NTELOS Holdings 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2006
For the transition period from to .
Commission File Number: 000-51798
NTELOS Holdings Corp.
(Exact name of registrant as specified in its charter)
401 Spring Lane, Suite 300, PO Box 1990, Waynesboro, Virginia 22980
(Address of principal executive offices) (Zip Code)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No
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. x Yes ¨ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes x No
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant on June 30, 2006 was $231,064,661 (based on the closing price for shares of the registrants common stock as reported on the NASDAQ Global Market on that date). In determining this figure, the registrant has assumed that all of its directors, executive officers and persons owning 10% or more of the outstanding common stock are affiliates. This assumption shall not be deemed conclusive for any other purpose.
There were 41,973,542 shares of the registrants common stock outstanding as of the close of business on March 6, 2007.
DOCUMENTS INCORORATED BY REFERENCE
2007 ANNUAL REPORT ON FORM 10-K
Any statements contained in this report that are not statements of historical fact, including statements about our beliefs and expectations, are forward-looking statements and should be evaluated as such. The words anticipates, believes, expects, intends, plans, estimates, targets, projects, should, may, will and similar words and expressions are intended to identify forward-looking statements. These forward-looking statements are contained throughout this report, for example in Business, Risk Factors, and Managements Discussion and Analysis of Financial Condition and Results of Operations. Such forward-looking statements reflect, among other things, our current expectations, plans and strategies, and anticipated financial results, all of which are subject to known and unknown risks, uncertainties and factors that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements. Many of these risks are beyond our ability to control or predict. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this report. Because of these risks, uncertainties and assumptions, you should not place undue reliance on these forward-looking statements. These risks and other factors include those listed under Risk Factors and elsewhere in this report. Furthermore, forward-looking statements speak only as of the date they are made. We do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise.
Item 1. Business.
We are a leading provider of wireless and wireline communications services to consumers and businesses primarily in Virginia and West Virginia under the NTELOS brand name. Our wireless operations are composed of an NTELOS-branded retail business and a wholesale business that we operate under an exclusive contract with Sprint Spectrum L.P. We believe our regional focus and contiguous service area provide us with a differentiated competitive position relative to our primary wireless competitors, all of whom are national providers. Our wireless revenues have experienced a 17% compound annual growth rate from 2004 to 2006 and accounted for 73% of our total revenues in 2006. We hold digital PCS licenses to operate in 29 basic trading areas with a licensed population of approximately 8.8 million, and we have deployed a CDMA network in 20 basic trading areas which currently covers a total population of approximately 5.2 million potential subscribers. As of December 31, 2006, our wireless retail business had approximately 367,000 NTELOS-branded subscribers, representing a 7.1% penetration of our total covered population.
We made significant investments in our network in 2005 and 2006, adding 147 new wireless cell sites, including 38 new wireless cell sites placed in service in the fourth quarter of 2006, and increasing our total cell sites to 984 at the end of 2006. These investments and other initiatives, including the introduction of national rate plans and enhanced data service offerings, contributed to a 9% increase in subscribers, a $1.08 increase in ARPU, and an 8% reduction in churn during 2006. We also have an agreement with Sprint Spectrum L.P. to act as their exclusive wholesale provider of network services through July 11, 2011. Under this arrangement, which we refer to as the Strategic Network Alliance, we are the exclusive PCS network service provider for all Sprint Nextel wireless customers in our western Virginia and West Virginia service area. For the year ended December 31, 2006, we realized wholesale revenues of $77.7 million, primarily related to the Strategic Network Alliance, representing an increase of 24% over the same period in 2005.
Founded in 1897, our wireline incumbent local exchange carrier business is conducted through two subsidiaries that qualify as RLECs under the Telecommunications Act. These two RLECs provide wireline communications services to residential and business customers in the western Virginia communities of Waynesboro, Covington, Clifton Forge and portions of Botetourt and Augusta counties. As of December 31, 2006, we operated 45,281 RLEC telephone access lines. We also own a 1,900-mile regional fiber optic network
which directly connects our networks with many of the largest markets in the mid-Atlantic region. We leverage our wireline network infrastructure to offer competitive voice and data communication services in Virginia and West Virginia outside our RLEC coverage area. Within our Competitive segment, we market and sell local and long distance, voice and data services almost exclusively to business customers through our competitive local exchange carrier, or CLEC, and Internet Service Provider, or ISP, operation. As of December 31, 2006, we served customers with 46,781 CLEC access line connections. We also offer DSL services in 94% of our RLEC service area and as of December 31, 2006 we operated 17,177 broadband access connections in our markets, representing an increase of 22.3% in 2006. In 2006 and 2005, our wireline operating income margins were 33.2% and 32.8%, respectively.
We were formed in January 2005 by Citigroup Venture Capital Equity Partners, L.P., or CVC, and certain of its affiliates, collectively referred to herein as the CVC Entities, and Quadrangle Capital Partners LP, or Quadrangle, and certain of its affiliates, collectively referred to herein as the Quadrangle Entities, for the purpose of acquiring NTELOS Inc. On January 18, 2005, we entered into a transaction agreement with NTELOS Inc. and certain of its shareholders to acquire NTELOS Inc. In accordance with this agreement, we acquired 24.9% of the NTELOS Inc. common stock and stock warrants on February 24, 2005. We completed our acquisition of all of NTELOS Inc.s remaining common stock, warrants and vested options by means of a cash merger on May 2, 2005. Following the merger transaction on May 2, 2005, NTELOS Inc. became our wholly-owned subsidiary.
Our principal executive offices are located at 401 Spring Lane, Suite 300, Waynesboro, Virginia 22980. The telephone number at that address is (540) 946-3500. Our internet address is www.ntelos.com. We conduct all of our business through our wholly-owned subsidiary NTELOS Inc. and its subsidiaries.
Our wireless business operates a 100% CDMA digital PCS network in Virginia, West Virginia, and portions of Kentucky, Ohio and North Carolina with a total covered population, or POPs, of 5.2 million people. We began acquiring PCS spectrum in western Virginia and West Virginia in June 1995 and began operations in Virginia in late 1997 and in West Virginia in late 1998. We entered eastern Virginia in July 2000 with the acquisition of the eastern Virginia assets of PrimeCo Personal Communications, L.P., or PrimeCo, following the Bell Atlantic/GTE merger. As of December 31, 2006, we served approximately 367,000 NTELOS-branded retail subscribers.
Our wireless business in Virginia covers Richmond, Fredericksburg, Hampton Roads/Norfolk, Roanoke, Lynchburg, Charlottesville, Staunton, Harrisonburg, Winchester, Danville and Martinsville, as well as our headquarters in Waynesboro. The coverage of our wireless business also includes Charleston, Huntington, Morgantown, Beckley and Bluefield in West Virginia, Ashland, Kentucky, Portsmouth, Ohio and the Outer Banks of North Carolina.
We hold licenses for all of the 1900 MHz PCS spectrum used in our network. At December 31, 2006, we operated our CDMA network in 20 basic trading areas with licensed POPs of 7.3 million with an average spectrum depth of 23 MHz. We also hold licenses in nine additional basic trading areas which are currently classified as excess spectrum. The following table shows a breakdown of our 1900 MHz PCS spectrum position.
NTELOS Spectrum Position (POPs in thousands)
as of December 31, 2006
During September 2006, we purchased seven Advanced Wireless Services (AWS) licenses. The AWS spectrum is potentially operable in seven cellular market areas with licensed POPs of 1.3 million, all of which are within our existing PCS licensed markets. The following table shows a breakdown of our AWS spectrum position at December 31, 2006.
In addition to PCS and AWS spectrum, we hold wireless communications service, or WCS, licenses in Columbus, OH, Broadband Radio Service (BRS), licenses in western Virginia (BRS was formerly known as multichannel multipoint distribution service) and local multipoint distribution service, or LMDS, licenses in portions of Virginia, Kentucky, West Virginia and Maryland.
Wireless Retail Business
Overview. We offer wireless voice and data products and services to retail customers throughout our service area under the NTELOS brand name. Many of our service plans target the local value segment, focusing on customers who will use their wireless phone primarily in their home market. We offer these customers value by providing unlimited and large numbers of minutes and premier customer service across our network. In 2005, we began to offer national calling plans for those customers who will use their phone outside of their home market. Our relationships with Sprint Nextel and other carriers allow us to provide these national plans at competitive prices. We offer customers a variety of Postpay and Prepay plans. Postpay represents the bulk of our retail subscribers and the primary focus of our marketing efforts. In 2006, Postpay represented 50% of gross additions and, as of December 31, 2006, 73% of total subscribers. Due to the higher churn in Prepay segments, we will continue to emphasize marketing to Postpay customers.
Service Offerings. The chart below briefly describes the plans and provides a breakdown of subscribers as of December 31, 2006:
Sales, Marketing and Customer Care. We target customers by advertising the best value available in a wireless provider. We target persons between the ages of 21 and 54 who use their phone primarily in their home market. Our belief is that many customers use their phone primarily in and around their home area, however, our NTELOS NATION plans allow us to address consumer needs for nationwide travel. We do not target heavy roamers such as business executives or national corporations, and our national plans take advantage of our access to the national Sprint Nextel wireless network under the Strategic Network Alliance.
We promote our Postpay products almost exclusively in our marketing communications. Prepay plans target only certain segments where a majority of the population would not want or qualify for Postpay service.
Advertising is focused on driving traffic to the companys retail locations and inside sales representatives. Company-owned distribution is a key component of our wireless growth strategy, with strong supporting distribution from indirect agent locations which extend our wireless retail points of presence. The focus on company-owned distribution is evidenced by wireless customer acquisitions. In the year ended December 31, 2006, 75% of gross additions were acquired through direct channels and, at December 31, 2006, we had 70 retail point-of-sale locations. Our direct distribution is supplemented by 88 regional agents with a total of 140 locations.
Our wireless customer care call centers are located in Waynesboro and Daleville, Virginia. We operate a single virtual call center, supporting a reduction in headcount and uniform customer service across our region. Business operations are supported by an integrated systems infrastructure. We provide customer care and operations representatives with incentives to up-sell additional products and features. Also, we utilize a retention team to focus on either renewing or maintaining our customers.
Wireless Wholesale Business
Overview. We provide digital PCS services on a wholesale basis to other PCS providers, most notably Sprint Nextel. Our wireless wholesale business began in 1999 when we signed a 10-year agreement with Horizon PCS to carry Horizon PCSs traffic in our territories in western Virginia and West Virginia. On August 15, 2003, Horizon PCS filed for Chapter 11 bankruptcy protection. As a part of Horizon PCSs restructuring, in June 2004 Sprint bought out Horizon PCSs interest in the approximately 95,000 Sprint-branded subscribers in Horizon PCSs territories which are serviced by our network. We subsequently entered into the Strategic Network Alliance with Sprint Nextel. The Strategic Network Alliance expires on July 31, 201l, but the agreement includes automatic five-year extensions unless the agreements notice provisions are exercised.
Our Strategic Network Alliance with Sprint Nextel. In 2004, we entered into a seven-year exclusive network agreement to be a wholesale provider of network services for Sprint Spectrum L.P. Under this arrangement, which we refer to as the Strategic Network Alliance, we are the exclusive PCS network service provider through July 2011 to all Sprint Nextel wireless customers in our western Virginia and West Virginia service area, including the following markets: Charlottesville, Danville, Lynchburg, Martinsville, Roanoke and Staunton-Waynesboro, Virginia; Beckley, Bluefield, Charleston, Clarksburg/Elkins, Fairmont, Huntington and Morgantown, West Virginia; and Ashland, Kentucky. Our CDMA network encompasses approximately 3.0 million POPs in these markets. The agreement prohibits Sprint Spectrum L.P. from directly or indirectly commencing construction of, contracting for or launching its own PCS or wireless communications network in these regions 180 days prior to the termination of the agreement. Sprint Nextel may construct its own cell sites or take such other action to provide geographic coverage in a portion of a market served by us where our network does not offer coverage, and Sprint Nextel requests that we provide coverage and we decline.
Under the Strategic Network Alliance, Sprint Nextel is required to pay us a per minute or per megabit rate for the voice and data services, respectively, that we provide to Sprint Nextel branded subscribers and the subscribers of mobile network operator partners of Sprint Nextel, such as Virgin Mobile and Qwest, who live in or travel through the Strategic Network Alliance service area. The agreement specifies a series of usage rates for
various types of services. Sprint Nextel pays a Travel rate to NTELOS for each voice minute of use by Sprint Nextel subscribers or Mobile Virtual Network Operators (MVNO) partners of Sprint Nextel who use the NTELOS network for voice service while traveling in the Strategic Network Alliance service areas. Sprint Nextel also pays a Home rate to NTELOS for each voice minute of use by a Sprint Nextel subscriber who is a local subscriber in the Strategic Network Alliance service area. Sprint Nextel also pays a Data rate for each megabit of data service consumed by either a Sprint Nextel Home subscriber or a Sprint Nextel Travel subscriber within the Strategic Network Alliance service area. The agreement provides us with a price protection for determining the Home rate and Travel rate and Sprint Nextels national retail 1x data revenue yield for determining the Data rate. This price protection period is one year on the Travel rate per MOU, three years on the voice rate per MOU for Home subscribers, and two years for the per megabit Data rate. After the initial pricing term, our price structure with Sprint Nextel will fluctuate under a formula tied to Sprint Nextels national wireless retail customer revenue yield and national retail 1x data revenue yield, neither of which can result in a price lower than the Companys allocated cost of providing these services. The Strategic Network Alliance also permits our NTELOS- branded customers to access Sprint Nextels national wireless network at reciprocal rates as the Sprint Nextel Travel rates.
The agreement provides that the PCS service we provide to Sprint Nextel customers will be of a quality and clarity no worse than what we provide to our customers. We are not required under the Strategic Network Alliance to make any future investment in high speed data transfer technology or any other significant network upgrade requested by Sprint Nextel to support its customers unless Sprint Nextel and we agree in advance of such investment to the compensation to be provided to us for making such investment. However, the agreement does provide that we must augment or expand our facilities, including implementing commercially reasonable network upgrades, at our expense to provide the products and services supported by us as of the execution date of the agreement and to maintain compliance with performance specifications set forth in the agreement. Sprint Nextel must reimburse us for a proportional amount of the expenses we incur to comply with all future network obligations mandated by governmental authorities or new industry standards, such as mobile equipment identifiers, or MEIDs.
Network Technology. We have deployed 3G 1xRTT CDMA digital PCS technology in each of our geographic regions.
Switching Centers. We employ four Mobile Switching Centers, or MSCs: two in the Virginia East region, one in the Virginia West region and one in West Virginia. The following table shows our switching center equipment:
Switching Center Equipment
Intelligent Network. We have deployed a Lucent Intelligent Network solution consisting of a mated pair Service Control Point, or SCP, and an Enhanced Services Manager, or ESM. Our mated Stand-alone Home Location Register functionality resides on this platform. Additionally, we have deployed a Short Messaging Service Center (SMSC) platform, Over-the-Air-Function (OTAF) platform, and Multimedia Messaging Service (MMS) platform, all provided by Airwide Solutions. The SMSC platform supports text messaging, the OTAF platform supports network and subscriber initiated Preferred Roaming List downloads, and the MMS platform supports picture messaging.
Cell Sites. As of December 31, 2006, there were 984 cell sites in operation, of which 63 were repeaters. We own 93 of these cell sites and lease the remaining 891, or 91%. Of the leased cell sites, 411, or 46%, are installed on facilities owned by Crown Communications and American Tower. We entered into master lease agreements with Crown Communications in 2000 and 2001, respectively. These master lease agreements had initial 5-year lease terms and were renewed for second 5-year lease terms in 2005 and 2006, respectively. Additionally, we entered into a master lease agreement with American Tower in 2001 with an initial lease term of 12 years. These master agreements with Crown Communications and American Tower contain additional options to renew. 100% of our cell sites are 3G 1xRTT data capable.
Network Performance. We currently process 60.9 million calls per week and demonstrate strong network operational performance metrics. For the year ended December 31, 2006, network performance has averaged less than 1.0% daily dropped calls and less than 0.2% blocked calls during the busy hour. Cell site availability as of December 31, 2006, exceeds 99.8%. We currently exceed Sprint Nextels network performance standards, as established in the agreement, in the regions underlying the Strategic Network Alliance.
Founded in 1897 as the Clifton Forge-Waynesboro Telephone Company, our wireline business and its predecessor organizations have a long history of providing exceptional telephone service in the rural Virginia areas of Waynesboro, Covington, Clifton Forge and, with the acquisition of R&B Communications in 2001, Botetourt County. We divide our wireline business into two operations: RLEC and Competitive Wireline (CLEC/Network and internet). As an RLEC, we own and operate two local telephone companies and serve three rural
Virginia regions. As a CLEC, we provide service to 16 areas in Virginia, West Virginia and Tennessee. Additionally, we offer both dial-up internet and high-speed broadband services in Virginia, West Virginia and Tennessee. As of December 31, 2006, we had approximately 137,000 access lines and data connections.
Our wireline business is supported by an extensive 1,900-mile fiber optic network. The network gives us the ability to originate, transport and terminate much of our customers communications traffic in many of our service areas. We utilize the network to backhaul communications traffic for retail services and to serve as a carriers carrier network, providing transport services to third parties for long distance, internet, wireless and private network services. Our fiber optic network is connected to and marketed with adjacent fiber optic networks in the mid-Atlantic region.
RLEC. We provide RLEC services to business and residential customers in three rural Virginia areas. We have owned and operated a 109-year-old telephone company in western Virginia since its inception in 1897. Additionally, we acquired a 106-year-old telephone company in southwestern Virginia through our acquisition of R&B Communications in 2001.
Competitive Wireline. The Competitive Segment includes the results of our CLEC, internet and wholesale carriers carrier network businesses. The CLEC business was launched in 1998 and currently serves 16 areas in Virginia, West Virginia and Tennessee. We market almost exclusively to business customers with residential service limited to bundled service offerings with DSL. As of December 31, 2006, we had 46,781 CLEC lines in service, virtually all of which were business lines.
The CLEC operations are based on an edge-out strategy that seeks to take advantage of our fiber network and RLEC back-office systems in order to deliver a high incremental return on investment to our core wireline business. Technicians, vehicles, operations and support systems, network planning and engineering, billing and core network assets are shared between the wireline segments.
In addition to utilizing a successful edge-out strategy, our CLEC business has also benefited from a commitment to an on-net access strategy for a true facilities-based approach. We have been careful in our decision to expand the CLEC network and generally require proven customer demand to dictate such investment choices. In addition to the higher-margin revenues that are characteristic of on-net expansion, we have also been able to deliver other competitive services such as high-bandwidth internet access and metro transport services as a direct result of on-net connectivity growth. Our dedication to the facilities-based strategy, combined with our commitment to customer service, has proven successful in attracting large customers in key vertical markets. Specifically, the education, healthcare, financial, and government sectors have been particularly receptive to our CLEC business model.
Through our wholesale carriers carrier network, we offer other carriers access to our 1,900-route-mile fiber network which provides connectivity to major retail cities. We sell backhaul services to major carriers. Through interconnections with other regional fiber networks, we are able to extend our network east to Richmond, Virginia, north to Carlisle, Pennsylvania, and Washington, D.C., and to areas south of Greensboro, North Carolina.
We launched our internet business in Virginia in 1995. Presently, we provide internet services in Virginia, West Virginia and Tennessee. As of December 31, 2006, we had approximately 17,177 broadband connections, including DSL, dedicated internet access, wireless broadband, broadband over fiber, metro Ethernet, ATM and frame relay. We also finished the year with over 94% DSL capability in our RLEC markets.
Products and Services
We offer a wide variety of voice services to our RLEC and CLEC customers, including:
In addition to traditional voice services, we provide internet access and data services including:
Sales, Marketing and Customer Care
We focus our wireline marketing efforts on residential customers in the RLEC segment and larger business customers in the Competitive segment. In particular, residential marketing is centered on selling bundles and
higher revenue-generating services to maximize penetration, average monthly revenues/unit in service, or ARPU, and retention. We seek to capitalize on the NTELOS brand name, technology leadership, positive service reputation and local presence of sales and service personnel in our Competitive marketing efforts. In 2007 we plan to offer video services within our RLEC market to over 2,300 households that we have passed with fiber optics as of December 31, 2006.
We utilize our own personnel to sell wireline products and services to our customers. We retain account executives to cultivate relationships with mid-size to large business customers in our RLEC and Competitive market areas. The wholesale business is supported by a dedicated channel team and the Valley Network Partnership (ValleyNet) resources. Much of our network is connected and marketed through ValleyNet, a partnership of three nonaffiliated communications companies that have interconnected their networks to form a nonswitched, fiber optic network. The ValleyNet network is connected to and marketed with other adjacent fiber networks creating a connected fiber optic network serving the ten-state mid-Atlantic region, stretching from Pennsylvania to Florida north to south and west as far as Charleston, WV.
We use an inside sales group to handle residential and small business voice and broadband sales. We maintain a wireline retail presence in Waynesboro, Daleville, and Covington, Virginia to allow walk-in payments and provide new services to RLEC customers.
Our wireline customer care call centers are located in Waynesboro and Daleville, Virginia. Business operations are supported by an integrated systems infrastructure. We provide customer care and operations representatives with incentives to up-sell additional products and features. Also, when customers contracts are near expiration or customers call in to discontinue service, our retention team focuses on either renewing or saving those customers.
Plant and Equipment
Our wireline network includes two Lucent 5ESS digital switches, which provide end-office functions for both the RLEC and Competitive businesses in Virginia. Our Waynesboro, Virginia switch also acts as an access tandem for our RLEC, Competitive and portions of our wireless traffic. Another Lucent 5ESS digital switch, located in Charleston, supports the Competitive business in West Virginia. We have twelve remote switching modules deployed throughout our RLEC territory and three more supporting our Competitive areas. VITAL, a company for which we serve as the managing partner, acts as a regional node on VeriSigns nationwide SS7 network using a pair of Tekelec signal transfer points located on our premises.
We use Lucent, Tellabs and Ciena digital loop carriers throughout our RLEC and Competitive access network. For DSL service in the RLEC and Competitive areas, we primarily use Cisco, Adtran and Paradyne equipment. Our centralized network operations center monitors wireline, wireless and data networks on a continuous basis using a Harris network management system. We provide ATM, Frame Relay, metro Ethernet and IP-enabled voice and transport services using a soft switch, routers and other equipment from Cisco Systems, Inc and feature servers from Broadsoft.
Many communications services can be provided without incurring a short-run incremental cost for an additional unit of service. As a result, once there are several facilities-based carriers providing a service in a given market, price competition is likely and can be severe. We have experienced price competition, which is expected to continue. In each of our service areas, additional competitors could build facilities. If additional competitors build facilities in our service areas, this price competition may increase significantly.
We compete in our territory with both digital and analog service providers. Several wireless carriers compete in portions of our market areas, including Sprint Nextel and its affiliates (including Virgin Mobile
USA), Verizon Wireless, ALLTEL, AT&T Wireless, T Mobile and U.S. Cellular, and affiliates of some of these companies. Many of these competitors have financial resources and customer bases greater than ours. Many of them have more established infrastructures, marketing programs and brand recognition. In addition, some of our competitors offer coverage in areas not serviced by our PCS network, or, because of their calling volumes or their affiliations with, or ownership of, wireless providers, offer roaming rates lower than ours. We expect these competitors will continue to build and upgrade their own networks in areas in which we operate. We also face competition from resellers, which provide wireless service to customers but do not hold FCC licenses or own facilities.
Several factors have resulted in increased competition in the local telephone market, including:
As the RLEC for Waynesboro, Clifton Forge, Covington and portions of Botetourt and Augusta Counties, Virginia, we are subject to competition, including from wireless carriers and cable companies. Although no CLECs have entered our incumbent markets to compete with us, it is possible that one or more may enter our markets. The regulatory environment governing RLEC operations has been, and we believe will likely continue to be, very liberal in its approach to promoting competition and network access. Other sources of potential competition include cable providers as they enhance their networks to offer voice service and wireless service providers. While still uncertain, we do expect to encounter competition in our RLEC in 2007 from Comcast, which acquired the Adelphia Communications Corporation properties serving Waynesboro and a portion of Botetourt and Augusta Counties. Voice over Internet Protocol, or VoIP, based carriers like Vonage could take voice customers from our RLECs using existing broadband connections (such as DSL or cable modem connections).
Our Competitive operations compete primarily with ILECs and, to a lesser extent, other CLECs. ILECs in our markets, Verizon and Embarq, have initiated aggressive win-back strategies. Although certain CLEC companies have exited from our markets, we continue to face competition in our Competitive markets from several other CLECs, including Level 3 (formerly TelCove), Fibernet, USLEC and Cox. We also face competition from other current and potential future market entrants.
The internet industry is characterized by the absence of significant barriers to entry and the rapid growth in internet usage among customers. As a result, we expect that our competition will increase from market entrants offering high-speed data services, including DSL, cable and wireless access. Our competition includes:
Many of our competitors have financial resources, corporate backing, customer bases, marketing programs and brand names that are greater than ours. Additionally, competitors may charge less than we do for internet services, causing us to reduce, or preventing us from raising, our fees.
As of December 31, 2006, we employed 1,305 full-time and 32 part-time persons. Of these employees, 74 are covered by a collective bargaining agreement for a portion of our wireline operation. This agreement expires June 30, 2008. We believe that we have good relations with our employees.
The following summary does not describe all present and proposed federal and state legislation and regulations affecting the telecommunications industry. Some legislation and regulations are currently the subject of judicial proceedings, legislative hearings and administrative proposals which could change the manner in which this industry operates. Neither the outcome of any of these developments, nor their potential impact on us, can be predicted at this time. Regulation can change rapidly in the telecommunications industry, and such changes may have an adverse effect on us in the future. See Risk Factors elsewhere in this report.
Our communications services are subject to varying degrees of federal, state and local regulation. Under the Communications Act, as amended by the Telecommunications Act, the FCC has jurisdiction over interstate and international common carrier services, over certain aspects of interconnection between carriers for the provision of competitive local services, and over the allocation, licensing, and regulation of wireless services. The Federal Aviation Administration regulates the location, lighting and construction of antenna structures. Our common carrier services are regulated to different degrees by state public service commissions, and local authorities have jurisdiction over public rights-of-way and antenna structures. In recent years, the regulation of the communications industry has been in a state of transition as Congress and state legislatures have passed laws seeking to foster greater competition in communications markets and various of these measures have been challenged in court.
Many of the services we offer are unregulated or subject only to minimal regulation. Our internet services are not considered to be common carrier services, although the regulatory treatment of internet services, including VoIP services, is evolving and still uncertain. Our wireless service is a commercial mobile radio service, or CMRS, and subject to FCC regulation as common carriage. The states are preempted from engaging in entry or rate regulation of CMRS, although the states may regulate other terms and conditions of such offerings.
Pursuant to the Communications Act, there are certain services that large ILECs are required by state and federal regulators to provide to our CLEC operations. The obligations of these ILECs to provide such services are in flux and could be further altered or removed by new legislation, regulations or court order.
Federal Regulation of the Wireless Communications Industry
The licensing, construction, modification, operation, sale, ownership and interconnection arrangements of wireless communications networks are regulated to varying degrees by the FCC, Congress, state regulatory agencies, the courts and other governmental bodies. Because we operate PCS systems, decisions by such bodies could have a significant impact on the competitive market structure among wireless providers and on the relationships between wireless providers and other carriers. These mandates may impose significant financial obligations on us and on other wireless providers. We are unable to predict the scope, pace or financial impact of legal or policy changes that could be adopted in these proceedings. Some examples of the kinds of regulation to which we are subject are presented below.
Licensing of PCS Systems. Broadband PCS licenses, such as those held by our subsidiaries, were generally originally awarded for specific geographic market area and for one of six specific spectrum blocks. The geographic license areas utilized included basic trading areas and collections of basic trading areas known as
major trading areas, or MTAs, although geographic partitioning policies have permitted licensees to subdivide and transfer those original licenses into other geographic areas. The spectrum blocks awarded were originally either 30 MHz or 10 MHz licenses, although spectrum disaggregation rules have permitted licensees to subdivide such licenses into smaller bandwidths.
All PCS licenses have a 10-year term, at the end of which they must be renewed. The FCCs rules provide a formal presumption that a PCS license will be renewed, called a renewal expectancy, if the PCS licensee (1) has provided substantial service during its past license term, and (2) has substantially complied with applicable FCC rules and policies and the Communications Act. The FCC defines substantial service as service which is sound, favorable and substantially above a level of mediocre service that might only minimally warrant renewal. If a licensee does not receive a renewal expectancy, then the FCC will accept competing applications for the license renewal period and, subject to a comparative hearing, may award the license to another party. We applied for and were granted renewal of seven of these licenses in 2005 and three of these licenses in 2006. We have nine licenses due to expire in 2007 for which we will need to apply for renewal.
Under existing law, no more than 20% of an FCC PCS licensees capital stock may be owned, directly or indirectly, or voted by non-U.S. citizens or their representatives, by a foreign government or its representatives or by a foreign corporation. If an FCC PCS licensee is controlled by another entity, as is the case with our ownership structure, up to 25% of that entitys capital stock may be owned or voted by non-U.S. citizens or their representatives, by a foreign government or its representatives or by a foreign corporation. Foreign ownership above the 25% holding company level may be allowed should the FCC find such higher levels not inconsistent with the public interest. The FCC has ruled that higher levels of foreign ownership in CMRS licensees, even up to 100%, are presumptively consistent with the public interest with respect to investors from certain nations. If our foreign ownership were to exceed the permitted level, the FCC could revoke our wireless licenses, although we could seek a declaratory ruling from the FCC allowing the foreign ownership or take other actions to reduce our foreign ownership percentage in order to avoid the loss of our licenses. We have no knowledge of any present foreign ownership in violation of these restrictions.
PCS Construction Requirements. All PCS licensees must satisfy buildout deadlines and geographic coverage requirements within five and/or ten years after the license grant date. Under the FCCs original rules, these initial requirements are met for 10 MHz licenses when adequate service is offered to at least one-quarter of the population of the licensed area, or the licensee provides substantial service, within five years, and for 30 MHz licenses when adequate service is offered to at least one-third of the population within five years and two-thirds of the population within ten years. The FCCs policies have now been modified, however, and 30 MHz licensees are permitted to make a demonstration of substantial service to meet the ten year build-out requirement. Failure to comply with these coverage requirements could cause the revocation of a providers wireless licenses or the imposition of fines and/or other sanctions.
Transfer and Assignment of PCS Licenses. The Communications Act and FCC rules require the FCCs prior approval of the assignment or transfer of control of a license for a PCS system, with limited exceptions, and the FCC may prohibit or impose conditions on assignments and transfers of control of licenses. Non-controlling interests in an entity that holds an FCC license generally may be bought or sold without FCC approval. Although we cannot assure you that the FCC will approve or act in a timely fashion upon any future requests for approval of assignment or transfer of control applications that we file, we have no reason to believe that the FCC would not approve or grant such requests or applications in due course. Because an FCC license is necessary to lawfully provide PCS service, if the FCC were to disapprove any such filing, our business plans would be adversely affected.
Pursuant to an order released in December 2001, as of January 1, 2003, the FCC rules no longer impose explicit limits on the amount of PCS and other commercial mobile radio service, or CMRS, spectrum that an entity may hold in a particular geographic market. The FCC now engages in a case-by-case review of transactions that involve the consolidation of spectrum licenses.
AWS Licenses. The Company recently acquired additional licenses in an auction conducted by the FCC for Advanced Wireless Services, or AWS, spectrum in the 1710-1755 MHz and 2110-2155 MHz bands. The FCC regulations applicable to these licenses are generally similar to those applied to the Companys PCS licenses, although the Companys AWS licenses have a longer, 15 year, term and are not subject to any construction requirements other than the requirement that they provide substantial service at renewal. Like other auctioned AWS licenses, the licenses acquired by the Company are subject to the rights of certain incumbents, including Federal government systems and microwave radio users. For the most part, Federal government users will transition their operations out of the band through a multiyear process funded through proceeds from the auction itself. The non-government users would have to be relocated by the Company if the Companys AWS deployments would interfere, and the Company may incur cost-sharing obligations even if it deploys after the links are relocated.
General FCC Obligations. The FCC has a number of other complex requirements and proceedings that affect our operations, and that could increase the cost or diminish the revenues of our business.
For example, the FCC requires CMRS carriers to make available emergency 911 services to subscribers, including enhanced emergency 911 services that provide the callers telephone number and detailed location information to emergency responders, as well as a requirement that emergency 911 services be made available to users with speech or hearing disabilities. Our obligations to implement these services occur in phases and on a market-by-market basis as emergency service providers request the implementation of enhanced emergency 911 services in their locales. Meeting these requirements will impose certain costs on us, and is partially dependent on the progress of our equipment vendor in making such handsets available at the rate at which our customers swap out their old handsets for newer models. Many carriers in the CMRS industry, including us, requested waivers of the FCCs December 31, 2005 deadline to ensure that 95% of all subscriber handsets in service nationwide on our system can deliver subscriber location information. By order adopted January 26, 2006, the FCC granted us a limited extension of the December 31, 2005 requirement by extending the date by which we were required to achieve 95% penetration until November 1, 2006 and we successfully met that deadline.
FCC rules also require that local exchange carriers and most CMRS providers, including PCS providers, allow customers to change service providers without changing telephone numbers. For CMRS providers, this mandate is referred to as wireless local number portability, or WLNP. The FCC also has adopted rules governing the porting of wireline telephone numbers to wireless carriers. We may not be able to recover our costs of implementing number portability. In addition, number portability may have increased positive or negative effects on our business by making it easier for customers to switch among carriers.
The FCC has the authority to order interconnection between CMRS operators and ILECs, and FCC rules provide that all local exchange carriers must enter into reciprocal compensation arrangements with CMRS carriers for the exchange of local traffic, whereby each carrier compensates the other for terminating local traffic originating on the other carriers network. As a CMRS provider, we are required to pay reciprocal compensation to a wireline local exchange carrier that transports and terminates a local call that originated on our network. Similarly, we are entitled to receive reciprocal compensation when we transport and terminate a local call that originated on a wireline local exchange network. We negotiate interconnection arrangements for our network with major ILECs and smaller RLECs. If an agreement cannot be reached, under certain circumstances, parties to interconnection negotiations can submit outstanding disputes to state authorities or the FCC, as appropriate, for arbitration. Negotiated interconnection agreements are subject to state approval. The FCCs interconnection rules and rulings, as well as state arbitration proceedings, will directly impact the nature and costs of facilities necessary for the interconnection of our network with other telecommunications networks. They will also determine the amount of revenue we receive for terminating calls originating on the networks of local exchange carriers and other telecommunications carriers. The FCC is currently considering changes to the local exchange-CMRS interconnection and other so-called intercarrier compensation schemes, and the outcome of such proceedings may affect the manner in which we are charged or compensated for the exchange of traffic.
Pursuant to the Communications Act, all telecommunications carriers that provide interstate telecommunications services, including CMRS providers like us, are required to make an equitable and non-discriminatory contribution to support the cost of federal universal service programs. These programs are designed to achieve a variety of public interest goals, including affordable telephone service nationwide, as well as subsidizing telecommunications services for schools and libraries. Contributions are calculated on the basis of each carriers interstate end-user telecommunications revenue. The FCC is currently examining the way in which it collects carrier contributions to the federal Universal Service Fund, or USF. In 2006, the FCC expanded the base of USF contributions by extending universal service contribution obligations to providers of interconnected VoIP service.
The Communications Assistance for Law Enforcement of 1994, or CALEA, requires all telecommunications carriers, including wireless carriers, to ensure that their equipment is capable of permitting the government, pursuant to a court order or other lawful authorization, to intercept any wire and electronic communications carried by the carrier to or from its subscribers. CALEA remains subject to FCC implementation proceedings. Compliance with the requirements of CALEA, further FBI requests, and the FCCs rules could impose significant additional direct and/or indirect costs on us and other wireless carriers.
Wireless networks also are subject to certain FCC and FAA regulations regarding the relocation, lighting and construction of transmitter towers and antennas and are subject to regulation under the National Environmental Policy Act, the National Historic Preservation Act, and various environmental regulations. Compliance with these provisions could impose additional direct and/or indirect costs on us and other licensees. The FCCs rules require antenna structure owners to notify the FAA of structures that may require marking or lighting, and there are specific restrictions applicable to antennas placed near airports.
We also are subject or potentially subject to number pooling rules; rules governing billing and subscriber privacy; rate averaging and integration requirements; and rules requiring us to offer equipment and services that are accessible to and usable by persons with disabilities. Some of these requirements pose technical and operational challenges to which we, and the industry as a whole, have not yet developed clear solutions. These requirements are all the subject of pending FCC or judicial proceedings, and we are unable to predict how they may affect our business, financial condition or results of operations.
We also must satisfy FCC requirements relating to technical and reporting matters. One such requirement is the coordination of proposed frequency usage with adjacent wireless users, permittees and licensees in order to avoid electrical interference between adjacent networks. In addition, the height and power of base radio transmitting facilities of certain wireless providers and the type of signals they emit must fall within specified parameters.
State Regulation and Local Approvals
The states in which we operate generally have agencies or commissions charged under state law with regulating telecommunications companies, and local governments generally seek to regulate placement of transmitters and rights of way. While the powers of state and local governments to regulate wireless carriers are limited to some extent by federal law, we will have to devote resources to comply with state and local requirements. For example, state and local governments generally may not regulate our rates or our entry into a market, but are permitted to manage public rights of way, for which they can require fair and reasonable compensation. Nevertheless, some states have attempted to assert certification requirements that we believe are in conflict with provisions of the Communications Act that prohibit states from regulating entry of wireless carriers.
States may also impose certain surcharges on our customers that could make our service, and the service of other wireless carriers, more expensive. In addition, a number of states and localities have banned, or are considering banning or restricting, the use of wireless phones while driving a motor vehicle.
Under the Communications Act, state and local authorities maintain authority over the zoning of sites where our antennas are located. These authorities, however, may not legally discriminate against or prohibit our services through their use of zoning authority. Therefore, while we may need approvals for particular sites or may not be able to choose the exact location for our sites, we do not foresee significant problems in placing our antennas at sites in our territory.
Federal Regulation of Interconnection and Interexchange Services
The Telecommunications Act requires all common carriers (including wireless carriers) to interconnect on a non-discriminatory basis with other carriers, imposes additional requirements on wireline local exchange carriers, and imposes even more comprehensive requirements on the largest ILECs. The latter must provide access to their networks to competing carriers. Among other things, the Communications Act requires these large ILECs to provide physical collocation to competitors to allow them to place qualifying equipment in ILEC central offices; to unbundle certain elements of local exchange network facilities and provide these Unbundled Network Elements, or UNEs, to CLECs at forward-looking prices; and to establish reciprocal compensation for the transport and termination of local traffic. The FCCs recent decision to eliminate the UNE Platform, or UNE-P, as well as the availability of UNE transport and high capacity UNE loops in some urban areas has had no material effect on our CLEC operations.
ILEC operating entities that serve fewer than 50,000 lines are rural telephone companies under the definition in the Communications Act and are exempt from these additional requirements unless and until such exemption is removed by the state regulatory body. Each of our RLEC operations is considered separately and each is currently exempt from the requirements imposed on the largest ILECs.
Interconnection Agreements and Recent Regulatory Events. In order to obtain access to an ILEC network, a CLEC must negotiate an interconnection agreement or opt-in to an existing interconnection agreement. These agreements cover, among other items, reciprocal compensation rates and required UNEs. If the parties cannot agree on the terms of an interconnection agreement, the matter is submitted to the applicable state public utility commission or to the FCC for binding arbitration.
The FCC on December 15, 2004 revised its rules concerning ILECs obligations to unbundle and make network elements available to other carriers for use in providing local telecommunications services. The FCC, among other things, eliminated the mandatory ILEC provisioning of a UNE-P and established a 12 month transition plan for existing customers. The FCC also modified its rules to curtail, in certain markets, the availability to CLECs of high-capacity (i.e., DS-1 and DS-3) UNE loops and UNE dedicated transport. None of the markets in which our CLECs provide service were affected by this curtailment.
Access Charges. The FCC regulates the prices that ILECs and CLECs charge for access to their local telephone networks in originating or terminating interstate transmissions. These access charges are paid by traditional carriers, but are not paid at this time by VoIP providers. The FCC is considering whether or not to assess access charges on VoIP providers.
The FCC has reformed and continues to reform the structure of the federal access charge system. The FCC has an active proceeding addressing access and other intercarrier payments. In 2006 (as in 2005), the FCC received comments on proposals by industry participants for reforming the intercarrier payment system, including the so-called Missoula Plan. Various members of the FCC have indicated an intention to further reform the intercarrier compensation system.
NTELOS Telephone Company, or NTELOS Telephone, is an average schedule company for purposes of interstate access charges. NTELOS Telephone participates in the common line pool tariff administered by the National Exchange Carrier Association, or NECA, and therefore charges subscriber line charges, or SLC, computed by NECA, but files its own traffic sensitive (i.e., per-minute) tariff to establish access rates
applicable to switching and transport of telecommunications traffic. R&B Telephone Company is a rate-of-return company for purposes of interstate access charges and participates in NECAs common line pool and NECAs traffic sensitive pool.
In its Intercarrier Compensation docket, the FCC is examining all aspects of intercarrier payments made on both the interstate and intrastate level, including access charges and reciprocal compensation rates for both wireless and wireline carriers of all sizes. It is not known what changes the FCC may make to intercarrier compensation, in what time frame the FCC may make them, and how such changes to intercarrier payments may affect us, or whether we will be able to recover any mandatory reductions in intercarrier charges through increased charges to our subscribers, increased universal service support, or other alternative sources of revenue.
Universal Service. Historically, network access charges were set at levels that subsidized the cost of providing local residential service. The Telecommunications Act requires the FCC to identify and remove such historical implicit subsidies of local service subsidy from network access rates, to establish an explicit Universal Service Fund to ensure the continuation of service to high-cost, low-income service areas and to develop a mechanism for the arrangements for payments into that fund by all providers of interstate telecommunications. In 1997, the FCC issued its first order implementing these directives and has continued to refine this implementation in subsequent orders since that time. The FCCs universal service order established funding mechanisms for high-cost and low-income service areas.
Federal universal service fund high cost payments are received by our rural RLECs and support the high cost of operations in rural markets. Under universal service rules adopted by the FCC, the funds may be distributed only to a carrier that is designated as an Eligible Telecommunications Carrier, or ETC, by the FCC or a state regulatory commission. Our RLECs have been designated as ETCs. Under the Communications Act, however, competitors also can obtain the same per-line support payments as we do without regard for whether the competitors cost structure is similar to our own, if the FCC or the SCC determines that granting such support payments to competitors would be in the public interest. Our wireless carrier has been certified as an ETC in Virginia, West Virginia and Kentucky and is receiving universal service fund payments in those states. Several wireless carriers have been designated as ETCs in all or part of our RLEC service territory.
The FCC is considering changes to the universal service rules and it is not known how such changes may affect us. See Risk Factors.
Federal Regulation of Internet and DSL
To date, the FCC has treated internet service providers, or ISPs, as enhanced service providers, rather than common carriers. Therefore, ISPs are exempt from most federal and state regulation, including the requirement to pay access charges or contribute to the federal USF. As internet services expand, federal, state and local governments may adopt rules and regulations, or apply existing laws and regulations to the internet.
State Regulation of RLEC, CLEC and Interexchange Services
Most states require telecommunications providers to obtain authority from state regulatory commissions prior to offering common carrier services. State regulatory commissions generally regulate RLEC rates for intrastate services, including rates for intrastate access services paid by providers of intrastate long distance services. RLECs must file tariffs setting forth the terms, conditions and prices for their intrastate services. Our RLECs are subject to regulation in Virginia by the SCC. Our tariffs are approved by and on file with the SCC for RLEC services in our certificated service territory in and around Waynesboro, Covington and Clifton Forge, Virginia and in portions of Botetourt and Augusta Counties, Virginia. In addition, the SCC establishes service quality requirements applicable to RLECs, including ours, and resolves disputes involving intrastate communications services.
The state regulatory commissions regulate the prices that ILECs and CLECs charge for access to their local telephone networks in originating or terminating intrastate toll transmissions. On December 1, 2006, Verizon Virginia Inc., Verizon South Inc., and MCImetro Access Transmission Services of Virginia, Inc., d/b/a Verizon Access Transmission Services of Virginia, (collectively, Verizon) filed an Application for modification of the rules governing intrastate access rates charged in Virginia by CLECs, including our CLECs. If the Verizon proposal is adopted, the intrastate access rates charged by CLECs would be capped at the level of the rates charged by the ILEC serving that market. By Order for Notice and Comment entered on December 27, 2006 (Order), the SCC directed interested persons to file comments on three specific questions. The first two questions were raised by Verizon in its December 1, 2006 filing on CLEC access charges. The third question solicited comments on the commencement of a separate generic proceeding regarding the issue of the appropriate level of intrastate access charges for all local exchange carriers, including our RLECs.
The Telecommunications Act preempts state statutes and regulations that restrict entry into the intrastate telecommunications market. As a result, we can provide the full range of competitive intrastate local and long distance services in all states in which we currently operate and in any states into which we may expand. We are certificated as a CLEC in Virginia, West Virginia and Tennessee. Although we file tariffs covering our CLEC services, our rates for such CLEC services generally fluctuate based on market conditions.
Local Government Authorizations
Certain governmental authorities require permits to open streets for construction and/or franchises to install or expand facilities. We obtain such permits and franchises as required.
On July 1, 2006, a new Virginia law took effect that imposes certain requirements and restrictions on localities in granting cable television franchises. The purpose behind the 2006 Virginia Cable Act is to expedite the franchising process from what would sometimes take several years to only a few months. The 2006 Virginia Cable Act provides for negotiated CATV franchises and ordinance CATV franchises. All new entrants must first attempt to negotiate a cable franchise with a locality. Should the negotiations not result in the granting of a franchise during a 45-day negotiation period, the applicant can elect to accept a default ordinance cable franchise that authorizes the applicant to begin offering CATV services 75 days after the initial negotiated franchise request, subject to the applicant abiding by certain requirements set forth in the new law. In September of 2006, NTELOS obtained a negotiated franchise in Waynesboro and an ordinance franchise in Botetourt County. Augusta County does not have a franchise requirement and, accordingly, NTELOS does not need to obtain a franchise prior to offering video services in Augusta County.
Item 1A. Risk Factors.
The following risk factors and other information included in this Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may adversely impact our business operations. Our business, financial condition or results of operations could be materially adversely affected by any or all of these risks.
Risks Relating to Our Business
The telecommunications industry is generally characterized by rapid development, introduction of new technologies, substantial regulatory changes and intense competition, any of which could cause us to suffer price reductions, customer losses, reduced operating margins and/or loss of market share.
The telecommunications industry has been, and we believe will continue to be, characterized by several trends, including the following:
We expect competition to intensify as a result of new competitors and the development of new technologies, products and services. Some or all of these risks may cause us to have to spend significantly more in capital expenditures than we currently anticipate in order to keep existing, and attract new, customers. Many of our voice and data competitors, such as cable providers, wireless service providers, internet access providers and long distance carriers have brand recognition and financial, personnel, marketing and other resources that are significantly greater than ours. In addition, due to consolidation and strategic alliances within the telecommunications industry, we cannot predict the number of competitors that will emerge, especially as a result of existing or new federal and state regulatory or legislative actions. Such increased competition from existing and new entities could lead to price reductions, loss of customers, reduced operating margins and/or loss of market share.
As competition develops and technology evolves, federal and state regulation of the telecommunications industry continues to change rapidly. We anticipate that this state of regulatory flux will persist in the future, as the FCC and state regulators respond to competitive, technological, and legislative developments by modifying their existing regulations or adopting new ones.
Taken together or individually, new or changed regulatory requirements affecting any or all of the wireless, local, and long distance industries may harm our business and restrict the manner in which we operate our business. The enactment of adverse regulation or regulatory requirements may slow our growth and have a
material adverse effect upon our business, results of operations and financial condition. We cannot assure you that changes in current or future regulations adopted by the FCC or state regulators, or other legislative, administrative or judicial initiatives relating to the communications industry, would not have a material adverse effect on our business, results of operations and financial condition. In addition, pending congressional legislative efforts to reform the Communications Act may cause major industry and regulatory changes that are difficult to predict.
Our leverage could adversely affect our financial health.
As of December 31, 2006, our total outstanding debt on a consolidated basis, including capital lease obligations, was approximately $626.5 million. Our indebtedness could adversely affect our financial health and business and future operations by, among other things:
The ability to make payments on our debt will depend upon our subsidiaries future operating performance, which is subject to general economic and competitive conditions and to financial, business and other factors, many of which we cannot control. If the cash flows from our subsidiaries operating activities are insufficient to service our debt obligations, we may take actions, such as delaying or reducing capital expenditures, attempting to restructure or refinance our debt, selling assets or operations or seeking additional equity capital. Any or all of these actions may not be sufficient to allow us to service our debt obligations. Further, we may be unable to take any of these actions on satisfactory terms, in a timely manner or at all. The NTELOS Inc. senior secured credit facility limits our subsidiaries ability to take several of these actions. Our failure to generate sufficient funds to pay our debts or to successfully undertake any of these actions could, among other things, materially adversely affect the market value of the securities offered hereby and our ability to repay our obligations under our indebtedness.
The NTELOS Inc. senior secured credit facility imposes operating and financial restrictions, which may prevent us from capitalizing on business opportunities and taking some corporate actions.
The NTELOS Inc. senior secured credit facility imposes operating and financial restrictions on our subsidiaries. These restrictions generally:
We cannot assure you that those covenants will not adversely affect our ability to pay dividends or repurchase stock, finance our future operations or capital needs or pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the NTELOS Inc. senior secured credit facility. If a default occurs, our indebtedness under the NTELOS Inc. senior secured credit facility could be declared immediately due and payable. As a result of general economic conditions, conditions in the lending markets, the results of our business or for any other reason, we may elect or be required to amend or refinance our indebtedness, at or prior to maturity, or enter into additional agreements for senior indebtedness.
We will require a significant amount of cash, which may not be available to us, to service our debt and fund our other liquidity needs.
Based on our total debt outstanding as of December 31, 2006 of $626.5 million, which includes capital lease obligations, we expect payments on our outstanding indebtedness to be approximately $13.2 million in 2007, inclusive of approximately $6.2 million related to required payments from 2006 excess cash flow (as defined under the credit facility). The aggregate maturities of our long-term debt based on the contractual terms of the instruments are $13.2 million in 2007, $6.6 million in 2008, $6.4 million in 2009, $153.7 million in 2010 and $446.6 million in 2011. Our ability to make payments on, or to refinance or repay, our debt, fund planned capital expenditures and expand our business will depend largely upon our future operating performance. Our future operating performance is subject to general economic, financial, competitive, legislative and regulatory factors, as well as other factors that are beyond our control. Our business may not generate enough cash flow, or future borrowings may not be available to us under the NTELOS Inc. senior secured credit facility or otherwise, in an amount sufficient to enable us to pay our debt or fund our other liquidity needs. If we are unable to generate sufficient cash to service our debt requirements, we will be required to refinance our indebtedness. We may not be able to refinance any of our debt under such circumstances, on commercially reasonable terms or at all. If we are unable to refinance our debt or obtain new financing under these circumstances, we would have to consider other options, including, sales of certain assets to meet our debt service requirements, sales of equity and negotiations with our lenders to restructure the applicable debt.
NTELOS Inc.s senior secured credit facility could restrict our ability to do some of these things. If we are forced to pursue any of the above options under distressed conditions, our business could be adversely affected.
We face substantial competition in the wireless telecommunications industry generally from competitors with substantially greater resources than we have that may be able to offer new technologies, services covering a broader geographical area and lower prices, which could decrease our profitability and cause prices for our services to continue to decline in the future.
We operate in an increasingly competitive environment. Our wireless business faces intense competition from other wireless providers, including Verizon Wireless, ALLTEL, Cellular One, T-Mobile, AT&T Wireless, U.S. Cellular and Sprint Nextel (including its affiliates and resellers, such as Virgin Mobile USA). Competition for customers is based principally upon services and features offered, system coverage, technical quality of the wireless system, price, customer service and network capacity. Our ability to compete will depend, in part, on our ability to anticipate and respond to various competitive factors affecting the telecommunications industry.
Many of our competitors are, or are affiliated with major communications companies that have substantially greater financial, technical and marketing resources than we have. These competitors may have greater name recognition and more established relationships with a larger base of current and potential customers and, accordingly, we may not be able to compete successfully. Consolidation continues in the wireless industry with the recent combinations of Sprint and Nextel, the acquisition by ALLTEL of Western Wireless, and AT&Ts acquisition of 100% ownership of AT&T Wireless. Companies such as Verizon Wireless and AT&T have the resources to sustain losses for some time and so have an advantage over those companies without access to these resources.
Over the last three years, the per-minute rate for wireless services has declined. Competition and market saturation may cause the prices for wireless products and services to continue to decline in the future. As per-minute rates continue to decline, our revenues and cash flows may be adversely impacted.
The effect of aggregate penetration of wireless services in all markets, including our markets, has made it increasingly difficult to attract new customers and retain existing ones. While recent consolidation in the wireless industry may reduce the number of carriers in our markets, the carriers resulting from such consolidation will be larger and potentially more effective in their ability to compete with NTELOS. As a result of increased competition, we anticipate that the price per minute for wireless voice services will continue to decline while costs to acquire customers, including, without limitation, handset subsidies and advertising and promotion costs, may increase. Our ability to continue to compete effectively will depend upon our ability to anticipate and respond to changes in technology, customer preferences, new service offerings, demographic trends, economic conditions and competitors pricing strategies. Failure to successfully market our products and services or to adequately and timely respond to competitive factors could reduce our market share or adversely affect our revenue or net income. In the current wireless market, our ability to compete also depends on our ability to offer regional and national calling plans to our customers. NTELOS relies on roaming agreements with other wireless carriers to provide roaming capabilities in areas not covered by its network. These agreements are subject to renewal and termination if certain events occur, including, without limitation, if network standards are not maintained. If NTELOS is unable to maintain or renew these agreements, our ability to continue to provide competitive regional and nationwide wireless service to our customers could be impaired, which, in turn, would have an adverse impact on our wireless operations.
We expect competition to intensify as a result of the rapid development of new technologies, including improvements in the capacity and quality of digital technology, such as the move to third generation, or 3G, wireless technologies. Several wireless carriers, including Verizon Wireless and Sprint Nextel, have upgraded or announced plans to upgrade all or parts of their 3G networks to include EVDO, which provides broadband wireless services at rates faster than the 3G one times radio transmission, or 1xRTT, technology we use in our markets. Such technological advances and industry changes could cause the technology used on our network to become dated. We may not be able to respond to such changes and implement new technology on a timely basis or at an acceptable cost. To the extent that we do not keep pace with technological advances, fail to offer technologies comparable to those of our competitors or fail to respond timely to changes in competitive factors in our industry, we could lose existing customers and experience a decline in revenues and net income. Each of these factors and sources of competition discussed above could have a material adverse effect on our business, financial condition and results of operations.
If we experience a high rate of wireless customer turnover or seek to prevent significant customer turnover, our revenues could decline and our costs could increase.
Many wireless providers in the U.S. have experienced and have sought to prevent a high rate of customer turnover. The rate of customer turnover may be the result of several factors, including limited network coverage, reliability issues such as blocked or dropped calls, handset problems, inability to roam onto third-party networks at competitive rates, or at all, price competition and affordability, customer care concerns, wireless number portability requirements that allow customers to keep their wireless phone number when switching between
service providers and other competitive factors. In addition, customers could elect to switch to another carrier that has service offerings dependent on newer network technology. We cannot assure you that our strategies to address customer turnover will be successful. If we experience a high rate of wireless customer turnover or seek to prevent significant customer turnover or fail to replace lost customers, our revenues could decline and our costs could increase which could have a material adverse effect on our business, financial condition and operating results.
The loss of our largest customer, Sprint Nextel, a decrease in its usage or a demand by Sprint Nextel that we provide new products or services may result in lower revenues or higher expenses.
Sprint Nextel accounted for approximately 20.1% of our operating revenues for the year ended December 31, 2006. If we were to lose Sprint Nextel as a customer, or if Sprint Nextel reduced its usage or became financially unable to pay our charges, our revenues could decline, which could cause our business, financial condition and operating results to suffer. While the 2005 merger of Sprint and Nextel has not had a negative impact on us to date, the ultimate impact of this merger is not known at this time. Also, Sprint Nextel acquired controlling ownership interest in Nextel Partners Inc., a wireless affiliate of Sprint Nextel, in 2006. Unlike Sprint Nextel, Nextel Partners owns a wireless network in all of the territory covered by our Strategic Network Alliance. Any future migration by Sprint Nextel of CDMA customers to their integrated digital enhanced network, or iDEN, technology could result in a decline in the usage of our network by Sprint Nextel and could cause an adverse impact on our business, financial condition and operating results.
The pricing arrangement under our Strategic Network Alliance with Sprint Nextel may fluctuate which could result in lower revenues.
Under the Strategic Network Alliance, after an initial pricing term in which the price Sprint Nextel is required to pay us is set by the agreement, our price structure will fluctuate under a formula tied to a national wireless retail customer revenue yield and a national retail 1x data revenue yield, provided that the new prices are not lower than the Companys allocated cost of providing these services. In addition, Sprint Nextel prices its national calling plans based on its business objectives and it could set price levels or change other characteristics of its plans in a way that may not be economically advantageous for our business or may result in reduction of usage from Sprint Nextel customers. Based on notification from Sprint Nextel of its retail yield for voice usage and data usage for 2006, pursuant to the terms of our Strategic Network Agreement, we expect pricing reductions to go into effect on July 1, 2007 relating to travel minute of use, data usage and, for the first time since entering into this agreement in 2004, for home minutes of use. Our discussions with Sprint Nextel as to the appropriate voice and data rates to commence on July 1, 2007 continue at this time.
If Sprint Nextel does not succeed, our business may not succeed.
If Sprint Nextel has a significant service disruption, fails to operate its business in an efficient manner or suffers a weakening of its brand name, our operating results would likely be negatively impacted. If Sprint Nextel should have significant financial problems, our business would suffer material adverse consequences, which could include termination or revision of our Strategic Network Alliance.
If the roaming rates we pay for our customers usage of third-party networks increase, our operating results may decline.
Many of our competitors have national networks which enable them to offer roaming and long-distance telephone services to their subscribers at a lower cost. We do not have a national network, and we must pay other carriers a per-minute charge for carrying roaming and long-distance calls made by our subscribers. To remain competitive, we absorb a substantial portion of the roaming and long-distance charges without increasing the prices we charge to our subscribers. We have entered into roaming agreements with other communications providers that govern the roaming rates that we are required to pay. In addition, under the terms of our Strategic
Network Alliance, we have favorable roaming rates with Sprint Nextel. If these roaming agreements are terminated, the roaming rates that we are charged may increase and, accordingly, our cash flow and operating results may decline.
We may incur significantly higher wireless handset subsidy costs than we anticipate to upgrade existing subscribers.
As our subscriber base grows, and technological innovations occur, more existing subscribers will begin to upgrade to new wireless handsets. We subsidize a portion of the price of wireless handsets and incur sales commissions on the sale or upgrade of handsets. The cost of handsets increases as they are able to offer more applications. Furthermore, we generally pay more to purchase handsets than many of our national competitors who buy from manufacturers in large volumes. If more subscribers purchase or upgrade to new wireless handsets than we project, our operating results would be adversely affected.
Our largest competitors and Sprint Nextel may build networks in our markets or use alternative suppliers, which may result in decreased revenues and severe price-based competition.
Our current roaming partners, larger wireless providers and Sprint Nextel ultimately may build their own digital wireless networks in our service areas or obtain roaming services from alternative sources. In addition to controlling the IDEN network as a result of the acquisition of Nextel Partners, Sprint Nextel controls 10 MHz of spectrum within our service territory in the 1900 MHz PCS band. While the terms of our agreement generally prohibit Sprint Spectrum L.P. from directly or indirectly commencing construction of, contracting for or launching its own PCS network in the Strategic Network Alliance service area until 180 days prior to termination of the agreement, the initial term of which ends on July 31, 2011, it would adversely affect our revenues and operating results if Sprint Nextel or another wireless provider were to do so. Should this occur, use of our networks would decrease and our roaming and/or wholesale revenues would be adversely affected. Once a digital wireless system is built, there are only marginal costs to carrying an additional call, so a larger number of facility-based competitors in our service areas could stimulate significant price competition, as has occurred in many areas in the U.S., with a resulting reduction in our revenues and operating results.
The loss of our licenses could adversely affect our ability to provide wireless services.
Our wireless licenses are generally valid for ten years from the effective date of the license. Licensees may renew their licenses for additional ten-year periods by filing renewal applications with the FCC. Our wireless licenses expire in various years. The renewal applications are subject to FCC review and potentially public comment to ensure that the licensees meet their licensing requirements and comply with other applicable FCC mandates. We applied for and were granted renewal of seven of these licenses in 2005 and three of these licenses in 2006. We have nine licenses due to expire in 2007 for which we will need to apply for renewal. If we fail to file for renewal of other of our licenses at the appropriate time or fail to meet any regulatory requirements for renewal, we could be denied a license renewal and, accordingly, our ability to continue to provide service in that license area would be adversely affected. In addition, many of our licenses are subject to interim or final construction requirements. While the licensees have generally met safe harbor standards for ensuring such benchmarks are met, we have relied on, and will in the future rely on, substantial service thresholds for meeting build-out requirements. In such cases, there is no guarantee that the FCC will find our construction sufficient to meet the applicable construction requirement, in which case the FCC could terminate our license and our ability to continue to provide service in that license area would be adversely affected.
Our failure to comply with regulatory mandates could adversely affect our ability to provide wireless services.
The FCC regulates the licensing, operation, acquisition and sale of the licensed spectrum that is essential to our business. We must comply with regulatory requirements, such as Enhanced 911, or E911, and CALEA and the customer privacy mandates of the Customer Proprietary Network Information (CPNI) rules. Failure to
comply with these and other regulatory requirements may have an adverse effect on our licenses or operations and could result in sanctions, fines or other penalties.
The FCC, together with the FAA, also regulates tower marking and lighting. In addition, tower construction is affected by federal, state and local statutes addressing zoning, environmental protection and historic preservation. The FCC adopted significant changes to its rules governing historic preservation review of projects, which makes it more difficult and expensive to deploy antenna facilities. The FCC is also considering changes to its rules regarding environmental protection as related to tower construction, which, if adopted, could make it more difficult to deploy facilities.
The licensing of additional spectrum by the FCC may adversely affect our ability to compete in providing wireless services.
The FCC, from time to time, auctions additional radio spectrum that may be suitable for services that compete, directly or indirectly, with our wireless offerings. For example, in August and September of 2006, the FCC auctioned an additional 90 MHz of radio spectrum for Advanced Wireless Services that can be used for services like our wireless offerings. We participated in that auction and we may also participate in future auctions in order to obtain spectrum necessary to increase the capacity of our systems or to allow us to offer new services. The auction of new spectrum may adversely impact our business by creating new competitors, enhancing the ability of our existing competitors to offer services we cannot offer, requiring the company to expend additional funds to acquire spectrum necessary for continued growth, or restricting our growth because we cannot acquire additional necessary spectrum.
If we lose the right to install our equipment on wireless cell sites or are unable to renew expiring leases for wireless cell sites on favorable terms or at all, our business and operating results could be adversely impacted.
As of December 31, 2006, 91% of our base stations were installed on leased cell site facilities, with 46% installed on facilities owned by American Tower and Crown Communications. A large portion of these cell sites are leased from a small number of large cell site companies pursuant to master agreements that govern the general terms of our use of that companys cell sites. If a master agreement with one of these cell site companies were to terminate, or if one of these cell site companies were unable to support our use of its cell sites, we would have to find new sites or rebuild the affected portion of our network. In addition, the concentration of our cell site leases with a limited number of cell site companies could adversely affect our operating results and financial condition if we are unable to renew our expiring leases with these cell site companies either on terms comparable to those we have today or at all. If any of the cell site leasing companies with which we do business were to experience severe financial difficulties, or file for bankruptcy protection, our ability to use cell sites leased from that company could be adversely affected. If a material number of cell sites were no longer available for our use, our financial condition and operating results could be adversely affected.
We cannot predict the effect of technological changes on our business.
The wireless telecommunications industry is experiencing significant technological change. We believe our continued success will depend, in part, on our ability to anticipate or adapt to technological changes and to offer, on a timely basis, services that meet customer demands. We cannot assure you that we will obtain access to new technology on a timely basis or on satisfactory terms, which could have a material adverse effect on our business, financial condition and operating results.
For us to keep pace with these technological changes and remain competitive, we must continue to make significant capital expenditures to our integrated communications system. Customer acceptance of the services that we offer will continually be affected by technology-based differences in our product and service offerings. Currently we do not offer data applications at speeds as high as those offered by our competitors who have upgraded to EVDO technology. Some competitors, most notably Sprint Nextel, offer push-to-talk. We do not offer our customers a push-to-talk service.
In addition, some competitors have announced plans to develop a Wi-Fi or Wi-Max enabled handset. Such a handset would permit subscribers to communicate using voice and data services with their handset using VoIP technology in any area equipped with a wireless internet connection, or hot spot, potentially bypassing our network. The number of hot spots in the U.S. is growing rapidly, with some major cities and urban areas being covered entirely. The availability of VoIP or another alternative technology to our subscribers could greatly reduce the usage of our network, which would have an adverse effect on our financial condition and operating results.
To accommodate next generation advanced wireless products such as push-to-talk, high-speed data and high-bandwidth streaming video, we would be required to make significant technological changes to our network. We also may be required to purchase additional spectrum. We cannot assure you that we could make these technological changes or gain access to this spectrum at a reasonable cost or at all. Failure to provide these services could have a material adverse effect on our ability to compete with wireless carriers offering these new technologies.
Our rural local telephone company subsidiaries face substantial competition from competitors that are less heavily regulated than we are, which could increase our expenses or force us to lower prices, causing our revenues and operating results to decline.
As the rural local telephone companies for the western Virginia communities of Waynesboro, Clifton Forge, Covington and portions of Botetourt and Augusta Counties, Virginia, we currently compete with a number of different providers, many of which are unregulated or less heavily regulated than we are. Our rural telephone company subsidiaries qualify as rural local telephone companies under the Telecommunications Act and are, therefore, exempt from many of the most burdensome obligations to facilitate the development of competition, such as the obligation to sell unbundled elements of our network to our competitors at forward-looking prices that the Telecommunications Act places on larger carriers. Nevertheless, our rural telephone company subsidiaries face significant competition, particularly from competitors that do not need to rely on access to our network to reach their customers. For example, wireless providers continue to increase their market share and pose a significant competitive risk to our business. A significant competitive development in 2006 was the acquisition by Comcast of the cable television markets in our service area previously served by Adelphia Communications Corporation. Comcast has announced that it will introduce wireline digital voice services to its cable customers in Charlottesville and other Virginia markets. We believe it is likely that Comcast will begin providing digital voice telephony to its customers in Waynesboro, Botetourt and Augusta Counties in 2007. Cable providers have had significant success in other markets offering wireline voice services and so this development could significantly harm our business.
Cable companies and other VoIP providers are able to compete with our rural telephone company subsidiaries even though the rural exemption under the Telecommunications Act is in place. If our rural exemption were removed, competitive local exchange carriers, or CLECs, could more easily enter our rural telephone company subsidiaries markets. Moreover, the regulatory environment governing wireline local operations has been, and we believe will likely continue to be, very liberal in its approach to promoting competition and network access.
Consistent with the experience of other rural telephone companies, our rural telephone company subsidiaries have experienced a reduction in access lines caused by, among other things, customer migration to broadband internet service from dial-up internet service (resulting in a disconnection of second lines), wireless competition and business customer migration from Centrex services to IP-based and other PBX services using fewer lines. As penetration rates of these technologies increase in our markets, our revenues could decline. Our rural telephone company subsidiaries experienced a net loss of 1,529 access lines in the year ended December 31, 2006, or 3.3% of our access lines served at the end of 2005. A continued net loss of access lines could impact our revenues and operating results.
Our rural telephone company subsidiaries are subject to several regulatory regimes and consequently face substantial regulatory burdens and uncertainties.
Many of our competitors are unregulated or less heavily regulated than we are. For example, VoIP technology is used to carry voice communications services over a broadband internet connection. The FCC has ruled that VoIP services are jurisdictionally interstate and that some VoIP arrangements (those not using the Public Switched Telephone Network) are not subject to regulation as telephone services. The United States Supreme Court upheld the FCCs ruling that cable broadband internet services are not subject to common carrier telecommunications regulation. In addition, the Virginia SCC imposes service quality obligations on our rural telephone company subsidiaries and requires us to adhere to prescribed service quality standards, but many of our competitors are not subject to these standards. These standards measure the performance of various aspects of our business. If we fail to meet these standards, the SCC may impose fines or penalties or take other actions that may impact our revenues or increase our costs.
Regulatory developments at the FCC and the Virginia SCC could reduce revenues that our rural telephone company subsidiaries receive from network access charges.
For the year ended December 31, 2006, approximately $37 million of our rural telephone company subsidiaries revenues came from network access charges, which are paid to us by long distance carriers for originating and terminating calls in the areas we serve. These revenues are highly profitable for us. The amount of access charge revenues that we receive is based on rates set by the FCC for interstate long distance calls and the SCC for intrastate long distance calls. Such access rates are subject to change. Our federal access charges are periodically reset by the FCC. The SCC could conduct rate cases and/or earnings reviews, which could result in rate changes.
The FCC has reformed and continues to reform the structure of the federal access charge system. The FCC has an active proceeding addressing access and other intercarrier payments. In 2006 (as in 2005), the FCC received comments on proposals by industry participants for reforming the intercarrier payment system, including the so-called Missoula Plan. Various members of the FCC have indicated an intention to further reform the intercarrier compensation system.
On December 1, 2006, Verizon Virginia Inc., Verizon South Inc., and MCImetro Access Transmission Services of Virginia, Inc., d/b/a Verizon Access Transmission Services of Virginia, (collectively, Verizon) filed an Application for modification of the rules governing intrastate access rates charged in Virginia by CLECs, including our CLECs. If the Verizon proposal is adopted, the intrastate access rates charged by CLECs would be capped at the level of the rates charged by the ILEC serving that market. By Order for Notice and Comment entered on December 27, 2006 (Order), the State Corporation Commission (SCC) directed interested persons to file comments on three specific questions. The first two questions were raised by Verizon in its December 1, 2006 filing on CLEC access charges. The third question solicited comments on the commencement of a separate generic proceeding regarding the issue of the appropriate level of intrastate access charges for all local exchange carriers, including our RLECs. If the SCC were to cap CLEC access rates as proposed by Verizon, such a cap would have an adverse financial effect on our CLEC operations. If the SCC were to reduce the level of access charges for our RLECs, such a reduction could have a significant adverse financial effect on our RLECs depending on the amount of the reduction.
Currently, VoIP providers generally do not pay us access charges for calls that originate or terminate on our network. Therefore, expanded use of VoIP technology could reduce the access or intercarrier revenues received by rural telephone companies like ours. The FCC is currently considering the extent to which VoIP providers should be obligated to pay, or entitled to receive, access charges, but we cannot predict the timing or ultimate result of this proceeding. If VoIP providers continue not to pay access charges to us, our revenues and operating results could be adversely affected to the extent that users substitute VoIP calls for traditional wireline communications.
Regulatory developments at the FCC could reduce revenues that our rural telephone company subsidiaries and our wireless subsidiaries receive from the Federal Universal Service Fund.
For the year ended December 31, 2006, we received approximately $4 million in payments from the federal Universal Service Fund in connection with our rural telephone company subsidiaries operations. The FCC is examining its Universal Service Fund rules and may change the amount of Universal Service Fund support available to carriers. The FCC may change its rules and reduce the amount of funding ultimately available to our rural telephone company subsidiaries. There can be no assurance that we will continue to receive the current level of Universal Service Fund revenues in the future. Loss of Universal Service Fund revenues could adversely affect our operating results.
The FCC is currently examining the way in which it collects carrier contributions to the federal Universal Service Fund. Today, as a telecommunications carrier, we contribute a percentage of our revenues, including DSL revenues, to the Universal Service Fund, which supports the delivery of services to high-cost areas and low-income consumers, as well as to schools, libraries, and rural health care providers. In 2006, the FCC expanded the base of USF contributions by extending universal service contribution obligations to providers of interconnected VoIP service.
Under the current FCC rules, our competitors can obtain the same per-line level of federal Universal Service Fund subsidies as we do, without regard for whether their costs of providing service are similar to ours, if either the FCC or the SCC determines that granting these subsidies to competitors would be in the public interest and the competitors offer and advertise certain telephone services as required by the Telecommunications Act. The FCC has allowed such designation as an Eligible Telecommunications Carrier to several wireless carriers in Virginia and West Virginia, including us, in all or part of our rural telephone company subsidiaries service territory. Under current rules, any Universal Service Fund payments to our competitors would not affect the level of support received by our rural telephone company subsidiaries, but this could change as a result of future FCC reform of the Universal Service Fund.
In December 2004, Congress suspended the application of a law called the Antideficiency Act to the Universal Service Fund until December 31, 2005 and, in November 2005, suspended the application for an additional year until December 31, 2006. The Antideficiency Act prohibits government agencies from making financial commitments in excess of their funds on hand. Currently, the Universal Service Fund administrator makes commitments to fund recipients in advance of collecting the contributions from carriers that will pay for these commitments. The FCC has not determined whether the Antideficiency Act would apply to payments to our rural telephone company subsidiaries. Congress has failed to extend the suspension past December 31, 2006. As a result, the Universal Service Fund support may be delayed or reduced in the future, or contributors to the fund, including us, could see their contribution obligations rise significantly.
Our CLEC operations face substantial competition and uncertainty relating to its interconnection agreements with the ILEC networks covering the CLEC markets we serve.
Our CLEC operations compete primarily with ILECs, including Verizon (including Verizon Business) and Embarq, and, to a lesser extent, other CLECs, including Level 3 (which purchased TelCove in 2006), Fibernet, USLEC and Cox. We will continue to face competition from other current and future market entrants.
We have interconnection agreements with the ILEC networks covering each market in which our CLEC serves. From time to time, we are required to negotiate amendments to, extensions of, or replacements for these agreements. Additionally, we may be required to negotiate new interconnection agreements in order to enter new markets in the future. We may not be able to successfully negotiate amendments to existing agreements, negotiate new interconnection agreements, renew our existing interconnection agreements, opt in to new agreements or successfully arbitrate replacement agreements for interconnection on terms and conditions acceptable to us. Our inability to do so would adversely affect our existing operations and opportunities to expand our CLEC business in existing and new markets. As the FCC modifies, changes and implements rules
related to unbundling of ILEC network elements and collocation of competitive facilities at ILEC central offices, we generally have to renegotiate our interconnection agreements to implement those new or modified rules.
Our competitors have substantial business advantages over our CLEC operations, and we may not be able to compete successfully.
The regional Bell operating companies and other large ILECs such as Embarq dominate the current market for business and consumer telecommunications services and have a virtual monopoly on telephone lines. These companies represent the dominant competition in much of our target service areas, and we expect this competition to intensify. The large ILECs have established brand names and reputations for high quality service in their service areas, possess sufficient capital to rapidly improve and deploy new equipment, own their telephone lines and can bundle digital data services with their existing analog voice services and other services, such as long-distance, wireless and video services, to achieve economies of scale in serving customers. Moreover, the large ILECs are aggressively implementing win-back programs to regain access line customers lost to competitors and use bundled services to assist in those programs. We pose a competitive risk to the large ILECs that serve our CLEC markets and, as both our competitors and our suppliers, they have no motivation to respond in a timely manner to our requests or to assist in the enhancement of the services we provide to our CLEC customers.
We face substantial competition in our internet and data services business and face regulatory uncertainty, each of which may adversely affect our business and results of operations.
We currently offer our internet and data services in rural markets and face competition from other internet and data service providers, including cable companies. The internet industry is characterized by the absence of significant barriers to entry and rapid growth in internet usage among customers. As a result, we expect that our competition will increase from market entrants offering high-speed data services, including DSL, cable and wireless access. Our competition includes:
Many of our competitors have financial resources, corporate backing, customer bases, marketing programs and brand names that are greater than ours. Additionally, competitors may charge less than we do for internet services, causing us to reduce, or preventing us from raising, our fees.
A significant portion of our dial-up internet customer base has transitioned to broadband services. We expect this trend to continue. Where we offer incumbent local exchange service or, to some extent, CLEC services, we have been able to maintain service to some of these customers through DSL services or service bundles. In those areas of our internet coverage area where we provide neither incumbent local exchange service nor CLEC service, we have been unable to retain dial-up internet customers who migrate to broadband services. In 2006 we experienced a 16.5% loss in the number of dial-up internet customers from 2005. Our dial-up internet service revenues for the year ended December 31, 2006 decreased to approximately $5.0 million from approximately $6.8 million for the year ended December 31, 2005.
In connection with our internet access offerings, we could become subject to laws and regulations as they are adopted or applied to the internet. To date, the FCC has treated ISPs as enhanced or information service providers, rather than common carriers. Therefore ISPs are exempt from most federal and state regulation, including the requirement to pay access charges or contribute to the federal Universal Service Fund. As internet services expand, federal, state and local governments may adopt rules and regulations, or apply existing laws and regulations to the internet. The FCC recently issued a decision that harmonizes the regulatory frameworks that apply to broadband access to the internet through telephone and cable providers communications networks.
We require additional capital to respond to customer demand and to competition, and if we fail to raise the capital or fail to have continued access to the capital required to build out and operate our planned networks, we may experience a material adverse effect on our business.
We require additional capital to build out and operate our wireless and wireline networks and for general working capital needs. Our aggregate capital expenditures for 2006 were $86.6 million. Of this amount, $59.4 million was associated with our wireless business of which approximately $23.5 million was for discretionary expansion projects for wireless network coverage expansion and enhancements within the coverage area for improved in-building penetration. Capital expenditures related to our wireline business were approximately $21.0 million in 2006, of which approximately $9.9 million was for fiber network expansion and enhancements utilized by our RLEC and competitive wireline operations. The remaining $11.1 million was used to maintain our regulated RLEC operations and to support the increased minutes of usage, maintenance and growth we project for our competitive wireline voice and data offerings. In addition, the remaining approximately $6.2 million was invested to enhance and maintain our back office support systems to support the continued growth and introduction of new service offerings and applications across our wireless and wireline businesses. We expect our aggregate capital expenditures for 2007 to be in the range of $77 million to $81 million (not including any discretionary capital expenditures for possible upgrades to our wireless network relating to EVDO). Furthermore, because of our intensely competitive market, we may be required, including under the terms of the Strategic Network Alliance, to expand the technical requirements of our wireless or wireline network or to build out additional areas within our territories that could result in increased capital expenditures. Any such unplanned capital expenditures may adversely affect our business, financial condition and operating results.
We are subject to numerous surcharges and fees from federal, state and local governments, and the applicability and amount of these fees is subject to great uncertainty.
Telecommunications providers pay a variety of surcharges and fees on their gross revenues from interstate and intrastate services. Interstate fees include federal Universal Service Fund fees and common carrier regulatory fees. In addition, state regulators and local governments impose surcharges, taxes and fees on our services and the applicability of these surcharges and fees to our services is uncertain in many cases and jurisdictions may argue as to whether we have correctly assessed and remitted those monies. The division of our services between interstate services and intrastate services is a matter of interpretation and may in the future be contested by the FCC or state authorities. In addition, periodic revisions by state and federal regulators may increase the surcharges and fees we currently pay. In 2004, the Virginia General Assembly passed legislation that required us to pay state sales taxes on purchases that were previously exempt from those taxes. As a result, we have added a surcharge to our customer bills to recover this increase in our taxes. It also is unknown if our tax burden will be similar to competitors using different technologies to provide similar services.
On March 7, 2006, the Virginia General Assembly passed legislation that significantly revises the taxation of communications services in Virginia and which took effect on January 1, 2007. The new law applies a uniform, statewide, sales and use tax to retail communications and video services on a competitively neutral basis. The communications sales and use tax rate is 5%. The sales and use tax is remitted by communications providers to the Virginia Department of Taxation, which will administer the distribution of the Communications Sales and Use Tax Trust Fund. The redistribution of taxes and fees from the trust fund to the localities is intended to be revenue neutral and replaces franchise fees and utility taxes set by localities.
The Federal government and many states apply transaction-based taxes to sales of our products and services and to our purchases of telecommunications services from various carriers. It is possible that our transaction-based tax liabilities could change in the future. We may or may not be able to recover some or all of those taxes from our customers.
We rely on a limited number of key suppliers and vendors for timely supply of equipment and services relating to our network infrastructure. If these suppliers or vendors experience problems or favor our competitors, we could fail to obtain sufficient quantities of the products and services we require to operate our businesses successfully.
We depend on a limited number of suppliers and vendors for equipment and services relating to our network infrastructure. If these suppliers experience interruptions or other problems delivering these network components on a timely basis, our subscriber growth and operating results could suffer significantly. Our initial choice of a network infrastructure supplier can, where proprietary technology of the supplier is an integral component of the network, cause us effectively to be locked into one or a few suppliers for key network components. As a result, we have become reliant upon a limited number of network equipment manufacturers, including Motorola Inc., Alcatel-Lucent and Cisco Systems, Inc. If alternative suppliers and vendors become necessary, we may not be able to obtain satisfactory and timely replacement supplies on economically attractive terms, or at all.
A system failure could cause delays or interruptions of service, which could cause us to lose customers.
To be successful, we must provide our customers reliable network service. Some of the risks to our network and infrastructure include:
Network disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and incur expenses.
We are dependent on third-party vendors for our information and billing systems. Any significant disruption in our relationship with these vendors could increase our cost and affect our operating efficiencies.
Sophisticated information and billing systems are vital to our ability to monitor and control costs, bill customers, process customer orders, provide customer service and achieve operating efficiencies. We currently rely on internal systems and third-party vendors to provide all of our information and processing systems. Some of our billing, customer service and management information systems have been developed by third parties and may not perform as anticipated. In addition, our plans for developing and implementing our information and billing systems rely to some extent on the delivery of products and services by third-party vendors. Our right to use these systems is dependent upon license agreements with third-party vendors. Some of these agreements are cancelable by the vendor, and the cancellation or nonrenewable nature of these agreements could impair our ability to process customer information and/or bill our customers. Since we rely on third-party vendors to provide some of these services, any switch in vendors could be costly and affect operating efficiencies.
If we lose our senior management, our business may be adversely affected.
The success of our business is largely dependent on our executive officers, as well as on our ability to attract and retain other highly qualified technical and management personnel. We believe that there is, and will continue to be, intense competition for qualified personnel in the telecommunications industry, and we cannot assure you that we will be able to attract and retain the personnel necessary for the development of our business. The loss of key personnel or the failure to attract additional personnel as required could have a material adverse effect on our business, financial condition and operating results.
Unauthorized use of, or interference with, our network could disrupt service and increase our costs.
We may incur costs associated with the unauthorized use of our network including administrative and capital costs associated with detecting, monitoring and reducing the incidence of fraud. Fraudulent use of our network may impact interconnection costs, capacity costs, administrative costs, fraud prevention costs and payments to other carriers for fraudulent roaming.
Security breaches related to our physical facilities, computer networks, and informational databases may cause harm to our business and reputation and result in a loss of customers.
Our physical facilities and information systems may be vulnerable to physical break-ins, computer viruses, theft, attacks by hackers, or similar disruptive problems. If hackers gain improper access to our databases, they may be able to steal, publish, delete or modify confidential personal information concerning our subscribers. In addition, misuse of our customer information could result in more substantial harms perpetrated by third parties. This could damage our business and reputation, and result in a loss of customers.
Our stock price has historically been volatile and may continue to be volatile.
The trading price of our common stock has been and may continue to be subject to fluctuations. Our stock price may fluctuate in response to a number of events and factors. Events and factors that could cause fluctuations in our stock price may include, among other things:
The CVC Entities and the Quadrangle Entities continue to have significant influence over our business and could delay, deter or prevent a change of control, change in management or business combination that may be beneficial to our stockholders and as a result, may depress the market price of our stock.
As of December 31, 2006, the CVC Entities and the Quadrangle Entities beneficially owned 24,525,752 shares of our common stock, or 58.4% of our outstanding common stock. In addition, four of the eight directors that serve on our board of directors are representatives of CVC and Quadrangle. By virtue of such stock
ownership and representation on the board of directors, the CVC Entities and the Quadrangle Entities continue to have a significant influence over day-to-day corporate and management policies and all matters submitted to our stockholders, including the election of the directors, and to exercise significant control over our business, policies and affairs. Such concentration of voting power could have the effect of delaying, deterring or preventing a change of control, change in management or business combination that might otherwise be beneficial to our stockholders and as a result, may depress the market price of our stock.
The interests of the CVC Entities and the Quadrangle Entities may not coincide with the interests of a holder of our common stock and because such entities continue to have significant influence over our business, they could cause us to enter into transactions or agreements adverse to the interests of our other stockholders.
The interests of the CVC Entities and the Quadrangle Entities may not always coincide with the interests of our other stockholders. Accordingly, because the CVC Entities and the Quadrangle Entities continue to have significant influence over our business, they could cause us to enter into transactions or agreements adverse to the interests of our other stockholders.
In addition, the CVC Entities and the Quadrangle Entities are in the business of making investments in companies and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us. Each of the CVC Entities and the Quadrangle Entities may also pursue, for their own account, acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. Additionally, we have specifically renounced in our shareholders agreement any interest or expectancy that the CVC Entities and the Quadrangle Entities will offer to us any investment or business opportunity of which they are aware.
Our stock price may decline due to the large number of shares eligible for future sale.
Sales of substantial amounts of our common stock, or the possibility of such sales, may adversely affect the market price of our common stock. These sales may also make it more difficult for us to raise capital through the issuance of equity securities at a time and at a price we deem appropriate.
We have granted the CVC Entities, the Quadrangle Entities and certain members of our management the right to require us to register their shares of our common stock, representing approximately 25 million shares of our common stock. Accordingly, the number of shares subject to registration rights is substantial and the sale of these shares may have a negative impact on the market price for our common stock.
Provisions in our charter documents and the General Corporation Law of Delaware could discourage potential acquisition proposals, could delay, deter or prevent a change in control and could limit the price certain investors might be willing to pay for our common stock.
Certain provisions of the General Corporation Law of Delaware, the state in which we are organized, and our certificate of incorporation and by-laws may inhibit a change of control not approved by our board of directors or changes in the composition of our board of directors, which could result in the entrenchment of current management. These provisions include:
We may not be able to pay dividends on our common stock in the future.
Any decision to declare and pay dividends or repurchase common stock, will be made at the discretion of the board of directors and will depend on, among other things, our results of operations, cash requirements, investment opportunities, financial condition, contractual restrictions and other factors that our board of directors may deem relevant. We are a holding company that does not operate any business of our own. As a result, we are dependent on cash dividends and distributions and other transfers from our subsidiaries to make dividend payments or repurchase our common stock. Amounts that can be made available to us to pay cash dividends or repurchase stock are restricted by the NTELOS Inc. Amended Credit Agreement.
If we are not able to implement the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner or with adequate compliance, we may be unable to provide the required financial information in a timely and reliable manner and may be subject to sanctions by regulatory authorities. The perception of these matters could cause our share price to fall.
Section 404 of the Sarbanes-Oxley Act requires that we evaluate and determine the effectiveness of our internal control over financial reporting as of December 31, 2007. We will be evaluating our internal controls systems to allow management to report on, and our independent registered public accounting firm to attest to, our internal controls. We are performing the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act. While we anticipate being able to fully implement the requirements relating to internal controls and all other aspects of Section 404 as of December 31, 2007, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC or Nasdaq. Any such action could adversely affect our financial results or investors confidence in our company, and could cause our stock price to fall. In addition, the controls and procedures that we implement may not comply with all of the relevant rules and regulations of the SEC and Nasdaq. If we fail to develop and maintain effective controls and procedures, we may be unable to provide financial information in a timely and reliable manner. The perception of these matters could cause our share price to fall.
Item 2. Properties.
We are headquartered in Waynesboro, Virginia and own offices and facilities in a number of locations within our operating markets. We believe that our current facilities are adequate to meet our needs in our existing markets for the foreseeable future. The table below provides the location, description and approximate square footage of our material owned properties.
We also lease the following material properties:
Item 3. Legal Proceedings.
We are involved in routine litigation in the ordinary course of our business. We do not believe that any pending or threatened litigation of which we are aware would have a material adverse effect on our financial condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of security holders during the fourth quarter of 2006.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock has been traded on the NASDAQ Global Market under the symbol NTLS since February 9, 2006. Prior to that time, there was no established public trading market for our common stock.
The following table sets forth the high and low prices per share of our common stock for the four quarters in 2006, which correspond to our quarterly fiscal periods for financial reporting purposes:
Stock Performance Graph
The following indexed line graph indicates our total return to stockholders from our initial public offering on February 8, 2006 to December 31, 2006, as compared to the total return for the Nasdaq Composite Index and the Nasdaq Telecommunications Index for the same period. The calculations in the graph assume that $100 was invested on February 8, 2006 in our Common Stock and each index and also assume dividend reinvestment.
Comparison of Five Year Cumulative Total Return
NTELOS, NASDAQ Stock Market
and Nasdaq Telecommunications Index
There were approximately 1,891 holders of our common stock on March 6, 2007.
We have not paid a regular dividend on our common stock since our initial public offering on February 8, 2006. Any decision to declare and pay dividends or repurchase common stock, will be made at the discretion of the board of directors and will depend on, among other things, our results of operations, cash requirements, investment opportunities, financial condition, contractual restrictions and other factors that our board of directors may deem relevant. We are a holding company that does not operate any business of our own. As a result, we are dependent on cash dividends and distributions and other transfers from our subsidiaries to make dividend payments or repurchase our common stock. Amounts that can be made available to us to pay cash dividends or repurchase stock are restricted by the NTELOS Inc. Amended Credit Agreement.
In June 2006, we paid a $30 million cash dividend on our Class B common stock. The payment of the dividend represented the payment in full of the $30 million Class B distribution preference provided for in our Restated Certificate of Incorporation. In the fourth quarter of 2006, all of the 27,000,000 authorized shares of Class B common stock were retired. As a result, the Companys Restated Certificate of Incorporation was amended so as to effect a reduction in the authorized number of shares of the Company by the elimination of the Class B common stock.
In October 2005, prior to our initial public offering, we paid a $125 million dividend to the holders of our Class L common stock.
Item 6. Selected Financial Data
SELECTED HISTORICAL FINANCIAL INFORMATION
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion of our financial condition in conjunction with our consolidated financial statements and the related notes included elsewhere in this report. This discussion contains forward looking statements that involve risks and uncertainties. For additional information regarding some of these risks and uncertainties that affect our business and the industry in which we operate, please see Risk Factors and Forward-Looking Statements elsewhere in this report.
For purposes of this discussion relative to the financial and operational results and cash flows for the year ended December 31, 2006 in comparison to the year ended December 31, 2005, we have combined the financial and operational results and cash flows for the period January 1, 2005 to May 1, 2005 of NTELOS Inc. with our financial and operational results and cash flows for the period May 2, 2005 to December 31, 2005. We had no operating activities prior to the completion of our acquisition of NTELOS Inc. on May 2, 2005. We believe this comparison provides the most practical way to comment on the results of operations and cash flows.
We are a leading provider of wireless and wireline communications services to consumers and businesses primarily in Virginia and West Virginia under the NTELOS brand name. Our wireless operations are composed of an NTELOS-branded retail business and a wholesale business that we operate under an exclusive contract with Sprint Spectrum L.P. We believe our regional focus and contiguous service area provide us with a differentiated competitive position relative to our primary wireless competitors, all of whom are national providers. Our wireless revenues have experienced a 17% compound annual growth rate from 2004 to 2006 and accounted for 73% of our total revenues in 2006. We hold digital PCS licenses to operate in 29 basic trading areas with a licensed population of approximately 8.8 million, and we have deployed a network using code division multiple access technology, or CDMA, in 20 basic trading areas which currently covers a total population of approximately 5.2 million potential subscribers. As of December 31, 2006, our wireless retail business had approximately 367,000 NTELOS-branded subscribers, representing a 7.1% penetration of our total covered population.
We made significant investments in our network in 2005 and 2006, adding 147 new wireless cell sites, including 38 new wireless cell sites placed in service in the fourth quarter of 2006, and increasing our total cell sites to 984 at the end of 2006. These investments and other initiatives, including the introduction of national rate plans and enhanced data service offerings, contributed to a 9% increase in subscribers, a $1.08 increase in ARPU, and an 8% reduction in churn during 2006. We also have an agreement with Sprint Spectrum L.P. to act as their exclusive wholesale provider of network services through July 11, 2011. Under this arrangement, which we refer to as the Strategic Network Alliance, we are the exclusive PCS network service provider for all Sprint Nextel wireless customers in our western Virginia and West Virginia service area. For the year ended December 31, 2006, we realized wholesale revenues of $77.7 million, primarily related to the Strategic Network Alliance, representing an increase of 24% over the same period in 2005.
Founded in 1897, our wireline incumbent local exchange carrier business is conducted through two subsidiaries that qualify as rural telephone companies, or RLECs, under the Telecommunications Act. These two RLECs provide wireline communications services to residential and business customers in the western Virginia communities of Waynesboro, Covington, Clifton Forge and portions of Botetourt and Augusta counties. As of December 31, 2006, we operated 45,281 RLEC telephone access lines. We also own a 1,900-mile regional fiber optic network which directly connects our networks with many of the largest markets in the mid-Atlantic region. We leverage our wireline network infrastructure to offer competitive voice and data communication services in Virginia and West Virginia outside our RLEC coverage area. Within our Competitive segment, we market and sell local and long distance, voice and data services almost exclusively to business customers through our competitive local exchange carrier, or CLEC, and Internet Service Provider, or ISP, operation. As of December 31, 2006, we served customers with 46,781 CLEC access line connections. We also offer DSL services in 94% of our RLEC service area and as of December 31, 2006 we operated 17,177 broadband access connections in our markets, representing an increase of 22.3% in 2006. In 2006 and 2005, our wireline operating income margins were 33.2% and 32.8%, respectively.
We were formed in January 2005 by the CVC Entities and the Quadrangle Entities for the purpose of acquiring NTELOS Inc. On January 18, 2005, we entered into a transaction agreement with NTELOS Inc. and certain of its shareholders to acquire NTELOS Inc. In accordance with this agreement, we acquired 24.9% of the NTELOS Inc. common stock and stock warrants on February 24, 2005. We completed our acquisition of all of NTELOS Inc.s remaining common stock, warrants and vested options by means of a cash merger on May 2, 2005. In connection with our acquisition of NTELOS Inc., we assumed approximately $625.7 million in debt including $624.0 million of the NTELOS Inc. senior secured credit facilities and $1.7 million of capital lease obligations. Following the merger transaction, NTELOS Inc. became our wholly-owned subsidiary. Accordingly, we began consolidating the results of NTELOS Inc. into our financial statements on May 2, 2005.
During the first quarter of 2006, we completed an initial public offering (the IPO) of 15,375,000 shares of our common stock at an offering price of $12.00 per share. The offering consisted of 14,375,000 shares of common stock sold on February 13, 2006 and 1,000,000 shares of common stock sold on March 15, 2006 pursuant to the exercise of the underwriters over-allotment option. We received proceeds from the offering of approximately $172.5 million, net of $12.0 million in underwriting fees. We used approximately $12.9 million of the net proceeds to terminate our advisory agreements with CVC and Quadrangle and $143.9 million to redeem our Floating Rate Senior Notes in full (including unpaid accrued interest of $4.6 million) on April 15, 2006. The remaining proceeds, combined with available cash, were used to pay a $30 million dividend on our 26,493,000 shares of Class B common stock on June 6, 2006. The payment of the dividend represented the payment in full of the $30 million Class B distribution preference provided for in our Restated Certificate of Incorporation. Subsequent to this distribution, all of the 26,493,000 shares of the Class B common stock were converted into shares of common stock, increasing the shares of common stock outstanding to approximately 41,965,000 at December 31, 2006, inclusive of approximately 94,000 shares of common stock issued from the exercise of stock options during the period and approximately 3,000 shares of common stock issued through the employee stock purchase plan.
Effects of Being a Public Company
Upon completion of the initial public offering, we became subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, and the other rules and regulations of the Securities and Exchange Commission, or SEC. We also are subject to various other regulatory requirements, including the Sarbanes-Oxley Act of 2002 (SOX). In addition, we are subject to the rules of the NASDAQ Global Market.
We are working with our independent legal, accounting and financial advisors to identify those areas in which changes should be made to our financial and management control systems to manage our growth and our obligations as a public company. These areas include corporate governance, corporate control, internal audit, disclosure controls and procedures and financial reporting and accounting systems. We have made, and will continue to make, changes in these and other areas, including our internal control over financial reporting.
In addition, compliance with reporting and other requirements applicable to public companies creates additional costs for us and will require the time and attention of management. We incurred approximately $1.5 million of incremental operating expenses in 2006, our first year of being a public company. The majority of these costs are associated with increased Director and Officer insurance costs and external consulting fees incurred to prepare for Sarbanes-Oxley Act compliance. We are required to be in compliance by December 31, 2007. Accordingly, we anticipate that we will incur additional incremental costs next year. At this time, we project that the total incremental operating expenses of being a public company will be approximately $2.1 million in 2007. The incremental costs are estimates, and actual incremental expenses could be materially different from these estimates.
Other Overview Discussion
To supplement our financial statements presented under generally accepted accounting principles, or GAAP, throughout this document we reference non-GAAP measures, such as average monthly revenues per handset/unit in service, or ARPU, to measure operating performance for which our operating managers are responsible and upon which we evaluate their performance.
ARPU is a telecommunications industry metric that measures service revenues per period divided by the weighted average number of handsets in service during that period. ARPU as defined below may not be similar to ARPU measures of other companies, is not a measurement under GAAP and should be considered in addition to, but not as a substitute for, the information contained in our consolidated statements of operations. We closely monitor the effects of new rate plans and service offerings on ARPU in order to determine their effectiveness. We believe ARPU provides management useful information concerning the appeal of our rate plans and service offerings and our performance in attracting and retaining high-value customers. The table below provides a reconciliation of subscriber revenues used to calculate ARPU to wireless communications revenues shown in the consolidated statements of operations for the years ended December 31, 2006, 2005 and 2004.
Our revenues are generated from the following categories:
Our operating expenses are incurred from the following categories:
Other Income (Expenses)
Our other income (expenses) are generated (incurred) from interest expense on debt instruments, including changes in fair value of our interest rate swap instrument, our equity share of the net loss of NTELOS Inc. from our 24.9% investment in NTELOS Inc. for the period February 24, 2005 through May 1, 2005, other income, which includes interest income and gain on sale of investment.
Our income tax liability or benefit and effective tax rate increases or decreases based upon changes in a number of factors, including our pre-tax income or loss, net operating losses and related carryforwards, valuation allowances, alternative minimum tax credit carryforwards, state minimum tax assessments, gain or loss on the sale of assets and investments, write-down of assets and investments, non-deductible expenses and other tax deductible amounts.
Minority Interests in Losses (Earnings) of Subsidiaries
Our minority interest relates to a 53.7% RLEC segment investment in a partnership that owns certain signaling equipment and provides service to a number of small RLECs and to Verisign. We also have a 97% majority interest in the Virginia PCS Alliance L.C., or the VA Alliance, that provides PCS services to a 1.9 million populated area in central and western Virginia. The VA Alliance has incurred significant cumulative operating losses since it initiated PCS services in 1997. We recognize a minority interest credit adjustment only to the extent of capital contributions from the 3% minority owners. No such contributions were made during the year ended December 31, 2006, 2005 and 2004. Amounts related to the RLEC segment minority interest were not material for all periods presented.
Results of Operations
Year ended December 31, 2006 compared to year ended December 31, 2005
Operating revenues increased $47.9 million, or 12.2% from $392.2 million for the year ended December 31, 2005 to $440.1 million for the year ended December 31, 2006. Wireless PCS accounted for 87.8% of this increase, with growth occurring from both subscriber revenues and wholesale revenues. Wireline contributed the remaining revenue increase primarily from minute-driven increases in access revenues and increases in key strategic products from the Competitive segment, partially offset by declines in revenues of other Competitive segment products.
Operating income increased $8.0 million over the comparative years, from $52.6 million for the year ended December 31, 2005 to $60.6 million for the year ended December 31, 2006. Net income decreased $7.8 million from net income of $0.6 million for the year ended December 31, 2005 to a net loss of $7.2 million for the year ended December 31, 2006. Included in the net loss for the year ended December 31, 2006 was a charge of $12.9 million for the termination of advisory agreements and an increase in interest expense of $14.7 million, primarily due to transaction-related charges of $8.6 million, $5.5 million of interest on our Floating Rate Notes, which were paid off in April 2006, and significantly lower interest during 2005 prior to the refinancing and merger transactions in late February 2005. Included in net income for the period ended December 31, 2005 was a gain on the interest rate swap instrument of $4.1 million. In addition, non-cash compensation charges were $3.7 million in 2005 and $13.2 million in 2006. Finally, income tax expense was $12.7 million and $12.2 million for the year ended December 31, 2005 and December 31, 2006, respectively.
The following tables identify our operating revenues on a business segment basis for the years ended December 31, 2006 and December 31, 2005, inclusive of NTELOS Inc.s revenues on a business segment basis for the period January 1, 2005 through May 1, 2005:
WIRELESS COMMUNICATIONS REVENUESWireless communications revenues increased $42.0 million from the year ended December 31, 2005 to the year ended December 31, 2006 due to an increase in our NTELOS-branded net subscriber revenue of $22.8 million, or 11.4%, a $15.1 million, or 24.1%, increase in wholesale and roaming revenues, and a $4.0 million, or 24.9%, increase in equipment sales revenues.
Subscriber revenues reflected subscriber growth of 9.2% over the comparative years, or 30,891 subscribers, from 336,306 subscribers as of December 31, 2005 to 367,197 subscribers as of December 31, 2006. As of December 31, 2006, postpay subscribers represented 73.1% of total subscribers, a decline of 3.1% from 76.2% as of December 31, 2005.
For the comparative years, subscriber revenues reflected the subscriber growth described above and an increase in ARPU of 2.1%, from $52.51 to $53.59 for the year ended December 31, 2005 and December 31, 2006, respectively. The increase in ARPU was driven in part by increased data revenue per subscriber which increased from $1.84 for the year ended December 31, 2005 to $2.71 for the year ended December 31, 2006. Additionally, ARPU increased due to the continued increase in higher service rate plans including the national plans. Other subscriber revenue increased 15.5% related in large part to growth in data services including data bundle packages introduced during the second quarter of 2006. Gross subscriber additions were 3.6% higher for 2006, at 164,375, than 2005 gross subscriber additions of 158,728. This increase in gross adds combined with the introduction of more feature-rich handsets sold in the 2006 period as compared to the 2005 period led to an increase in equipment sales revenue of $4.0 million, or 24.9%, from the year ended December 31, 2005 to the year ended December 31, 2006. Total subscriber churn decreased 1.3%, from 3.22% for 2005 (124,413 subscribers) to 3.18% for 2006 (133,484 subscribers), due to year over year improvement in both postpay and prepay churn due primarily to an increased take-rate of the national plans and other program improvements in 2006.
The increase in wholesale revenues for the comparative periods was driven by increased voice and data usage under the Strategic Network Alliance. Wholesale revenues grew 24.1%, from $62.7 million for the year ended December 31, 2005 to $77.7 million for the year ended December 31, 2006. Pricing reductions went into effect on July 1, 2005 and July 1, 2006 relating to travel minutes of use (minutes from Sprint Nextel customers from outside our region) and July 1, 2006 relating to data usage in accordance with the annual pricing reset provisions of this wholesale agreement. Similar to this past year, the impact of the July 2006 pricing reductions was more than offset by increased usage. Our wholesale revenues are derived primarily from the voice usage (or home minutes of use) by Sprint Nextel customers who live in the Strategic Network Alliance service area, those customers of Sprint Nextel who use our voice services (travel minutes of use) while traveling through the Strategic Network Alliance service area and data usage by Sprint Nextel customers who live in or travel through the Strategic Network Alliance service area. In addition to volume increases experienced on existing cell sites, we have added 61 cell sites within this wholesale service area since December 2005 (27 during the fourth quarter of 2006), improving existing service and extending this coverage area. Based on notification from Sprint Nextel of its retail yield for voice usage and data usage for 2006, pursuant to the terms of our Strategic Network Agreement, further pricing reductions are expected to go into effect on July 1, 2007 relating to travel minutes of use and, for the first time since entering into the contract in 2004, for home minutes of use. Sprint Nextels proposed data revenue yield is significantly lower than the comparable rate for the prior year. We have experienced significant growth in data usage in 2006 and expect continued growth in 2007. Our discussions with Sprint Nextel as to the appropriate voice and data rates to commence on July 1, 2007 continue at this time. We expect continued growth in voice and data usage which should result in continued growth in wholesale revenue for 2007 compared to 2006.
We entered into a seven-year exclusive wholesale agreement with Sprint Spectrum L.P. in 2004. While the 2005 merger of Sprint and Nextel has not had a negative impact on us to date, the ultimate impact of this merger is not known at this time. Further, Sprint Nextel acquired controlling ownership interest in Nextel Partners Inc., a wireless affiliate of Sprint Nextel, in 2006 and the potential impact of any such consolidation is unknown. See Risk Factors contained in Item 1A. of this Annual Report on Form 10-K for the year ended December 31, 2006.
WIRELINE COMMUNICATIONS REVENUESWireline communications revenues increased $5.9 million from $111.0 million for the year ended December 31, 2005 to $116.9 million for the year ended December 31, 2006.
The access line loss noted above is reflective primarily of a reduction in Centrex lines, a loss of second lines due to migration away from dial-up internet access, wireless substitution and the loss of PRI lines serving our own and other ISP operations within the RLEC service area. These line losses, to date, do not reflect the introduction of competitive voice service offerings, such as from cable companies or CLECs, in our markets. While still uncertain, we do anticipate cable competition from Comcast to commence in 2007. We have estimated that our access line losses may be between 5% and 9% in 2007, assuming cable competition does occur which would impact RLEC revenues, principally from residential consumers.
Revenues from our key strategic products in the Competitive wireline segment grew $4.0 million, or 10.8%, over the comparative years, offset by declines in other Competitive revenues. Local access and PRI revenues increased $0.3 million, or 1.9%, due to an increase in PRI and local access lines of 4.1%, from 44,948 lines as of December 31, 2005 to 46,781 lines as of December 31, 2006, partially offset by increased sales of business advantage bundle packages and longer term contracts which are sold at prices below our current overall blended average. Revenue from Broadband and integrated access services increased $1.8 million, or 20.9%, from 2005 to 2006 due primarily to customer growth of 22.3% with the Broadband products. Revenue from private line, CAP and transport increased $1.9 million, or 13.5%, over the comparative years from new circuit additions with carriers. Long distance revenue increased $0.2 million, or 6.5%, from 2005 to 2006 customers due to an increase in customers of 12.4% over the comparable periods, from 40,263 as of December 31, 2005 to 45,237 as of December 31, 2006, partially offset by a decrease in ARPU. Offsetting this were declines in internet, switched access and reciprocal compensation revenues. Dial-up revenue declined $1.8 million from continued customer erosion, with 5,450 fewer customers, or 16.5%, from 33,078 at December 31, 2005 to 27,628 at December 31, 2006. In addition, switched access and reciprocal compensation revenues declined $0.6 million due to rate and volume reductions, offset by an increase in wireless transport revenues of $0.3 million.
OTHER COMMUNICATIONS SERVICES REVENUESOther communications services revenue decreased $0.1 million due to continued decline in our paging business, from $0.9 million for the year ended December 31, 2005 to $0.8 million for the year ended December 31, 2006.
The following tables identify our operating expenses on a business segment basis, consistent with the tables presenting operating revenues above, for the years ended December 31, 2006 and December 31, 2005, inclusive of NTELOS Inc.s operating expenses on a business segment basis for the period January 1, 2005 through May 1, 2005:
The following describes our operating expenses on an aggregate basis and on a basis consistent with our financial statement presentation.
TOTAL OPERATING EXPENSESAs noted above, total operating expenses increased $39.9 million, or 11.7%, over the comparative years. Operating expenses before depreciation and amortization, gain on sale of assets, accretion of asset retirement obligations, termination of advisory agreements, non-cash compensation and capital restructuring charges increased $22.2 million, or 9.0%, from the year ended December 31, 2005 to the year ended December 31, 2006.
Total wireless operating expenses before depreciation and amortization, accretion of asset retirement obligations, termination of advisory agreements, non-cash compensation charges and capital restructuring charges grew $19.7 million, or 10.3%, over the comparative years. Increased cost of sales, particularly roaming costs, handsets, handset insurance and features, accounted for $11.1 million of the increase. Excluding cost of sales, the remaining increase of $8.6 million, or 6.4%, over the comparative years was primarily due to increased retention costs of the larger subscriber base, an increase in agent commissions due to increased sales and an increase in cell site expense related to a 9.7% increase in the number of cell sites and the increased subscriber base. These increases were offset by improvement in bad debt expense of $1.8 million, or 23.0%, over the comparative years due to improved collections experience.
Wireline operating expenses before depreciation and amortization, accretion of asset retirement obligations, termination of advisory agreements, non-cash compensation charges and capital restructuring charges increased
$2.7 million, or 5.4%, over the comparative years. This increase was largely related to increased access expense, repairs and maintenance expense, long distance wholesale expense, sales commissions and increased salary, wage and benefit expense due primarily to increased average headcount year over year.
Other operating expenses, before depreciation and amortization, accretion of asset retirement obligations, termination of advisory agreements, non-cash compensation and capital restructuring charges from the other communication service businesses decreased $0.2 million from the year ended December 31, 2005 to the year ended December 31, 2006 due primarily to a decrease of $0.8 million in advisory fees. These costs were eliminated during the first quarter of 2006 as a result of the termination of our advisory agreement with CVC Management LLC and Quadrangle Advisors LLC (the Advisors) in February 2006. Absent the decrease in advisory fees, these operating expenses increased $0.6 million over the comparative years. This increase was primarily due to increased unallocated corporate costs associated with the Company becoming a publicly traded company in 2006.
COST OF WIRELESS SALESCost of wireless sales increased $11.1 million, or 19.4%, from $57.3 million for the year ended December 31, 2005 to $68.4 million for the year ended December 31, 2006. Equipment cost of sales, or COS, increased $2.5 million in 2006 compared to 2005 primarily due to 5,647 more wireless gross customer additions over the comparative years and sales of feature-rich, more expensive handsets. Roaming costs related to increased sales for national plans and other plans which contain more package roaming minutes increased $5.5 million over the twelve month comparative periods. Subscribers with a national plan represented 9.1% and 25.5% of the subscriber base at December 31, 2005 and 2006, respectively. The Company expects continued growth in roaming costs from sales of national plans which commenced in late September 2005. Other feature cost of sales increased $3.5 million in 2006 compared to 2005, driven primarily by a $2.7 million increase in the cost of handset insurance and a $0.8 million increase in the cost of advanced data features and the related take rates. These increases were primarily offset by a $0.6 million decrease in toll cost of sales for 2006 compared to 2005 due to long distance rate reductions partially offset by higher usage.
MAINTENANCE AND SUPPORT EXPENSESMaintenance and support expenses increased $9.4 million, or 13.7%, from $68.6 million to $78.0 million for the years ended December 31, 2005 and 2006, respectively. Cell site costs for wireless increased $4.7 million over the comparative years as a result of the larger subscriber base and a 9.7% increase in cell sites placed in service between December 31, 2005 and December 31, 2006. In connection with 2007 planned network expansion and enhancements, we are planning an additional 7% to 8% increase in the number of cell sites in 2007. Accordingly, when these and future cell sites are placed in service, we expect these costs to increase. The increase in maintenance and support is also attributable to transport and access expense which increased $1.5 million over the comparative years due to the wireless PCS growth and growth of the strategic wireline Competitive services and CLEC access line charge increases. Repairs and maintenance expense increased $0.9 million from 2005 to 2006 due to new equipment maintenance contracts and required maintenance on existing routes. Long distance wholesale expense increased $0.3 million due to long distance subscriber growth of 12.4%. In addition to these increases, we recorded $1.1 million of non-cash compensation charges during 2006 and $0.3 million during 2005 related to the original Class A common stock and option instruments held by certain members of operations and engineering management. The remaining increase is primarily attributable to increased compensation expenses related to an increased workforce year over year.
CUSTOMER OPERATIONS EXPENSESCustomer operations expenses increased $7.4 million, or 8.0%, from $92.6 million for 2005 to $100.0 million for 2006. During the years ended December 31, 2005 and 2006, we recorded $0.4 million and $1.4 million of non-cash compensation charges, respectively, related to the original Class A common stock and option instruments held by certain members of sales, marketing and customer care executive management. The remainder of the increase is primarily related to the direct costs associated with an increased wireless PCS customer base and the rapidly changing competitive environment in wireless during the comparative periods, including a $4.1 million increase in customer retention costs and a $1.8 million increase in employee and agent sales commissions and other selling expenses due to volume and incentives. Compensation
and other customer operation expenses increased $2.1 million, or 3.7%, over the comparative periods related primarily to the 9.2% growth in wireless subscribers. These increases were primarily offset by an improvement in bad debt expense of $1.6 million over the comparative years.
CORPORATE OPERATIONS EXPENSESFor the comparative periods, corporate operations expenses increased $3.7 million, or 12.1%, from $30.7 million for the year ended December 31, 2005 to $34.4 million for the year ended December 31, 2006. This increase primarily relates to an increase of $7.7 million of non-cash compensation charges and a $1.0 million increase in certain insurance expenses and wireless regulatory fees. These increases were primarily offset by a decrease in advisory fee charges of $0.8 million, a $2.5 million decrease in compensation related expenses due primarily to lower bonus and medical claims expenses and a $2.0 million decrease related to favorable settlements of operating tax matters and favorable developments resulting in reductions to other operating tax reserve.
DEPRECIATION AND AMORTIZATION EXPENSESDepreciation and amortization expenses increased $2.0 million, or 2.4%, from $82.9 million for the year ended December 31, 2005 to $84.9 million for the year ended December 31, 2006. As of the May 2, 2005 merger date, the Company revalued its long-lived assets. As a result, depreciable fixed assets decreased $12.2 million and other intangibles increased $46.5 million. The increase in other intangibles resulted in a monthly increase in amortization expense of approximately $0.8 million for the periods after May 1, 2005 as compared to amortization of other intangibles for the period ended May 1, 2005 and before, and it accounts for $3.1 million of the total increase in depreciation and amortization expense for the comparative years. Depreciation expense related to fixed asset additions was more than offset by assets that became fully depreciated during a period subsequent to December 31, 2005 and by accelerated depreciation related to the 3G-1xRTT network upgrade which commenced in 2005 and was completed during the second quarter of 2006.
GAIN ON SALE OF ASSETSFor the year ended December 31, 2005, we recognized a gain of approximately $8.7 million on the sale of certain inactive PCS licenses covering populations in Pennsylvania.
ACCRETION OF ASSET RETIREMENT OBLIGATIONSAccretion of asset retirement obligations is recorded in order to accrete the estimated asset retirement obligation over the life of the related asset up to its future expected settlement cost. This charge increased $0.1 million over the comparative years, from $0.7 million for the year ended December 31, 2005 to $0.8 million for the year ended December 31, 2006.
CAPITAL RESTRUCTURING CHARGESCapital restructuring charges of $15.6 million were recorded in 2005 for legal, financial and consulting costs, accelerated payment of certain retirement obligations and employee retention related costs, all of which are directly attributable to the refinancing merger transactions, the initial closing of which occurred on February 24, 2005 with NTELOS Inc. borrowing $625 million from the new $660 million senior secured credit facilities and using these proceeds to refinance substantially all of its existing indebtedness and repurchase, pursuant to a tender offer for $440 million, or approximately 75% of its existing common stock, warrants and options. On May 2, 2005, we acquired all of NTELOS Inc.s remaining common shares, warrants and options by means of a merger.
TERMINATION OF ADVISORY AGREEMENTThe Company (through NTELOS Inc.) entered into advisory agreements with the Advisors, whereby the Advisors would provide advisory and other services to the Company for a period of ten years for a combined annual advisory fee of $2.0 million payable quarterly at the beginning of each quarter. Under certain conditions set forth in these agreements, the Company could terminate these agreements prior to expiration. On February 13, 2006, commensurate with its IPO, the Company terminated the advisory agreements, paying a $12.9 million termination fee on that date.
OTHER INCOME (EXPENSES)
Interest expense on debt instruments for the comparative years increased $14.7 million, or 32.5%, from $45.2 million to $59.9 million due primarily to the low interest expense during the 2005 period prior to the
merger and refinancing transactions in February 2005 when the Company added $445 million of debt. Interest during this period was approximately $6.4 million lower than it would have been if the transactions had occurred on January 1, 2005. In the second quarter of 2006, we incurred $5.1 million and $1.3 million of interest charges related to the write-off of the high yield Floating Rate Notes deferred issuance costs and discount, respectively, when the Notes were repaid. Additionally, we incurred a $2.3 million prepayment penalty recorded as an interest charge related to the second lien term loan repayment. We also incurred interest on the high yield Floating Rate Notes, which were originally issued during the fourth quarter of 2005 and repaid on April 15, 2006, of $5.3 million in 2006 ($3.8 million of interest was recognized in the fourth quarter of 2005) prior to the repayment. This increase was offset by decreased interest rates associated with the debt refinancing in June 2006 where the $225 million second lien credit facility which bore interest at 5.0% above the Eurodollar rate was refinanced with a new first lien credit facility bearing interest at 2.25% above the Eurodollar rate. The blended rate improvement realized from this refinancing is approximately 0.94%, or a $6.2 million annual savings at the current level of senior debt.
The change in fair value of interest rate swap instrument was a loss of $0.2 million for the year ended December 31, 2006 compared with a gain of $4.1 million for the year ended December 31, 2005. Our swap agreement, entered into in connection with the February 24, 2005 financing transactions, was not designated as an interest rate hedge instrument for accounting purposes and therefore the changes in the fair value of the swap agreement are recorded as a charge or credit to (loss) gain on interest rate swap. For the period January 1, 2005 through February 24, 2005, we had a swap agreement with a notional amount of $162.5 million, $150 million less than our current swap agreement. The fair value of the current interest rate swap agreement at December 31, 2006 has been recorded as deferred assetinterest rate swap of $3.9 million. The interest rate swap agreement matures in February 2008.
Other income primarily relates to interest income from cash and cash equivalents. Other income totaled $2.8 million for the year ended December 31, 2006, $1.0 million higher than the prior year due to an increase in cash, due primarily to cash proceeds from the IPO and cash generated from operations in 2006. We also realized interest rate improvements between the comparable periods. We recorded gains on sale of investments totaling $1.7 million for the year ended December 31, 2006 related to the redemption of the RTB stock for which we received the cash in April 2006 (see Note 8 to the consolidated financial statements included in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for the year ended December 31, 2006). This has been classified in other income below operating income due to the fact that the RTB stock was of a non-operational nature.
Income tax expense for the year ended December 31, 2006 was $12.2 million, representing primarily the effects of non-deductible, non-cash stock based compensation, non-deductible transaction costs and interest cost in excess of Internal Revenue Code defined yields. We expect our recurring non-deductible expenses to relate primarily to certain non-cash stock based compensation. The annual amounts of these charges are projected to be approximately $4 million in 2007. Income taxes for the year ended December 31, 2005 were $12.7 million, driven by non-cash stock based compensation which is non-deductible.
The Company has NOLs of approximately $227.5 million, of which approximately $168.1 million (as adjusted for realized built-in losses occurring post-confirmation of NTELOS Inc.) originated from the NTELOS Inc. subsidiary group and existed at emergence from its bankruptcy. The NOLs existing at emergence, and the adjustments related to realized built-in losses, were subject to an annual utilization limitation of approximately $9.2 million. Subsequent to NTELOS Inc.s emergence from bankruptcy and through May 2, 2005, the NTELOS Inc. subsidiary group incurred additional NOLs of approximately $78.9 million. All of the NOLs existing at May 2, 2005 (the merger date), including the amounts which were subject to the first limitation, are now subject to an annual limitation of $1.6 million (prior to adjustment for realized built-in gains occurring after the merger). Built-in gains existing at the merger date, which are realized subsequent to that date, increase the annual
limitation, and could be significant. Due to the limited carry forward life of NOLs and the amount of the annual limitation, it is likely that we will only be able to realize approximately $130 million of our NOLs. We expect that we will have NOLs available for use of approximately $24 million in 2007, $18 million in 2008, $9 million in 2009 and 2010 and $2 million per year during the remaining carry forward period. Our ability to use these NOLs in a given year will be dependent on the amount of taxable income for that year. Any unused amounts will be available for use in subsequent years.
Year ended December 31, 2005 compared to year ended December 31, 2004
Operating revenues increased $48.9 million, or 14%, from $343.3 million for the year ended December 31, 2004, to $392.2 million for the year ended December 31, 2005. Operating income decreased $2.0 million, or 4% from $54.6 million for 2004 to $52.6 million for 2005.
As a result of an 11% growth in subscribers, a 9% increase in average revenue per handset/unit or ARPU and a 22% increase in wholesale revenue, primarily under our Strategic Network Alliance, our gross wireless operating revenues increased $45.6 million, or 19%, for 2005 as compared to 2004. Total wireless operating expenses before depreciation and amortization, accretion of asset retirement obligations, gain on sale of assets and capital restructuring charges over these periods grew $21.8 million, or 13%, driven by a $9.5 million increase, or 20%, in cost of sales due to a 19% increase in gross subscriber additions and the continued implementation of data products in 2005. Excluding cost of sales, the remaining increase of $12.3 million was primarily due to the $8.9 million increase in customer operations expenses primarily from increases in retention costs of the larger subscriber base and costs associated with the increase in subscribers and the $4.1 million increase in maintenance and support expenses primarily from additional network expenses related to the increase in cell sites and maintenance contracts on equipment.
Wireline communications services realized revenue improvement of $4.1 million, or 4%, in 2005 as compared to 2004. Wireline operating expenses before depreciation and amortization, accretion of asset retirement obligations, gain on sale of assets and capital restructuring charges increased $1.1 million, or 2%, in 2005 as compared to 2004. This is a composite of a $1.9 million decrease in our RLEC expenses offset by an increase of $3.0 million in competitive wireline expenses. RLEC customers decreased by 3% as of December 31, 2005 compared to December 31, 2004. Our CLEC and Broadband customers increased by 7% and 30%, respectively, as of December 31, 2005 compared to December 31, 2004, and our dial-up internet customers declined by 19% as of the year ended 2005 compared to 2004.
Other communications services revenue declined $0.9 million, from $1.8 million for 2004 to $0.9 million for 2005 due to the exit from our wireless cable business in the first quarter of 2004 and reduced equipment sales in communications services and decline in the paging business.
The following tables identify our operating revenues on a business segment basis for the year ended December 31, 2005, inclusive of NTELOS Inc.s revenues on a business segment basis for the period January 1, 2005 through May 1, 2005, and for the year ended December 31, 2004, inclusive of NTELOS Inc.s revenues on a business segment basis for the entire year:
WIRELESS COMMUNICATIONS REVENUESWireless communications revenues increased $45.6 million, or 19%, primarily due to an increase in our NTELOS-branded net subscriber revenue of $30.6 million, or 18%, an $11.1 million, or 22%, increase in wholesale and roaming revenues, and a $3.8 million increase in equipment sales revenues. Subscriber revenues reflected subscriber growth of 11%, or 34,100 subscribers, from 302,200 subscribers at December 31, 2004 to 336,300 subscribers at December 31, 2005 and an increase in ARPU of 9% from $48.30 for 2004 to $52.51 for 2005. The increase in ARPU was driven in part by increased data and other service revenue per subscriber. Gross subscriber additions were 19% greater in 2005, at 158,700, compared to 133,400 for 2004, contributing to the growth in both subscriber and equipment sales revenues. Postpay subscriber churn remained stable over the comparative periods at 2.3%. Reductions in total subscriber churn contributed to the net subscriber growth as total churn declined from 3.3% to 3.2% for 2004 and 2005, respectively. Growth in wholesale revenues was driven by increased voice and data usage under the Strategic Network Alliance as these revenues grew 21% from $50.8 million in 2004 to $61.7 million in 2005. Our wholesale revenues are derived primarily from the voice and data usage by Sprint Nextel customers who live in the Strategic Network Alliance service area, our Home wholesale subscribers, and those customers of Sprint Nextel, and affiliates of Sprint Nextel such as Virgin Mobile and Qwest, who use our voice and data services while traveling through the Strategic Network Alliance service area.
Our wireless wholesale business began in 1999 when we signed a ten-year agreement with Horizon PCS to carry Horizon PCSs traffic in our territories in western Virginia and West Virginia. On August 15, 2003, Horizon PCS filed for Chapter 11 bankruptcy protection. On June 15, 2004, Sprint purchased from Horizon PCS the 97,000 PCS subscribers in the markets covered by our wholesale network service agreement. We refer to these subscribers together with new subscribers acquired by Sprint Nextel in the Strategic Network Alliance coverage area as Home wholesale subscribers. We executed a new seven-year exclusive wholesale agreement concurrent with this transaction, which we refer to herein as the Strategic Network Alliance. While management believes the merger of Sprint and Nextel will likely have a positive impact for our wholesale business, the level of future wholesale revenue to be generated under this agreement is uncertain. Further, it is possible that there will be additional consolidation among the Sprint Nextel network affiliates and the potential impact of any such future consolidation is unknown. See Risk Factors.
WIRELINE COMMUNICATIONS REVENUESWireline communications revenues increased $4.1 million, or 3.9%, from $106.9 million for the year ended December 31, 2004 to $111.0 million for the year ended December 31, 2005.
OTHER COMMUNICATIONS SERVICES REVENUESOther communications services revenue declined $0.9 million, from $1.8 million in 2004 to $0.9 million in 2005, due to the exit from our wireless cable business in the first quarter of 2004 and reduced equipment sales in communication services and continued decline in our paging business.
The following tables identify our operating expenses on a business segment basis, consistent with the tables presenting operating revenues above, for the years ended December 31, 2005, inclusive of NTELOS Inc.s operating expenses on a business segment basis for the period January 1, 2005 through May 1, 2005, and for the year ended December 31, 2004 inclusive of NTELOS Inc.s operating expenses on a business segment basis for the entire year:
The following describes our operating expenses on an aggregate basis and on a basis consistent with our financial statement presentation.
TOTAL OPERATING EXPENSESAs noted above, total operating expenses increased $50.9 million, or 17.6% from 2004 to 2005. Operating expenses before depreciation and amortization, accretion of asset retirement obligations, gain on sale of assets, capital restructuring charges and non-cash compensation charges increased $23.3 million, or 10.5%, from 2004 to 2005. Wireless operating expenses, before depreciation and amortization, accretion of asset retirement obligations, gain on sale of assets, capital restructuring charges and non-cash compensation charges increased $21.8 million, or 12.9% over the respective periods due to direct costs associated with a higher subscriber base and a 19% increase in customer gross additions for 2005 compared to 2004. Wireline operating expenses, before depreciation and amortization, accretion of asset retirement obligations, gain on sale of assets, capital restructuring charges and non-cash compensation charges increased $1.1 million, or 2.4% in 2005 as compared to 2004. RLEC operating expenses decreased $1.9 million due primarily to a decrease in bad debt expenses and reductions in compensation expenses related to efficiency-driven headcount reductions. Competitive wireline operating expenses increased $3.0 million due to the increased customer and revenue base, primarily related to increases in unbundled network element expenses and other network transport expenses and increases in systems related back-office support expenses. Operating expenses, before depreciation and amortization, accretion of asset retirement obligations, gain on sale of assets, capital restructuring charges, and non-cash compensation charges from the other communication service businesses increased $0.4 million, or 7.7% from 2004 to 2005.
COST OF WIRELESS SALESCost of wireless sales increased $9.5 million, or 19.8%, from $47.8 million in 2004 to $57.3 million in 2005. Equipment cost of sales, or COS, increased $4.2 million, or 19%, primarily due to
the year over year increase in the number of gross customer additions. Cell site access, toll and other wireless COS increased $5.3 million, or 20%, over the comparative periods related to the increased subscriber base and the continued increase in the percentage of the subscribers in larger minute plans resulting in higher average minutes per subscriber, both of which drive higher usage based network expenses captured in cost of wireless sales.
MAINTENANCE AND SUPPORT EXPENSESMaintenance and support expenses increased $4.1 million, or 6.3%, from $64.5 million to $68.6 million for 2004 and 2005, respectively. The primary driver of this expense increase is related to non-usage based transport and access expense which increased due to the wireless PCS backhaul to support customer growth and minute growth, wireline CLEC customer growth and CLEC access line charge increases. Cell site costs also increased for wireless reflecting the larger subscriber base and the addition of 60 cell sites placed in service during 2005. Further cell site additions are expected in 2006 which will further increase this cost. These increases are partially offset by reductions in access expenses associated with dial-up internet related to the 19% decrease in the number of customers taking this service.
CUSTOMER OPERATIONS EXPENSESCustomer operations expenses increased $9.8 million, or 11.8%, from $82.8 million in 2004 to $92.6 million in 2005. This increase is related to the direct costs associated with the 11% increase in wireless PCS subscribers, the rapid growth in popularity of higher feature-rich handsets and the increased customer retention costs, all of which increased a combined $7.2 million, or 34%.
CORPORATE OPERATIONS EXPENSESCorporate operations expenses increased $3.8 million, or 13.9%, from $26.9 million in 2004 to $30.7 million in 2005. Corporate operations expenses in 2005 included $1.3 million in advisory fees which commenced May 2, 2005 and $3.0 million of the total $3.7 million charges related to non-cash compensation were classified as corporate operations expenses. The remaining $0.7 million of non-cash compensation charges were split between customer operations and maintenance and support as indicated on the face of the statement of operations. The non-cash compensation charges relate to the accounting for the increase in the intrinsic value of Class A common stock and options as further discussed in Note 9 of the footnotes to the NTELOS Holdings Corp. consolidated financial statements included herein. Additionally, we experienced increased expenses with respect to USF related regulatory fees, pension expenses due to a 0.5% decrease in the discount rate assumption effective May 2, 2005, and increases in compensation expenses. The aforementioned increases in 2005 expenses were partially offset by a $1.9 million operating tax accrual relating to certain unbilled locality taxes and $0.6 million of legal and professional fees related to the Horizon PCS settlement and our Sprint wholesale agreement recorded in 2004 and which were not recurring in 2005.
DEPRECIATION AND AMORTIZATION EXPENSESDepreciation and amortization expenses increased $17.7 million, or 27.2%, from $65.2 million for 2004 to $82.9 million for 2005. As of the May 2, 2005 merger date, the Company revalued its long-lived assets. As a result, depreciable fixed assets were written down $12.2 million but other amortizable intangibles increased $46.5 million. The increase in other intangibles resulted in a monthly increase in amortization expense of approximately $0.8 million ($9.4 million annually) for the periods after May 1, 2005 as compared to amortization of other intangibles for the period ended May 1, 2005 and before. For 2005, we purchased approximately $89 million of depreciable property, plant and equipment driving significant year over year increased depreciation.
GAIN ON SALE OF ASSETSWe recorded gains on sale of assets totaling $8.7 million in 2005. This consisted primarily of the February 2005 sale of certain inactive PCS licenses covering populations in Pennsylvania resulting in a gain of approximately $5.2 million, and the sale of the MMDS spectrum licenses, spectrum leases and wireless cable equipment in the Richmond, Virginia market, resulting in a gain of approximately $3.5 million in April 2005. See Note 8 to NTELOS Holdings Corps audited consolidated financial statements included herein.
ACCRETION OF ASSET RETIREMENT OBLIGATIONSAccretion of asset retirement obligations increased $61,000 in 2005 over 2004, from $680,000 in 2004 to $741,000 in 2005. This charge is recorded in order to accrete the estimated asset retirement obligation over the life of the related asset up to its future expected settlement cost.
CAPITAL RESTRUCTURING CHARGESCapital restructuring charges of $15.6 million were recorded in 2005 for legal, financial and consulting costs, accelerated payment of certain retirement obligations, and retention related costs, all of which are directly attributable to the refinancing merger transactions. On January 18, 2005, NTELOS Inc. and certain of its shareholders entered into an agreement pursuant to which NTELOS Inc. would be recapitalized and sold to us. We were formed in contemplation of this transaction. On February 24, 2005, NTELOS Inc. borrowed $625 million from the new $660 million senior secured credit facilities and used these proceeds to refinance substantially all of its existing indebtedness and repurchase, pursuant to a tender offer for $440 million, or approximately 75% of its existing common stock, warrants and options. On May 2, 2005, we acquired all of NTELOS Inc.s remaining common shares, warrants and options by means of a merger. The recapitalization and sale is described in Note 2 of the footnotes to the NTELOS Inc. financial statements included in Item 8 of the annual report on form 10-K for the year ended December 31, 2005.
OTHER INCOME (EXPENSES)
Interest expense on debt instruments for the comparative years increased $29.4 million, or 187%, from $15.7 million to $45.2 million. The increase was due to the signing of our new $660 million senior secured credit facilities on February 24, 2005 and the issuance on October 17, 2005 of $135 million of floating rate senior notes (notes). The proceeds of the $660 million senior secured credit facilities were used to repay the outstanding balance of the existing $325 million senior credit facility and other senior secured debt obligations (See Note 4 to the NTELOS Holdings Corp. audited consolidated financial statements included herein). Including the interest exchanged in the interest rate swap agreement, interest expense relating to our new $625 million facility was $38.3 million in 2005. Interest expense relating to the retired $325 million senior credit facility in 2005 was $1.5 million compared to $10.2 million in 2004. Interest on the $135 million notes was $4.1 million in 2005. Other interest in 2004 related primarily to the $75 million of convertible senior notes which were converted to common stock on September 30, 2004. In 2005, the remaining $1.3 million of interest expense relates to amortization of debt issuance costs and interest on capital lease obligations.
Gain (loss) on interest rate swap instruments changed $4.6 million, from a loss of ($0.5) million in 2004 to a gain of $4.1 million in 2005. Concurrent with the inception of the new $625 million NTELOS Inc. senior secured credit facilities, we entered into an interest rate swap agreement with a notional amount of $312.5 million. This interest rate swap agreement was not designated as an interest rate hedge instrument for accounting purposes and therefore the changes in the market value of the swap agreement were recorded as a charge or credit to gain (loss) on interest rate swap instruments. In 2004, we had a swap agreement with a notional amount of $162.5 million related to the $325 million senior credit facility. This agreement was also not designated as an interest rate hedge instrument for accounting purposes. Therefore, payments were split between associated swap agreement obligation and interest expense based on the projected future payment stream with a majority being recorded as a reduction of the liability. Changes between the fair value and carrying value of the previous swap obligation were also included as adjustments to gain (loss) on interest rate swap instruments.
Other income, which primarily relates to interest income from cash and cash equivalents, increased $1.5 million, from $0.4 million in 2004 to $1.9 million in 2005.
Income tax expense was approximately $4.6 million in the period May 2, 2005 through December 31, 2005. This represents an effective tax rate of approximately 80.7%. The effective tax rate results primarily from recognition of non-deductible equity losses in NTELOS Inc. prior to consolidation, non-deductible equity compensation associated with our Class A common stock, and state minimum taxes. All of the companys deferred tax assets that existed as of the merger date were fully reserved. Accordingly, the benefit of the utilization of these pre-merger deferred tax assets is recognized as a reduction to goodwill instead of the income tax provision. Approximately $4.0 million of pre-merger deferred tax asset utilization reduced goodwill during the reporting period.
During 2004, NTELOS Inc. recognized income tax expense of $1.0 million. This was related to state minimum taxes.
We had approximately $235.1 million of available net operating losses at December 31, 2005, all of which will be subject to an annual utilization limit of $1.6 million. NTELOS Inc. generated approximately $84.9 million of net operating losses after its emergence from bankruptcy and prior to our May 2, 2005 merger. Annual utilization of these losses will be increased during the first five years following the merger for realized built-in gains estimated at $22.4 million each year. Due to the limited carry forward life of net operating losses and the amount of the annual utilization limitation, it is unlikely that we will be able to realize in excess of $43 million of the approximately $153.2 million of NTELOS Inc.s net operating losses existing prior to their emergence from bankruptcy. See Note 12 to our December 31, 2005 audited consolidated financial statements.
The following table sets forth selected unaudited consolidated quarterly statement of operations data for the four quarters in 2005 and 2006. To facilitate comparisons with results for other quarters, we have combined the results of NTELOS Inc. from April 1, 2005 to May 1, 2005 with our results from May 2, 2005 to June 30, 2005. We had no operating activities prior to the acquisition of NTELOS Inc. This unaudited information has been prepared on substantially the same basis as our consolidated financial statements appearing elsewhere in this report and includes all adjustments (consisting of normal recurring adjustments) we believe necessary for a fair statement of the unaudited consolidated quarterly data. The unaudited consolidated quarterly statement of operations data should be read together with the consolidated financial statements and related notes thereto included elsewhere in this report. The results for any quarter are not necessarily indicative of results for any future period, and you should not rely on them as such.
Liquidity and Capital Resources
For the years ended December 31, 2005 and 2006, we funded our working capital requirements and capital expenditures from net cash provided from operating activities and borrowings under the former NTELOS Inc. credit facilities or the NTELOS Inc. senior secured credit facilities, as applicable. We believe our cash from operations will continue to grow in the future as we continue to execute on our business strategy and increase our subscriber base, particularly in our wireless segment. In addition, the predictability of our cash flow is enhanced by our long-term Strategic Network Alliance with Sprint Nextel. See Business contained in Item 1, Part I of this annual report on Form 10-K for the year ended December 31, 2006.
As of December 31, 2006, we had $675.2 million in aggregate long term liabilities, consisting of $613.4 million in outstanding long-term debt ($626.5 million including the short-term element) and approximately $61.8 million in other long-term liabilities. On February 24, 2005, NTELOS Inc. borrowed $400 million under a senior secured first lien bank facility (the First Lien Term Loan) and $225 million under a senior secured second lien term loan facility (the Second Lien Term Loan). The proceeds of the NTELOS Inc. senior secured credit facilities were used to pay off the existing debt of NTELOS Inc., finance the tender offer of NTELOS Inc. and to pay fees and expenses incurred in connection with such transactions.
On June 1, 2006, NTELOS Inc. refinanced the Second Lien Term Loan by entering into the first lien Restated and Amended Credit Agreement (the Amended Credit Agreement), consisting of $395 million of the prior First Lien Term Loan and $235 million of new borrowings. The new borrowings were used to repay the Second Lien Term Loan of $225 million and to pay other costs associated with the borrowing, including a $2.3 million prepayment penalty on the Second Lien Term Loan. In connection with this refinancing, NTELOS Inc. also paid the Company a dividend of $16.0 million on June 6, 2006. The Amended Credit Agreement also includes a revolving credit facility of $35 million (the Revolving Credit Facility), none of which is outstanding
as of December 31, 2006. The Revolving Credit Facility is available for our working capital requirements and other general corporate purposes. Our blended interest rate on our long-term debt as of December 31, 2006 is 6.9%. The aggregate maturities of our long-term debt, excluding capital lease obligations, based on the contractual terms of the instruments are $12.5 million in 2007, $6.3 million per year in 2008 and 2009, $153.6 million in 2010 and $446.6 million in 2011.
On March 9, 2007, NTELOS Inc. amended its Amended Credit Agreement. The principal purpose of the amendment was to establish a restricted payment basket, initially set at $30.0 million, which can be used to make certain restricted payments, as defined under the Credit Agreement, including the ability to pay dividends, repurchase stock or advance funds to the Company. This restricted payment basket will be increased by $6.5 million per quarter commencing with the quarter ending March 31, 2007 and will be decreased by any actual restricted payments during the quarter. In addition, on an annual basis, the restricted payment basket will be increased by the amount, if any, by which 50% (or, if the leverage ratio, as defined, as of the most recently ended calendar year, was less than 3.25:1:00, 75%) of the excess cash flow, as defined, for the most recently ended fiscal year, exceeds $26.0 million. Under the amendment, mandatory debt repayment of 50% of the excess cash flow, as defined, for the most recently ended calendar year (beginning with the year ended December 31, 2007) must be made by March 31 of the following year, if the leverage ratio is above 3.25:1.00. NTELOS Inc. incurred an amendment fee and costs of approximately $1.0 million in connection with this amendment which will be amortized to interest expense over the remaining life of the Amended Credit Agreement. We are a holding company that does not operate any business of our own. As a result, we are dependent on cash dividends and distributions and other transfers from our subsidiaries to make dividend payments or repurchase our common stock. Amounts that can be made available to us to pay cash dividends or repurchase stock are restricted by the NTELOS Inc. Amended Credit Agreement.
Under the Amended Credit Agreement, NTELOS Inc. is also bound by certain financial covenants, specifically a maximum ratio of total debt outstanding to EBITDA and a minimum interest coverage ratio. Noncompliance with any one or more of the debt covenants may have an adverse effect on our financial condition or liquidity in the event such noncompliance cannot be cured or should we be unable to obtain a waiver from the lenders of the NTELOS Inc. senior secured credit facilities. As of December 31, 2006, we are in compliance with all of our debt covenants, and our ratios at December 31, 2006 would be in compliance with any future period financial covenant ratio requirement under the Amended Credit Agreement. Our ratios under the foregoing restrictive covenants as of December 31, 2006 are as follows:
On October 17, 2005, we issued $135 million in aggregate principal amount of Floating Rate Notes. On the same day, we paid approximately $125 million of the net proceeds from this offering as a dividend to the holders of our Class L common stock. The Floating Rate Notes were repaid in full on April 15, 2006 with approximately $143.9 million in proceeds from our February 13, 2006 IPO.
In addition to the long-term debt discussed above, we also enter into capital leases on vehicles used in our operations with lease terms of four to five years. At December 31, 2006, the net present value of these future minimum lease payments was $1.3 million.
During the year ended December 31, 2006, net cash provided by operating activities was approximately $97.0 million. We generated $112.3 million of cash from operations before taking into account changes in operating assets and liabilities. During this period, we recognized $119.5 million of depreciation, amortization and other non-cash charges (net), including $13.2 million in Class A common stock and stock options non-cash compensation charges. Additionally, we paid a $2.3 million prepayment penalty associated with the debt refinancing in June 2006 which was recorded as interest expense. Total net changes in operating assets and liabilities used $15.3 million. The principal changes in operating assets and liabilities from December 31, 2005 to
December 31, 2006 were as follows: accounts receivable increased by $0.7 million, or 1.9%, due to increased revenues partially offset by improved accounts receivable aging; inventories and supplies increased $2.1 million driven by a number of new handsets introduced late in 2006 and related bulk purchases with favorable pricing; other current assets increased $0.9 million largely related to increases in prepaid rents; accounts payable decreased by $4.9 million related to operating activities with a significantly higher amount of purchases occurring at the end of 2005 (paid for after year-end) as compared to 2006 year-end purchase activity; and other current liabilities decreased $2.3 million due primarily to a $1.1 million reduction in accrued compensation primarily related to a reduction in unpaid annual incentive compensation, $0.3 million payment of deferred compensation related to early retirement, and a $1.0 million reduction in certain tax reserves from favorable settlements. Retirement benefit payments for 2006 were approximately $7.0 million due primarily to the $6.3 million pension plan funding.
During the year ended December 31, 2005, net cash provided by operating activities was approximately $97.7 million. The primary sources of our net cash provided by operating activities included: approximately $0.6 million of net income, which is net of $97.1 million of depreciation, amortization and other non-cash charges (net). Therefore, cash generated from operations before taking into account changes in operating assets and liabilities was $97.7 million. This amount is net of $15.6 million in capital restructuring charges related to the tender offer and merger transactions. The total change in net operating assets and liabilities was less than a $0.1 million use of funds. The principal changes in operating assets and liabilities from December 31, 2004 to December 31, 2005 were as follows: accounts receivable increased by $8.6 million, or 29%, due primarily to a 17% increase in revenues for the relevant period prior to December 31, 2005 and December 31, 2004 and a slight decline in the accounts receivable aging; inventories and supplies decreased $0.2 million; other current assets increased $0.6 million; accounts payable increased by $6.3 million due primarily to higher expenditures late in 2005, paid for after year-end, as compared to the purchasing activity late in 2004; and, other current liabilities increased $5.8 million due to increases in advance billings and customer deposits associated with continued NTELOS-branded subscriber growth and the increase in NTELOS-branded service offerings that require a deposit and increases in accrued incentive compensation related to performance above plan. Retirement benefit payments during the year ended December 31, 2005 were approximately $9.7 million due primarily to accumulated benefit obligation payments under our non-qualified pension plan made in connection with the acquisition of NTELOS Inc. and increases in contributions to the pension plan.
Our cash flows used in investing activities for the year ended December 31, 2006 were approximately $83.8 million and include the following:
Our net cash flows used in investing activities for 2005 were approximately $85.0 million and include the following:
We currently expect capital expenditures for 2007 to be in the range of $77 million to $81 million (not including any discretionary capital expenditures for possible upgrades to our wireless network related to EVDO). We expect that our capital expenditures associated with our wireless business in 2007 will be in the range of $51 million to $53 million, of which approximately $20 million to $22 million is expected to be used for continued incremental network coverage expansion and enhancements within our coverage area, which we consider discretionary expansion projects, $19 million to provide additional capacity to support our projected growth in our NTELOS-branded subscribers and increased usage by existing subscribers and growth in voice and data usage under the Strategic Network Alliance, and the remaining $12 million is targeted to maintain and support our existing networks and other business needs. We expect that our capital expenditures associated with our wireline business in 2007 will be in the range of $20 million to $22 million, which is targeted to provide regular maintenance and support for our RLEC operations, to support the projected growth of our Competitive wireline voice and data offerings, including strategic fiber builds, and fiber deployment in the RLEC territory related to an infrastructure upgrade to offer, among other services, an enhanced broadband service offering which commenced in the fourth quarter of 2006 and the planned launch of a new video service offering in 2007. In addition, we expect to invest approximately $6 million in enhancements and upgrades to our information technology and corporate expenditures to enhance and maintain the back office support systems to support the continued growth and introduction of new service offerings and applications.
Net cash provided by financing activities for the year ended December 31, 2006 aggregated $2.8 million, which primarily represents the following:
Net cash used in financing activities for 2005 aggregated $15.8 million for NTELOS Inc., which primarily represents the following:
As noted above, the cash flows for the period ended December 31, 2005 are for NTELOS Inc. In addition, NTELOS Holdings Corp. invested $125.7 million for the purchase of NTELOS Inc. This was financed by the sale of $120.0 million of common stock and the issuance of $5.7 million in convertible notes. In addition to this, NTELOS Holdings Corp. received $133.7 million from the issuance of Floating Rate Notes which were used to pay a $125.0 million dividend to Class L common stockholders. Finally, the $5.7 million convertible notes were repaid with the proceeds received from agreed upon sale of certain assets from NTELOS Inc.
As of December 31, 2005 and December 31, 2006 we had approximately $28.1 million and $44.2 million, respectively, in cash and cash equivalents and working capital (current assets minus current liabilities) of approximately $7.4 million and $25.0 million, respectively. Of the cash and cash equivalents on hand on December 31, 2006, $41.0 million was held by NTELOS Inc. and its subsidiaries which is subject to usage restrictions pursuant to the Amended Credit Agreement.
We believe that our existing borrowing availability, our current cash balances and our cash flow from operations will be sufficient to satisfy our currently foreseeable working capital and capital expenditures for at least the next 24 months. This takes into account possible higher capital expenditure levels during this period than we have had in 2005 and 2006 as we continue to grow our business and evaluate additional growth opportunities, including potential discretionary upgrades to our 3G networks for higher speed data communications applications such as EVDO. If our growth opportunities result in currently unforeseeable capital expenditures during this period, we may seek additional financing in the future. However, as noted above, we have grown our cash balance during 2006 to $44.2 million at year end and we believe our cash from operations will continue to grow.
Contractual Obligations and Commercial Commitments
We have contractual obligations and commercial commitments that may affect our financial condition. The following table summarizes our significant contractual obligations and commercial commitments as of December 31, 2006:
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements or financing activities with special purpose entities.
Critical Accounting Policies and Estimates
The fundamental objective of financial reporting is to provide useful information that allows a reader to comprehend our business activities. To aid in that understanding, management has identified our critical accounting policies for discussion herein. These policies have the potential to have a more significant impact on our financial statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events which are continuous in nature.
Principles of Consolidation
We purchased 24.9% of NTELOS Inc. and its subsidiaries on February 24, 2005 and purchased the remaining 75.1% on May 2, 2005. We accounted for the results of operations for NTELOS Inc. from February 24, 2005 through May 1, 2005 using the equity method of accounting. For the period commencing on the May 2, 2005 merger date, we consolidated the financial statements of NTELOS Inc. The consolidated financial statements include the accounts of us, NTELOS Inc. and all of its wholly-owned subsidiaries and those limited liability corporations where NTELOS Inc., as managing member, exercises control. All significant intercompany accounts and transactions have been eliminated.
Revenue Recognition Policies
We recognize revenue when services are rendered or when products are delivered, installed and functional, as applicable. Certain services that we provide require payment in advance of service performance. In such cases, we record a service liability at the time of billing and subsequently recognize revenue over the service period. We are required to bill customers certain transactional taxes on service revenues. These transactional taxes are not included in reported revenues as they are recognized as liabilities at the time customers are billed.
With respect to our wireline and wireless businesses, we earn revenue by providing access to and usage of its networks. Local service and airtime revenues are recognized as services are provided. Wholesale revenues are earned by providing switched access and other switched and dedicated services, including wireless roamer management, to other carriers. Revenues for equipment sales are recognized at the point of sale. PCS handset equipment sold with service contracts are sold at prices below cost, based on the terms of service contract. We recognize the entire cost of the handsets at the time of sale, rather than deferring such costs over the service contract period.
We evaluate related transactions to determine whether they should be viewed as multiple deliverable arrangements which impacts revenue recognition. Multiple deliverable arrangements are presumed to be bundled transactions and the total consideration is measured and allocated to the separate units based on their relative fair value conditional on certain limitations. We have determined that sales of handsets with service contracts related to these sales generated from our retail stores are multiple deliverable arrangements. Accordingly, substantially all of the nonrefundable activation fee revenues (as well as the associated direct costs) are recognized at the time of the related wireless handset is sold. However, revenue and certain associated direct costs for activations at third party retail locations are deferred and amortized over the estimated period of the related service revenue as we are not a principal in the transaction to sell the handset. Nonrefundable activation fee revenue and certain associated direct costs for transactions in segments other than wireless are deferred as they are not associated with multiple deliverable arrangements. In all cases, the direct activation costs exceed the related activation revenues. When deferral is appropriate, we defer these direct activation costs up to but not in excess of the related deferred revenue.
We periodically make claims for recovery of access charges on certain minutes of use terminated by us on behalf of other carriers. We recognize revenue in the period that we are able to reliably estimate, and are assured of the collection of, these claims.
We sell our services to residential and commercial end-users and to other communication carriers primarily in Virginia and West Virginia. The carrying amount of our trade accounts receivable approximates fair value. We have credit and collection policies to ensure collection of trade receivables and require deposits on certain of our sales. We maintain an allowance for doubtful accounts, which management believes adequately covers all anticipated losses with respect to trade receivables. Actual credit losses could differ from such estimates.
Inventories and Supplies
Our inventories and supplies consist primarily of items held for resale such as PCS handsets, pagers, wireline business phones and accessories. We value our inventory at the lower of cost or market. Inventory cost is computed on a currently adjusted standard cost basis (which approximates actual cost on a first-in, first-out basis). Market value is determined by reviewing current replacement cost, marketability and obsolescence.
Long-lived Asset Recovery
Long-lived assets include property and equipment, radio spectrum licenses, long-term deferred charges and intangible assets to be held and used. Long-lived assets, excluding intangible assets with indefinite useful lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed pursuant to Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, or SFAS No. 144. The criteria for determining impairment for such long-lived assets to be held and used is determined by comparing the carrying value of these long-lived assets to managements best estimate of future undiscounted cash flows expected to result from the use of the assets.
Depreciation of property, plant and equipment is calculated on a straight-line basis over the estimated useful lives of the assets. Buildings are depreciated over a 50-year life and leasehold improvements, which are categorized with land and building, are depreciated over the shorter of the estimated useful lives or the remaining lease term. Network plant and equipment are depreciated over various lives from 4 to 40 years, with an average life of approximately 10 years. Furniture, fixtures and other equipment are depreciated over various lives from 5 to 18 years.
Because we applied purchase accounting on the May 2, 2005 merger date, property, plant and equipment and other long-lived assets were adjusted to fair market value on that date and accumulated depreciation and amortization was reset to zero.
We believe that no impairment indicators exist as of December 31, 2006, which would require us to test for impairment in accordance with SFAS No. 144. In the event that there are changes in the planned use of our long-lived assets or our expected future undiscounted cash flows are reduced significantly, our assessment of our ability to recover the carrying value of these assets under SFAS No. 144 could change.
Goodwill and Indefinite-Lived Intangibles
Goodwill, franchise rights and radio spectrum licenses are considered indefinite-lived intangible assets. Indefinite-lived intangible assets are not subject to amortization but are instead tested for impairment annually or more frequently if an event indicates that the asset might be impaired. We assess the recoverability of indefinite-lived assets whenever adverse events or changes in circumstances indicate that impairment may have occurred and annually on October 1. Based on the results of this testing, goodwill and indefinite-lived intangible assets were determined to be unimpaired at October 1, 2006. The Company reviewed the results of this testing as of December 31, 2006 and concluded that no material changes would have been made to the underlying assumptions that would have resulted in materially different test results from those performed as of October 1, 2006.
Accounting For Asset Retirement Obligations
Statement of Financial Accounting Standard No. 143, Accounting for Asset Retirement Obligations, or SFAS No. 143, establishes accounting standards for recognition and measurement of a liability for an asset retirement obligation and the associated asset retirement cost. The fair value of a liability for an asset retirement obligation is to be recognized in the period in which it is incurred if a reasonable estimate can be made. The associated retirement costs are capitalized and included as part of the carrying value of the long-lived asset and amortized over the useful life of the asset. Accretion expense related to the asset retirement obligations for the period January 14, 2005 (inception) through December 31, 2005 was $0.5 million and for the year ended December 31, 2006 was $0.8 million.
We enter into long-term leasing arrangements primarily for cell sites and retail store locations in our wireless segment. Additionally, in our wireline operations, we enter into various facility co-location agreements and are subject to locality ordinances. In both cases, we construct assets at these locations and, in accordance with the terms of many of these agreements, we are obligated to restore the premises to their original condition at the conclusion of the agreements, generally at the demand of the other party to these agreements. We recognized the fair value of a liability for an asset retirement obligation and capitalized that cost as part of the cost basis of the related asset, depreciating it over the useful life of the related asset.
Included in certain of the franchise ordinances under which the rural local exchange carriers (RLECs) operate are clauses that require the removal of the RLECs equipment at the termination of the franchise agreement. The Company has not recognized an ARO for these liabilities as the removal of the equipment is not estimable due to an indeterminable end date and the fact that the equipment is part of the public switched telephone network and it is not reasonable to assume the jurisdictions would require its removal.
Pension Benefits and Retirement Benefits Other Than Pensions
NTELOS Inc. sponsors a non-contributory defined benefit pension plan (Pension Plan) covering all employees who meet eligibility requirements and were employed by NTELOS Inc. prior to October 1, 2003. The Pension Plan was closed to NTELOS Inc. employees employed on or after October 1, 2003. Pension benefits vest after five years of service and are based on years of service and average final compensation subject to certain reductions if the employee retires before reaching age 65 and elects to receive the benefit prior to age 65. Section 412 of the Internal Revenue Code and ERISA Section 302 establishes minimum funding requirements for defined benefit pension plans, historically requiring that the funded current liability percentage must be at least 90% of the current liability in order to prevent noticing to members of an underfunded plan. Our policy is to make contributions to stay at or above this threshold and is intended to provide not only for benefits based on service to date, but also for those expected to be earned in the future. Notice and funding requirements have changed for the 2006 plan year and beyond. The Pension Protection Act of 2006 repealed participant notice requirements for plan years beginning after December 31, 2006, but notice of funding will be required irrespective of funding levels by 2009. This act contains a number of provisions designed to get plans to a fully funded status over a seven year transition period beginning in 2008.
The Company also sponsors a contributory defined contribution plan under Internal Revenue Code Section 401(k) for substantially all employees. The Companys policy is to match 60% of each participants annual contribution for contributions up to 6% of each participants annual compensation. Company contributions to this plan vest after three years of service. Also, the Company has nonqualified pension plans which are accounted for in a manner similar to its Pension Plan.
NTELOS Inc. provides certain health care and life benefits for retired employees that meet eligibility requirements. Employees hired after April 1993 are not eligible for these benefits. The Companys share of the estimated costs of benefits that will be paid after retirement is generally being accrued by charges to expense over the eligible employees service periods to the dates they are fully eligible for benefits.
In September 2006, the FASB issued FASB Statement No. 158 (SFAS No. 158), Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106 and 132(R). SFAS No. 158 requires an employer to recognize in its statement of financial position the overfunded or underfunded status of a defined benefit postretirement plan measured as the difference between the fair value of plan assets and the benefit obligation. Related to this, employers must recognize as a component of other comprehensive income, net of tax, the actuarial gains and losses and the prior service costs and credits. The Company has adopted the provisions of SFAS No. 158 for fiscal year 2006. The adoption of this standard resulted in a net reduction to retirement benefits of $0.8 million, the amount of the previously unrecognized gain, offset by a $0.5 million credit to other comprehensive income, net of $0.3 million of the deferred tax liability.
Deferred income taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Accounting for Share-Based Payments
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS No. 123R. SFAS No. 123R requires the recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements and measurement based on the grant-date fair value of the award. It requires the cost to be recognized over the period during which an employee is required to provide
service in exchange for the award. Additionally, compensation expense will be recognized over the remaining employee service period for the outstanding portion of any awards for which compensation expense had not been previously recognized or disclosed under SFAS No. 123, Accounting for Stock-Based Compensation, or SFAS No. 123. SFAS No. 123R replaces SFAS No. 123 and supersedes Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, or APB opinion No. 25, and its related interpretations. We were required to adopt the provisions of SFAS No. 123R effective January 1, 2006.
Prior to our adoption of SFAS No. 123R, we accounted for stock-based employee compensation plans under APB Opinion No. 25 and related interpretations and followed the disclosure provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure.
Under the provisions of SFAS No. 123R, our Class A shares and options were designated as liability based awards under the fair value approach. Under this approach, we determined the fair value of these instruments on January 1, 2006. Prior to this, we recorded non-cash compensation based on the instruments intrinsic value as of the financial statement date, recording an adjustment in each period in order to reflect the cumulative amount to be recognized at that date considering the life to date service period earned and the current intrinsic value of the instrument over a graded vesting schedule. This variable accounting and non-cash compensation recognition was required due to the classification of these instruments as liabilities. The difference in the cumulative non-cash compensation calculated at January 1, 2006 as compared to the non-cash compensation recorded under the rules in effect prior to January 1, 2006 was not material.
On the February 8, 2006 IPO date, the Class A shares and Class L shares were converted into Class B shares and the Class A options were converted into common stock options. In each case, the instruments went from a liability based classification to an equity based classification as a result of the modification to the awards. The fair value of the unvested Class A shares on February 8, 2006 prior to conversion was $11.31 per share. Immediately after conversion, the Class B shares fair value was $12.00 per share. The difference in fair value before and after the conversion (approximately $0.3 million) is being recognized in non-cash compensation over the remaining vesting period. Future compensation became fixed based on the post conversion fair value of both the Class B shares and common stock options. We have elected to recognize this compensation over the future service period ratably.
Non-cash compensation charges were $13.2 million for the year ended December 31, 2006. Non-cash compensation for the years 2007 through 2010 will be approximately $3.6 million, $1.4 million, $0.3 million and less than $0.1 million, respectively, related to capital stock and stock options outstanding as of December 31, 2006.
Significant Factors, Assumptions and Methodologies Used in Determining Fair Value
The primary factor in determining the fair value of the initial sale of Class A common stock and the exercise price of the Class A common stock options granted was our enterprise value as of the closing of our acquisition of NTELOS Inc. in May 2005. This value was derived after a competitive bidding process. We valued all of our assets and liabilities utilizing a combination of methods such as a market approach, cost approach and income approach. These valuations were prepared based on a number of projections, assumptions, risk assessments, industry and economic tables and other factors. Our total equity value was determined by subtracting the long-term debt, net of cash, from our enterprise value. We then determined the residual equity value that is apportioned to the Class L common stock and Class A common stock based on their respective ownership percentages, by subtracting from the total equity value the liquidation preference associated with the Class L common stock. The per share value of the Class A common stock was then derived by dividing the residual equity apportioned to the Class A common stock by the number of shares of Class A common stock outstanding.
The per share values used for the September and October 2005 equity transactions were determined based on the formula used to value our acquisition of NTELOS Inc. However, because the September 2005 stock
issuance and option grant were during the third quarter 2005, they were based on our operating results for the June 30, 2005 trailing year. Therefore, the increase in valuation of the Class A common stock in September 2005 compared to the valuation when we acquired NTELOS Inc. in May 2005 was due in part to an increase in our operating performance during such period, which exceeded our performance goals. The October 2005 option grant was valued based on the September valuation as adjusted to estimate the additional increase expected in the trailing year operating performance through September 30, 2005.
In conjunction with applying the foregoing valuation methodology and analysis, we also considered numerous objective and subjective factors to determine the value of shares of Class A common stock on each grant date, including the factors described below:
This valuation methodology was deemed appropriate based on the fact that there was no significant change in operations or material event that would warrant a different valuation multiple from that which was used in our acquisition of NTELOS Inc. which closed in the prior quarter.
For purposes of recording compensation expense related to our Class A common stock and options, we determined the pre-split fair value to be $1.53, $9.20 and $13.66 per share as of June 30, 2005, September 30, 2005 and December 31, 2005, respectively. This resulted in non-cash compensation expense of approximately $3.7 million for the period May 2, 2005 through December 31, 2005. We performed these valuations retrospectively. While these values are consistent with the transaction date valuations discussed above, the reporting date valuation method concentrated on the income approach. Various assumptions, including discount rates, were adjusted at each period to account for the changes in our operating plan, changes in the market and the progress of our initial public offering as we engaged underwriters during the third quarter and subsequently filed the registration statement covering such initial public offering. We believe this valuation approach is consistent with valuation methodologies applied to other similar companies for financial reporting purposes pursuing an initial public offering.
Significant factors contributing to the difference between fair value as of the date of the sale of our Class A common stock and each of our grants of options to purchase Class A common stock and the initial public offering price include the following: our improved operating results, which results in a disproportionately higher increase in the value of our common equity; our successful completion of our Floating Rate Senior Notes offering in October 2005, which offers an indication of the markets demand for our securities; the fact that there would be a public market for our common equity upon consummation of this proposed initial public offering; improved market valuations of comparable companies in our markets since the September and October option grants; and significant recent merger activity in the wireless industry.
Recent Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48 (FIN No. 48), Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement 109. FIN No. 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to
be taken on a tax return, including a decision whether to file or not to file income tax returns in a particular jurisdiction. Generally, FIN No. 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as more-likely-than-not to be sustained by the taxing authority. The Company currently recognizes the benefits of tax positions that are considered to have a probable likelihood of being sustained by the taxing authority. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. If there are changes in net assets as a result of application of FIN No. 48, these will be accounted for as an adjustment to retained earnings. The Company will adopt the provisions of FIN No. 48 in its first fiscal quarter of 2007. We are currently evaluating certain deductions on prior returns to determine if they meet the new reporting threshold. Additionally, we are still evaluating the effects of certain NOL limitations. We anticipate that any required adjustments for NOLs would be reflected as an adjustment to goodwill. We do not believe that the adoption of FIN No. 48 will have an adverse effect on the financial position, results of operations or cash flows of the Company.
In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurement (SFAS No. 157). SFAS No. 157 defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measures. SFAS No. 157 is effective for fair value measures already required or permitted by other standards for fiscal years beginning after November 15, 2007. The Company is required to adopt SFAS No. 157 beginning on January 1, 2008. SFAS No. 157 is required to be applied prospectively, except for certain financial instruments. Any transition adjustment will be recognized as an adjustment to opening retained earnings in the year of adoption. The Company is currently evaluating the impact of adopting SFAS No. 157 on its results of operations and financial position.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and LiabilitiesIncluding an amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure certain financial assets and liabilities at fair value (the fair value option). Unrealized gains and losses, arising subsequent to adoption, are reported in earnings. The Company is required to adopt SFAS 159 in the first quarter of 2008. The Company is currently evaluating the impact of adopting SFAS No. 159 on its results of operations and financial position.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to market risks primarily related to interest rates. As of December 31, 2006, $625.2 million was outstanding under the First Lien Term Loan. As of December 31, 2006, NTELOS Inc. achieved a leverage ratio of 3.5:1.0 and an interest coverage ratio of 3.6:1.0, both of which are favorable to any future covenant requirement. This facility bears interest at 2.25% above the Eurodollar rate or 1.25% above the Federal Funds rate. We have other fixed rate, long-term debt totaling $1.3 million as of December 31, 2006.
We have a $312.5 million interest rate swap agreement which is used to manage our exposure to interest rate market risks and to comply with the terms and conditions of the First Lien Term Loan. This swap agreement helps minimize our exposure to interest rate movements by effectively converting a portion of our long-term debt from variable rate debt to fixed rate debt. Our fixed rate payments due under the swap agreement are calculated at a per annum rate of 4.1066%. Our swap counterpartys variable rate payments are based on three month U.S. Dollar LIBOR, which was 2.64% for the initial calculation period and 5.36% as of December 31, 2006. Interest rate differentials paid or received under the swap agreement are recognized for GAAP purposes over the three month maturity periods as adjustments to our interest expense. We have interest rate risk on borrowings under the First Lien Term Loan in excess of the $312.5 million covered by the swap agreement and we are exposed to loss if the counterparty to the swap agreement defaults.
At December 31, 2006, we had a $3.9 million exposure to credit loss on interest rate swaps as the swap agreement had a fair value of $3.9 million above its face value. At December 31, 2006, our senior bank debt of $625.2 million is $312.7 million over the swap agreement.
At December 31, 2006, our financial assets included cash and cash equivalents of $44.2 million. Our primary investment at December 31, 2005 was a $2.8 million investment in RTB stock. Redemption certificates were filed during the first quarter of 2006 which resulted in a $1.7 million gain. In April 2006, $4.5 million of proceeds were received. Other securities and investments totaled $0.3 million at December 31, 2006.
The following sensitivity analysis indicates the impact at December 31, 2006, on the fair value of certain financial instruments, which are potentially subject to material market risks, assuming a ten percent increase and a ten percent decrease in the levels of our interest rates or, in the case of the swap agreement, a one percent increase and a one percent decrease in the interest rates:
Item 8. Financial Statements and Supplementary Data.
NTELOS HOLDINGS CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
NTELOS Holdings Corp.:
We have audited the accompanying consolidated balance sheets of NTELOS Holdings Corp. (the Company) as of December 31, 2006 and 2005 and the related consolidated statements of operations, cash flows, and stockholders equity for the year ended December 31, 2006 and the period January 14, 2005 (inception) to December 31, 2005. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NTELOS Holdings Corp. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for the year ended December 31, 2006 and the period January 14, 2005 (inception) to December 31, 2005, in conformity with U.S. generally accepted accounting principles.
As discussed in note 2 to the consolidated financial statements, effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, and on December 31, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans.
/s/ KPMG LLP
March 12, 2007
Consolidated Balance Sheets
See accompanying Notes to Consolidated Financial Statements
NTELOS Holdings Corp.
Consolidated Balance Sheets
See accompanying Notes to Consolidated Financial Statements.
Consolidated Statements of Operations