Company’s wireless customers was 8.8%, known as the Net Service Fee.  The Net Service Fee percentage was applied to future net revenues to compensate Sprint Nextel for the net expenses due.  The amendment allowed either party to annually request a review of the Net Service Fee, with the percentage needing to change by 100 basis points or more in either direction before there would be a change in the Net Service Fee, with the maximum Net Service Fee not exceeding 12%.

In the second quarter of 2010, Sprint Nextel for the first time exercised their option to review the Net Service Fee percentage, and effective June 2010, the Net Service Fee increased to 12%, the maximum allowed by contract.  The Net Service Fee will remain at 12% until either party requests a review and the review determines that the underlying costs have changed, causing the Fee percentage to drop 100 basis points or more.  This increase is expected to reduce revenues by approximately $0.3 million per month, or nearly $4 million annually, at current levels of revenue.

The increase in tower lease revenue resulted primarily from additional cell site leases.

The increase in equipment revenue resulted from a 4.5% decrease in wireless handsets sold, but at 33% higher net revenue per phone.

The increase in other revenue primarily resulted from a one-time adjustment to straight-line rent accruals recorded in the third quarter of 2010 on a small number of leases due to a determination that the leases were longer-term than initially thought.

In March, 2010, PCS signed Addendum X to the Sprint PCS Management Agreement that allows PCS to sell 3G/4G datacards in our territory, with the expectation that PCS would be able to sell 3G/4G handsets when they became available later in 2010.  In May 2010, 4G services became available in portions of the Harrisburg and York, Pennsylvania, areas of the Company’s PCS territory.  During the third quarter of 2010, 4G capable handsets were our top sellers.

Cost of goods and services

Cost of goods and services increased $2.6 million, or 27.5%, in the 2010 third quarter from the third quarter of 2009.   Costs associated with the prepaid wireless plans included handset subsidies of $1.5 million.  Postpaid handset costs increased $0.7 million, principally due to higher cost smartphones and 4G phones.  Costs of the expanded network and EVDO coverage resulted in a $0.4 million increase in network costs including rent for additional tower and co-location sites, power and backhaul line costs.

Selling, general and administrative

Selling, general and administrative expenses increased $1.8 million, or 42.7%, in the third quarter of 2010 versus the 2009 third quarter, principally due to $1.4 million in pass-through charges related to prepaid wireless revenues.  Operating taxes also increased $0.2 million due to increases in tower and base station assets added during 2009.

Depreciation and amortization

Depreciation and amortization increased $1.2 million in 2010 over the 2009 third quarter, principally due to $1.1 million of amortization on the $6.9 million of acquired prepaid customer contract.

 
22


Operating Results for the Nine Months Ended September 30, 2010

 
(in thousands)
 
Nine Months Ended
September 30,
   
Change
 
   
2010