SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Income Taxes Other Results of Continuing Operations 2003 compared to 2002 subsidy. The Company does not receive any revenues from the sale of handsets and accessories by national retailers. The Company classifies these handset subsidy charges as a cost of goods expense. participates in the Sprint national and regional distribution programs in which national retailers sell Sprint wireless products and services. In order to facilitate the sale of Sprint wireless products and services, national retailers purchase wireless handsets from Sprint for resale and receive compensation from Sprint for Sprint wireless products and services sold. For industry competitive reasons, Sprint subsidizes the price of these handsets by selling the handsets at a price below cost. Under the Company’s agreements with Sprint, when a national retailer sells a handset purchased from Sprint to a subscriber in the Company’s territories, the Company is obligated to reimburse Sprint for the handset Through December 31, 2003, the Agreement provided that Sprint retains 8% of collected service revenues from subscribers based in the Company’s markets and from non-Sprint wholesale subscribers who roam onto the Company’s network. The amount of revenue retained by Sprint is recorded as an offset to the revenues recorded. All revenues derived from the sale of handsets and accessories by the Company and from certain roaming services (outbound roaming and travel revenues from Sprint and its PCS Affiliate subscribers) are retained by the Company. Income Taxes The Company defers direct subscriber activation costs on subscribers whose activation falls within the SAB 101 guidelines. The activation costs are deferred when incurred, and then amortized using the straight-line method over 30 months, which is the estimated average life of a subscriber. Direct subscriber activation costs also include the activation charge from Sprint, and credit check fees. These fees are charged to the Company by Sprint at approximate $12.50 per subscriber. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company evaluates the recoverability of tax assets generated on a state-by-state basis from net operating losses apportioned to that state. Management uses a more likely than not threshold to make that determination and has established a valuation allowance against the tax assets, in case they are not recoverable. For 2003, the Company added an additional reserve of $0.2 million to its valuation allowance due to the uncertainty of the recoverability of the net operating loss carry-forwards in certain states. The valuation allowance now stands at $0.9 million as of December 31, 2003. Management will evaluate the effective rate of taxes based on apportionment factors, the Company’s operating results, and the various state income tax rates. Currently, management anticipates the normalized effective income tax rate to be approximately 39%. The Company does not have any unrecorded off-balance sheet transactions or arrangements, however, the Company has commitments under operating leases and is subject to certain capital calls under one of its investments. Total revenue was $105.9 million in 2003, an increase of $12.9 million or 13.9%. Total revenues included $70.0 million of wireless revenues, an increase of $12.0 million or 20.7%; wireline revenues of $29.0 million, an increase of $0.3 million or 0.9%; and other revenues of $7.0 million, an increase of $0.6 million or 9.7%. Within wireless revenues, the PCS operation contributed $69.8 million, an increase of $11.6 million, or 20.8%. PCS service revenues were $44.4 million, an increase of $10.9 million or 32.4%. Service revenue growth was driven by the increase in subscribers, totaling 85,139 at December 31, 2003, an increase of 17,297 or 25.5%, compared to 67,842 subscribers at year-end 2002. The company had churn of 2.1% in 2003 compared to 2.8% in 2002. The decline in the churn rate is the result of tightening the credit screening for new subscribers as well as continued efforts to improve the after sales support. Competition in the wireless industry continues to have a significant impact on the results of the Company’s PCS operation. PCS travel revenue, including reseller revenue, which is compensation between Sprint and its PCS Affiliates for use of the other party’s network, was $16.8  million, an increase of $0.3 million or 1.8%. Travel revenue is impacted by the geographic size of the Company’s network service area, the overall number of Sprint wireless customers, their travel patterns and the travel exchange rate. The rate received on travel was $0.058 per minute in 2003, compared to $0.10 per minute in 2002. As a part of the amended management agreement signed on January 30, 2004, Sprint and the Company agreed to maintain the travel rate at $0.058 per minute through December 31, 2006. 45 ■  2003 ANNUAL REPORT