SHEN

Business Context and Reporting Period

Company: Shenandoah Telecommunications Company (Shentel)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2010
Overview: Shentel is a diversified telecommunications holding company providing regulated and unregulated voice, video, and data services in the southeastern United States. The company operates through three primary segments: Wireless (Sprint Nextel affiliate), Wireline (local exchange and fiber leasing), and Cable TV. The 2010 fiscal year was defined by significant expansion in the Cable segment through major acquisitions and the continued management of a discontinued operation (Converged Services) held for sale.

Key Financial Metrics

Note: Total debt increased significantly in 2010 due to financing the JetBroadBand acquisition.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 21.3% to $194.9 million, driven primarily by $19.1 million in revenue from cable acquisitions (JetBroadBand and Suddenlink) and a $9.1 million increase in Wireless service revenue.
• Profitability Decline: Net income from continuing operations decreased 25.4% to $18.7 million. This decline was attributed to one-time pension settlement charges ($3.8 million), transaction costs from cable acquisitions, costs associated with acquiring prepaid wireless customers, and increased interest expense from new debt.
• Debt Expansion: Total debt surged from $33.0 million in 2009 to $195.1 million in 2010. The company executed a new $198 million credit facility in July 2010 to refinance existing debt and fund the JetBroadBand acquisition.
• Segment Performance:
  • Wireless: Operating income decreased 4.5% to $38.3 million due to increased fees retained by Sprint Nextel (Net Service Fee increased to 12%) and costs for prepaid subscriber acquisition.
  • Cable TV: Operating loss widened to $15.4 million (from $6.1 million) due to the inclusion of newly acquired systems and associated transaction costs, though revenues grew 134.5%.
  • Wireline: Operating income increased 34.9% to $17.0 million, aided by a $4.0 million gain on the sale of the telephone directory.

Guidance, Outlook, and Risks

Management Commentary & Outlook:

• Acquisition Integration: Management expects the JetBroadBand acquisition to cause a downward trend in net income in the initial years, with the most significant negative impact anticipated in 2011. Long-term positive impacts are expected to materialize in 2012 and beyond as network upgrades are completed and penetration rates improve.
• Capital Plan: Capital expenditures for 2011 are budgeted at approximately $82.6 million, with nearly $50 million allocated to upgrading cable systems acquired in 2010.
• Dividends: The company paid a $0.33 per share dividend in 2010. Future dividend payments are restricted by the new credit agreement, limited to 50% of consolidated net income from October 1, 2009, to the date of declaration.

Key Risks & Contingencies:

• Sprint Nextel Dependence: Approximately 60% of total operating revenues are generated through Sprint Nextel. Risks include Sprint's financial performance, changes in management fees, and potential termination of the management agreement.
• Regulatory Changes: The company faces risks from FCC rule changes regarding intercarrier compensation, universal service fund (USF) reductions, and net neutrality regulations which could increase costs or reduce revenues.
• Debt Covenants: The new credit agreement imposes strict financial covenants, including a maximum leverage ratio of 3.00:1 (decreasing to 2.00:1) and minimum liquidity requirements. Failure to meet these could result in default.
• Discontinued Operations: The sale of Converged Services remains pending. The company recorded an additional $1.9 million impairment loss in 2010 related to these assets.

Investor Verification Checklist

• Debt Service Coverage: Verify the company's ability to meet the new, stricter financial covenants (leverage and coverage ratios) under the July 2010 Credit Agreement, given the significant increase in interest expense.
• JetBroadBand Integration: Monitor the 2011 financial results to confirm the anticipated "downward trend" in net income and assess the timeline for realizing the projected long-term synergies.
• Sprint Fee Impact: Confirm the ongoing impact of the increased 12% Net Service Fee on Wireless segment margins and whether this fee structure remains stable.
• Converged Services Sale: Track the status of the Converged Services disposition to determine if further impairment charges are necessary or if a gain/loss will be realized upon sale.
• Capital Expenditure Execution: Verify that the planned $82.6 million in 2011 capital expenditures is funded and executed as budgeted to support the cable network upgrades.