SHENANDOAH TELECOMMUNICATIONS CO quarterly report, Q2 FY2016

Business context and reporting period

Shenandoah Telecommunications Company (Shentel) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. It operates Wireless, Cable and Wireline businesses. Results include nTelos only from its May 6, 2016 acquisition, so reported comparisons with 2015 are not like-for-like.

On May 6, Shentel acquired nTelos for $663.7 million in cash, net of cash acquired, and immediately exchanged certain acquired spectrum and customer rights with Sprint for an expanded affiliate territory and additional customer rights. The amended Sprint agreement extends to 2029 and includes management-fee waivers and network-upgrade commitments.

Financial performance and position

• Q2 operating margin was approximately negative 4.7%, versus 21.9% a year earlier; six-month margin was 6.8%, versus 21.9%. Higher revenue was outweighed by acquisition-related costs, depreciation and amortization, and interest expense.
• Q2 revenue increased 52.1%; six-month revenue increased 31.1%. Wireless contributed most of the increase, largely from nTelos and the expanded Sprint footprint. Cable and Wireline also grew.
• Q2 integration and acquisition expense was $20.1 million; six-month expense was $20.4 million. Management cited an expected total of $106–$126 million of integration and acquisition costs, excluding approximately $24 million of debt issuance costs.
• Six-month investing cash outflow was $714.7 million, including $654.8 million paid for the acquisition, net of cash acquired, and $60.1 million of capital expenditures. Financing activities provided $617.7 million. Cash declined $36.2 million to $40.6 million; restricted cash was $2.2 million.
• At June 30, total debt was $835.4 million before $19.8 million of unamortized loan fees, or $815.6 million net. The stated weighted-average effective interest rate was approximately 3.84%. Debt is primarily variable-rate term loans; the company hedged approximately half of expected outstanding debt.
• Current assets were $158.1 million and current liabilities $138.5 million. A $75 million revolver was available under the credit agreement. Shentel reported compliance with its covenants: total leverage ratio 2.93 against a maximum of 3.75, and debt-service coverage ratio 3.72 against a minimum of 2.00.
• Adjusted OIBDA, a non-GAAP measure, was $55.9 million in Q2 and $96.3 million for the six months; continuing OIBDA was $49.8 million and $90.2 million, respectively. These measures exclude specified costs and adjustments and should not be treated as GAAP operating income or cash flow.

Material changes versus the prior comparable period

• nTelos substantially expanded Wireless scale: reported June 30 subscriber counts included approximately 404,000 acquired postpaid and 155,000 acquired prepaid subscribers. Reported Wireless revenue and operating costs therefore include only a partial quarter of acquired operations.
• Q2 operating results moved from $18.8 million of income to a $6.2 million loss; six-month operating income fell 59.3%. Interest expense rose to $5.9 million in Q2 from $1.9 million, and to $7.5 million for six months from $3.9 million.
• Balance-sheet assets rose to $1.46 billion from $627.2 million at December 31, 2015, while net debt rose to $815.6 million from $199.7 million, primarily reflecting the acquisition and its financing.
• Wireless postpaid monthly churn was 1.56% in Q2, versus 1.40% a year earlier; prepaid churn was 4.74%, versus 5.07%. Cable revenue-generating units and Wireline fiber/access revenue increased, while Wireline access-line counts continued to decline.

Outlook, commentary, risks and unusual items

• Management budgeted $218.5 million of 2016 capital expenditures, including $120.3 million for Wireless network upgrades and expansion. It said cash, operating cash flow and expected borrowing availability should fund planned spending, scheduled debt service and other needs for at least the next 12 months. Approximately $13.1 million of the budget is success-based and may be scaled back if customer growth does not support it.
• Management expects former nTelos customer migration to Sprint billing and network systems to continue into 2017. The company must maintain legacy billing, customer-care and switching systems until migration is complete; integration costs and anticipated benefits remain uncertain.
• Interest-rate exposure is significant: the filing estimates a 1 percentage-point rate increase would add about $8.3 million to annual interest expense before swaps. Approximately $417.5 million of variable-rate debt was unprotected at June 30.
• Key risks include the increased debt burden, ability to integrate nTelos and realize expected synergies, reliance on Sprint for billing, collections and customer-care services, customer retention and growth, and future capital needs. Management noted that failure to achieve expected acquisition benefits could impair debt service capacity.
• Former nTelos shareholders holding approximately one million shares exercised appraisal rights. Shentel recorded approximately $9.3 million payable and said the outcome and timing are uncertain; the unpaid amount accrues interest at 6.1% annually until resolution.
• The purchase-price allocation remained preliminary and subject to final appraisal review. The filing also reports a noncash straight-line adjustment related to Sprint management-fee waivers and amortization of the expanded affiliate-agreement intangible asset, which affect reported revenue.
• No specific full-year revenue or earnings guidance is provided in the filing.

Important facts for investors to verify

• Progress, final cost and expected benefits of nTelos integration, including the $106–$126 million cost estimate and migration timeline.
• Debt repayment capacity, covenant headroom, variable-rate exposure and availability under the $75 million revolver.
• Final acquisition valuation and any measurement-period adjustments, as well as the resolution and cost of the appraisal-rights action.
• Wireless customer retention, churn and service economics after migration, and Shentel’s ongoing reliance on Sprint’s systems and reporting.
• Actual capital spending versus the $218.5 million budget and whether growth supports the success-based portion.