Business context and reporting period
Shenandoah Telecommunications Company (Shentel) filed this Form 10-K for the fiscal year ended December 31, 2018. The company provides Sprint-branded wireless service and Shentel-branded cable, broadband, voice and wireline services, and operates fiber networks and cell-site towers. Wireless generated approximately 68% of 2018 consolidated revenue, making Sprint a significant customer and business partner.
Financial and operating highlights
| Metric | 2018 | 2017 |
|---|---|---|
| Operating revenue | $630.9 million | $612.0 million |
| Operating income | $93.2 million | $46.5 million |
| Operating margin | 14.8% | 7.6% |
| Net income | $46.6 million | $66.4 million |
| Diluted EPS | $0.93 | $1.33 |
| Cash from operations | $265.6 million | $222.9 million |
| Capital expenditures | $136.6 million | $146.5 million |
| Cash and cash equivalents, year-end | $85.1 million | $78.6 million |
Revenue increased 3.1% as reported; excluding the presentation effects of adopting Topic 606, management reported growth of approximately 4.7%. Operating income doubled, while net income fell 29.8%, chiefly because 2017 included a $53.4 million non-cash tax benefit from U.S. tax reform. 2018 income tax expense was $15.5 million. Operating cash flow less capital expenditures was approximately $129.0 million, compared with approximately $76.4 million in 2017.
Wireless operating revenue was $462.7 million and operating income was $92.8 million. Postpaid subscribers grew 8.0% to 795,176 and prepaid subscribers grew 14.6% to 258,704. Cable revenue increased 8.2% to $128.9 million and operating income increased to $23.8 million; broadband subscribers rose while video subscribers declined. Wireline revenue fell 2.7% to $77.1 million and operating income fell 14.8% to $17.9 million, partly reflecting lower backhaul and voice revenue.
At year-end, gross debt was $785.2 million ($770.2 million net of unamortized loan fees), versus $836.5 million gross at the end of 2017. The weighted average effective interest rate was approximately 3.97%; all debt was variable-rate, with swaps covering about half. The company reported $159.0 million of covenant-defined liquidity, full availability on its $75 million revolver, and compliance with its debt covenants (leverage ratio 2.54 versus a 3.50 maximum; debt-service coverage 3.63 versus a 2.00 minimum). The 2018 dividend was $0.27 per share, subject to credit-agreement restrictions.
Material changes and unusual items
- Topic 606 was adopted January 1, 2018 using the modified retrospective method. It changed gross-versus-net presentation of device sales and Sprint reimbursements and deferred certain contract costs. The company recorded a $56.1 million increase to opening retained earnings. Reported revenue and expense comparisons are therefore not fully comparable; management’s adjusted growth figures should be read alongside GAAP results.
- In February 2018, Shentel expanded its Sprint territory by approximately 1.1 million population points, paying $52.0 million, with a possible additional payment of up to $5.0 million. The expansion included network build-out obligations.
- In November 2018, the credit agreement amendment lowered the applicable base interest rate by 75 basis points, reduced near-term principal payments, and extended term-loan maturities to 2023 and 2025.
- After year-end, on February 28, 2019, Shentel completed the acquisition of Big Sandy Broadband, adding approximately 4,747 customers.
- The 2018 quarterly statements were revised for an immaterial revenue-recognition error. The filing says the error understated revenue in earlier 2018 quarters; corrected first-half net income increased by $3.6 million.
Outlook, risks and contingencies
Management budgeted approximately $147.4 million of 2019 capital expenditures, including $64.1 million for wireless, $52.9 million for cable, and $20.5 million for wireline. It expected cash, operating cash flow and available borrowing capacity to fund planned spending, debt service and other needs for at least the next 12 months, while cautioning that cash generation and borrowing access are not assured. No specific revenue or earnings guidance is provided.
- Sprint concentration and transaction risk: Sprint accounted for 68% of 2018 revenue and provides key network, billing and customer-support services. The proposed T-Mobile/Sprint combination could affect the affiliate relationship. Under specified circumstances, the combined company could purchase Shentel’s wireless operating assets at 90% of contract-defined entire business value if no acceptable agreement is reached.
- Competition and execution: Intense wireless, broadband and video competition, pricing pressure, subscriber churn, rising programming costs and network investment requirements may affect growth and margins.
- Debt and rates: Variable-rate debt exposes earnings and cash flow to interest-rate increases; the company estimated a 1 percentage-point rise would add about $7.8 million to annual interest expense before swap effects. Credit covenants and restrictions also constrain financial flexibility.
- Regulatory and legal matters: Changes to intercarrier compensation, universal-service funding, broadband rules, privacy requirements, cable regulation and pole-attachment costs could affect revenue or expenses. Routine interconnection disputes and possible tariff refunds are disclosed; management did not expect litigation to have a material adverse financial impact.
- Internal controls: Management concluded internal control over financial reporting and disclosure controls were ineffective at December 31, 2018 due to continuing material weaknesses in staffing, risk assessment, information and communication, monitoring, and process-level controls. KPMG issued an adverse opinion on internal control, while giving an unqualified opinion on the financial statements. Management described remediation steps planned for 2019.
- Other exposures: The filing cites cybersecurity, weather-related network damage, pension funding, goodwill and intangible-asset impairment, and lease obligations as risks. The company reported $425.5 million of future minimum operating lease payments and a pension-plan underfunding of approximately $5.1 million.
Most important facts for investors to verify
- Reconcile GAAP revenue trends and margins with Topic 606’s presentation changes and the corrected 2018 quarterly figures.
- Track remediation of the material weaknesses, including whether controls are tested and independently validated as effective.
- Monitor the T-Mobile/Sprint transaction and any changes to Shentel’s affiliate agreement, asset-purchase provisions, spectrum access or service economics.
- Assess whether 2019 capital spending, expansion build-out and the Big Sandy acquisition generate expected subscriber growth and cash returns.
- Review debt amortization, variable-rate exposure, covenant headroom, dividend capacity and the continuing availability of revolver liquidity.