Shenandoah Telecommunications Company — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing; fourth-quarter figures are identified separately below. Amounts are in U.S. dollars unless noted.
Business context
Shentel provides wireless, cable, wireline, fiber and related telecommunications services in the Mid-Atlantic region. Its three reportable segments are Wireless, Cable and Wireline. The May 6, 2016 acquisition of nTelos substantially expanded the wireless footprint and customer base; nTelos results are included only from the acquisition date. The company also acquired Colane Cable assets effective January 1, 2016.
Financial and operating results
| Metric | 2016 | 2015 |
|---|---|---|
| Operating revenue | $535.3 million | $342.5 million |
| Operating income | $22.5 million | $74.1 million |
| Net income (loss) | $(0.9) million | $40.9 million |
| Diluted EPS | $(0.02) | $0.83 |
| Cash from operations | $161.5 million | $119.3 million |
| Capital expenditures | $173.2 million | $69.7 million |
Revenue rose 56.3%, primarily due to nTelos, but operating expenses increased 91.0% to $512.8 million. Operating margin was approximately 4.2%, down from 21.6% in 2015. Net loss reflects sharply higher depreciation and amortization, acquisition/integration/migration costs and interest expense; income tax expense was $2.8 million despite pretax income of only $1.9 million, producing a 146% effective tax rate.
- Wireless: Revenue increased 86.2% to $388.8 million; segment operating income fell 65.0% to $26.2 million. Year-end postpaid subscribers were 722,562 and prepaid subscribers 236,138, with much of the increase attributable to nTelos. Wireless operating costs included $25.9 million of integration and acquisition expense.
- Cable: Revenue increased 11.4% to $108.7 million; segment operating income was $7.0 million versus $0.5 million. Internet growth and higher revenue per subscriber contributed, while video customer penetration continued to decline.
- Wireline: Revenue increased 11.2% to $75.0 million and segment operating income increased 25.1% to $20.5 million, supported by carrier access and fiber revenue. Telephone access lines declined to 18,443.
- Non-GAAP measures: Adjusted OIBDA was $246.1 million and Continuing OIBDA was $221.5 million. These exclude specified items and are not substitutes for GAAP results.
Fourth-quarter revenue was $155.6 million, operating income $12.2 million and net loss $0.2 million; diluted loss per share rounded to $0.00.
Cash, debt and liquidity
- Operating cash flow was $161.5 million. Capital expenditures were $173.2 million, so operating cash flow less capital expenditures was approximately negative $11.7 million, before acquisitions and other investing activity.
- Net cash used in investing was $820.0 million, including $657.4 million for acquisitions. Financing activities provided $617.9 million, including $860.0 million of borrowings. Cash and cash equivalents ended the year at $36.2 million, down from $76.8 million.
- Gross debt was $847.9 million; debt net of unamortized fees was $829.3 million. Debt was variable-rate, with an approximately 3.83% annualized effective rate after swaps. Interest expense rose to $25.1 million from $7.4 million.
- The company reported covenant liquidity of $136 million, versus a $25 million minimum, and compliance with its financial covenants at year-end. Its leverage ratio was 2.81 against a 3.75 maximum through 2018; debt-service coverage was 4.23 against a 2.00 minimum.
Material changes, outlook and risks
The nTelos purchase price was $667.8 million net of cash acquired. Sprint-related exchanges expanded Shentel’s service area and extended the affiliate agreement to 2029; Sprint also agreed to waive management fees up to $252 million over approximately six years. The company expected approximately $90 million in acquisition and integration expenses, excluding about $23 million of debt issuance costs, and had incurred $54.7 million by year-end. Purchase accounting remained subject to measurement-period adjustments.
Management budgeted $152.3 million of 2017 capital expenditures, including $99.2 million for wireless network upgrades and expansion. Management said cash, operating cash flow and available borrowing capacity should fund planned spending and obligations for at least the next 12 months. This outlook depends on operating cash generation, integration progress and continued access to financing.
- Sprint and its customers generated approximately 69% of 2016 revenue. Shentel relies on Sprint for billing, collections, customer care and other key wireless services; changes in Sprint’s business or agreement terms could materially affect results.
- Debt increased substantially following the acquisition, and variable interest rates expose earnings and cash flow to rate increases. A 1% rate increase was estimated to add about $8.5 million of annual interest expense before swaps.
- Competition, wireless pricing and churn, declining legacy telephone lines, rising programming costs, regulatory changes and execution of the nTelos network upgrade are significant business risks.
- Management identified material weaknesses in controls over complex transactions, income taxes and cash-flow statement preparation. Management concluded internal control over financial reporting and disclosure controls were ineffective at December 31, 2016; the independent auditor issued an adverse opinion on internal control effectiveness, while issuing an unqualified opinion on the financial statements. Remediation was planned for 2017, but completion was not assured.
- The acquired nTelos pension plan was underfunded by approximately $10.3 million at year-end; no 2017 contribution was expected, but future contributions may be required.
Most important facts for investors to verify
- How much of reported revenue and subscriber growth is attributable to the partial-year nTelos consolidation, and how quickly are integration benefits and costs emerging?
- Whether the company achieves its 2017 network investment plan while maintaining covenant headroom and adequate liquidity.
- Whether wireless customer churn, pricing and Sprint-related fee waivers support sustainable segment profitability after migration costs end.
- Progress in remediating the material weaknesses, particularly controls over acquisition accounting, taxes and cash-flow reporting.
- Potential effects of variable-rate debt, regulatory changes and continued concentration of revenue and operating functions with Sprint.