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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 June 30, 2014

 

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

 

For the transition period from__________ to __________

Commission File No.: 000-09881

SHENANDOAH TELECOMMUNICATIONS COMPANY

(Exact name of registrant as specified in its charter)

500 Shentel Way, Edinburg, Virginia    22824

(Address of principal executive offices)  (Zip Code)

(540) 984-4141

(Registrant's telephone number, including area code)

 

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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ   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  þ   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.

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

 

The number of shares of the registrant’s common stock outstanding on July 24, 2014 was 24,113,100.

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY

INDEX

 

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

See accompanying notes to unaudited consolidated financial statements.

(Continued)

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

(in thousands)

See accompanying notes to unaudited consolidated financial statements.

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME AND

COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share amounts)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
Operating revenues		$	81,416			$	77,454			$	161,868			$	153,463
Operating expenses:
Cost of goods and services, exclusive of depreciation and amortization shown separately below			32,403				30,528				64,639				61,229
Selling, general and administrative, exclusive of depreciation and amortization shown separately below			16,625				16,355				33,773				32,484
Depreciation and amortization			16,595				16,071				31,983				30,042
Total operating expenses			65,623				62,954				130,395				123,755
Operating income			15,793				14,500				31,473				29,708
Other income (expense):
Interest expense			(2,065	)			(2,068	)			(4,112	)			(4,220	)
Gain on investments, net			114				30				96				178
Non-operating income, net			459				458				1,086				979
Income before taxes			14,301				12,920				28,543				26,645
Income tax expense			5,686				5,078				11,312				10,452
Net income		$	8,615			$	7,842			$	17,231			$	16,193
Other comprehensive income (loss):
Unrealized gain (loss) on interest rate hedge, net of tax			(913	)			2,775				(1,260	)			3,307
Comprehensive Income		$	7,702			$	10,617			$	15,971			$	19,500
Earnings per share:
Basic		$	0.36			$	0.33			$	0.72			$	0.67
Diluted		$	0.35			$	0.33			$	0.71			$	0.67
Weighted average shares outstanding, basic			24,102				23,996				24,080				23,985
Weighted average shares outstanding, diluted			24,320				24,078				24,271				24,055

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(in thousands, except per share amounts)

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

(Continued)

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

During the first six months of 2013, the Company traded in certain PCS equipment and received credits of $10,778 against the purchase price of new equipment.

At December 31, 2013, accounts payable included approximately $7.6 million associated with the capital expenditures related to the Network Vision project. These payables were disbursed during 2014.

See accompanying notes to unaudited consolidated financial statements.

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SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.	Basis of Presentation

The interim consolidated financial statements of Shenandoah Telecommunications Company and Subsidiaries (collectively, the “Company”) are unaudited.  In the opinion of management, all adjustments necessary for a fair presentation of the interim results have been reflected therein.  All such adjustments were of a normal and recurring nature.  These statements should be read in conjunction with the consolidated financial statements and related notes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.  The balance sheet information at December 31, 2013 was derived from the audited December 31, 2013 consolidated balance sheet.  Operating revenues and income from operations for any interim period are not necessarily indicative of results that may be expected for the entire year.

2.	Property, Plant and Equipment

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

3.	Earnings per share

Basic net income per share was computed on the weighted average number of shares outstanding.  Diluted net income per share was computed under the treasury stock method, assuming the conversion as of the beginning of the period, for all dilutive stock options.  Of 694 thousand and 809 thousand shares and options outstanding at June 30, 2014 and 2013, respectively, zero and 345 thousand were anti-dilutive, respectively.  These options have been excluded from the computations of diluted earnings per share for their respective period.  There were no adjustments to net income for either period.

4.	Investments Carried at Fair Value

Investments include $2.7 million and $2.5 million of investments carried at fair value as of June 30, 2014 and December 31, 2013, respectively, consisting of equity, bond and money market mutual funds.  These investments were acquired under a rabbi trust arrangement related to a non-qualified supplemental retirement plan maintained by the Company.  During the six months ended June 30, 2014, the Company recognized $104 thousand in dividend and interest income from investments, and recorded net unrealized gains of $74 thousand on these investments.  Fair values for these investments held under the rabbi trust were determined by Level 1 quoted market prices for the underlying mutual funds.

5.	Financial Instruments

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

6.	Derivative Instruments, Hedging Activities and Accumulated Other Comprehensive Income

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

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The Company entered into a pay-fixed, receive-variable interest rate swap of $63.3 million of notional principal in August 2010.  This interest rate swap was not designated as a cash flow hedge.  Changes in the fair value of interest rate swaps not designated as cash flow hedges are recorded in interest expense each reporting period.  The changes in fair value recorded in interest expense for the three and six months ended June 30, 2013 were decreases of $102 thousand and $206 thousand, respectively. This swap expired in July 2013.

The Company entered into a pay-fixed, receive-variable interest rate swap of $174.6 million of notional principal in September 2012.  This interest rate swap was designated as a cash flow hedge.  The total outstanding notional amount of cash flow hedges was $174.6 million as of June 30, 2014.

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

Amounts reported in accumulated other comprehensive income related to the interest rate swap designated and that qualify as a cash flow hedge are reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. As of June 30, 2014, the Company estimates that $1.6 million will be reclassified as an increase to interest expense during the next twelve months due to the interest rate swap since the hedge interest rate exceeds the variable interest rate on the debt.

The table below presents the fair value of the Company’s derivative financial instruments as well as its classification on the consolidated balance sheet as of June 30, 2014 and December 31, 2013 (in thousands; amounts in parentheses indicate debits):

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

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The table below presents change in accumulated other comprehensive income by component for the six months ended June 30, 2014 (in thousands):

7.	Segment Information

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

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

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

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

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

The Company’s assets by segment are as follows:

 

8.	Income Taxes

The Company files U.S. federal income tax returns and various state and local income tax returns.  With few exceptions, years prior to 2010 are no longer subject to examination. The Company is under audit in the state of Maryland for the 2009, 2010 and 2011 tax years.  No other state or federal income tax audits were in process as of June 30, 2014.

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ITEM 2.

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

This management’s discussion and analysis includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  When used in this report, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan” and similar expressions as they relate to Shenandoah Telecommunications Company or its management are intended to identify these forward-looking statements.  All statements regarding Shenandoah Telecommunications Company’s expected future financial position and operating results, business strategy, financing plans, forecasted trends relating to the markets in which Shenandoah Telecommunications Company operates and similar matters are forward-looking statements.  We cannot assure you that the Company’s expectations expressed or implied in these forward-looking statements will turn out to be correct.  The Company’s actual results could be materially different from its expectations because of various factors, including those discussed below and under the caption “Risk Factors” in the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2013.  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, 2013, including the financial statements and related notes included therein.

General

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

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

 

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

 

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

 

*

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

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Results of Operations

Three Months Ended June 30, 2014 Compared with the Three Months Ended June 30, 2013

Consolidated Results

The Company’s consolidated results for the second quarters of 2014 and 2013 are summarized as follows:

Operating revenues

For the three months ended June 30, 2014, operating revenues increased $4.0 million, or 5.1%. Wireless segment revenues increased $2.0 million compared to the second quarter of 2013. Net postpaid service revenues increased $1.2 million, driven by growth of data revenue and 4.2% year-over-year growth in average postpaid subscribers. Other Wireless revenue increased $0.6 million, as the prior year period included a $0.5 million adjustment to straight-line rent accruals related to the termination of iDEN tower leases. Cable segment revenue grew $2.1 million. A $1.1 million increase in cable service revenue reflected 6.3% growth in average subscriber counts and an increase in revenue per subscriber, while growth in equipment revenue of $1.0 million resulted primarily from an increase in customer premise equipment rents.  Wireline segment revenue increased $0.4 million due primarily to an increase in affiliate revenue, which is eliminated in consolidation.

Operating expenses

Total operating expenses were $65.6 million in the second quarter of 2014 compared to $63.0 million in the prior year period.  Cost of goods and services sold increased $1.9 million, including increases of $0.7 million in cable programming costs, $0.7 million in network maintenance costs and $0.6 million in PCS handset costs.  Selling, general and administrative expenses increased $0.3 million.  Depreciation and amortization expense increased $0.5 million, primarily due to completion of the Network Vision upgrade project.

Other income (expense), net

Other income increased in the current year period due primarily to higher investment gains.

Income tax expense

The Company’s effective tax rate increased to 39.8% in the quarter ended June 30, 2014 from 39.3% in the 2013 quarter.

Net income

For the three months ended June 30, 2014, net income increased $0.8 million, or 9.9%, primarily reflecting growth in subscriber counts and revenue per subscriber in both the wireless and cable segments.

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Six Months Ended June 30, 2014 Compared with the Six Months Ended June 30, 2013

Consolidated Results

The Company’s consolidated results for the first six months of 2014 and 2013 are summarized as follows:

Operating revenues

For the six months ended June 30, 2014, operating revenues increased $8.4 million, or 5.5%. Wireless segment revenues increased $4.9 million compared to the first six months of 2013.  Net postpaid service revenues increased $2.4 million, driven by data fees and 4.3% year-over-year growth in average postpaid subscribers.  Net prepaid service revenues grew $2.3 million, or 11.7%, due to 4.5% growth in average prepaid subscribers and higher average revenue per subscriber in 2014 over 2013. Cable segment revenues increased $4.1 million due to a 6.0% increase in average revenue generating units compared to the 2013 period and to a $1.1 million increase in rent revenues for customer premise equipment, due to a change in January 2014 of charging customers for their first set top box, which previously had been at no charge. Wireline segment revenue increased $1.1 million, due primarily to a $1.4 million increase in affiliate revenue, which is eliminated in consolidation.

Operating expenses

Total operating expenses were $130.4 million in the six months ended June 30, 2014 compared to $123.8 million in the prior year period.  Cost of goods and services sold increased $3.4 million, including increases of $1.5 million in network maintenance costs, $1.3 million in PCS handset costs and $0.8 million in video programming costs.  Selling, general and administrative expenses increased $1.3 million, due to higher personnel costs, partially offset by lower wireless prepaid and bad debt expenses.  Depreciation and amortization expense increased $1.9 million, primarily due to completion of the Network Vision upgrade project.

Interest and other income (expense), net

Interest expense declined $0.1 million from the prior year period. During the first six months of 2013, the company recorded $0.1 million of interest expense charges to reflect changes in the fair value of an interest rate swap not designated as a cash flow hedge. This swap expired in July 2013.

Income tax expense

The Company’s effective tax rate increased to 39.6% in the six months ended June 30, 2014 from 39.2% in the 2013 period.

Net income

For the six months ended June 30, 2014, net income increased $1.0 million, or 6.4%, reflecting growth in subscriber counts and revenue per subscriber in both the Wireless and Cable segments, partially offset by increases in operating expenses incurred in support of this growth.

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Wireless

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

PCS receives revenues from Sprint for postpaid and prepaid subscribers that obtain service in PCS’s network coverage area.  PCS relies on Sprint to provide timely, accurate and complete information to record the appropriate revenue for each financial period.  Through July 31, 2013, postpaid revenues received from Sprint were recorded net of certain fees totaling 20% of net postpaid billed revenue retained by Sprint.  These fees included an 8% management fee and a 12% net service fee.  Effective August 1, 2013, the net service fee increased to 14%, the maximum allowed by the current Sprint Affiliate contract. The management fee remained unchanged at 8%. Sprint also retains a 6% management fee on prepaid revenues.

During the second quarter of 2014, the Company’s PCS stores began participating in Sprint’s Easy Pay handset financing program, whereby Sprint enters into a financing agreement with the subscriber and the subscriber receives a handset from Sprint.  The equipment revenue from the subscriber and the expense of the handset are Sprint’s responsibility.

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

 

 

 

1)

POPS refers to the estimated population of a given geographic area and is based on information purchased from third party sources.  Market POPS are those within a market area which the Company is authorized to serve under its Sprint PCS affiliate agreements, and Covered POPS are those covered by the Company’s network.

2)

The decrease from December 31, 2013 to June 30, 2014 is primarily a result of termination of Sprint iDEN leases associated with the former Nextel network.

3)

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

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Three Months Ended June 30, 2014 Compared with the Three Months Ended June 30, 2013

 

Operating revenues

Wireless service revenue increased $1.5 million, or 3.2%, for the three months ended June 30, 2014, compared to the comparable 2013 period.  Net postpaid service revenues increased $1.2 million, driven by data revenues and 4.2% year-over-year growth in average postpaid subscribers. As stated above, the net service fee increased from 12% of net billed revenues to 14% on August 1, 2013, reducing net postpaid service revenue by $0.9 million, approximately $0.3 million per month.  Net prepaid service revenues grew $0.3 million, or 3.1%, due to 3.4% growth in average prepaid subscribers over 2013.

The decrease in tower lease revenue resulted from the termination of Sprint iDEN leases associated with the former Nextel network. Other revenue increased, as the prior year period included a $0.5 million unfavorable adjustment to straight-line rent accruals related to the termination of iDEN leases.

Cost of goods and services

Cost of goods and services increased $0.6 million, or 3.5%, in 2014 from the second quarter of 2013. Postpaid handset costs increased $1.0 million, as higher volume of handset upgrades drove a $0.6 million increase and higher volume of tablets drove $0.2 million of incremental cost. Prepaid handset subsidies decreased $0.5 million on lower volume of handsets sold.

Selling, general and administrative

Selling, general and administrative costs decreased $0.4 million, or 5.1%, in the second quarter of 2014 from the comparable 2013 period.  Costs to add new prepaid subscribers decreased $0.7 million due to lower volume of gross additions in the current year. This decrease was partially offset by growth in advertising expense and general and administrative support.

Depreciation and amortization

Depreciation and amortization increased $0.3 million, or 3.7%, in the second quarter of 2014 over the comparable 2013 period, following completion of Network Vision upgrades.

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Six Months Ended June 30, 2014 Compared with the Six Months Ended June 30, 2013