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NTELOS Holdings 10-K 2009 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
(Mark One)
For the fiscal year ended December 31, 2008 or
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) (540) 946-3500 (Registrant’s 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: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes ¨ 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 registrant’s 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, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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, 2008 was $777,804,851 (based on the closing price for shares of the registrant’s 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 beneficially owning more than 10% of the outstanding common stock are affiliates. This assumption shall not be deemed conclusive for any other purpose. There were 42,185,308 shares of the registrant’s common stock outstanding as of the close of business on February 23, 2009. DOCUMENTS INCORORATED BY REFERENCE
Table of Contents2008 ANNUAL REPORT ON FORM 10-K INDEX
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Table of ContentsPART I FORWARD-LOOKING STATEMENTS 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 “Management’s 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.
Overview 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, an indirect wholly owned subsidiary of Sprint Nextel Corporation (hereinafter collectively referred to as “Sprint Nextel”). 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 13.6% compound annual growth rate from 2006 to 2008 and accounted for 77% of our total revenues in 2008. We hold digital PCS licenses to operate in 29 basic trading areas with a licensed population of approximately 8.9 million, and we have deployed a network using code division multiple access technology, or CDMA, in 21 basic trading areas which currently cover a total population of approximately 5.5 million potential subscribers. As of December 31, 2008, our wireless retail business had approximately 435,000 NTELOS-branded subscribers, representing a 7.9% penetration of our total covered population. We made significant investments in our wireless network, adding 160 new wireless cell sites in 2008 and increasing our total cell sites to 1,183 at the end of 2008. These investments and other initiatives, including the increased take rate of national rate plans and enhanced data service offerings, contributed to a 6.9% increase in subscribers during 2008. We amended our agreement with Sprint Spectrum L.P. during 2007 to act as their exclusive wholesale provider of network services through July 31, 2015. Under this arrangement, which we refer to as the Strategic Network Alliance, we are the exclusive PCS service provider in our western Virginia and West Virginia service area for all Sprint Nextel CDMA wireless customers (see “Business – Wireless Business – Our Strategic Network Alliance with Sprint Nextel”). Under the terms of the Agreement, we are committed to upgrade our wireless network to Evolution-Data Optimized Revision A (“EV-DO”) in the territory covered by the Agreement, and we satisfied this upgrade commitment in the fourth quarter of 2008. As of December 31, 2008, 833 (or 70%) of our total cell sites have been upgraded to EV-DO. We expect our aggregate incremental capital expenditures for this upgrade to EV-DO in all of our markets to be approximately $65 million, of which $25 million was spent in 2007, $37 million was spent in 2008 and the remainder of approximately $3 million is expected to be spent in 2009. For the year ended December 31, 2008, we realized wholesale revenues of $111.1 million, primarily related to the Strategic Network Alliance, representing an increase of 15.8% over the same period in 2007. Founded in 1897, our wireline incumbent local exchange carrier business is conducted through two subsidiaries that qualify as rural local exchange carriers (“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, 2008, we operated approximately 41,100 RLEC telephone access lines. We also own a 2,200 route-mile regional fiber
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Table of Contentsoptic network and participate in partnerships that directly connect 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, 2008, we served customers with approximately 49,900 CLEC access line connections. We also offer DSL services in over 97% of our RLEC service area and as of December 31, 2008 we operated approximately 22,500 broadband access connections in our markets, representing an increase of 11.6% in 2008. The wireline Competitive segment strategic products (local phone services, broadband voice and data services and high-capacity network access and transport services) experienced revenue growth of 12.8% over 2007 which was partially offset by declines in RLEC revenues and other revenues from the competitive segment. In 2008 and 2007, our wireline operating income margins were 33.3% and 31.5%, respectively. Commencing in late 2007, we have been introducing NTELOS video in selected neighborhoods within our two RLEC service areas. The product provides an alternative to cable and satellite TV, offering video entertainment services with more than 250 all-digital channels and 43 high-definition channels. It is delivered via fiber to the home which allows us to deliver video, local and long distance telephone services, plus Internet access at speeds up to 20 megabits per second. Revenues from this product are included in the Competitive wireline segment. 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. Wireless Business Overview Our wireless business operates a 100% CDMA digital PCS network in Virginia, West Virginia, and portions of Kentucky, Maryland, Ohio and North Carolina with a total covered population, or POPs, of 5.5 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, 2008, we served approximately 435,000 NTELOS-branded retail subscribers. Our wireless business in Virginia covers Richmond, Hampton Roads/Norfolk, Roanoke, Lynchburg, Charlottesville, Staunton, Harrisonburg, Covington, Clifton Forge, Winchester, Danville, Tazewell, and Martinsville, as well as our headquarters in Waynesboro. The coverage of our wireless business also includes Charleston, Huntington, Parkersburg, Morgantown, Clarksburg, Fairmont, Beckley, Bluefield, and Lewisburg in West Virginia, Ashland, Kentucky, Portsmouth, Ohio and the Outer Banks of North Carolina. Spectrum Holdings PCS We hold licenses for all of the 1900 MHz PCS spectrum used in our network. At December 31, 2008, we operated our CDMA network in 21 basic trading areas with licensed POPs of 7.7 million with an average spectrum depth of 23 MHz. We also hold licenses in eight 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, 2008
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AWS 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 presents a breakdown of our AWS spectrum position at December 31, 2008.
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Other Spectrum 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. With the exception of our BRS licenses, other spectrum is non-operational. Wireless Operations Wireless Retail Business Overview We offer wireless voice and data services to retail customers throughout our service area under the NTELOS brand name. Our service plans target the local value segment, focusing on customers who will use their wireless phone primarily in their home market, but also target customers with limited out of market needs through our national plans. We offer these customers value by providing unlimited and large numbers of minutes, data features and premier customer service across our network. We offer national voice and data plans for those customers who wish to use their phones on a nationwide footprint. 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. In 2008, Postpay represented 49% of gross additions and, as of December 31, 2008, 71% of total subscribers. We plan to continue to emphasize marketing to Postpay customers due to their better lifetime value, higher ARPU and lower churn than traditional Prepay customers.
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Table of ContentsService Offerings. The chart below briefly describes the plans and provides a breakdown of subscribers as of December 31, 2008:
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Table of ContentsSales, Marketing and Customer Care. We target value-conscious customers by advertising the “best value” available in a wireless provider. We primarily target persons between the ages of 21 and 54, including individuals and families. 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 national corporations, and our national plans take advantage of our access to the national Sprint Nextel wireless network under the Strategic Network Alliance. We primarily promote our Postpay products in our marketing communications. Prepay plans are promoted to target segments where a majority of the population would not want or qualify for Postpay service. Advertising is focused on driving traffic to the company’s retail locations, inside sales representatives and our website. 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, 2008, 78.0% of gross additions were acquired through direct channels and, at December 31, 2008, we had 84 retail point of sale locations. Our direct distribution is supplemented by 115 regional agents with a total of 285 locations. Our wireless customer care call centers are located in Waynesboro, Covington and Daleville, Virginia. We operate a single virtual call center, minimizing headcount and supporting 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 We provide digital PCS services on a wholesale basis to other PCS providers, most notably 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. Effective as of July 1, 2007, we amended and restated this network agreement with Sprint Spectrum L.P. The amended and restated network agreement, which we refer to as the Strategic Network Alliance, superseded and replaced the 2004 network agreement. Under the Strategic Network Alliance, we will continue as the exclusive provider of PCS services through July 31, 2015, a four year extension of the network agreement, and then subject to automatic three-year extensions unless the notice provisions are exercised, to all Sprint Nextel wireless customers in its western Virginia and West Virginia service area, including the following markets, which we refer to as the “Market”: Charlottesville, Danville, Lynchburg, Martinsville, Roanoke and Staunton-Waynesboro, Virginia; Beckley, Bluefield, Charleston, Clarksburg/Elkins, Fairmont, Huntington and Morgantown, West Virginia; and Ashland, Kentucky. In addition to PCS services, the Strategic Network Alliance gives us exclusivity for all other CDMA services in the Market. We will also be the exclusive provider of roaming/travel services in the Market to all Sprint Nextel PCS customers. Subject to certain limited exceptions, we agreed under the Strategic Network Alliance to achieve EV-DO deployment in 95% of the Market by January 31, 2010 and 98% of the Market by January 31, 2011. We met these build-out requirements during the fourth quarter of 2008, achieving EV-DO build-out of 98% of the network in the Market. The amended and restated network agreement specifies a series of rates for various types of services. The voice rate pricing under the amended and restated network agreement is comparable to the rates in the 2004 network agreement, but provides for greater volume discounts in the future to provide incentives for the migration of additional traffic onto the network. Generally, the data rate pricing is lower under the amended and restated network agreement compared to the rates agreed to in the 2004 network agreement in recognition of the significant growth experience in data usage and anticipated growth from the introduction of higher speed data services as a result of the network upgrade and to also provide incentives for the migration of additional traffic onto the network. Specifically, there are separate rate structures for each of the PCS services to be provided as follows:
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The Strategic Network Alliance also permits our NTELOS-branded customers to access Sprint Nextel’s national wireless network at reciprocal rates as the Sprint Nextel travel rates. In addition, Sprint Nextel will pay us the greater of (i) $8.0 million per calendar month (or $9.0 million per calendar month in the calendar month after we achieve 98% completion of EV-DO deployment in the Market) or (ii) any and all monthly usage charges associated with the use of the PCS services by Sprint Nextel customers. In October 2008, we achieved 98% EV-DO deployment in the Market. Our revenue based on use of services exceeded the $9.0 million minimum during the fourth quarter and will likely continue to exceed minimum through June 2009. However, we anticipate the first travel data rate reset which will occur effective July 1, 2009 will cause the revenue to decline to the $9.0 million minimum for at least the remainder of 2009. The amended and restated network 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 retail customers in similar rural markets. Except for the EV-DO deployment described above, we are not required under the Strategic Network Alliance to make any future investment in any subsequent high speed data transfer technology or any other significant network upgrade requested by Sprint Nextel to support its customers unless mutually agreed upon. The amended and restated network agreement prohibits Sprint Nextel from directly or indirectly commencing construction of, contracting for or launching its own wireless communications network that provides PCS services provided by us in the Market until 18 months prior to the termination of the amended and restated network agreement or renewals thereof. 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 Sprint Nextel’s network does not offer coverage, if Sprint Nextel requests that we provide coverage and we decline. Wireless Network Network Technology. We have both 3G EV-DO Rev A and 3G 1xRTT CDMA digital PCS technology deployed in each of our geographic regions. In connection with the EV-DO network upgrade pursuant to the terms of the Amended and Restated Resale Agreement with Sprint Spectrum L.P. and based on our plan to upgrade substantially all of our current service coverage areas outside our wholesale territory, we entered into a three-year agreement with Alcatel-Lucent to purchase $88.2 million of network equipment ($69.6 million of which was spent by December 31, 2008 and the remaining $18.6 million of which will be spent in 2009). We expect to spend an incremental $65 million related to this technology upgrade, of which $25 million was spent in 2007, $37 million was spent in 2008 and the remainder of approximately $3 million is expected to be spent in 2009.
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Table of ContentsSwitching 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 Mi-Life Application Server 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. We have added a new Alcatel-Lucent SMSC platform to eventually replace our existing Airwide Solutions SMSC due to the growth of text messaging and content related services for text messaging. Cell Sites. As of December 31, 2008, we had 1,183 cell sites in operation, of which 26 were repeaters. We own 102 of these cell sites and lease the remaining 1,081, or 91%. Of our total cell sites, 833 are EV-DO capable and the remaining 350 are 1xRTT data capable. Of the leased cell sites, 483, or 45%, are installed on facilities owned by Crown Communications and American Tower. We entered into master lease agreements with Crown
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Table of ContentsCommunications 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. Network Performance. We currently process approximately 69 million calls per week and demonstrate strong network operational performance metrics. For the year ended December 31, 2008, network performance has averaged less than 0.82% daily dropped calls and less than 0.11% bouncing busy hour blocked calls. Average cell site availability as of December 31, 2008 exceeds 99.76%. We currently exceed Sprint Nextel’s network performance standards, as established in the agreement, in the regions underlying the Strategic Network Alliance. Wireline Business Overview 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 Competitive provider, we market service to 25 areas in Virginia and West Virginia. Additionally, we offer both dial-up internet and high-speed broadband services in Virginia, West Virginia and Tennessee. As of December 31, 2008, we had approximately 129,400 access lines and data connections. Our wireline business is supported by an extensive 2,200 route-mile fiber optic network. 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. Wireline Operations RLEC. We provide RLEC services to business and residential customers in three rural Virginia areas. We have owned and operated a 111-year-old telephone company in western Virginia since its inception in 1897. Additionally, we acquired a 108-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 was the basis for our Competitive broadband business that currently serves 25 areas in Virginia and West Virginia. We market exclusively to business customers. As of December 31, 2008, we had approximately 49,900 CLEC lines in service, virtually all of which were business lines. The Competitive 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 Competitive 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 Competitive 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 Competitive business model. Through our wholesale carriers’ carrier network, we offer other carriers access to our 2,200 route-mile fiber network which provides connectivity to major retail cities. We sell backhaul services to major wireline and wireless carriers including connectivity to cell sites located near our fiber network in our Competitive and RLEC markets. 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.
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Table of ContentsWe launched our internet business in Virginia in 1995. Presently, we provide internet services in Virginia, West Virginia and Tennessee. As of December 31, 2008, we had approximately 22,500 broadband access connections, including DSL, dedicated internet access, broadband over fiber, and Metro Ethernet. We also finished the year with over 97% DSL capability in our RLEC markets. In the third quarter of 2007, we began to offer IPTV video services within our RLEC market. At December 31, 2008, we had over 1,000 video customers and passed approximately 4,900 households with fiber optics. In May of this year we began offering video service outside our RLEC market in a mixed-use development in Lynchburg, VA. 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:
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Table of ContentsSales, 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-per-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. 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. We use an inside sales group to handle residential and small business voice, broadband and IPTV sales. We maintain a wireline retail presence in Waynesboro, Daleville, and Covington, Virginia, to market our video and data services, and allow walk-in payments for our RLEC customers. Our wireline customer care call centers are located in Waynesboro and Daleville, Virginia. The call center operation is supported by an integrated systems infrastructure and automated linkages to our billing, operations, and engineering systems. We provide customer care and operations representatives with incentives to up-sell additional products and features and retain current customers that may disconnect services. 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 between us and two unaffiliated communications companies that have interconnected our networks to form a non-switched, 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 and west as far as Ashland, KY. Plant and Equipment Our wireline network includes two Alcatel-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 and Competitive segments and portions of our wireless and other carriers’ traffic. Another Alcatel-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 two more supporting our Competitive areas. VITAL, a company for which we serve as the managing partner, acts as a regional node on VeriSign’s nationwide SS7 network using a pair of Tekelec signal transfer points located on our premises. We use Alcatel-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 Pannaway equipment. Our centralized network operations center monitors wireline, wireless and data networks on a continuous basis using a Harris network management system. We provide 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. We have also deployed a Tandberg Head-End and utilize Microsoft’s Mediaroom software to deliver IPTV-based video services. Competition 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. Wireless We compete in our territory with digital service providers. Several wireless carriers compete in portions of our market areas, including Sprint Nextel and its affiliates, Verizon Wireless, Alltel, AT&T Wireless, T Mobile and U.S. Cellular, and affiliates of some of these companies. These competitors have financial resources and customer bases greater than ours. Many of them have more established infrastructures, marketing programs and brand recognition. 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.
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Table of ContentsWireline Several factors have resulted in increased competition in the landline telephone market, including:
As the RLEC for Waynesboro, Clifton Forge, Covington and portions of Botetourt and Augusta Counties, Virginia, we are subject to competition, today from wireless carriers and cable companies. A portion of the residential customers moving into our service area do not purchase landline phone service. Comcast launched voice service in late May of 2008 in our Waynesboro and Augusta County market. We expect to encounter additional voice competition from Comcast in our Botetourt County RLEC market and from Rapid Communications, now owned by Shenandoah Telecommunications Company, in our Alleghany County RLEC market in 2009. 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). 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. 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, Fibernet, KDL, PAETEC 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. Employees As of December 31, 2008, we employed 1,398 full-time and 56 part-time persons. Of these employees, 72 are covered by a collective bargaining agreement for a portion of our wireline operation. This agreement expires June 30, 2011. We believe that we have good relations with our employees. In May 2008, we had 22 wireline employees accept an early retirement offer with retirement dates through July 1, 2008.
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Table of ContentsRegulation 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. Regulation Overview Our communications services are subject to varying degrees of federal, state and local regulation. Under the Communications Act, as amended by the Telecommunications Act of 1996, the Federal Communications Commission, or 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. 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. The Federal Aviation Administration, or FAA, regulates the location, lighting and construction of antenna structures. For many 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 certain internet services, including VoIP services, is evolving and still uncertain. Our wireless services are generally classified as commercial mobile radio services, 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. 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, 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 FCC’s 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 nineteen of these licenses between 2005 and 2007. Our remaining six PCS licenses must be renewed in mid-2009. Under existing law, no more than 20% of an FCC PCS licensee’s 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 entity’s capital stock may be owned or voted by non-U.S. citizens or their representatives, by a
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Table of Contentsforeign 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 build-out deadlines and geographic coverage requirements within five and/or ten years after the license grant date. Under the FCC’s 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 FCC’s 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 provider’s 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 FCC’s 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. In the course of such review, we further note that the FCC engages in a case-by-case competitive review of transactions that involve the consolidation of spectrum licenses. AWS Licenses. In 2006, we 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 our PCS licenses, although our AWS licenses have a longer, 15 year, term and are not subject to any construction requirements other than the requirement that we be providing substantial service at renewal. Like other auctioned AWS licenses, the licenses acquired by us 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 us if our AWS deployments would interfere, and we may incur cost-sharing obligations even if we deploy 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 caller’s 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. On September 11, 2007, the FCC adopted an order mandating that wireless E911 location accuracy be measured on the public safety answering point (PSAP) level, but deferred effectiveness of the mandate for five years while requiring interim milestones. The interim milestones cover increasingly smaller geographic areas. The Rural Cellular Association and T-Mobile appealed this FCC Order. On March 25, 2008, the United States Court of Appeals for the District of Columbia Circuit (Court) stayed the Location Accuracy Order. On July 31, 2008, the FCC has asked the U.S. Court of Appeals for the District of Columbia to vacate and remand the order to the FCC and, on September 17, 2008, the court granted the FCC’s request. On September 22, 2008, the FCC sought comments on a new proposal for E911 accuracy requirements for both handset-based and network-based technologies to achieve E911 accuracy compliance at the county-level. That proposal was filed by the Association of Public-Safety Communications Officials and the National Emergency Number Association, Verizon Wireless, Sprint Nextel Corporation, and AT&T.
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Table of ContentsFCC 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. 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 carrier’s network. As a CMRS provider, we are required to pay reciprocal compensation under such arrangements to a wireline local exchange carrier that transports and terminates a local call that originated on our network. Similarly, in the absence of the agreement of both parties for a “bill and keep” arrangement, 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 FCC’s 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 carrier’s interstate telecommunications revenue. The FCC is currently examining the way in which it collects carrier contributions to the federal Universal Service Fund, or USF. On May 1, 2008, the FCC placed an interim cap on the amount of USF funding distributed to competitive providers, including CMRS carriers and CLECs. USF funding to competitive providers is now capped at the level of support that such carriers were eligible to receive in each state during March 2008. 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 FCC’s 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 FCC’s 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; rules requiring us to offer equipment and services that are accessible to and usable by persons with disabilities; and rules governing back-up power at our cell sites. 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.
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Table of ContentsWe 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 FCC’s 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. 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. On November 5, 2008, the Federal Communications Commission adopted a Further Notice of Proposed Rulemaking (“November 5th Further Notice”) requesting comment on three alternative proposals for reform of the Universal Service Fund (“USF”) and the intercarrier compensation rules, including both federal and state access charges. It is uncertain whether the FCC will ultimately adopt any of the three proposed plans and what matters will be addressed in any plan that is ultimately
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Table of Contentsadopted. Intercarrier compensation reform could result in significant decreases in the access charge revenues received by our rural telephone companies. While we expect that the FCC would allow these changes to occur over some transition period and would permit our rural telephone companies to offset the impact of reduced revenues with increased subscriber line charges and USF payments, it is unknown whether all or only a portion of the access revenues would be so recovered. In a USF reform plan, there can be no assurance that our rural telephone companies would continue to receive the current level of Universal Service Fund revenues. Loss of USF and access revenues could have a significant adverse financial effect on our rural telephone companies depending on the amount of the reduction. 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 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 NECA’s common line pool and NECA’s traffic sensitive pool. 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 FCC’s 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 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 current FCC rules, however, competitors also can obtain the same per-line support payments as we do without regard for whether the competitor’s 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 and the competitors offer and advertise certain telephone services as required by the Telecommunications Act. 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 currently considering a recommendation from the Federal-State Joint Board on Universal Service, an advisory panel composed of FCC commissioners and state telecommunications regulators, that the fund be divided into three distinct funds each with a separate distribution mechanism and funding allocation. The three funds would be a Broadband Fund, a Mobility Fund, and a Provider of Last Resort Fund. Under the current 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 joint board’s recommendation would eliminate this “identical support” rule. On May 1, 2008, the FCC placed an interim cap on the amount of USF funding distributed to competitive providers, including CMRS carriers and CLECs. USF funding to competitive providers is now capped at the level of support that such carriers were eligible to receive in each state during March 2008. In addition to considering the joint board recommendations, the FCC has asked for comments on a proposal to use “reverse auctions” as a means to distribute certain Universal Service funding. It is not known how these changes, if adopted, 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. In 2006, the FCC expanded the base of USF contributors by extending contributing obligations to providers of interconnected VoIP services. As internet services expand, federal, state and local governments may adopt rules and regulations, or apply existing laws and regulations to the internet.
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Table of ContentsState 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. Some 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 September 28, 2007, the Virginia SCC issued a final order in a rulemaking docket that capped CLECs’ intrastate switched access charges, including the access charges of our CLECs, at the higher of the CLEC’s interstate switched access charge or the intrastate switched access charge of the ILEC (or the average of all ILECs) providing service in the territory served by the CLEC. The cap took effect on March 31, 2008. On April 25, 2008, Verizon filed a petition with the West Virginia Public Service Commission asking that a similar cap on intrastate CLEC access charges be adopted in West Virginia. On October 1, 2008, the Staff of the West Virginia Commission filed in support of Verizon’s request and the Administrative Law Judge’s decision is due by March 4, 2009. While this could have a significant impact to our long-term revenue growth potential in WV, it is not expected to have a material impact to our existing revenue stream. If, in a future proceeding, the SCC were to reduce the level of switched access charges that could be charged by our RLECs, such a reduction could have a significant adverse financial effect on our RLECs depending on the amount of the reduction. The SCC is currently considering a January 2009 recommendation by an SCC Hearing Examiner that Embarq be required to lower its intrastate access rates. An SCC order to reduce these rates would not impact the rates charged by our RLECs. See “Risk Factors.” The Telecommunications Act preempts state statutes and regulations that restrict entry into the 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, we obtained a negotiated franchise in Waynesboro and an ordinance franchise in Botetourt County. Augusta County does not have a franchise requirement and, accordingly, we did not need to obtain a franchise prior to offering video services in Augusta County. In October of 2007, we obtained a negotiated franchise in Lynchburg, Virginia for a new mixed-use residential development called Cornerstone. On January 12, 2009, we requested a negotiated franchise in Harrisonburg, Virginia for a residential development called Liberty Square.
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.
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Table of ContentsRisks 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 trends 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. Adverse economic conditions may harm our business. Economic conditions have been deteriorating and may remain depressed for the foreseeable future. Unfavorable economic conditions, including the recession and recent disruptions to the credit and financial markets, could cause customers to slow spending. If demand for our services decreases, our revenues would be adversely affected and churn may increase. In addition, during challenging economic times our customers may face issues gaining timely access to sufficient credit, which may impair the ability of our customers to pay for services they have purchased. Any of the above could have a material effect on our business, financial position, results of operations and cash flows.
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Table of ContentsWe are also susceptible to risks associated with the potential financial instability of the vendors and third parties on which we rely to provide services or to which we outsource certain functions. The same economic conditions that may affect our customers could also adversely affect vendors and third parties and lead to significant increases in prices, reduction in quality or the bankruptcy of our vendors or third parties upon which we rely. Any interruption in the services provided by our vendors or by third parties could adversely affect our business, financial position, results of operating and cash flows. Our leverage could adversely affect our financial health. As of December 31, 2008, our total outstanding debt on a consolidated basis, including capital lease obligations, was approximately $607.9 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, reducing or eliminating our quarterly cash dividend, 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 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:
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Table of ContentsWe 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, 2008 of $607.9 million, which includes capital lease obligations, we expect payments on our outstanding indebtedness to be approximately $6.7 million in 2009. The aggregate maturities of our long-term debt based on the contractual terms of the instruments are $6.7 million in 2009, $154.0 million in 2010, $446.9 million in 2011, $0.2 million in 2012 and less than $0.1 million thereafter. Our ability to make payments on, or to refinance or repay, our debt, fund planned capital expenditures, pay quarterly cash dividends 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. Additionally, if we were to borrow under our revolving credit facility to obtain additional capital, we would be required to repay such borrowings by the February 24, 2010 expiration date of this facility. 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. This risk would be exacerbated if capital market conditions do not improve over current conditions. 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. Wireless Telecommunications 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 a very competitive environment. Our wireless business faces intense competition from other wireless providers, including Verizon Wireless, Alltel, T-Mobile, AT&T Wireless, U.S. Cellular and Sprint Nextel (including its network managers (formerly referred to as 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. Some of the carriers with which we compete provide wireless services using cellular frequencies in the 800 MHz band and in the future will use 700 MHz frequencies that were recently auctioned by the FCC. These frequencies enjoy propagation advantages over the PCS and AWS spectrum we currently hold, which may cause us to have to spend more capital than our competitors to achieve the same coverage. Consolidation continues in the wireless industry with the combinations of Verizon and Alltel, Sprint and Nextel, AT&T’s acquisition of 100% ownership of AT&T Wireless as well as its acquisition of Dobson, the acquisitions by Verizon Wireless of Rural Cellular and by T-Mobile of Suncom. These and other 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. Two of our national wireless competitors acquired a significant portion of the 700 MHz spectrum recently auctioned by the FCC. The national wireless carriers in many instances on average have more spectrum in each of our licensed areas than we do. We may not be able to obtain additional spectrum and thus may be unable to offer future developed services which utilize PCS spectrum or offer services developed for other specific spectrum as a result of not having as much spectrum, or as much spectrum in specific bands, as our competitors do.
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Table of ContentsIn addition, each of the four largest wireless carriers offers handsets for which that carrier has the exclusive right to provide customers. Recent estimates are that over 50 handset models are under exclusive arrangements with these carriers. We do not have exclusivity for any handset that we provide to our customers and are unable to provide the handsets that are available exclusively from other carriers. We may be unable to attract some new customers, and we may lose existing customers, because of our inability to offer these handsets. 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 service in areas not covered by our 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 EV-DO and Wi-Max 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 EV-DO, which provides broadband wireless services at rates faster than the 3G one times radio transmission, or 1xRTT, technology. We have upgraded our network to EV-DO, with over 70% of the cell sites EV-DO capable as of December 31, 2008, and we anticipate that approximately 85% of the cell sites will be upgraded to EV-DO by mid-year 2009. We will continue to the utilize 1xRTT technology in areas where the demand for high speed data service is less. Competitors continue to explore further technological advances such as Wi-Max and LTE which could cause the technology used on our network to become dated. We may not be able to respond to future 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.
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Table of ContentsThe loss of our largest customer, Sprint Nextel, or a decrease in its usage may result in lower revenues or higher expenses. Sprint Nextel accounted for approximately 22.0% of our operating revenues for the year ended December 31, 2008. If we were to lose Sprint Nextel as a customer or if Sprint Nextel became financially unable to pay our charges, our revenues would decline, which could have a material adverse effect on our business, financial condition and operating results. Additionally, if Sprint Nextel’s current financial condition should worsen in a material manner, our business would suffer material adverse consequences which could include termination or revision of our Strategic Network Alliance. 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 customers to non-CDMA 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. Continued decline in Sprint Nextel’s subscriber base could have an adverse effect on its long-term growth, financial condition and strategic direction, which could, in turn, have an adverse effect on our wireless wholesale revenues under the Strategic Network Alliance. The pricing arrangement under our Strategic Network Alliance with Sprint Nextel may fluctuate which could result in lower revenues or a decline in the historical growth of our wholesale wireless revenues. Under the Strategic Network Alliance, our wholesale revenues effective July 1, 2007, will be the greater of $8.0 million per month ($9.0 million per month in the calendar month after 98% of our cell sites are upgraded to EV-DO in this wholesale area) or the revenues derived based on voice and data usage by Sprint Nextel of our network priced at the applicable rates and terms for each of the services categories. We attained the 98% threshold during the fourth quarter of 2008 and our actual revenue based on voice and data usage exceeded the $9.0 million per month minimum during the fourth quarter 2008 and is expected to continue to exceed this level throughout the first half of 2009. However, travel data rates will be reset effective July 1, 2009 and quarterly thereafter. We anticipate that this reset will result in a significant rate reduction for this element and that the total revenues after this reset will be at the $9.0 million minimum for at least the remainder of 2009. All of the rate elements generally fluctuate for the periods specified for each service under the agreement under a formula tied to a national wireless retail customer revenue yield and a national retail data revenue yield. 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. Accordingly, we could remain at the $9.0 million minimum longer for a period longer than we anticipate which could impact our longer term profitability. 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 more economically offer roaming and long-distance telephone services to their subscribers. 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. As the wireless industry consolidates, our ability to replicate our roaming service offerings at rates which will make us, or allow us to be, competitive is uncertain at this time and may become more difficult. The roaming agreements do not cover all geographic areas where our customers may seek service when they travel and a number of the roaming agreements may be terminated on relatively short notice and may not be renewed in the future. In addition, we believe the rates we are charged by certain carriers in some instances are higher than the rates they charge to other roaming partners. We may also be unable to continue to receive roaming services in areas in which we hold licenses or lease spectrum after the expiration or termination of our existing roaming agreements. Any future renewal also may not include roaming for data services. 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.
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Table of ContentsWe 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 are upgrading to new wireless handsets, especially handsets that offer more applications including data-centric and smart phones. 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 increase with an increase in features, functionality, and the number of applications they support. This results in our incurring higher handset subsidies. 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 during the period of the sale or upgrade. 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 CDMA network in the Strategic Network Alliance service area until 18 months prior to termination of the agreement, the initial term of which ends on July 31, 2015, 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 nineteen of our licenses between 2005 and 2007. We have six remaining licenses due to expire in June 2009 for which we will need to apply for renewal. If we fail to file for renewal of our other 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 provide or continue to provide service in that license area would be adversely affected. 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. We have executed a long term lease agreement and a license purchase agreement for the provision of assistance in meeting build-out requirements in two non-operational markets. These agreements will require us to transfer 15 MHz of C block spectrum in Wheeling, WV and 20 MHz of C block spectrum in Cumberland, MD. Accordingly, we have recorded an asset impairment charge of $1.4 million (included in depreciation and amortization on the Consolidated Statement of Operations) to reduce the carrying value of spectrum to the net fair value of the spectrum to be retained. If we are unable have these licenses perfected through the terms of these agreements or through other means of perfection, we would be at risk of losing these licenses and, accordingly, we would incur an additional asset impairment charge of $1.4 million, representing the remaining carrying value of these licenses. 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.
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Table of ContentsOn September 11, 2007, the FCC adopted an order mandating that wireless E911 location accuracy be measured on the public safety answering point (PSAP) level, but deferred effectiveness of the mandate for five years while requiring interim milestones. The FCC has since withdrawn that order and, on September 22, 2008, the FCC sought comments on a new proposal for E911 accuracy requirements for both handset-based and network-based technologies to achieve E911 accuracy compliance at the county-level. That proposal was filed by the Association of Public-Safety Communications Officials and the National Emergency Number Association, Verizon Wireless, Sprint Nextel Corporation, and AT&T. 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. Our decision not to participate at this time in the FCC’s new point-to-multipoint emergency alert capabilities program may result in increased churn or slower growth. In 2006, Congress passed the Warning, Alert, and Response Network Act which required the FCC to adopt technical standards and procedures to enable alerting capability for CMRS providers that voluntarily elect to transmit emergency alerts. The FCC adopted such a program in April of 2008. Under the Warning, Alert, and Response Network Act, a CMRS carrier can elect not to participate in providing such alerting capability and we have made such an election not to participate at this time. As a result of our election not to participate, we may experience slower growth and higher churn if subscribers do not purchase our service or terminate service because we have elected not to provide this capability. 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. In early 2008, the FCC conducted an auction of additional wireless service spectrum in the 700 MHz range. We participated in the 2006 auction but decided not to participate in the 2008 auction. We may participate in other 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 us 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, 2008, 91% of our base stations were installed on leased cell site facilities, with 45% 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, including American Tower and Crown Communications, pursuant to master agreements that govern the general terms of our use of that company’s 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.
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Table of ContentsWe 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. Some competitors, most notably Sprint Nextel, offer “push-to-talk.” We do not offer our customers a “push-to-talk” service. Competitors are also introducing LTE, a form of wireless broadband with significantly higher speeds than EV-DO. This technology will likely be introduced in 2010 in major metropolitan areas and may be introduced in our markets as well. Additionally, femtocells will likely be introduced in the near future. Femtocells are mini-cell sites that are portable and can be located in a home or office, thus improving wireless in-building coverage. They backhaul traffic over the users’ landline connection. 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,” or data and streaming video at speeds significantly above that of EV-DO, we could 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. We and our suppliers may be subject to claims of infringement regarding telecommunications technologies that are protected by patents and other intellectual property rights. In general, we do not manufacture any of the equipment or software used in our telecommunications businesses and we do not own any patents. Instead, we purchase the infrastructure equipment, handsets and software used in our business from third parties and we obtain licenses to use the associated intellectual property. Telecommunications technologies are protected by a wide variety of patents and other intellectual property rights. We and some of our suppliers and service providers may receive assertions and claims from third parties that the products or software utilized by us or our suppliers and service providers infringe on the patents or other intellectual property rights of these third parties. These claims could require us or an infringing supplier or service provider to cease certain activities or to cease selling the relevant products and services. The manufacturers and suppliers that provide us with the equipment and technology we use in our business may agree to indemnify us against possible infringement claims. However, we do not always have such indemnification protections in place and, even if we have such agreements in place, we may not be fully protected against all losses associated with infringement claims. In addition, the manufacturers and suppliers also may require us to indemnify them against infringement claims asserted against them with respect to equipment they sell to us. Whether or not infringement claims are valid or successful, such claims could also adversely affect our business by diverting management attention, involving us in costly and time-consuming litigation, requiring us to enter into royalty or licensing agreements (which may not be available on acceptable terms, or at all), or requiring us to cease certain activities or to cease selling certain products and services to avoid claims of infringement. All suppliers of our CDMA handsets license intellectual property from Qualcomm Incorporated (“Qualcomm”). Some of this Qualcomm intellectual property has been found to infringe on certain patents owned by Broadcom Corporation (“Broadcom”). The International Trade Commission (“ITC”) has found that Qualcomm infringes certain of Broadcom’s intellectual property, and a United States district court recently enjoined Qualcomm from further infringement of other patents and from certain other activities. Although that injunction was effective immediately, the ruling contained a sunset provision for certain Qualcomm products, which was due to expire on January 31, 2009, that provided time for Qualcomm to modify its infringing products to avoid infringement.
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Table of ContentsOn October 14, 2008, the U.S Court of Appeals vacated and remanded the ITC’s order that barred importation of devices that include the Qualcomm chips. Wireline Telecommunications 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 introduced wireline digital voice services to its cable customers in Charlottesville and other Virginia markets, including in Waynesboro and Augusta County in May 2008, and it may offer these services in our Botetourt County service area in the future. Shenandoah Telecommunications Company purchased the cable property overlapping our RLEC territory in Clifton Forge and Covington, Virginia. We believe it is likely that Shenandoah will began providing digital voice and data services to its customers in these markets in the future. Cable providers have had significant success in other markets offering wireline voice services and, accordingly, 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, 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 2,403 access lines in the year ended December 31, 2008, or 5.5% of our access lines served at the end of 2007. A continued net loss of access lines would 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. In 2006, the FCC expanded the base of USF contributions by extending universal service contribution obligations to providers of interconnected VoIP service. The United States Supreme Court upheld the FCC’s ruling that cable broadband internet services are not subject to common carrier telecommunications regulation. In addition, the Virginia State Corporation Commission, or 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.
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Table of ContentsRegulatory developments at the FCC and the Virginia SCC could reduce revenues that our rural telephone company and CLEC subsidiaries receive from network access charges. For the year ended December 31, 2008, approximately $36.2 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 and on July 1, 2009, will be subject to a biennial reset (reduction). The SCC could conduct an access reform proceeding or rate cases and earnings reviews, all of 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, which reduce the revenues we receive from other carriers. On November 5, 2008, the Federal Communications Commission adopted a Further Notice of Proposed Rulemaking (“November 5th Further Notice”) requesting comment on three alternative proposals for reform of the Universal Service Fund (“USF”) and the intercarrier compensation rules, including both federal and state access charges. It is uncertain whether the FCC will ultimately adopt any of the three proposed plans and what matters will be addressed in any plan that is ultimately adopted. Intercarrier compensation reform could result in significant decreases in the access charge revenues received by our rural telephone companies. While we expect that the FCC would allow these changes to occur over some transition period and would permit our rural telephone companies to offset the impact of reduced revenues with increased subscriber line charges and USF payments, it is unknown whether all or only a portion of the access revenues would be so recovered. On September 28, 2007, the Virginia SCC issued a final order in a rulemaking docket that capped CLECs’ intrastate switched access charges, including the access charges of our CLECs, at the higher of the CLEC’s interstate switched access charge or the intrastate switched access charge of the ILEC (or the average of all ILECs) providing service in the territory served by the CLEC. The cap took effect at the end of a transition period that began on December 1, 2007 and ended on March 31, 2008. As part of that transition, we reduced our CLEC access rates effective on January 1, 2008 and then again March 31, 2008. These lower rates reduced our CLEC access revenues by a total of $1.2 million in 2008. On April 25, 2008, Verizon filed a petition with the West Virginia Public Service Commission asking that a similar cap on intrastate CLEC access charges be adopted in West Virginia. On October 1, 2008, the Staff of the West Virginia Commission filed in support of Verizon’s request and the Administrative Law Judge’s decision is due by March 4, 2009. It is likely that the West Virginia Commission will adopt the staff’s recommendation. While this could have a significant impact to our long-term revenue growth potential in WV, it is not expected to have a material impact to our existing revenue stream. If, in a future proceeding, the SCC were to reduce the level of switched access charges that could be billed by our RLECs, such a reduction could have a significant adverse financial effect on our RLECs depending on the amount of the reduction. The SCC is currently considering a January 2009 recommendation by an SCC Hearing Examiner that Embarq be required to lower its intrastate access rates. An SCC order to reduce these rates would not impact the rates charged by our RLECs. 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, 2008, we received approximately $4.4 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 as noted above. 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.
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Table of ContentsThe FCC is currently considering a recommendation from the Federal-State Joint Board on Universal Service, an advisory panel composed of FCC commissioners and state telecommunications regulators, that the fund be divided into three distinct funds each with a separate distribution mechanism and funding allocation. The three funds would be a Broadband Fund, a Mobility Fund, and a Provider of Last Resort Fund. Under the current 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 joint board’s recommendation would eliminate this “identical support” rule. The joint board has also recommended that the FCC adopt an interim, emergency cap on high-cost universal service support for competitive ETCs, such as our wireless affiliates. In addition to considering the joint board recommendations, the FCC has asked for comments on a proposal to use “reverse auctions” as a means to distribute certain Universal Service funding. It is not known how these changes, if adopted, may affect us. The FCC is also 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 interstate 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. In December 2004, Congress suspended the application of a law called the Antideficiency Act to the Universal Service Fund until December 31, 2005 and has repeatedly extended this exemption. The most recent exemption expired on December 31, 2008 and Congress is currently considering legislation to permanently exempt the Universal Service Fund from the Antideficiency Act. 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. If Congress does not continue to extend the exemption, 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 their 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, Fibernet, PAETEC 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 upgrade existing 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.
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Table of ContentsWe 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 2008 we experienced a 27.3% loss in the number of dial-up internet customers from 2007. Our dial-up internet service revenues for the year ended December 31, 2008 decreased to approximately $3.0 million from approximately $3.8 million for the year ended December 31, 2007. 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, although it has subjected ISPs, such as providers of broadband, to many obligations formerly placed on common carriers, such as the requirements of the Communications Assistance for Law Enforcement Act. 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. General Matters We may 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 2008 were $132.5 million, of which approximately $37 million represented incremental capital expenditures related to our network upgrade to EV-DO. We expect our aggregate capital expenditures for 2009 to be in the range of $111 million to $119 million, including incremental capital expenditures for an upgrade to our wireless network relating to EV-DO. We expect our aggregate incremental capital expenditures for 2007 through 2009 for the upgrade to EV-DO in all of our markets to be approximately $65 million, of which $62 million was spent in 2007 and 2008 and the remainder of approximately $3 million is expected to be spent in 2009. 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.
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Table of ContentsWe 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. Virginia legislation that significantly revised the taxation of communications services in Virginia took effect on January 1, 2007. The new law applied 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 administers 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 Alcatel-Lucent, who is the exclusive provider of the equipment for our EV-DO upgrade, Cisco Systems, Inc. and others. 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.
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Table of ContentsWe 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 or the third parties may experience interruptions or other problems delivering these systems. 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. Our current pre-pay billing vendor, Verisign, plans to exit the billing services business. We have a contract with Verisign through the end of the year 2009 that will allow us to transition our billing services to a third party. We have contracted with Convergys Information Management Group Inc for pre-pay billing services and are in the process of transitioning to Convergys. If we are unable to transition our billing services to Convergys before the end of the transition period with Verisign, we may not be able to bill our pre-pay customers and we may experience increased churn among our pre-pay customers. If or when we lose a member or members of 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. Carl A. Rosberg announced his retirement effective in early 2009 and resigned as President-Wireless as of December 31, 2008 and Francis C. Guido, Executive Vice President, assumed the duties of President of Wireless Operations on January 1, 2009. Additionally, James A. Hyde will join the Company as President and Chief Operating Officer in March 2009. We intend for Mr. Hyde to succeed James S. Quarforth as Chief Executive Officer upon Mr. Quarforth’s eventual retirement. 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 unexpected 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. We may not be able to pay dividends on our common stock in the future. We intend to continue to pay regular quarterly dividends on our common stock. Any decision to declare future dividends 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 to make other distributions to our stockholders, including by means of a stock repurchase. Amounts that can be made available to us to pay cash dividends or repurchase stock are restricted by the NTELOS Inc. Amended Credit Agreement.
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Table of ContentsOur 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:
Quadrangle Capital Partners LLP and certain of its affiliates, collectively “Quadrangle”, 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 not be beneficial to our stockholders and as a result, may depress the market price of our stock. As of December 31, 2008, Quadrangle beneficially owned 11,306,102 shares of our common stock, or 26.8% of our outstanding common stock. In addition, three of the eight directors that serve on our board of directors are representatives or designees of Quadrangle. By virtue of such stock ownership and representation on the board of directors, Quadrangle continues 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. 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 certain of our stockholders, including the Quadrangle Entities, the right to require us to register their shares of our common stock, representing approximately 12.1 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.
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Table of ContentsProvisions 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:
Not applicable.
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:
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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 will have a material adverse effect on our financial condition, results of operations or cash flows.
No matter was submitted to a vote of security holders during the fourth quarter of 2008. PART II
Market Information 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. On February 23, 2009, the last reported sale price for our common stock was $19.09 per share. The following tables set forth the high and low prices per share of our common stock and the cash dividends declared per common share for the four quarters in each of 2007 and 2008, which correspond to our quarterly fiscal periods for financial reporting purposes:
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Table of ContentsStock 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, 2008, 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. Cumulative Total Shareholder Return NTELOS, NASDAQ Stock Market and Nasdaq Telecommunications Index (02/8/06 - 12/31/08)
Holders There were approximately 11,058 holders of our common stock on February 23, 2009. Dividends/Dividend Policy We intend to continue to pay regular quarterly dividends on our common stock. On February 26, 2009, we declared a dividend to be paid on April 13, 2009 to common stock shareholders of record on March 19, 2009 at a rate of $0.26 per share. Any decision to declare future dividends 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 the 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 to make other distributions to our stockholders, including by means of a stock repurchase. Amounts that can be made available to us to pay cash dividends or repurchase stock are restricted by the NTELOS Inc. Amended Credit Agreement.
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SELECTED HISTORICAL FINANCIAL INFORMATION
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You should read the following discussion of our financial condition in conjunction with our consolidated financial statements and the related notes included herein (Item 8). 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. Overview 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, an indirect wholly owned subsidiary of Sprint Nextel Corporation (hereinafter collectively referred to as “Sprint Nextel”). 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 13.6% compound annual growth rate from 2006 to 2008 and accounted for 77% of our total revenues in 2008. We hold digital PCS licenses to operate in 29 basic trading areas with a licensed population of approximately 8.9 million, and we have deployed a network using code division multiple access technology, or CDMA, in 21 basic trading areas which currently cover a total population of approximately 5.5 million potential subscribers. As of December 31, 2008, our wireless retail business had approximately 435,000 NTELOS-branded subscribers, representing a 7.9% penetration of our total covered population. We have made significant investments in our wireless network since 2006, adding 286 new wireless cell sites and increasing our total cell sites to 1,183 by the end of 2008. These investments and other initiatives contributed to a 6.9% increase in subscribers in 2008. We amended our agreement with Sprint Spectrum L.P. during 2007 to act as their exclusive wholesale provider of network services through July 31, 2015. Under this arrangement, which we refer to as the Strategic Network Alliance, we are the exclusive PCS service provider in our western Virginia and West Virginia service area for all Sprint Nextel CDMA wireless customers (see “Business – Wireless Business – Our Strategic Network Alliance with Sprint Nextel”). Under the terms of the Agreement, we are committed to upgrading our wireless network to Evolution-Data Optimized Revision A (“EV-DO”) in the territory covered by the Agreement. We expect our aggregate incremental capital expenditures for this upgrade to EV-DO in all of our markets to be approximately $65 million, of which $25 million was spent in 2007, $37 million was spent in 2008 and the remainder of approximately $3 million is expected to be spent in 2009. We met the 98% build-out completion target defined in the Strategic Network Alliance during the fourth quarter 2008, after which the monthly revenue minimum was increased from $8 million to $9 million. As of December 31, 2008, 833 (or 70%) of our total cell sites have been upgraded to EV-DO. For the year ended December 31, 2008, we realized wholesale revenues of $111.1 million, primarily related to the Strategic Network Alliance, representing an increase of 15.8% over 2007. In addition, this upgrade has helped increase retail data ARPU by $2.76, offsetting the downward pressure on voice ARPU. Founded in 1897, our wireline incumbent local exchange carrier business is conducted through two subsidiaries that qualify as rural local exchange carriers (“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, 2008, we operated approximately 41,100 RLEC telephone access lines. We also own a 2,200 route-mile regional fiber optic network and participate in partnerships that directly connect 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, 2008, we served customers with approximately 49,900 CLEC access line connections. We also offer DSL services in over 97% of our RLEC service area and as of December 31, 2008 we operated approximately 22,500 broadband access connections in our markets, representing an increase of 11.6% in 2008. The wireline Competitive segment strategic products (local phone services, broadband voice and data services and high-capacity network access and transport services) experienced revenue growth of 12.8% over 2007. In 2008 and 2007, our wireline operating income margins were 33.3% and 31.5%, respectively. Commencing in late 2007, we have been introducing NTELOS video in selected neighborhoods within our two RLEC service areas.
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Table of ContentsThe product provides an alternative to cable and satellite TV, offering video entertainment services with more than 250 all-digital channels and 43 high-definition channels. It is delivered via fiber-to-the-home which allows us to deliver video, local and long distance telephone services, plus Internet access at speeds up to 20 megabits per second. At December 31, 2008, we had approximately 1,000 video customers and passed 4,900 homes with fiber. Revenues from the broadband and video products are included in the Competitive wireline segment. We were formed in January 2005 by Citigroup Venture Capital Equity Partners, L.P., and certain of its affiliates, collectively “CVC”, and Quadrangle Capital Partners LLP and certain of its affiliates, collectively “Quadrangle”, for the purpose of acquiring NTELOS Inc. On January 18, 2005, we entered into an agreement with NTELOS Inc. and certain of its shareholders to acquire the common stock of NTELOS Inc., making an initial investment on February 24, 2005. On May 2, 2005, we acquired all of NTELOS Inc.’s remaining common shares, warrants and vested options by means of a merger at which time NTELOS Inc. became a wholly-owned subsidiary. During the first quarter of 2006, Holdings Corp. completed an initial public offering (the “IPO”) of 15,375,000 shares of its common stock at a price of $12.00 per share. We received net proceeds from the offering of approximately $172.5 million which we used to make a termination payment of the advisory agreements with CVC and Quadrangle, redeem our Floating Rate Senior Notes in full, and the balance, combined with available cash, was used to pay a dividend on the Company’s Class B common. All Class B common stock was subsequently converted to common stock during 2006. On April 4, 2007, in a secondary offering of our common stock, CVC and Quadrangle and certain of their affiliates sold an aggregate of 12,650,000 shares priced at $18.25 per share. This resulted in their combined ownership declining from 58% to approximately 27%. We did not receive any proceeds from the offering and our total shares outstanding did not change as a result of this offering. Direct costs of this offering, primarily legal, printing and accounting fees, totaled $0.6 million. On September 25, 2007, Quadrangle agreed to acquire all of the shares of NTELOS common stock owned by CVC and certain affiliated limited partnerships. With this acquisition, private equity funds affiliated with Quadrangle own approximately 27% of our outstanding common stock. We began paying cash dividends on our common stock during 2007. The board of directors declared cash dividends in the amount of $0.89 per share during 2008, which amounted to $37.5 million. The board of directors declared cash dividends in the amount of $0.51 per share during 2007, which amounted to $21.4 million. We expect many of the factors which affected our results of operations in 2008 to continue into 2009. Additionally, the impact of overall economic conditions that we began to experience in the fourth quarter of 2008 is expected to continue into 2009. In wireless, the current economic climate contributed to slower wireless subscriber growth and an increase in customer churn in 2008 and these trends are expected to continue in 2009. Additionally, postpay competition is expected to stiffen as the market gets closer to saturation. Competition with prepaid products also will likely intensify as more competitors target this segment as a means to sustain growth and increase market share. Average monthly revenues per handset/unit in service, or ARPU, from voice is expected to continue to decline due to competitive and economic conditions. However, we anticipate data ARPU will continue to grow and more than offset the decline in voice ARPU. Higher handset subsidy costs are expected in 2009 as compared to 2008 due to an expected higher mix of smart phones and air cards associated with the projected growth in data ARPU. Data ARPU and revenue are expected to grow due to the continued increase in penetration and usage escalating from our EV-DO deployment, however, this also will result in a significant increase in network expenses and data cost of sales, both of which are captured in cost of sales and services. The network expenses will increase in 2009 due to having a full year of expenses related to EV-DO markets deployed during 2008 and to new EV-DO deployment in 2009. Capital expenditures associated with the EV-DO upgrade are expected to decrease as a large portion of that upgrade was completed in 2008. Wireless wholesale revenue is expected to continue to grow for the first half of 2009 driven by growth in revenue from the Strategic Network Alliance with Sprint. However, effective July 1, 2009, one of the key rate elements will be reset and is expected to be reduced, the impact of which will likely result in total revenue from the Sprint agreement being billed at the $9 million monthly minimum for the balance of 2009. Wireline revenue within the competitive segment is expected to continue to grow from our strategic products although the economy may have an adverse impact in 2009. Additionally, access line losses are expected to continue, impacted by continued cable competition and wireless substitution.
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Table of ContentsThe swap agreement fair value was a $9.2 million liability at December 31, 2008. This liability will likely be reduced by December 31, 2009 as it approaches expiration in February 2010. 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 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 operating revenue from our wireless segment (Note 3 in our Notes to Consolidated Financial Statements) to subscriber revenues used to calculate average monthly ARPU for the years ended December 31, 2008, 2007 and 2006.
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Operating Revenues Our revenues are generated from the following categories:
Operating Expenses 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, other income, which includes interest income, and gain on sale of investments.
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Table of ContentsIncome Taxes Our income tax expense and effective tax rate increases or decreases based upon changes in a number of factors, including our pre-tax income or loss, state minimum tax assessments, and non-deductible expenses. 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 cumulative operating losses since it initiated PCS services in 1997. Given that the total of minority member contributions and cumulative operating results are negative during all periods reported, we recognize a credit to minority interest only to the extent of capital contributions from the 3% minority owners. No such contributions were made during the years ended December 31, 2008, 2007 or 2006. Results of Operations Year ended December 31, 2008 compared to year ended December 31, 2007 Operating revenues increased $39.4 million, or 7.9%, from the year ended December 31, 2007 to the year ended December 31, 2008. Wireless PCS accounted for 96.6% of the increase, with growth occurring from subscriber revenues, wholesale revenues and equipment sales. Wireline contributed the remaining revenue increase primarily from growth in key strategic product revenues in the Competitive segment, partially offset by declines in other revenues from the Competitive segment and RLEC revenues. Operating income increased $19.3 million over the comparative year, from $100.2 million for the year ended December 31, 2007 to $119.5 million for the year ended December 31, 2008. Operating margin increased from 20.0% for the year ended December 31, 2007 to 22.1% for the year ended December 31, 2008. Net income increased $14.8 million over the comparative year. In addition to the $19.3 million increase in operating income, interest expense decreased $10.6 million. These changes, which served to increase net income, were partially offset by an increase in the loss on the fair value of swap instruments of $6.0 million and an increase in income tax expense of $7.4 million. OPERATING REVENUES The following table identifies our external operating revenues on a business segment basis for the years ended December 31, 2008 and 2007:
WIRELESS COMMUNICATIONS REVENUES—Wireless communications revenues increased $38.1 million from 2007 to 2008 due to an increase in our NTELOS-branded net subscriber revenue of $20.4 million, or 7.9%, a $15.1 million, or 15.8%, increase in wholesale and roaming revenues and an increase in equipment sales revenues of $2.4 million, or 11.4%.
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Table of ContentsThe increase in subscriber revenue reflect increased postpay revenue of $14.3 million, or 7.5%, $8.0 million of which is from growth in data revenues. Underlying this 47.4% growth in data revenue was the technology upgrade to EV-DO (deployed to 70% of our cell sites by year-end), and an increased sales emphasis on smart phones and other data-centric handsets coupled with a richer array of data packages. The total data ARPU for all prepay and postpay products was $7.43 for 2008 compared to $4.67 for 2007, an increase of 59.1%. In addition to this APRU growth, the take rates on data packages and usage rates continues to rapidly expand. Growth in data ARPU has offset declines in voice rates resulting from economic and competitive pressure, leading to blended ARPU of $55.23 for 2008, 1.3% below blended ARPU of $55.98 for 2007. However, pro forma of the handset insurance reporting change (see footnote 1 to the ARPU reconciliation table above), blended ARPU increased 1.9% year over year, from $53.66 in 2007 to $54.67 in 2008. In addition to the data ARPU growth, total subscribers increased from 406,795 at December 31, 2007 to 435,008 at December 31, 2008, a 28,213, or 6.9%, net subscriber growth. The year-over-year increase in wholesale and roaming revenues was driven by a $12.8 million, or 13.5%, increase in revenue from the Strategic Network Alliance. Additionally, roaming revenues from other carriers grew $2.4 million. Our wholesale revenues derived from the Strategic Network Alliance are primarily from the voice usage by Sprint Nextel customers who live in the Strategic Network Alliance service area (“home minutes of use”), those customers of Sprint Nextel who use our network for voice services while traveling through the Strategic Network Alliance service area (“travel minutes of use”) 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 added 117 cell sites within this wholesale service area in 2008, improving existing service and extending this coverage area. On July 31, 2007, we entered into an Amended and Restated Resale Agreement (“Agreement”) with Sprint Spectrum L.P, which became effective as of July 1, 2007. The Agreement superseded and replaced the original 2004 Resale Agreement and extended the term of the original 2004 Resale Agreement, committed us to perform network upgrades and changed pricing structures, including the addition of revenue minimum guarantees. We met the 98% build-out completion target defined in the Agreement during the fourth quarter 2008, after which the monthly revenue minimum was increased from $8 million to $9 million. The term extension noted above was four years over the 2004 Resale Agreement term, to July 31, 2015, subject to automatic three-year extensions unless certain notice provisions are exercised. The Agreement prohibits Sprint Nextel from directly or indirectly commencing construction of, contracting for or launching its own wireless communications network in the Agreement territory until 18 months prior to end of the Agreement. The Agreement specifies a series of usage rates for various types of services. The voice rate pricing under the Agreement was fixed through July 1, 2008, at rates comparable to the rates in the 2004 Resale Agreement, but provides for greater volume discounts in the future to provide incentives for the migration of additional traffic onto the network. After July 1, 2008, the voice rates will be reset semi-annually based on Sprint Nextel’s voice revenue yield. Generally, the data rate pricing is lower under the Agreement compared to the rates agreed to in the 2004 Resale Agreement in recognition of the significant growth experience in data usage and anticipated growth from the introduction of higher speed data services as a result of the network upgrade and to also provide incentives for the migration of additional traffic onto the network. Data rates for Sprint Nextel in-market home subscribers are on a per subscriber basis. The data rate for Sprint Nextel customers that are traveling through the territory covered by the Agreement and use the network are on a per kilobyte basis, reset quarterly beginning July 1, 2009. The Strategic Network Alliance also permits our NTELOS-branded customers to access Sprint Nextel’s national wireless network at reciprocal rates as the Sprint Nextel travel rates. We estimate that the July 1, 2009 travel data rate reset will significantly decrease the rate currently in effect and will result in total revenue from this Agreement to be billed at the $9 million monthly minimum for the balance of 2009. WIRELINE COMMUNICATIONS REVENUES—Wireline communications revenues increased $1.5 million, or 1.2%, with revenues from strategic products increasing $5.9 million, or 12.8%, and revenues from RLEC and other revenues from the Competitive segment decreasing $1.9 million and $2.5 million, respectively.
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The access line loss noted above is reflective of residential wireless substitution, second line losses and the introduction of competitive voice service offerings from Comcast, which commenced in May 2008 in one of our three RLEC markets. We expect that this competition will primarily be for residential customers. We expect to encounter additional voice competition from Comcast and Rapid Communications, now owned by Shenandoah Telecommunications Company, in 2009. We project our access line loss percent in 2009 will be similar to that of 2008.
On September 28, 2007, the Virginia State Corporation Commission issued a final order in a rulemaking docket that capped CLECs’ intrastate switched access charges, including the access charges of our CLECs, at the higher of the CLEC’s interstate switched access charges or the intrastate switched access charges of the ILEC (or the average of all ILECs) providing service in the geographic area served by the CLEC. The cap took effect at the end of a transition period that began on December 1, 2007 and ended on March 31, 2008. As part of that transition, we reduced our CLEC access rates effective on December 1, 2007 and again on April 1, 2008. These lower rates reduced our CLEC access revenues by a total of $1.2 million in 2008.
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Table of ContentsOPERATING EXPENSES The following table identifies our operating expenses on a business segment basis, consistent with the table presenting operating revenues above, for the years ended December 31, 2008 and 2007:
OPERATING EXPENSES – The following describes our operating expenses by segment and on a basis consistent with our financial statement presentation. The discussion below relates to our operating expenses by segment before non-cash compensation charges, voluntary early retirement plan charges, secondary offering costs, depreciation and amortization and accretion of asset retirement obligations:
We expect continued growth in COS expenses as our customer base grows, sales of national plans increase, sales of smart phones continue to represent a significantly higher percentage of total sales than in the prior year and usage of data features increases. The remaining operating expense increase in wireless communications over the comparative period was due to increased costs of maintaining our network, combined with direct and indirect costs of sales and services expenses. Specifically, cell site and network access expenses increased $6.1 million year over year related to additional access connectivity to support high-speed data over the EV-DO network and to support our increased subscriber base, and a 15.6% increase in the number of cell sites as of December 31, 2008 over December 31, 2007. Finally, customer retention and advertising expense increased $1.0 million year over year and operating taxes and regulatory fees increased a total of $3.7 million (see further discussion below under corporate operations expenses).
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COST OF SALES AND SERVICES—Cost of sales and services increased $11.3 million, or 7.0%, from 2007 to 2008. As discussed above, wireless variable cost of sales and services increased $4.4 million year over year and cell site and network access expenses increased $6.1 million related to cell site expansion and the capacity increase related to the network upgrade to EV-DO. The portion of this increase related to the EV-DO upgrade ($3.5 million) results in our adding additional access expenses for every cell site upgraded. Equipment cost of sales increased $4.3 million in 2008 over 2007 due to the increase in subscriber additions, the increase in exchanges and sales to existing customers, and the increase in handset sales to our handset insurance provider. Roaming COS increased $5.0 million year over year primarily to an increased mix of national plans and other plans which contain more roaming minutes, partially offset by in-network roaming savings related to continued cell site expansion. The percentage of subscribers with a national plan increased from 32.8% as of December 31, 2007 to 35.9% as of December 31, 2008. Data COS increased $1.1 million in 2008 over 2007 consistent with increased data usage and revenues. These and other increases in wireless cost of sales and services were offset by an $8.2 million decrease in handset insurance cost of sales from 2007 primarily related to a change in the reporting of handset insurance from a gross to a net basis effective April 1, 2008 (see footnote 1 to the ARPU reconciliation table above). As noted above, wireline network access and other network related expenses were flat due to improved utilization, efficiency and on-network traffic. This is a result of grooming provision configuration enhanced by our commitment over the last three years to invest in our network to move traffic from leased to owned facilities and in improve margins and control service quality. CUSTOMER OPERATIONS EXPENSES—Customer operations expenses increased $2.3 million, or 2.1%, from 2007 to 2008. Wireless retention and advertising expenses increased $1.0 million related to an increase in promotional pricing needed to combat the increase in competitive and economic pressures experienced in 2008. Compensation and benefits expenses increased $2.2 million associated with inflationary growth in wages and an increase in personnel to support subscriber growth. The remaining increases in 2008 over 2007 primarily relate to contracted services, rent expense, postage and our phonebook directory. Offsetting these increases were decreases in bad debt expense of $1.2 million due to improvement in accounts receivable aging and collections forecasts at December 31, 2008 versus the prior year-end. Also, wireless selling expenses decreased $1.1 million due to the decrease in sales through the higher-cost third-party agent channel. CORPORATE OPERATIONS EXPENSES— Corporate operations expenses increased $0.6 million, or 1.9%, from 2007 to 2008. The results for 2008 contain $1.0 million of charges related to a voluntary early retirement plan offered to a select number of wireline employees. These charges primarily represent an enhanced pension benefit offered to the 22 employees who accepted the early retirement offer. Regulatory fees increased $0.9 million and operating taxes increased $2.9 million. In 2007, we resolved a tax dispute which resulted in a $1.2 million operating tax recovery related to a favorable ruling from tax authorities. Additionally, in 2007 we resolved other operating tax matters which favorably impacted 2007 operating tax expense. Finally, 2008 operating taxes increased related to the increase in assets and revenues and other items which are the basis from which these taxes are calculated. Offsetting
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Table of Contentsthese increases was a decrease of $0.6 million relating to legal, accounting and other expenses associated with the secondary stock offering completed in the first quarter of 2007, a $2.6 million decrease in compensation expense due to a decrease in performance-based compensation expense and a $1.3 million decrease in non-cash compensation. Non-cash compensation expense decreased as a result of the final vesting of the majority of our former Class A shares in the second quarter of 2008 (Note 8). DEPRECIATION AND AMORTIZATION EXPENSES— Depreciation and amortization expenses increased $5.9 million, or 6.1%, from 2007 to 2008. This increase is primarily attributable to an increase in accelerated depreciation of $3.5 million related to 3G-1xRTT and other equipment scheduled to be replaced earlier than originally anticipated related to the EV-DO upgrade discussed below and a $1.4 million impairment charge recorded in 2008 related to certain C block PCS spectrum. The spectrum impairment charge reflects the reduction in value of the remaining C block PCS spectrum not in service in two markets to their current estimated net realizable value. In addition to this, normal depreciation increased $2.6 million due to the $97.8 million increase in the average depreciable base, with significant investments in property, plant and equipment during 2007 and 2008, as further discussed in the liquidity and capital resource section below. Partially offsetting this was a $1.7 million year over year decrease in amortization expense related to the change in the remaining useful life of the intangible asset associated with the Strategic Network Alliance with Sprint Nextel due to the extension of the contract period-end to July 2015. As discussed above in the “wireless communications revenue” section, we have upgraded a majority of our coverage areas with EV-DO. During 2007 and 2008, we have recorded $18.3 million and $21.9 million, respectively, in accelerated depreciation primarily on the 3G-1xRTT assets as they have been disposed of or are planned for disposal prior to their previously planned useful lives. We expect to record approximately $4.5 million of additional accelerated depreciation in 2009. ACCRETION OF ASSET RETIREMENT OBLIGATIONS—Accretion 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 $0.2 million in 2008 over 2007 primarily due to cell site expansion. OTHER INCOME (EXPENSES) Interest expense on debt instruments decreased $10.6 million, or 24.6%, from 2007 to 2008 due primarily to the precipitous drop in LIBOR rates and a lower debt balance due to $12.5 million of debt repayment during 2007 and $6.3 million of scheduled debt repayments in 2008. Loss on interest rate swap instrument(s) increased $6.0 million from 2007 to 2008. In February 2008, NTELOS Inc. entered into a new, 18 month interest rate swap agreement which commenced in September 2008 to replace the previous interest rate swap. These swap agreements were not designated as interest rate hedge instruments for accounting purposes and, therefore, the changes in the fair value of the swap agreements were recorded as gain (loss) on interest rate swap. The $9.5 million loss on interest rate swap recorded in 2008 related primarily to the sharp downturn during the fourth quarter in projected LIBOR rates over the remaining life of the swap agreement. The $3.5 million loss recorded in 2007 was a result of the underlying instruments having a fair value of a $3.9 million asset at the end of 2006 compared to a fair value of a $0.3 million asset at December 31, 2007 (included in the securities and investments section of the Consolidated Balance Sheets). The current swap agreement had a fair value of a $9.2 million liability which is included in the long-term liabilities section of the Consolidated Balance Sheets.
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Table of ContentsOther income primarily relates to interest income from cash and cash equivalents. It declined $1.6 million from 2007 to 2008 due to significantly lower short-term investment interest rates partially offset by a higher average cash and cash equivalent balance in the current versus the prior year. INCOME TAXES Income tax expense for the year ended December 31, 2008 was $31.8 million, representing the statutory tax rate applied to pre-tax income and the effects of non-deductible, non-cash stock based compensation. We expect our recurring non-deductible expenses to relate primarily to certain non-cash stock based compensation. The annual amounts of these charges based on equity-based awards outstanding as of December 31, 2008 are projected to be approximately $0.9 million in 2009. Income tax expense for the year ended December 31, 2007 was $24.4 million. The primary permanent differences relate to the effects of non-deductible, non-cash stock based compensation, state minimum taxes, and non-deductible secondary offering transaction costs. We have unused net operating losses (“NOLs”) totaling $178.0 million as of December 31, 2008. These NOLs, along with net unrealized losses existing at the September 2003 bankruptcy emergence date, are subject to an annual utilization limitation of $1.6 million (prior to adjustment for realization of built-in gains that existed as of the 2005 merger, with a maximum limitation of $9.2 million). Based on this limitation and the adjustments required for certain built-in gains realized or to be realized during the five year period immediately following our May 2, 2005 merger, we expect to use NOLs of approximately $152.6 million as follows: $9.2 million per year in 2009 through 2024, $5.1 million in 2025 and $0.8 million in 2026. Year ended December 31, 2007 compared to year ended December 31, 2006 OVERVIEW Operating revenues increased $60.3 million, or 13.7%, from the year ended December 31, 2006 to the year ended December 31, 2007. Wireless PCS accounted for 91.9% of the increase, with growth occurring from subscriber revenues, wholesale revenues and equipment sales. Wireline contributed the remaining revenue increase primarily from minute-driven increases in RLEC access revenues and increases in key strategic products in the Competitive segment, partially offset by declines in other revenues from the Competitive segment (dial-up Internet services, switched access and reciprocal compensation). Operating income increased $39.7 million over the comparative years, from $60.6 million for the year ended December 31, 2006 to $100.2 million for the year ended December 31, 2007. Operating margin, before non-cash compensation, advisory fees and termination of advisory agreements, increased from 19.6% for the year ended December 31, 2006 to 20.9% for the year ended December 31, 2007. Net income increased $39.6 million from a net loss of $7.2 million for the year ended December 31, 2006 to net income of $32.5 million for the year ended December 31, 2007. Included in net loss for the year ended December 31, 2006 was a charge of $12.9 million for the termination of advisory agreements and interest expense that was $16.8 million higher during 2006 than 2007, which related to interest on the Floating Rate Notes (retired in April 2006), $8.7 million of non-recurring interest expense charges related to the early retirement of debt and lower interest during 2007 as a result of the refinancing transaction in June 2006. Non-cash compensation charges were $8.9 million higher during 2006 than 2007 driven by expense recognition commensurate with the IPO. In addition, there was a $12.2 million year-over-year increase in income tax expense, which was primarily driven by the significant change in taxable income.
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Table of ContentsOPERATING REVENUES The following table identifies our external operating revenues on a business segment basis for the years ended December 31, 2007 and 2006:
WIRELESS COMMUNICATIONS REVENUES—Wireless communications revenues increased $55.4 million from the year ended December 31, 2006 to the year ended December 31, 2007 primarily due to an increase in our NTELOS-branded net subscriber revenue of $35.8 million, or 16.0%, an $18.2 million, or 23.4%, increase in wholesale and roaming revenues, and a $1.2 million, or 5.8%, increase in equipment sales revenues related to a 4.4% increase in gross subscriber additions. Subscriber revenues reflected subscriber growth of 10.8%, or approximately 39,600 subscribers, from approximately 367,200 subscribers as of December 31, 2006 to approximately 406,800 subscribers as of December 31, 2007. For the comparative years, subscriber revenues reflected the subscriber growth described above and also reflect an increase in ARPU of 4.5%, from $53.59 to $55.98 for the years ended December 31, 2006 and 2007, respectively. This increase in ARPU is primarily attributable to the continued growth in data services, data packages and higher-priced product offerings. Total data ARPU was $4.67 for the year ended December 31, 2007, up from $2.71 for the year ended December 31, 2006 (see footnote to the ARPU Reconciliation table above). Gross subscriber additions were 4.4% higher for 2007, at approximately 171,700, compared to gross subscriber additions of approximately 164,400 for 2006. This increase in gross additions combined with the introduction of more feature-rich handsets sold in the 2007 period as compared to the 2006 period led to an increase in equipment sales revenue of $1.2 million, or 5.8%, from the year ended December 31, 2006 to the year ended December 31, 2007. Also contributing to the revenue increase was a 35 basis point decrease in total subscriber churn, from 3.18% for the year ended December 31, 2006 (approximately 133,500 subscribers) to 2.83% for the year ended December 31, 2007 (approximately 132,100 subscribers), due to network and service quality improvements and the continued increase in the number of national and unlimited postpay subscriber plans and other program improvements in 2007. The increase in wholesale revenues for the twelve month comparative periods was driven by increased voice and data usage under the Strategic Network Alliance. Wholesale revenues grew 23.4% for the year, from $77.7 million for the year ended December 31, 2006 to $96.0 million for the year ended December 31, 2007. In addition to volume increases experienced on existing cell sites, we have added 70 cell sites within this wholesale service area over the last two years, improving existing service and extending this coverage area. Wholesale pricing reductions under the Strategic Network Alliance went into effect on July 1, 2006 relating to travel minutes of use and data usage in accordance with the annual pricing reset provisions of this wholesale agreement. The impact of the July 2006 pricing reductions was more than offset by increased usage. On July 31, 2007, we entered into an Amended and Restated Resale Agreement (“Agreement”) with Sprint Spectrum L.P, which became effective as of July 1, 2007. The Agreement supersedes and replaces the original 2004 Resale Agreement and extends the term of the original 2004 Resale Agreement, commits us to perform network upgrades and changes pricing structures, including the addition of revenue minimum guarantees as discussed in the 2008 revenue discussions above.
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Table of ContentsWIRELINE COMMUNICATIONS REVENUES—Wireline communications revenues increased $5.0 million over the comparative years.
The access line loss noted above is reflective primarily of residential wireless substitution, second line losses and PBX displacement of Centrex lines. These line losses do not reflect the introduction of competitive voice service offerings, such as from cable companies or CLECs, in our markets.
As discussed in the 2008 revenue section above, intrastate switched access charges, including the access charges of our CLECs, were capped at the higher of the CLEC’s interstate switched access charges or the intrastate switched access charges of the ILEC (or the average of all ILECs) providing service in the geographic area served by the CLEC. The cap takes effect at the end of a transition period that began on December 1, 2007 and ends on March 31, 2008.
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Table of ContentsOPERATING EXPENSES The following table identifies our operating expenses on a business segment basis, consistent with the table presenting operating revenues above, for the years ended December 31, 2007 and 2006:
OPERATING EXPENSES – The following describes our operating expenses by segment and on a basis consistent with our financial statement presentation. The discussion below relates to our operating expenses by segment before non-cash compensation charges, termination of advisory agreements, secondary offering costs, depreciation and amortization, and accretion of asset retirement obligations:
The remaining operating expense increases in wireless communications over the comparative periods were due to increased costs of improving and maintaining our network, combined with direct and indirect costs of sales and services expenses. Specifically, cell site expenses increased $2.3 million related to additional capacity due to the increased subscriber base and a 4.0% increase in the number of cell sites in service from December 31, 2006 to December 31, 2007. Also increasing was customer retention associated with increased wireless PCS customer additions between the comparative periods, existing customer handset upgrades and the increased subscriber base. These costs increased $3.9 million over the comparative years. Compensation expenses also increased $4.6 million over the comparative years reflecting inflationary growth in wages and an increase in personnel to support subscriber growth. Wireless communications experienced a $2.4 million increase in bad debt expense over the comparative years primarily due to an increased level of subscriber revenues and accounts receivable. The remaining increase is due primarily to
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COST OF SALES AND SERVICES—Cost of sales and services increased $14.9 million, or 10.2%, over the comparative years. Roaming COS increased $5.4 million related primarily to increased sales of national plans and other plans which contain more roaming minutes, partially offset by a decline in roaming rates and in-network roaming savings related to continued cell site expansion. The percentage of subscribers with a national plan increased from 25.5% as of December 31, 2006 to 32.8% as of December 31, 2007. Data and other features COS increased $1.8 million over the comparative years consistent with increased data usage. Access and toll COS increased $0.8 million collectively over the comparative years due to volume from fixed rate plans. Equipment COS increased $0.8 million over the comparative years due to approximately 7,300 more wireless gross customer additions in 2007 than 2006, combined with sales of feature-rich, more expensive handsets to new customers and upgrades by existing customers. The remaining increase in cost of sales and services of $6.1 million, or 7.8%, is attributable to increased network related expenses. Partially offsetting the increase over the comparative periods was a decrease in non-cash compensation of $0.7 million related to the original Class A common stock and option instruments held by certain members of operations and engineering management. CUSTOMER OPERATIONS EXPENSES—Customer operations expenses increased $8.9 million, or 8.9%, from the year ended December 31, 2006 to the year ended December 31, 2007. This increase is primarily related to the direct costs associated with increased wireless customer additions between the comparative periods and the related increase in the customer base, as discussed above. The remaining increase is primarily attributable to increased bad debt expenses, as described above, and increases in other collection and customer care driven expenses. The increase over the comparative years was primarily offset by a decrease in non-cash compensation expense of $0.8 million related to the original Class A common stock and option instruments held by certain members of sales, marketing and customer care executive management. CORPORATE OPERATIONS EXPENSES—Corporate operations expenses decreased $2.3 million, or 6.7% from the year ended December 31, 2006 to the year ended December 31, 2007. This decrease primarily relates to a decrease of $7.4 million of non-cash compensation charges, a decrease in advisory fee charges of $0.5 million and a $1.2 million reduction in operating tax reserves based on a favorable ruling from tax authorities, which was refunded in January 2008. Offsetting these decreases was an increase in compensation expenses of $4.3 million, or 38.5%, due primarily to the increase in performance-based bonus expense and inflationary wage increases, and an increase of $0.6 million relating to legal, accounting and other costs associated with the secondary stock offering discussed in the overview section above. The remaining increase is primarily attributable to increases in regulatory fees, other professional fees and sponsorships. DEPRECIATION AND AMORTIZATION EXPENSES—Depreciation and amortization expenses increased $12.1 million, or 14.3%, over the comparative years. Of this increase, $15.9 million is attributable to accelerated depreciation for the period August 1, 2007 through December 31, 2007 related to 3G-1xRTT and other equipment scheduled to be replaced early related to the EV-DO upgrade discussed below. This is offset by accelerated depreciation recorded in 2006 related to other network upgrades. Amortization expense for our customer
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Table of Contentsrelationship intangible related to our Strategic Network Alliance with Sprint Nextel decreased $0.7 million over the comparative years related to the re-evaluation of the intangible asset’s remaining useful life due to the extension of the Sprint contract from April 2012 to July 2015. The remaining decrease of $1.9 million over the comparative years relates to assets becoming fully depreciated, retired or whose life was extended (and future depreciation reduced) as they continued in service beyond the original expected life. ACCRETION OF ASSET RETIREMENT OBLIGATIONS—Accretion 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 was $0.8 million for the years ended December 31, 2006 and 2007. TERMINATION OF ADVISORY AGREEMENTS—On February 13, 2006, commensurate with our IPO, we terminated the advisory agreements, paying a $12.9 million termination fee on that date. OTHER INCOME (EXPENSES) Interest expense on debt instruments decreased $16.8 million, or 28.1%, over the comparative year due primarily to the repayment of the Floating Rate Notes in April 2006. Prior to their repayment, we recorded $5.3 million of interest on the Floating Rate Notes. Additionally, 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 and a $2.3 million prepayment penalty recorded as an interest charge related to the second lien term loan repayment. In addition to the factors causing the decrease in interest expense noted above, interest on our senior credit facilities decreased due to the reduced 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. Our swap agreement is 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. The fair value of the current interest rate swap agreement of $0.3 million at December 31, 2007 has been recorded as “interest rate swap” on the consolidated balance sheets. The interest rate swap agreement matures in February 2008. Other income primarily relates to interest income from cash and cash equivalents. Other income totaled $3.1 million for the year ended December 31, 2007, $1.4 million lower than the prior year due to lower cash balances after our IPO proceeds were used to repay obligations in the second quarter of 2006. We also recorded a gain on sale of investment totaling $1.7 million during the year ended December 31, 2006 related to the redemption of the Rural Telephone Bank (“RTB”) stock in April 2006. INCOME TAXES Income tax expense for the year ended December 31, 2007 was $24.4 million, representing the statutory tax rate applied to pre-tax income and the effects of non-deductible, non-cash stock based compensation, state minimum taxes and non-deductible secondary offering transaction costs. Income tax expense for the year ended December 31, 2006 was $12.2 million. The primary permanent differences relate to 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.
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Table of ContentsQuarterly Results The following table sets forth selected unaudited consolidated quarterly statement of operations data for the four quarters in 2007 and 2008. 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.
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Table of ContentsLiquidity and Capital Resources For the years ended December 31, 2008 and 2007, we funded our working capital requirements, capital expenditures and cash dividend payments from cash on hand and net cash provided from operating activities. 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. As of December 31, 2008, we had $694.0 million in aggregate long term liabilities, consisting of $601.2 million in outstanding long-term debt ($607.9 million including the current portion) and $92.8 million in other long-term liabilities. Our Amended Credit Agreement also includes a revolving credit facility of $35 million (the “Revolving Credit Facility”), which is available for our working capital requirements and other general corporate purposes. While we have received no indication that this would be the case at this time, continued volatility in the financial markets could restrict our ability to draw on the Revolving Credit Facility if any of the lenders, some of whom are large financial institutions, are unable to perform their obligations under this facility. If we were to borrow under our Revolving Credit Facility to obtain additional capital, we would be required to repay such borrowings by the February 24, 2010 expiration date of this facility. Our blended interest rate on our long-term debt as of December 31, 2008 is 4.14%. In addition to the long-term debt from the Amended Credit Agreement, we also enter into capital leases on vehicles used in our operations with lease terms of four to five years. At December 31, 2008, the net present value of these future minimum lease payments was $1.4 million. The aggregate maturities of our long-term debt, excluding capital lease obligations, based on the contractual terms of the instruments are $6.3 million in 2009, $153.6 million in 2010 and $446.6 million in 2011. We have 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 us. This restricted payment basket is increased by $6.5 million per quarter plus an additional amount annually for calculated excess cash flow above $26.0 million, based on the definition in the Credit Agreement, and is decreased by any actual restricted payments. Based on the results for the year ended December 31, 2008, the excess cash flow was below $26.0 million and thus did not affect the restricted payment basket. The restricted payment basket was $34.0 million and $43.4 million as of December 31, 2008 and 2007, respectively. Following the $11.0 million dividend declared on November 5, 2008 and paid on January 12, 2009, the restricted payment basket was further reduced to $23.0 million. 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 (as defined under the Amended Credit Agreement) 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, 2008, we are in compliance with all of our debt covenants, and our ratios at December 31, 2008 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, 2008 are as follows:
During the year ended December 31, 2008, net cash provided by operating activities was approximately $185.3 million. Net income during this period was $47.2 million. We recognized $141.6 million of depreciation, amortization, deferred taxes and other non-cash charges (net). Total net changes in operating assets and liabilities used $3.5 million. The principal changes in operating assets and liabilities from December 31, 2007 to December 31, 2008 were as follows: accounts receivable increased by $5.7 million due to increased revenues of 7.9% and increased accounts receivable aging on December 31 of the respective years; inventories and supplies increased $3.4
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Table of Contentsmillion driven by an increase in demand and thus inventory on hand of higher-priced handsets; other current assets decreased $0.5 million; income tax receivable decreased $11.8 million due primarily to the receipt of a $10.3 million tax refund (as discussed later in this section); accounts payable increased $0.1 million; and other current liabilities decreased $0.7 million. Retirement benefit payments for 2008 were approximately $6.2 million which includes a $5.4 million pension plan funding. During 2008, the pension plan assets declined in value. Pension plan assets were valued at $41.9 million at December 31, 2007 and $29.1 million at December 31, 2008. We made a cash contribution to the pension plan of $5.4 million in March 2008. Payments to participants in 2008 did not change materially from 2007 payment levels. We expect to make cash contributions to the pension plan totaling $9.0 million in 2009. Net periodic benefit cost for 2009 is expected to increase to $4.6 million, from $2.9 million for 2008. During the year ended December 31, 2007, net cash provided by operating activities was approximately $143.9 million. Net income during this period was $32.5 million. We recognized $131.9 million of depreciation, amortization, deferred taxes and other non-cash charges (net). Total net changes in operating assets and liabilities used $20.5 million. The principal changes in operating assets and liabilities from December 31, 2006 to December 31, 2007 were as follows: accounts receivable increased by $7.1 million due to increased revenues of 14%; inventories and supplies increased $2.2 million driven by an increase in demand and thus inventory on hand of higher-priced handsets and increases due to attractive volume purchase incentives; other current assets increased $1.9 million largely related to increases in prepaid maintenance contracts; income tax receivable increased by $11.6 million, representing excess estimated payments resulting after favorable resolution of certain NOL limitation calculations; accounts payable increased by $6.3 million; and other current liabilities increased $2.9 million due primarily to increased advance billings and accrued compensation primarily related to an increase in unpaid annual incentive compensation. Retirement benefit payments for 2007 were approximately $6.9 million which includes a $6.0 million pension plan funding. During the year ended December 31, 2006, net cash provided by operating activities was approximately $97.0 million. Net loss during this period was $7.2 million. 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 and 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. Our cash flows used in investing activities for the year ended December 31, 2008 were approximately $132.4 million used for the purchase of property and equipment comprised of (i) approximately $88.4 million related to our wireless business, including approximately $37.5 million of incremental capital expenditures related to our network upgrade to EV-DO, approximately $19.1 million of continued network coverage expansion and enhancements within our coverage area, approximately $23.0 million of expenditures for 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 approximately $8.8 million to maintain and support our existing networks and other business needs, (ii) approximately $35.1 million for routine capital outlays and facility upgrades supporting our RLEC operations, for the actual and projected growth of our Competitive wireline voice and data offerings, and for fiber deployment in the RLEC territory related to an infrastructure upgrade to offer, among other services, an enhanced broadband service offering and an IPTV-based video service offering, and (iii) approximately $9.0 million related to information technology and corporate expenditures to enhance and maintain the back office support systems.
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Table of ContentsOur cash flows used in investing activities for the year ended December 31, 2007 were approximately $109.6 million used for the purchase of property and equipment comprised of (i) approximately $77.6 million related to our wireless business, including approximately $24.7 million of incremental capital expenditures related to our network upgrade to EV-DO, approximately $16.1 million of continued network coverage expansion and enhancements within our coverage area, approximately $24.2 million of expenditures for 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 approximately $12.6 million to maintain and support our existing networks and other business needs, (ii) approximately $24.6 million for routine capital outlays and facility upgrades supporting our RLEC operations, for the actual and projected growth of our Competitive wireline voice and data offerings, and for 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 third quarter 2007 launch of a new IPTV-based video service offering, and (iii) approximately $7.4 million related to information technology and corporate expenditures to enhance and maintain the back office support systems. Our cash flows used in investing activities for the year ended December 31, 2006 were approximately $83.8 million and include the following:
We currently expect capital expenditures for 2009 to be in the range of $111 million to $119 million, including incremental capital expenditures for an upgrade to our wireless network related to EV-DO. We expect that our capital expenditures associated with our wireless business in 2009 will be in the range of $62 million to $66 million, of which approximately $3 million represents incremental capital expenditures related to our network upgrade to EV-DO, $18 million to $19 million represents continued network coverage expansion and enhancements within our coverage area, $35 million to $38 million represents expenditures for 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 $6 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 2009 will be in the range of $31 million to $34 million, which is targeted to provide normal network facility upgrades 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, continued deployment of fiber to the home and growth in IPTV-based video subscribers. In addition, we expect to invest approximately $11 million to $12 million for a new wireless prepay billing platform which will provide for increased functionality, and a web portal which will enhance the customer interface and allow for more online services. We expect to spend another $7 million for enhancements and upgrades to our other 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.
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Table of ContentsNet cash used in financing activities for the year ended December 31, 2008 aggregated $40.7 million, which primarily represents the following:
Net cash used in financing activities for the year ended December 31, 2007 aggregated $25.1 million, which primarily represents the following:
Net cash provided by financing activities for the year ended December 31, 2006 aggregated $2.8 million, which primarily represents the following:
As of December 31, 2007, we had approximately $53.5 million in cash and cash equivalents and working capital (current assets minus current liabilities) of approximately $45.8 million. As of December 31, 2008, we had approximately $65.7 million in cash and working capital of approximately $53.6 million. Of the cash on hand on December 31, 2008, $62.4 million was held by NTELOS Inc. and its subsidiaries which are subject to usage restrictions pursuant to the Amended Credit Agreement. During March 2008, we applied for an accelerated federal income tax refund, net of a portion of current year estimated tax, of $10.3 million pertaining to tax overpayments existing as of December 31, 2007. The refund was received on April 14, 2008. In 2008, we paid dividends of $0.84 per share in the aggregate, totaling $35.4 million. We paid a dividend of $0.26 per share on January 12, 2009, which was declared on November 4, 2008 for stockholders of record on December 19, 2008 that totaled $11.0 million. On February 26, 2009, the board of directors declared a dividend to be paid on April 13, 2009 to shareholders of record on March 19, 2009 at a rate of $0.26 per share. We intend to continue to pay regular quarterly dividends on our common stock. Any decision to declare future dividends 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 the 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 to make other distributions to our stockholders, including by means of a stock repurchase. Amounts that can be made available to us to pay cash dividends or repurchase stock are restricted by the NTELOS Inc. Amended Credit Agreement (as discussed earlier in this section).
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Table of ContentsWe believe that our current cash balances of $65.7 million and our cash flow from operations will be sufficient to satisfy our foreseeable working capital requirements, capital expenditures and cash dividend payments until December 31, 2010 (assuming we are able to refinance our long-term debt facility prior to December 31, 2010). Our projected capital expenditure levels in 2009 are $111 million to $119 million, substantial amounts of which are for cell site additions and fiber construction which are highly discretionary in nature. If our growth opportunities result in unforeseeable capital expenditures during this period, we may seek additional financing in the future. Additionally, on December 31, 2010, we have our first of four quarterly debt repayments of $153.6 million scheduled for payment which will require refinancing of our long-term debt facility prior to December 31, 2010. 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, 2008:
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.
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Table of ContentsPrinciples of Consolidation The consolidated financial statements include the accounts of the Company, 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 The Company recognizes revenue when services are rendered or when products are delivered, installed and functional, as applicable. Certain services of the Company require payment in advance of service performance. In such cases, the Company records a service liability at the time of billing and subsequently recognizes revenue over the service period. The Company is 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. The Company earns revenue by providing access to and usage of its networks in both its wireline and wireless divisions. 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 generally sold at prices below cost, based on the terms of the service contracts. The Company recognizes the entire cost of the handsets at the time of sale. The Company evaluates related transactions to determine whether they should be viewed as multiple deliverable arrangements, which impact 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 with certain limitations. The Company has determined that sales of handsets with service contracts related to these sales generated from Company owned 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 the related wireless handset is sold based on the fact that the handsets are generally sold below cost and on the relative fair value evaluation. However, revenue and certain associated direct costs for activations sold at third party retail locations are deferred and amortized over the estimated life of the customer relationship as the Company is 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 but are directly associated with the underlying service being provided over the applicable coverage period. In all cases, the direct activation costs exceed the related activation revenues. When deferral is appropriate, the Company defers these direct activation costs up to but not in excess of the related deferred revenue. The Company periodically makes claims for recovery of access charges on certain minutes of use terminated by the Company on behalf of other carriers. The Company recognizes revenue in the period that it is able to estimate the amount and when the collection of such amount is considered probable. Accounts Receivable The Company sells its services to residential and commercial end-users and to other communication carriers primarily in Virginia and West Virginia. The Company has credit and collection policies to ensure collection of trade receivables and requires deposits on certain sales. The Company maintains an allowance for doubtful accounts based on historical results, current and expected trends and changes in credit policies. Management believes the allowance adequately covers all anticipated losses with respect to trade receivables. Actual credit losses could differ from such estimates. Inventories and Supplies The Company’s inventories and supplies consist primarily of items held for resale such as PCS handsets and accessories, and wireline business phones and accessories. The Company values its 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.
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Table of ContentsLong-lived Asset Recovery Long-lived assets include property, plant 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 (“SFAS No. 144”). Impairment is determined by comparing the carrying value of these long-lived assets to management’s best estimate of future undiscounted cash flows expected to result from the use of the assets. If the carrying value exceeds the estimated undiscounted cash flows, the impairment is measured as the excess of carrying value over the estimated fair value. In 2007, the Company tested for impairment of its wireless segment assets in accordance with SFAS No. 144 based on the planned Evolution-Data Optimized Revision A (“EV-DO”) upgrade. No impairment existed then and the Company believes that no other impairment indicators existed between then and December 31, 2008 that would require it to perform further impairment testing. Depreciation of property, plant and equipment is calculated on a straight-line basis over the estimated useful lives of the assets, which the Company reviews and updates based on historical experiences and future expectations. Buildings are depreciated over a 50-year life and leasehold improvements, which are categorized with land and buildings, are depreciated over the shorter of the estimated useful lives or the remaining lease terms. Network plant and equipment are depreciated over various lives from 3 to 50 years, with a weighted average life of approximately 10 years. Furniture, fixtures and other equipment are depreciated over various lives from 2 to 24 years. 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. The Company assesses the recoverability of indefinite-lived assets annually on October 1 and whenever adverse events or changes in circumstances indicate that impairment may have occurred. The Company has PCS radio spectrum licenses with a book value of $2.8 million in two markets where it is not currently providing service and which have build-out requirements in June 2009. The Company has executed a long term lease agreement and a license purchase agreement that establish the framework for assistance with meeting the build-out requirements in exchange for transferring a portion of each license. Therefore, the Company has recorded a $1.4 million impairment ($0.9 million after income tax) on these licenses, reflecting the reduction in value of the remaining PCS spectrum licenses not in service in these markets to their current estimated net realizable value. This impairment has been classified within depreciation and amortization on the Consolidated Statement of Operations for the year ended December 31, 2008. Based on the Company’s evaluation of fair value of its other licenses not in service, as well as its licenses in service, all of which represent the Company’s indefinite-lived intangible assets, no impairment existed as of October 1, 2008. Additionally, the Company tested goodwill for impairment at October 1, 2008 and determined that it was not impaired. The Company reviewed the results of the testing for goodwill and licenses as of December 31, 2008 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, 2008. 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 hired on or after October 1, 2003. Pension benefits vest after five years of service and are based on years of service and an average of the five highest consecutive years of compensation subject to certain reductions if the employee retires before reaching age 65 and elects to receive the benefit prior to age 65.
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Table of ContentsSections 412 and 430 of the Internal Revenue Code and ERISA Sections 302 and 303 establish minimum funding requirements for defined benefit pension plans. The minimum required contribution is generally equal to the target normal cost plus the shortfall amortization installments for the current plan year and each of the six preceding plan years. If plan assets are equal to or exceed the funding target, the minimum required contribution is the target normal cost reduced by the excess funding, but not below zero. The Company’s policy is to make contributions to stay at or above the threshold required in order to prevent plan restrictions and related additional notice requirements 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. Also, NTELOS Inc. has nonqualified pension plans that are accounted for 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 Company’s share of the projected 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 accordance with the requirements of FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS No. 158), the Company began measuring these plans assets and liabilities on December 31 in 2008. Prior to 2008, the Company measured applicable assets and liabilities of these plans on September 30 of each year. The Company applied the measurement date provisions required by SFAS No. 158 for its Pension Plan, Other Postretirement Benefit plan and nonqualified pension plans in the first quarter of 2008. The Company elected to continue to use the measurements determined for the prior fiscal year-end reporting based on a September 30, 2007 measurement date to estimate the effects of the change and, accordingly, an adjustment was made to retained earnings for the portion of the net periodic benefit cost relating to the period between September 30, 2007 and December 31, 2007. The effects of this change are reported in the Consolidated Statement of Stockholders’ Equity. NTELOS Inc. also sponsors a contributory defined contribution plan under Internal Revenue Code Section 401(k) for substantially all employees. The Company’s policy is to match 100% of each participant’s annual contributions for contributions up to 1% of each participant’s annual compensation and 50% of each participant’s annual contributions up to an additional 5% of each participant’s annual compensation. Company contributions vest after two years of service. Income Taxes 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. The Company accrues interest and penalties related to unrecognized tax benefits in interest expense and income tax expense, respectively. Recent Accounting Pronouncements In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement. 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 adopted SFAS No. 157 beginning on January 1, 2008. However, the effective date of SFAS No. 157 as it relates to fair value measurement requirements for nonfinancial assets and liabilities that are not re-measured at fair value on a recurring basis has been deferred to fiscal years beginning after November 15, 2008. SFAS No. 157 is required to be applied prospectively, except for certain financial instruments. The effect of adoption was immaterial to the Company and resulted in expanded disclosures regarding its interest rate swap. In December 2007, the FASB issued SFAS No. 141R, Business Combinations. SFAS No. 141R requires most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at “full fair value.” Statement 141R applies to all business combinations, including combinations among mutual entities and combinations by contract alone. Under SFAS No. 141R, all business combinations will be accounted for by applying the acquisition method. Statement 141R is effective for periods beginning on or after December 15, 2008. SFAS No. 141R will be applied to business combinations occurring after the effective date.
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Table of ContentsIn December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51. SFAS No. 160 will require noncontrolling interests (previously referred to as minority interests) to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. The Statement applies to the accounting for noncontrolling interests and transactions with noncontrolling interest holders in the consolidated financial statements. SFAS No. 160 is effective for periods beginning on or after December 15, 2008. SFAS No. 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date except that comparative period information will be recast to classify noncontrolling interests in equity, attributable to net income and other comprehensive income to noncontrolling interests, and provide other disclosures required by SFAS No. 160. In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 requires companies with derivative instruments to disclose information about how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. The Statement expands the current disclosure framework in SFAS No. 133. SFAS No. 161 is effective prospectively for periods beginning on or after November 15, 2008. In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets. Under the FSP, companies estimating the useful life of a recognized intangible asset must consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, must consider assumptions that market participants would use about renewal or extension as adjusted for Statement 142’s entity-specific factors. The guidance is restricted to estimating the useful life of recognized intangible assets; it contains no guidance on how to measure or amortize them or account for the costs of renewals. The FSP also adds disclosures to those already required by SFAS No. 142. This FSP is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. The Company expects to apply the provisions of this FSP prospectively to intangible assets acquired after the effective date of this FSP and will apply the increased disclosure requirements for all intangible assets recognized as of, and subsequent to, the effective date of this FSP. In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. This FSP will require unvested share-based payments that entitle employees to receive nonrefundable dividends to also be considered participating securities. This FSP is effective for fiscal years beginning after December 15, 2008 and interim periods within those years, and early adoption is prohibited. The Company is currently evaluating the impact of this FSP on its calculation of earnings per share. In December 2008, the FASB issued FSP FAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets. This FSP provides guidance on an employers’ disclosures about plan assets of a defined benefit pension or other postretirement plan. The disclosures about plan assets required by FSP FAS 132(R)-1 shall be provided for fiscal years ending after December 15, 2009. Upon initial application, the provisions of this FSP are not required for earlier periods that are presented for comparative purposes. The Company is currently evaluating the impact of this FSP on its disclosure requirements for fiscal year 2009. In November 2008, the FASB issued EITF 08-7, Accounting for Defensive Intangible Assets. EITF 08-7 applies to acquired intangible assets in situations in which an entity does not intend to actively use the asset but intends to hold (lock up) the asset to prevent others from obtaining access to the asset (a defensive intangible asset), except for intangible assets that are used in R&D activities. The consensus specifies that a defensive intangible asset should be accounted for as a separate unit of accounting and must be assigned a useful life in accordance with paragraph 11 of FASB Statement No. 142, Goodwill and Other Intangible Assets. EITF 08-7 is effective for intangible assets acquired on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company will apply the guidance in EITF 08-7 for any defensive intangible assets acquired on or after January 1, 2009. In November 2008, the FASB issued EITF 08-6, Equity Method Investment Accounting Considerations. EITF 08-6 applies to all investments accounted for under the equity method and clarifies the accounting for certain transactions and impairment considerations involving these investments. EITF 08-6 is effective in fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. The Company currently has no investments accounted for under the equity method.
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We are exposed to market risks primarily related to interest rates. As of December 31, 2008, $606.5 million was outstanding under the First Lien Term Loan. As of December 31, 2008, NTELOS Inc. had a leverage ratio of 2.65:1.00 and an interest coverage ratio of 7.09:1.00, 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 in the form of capital leases totaling $1.4 million as of December 31, 2008. We have a $600.0 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 4.91%. Our swap counterparty’s variable rate payments are based on three month U.S. Dollar LIBOR, which was 1.44% as of December 31, 2008. 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 $600.0 million covered by the swap agreement ($6.5 million at December 31, 2008) and we could be exposed to loss if the counterparty to the swap agreement defaults. This swap agreement matures in March 2010. During 2008, the counterparty to the interest rate swap experienced liquidity problems and in June 2008 merged with another prominent financial institution. We were notified that the swap was guaranteed and a formal legal novation occurred on November 6, 2008. The acquiring financial institution has a strong credit rating and, accordingly, we did not adjust the value of the swap asset for credit risk exposure. At December 31, 2008, our financial assets included cash of $65.7 million, of which $64.2 million was invested in a money rate savings account. We invest cash not used in daily operations in a money market account held by a high credit quality financial institution that is available on demand. This account is subject to the FDIC insurance limit of $250,000. Other securities and investments totaled $0.8 million at December 31, 2008. The following sensitivity analysis indicates the impact at December 31, 2008, 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:
A ten percent increase or decrease in interest rates would result in a change of $5.6 million in interest expense for 2009, based on an assumption that the LIBOR rate at December 31, 2008 remained unchanged throughout 2009 and that $600 million of the Senior credit facility is covered by the swap agreement at a LIBOR rate of 2.66%.
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NTELOS HOLDINGS CORP. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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Table of ContentsReport 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, 2008 and 2007, and the related consolidated statements of operations, cash flows, and stockholders’ equity for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s 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, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. As discussed in notes 2, 10 and 11 to the accompanying consolidated financial statements, effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, and effective December 31, 2006, the Company adopted Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
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Table of ContentsConsolidated Balance Sheets NTELOS Holdings Corp.
See accompanying Notes to Consolidated Financial Statements.
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Table of ContentsConsolidated Balance Sheets NTELOS Holdings Corp.
See accompanying Notes to Consolidated Financial Statements.
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Table of ContentsConsolidated Statements of Operations NTELOS Holdings Corp.
See accompanying Notes to Consolidated Financial Statements.
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Table of ContentsConsolidated Statements of Cash Flows NTELOS Holdings Corp.
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