UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-556
SUREWEST COMMUNICATIONS
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
California 68-0365195
- --------------------------------------- --------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
200 Vernon Street, Roseville, California 95678
- ---------------------------------------- ----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (916) 786-6141
--------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock - Without Par Value
(Title of class)
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.
Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of August 5, 2003, 14,537,144 shares of the registrant's Common Stock were
outstanding.
SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Amounts in thousands, except per share amounts)
Quarter Quarter Six Months Six Months
Ended Ended Ended Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
Operating revenues:
Local service $16,292 $16,436 $31,288 $32,950
Network access service 13,984 12,843 27,401 26,145
Directory advertising 3,705 3,616 7,543 7,354
Long distance service 1,257 1,332 2,510 2,659
Wireless service 6,686 5,943 13,189 11,269
Internet service 3,957 1,423 7,671 2,761
Residential broadband service 2,276 - 4,143 -
Business broadband service 917 578 1,667 1,029
Other 1,215 947 2,306 2,402
------- ------- ------- -------
Total operating revenues 50,289 43,118 97,718 86,569
Operating expenses:
Cost of services and products 13,947 14,444 28,652 28,464
Customer operations and selling 8,407 7,216 17,089 15,331
General and administrative 9,857 7,385 19,607 13,124
Depreciation and amortization 12,511 11,026 24,898 21,474
------- ------- ------- -------
Total operating expenses 44,722 40,071 90,246 78,393
------- ------- ------- -------
Income from operations 5,567 3,047 7,472 8,176
Other income (expense):
Interest income 354 225 437 428
Interest expense (1,262) (337) (2,094) (699)
Gain on sale of alarm
monitoring assets - - - 4,435
Other, net (29) (82) (56) (107)
------- ------- ------- -------
Total other (expense)income,
net (937) (194) (1,713) 4,057
------- ------- ------- -------
Income before income taxes 4,630 2,853 5,759 12,233
Income taxes 1,917 1,150 2,371 4,921
------- ------- ------- -------
Net income $ 2,713 $ 1,703 $ 3,388 $ 7,312
======= ======= ======= =======
Basic and diluted earnings per
share (1) $ 0.19 $ 0.12 $ 0.23 $ 0.49
Cash dividends per share (2) $ 0.25 $ 0.25 $ 0.50 $ 0.50
======= ======= ======= =======
Shares of common stock used to
calculate earnings per share 14,521 14,775 14,521 15,006
======= ======= ======= =======
(1) Shares used in the computation of basic earnings per share are based on the
weighted average number of common shares outstanding, excluding unvested
restricted common shares. Shares used in the computation of diluted
earnings per share are based on the weighted average number of common and
other potentially dilutive securities outstanding in each period.
(2) Cash dividends per share are based on the actual dividends per share, as
declared by the Company's Board of Directors.
See accompanying notes.
SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands)
June 30, 2003 December 31, 2002
------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 27,609 $ 20,385
Short-term investments 38,763 -
Accounts receivable, net 20,841 19,747
Refundable income taxes 8,317 6,868
Inventories 6,249 4,649
Deferred directory costs 4,410 3,657
Prepaid expenses and other current assets 3,051 2,325
-------- --------
Total current assets 109,240 57,631
Property, plant and equipment, net 325,956 320,261
Intangible and other assets:
Wireless licenses, net 13,566 13,566
Goodwill 2,171 2,171
Intangible asset relating to pension
plans 1,507 1,507
Intangible asset relating
to favorable operating leases, net 721 1,260
Deferred charges and other assets 706 343
-------- --------
18,671 18,847
-------- --------
$453,867 $396,739
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt $ 4,708 $ 5,779
Current portion of capital lease
obligations 319 309
Accounts payable and other accrued
liabilities 11,601 7,112
Estimated shareable earnings obligations 12,121 9,350
Advance billings and deferred revenues 9,697 8,142
Accrued pension benefits 8,803 5,613
Accrued compensation 5,585 4,902
-------- --------
Total current liabilities 52,834 41,207
Short-term borrowings refinanced on a
long-term basis - 15,000
Long-term debt 96,364 36,364
Long-term capital lease obligations 451 607
Deferred income taxes 31,440 26,552
Other liabilities and deferred revenues 7,524 8,004
Commitments and contingencies
See accompanying notes.
SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(Unaudited)
(Amounts in thousands)
June 30, 2003 December 31, 2002
-------------- -----------------
Shareholders' equity:
Common stock, without par value;
100,000 shares authorized, 14,537 and 14,529 shares issued
and outstanding at June 30, 2003 and December 31, 2002,
respectively 158,782 158,567
Deferred stock-based compensation (202) (116)
Accumulated other comprehensive loss (1,637) (1,637)
Retained earnings 108,311 112,191
-------- --------
Total shareholders' equity 265,254 269,005
-------- --------
$453,867 $396,739
======== ========
See accompanying notes.
SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(Unaudited)
(Amounts in thousands)
Six Months Six Months
Ended Ended
June 30, 2003 June 30, 2002
-------------- --------------
Net cash provided by
operating activities $40,175 $19,681
Cash flows from investing activities:
Deposit for the purchase of substantially
all of the assets of Western Integrated
Networks, LLC - (700)
Proceeds from sale of alarm
monitoring division - 4,495
Capital expenditures for property, plant
and equipment (30,423) (26,602)
Purchases of short-term investments (38,763) -
Maturities of held-to-maturity investments - 1,723
Changes in deferred charges and other
assets (425) 6
------- -------
Net cash used in investing activities (69,611) (21,078)
Cash flows from financing activities:
Repayment of short-term borrowings (15,000) -
Proceeds from long-term debt 60,000 -
Principal payments of long-term debt (1,072) (1,071)
Dividends paid (7,268) (7,479)
Repurchase of common stock - (28,220)
Proceeds from exercise of stock options - 726
------- -------
Net cash provided by (used in)
financing activities 36,660 (36,044)
------- -------
Increase (decrease) in cash and cash
equivalents 7,224 (37,441)
Cash and cash equivalents at beginning of
period 20,385 54,520
------- -------
Cash and cash equivalents at end of
period $27,609 $17,079
======= =======
See accompanying notes.
SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except share and per share amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The condensed consolidated financial statements of SureWest Communications
(the "Company") have been prepared in accordance with accounting principles
generally accepted in the United States for interim financial information
and pursuant to the rules and regulations of the Securities and Exchange
Commission (the "SEC"). In the opinion of management, all adjustments
(consisting only of normal recurring adjustments) considered necessary for
fair presentation of the results for the interim periods shown have been
included. Certain information and footnote disclosures normally included in
annual financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to such SEC rules and regulations and accounting
principles applicable for interim periods. Management believes that the
disclosures made are adequate to make the information presented not
misleading. These condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements and notes
thereto included in the Company's 2002 Annual Report on Form 10-K filed
with the SEC.
The Company is a holding company with wholly-owned subsidiaries that
provide integrated communications services. The Company's principal
operating subsidiary is Roseville Telephone Company ("Roseville
Telephone"). SureWest Directories, Roseville Long Distance Company
("Roseville Long Distance"), SureWest Broadband, SureWest Wireless and
SureWest Televideo ("SureWest Broadband/Residential Services") are each
subsidiaries of the Company. The Company expects that the sources of its
revenues and its cost structure may be different in future periods as a
result of its entry into new communications markets.
On July 12, 2002, the Company purchased substantially all of the assets of
Western Integrated Networks, LLC and certain affiliates (collectively,
"WIN") in a transaction supervised by the United States Bankruptcy Court
for the District of Colorado. The purchase price for the assets of WIN
consisted of (i) $12,000 in cash, (ii) direct acquisition costs of $622 and
(iii) the assumption of certain current liabilities aggregating $4,717
relating principally to executory contracts and capital lease obligations.
Prior to July 12, 2003, the Company obtained additional information
regarding the fair values of certain assets acquired and liabilities
assumed from WIN. Accordingly, the Company has prospectively adjusted the
preliminary purchase price allocation in connection with the preparation of
its second quarter 2003 condensed consolidated financial statements. The
following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition, July 12, 2002, based on
the Company's final allocation of the aforementioned purchase price:
Accounts receivable, net $ 615
Equipment held for sale 2,573
Other current assets 931
Property, plant and equipment 12,327
Intangible asset relating
to favorable operating leases 893
-------
Total assets acquired 17,339
Current liabilities assumed under
executory contracts 3,483
Liabilities assumed under capital
lease obligations 1,064
Other liabilities 170
-------
Total liabilities assumed 4,717
-------
$12,622
Net assets acquired =======
On January 25, 2002, the Company sold substantially all of the assets of
its alarm monitoring division, which was a component of the Telecom
segment, for approximately $5,150. This sale resulted in a pre-tax gain of
$4,435 during 2002. Through June 30, 2003, the Company had received cash
proceeds of $4,995, of which $4,495 and $500 were received during 2002 and
the fourth quarter of 2001, respectively. The alarm monitoring assets
consisted primarily of customer contracts and equipment, which had a net
book value of approximately $355 as of the date of the sale. The purchaser
of the assets commenced litigation against the Company relating to claims
under the asset agreement, generally in connection with certain contracts
assigned to the purchaser. On July 17, 2003, the Company and the purchaser
settled the litigation and the Company agreed to pay the purchaser $375.
Accordingly, the Company accrued this settlement liability as of June 30,
2003 through a charge to general and administrative expense for the three
months ended June 30, 2003. Total operating revenues attributable to the
Company's alarm monitoring division during the quarter and year to date
periods ended June 30, 2002 were $279 (none in 2003).
On May 17, 2002, the Company's shareholders approved a proposal to change
the Company's state of incorporation from California to Delaware. In
addition, the shareholders approved an increase of the Company's authorized
common stock from 100 million shares to 200 million shares with a par value
of $0.01 and also authorized 10 million shares of preferred stock with a
par value of $0.01. The enactment of the aforementioned approvals was left
to the discretion of the Board of Directors. At present, the
reincorporation has not been implemented, but is anticipated to occur in
2003.
Stock-based compensation
The Company accounts for stock-based awards to (i) employees using the
intrinsic value method and (ii) non-employees using the fair value method.
Under the intrinsic value method, when the exercise price of the Company's
employee stock options equals or exceeds the market price of the underlying
stock on the date of grant, no compensation expense is recognized. The
following table illustrates the pro forma effect on net income and earnings
per share for the quarters and six months ended June 30, 2003 and 2002 had
the Company applied the fair value method to account for stock-based awards
to employees:
Quarter Quarter Six Months Six Months
Ended Ended Ended Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------------- ------------------- ------------------- -------------------
Net income, as reported $ 2,713 $ 1,703 $ 3,388 $ 7,312
Add stock-based employee
compensation expense included
in the determination of net
income as reported, net of tax 36 29 76 72
Less stock-based employee
compensation expense that would
have been included in the determination
of net income if the fair value method
had been applied to all
awards, net of tax (350) (315) (706) (612)
------------- ------------ ------------ ------------
Pro forma net income $ 2,399 $ 1,417 $ 2,758 $ 6,772
============= ============ ============ ============
Basic net income per share:
As reported $ 0.19 $ 0.12 $ 0.23 $ 0.49
Pro forma $ 0.17 $ 0.10 $ 0.19 $ 0.45
Diluted net income per share:
As reported $ 0.19 $ 0.12 $ 0.23 $ 0.49
Pro forma $ 0.17 $ 0.10 $ 0.19 $ 0.45
Comprehensive Income
Significant components of the Company's comprehensive income (loss) are as follows:
Quarter Ended Six Months Ended
Cumulative June 30, June 30,
Amounts 2003 2002 2003 2002
------------------- -- ------------ ------------- -- ------------ ------------
Net income $108,311 $2,713 $1,703 $3,388 $7,312
Minimum pension and
post-retirement
benefit liability
adjustment, net of
income taxes (1,637) - - - -
-------- ------ ------ ------ ------
Comprehensive income $106,674 $2,713 $1,703 $3,388 $7,312
======== ====== ====== ====== ======
Cumulative effect of change in accounting principle
The Company adopted SEC Staff Accounting Bulletin ("SAB") No. 101, "Revenue
Recognition in Financial Statements," effective January 1, 2000, which
requires non-recurring revenues associated with service and activation
charges to be deferred. The cumulative effect of this change in accounting
principle was $3,273, net of tax, ($0.21 per share) in 2000.
For the three-month periods ended March 31 and June 30, 2003 and 2002, the
Company recognized the following revenues that were included in the
cumulative effect adjustment as of January 1, 2000:
Three Months Ended:
March 31, 2003 $128
June 30, 2003 $114
March 31, 2002 $298
June 30, 2002 $251
The net effect of these revenues in 2003 was to increase net income in the
three-month periods ended March 31 and June 30 by $75 and $68,
respectively.
The net effect of these revenues in 2002 was to increase net income in the
three-month periods ended March 31 and June 30 by $178 and $150,
respectively.
Reclassifications
Certain amounts in the Company's 2002 condensed consolidated financial
statements have been reclassified to conform with the presentation of its
2003 condensed consolidated financial statements.
2. BUSINESS SEGMENTS
The Company has three reportable business segments: Telecom, Broadband and
Wireless. The Telecom segment primarily provides local, network access and
long distance services, directory advertising services, and the sale of
certain non-regulated products and services principally to customers
residing in Roseville Telephone's service area. The Broadband segment
provides various services including high-speed and dial-up Internet,
digital cable, local, network access and toll telephone and managed
services in the greater Sacramento area, principally to customers residing
outside of Roseville Telephone's service area. This segment includes the
Company's subsidiaries SureWest Broadband and SureWest Broadband
Residential Services. SureWest Broadband is comprised, in part, of a
division of Roseville Telephone operating as a Competitive Local Exchange
Carrier. The Wireless segment provides wireless services and the sale of
related communications equipment. Corporate operations includes: cash;
investments; certain property, plant, and equipment and miscellaneous other
assets not allocated to the segments. However, the investment income
associated with cash and investments held by Corporate Operations is
included in the results of the operations of the Company's segments.
These segments are strategic business units that offer different products
and services. The Company accounts for intersegment revenues and expenses
at prevailing market rates. The Company's business segment information is
as follows (the Company's 2002 business segment information has been
restated to conform to the Company's organizational structure in 2003):
For the three months Corporate Intercompany
ended June 30, 2003 Telecom Broadband Wireless Operations Eliminations Consolidated
-------- --------- -------- -------- ------------ ------------
Operating revenues
from external
customers $36,453 $ 7,150 $6,686 $ - $ - $50,289
Intersegment revenues 5,867 254 146 - (6,267) -
Operating expenses 19,996 10,389 8,093 - (6,267) 32,211
Depreciation and
Amortization 7,691 965 3,855 - - 12,511
Income (loss) from
Operations 14,633 (3,950) (5,116) - - 5,567
Net income (loss) $ 8,727 $(2,727) $(3,287) $ - $ - $ 2,713
2. BUSINESS SEGMENTS (CONTINUED)
For the three months Corporate Intercompany
ended June 30, 2002 Telecom Broadband Wireless Operations Eliminations Consolidated
------- --------- -------- -------- ------------ ------------
Operating revenues
from external
Customers $35,174 $ 2,001 $ 5,943 $ - $ - $43,118
Intersegment revenues 3,781 70 99 - (3,950) -
Operating expenses 22,060 3,020 7,915 - (3,950) 29,045
Depreciation and
Amortization 6,926 372 3,728 - - 11,026
Income (loss) from
Operations 9,969 (1,321) (5,601) - - 3,047
Net income (loss) $ 6,068 $ (761) $(3,604) $ - $ - $ 1,703
As of and for the
six months ended Corporate Intercompany
June 30, 2003 Telecom Broadband Wireless Operations Eliminations Consolidated
-------- --------- -------- -------- ------------ ------------
Operating revenues
from external
Customers $ 71,048 $13,481 $ 13,189 $ - $ - $ 97,718
Intersegment revenues 11,390 782 302 - (12,474) -
Operating expenses 41,471 20,544 15,807 - (12,474) 65,348
Depreciation and
Amortization 15,450 1,814 7,634 - - 24,898
Income (loss) from
Operations 25,517 (8,095) (9,950) - - 7,472
Net income (loss) 15,096 (5,321) (6,387) - - 3,388
Total assets $555,390 $85,315 $132,380 $68,489 $(387,707) $453,867
As of and for the
six months ended Corporate Intercompany
June 30, 2002 Telecom Broadband Wireless Operations Eliminations Consolidated
------- --------- -------- -------- ------------ ------------
Operating revenues
from external
Customers $ 71,510 $ 3,790 $ 11,269 $ - $ - $ 86,569
Intersegment revenues 7,711 116 191 - (8,018) -
Operating expenses 42,384 5,758 16,795 - (8,018) 56,919
Depreciation and
Amortization 13,512 640 7,322 - - 21,474
Income (loss) from
Operations 23,325 (2,492) (12,657) - - 8,176
Net income (loss) 16,820 (1,449) (8,059) - - 7,312
Total assets $492,629 $38,163 $129,751 $16,973 $(300,796) $376,720
3. RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting
for Costs Associated with an Exit or Disposal Activity." SFAS No. 146
revises the accounting for exit and disposal activities under Emerging
Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)," by extending the
period in which expenses related to restructuring activities are reported.
A commitment to a plan to exit an activity or dispose of long-lived assets
is no longer sufficient to record a one-time charge for most restructuring
activities. Instead, companies will record exit or disposal costs when they
are "incurred" and can be measured at fair value. In addition, the
resultant liabilities must be
3. RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)
subsequently adjusted for changes in estimated cash flows. The Company
adopted SFAS No. 146 on January 1, 2003, and the adoption of this new
standard did not have a material effect on the Company's condensed
consolidated financial statements as of and for the quarter and six-month
period ended June 30, 2003.
On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends
SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for an entity that voluntarily changes to
the fair value method of accounting for stock-based employee compensation.
In addition, it also amends the disclosure provisions of SFAS No. 123 to
require prominent disclosure about the effects on reported net income
including per share amounts, of an entity's accounting policy decisions
with respect to stock-based employee compensation in annual and interim
financial statements. SFAS No. 148 does not amend SFAS No. 123 to require
companies to account for their stock-based employee compensation using the
fair value method. The disclosure provisions of SFAS No. 123 were effective
immediately in 2002. As of June 30, 2003, the Company does not have any
immediate plans to change its method of accounting for stock-based employee
compensation to the fair value method.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made.
The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. The Company adopted SFAS No. 143
on January 1, 2003. The adoption of this new standard did not have a
material effect on the Company's condensed consolidated financial
statements as of and for the quarter and six-month period ended June 30,
2003.
In October 2002, the FASB's EITF reached a consensus on EITF Issue No.
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Under EITF Issue No. 00-21, revenue arrangements with multiple deliverables
are required to be divided into separate units of accounting under certain
circumstances. The Company will prospectively adopt EITF Issue No. 00-21
for arrangements entered into beginning after June 30, 2003, and it does
not believe the adoption of this new guidance will have a material effect
on its condensed consolidated financial statements.
In November 2002, the FASB issued interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN No. 45
requires certain guarantees to be recorded at fair value, which is
different from current practice, which is generally to record a liability
only when a loss is probable and reasonably estimable. FIN No. 45 also
requires a guarantor to make significant new disclosures, even when the
likelihood of making any payments under the guarantee is remote. The
disclosure provisions of FIN No. 45 were effective immediately in 2002. The
Company adopted the recognition and measurement provisions of FIN No. 45 on
a prospective basis with respect to guarantees issued or modified after
December 31, 2002. The adoption of the recognition and measurement
provisions of FIN No. 45 did not have a material effect on the Company's
condensed consolidated financial statements as of and for the quarter and
six-month period ended June 30, 2003.
4. ESTIMATED SHAREABLE EARNINGS OBLIGATIONS
Roseville Telephone's revenues from certain telephone services are affected
by rates authorized by various regulatory agencies. Intrastate service
rates are subject to regulation by the California Public Utilities
Commission. Beginning in January 2002, Roseville Telephone began paying a
consumer dividend for intrastate overearnings relating to the years 1998
and 1999. A portion of the consumer's intrastate service charges was
returned in the form of a surcredit beginning in January 2002 and ending in
January 2003, totaling approximately $4,600 (of which $294 was returned
during January 2003).
As a result of periodic cost separation studies, the Company changed its
estimate for a portion of Roseville Telephone's interstate and intrastate
shareable earnings obligations and certain National Exchange Carrier
Association ("NECA") Carrier Common Line ("CCL") accounts receivable
balances during the first quarter of 2003. These changes in accounting
estimates decreased the Company's consolidated revenues by $277 and net
income by $166 ($0.01 per share) for the six months ended June 30, 2003.
During the year ended December 31, 2001, Roseville Telephone made payments
to certain telecommunications companies aggregating $6,800 (no similar
payments were made during the quarter or six-month periods ended June 30,
2003 or 2002). The payments related to interstate shareable earnings
obligations for the monitoring period 1999-2000. On June 26, 2003, the
Company entered into a Final Settlement Agreement (the "Settlement
Agreement") to recover $1,950 of the amount paid to a telecommunications
company in 2001. Therefore, the Company recognized a receivable from this
telecommunications company in the amount of $1,950 as of June 30, 2003
through a credit to network access service revenues for the three months
ended June 30, 2003. The Company received the funds pursuant to the
Settlement Agreement on July 8, 2003. The Company is currently seeking a
similar refund from another telecommunications company. However, the
recoverability of the remaining funds cannot presently be determined as the
telecommunications company from which the Company is seeking a refund has
filed for bankruptcy protection.
As of June 30, 2003, the Company's condensed consolidated balance sheet
reflected aggregate liabilities of $12,121 relating to Roseville
Telephone's estimated interstate and intrastate shareable earnings
obligations. The calculations supporting these liabilities are very complex
and involve a variety of estimates prior to the ultimate settlement of such
obligations. In addition, Roseville Telephone's interstate shareable
earnings obligations lapse over time if Roseville Telephone's interexchange
carrier and other customers do not claim the amounts ascribed to them.
Accordingly, it is reasonably possible that management's estimates of the
Company's liabilities for interstate and intrastate shareable earnings
obligations could change in the near term, and the amounts involved could
be material.
5. NOTE PURCHASE AGREEMENT
On March 13, 2003, the Company completed a note purchase agreement for the
issuance of its unsecured Series B Senior Notes ("Series B Notes") in the
aggregate principal amount of $60,000. The Series B Notes have a final
maturity of ten years and an average life of eight years. Interest is
payable semi-annually at a fixed rate of 4.74%. Principal payments are due
in equal annual installments of $12,000 commencing in March 2009 and ending
in March 2013. The Company used a portion of the proceeds from the issuance
of the Series B Notes to retire certain short-term borrowings, described in
Note 6, which had an aggregate outstanding principal balance of $15,000 as
of December 31, 2002.
6. LINE OF CREDIT
In March 2000, the Company entered into a business loan agreement with a
bank for a $30,000 line of credit with a term of three years. In July 2002,
the bank amended the credit facility increasing the borrowing capacity from
$30,000 to $50,000 through June 1, 2004. There were no amounts outstanding
under this credit facility as of June 30, 2003.
7. PRO FORMA STOCK-BASED COMPENSATION INFORMATION
Pro forma information regarding the results of operations and net income
per share (Note 1) is determined as if the Company had accounted for its
employee stock options using the fair value method, and such pro forma
stock-based compensation is amortized to pro forma results of operations
using the straight-line method. Under this method, the fair value of each
option granted is estimated on the date of grant using the Black-Scholes
option valuation model.
The Company uses the intrinsic value method in accounting for its employee
stock options because, as discussed below, the alternative fair value
accounting requires the use of option valuation models that were not
developed for use in valuing employee stock options. Under the intrinsic
value method, when the exercise price of the Company's employee stock
options equals or exceeds the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
Option valuation models were developed for use in estimating the fair value
of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of
highly subjective assumptions, including the expected life of the option.
Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in
the subjective input assumptions can materially affect the fair value
estimates, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of the Company's
employee stock options.
For the six months and quarters ended June 30, 2003 and 2002, the fair
value of the Company's stock-based awards to employees was estimated using
the following weighted-average assumptions:
Quarter Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------------- ------------- ---------------- ------------------
Expected life of options in years 4.0 5.0 4.0 5.0
Volatility 42.72% 36.77% 42.48% 36.77%
Risk-free interest rate 1.73% 4.48% 1.79% 4.47%
Expected dividend yield 2.50% 1.73% 2.50% 1.72%
PART I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Certain information included in the Company's quarterly report on Form 10-Q,
including that which relates to the impact on future revenue sources and
potential sharing obligations of pending and future regulatory orders, continued
expansion of the telecommunications network and expected changes in the sources
of the Company's revenue and its cost structure resulting from the its entrance
into new communications markets, are forward looking statements and are made
pursuant to the safe harbor provisions of the Securities Litigation Reform Act
of 1995. Such forward looking statements are subject to a number of risks,
assumptions and uncertainties that could cause the Company's actual results to
differ from those projected in such forward looking statements.
Important factors that could cause actual results to differ from those set forth
in the forward looking statements include, but are not limited to: advances in
telecommunications technology, changes in the telecommunications regulatory
environment, changes in the financial stability of other telecommunications
providers who are customers of the Company, changes in competition in markets in
which the Company operates, adverse circumstances affecting the economy in
California in general, and in the Sacramento, California Metropolitan area in
particular, the availability of future financing, changes in the demand for
services and products, new product and service development and introductions,
pending and future litigation and unanticipated changes in the growth of the
Company's emerging businesses, including the wireless, Internet, video and
Competitive Local Exchange Carrier operating entities.
Corporate Structure
SureWest Communications (the "Company") is a holding company with wholly-owned
subsidiaries operating in the Telecommunications ("Telecom"), Broadband and
Wireless segments.
The Telecom segment is aligned with specific subsidiaries of the Company that
provide landline telecommunications services, directory advertising, high-speed
Internet, long distance services and certain non-regulated services. Roseville
Telephone Company ("Roseville Telephone"), which is the principal operating
subsidiary of the Telecom segment, provides local and toll telephone services,
network access services, billing and collection services, and certain
non-regulated services. SureWest Directories publishes and distributes Roseville
Telephone's directory, including the sale of yellow pages advertising. SureWest
Directories is also engaged in the business of producing, publishing and
distributing directories in other Northern California communities outside of
Roseville Telephone's service areas. Roseville Long Distance Company ("Roseville
Long Distance"), is engaged in the provision of long distance services.
The Broadband segment provides various services including: High-speed and
dial-up Internet, digital cable, local, network access and toll telephone and
managed services in the greater Sacramento area, principally to customers
residing outside of Roseville Telephone's service area. The Broadband segment
includes the Company's subsidiaries SureWest Broadband and SureWest Televideo
("SureWest Broadband/Residential Services"). SureWest Broadband is comprised, in
part, of a division of Roseville Telephone operating as a Competitive Local
Exchange Carrier.
The Wireless segment consists of the Company's subsidiary SureWest Wireless,
which provides wireless services. SureWest Wireless derives its revenue from the
provision of wireless services and the sale of handsets and related
communications equipment. Revenues include wireless voice services, sales of
handsets and related accessories, long distance, telephone insurance, roaming
service and custom calling features. Wireless services are provided on a
month-to-month basis and are generally billed in advance.
The Company expects that the sources of its revenues and its cost structure may
be different in future periods as a result of its entry into new communications
markets.
Results of Operations
Consolidated Results of Operations
The following table summarizes the Company's consolidated financial results for
the quarters and six months ended June 30, 2003 and 2002:
Quarter Ended Six-Month Period
June 30, Ended June 30,
2003 2002 $Change %Change 2003 2002 $Change %Change
- ----------------------------- ---------- --------- ----------- ----------- ----------- ----------- ----------- -----------
(Amounts in millions)
Operating revenues $50.3 $43.1 $7.2 17% $97.7 $86.6 $11.1 13%
Operating expenses 32.2 29.0 3.2 11 65.3 56.9 8.4 15
Depreciation and
amortization 12.5 11.0 1.5 14 24.9 21.5 3.4 16
Operating income 5.6 3.1 2.5 81 7.5 8.2 (0.7) (9)
Net income $ 2.7 $ 1.7 $1.0 59% $ 3.4 $ 7.3 $(3.9) (53)%
Consolidated operating revenues increased $7.2 million and $11.1 million during
the quarter and six-month periods ended June 30, 2003, respectively, compared to
the same periods in 2002. The increase in consolidated operating revenues was
due to 1) continued additions to the wireless customer base, with a 23% overall
increase in wireless subscribers based on average subscriber counts, 2)
increased revenues due to the acquisition of the SureWest Broadband/Residential
Services assets in the third quarter of 2002, 3) continued growth in Business
Broadband service, 4) increased demand for DSL services and dedicated access and
5) a Final Settlement Agreement (the "Settlement Agreement") the Company entered
into during the quarter ended June 30, 2003. As discussed in greater detail in
the Regulatory Matters section, the Settlement Agreement provided for a $2.0
million refund from another telecommunications company for a payment made by the
Company in 2001 related to interstate shareable earnings obligations. As
discussed more fully in Segment Results of Operations, the increase in operating
revenues during the six months ended June 30, 2003 was offset in part due to
changes in accounting estimates related to a portion of the Company's interstate
and intrastate shareable earnings obligations and certain National Exchange
Carrier Association ("NECA") Common Carrier line ("CCL") accounts receivable
balances.
Consolidated operating expenses, including depreciation and amortization,
increased $4.6 million and $11.8 million, respectively, during the quarter and
six-month periods ended June 30, 2003 compared to the same periods in 2002. The
increase in operating expenses was due primarily to 1) increased expenses due to
the acquisition of the SureWest Broadband/Residential Services assets in the
third quarter of 2002 and 2) increased depreciation and amortization expense due
to additions to property, plant and equipment and internal-use software. These
increases were offset in part by decreased sales commissions related to wireless
service and decreased depreciation expense due to a change in accounting
estimate during the fourth quarter of 2002, which increased from five to ten
years the estimated useful lives related primarily to wireless switching and
voice email equipment.
Segment Results of Operations
Telecom
Quarter Ended Six-Month Period
June 30, Ended June 30,
2003 2002 $Change %Change 2003 2002 $Change %Change
- -------------------------------------- ---------- --------- ----------- ----------- ----------- ------------ ----------- -----------
(Amounts in millions)
Local service $16.3 $16.4 $(0.1) (1)% $31.3 $33.0 $(1.7) (5)%
Network access service 14.0 12.9 1.1 9 27.4 26.1 1.3 5
Directory advertising 3.7 3.6 0.1 3 7.5 7.3 0.2 3
Long distance service 1.3 1.3 - - 2.5 2.7 (0.2) (7)
Other 1.2 1.0 0.2 20 2.3 2.4 (0.1) (4)
Total operating revenues
from external customers 36.5 35.2 1.3 4 71.0 71.5 (0.5) (1)
Intersegment revenues 5.8 3.8 2.0 53 11.4 7.7 3.7 48
Operating expenses 20.0 22.1 (2.1) (10) 41.5 42.4 (0.9) (2)
Depreciation and
amortization 7.7 6.9 0.8 12 15.5 13.5 2.0 15
Operating income 14.6 10.0 4.6 46 25.4 23.3 2.1 9
Net income $ 8.7 $ 6.1 $2.6 43% $15.1 $16.8 $(1.7) (10)%
Operating revenues
Operating revenues from external customers in the Telecom segment increased $1.3
million and decreased $463 thousand for the quarter and six-month period ended
June 30, 2003, respectively, compared to the same periods in 2002. Revenues from
services subject to regulation, which include local and network access services,
increased $997 thousand and decreased $406 thousand for the quarter and
six-month period ended June 30, 2003, respectively, compared to the same periods
in 2002. The decrease in the six-month results was due in part to an increase in
the Company's provision for its estimated intrastate shareable earnings
obligations resulting in a decrease to consolidated revenues of $293 thousand
and $646 thousand for the quarter and six-month period ended June 30, 2003,
respectively, compared to the same periods in 2002. In addition, the decreases
were also due to changes in accounting estimates pertaining to the Company's
estimated interstate and intrastate shareable earning obligations and certain
NECA CCL accounts receivable. The changes in accounting estimates decreased the
Company's consolidated revenues and net income by $277 thousand and $166
thousand ($0.01 per share), respectively, during the first quarter of 2003.
Additionally, commencing in the third quarter of 2002, Roseville Telephone
entered into a wholesaling arrangement for its digital subscriber line ("DSL")
service, resulting in a decrease to network access revenues of $1.6 million and
$3.2 million, respectively, during the quarter and six-month period ended June
30, 2003. This decrease was offset in part by continued growth and demand for
dedicated access as well as an increase in Roseville Telephone's billing
surcharge. The decrease in operating revenues in the Telecom segment was also
offset, in part, by the $2.0 million Settlement Agreement. The Settlement
Agreement resulted in a refund to the Company of a portion of a prior payment to
a telecommunications company related to interstate shareable earnings
obligations for the monitoring period 1999-2000.
The Company adopted Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements,"
effective January 1, 2000, which requires non-recurring revenues associated with
service and activation charges to be deferred. The cumulative effect of this
change in accounting principle was $3.3 million, net of tax, ($0.21 per share)
in 2000.
For the three-month periods ended March 31 and June 30 2003, and 2002, the
Company recognized the following revenues that were included in the cumulative
effect adjustment as of January 1, 2000:
Three Months Ended:
March 31, 2003 $128 thousand
June 30, 2003 $114 thousand
March 31, 2002 $298 thousand
June 30, 2002 $251 thousand
The net effect of these revenues in 2003 was to increase net income in the
three-month periods ended March 31 and June 30 by $75 thousand and $68 thousand,
respectively.
The net effect of these revenues in 2002 was to increase net income in the
three-month periods ended March 31 and June 30 by $178 thousand and $150
thousand, respectively.
Directory advertising revenues increased $89 thousand and $189 thousand for the
quarter and six-month period ended June 30, 2003, respectively, compared to the
same periods in 2002 due to increased advertising sales.
Other operating revenues primarily consist of carrier billing and collection
services, certain non-regulated sales and services, directory and operator
assistance and other miscellaneous services. Other operating revenues increased
$267 thousand and decreased $98 thousand for the quarter and six-month period
ended June 30, 2003, respectively, compared to the same periods in 2002. The
increase in the current year quarter was due primarily to a reduction of revenue
during the second quarter of 2002 relating to a bankruptcy filing by a
telecommunications company owing the Company money for services rendered.
Operating Expenses
Operating expenses for the Telecom segment decreased $2.1 million and $914
thousand for the quarter and six-month period ended June 30, 2003, respectively,
compared to the same periods in 2002. Cost of services and products decreased
$1.1 million and $1.5 million during the quarter and six-month period ended June
30, 2003, respectively, compared to the same periods in 2002. These decreases
were due primarily to 1) reduced spending for minor materials and contracted
services driven by internal efficiencies and 2) a decrease in corporate
operations rent expense as a result of economies of scale.
Customer operations and selling expense decreased $634 thousand and $467
thousand for the quarter and six-month period ended June 30, 2003, respectively,
compared to the same periods in 2002 due primarily to 1) internal efficiencies
resulting from integrated customer support systems and productivity gains and 2)
a decrease in print and radio advertising costs.
General and administrative expenses decreased $279 thousand for the quarter
ended June 30, 2003 compared to the same period in 2002. This decrease was due
primarily to $1.1 million of bad debt expense recognized during the second
quarter of 2002 associated with access charge billings to an interexchange
carrier that filed for bankruptcy protection. For the six-month period ended
June 30, 2003, general and administrative expenses increased $1.0 million. This
increase was due primarily to 1) a $375 thousand one-time settlement reached in
connection with the litigation arising from the agreement for the sale of alarm
monitoring assets during 2002, 2) increases in medical and liability insurance
and 3) an increase in the size of the Company's workforce.
Depreciation and amortization increased $765 thousand and $1.9 million for the
quarter and six-month period ended June 30, 2003, respectively, compared to the
same periods in 2002 due primarily to additions to central office assets and
internal-use software.
Certain of the Company's customers filed for bankruptcy protection in 2002, the
most notable of which was WorldCom, Inc. ("WorldCom"), which, together with its
affiliates, filed for bankruptcy protection on July 21, 2002. As a result of the
bankruptcy filing, the Company recognized as bad debt expense in the second
quarter of 2002 amounts owed from WorldCom to the Company for services prior to
the bankruptcy filing.
With respect to post-petition obligations, WorldCom had proposed, pursuant to a
provision of the Bankruptcy Code, and the Bankruptcy Court has agreed, that
utilities are entitled to "adequate assurances" that WorldCom will satisfy its
obligations for post-petition services. In its original filings, WorldCom
proposed its own set of assurances to utilities, but such assurances did not
include either deposits or advance payments. Although the Bankruptcy Court did
not require WorldCom to provide any deposits or advance payments as adequate
assurance of payment, it did provide, with respect to any post-petition services
provided after August 14, 2002, that all utilities will have a junior
superiority administrative claim senior to other administrative claims and
junior only to the claims of WorldCom's post-petition lenders. If WorldCom fails
to pay for post-petition services, a utility can either take appropriate action
under any applicable tariff or regulation, or seek, on an expedited basis, an
order from the Bankruptcy Court requiring immediate payment or other relief. As
of June 30, 2003, obligations owed by WorldCom to the Company for post-petition
services have been paid on a timely basis.
Regulatory matters
Revenues from services subject to regulation constituted approximately 60% of
the Company's total operating revenues for the quarter and six-month period
ended June 30, 2003. In the prior year periods, revenues from services subject
to regulation constituted approximately 68% of the Company's total operating
revenues. Such revenues, which include local service, network access service and
toll service, are derived from various sources, including billings to business
and residential subscribers for basic exchange services, extended area service
charges, surcharges mandated by the California Public Utilities Commission
("P.U.C."), billings to SBC Communications, Inc. ("SBC") (formerly Pacific
Bell), long distance carriers, competitive access providers and subscribers for
network access services, interstate settlement revenues from the NECA, and
support payments from the Universal Service Fund and a California High Cost Fund
("CHCF").
Total revenues from certain telephone services are affected by rates authorized
by various regulatory agencies. Intrastate service rates are subject to
regulation by the P.U.C. With respect to toll calls initiated by customers of
interexchange carriers, interexchange carriers are assessed access charges based
on tariffs filed by Roseville Telephone. Interstate access rates and resulting
earnings are subject to regulation by the Federal Communications Commission
("F.C.C."). With respect to interstate services, Roseville Telephone has filed
its own tariff with the F.C.C. for all elements of access services except
carrier common line charges, for which Roseville Telephone concurs with tariffs
filed by NECA.
The F.C.C. monitors Roseville Telephone's interstate earnings through the use of
annual cost separation studies prepared by Roseville Telephone, which utilize
estimated cost information and projected demand usage. The F.C.C. establishes
rules that carriers must follow in the preparation of the annual studies. In
January 2001, the F.C.C. issued a Memorandum Opinion and Order to another
telephone company in which it clarified how Internet traffic, which the F.C.C.
had prior to that date characterized as largely interstate in nature, should be
treated. Additionally, under current F.C.C. rules governing rate making,
Roseville Telephone is required to establish interstate rates based on projected
demand usage for its various services and determine the actual earnings from
these rates once actual volumes and costs are known.
During 2000 and 2001, Internet traffic and DSL service grew substantially, far
exceeding Roseville Telephone's estimates, which resulted in actual earnings
exceeding the levels allowed by the F.C.C. Based on preliminary cost studies,
the Company recognized liabilities relating to Roseville Telephone's estimated
interstate shareable earnings obligations of $86 thousand and $163 thousand for
the quarters ended June 30, 2003 and 2002, respectively, through reductions of
revenues. For the six-month periods ended June 30, 2003 and 2002, the Company
recognized liabilities relating to Roseville Telephone's estimated interstate
shareable earnings obligations of $172 thousand and $325 thousand, respectively,
through reductions of revenues. During the year ended December 31, 2001,
Roseville Telephone made payments to certain telecommunications companies
aggregating $6.8 million (no similar payments were made during the quarter or
six-month periods ended June 30, 2003 or 2002). The payments related to
interstate shareable earnings obligations for the monitoring period 1999-2000.
On June 26, 2003, the Company entered into a Settlement Agreement to recover
$2.0 million of the amount paid to a telecommunications company in 2001.
Therefore, the Company recognized a receivable from this telecommunications
company in the amount of $2.0 million as of June 30, 2003 through a credit to
network access service revenues for the three months ended June 30, 2003. The
Company received the funds pursuant to the Settlement Agreement on July 8, 2003.
The Company is currently seeking a similar refund from another
telecommunications company. However, the recoverability of the remaining funds
cannot presently be determined as the telecommunications company from which the
Company is seeking a refund has filed for bankruptcy protection.
Prior to January 1, 2002, Roseville Telephone billed SBC various charges for
certain local service and network access service revenues in accordance with
certain agreements as described below. In 1999, SBC expressed interest in
withdrawing from the designated carrier plan ("DCP") for Roseville Telephone's
toll traffic. The DCP was a compensation arrangement between Roseville Telephone
and SBC for certain intrastate toll services. Roseville Telephone and SBC agreed
to allow the DCP arrangement to expire in December 2001. The termination of the
DCP did not have a material impact on the Company's consolidated financial
position as of June 30, 2003 or results of operations for the six months then
ended.
In 1999, SBC also expressed interest in entering into a new, permanent
compensation arrangement for extended area service ("EAS"). At that time, SBC
had been paying Roseville Telephone $11.5 million per year for EAS pursuant to a
Settlement Transition Agreement. In November 2000, the P.U.C. authorized SBC to
terminate its annual EAS payments to Roseville Telephone effective November 30,
2000. The P.U.C. authorized replacement funding to Roseville Telephone on an
interim basis using the current reserve in the CHCF. In addition, the P.U.C.
opened an Order Instituting Investigation ("OII") for the purpose of determining
whether future recovery of all, none, or a portion of the $11.5 million annual
payments previously received from SBC should come from Roseville Telephone's
ratepayers or other regulatory recovery mechanisms. This proceeding began in
2001, evidentiary hearings were held during 2002, and briefing was completed in
February 2003. In this proceeding, the Office of Ratepayer Advocates ("ORA")
recommended that the P.U.C. discontinue Roseville Telephone's present interim
EAS funding from the CHCF without replacement revenues from ratepayers. The
P.U.C.'s decision in this matter is expected during 2003. The P.U.C. has made no
indication as to what, if any, changes will be forthcoming relating to EAS
revenues. The results of these proceedings and their potential effects on
Roseville Telephone cannot yet be determined.
In 1996, the P.U.C. issued a decision in connection with Roseville Telephone's
general rate proceeding, which authorized Roseville Telephone to implement a New
Regulatory Framework ("NRF") for services furnished within Roseville Telephone's
service area in order to accommodate market and regulatory movement toward
competition and greater pricing flexibility. Under the NRF, Roseville Telephone
is subject to ongoing monitoring and reporting requirements, including a sharing
mechanism whereby Roseville Telephone is required to share earnings with
customers through a reductions of revenues if its earned annual rate-of-return
exceeds that authorized by the P.U.C.
In accordance with the requirements of its general rate case order, Roseville
Telephone filed an application for review of its NRF in 1999. In connection with
this proceeding, the P.U.C.'s ORA undertook a verification audit of Roseville
Telephone's non-regulated and affiliated transactions pursuant to the general
rate case and other P.U.C. orders. In June 2001, the P.U.C. adopted its decision
in this matter (the "Decision"). The Decision did not suspend the sharing
mechanism as Roseville Telephone had requested and the P.U.C. ruled that
Roseville Telephone must change the method used to allocate costs for services
provided by Roseville Telephone to its affiliates, the treatment of certain
directory revenues and the treatment of internal-use software costs.
Additionally, in accordance with the provisions of the Decision, the Company
recorded liabilities and reductions of revenues of $807 thousand and $1.7
million relating to estimated intrastate shareable earnings obligations during
the quarter and six-month period ended June 30, 2003. For the quarter and
six-month period ended June 30, 2002, the Company recorded a liability through a
reduction of revenues of $438 thousand and $875 thousand respectively, relating
to estimated intrastate shareable earnings obligations.
Beginning in January 2002, Roseville Telephone began paying a consumer dividend
for intrastate overearnings relating to the years 1998 and 1999. A portion of
the consumer's intrastate service charges was returned in the form of a
surcredit beginning in January 2002 and ending in January 2003, totaling
approximately $4.6 million (of which $294 thousand was returned during 2003).
As a result of periodic cost separation studies, the Company changed its
estimate for a portion of Roseville Telephone's interstate and intrastate
shareable earnings obligations and certain NECA CCL accounts receivable balances
during the first quarter of 2003. These changes in accounting estimates
decreased the Company's consolidated revenues by $277 thousand and net income by
$166 thousand ($0.01 per share) for the six months ended June 30, 2003.
As of June 30, 2003, the Company's consolidated balance sheet reflected
aggregate liabilities of $12.1 million relating to Roseville Telephone's
estimated interstate and intrastate shareable earnings obligations. The
calculations supporting these liabilities are very complex and involve a variety
of estimates prior to the ultimate settlement of such obligations. In addition,
Roseville Telephone's interstate shareable earnings obligations lapse over time
if Roseville Telephone's interexchange carrier and other customers do not claim
the amounts ascribed to them. Accordingly, it is reasonably possible that
management's estimates of the Company's liabilities for interstate and
intrastate shareable earnings obligations could change in the near term, and the
amounts involved could be material.
Broadband
Quarter Ended Six-Month Period
June 30, Ended June 30,
2003 2002 $Change %Change 2003 2002 $Change %Change
- -------------------------------------- ---------- ---------- ----------- ----------- ----------- ----------- ----------- -----------
(Amounts in millions)
Internet service $ 3.9 $ 1.4 $ 2.5 179% $ 7.7 $ 2.8 $ 4.9 175%
Residential Broadband
service 2.3 - 2.3 100 4.1 - 4.1 100
Business Broadband
service 0.9 0.6 0.3 50 1.7 1.0 0.7 70
Total operating revenues
from external customers 7.1 2.0 5.1 255 13.5 3.8 9.7 255
Intersegment revenues 0.3 0.1 0.2 200 0.8 0.1 0.7 700
Operating expenses 10.3 3.0 7.3 243 20.5 5.7 14.8 260
Depreciation and
amortization 1.0 0.4 0.6 150 1.8 0.7 1.1 157
Operating loss (3.9) (1.3) (2.6) 200 (8.0) (2.5) (5.5) 220
Net loss $(2.7) $(0.8) $(1.9) 238% $(5.3) $(1.4) $(3.9) 279%
Operating revenues
Operating revenues from external customers in the Broadband segment increased
$5.1 million and $9.7 million for the quarter and six-month period ended June
30, 2003, respectively, compared to the same periods in 2002. The increase in
Broadband revenues is due in large part to 1) the purchase of the SureWest
Broadband/Residential Services assets during the third quarter of 2002, 2)
continued addition to the customer base, with a 32% overall increase in
residential and business DSL subscribers based on average subscriber counts for
the six months ended June 30, 2003 compared to the same period in 2002, 3) the
continued expansion of the Business Broadband services and 4) the commencement
of a wholesale DSL service arrangement with Roseville Telephone in the fourth
quarter of 2002.
Operating expenses
Total operating expenses for the Broadband segment increased $7.3 million and
$14.8 million for the quarter and six-month period ended June 30, 2003,
respectively, compared to the same periods in 2002. Cost of services and
products increased $3.3 million and $6.6 million during the quarter and
six-month period ended June 30, 2003, respectively, compared to the same periods
in 2002 due primarily to 1) the purchase of the SureWest Broadband/Residential
Services assets during the third quarter of 2002 and 2) increased transport
costs.
Customer operations expense, general and administrative expense and depreciation
and amortization increased $1.3 million, $2.8 million and $593 thousand,
respectively, for the quarter ended June 30, 2003 compared to the same period in
2002. For the six-month period ended June 30, 2003, customer operations expense,
general and administrative expense and depreciation and amortization increased
$2.5 million, $5.6 million and $1.1 million, respectively. The increases are
primarily due to the asset purchase described above during the third quarter of
2002 and an increase in depreciation expense resulting from property, plant and
equipment additions at SureWest Broadband.
Wireless
Quarter ending Six-month period
June 30, Ending June 30,
2003 2002 $Change %Change 2003 2002 $Change %Change
- --------------------------------- ----------- ----------- ------------ ----------- ----------- ----------- ----------- -----------
(Amounts in millions)
Wireless revenues from
external customers $ 6.7 $ 5.9 $0.8 14% $13.2 $11.3 $1.9 17%
Intersegment revenues 0.1 0.1 - - 0.3 0.2 0.1 50
Operating expenses 8.1 7.9 0.2 3 15.8 16.8 (1.0) (6)
Depreciation and
amortization 3.8 3.7 0.1 3 7.6 7.3 0.3 4
Operating loss (5.1) (5.6) 0.5 9 (9.9) (12.6) 2.7 21
Net loss $(3.3) $(3.6) $0.3 8% $(6.4) $(8.1) $1.7 21%
Operating revenues
Operating revenues from external customers in the Wireless segment increased
$743 thousand and $1.9 million for the quarter and six-month period ended June
30, 2003, respectively, compared to the same periods in 2002. The increase in
Wireless revenues is due primarily to 1) continued additions to the customer
base, with a 23% overall increase in wireless subscribers based on average
subscriber counts for the six-month period ended June 30, 2003 compared to the
same period in 2002, 2) increased long distance and roaming, 3) the introduction
of new features and 4) a decrease in uncollectible revenues.
Operating expenses
Total operating expenses for the Wireless segment increased $178 thousand and
decreased $987 thousand for the quarter and six-month period ended June 30,
2003, respectively, compared to the same periods in 2002. Cost of services and
products decreased $384 thousand and $563 thousand during the quarter and
six-month period ended June 30, 2003, respectively, compared to the same period
in 2002. This decrease was due primarily to 1) increased promotional activity
during 2002 which included a free handset or related equipment with the
activation of service, 2) a reduction in network engineering labor costs due to
a modest reduction in the workforce and 3) decreased handset insurance costs due
to fewer claims submitted and outsourcing of the insurance function to a third
party. This decrease was offset in part by increased interconnect usage
associated with the increase in subscriber base.
Customer operations and selling expense increased $565 thousand for the quarter
ended June 30, 2003 compared to the same period in 2002. During the second
quarter of 2002 certain customer operations and selling expenses were
reclassified to other operating expense categories. These reclassifications
included expenses for the six months ended June 30, 2002. For the six-month
period ended June 30, 2003 customer operations and selling expense decreased
$295 thousand compared to the same period in 2002 due primarily to decreased
dealer commissions and fewer promotions resulting in decreased advertising
costs.
Depreciation and amortization
Depreciation and amortization increased $127 thousand and $312 thousand for the
quarter and six-month period ended June 30, 2003, respectively, compared to the
same periods in 2002 due primarily to increases in wireless property, plant and
equipment and amortization of internal-use software. This increase was partially
offset by a change in accounting estimate during the fourth quarter 2002,
increasing from five to ten years the estimated useful lives related primarily
to wireless switching and voice mail equipment. This change in accounting
estimate resulted in decreased depreciation expense of $299 thousand and $542
thousand for the quarter and six-month period ended June 30, 2003.
Non-operating Items
Interest income and expense, net
Interest expense increased $925 thousand and $1.4 million during the quarter and
six-month period ended June 30, 2003, respectively, compared to the same periods
in 2002 due to the increased short-term borrowings in the 2003 periods and the
Company's issuance in March 2003 of its unsecured Series B Senior Notes ("Series
B Notes").
Income taxes
Income taxes for the quarter and six-month period ended June 30, 2003, increased
$767 thousand and decreased $2.6 million, respectively, compared to the same
periods in 2002, due primarily to corresponding increases and decreases in
income subject to tax. The effective federal and state income tax rates were
approximately 41.2% and 40.2% for the six-month periods ended June 30, 2003 and
2002.
Liquidity and Capital Resources
As reflected in the Condensed Consolidated Statements of Cash Flows, net cash
provided by operating activities was $40.2 million and $19.7 million for the
six-month periods ended June 30, 2003 and 2002, respectively. The increase in
cash provided by operating activities for the current year compared to the same
period in the prior year was due primarily to 1) increases in liabilities
related to the Company's pension obligation, 2) increases in non-cash charges
consisting principally of depreciation and amortization and 3) increases in
accrued liabilities. Net cash provided by operating activities during the
six-month period ended June 30, 2003 was greater than net income of $3.4 million
due to 1) non-cash charges consisting principally of depreciation and
amortization, 2) increases in accrued liabilities, 3) increases in liabilities
related to estimated shareable earnings obligations and 4) increases in deferred
revenues. During the six-month period ended June 30, 2003, the Company used cash
flows from operations, proceeds from the issuance of its Series B Notes and
existing cash and cash equivalents to fund 1) capital expenditures of $30.4
million pertaining to ongoing plant construction projects, 2) dividends of $7.3
million, 3) principal payments of $1.1 million to retire long-term debt and 4)
$15 million to retire short-term borrowings.
The Company's most significant use of funds for the remainder of 2003 is
expected to be for 1) budgeted capital expenditures of approximately $30.7
million, 2) scheduled payments of long-term debt of $4.7 million, 3) support of
the operations of SureWest Broadband/Residential Services up to an anticipated
$4.2 million and 4) support of the operations of SureWest Wireless up to an
anticipated $3.5 million.
On May 17, 2002, the Company's shareholders approved a proposal to change the
Company's state of incorporation from California to Delaware. In addition, the
shareholders approved an increase of the Company's authorized common stock from
100 million shares to 200 million shares with a par value of $0.01 and also
authorized 10 million shares of preferred stock with a par value of $0.01. The
enactment of the aforementioned approvals was left to the discretion of the
Board of Directors. At present, the reincorporation has not been implemented,
but is anticipated to occur in 2003.
In February 2000, the Board of Directors authorized the repurchase of up to 1
million shares of the Company's common stock. In June 2002, the Board of
Directors approved the repurchase of an additional 500 thousand shares. The
shares are purchased from time to time in the open market or through privately
negotiated transactions subject to overall financial and market conditions.
Additionally, the Company implemented an odd-lot repurchase program during 2001.
Through June 30, 2003, approximately 1 million shares of common stock have been
repurchased through these programs. The Company has remaining authorization from
the Board of Directors to repurchase an additional 469 thousand outstanding
shares as of June 30, 2003.
On March 13, 2003, the Company completed a note purchase agreement for the
issuance of its Series B Notes in the aggregate principal amount of $60 million.
The Series B Notes have a final maturity of ten years and an average life of
eight years. Interest is payable semi-annually at a fixed rate of 4.74%.
Principal payments are due in equal annual installments of $12 million
commencing in March 2009 and ending in March 2013. The Company used a portion of
the proceeds from the issuance of the Series B Notes to retire certain
short-term borrowings, which had an aggregate outstanding principal balance of
$15 million as of December 31, 2002.
In March 2000, the Company entered into a business loan agreement with a bank
for a $30 million line of credit with a term of three years. In July 2002, the
bank amended the credit facility increasing the borrowing capacity from $30
million to $50 million through June 1, 2004. There were no amounts outstanding
under this credit facility as of June 30, 2003.
In 2000, the Company entered into a 3-year non-exclusive agreement with Global
Crossing Ltd. ("Global Crossing"), a long distance service provider, for the
right to provide long distance service to the Company's customers at a fixed
price during the term of the agreement. This agreement expired in July 2003, and
the Company had a minimum remaining aggregate long distance service usage
commitment of approximately $40 thousand as of June 30, 2003. On January 28,
2002, Global Crossing filed for protection under Chapter 11 of the U.S.
Bankruptcy Code. Effective December 2002, the Company entered into a 2-year
non-exclusive agreement with Sprint Communications Company L.P. ("Sprint"), a
long-distance service provider, for the right to provide network transport
services to the Company's customers at fixed prices during the term of the
agreement. The Company has a monthly minimum usage requirement of $25 thousand
effective June 2003. The minimum usage requirement for 2003 is $175 thousand. As
of June 30, 2003, the Company has a minimum remaining aggregate long distance
usage commitment of approximately $150 thousand with Sprint. Rates for the
services provided by Sprint are substantially the same as those offered by
Global Crossing. Therefore, the Company does not believe that Global Crossing's
bankruptcy filing will have a material effect on its consolidated financial
position or results of operations.
On July 12, 2002, the Company purchased substantially all of the assets of
Western Integrated Networks, LLC and certain affiliates (collectively, "WIN") in
a transaction supervised by the United States Bankruptcy Court for the District
of Colorado. The purchase price for the assets of WIN consisted of (i) $12
million in cash, (ii) direct acquisition costs of $622 thousand and (iii) the
assumption of certain current liabilities aggregating $4.7 million relating
principally to executory contracts and capital lease obligations.
Prior to July 12, 2003, the Company obtained additional information regarding
the fair values of certain assets acquired and liabilities assumed from WIN.
Accordingly, the Company has prospectively adjusted the preliminary purchase
price allocation in connection with the preparation of its second quarter 2003
condensed consolidated financial statements. The following table summarizes the
estimated fair values of the assets acquired and liabilities assumed at the date
of acquisition, July 12, 2002, based on the Company's final allocation of the
aforementioned purchase price:
(Amounts in thousands)
Accounts receivable, net $ 615
Equipment held for sale 2,573
Other current assets 931
Property, plant and equipment 12,327
Intangible asset relating
to favorable operating leases 893
-------
Total assets acquired 17,339
Current liabilities assumed under
executory contracts 3,483
Liabilities assumed under capital
lease obligations 1,064
Other liabilities 170
-------
Total liabilities assumed 4,717
-------
Net assets acquired $12,622
=======
On January 25, 2002, the Company sold substantially all of the assets of its
alarm monitoring division, which was a component of the Telecom segment, for
approximately $5.2 million. This sale resulted in a pre-tax gain of $4.4 million
during 2002. Through June 30, 2003, the Company has received cash proceeds of
$5.0 million, of which $500 thousand and $4.5 million were received during 2002
and the fourth quarter of 2001, related to the sale of the alarm monitoring
division assets. The alarm monitoring assets consisted primarily of customer
contracts and equipment, which had a book value of approximately $355 thousand
as of the date of the sale. The purchaser of the assets commenced litigation
against the Company relating to claims under the asset agreement, generally in
connection with certain contracts assigned to the purchaser. On July 17, 2003,
the Company and the purchaser settled the litigation and the Company agreed to
pay the purchaser $375 thousand. Accordingly, the Company accrued this
settlement liability as of June 30, 2003 through a charge to general and
administrative expense for the three months ended June 30, 2003. Total operating
revenues attributable to the Company's alarm monitoring division during the
quarter and year to date periods ended June 30, 2002 were $279 thousand (none
during 2003).
The Company had cash, cash equivalents and short-term investments at June 30,
2003, of $66.4 million. The Company believes that its working capital position,
the proceeds available from its line of credit facility, operating cash flows
and borrowing capacity are more than sufficient to satisfy its liquidity
requirements for the remainder of 2003. In addition, the Company believes, given
its financial position and debt-to-equity position, it has substantial
additional short and long-term borrowing capacity.
Critical Accounting Policies and Estimates
Below is a summary of the Company's critical accounting policies and estimates.
Management has discussed development and selection of critical accounting
policies and estimates with its Audit Committee.
o Total revenues from telephone services are affected by rates authorized by
various regulatory agencies. The F.C.C. monitors Roseville Telephone's
interstate earnings through the use of annual cost separation studies
prepared by Roseville Telephone, which utilize estimated cost information
and projected demand usage. The F.C.C. establishes rules that carriers must
follow in the preparation of the annual studies. In addition, under NRF,
Roseville Telephone is subject to ongoing monitoring and reporting
requirements by the P.U.C., including a sharing mechanism whereby Roseville
Telephone may be required to share earnings with customers based on its
earned annual rate-of-return. The calculations supporting the liabilities
associated with the Company's estimated shareable earnings obligations are
very complex and involve a variety of estimates prior to the ultimate
settlement of such obligations. Accordingly, it is reasonably possible that
management's estimates of Roseville Telephone's shareable earnings
obligations could change in the near term, and the amounts involved could
be material.
o The Company recognizes revenue when (i) persuasive evidence of an
arrangement between the Company and the customer exists, (ii) delivery of
the product to the customer has occurred or service has been provided to
the customer, (iii) the price to the customer is fixed or determinable and
(iv) collectibility of the sales price is reasonably assured.
o The Company maintains allowances for doubtful accounts for estimated losses
resulting from the potential inability of its customers to make required
payments. If the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
o The Company states its inventories at lower of cost or market. In assessing
the ultimate recoverability of inventories, the Company is required to make
estimates regarding future customer demand.
o Property, plant and equipment and intangible assets are recorded at cost.
Retirements and other reductions of regulated telephone plant and equipment
are charged against accumulated depreciation with no gain or loss
recognized in accordance with the composite group remaining life
methodology utilized for telephone plant assets. When property applicable
to non-telephone operations is sold or retired, the asset and related
accumulated depreciation are removed from the accounts and the associated
gain or loss is recognized. Property, plant and equipment and intangible
assets are depreciated or amortized using the straight-line method over
their estimated economic lives, certain of which were significantly revised
in the fourth quarter of 2000. In assessing the recoverability of the
Company's property, plant and equipment and intangible assets, which
consist of wireless licenses and goodwill, the Company must make
assumptions regarding estimated future cash flows and other factors to
determine the fair value of the respective assets. If these estimates and
assumptions change in the future, the Company may be required to record
impairment charges relating to its intangible assets.
o The Company accounts for income taxes using the liability method. Under
this method, deferred tax assets and liabilities are determined based on
differences between the financial reporting and tax basis of assets and
liabilities and are measured using the enacted tax rates and laws that are
expected to be in effect when the differences are expected to reverse. The
Company does not have a valuation allowance on its deferred tax asset as of
June 30, 2003 or December 31, 2002 because it believes it is more likely
than not that such deferred tax asset will be realized. Should the Company
determine that it would not be able to realize all or part of its deferred
tax asset in the future, an adjustment to the deferred tax asset would be
charged to income in the period in which the determination was made.
o The Company has pension and post-retirement benefit costs and obligations.
The Company's pension and post-retirement benefit obligations are
actuarially determined based on estimates of discount rates, long-term
rates of return on plan assets and increases in future compensation levels.
Changes in these estimates and other factors could significantly impact the
Company's pension and post-retirement benefit costs and obligations.
o The Company is a party to a variety of litigation, regulatory proceedings
and other contingencies that arise in the ordinary course of business. The
Company is required to assess the likelihood of any adverse judgments or
outcomes to these matters, as well as potential ranges of probable losses
for certain of these matters. The determination of the liabilities
required, if any, for loss contingencies is made after careful analysis of
each individual issue. In the opinion of management, the ultimate outcome
of these matters will not materially affect the Company's consolidated
financial position and results of operations.
o The Company accounts for stock-based awards to employees using the
intrinsic value method, and non-employees using the fair value method.
Under the intrinsic value method, when the exercise price of the Company's
employee stock options equals or exceeds the market price of the underlying
stock on the date of grant, the Company does not record compensation
expense in its condensed consolidated statements of operations. The Company
uses the intrinsic value method in accounting for employee stock options
because the alternative fair value accounting requires the Company to use
option valuation models that were developed for use in estimating the fair
value of traded options that have no vesting restrictions and are fully
transferable. Because the Company's employee stock options have
characteristics significantly different from those of traded options and
because changes in the subjective input assumptions can materially affect
the fair value estimates of these valuation models, the Company believes
such existing models do not necessarily provide a reliable single measure
of the fair value of employee stock options.
Recent Accounting Pronouncements
In July 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 146, "Accounting for Costs Associated with an Exit or Disposal
Activity." SFAS No. 146 revises the accounting for exit and disposal
activities under Emerging Issues Task Force ("EITF") Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)," by extending the period in which expenses related to
restructuring activities are reported. A commitment to a plan to exit an
activity or dispose of long-lived assets is no longer sufficient to record
a one-time charge for most restructuring activities. Instead, companies
must record exit or disposal costs when they are "incurred" and can be
measured at fair value. In addition, the resultant liabilities must be
subsequently adjusted for changes in estimated cash flows. The Company has
adopted SFAS No. 146 on January 1, 2003, and the adoption of this new
standard did not have a material effect on the Company's condensed
consolidated financial statements as of and for the quarter and six-month
period ended June 30, 2003.
On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends
SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for an entity that voluntarily changes to
the fair value method of accounting for stock-based employee compensation.
In addition, it also amends the disclosure provisions of SFAS No. 123 to
require prominent disclosure about the effects on reported net income
including per share amounts, of an entity's accounting policy decisions
with respect to stock-based employee compensation in annual and interim
financial statements. SFAS No. 148 does not amend SFAS No. 123 to require
companies to account for their stock-based employee compensation using the
fair value method. The disclosure provisions of SFAS No. 123 were effective
immediately in 2002. As of June 30, 2003, the Company does not have any
immediate plans to change its method of accounting for stock-based employee
compensation to the fair value method.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made.
The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. The Company adopted SFAS No. 143
on January 1, 2003, and the adoption of this new standard did not have a
material effect on the Company's condensed consolidated financial
statements for the quarter and six-month period ended June 30, 2003.
In October 2002, the FASB's EITF reached a consensus on EITF Issue No.
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Under EITF Issue No. 00-21, revenue arrangements with multiple deliverables
are required to be divided into separate units of accounting under certain
circumstances. The Company will prospectively adopt EITF Issue No. 00-21
for arrangements entered into beginning after June 30, 2003, and it does
not believe the adoption of this new guidance will have a material effect
on its condensed consolidated financial statements.
In November 2002, the FASB issued interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN No. 45
requires certain guarantees to be recorded at fair value, which is
different from current practice, which is generally to record a liability
only when a loss is probable and reasonably estimable. FIN No. 45 also
requires a guarantor to make significant new disclosures, even when the
likelihood of making any payments under the guarantee is remote. The
disclosure provisions of FIN No. 45 were effective immediately in 2002. The
Company adopted the recognition and measurement provisions of FIN No. 45 on
a prospective basis with respect to guarantees issued or modified after
December 31, 2002. The adoption of the recognition and measurement
provisions of FIN No. 45 did not have a material effect on the Company's
condensed consolidated financial statements as of and for the quarter and
six-month period ended June 30, 2003.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Company management, including the chief executive officer and chief financial
officer, have evaluated the Company's disclosure controls and procedures (as
defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of the end of the period covered by this Quarterly
Report on Form 10-Q. Based on that evaluation, the chief executive officer and
chief financial officer have concluded that the Company's disclosure controls
and procedures are effective to ensure that information required to be disclosed
by the Company in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time period specified in
SEC rules and forms.
Changes in Internal Controls
There have been no significant changes in the Company's internal control over
financial reporting or in other factors which could, or could be reasonably
likely to, significantly affect internal control over financial reporting
subsequent to the date of the evaluation.
PART II
Item 1. Legal Proceedings.
Except for the proceedings described below, the Company is not aware of any
material pending legal proceedings, other than ordinary routine litigation
incidental to its business, to which it is a party or to which any of its
property is subject.
As indicated in Item 1 above, Roseville Telephone is subject to regulation by
the Federal Communications Commissions ("F.C.C.") and Public Utilities
Commission ("P.U.C"). In the past, there have been various proceedings before
these agencies to which Roseville Telephone has been a party. Reference is made
to Item 1 for further information regarding the nature of the jurisdiction of
the F.C.C. and P.U.C. over the business and operations of Roseville Telephone.
In 1996, the P.U.C. issued a decision in connection with Roseville Telephone's
general rate proceeding, which authorized Roseville Telephone to implement a New
Regulatory Framework ("NRF") for services furnished within Roseville Telephone's
service area in order to accommodate market and regulatory movement toward
competition and greater pricing flexibility. Under the NRF, Roseville Telephone
is subject to ongoing monitoring and reporting requirements, including a sharing
mechanism whereby Roseville Telephone is required to share earnings with
customers through a reduction of revenues if its earned annual rate-of-return
exceeds that authorized by the P.U.C.
In accordance with the requirements of its general rate case order, Roseville
Telephone filed an application for review of its NRF in 1999. In connection with
this proceeding, the P.U.C.'s Office of Ratepayer Advocates ("ORA") undertook a
verification audit of Roseville Telephone's non-regulated and affiliated
transactions pursuant to the general rate case and other P.U.C. orders. In June
2001, the P.U.C. adopted its decision in this matter (the "Decision"). The
Decision did not suspend the sharing mechanism as Roseville Telephone had
requested, and further provided that Roseville Telephone must change the method
used to allocate costs for services provided by Roseville Telephone to its
affiliates, the treatment of certain directory revenues and the treatment of
internal-use software costs. Additionally, in accordance with the provisions of
the Decision, the Company recorded certain liabilities and reductions of
revenues relating to estimated intrastate shareable earnings obligations.
Prior to January 1, 2002, Roseville Telephone billed SBC various charges for
certain local service and network access service revenues in accordance with
certain agreements as described below. In 1999, SBC expressed interest in
withdrawing from the designated carrier plan ("DCP") for Roseville Telephone's
toll traffic. The DCP was a compensation arrangement between Roseville Telephone
and SBC for certain intrastate toll services. Roseville Telephone and SBC agreed
to allow the DCP arrangement to expire in December 2001.
In 1999, SBC also expressed interest in entering into a new, permanent
compensation arrangement for extended area service ("EAS"). At that time, SBC
had been paying Roseville Telephone $11.5 million per year for EAS pursuant to a
Settlement Transition Agreement. In November 2000, the P.U.C. authorized SBC to
terminate its annual EAS payments to Roseville Telephone effective November 30,
2000. The P.U.C. authorized replacement funding to Roseville Telephone on an
interim basis using the current reserve in the California High Cost Fund
("CHCF"). In addition, the P.U.C. opened an Order Instituting Investigation
("OII") for the purpose of determining whether future recovery of all, none, or
a portion of the $11.5 million annual payments previously received from SBC
should come from Roseville Telephone's ratepayers or other regulatory recovery
mechanisms. This proceeding began in 2001, evidentiary hearings were held during
2002, and briefing was completed in February 2003. In this proceeding, the ORA
recommends that the P.U.C. discontinue Roseville Telephone's present interim EAS
funding from the CHCF without replacement revenues from ratepayers. The P.U.C.'s
decision in this matter is expected during 2003. The P.U.C. has made no
indication as to what, if any, changes will be forthcoming relating to EAS
revenues. The results of these proceedings and their potential effects on
Roseville Telephone cannot yet be determined.
Roseville Telephone's operations may also be impacted by the Telecommunications
Act of 1996 (the "Act"). The Act significantly changed the regulatory
environment for telecommunications companies. Beginning in 1996, the F.C.C.
conducted proceedings and adopted orders implementing the Act's provisions to
open local exchange service markets, such as the market of Roseville Telephone,
to competition. These proceedings and orders address interconnection, access
charges and universal service.
Given the ongoing activities of the F.C.C. to promulgate rules and regulations
on interconnection, access charges, and universal service reform, and the
various on-going legal challenges considering the validity of these F.C.C.
orders, it is not yet possible to determine fully the impact of the Act and
related F.C.C. regulations on Roseville Telephone's operations.
There are a number of other regulatory proceedings occurring at the federal and
state levels that may have a material impact on Roseville Telephone. These
regulatory proceedings include, but are not limited to, consideration of changes
to the jurisdictional separations process, the interstate universal service
fund, access charge reform and the regulation of local exchange carriers. The
outcomes and impact on Roseville Telephone's operations of these proceedings and
related court matters cannot be determined at this time.
The regulatory proceedings occurring at the state and federal levels described
above may also broaden the scope of competition in the provision of regulated
services and change the rates and rate structure for regulated services
furnished by Roseville Telephone, the effects of which on Roseville Telephone
cannot yet be determined.
Item 4. Submission of Matters to a Vote of Security Holders.
On May 16, 2003, the Company held its regularly scheduled Annual Meeting of
Shareholders, at which the shareholders elected a Board of seven (7) Directors.
The seven nominees to serve as directors, which constituted the entire Board of
Directors as of the meeting date, were all reelected to serve as directors by
the following votes (out of 14,537,144).
Broker Non-Votes
and Abstentions
Votes Votes Withheld
Director For
------------ ----------- -------------- ----------------
Thomas E. Doyle 11,715,141 98,753 N/A
Kirk C. Doyle 11,609,334 204,560 N/A
Brian H. Strom 11,715,285 98,609 N/A
John R. Roberts III 11,717,834 96,060 N/A
Chris L. Branscum 11,687,583 126,311 N/A
Timothy D. Taron 11,716,409 97,485 N/A
Neil J. Doerhoff 11,706,013 107,881 N/A
Item 6. Exhibits and Reports on Form 8-K.
a) See Index to Exhibits.
b) Reports on Form 8-K:
The Company filed a report on Form 8-K on May 1, 2003 relating to the
announcement of first quarter 2003 financial results.
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 6 (a))
Method
Exhibit No. Description of Filing Page
3(a) Articles of Incorporation of Registrant, together with Incorporated by -
Certificate of Amendment of Articles of Incorporation dated reference
January 25, 1996 and Certificate of Amendment of Articles
of Incorporation dated June 21, 1996 (Filed as Exhibit 3(a)
to Form 10-Q Quarterly Report for the quarter ended
September 30, 1996)
3(b) Certificate of Amendment of Articles of Incorporation dated Incorporated by -
May 18, 2001 (Filed as Exhibit 3(b) to Form 10-Q Quarterly reference
Report for the quarter ended June 30, 2001)
3(c) Bylaws of Registrant (Filed as Exhibit 3(b)to Form 10-K Incorporated by -
Annual Report of the Registrant for the year ended December reference
31, 2000)
4(a) Shareholder Rights Plan(Filed as Exhibit 2.1 to Form 8-A Incorporated by -
Registration Statement under the Securities Act of 1934) reference
10(a) Credit Agreement of Roseville Telephone Company with Bank Incorporated by -
of America National Trust and Savings Association, dated reference
January 4, 1994 (Filed as Exhibit 10(c) to Form 10-K Annual
Report of Registrant for the year ended December 31, 1993)
10(b) Note Purchase Agreement for Series A Senior Notes in the Incorporated by -
aggregate amount of $40,000,000 dated December 9, 1998 reference
(Filed as Exhibit 10(b) to Form 10-K Annual Report of
Registrant for the year ended December 31, 1998)
10(c) Supplement to Note Purchase Agreement for Series B Senior Incorporated by -
Notes in the aggregate amount of $60,000,000 dated March reference
13, 2003 (Filed as Exhibit 99.1 to the Form 8-K filed March
13, 2003)
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 6 (a))
Method
Exhibit No. Description of Filing Page
10(d) Business Loan Agreement of Registrant with Bank of America, Incorporated by -
dated March 15, 2000, as amended by Amendment No. 1 dated reference
as of April 10, 2000 (Filed as Exhibit 10(f) to Form 10-Q
Quarterly Report of Registrant for the quarter ended March
31, 2000), as amended by Amendment No. 2 dated as of
September 15, 2000, Amendment No. 3 dated as of July 17,
2001, and Amendment No. 4 dated as of June 26, 2002 (Filed
as Exhibit 10(l) to Form 10-Q Quarterly Report of
Registrant for the Quarter ended June 30, 2002)
10(e) Amendment No. 5 to Business Loan Agreement dated February Incorporated by -
26, 2003 (Filed as Exhibit 10(e) to Form 10-K Annual Report reference
of Registrant for the year ended December 31, 2002)
10(f) 1999 Restricted Stock Bonus Plan (Filed as Exhibit 10(d) to Incorporated by -
Form 10-K Annual Report of Registrant for the year ended reference
December 31, 1998)
10(g) 2000 Equity Incentive Plan (Filed as Incorporated -
Exhibit 10(e) to Form 10-K Annual Report of Registrant for by reference
the year ended December 31, 1999)
10 (h) SureWest KSOP (Filed as Exhibit 4.1 to Registration Incorporatedby -
Statement on Form S-8 [No 333-87222]) reference
10 (i) Letter agreement dated January 16, 2001 Incorporated by -
between Registrant and Brian H. Strom (Filed as Exhibit 10 reference
(g) to Form 10-K Annual Report of Registrant for the year
ended December 31, 2000)
10 (j) Letter agreement dated January 16, 2001 Incorporated by -
between Registrant and Michael D. Campbell (Filed as reference
Exhibit 10 (h) to Form 10-K Annual Report of Registrant for
the year ended December 31, 2000)
10 (k) Letter agreement dated January 16, 2001 Incorporated by -
between Registrant and Jay B. Kinder (Filed as Exhibit 10 reference
(i) to Form 10-K Annual Report of Registrant for the year
ended December 31, 2000)
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 6 (a))
Method
Exhibit No. Description of Filing Page
10 (l) Letter agreement dated January 16, 2001 Incorporated by -
between Registrant and Philip D. Germond (Filed as Exhibit reference
10 (j) to Form 10-K Annual Report of Registrant for the
year ended December 31, 2000)
10(m) Letter agreement dated January 16, 2001 Incorporated by -
between Registrant and Robert M. Burger (Filed as Exhibit reference
10 (k) to Form 10-K Annual Report of Registrant for the
year ended December 31, 2000)
31(a) Certification of Brian H. Strom, President and Chief Filed herewith 39
Executive Officer, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31(b) Certification of Michael D. Campbell, Executive Vice Filed herewith 41
President and Chief Financial Officer, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32(a) Certification of Brian H. Strom, President and Chief Filed herewith 43
Executive Officer, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
32(b) Certification of Michael D. Campbell, Executive Vice Filed herewith 44
President and Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SUREWEST COMMUNICATIONS
(Registrant)
Date: August 4, 2003 By: /s/BRIAN H. STROM
-----------------------------------
Brian H. Strom,
President and Chief
Executive Officer
Date: August 4, 2003 By: /s/MICHAEL D. CAMPBELL
-----------------------------------
Michael D. Campbell,
Executive Vice President
and Chief Financial Officer
signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SUREWEST COMMUNICATIONS
(Registrant)
Date: August 4, 2003 By: ___________________________
Brian H. Strom,
President and Chief
Executive Officer
Date: August 4, 2003 By: ___________________________
Michael D. Campbell,
Executive Vice President
and Chief Financial Officer
EXHIBIT 31(a)
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Brian Strom, President and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SureWest
Communications;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)):
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: August 4, 2003
/s/Brian H. Strom
-----------------------------------
Brian H. Strom
President and Chief Executive Officer
EXHIBIT 31(b)
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Michael D. Campbell, Executive Vice President and Chief Financial Officer,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of SureWest
Communications;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)):
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: August 4, 2003
/s/Michael D. Campbell
-----------------------------------
Michael D. Campbell
Executive Vice President and
Chief Financial Officer
EXHIBIT 32 (a)
CERTIFICATION PURSUANT TO
18 U.S.C SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of SureWest Communications (the
"Company"), on Form 10-Q for the period ended June 30, 2003 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), the
undersigned, as the Chief Executive Officer of the Company, hereby certifies
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) and
Section 15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: August 4, 2003
/s/Brian H. Strom
-----------------------------------
Brian H. Strom
President and Chief Executive Officer
A signed original of this written statement required by Section 906 has been
provided to SureWest Communications and will be retained by SureWest
Communications and furnished to the Securities and Exchange Commission or its
staff upon request.
EXHIBIT 32 (b)
CERTIFICATION PURSUANT TO
18 U.S.C SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of SureWest Communications (the
"Company"), on Form 10-Q for the period ended June 30, 2003 as filed with the
Securities and Exchange Commission of the date hereof (the "Report"), the
undersigned, as the Executive Vice President and Chief Financial Officer of the
Company, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) and
Section 15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: August 4, 2003
/s/Michael D. Campbell
-----------------------------------
Michael D. Campbell
Executive Vice President and
Chief Financial Officer
A signed original of this written statement required by Section 906 has been
provided to SureWest Communications and will be retained by SureWest
Communications and furnished to the Securities and Exchange Commission or its
staff upon request.