Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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 to be registered pursuant to Section 12(b) of the Act:
None
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes X No _____
-----
On June 30, 2003, which was the last business day of the registrant's most
recently completed second fiscal quarter, the registrant had 14,537,144 shares
of Common Stock outstanding and the market value of shares held by
non-affiliates was approximately $382,904,028 (based on 12,620,436 shares of
Common Stock then held by non-affiliates and a closing price that day of $30.34
per share of Common Stock on the Nasdaq National Market). The market value
calculations exclude shares held on the stated date by registrant's employee
benefit plans, directors and officers on the assumption such shares may be
shares owned by affiliates. (Exclusion from these public market value
calculations does not imply affiliate status for any other purpose).
On March 1, 2004, the registrant had 14,580,904 shares of Common Stock
outstanding.
Documents INCORPORATED BY REFERENCE
Incorporated by reference into Part II, Item 5 and Part III hereof are portions
of the registrant's definitive proxy statement to be filed pursuant to
Regulation 14A within 120 days after the Registrant's fiscal year-end of
December 31, 2003.
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business....................................................................................... 4
Item 2. Properties..................................................................................... 14
Item 3. Legal Proceedings.............................................................................. 14
Item 4. Submission of Matters to a Vote of Security Holders............................................ 17
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities................................................................. 19
Item 6. Selected Financial Data........................................................................ 19
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................................. 22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................................... 50
Item 8. Financial Statements and Supplementary Data.................................................... 51
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure........................................................................... 89
Item 9A. Controls and Procedures........................................................................ 89
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 92
Item 11. Executive Compensation......................................................................... 92
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters........................................................................... 92
Item 13. Certain Relationships and Related Transactions................................................. 93
Item 14. Principal Accountant Fees and Services......................................................... 93
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................... 94
SIGNATURES .......................................................................................... 98
CERTIFICATIONS............................................................................................ 136
PART I
Item 1. Business.
General Development of Business
SureWest Communications (the "Company" or "we") is a California holding company
whose operating subsidiaries provide a wide range of telecommunications, digital
video, and other facilities-based communication services in Northern California,
primarily in the greater Sacramento region. The Company was incorporated under
the laws of the State of California in 1995, and its predecessor, Roseville
Telephone Company, was incorporated in 1914.
As of December 31, 2003, the Company's wholly-owned subsidiaries included
SureWest Telephone, SureWest Directories, SureWest Long Distance, SureWest
Wireless, SureWest Broadband, SureWest TeleVideo and SureWest Televideo of
Roseville ("SureWest Broadband/Residential Services"), SureWest Internet, and
SureWest Custom Data Services (formerly Quiknet, Inc.). Until October 27, 2003,
SureWest Telephone was named Roseville Telephone Company and SureWest Long
Distance was named Roseville Long Distance Company.
The Company's strategy is to become the first choice as a dominant integrated
communications provider in the Sacramento region. It seeks to achieve this
position by leveraging its existing advanced fiber network to extend its
operations throughout Sacramento, Placer and adjacent counties, by providing
superior customer service and by integrating its systems, products and operating
functions.
No customer accounted for more than 10% of the Company's consolidated operating
revenues during the years ended December 31, 2003, 2002 and 2001.
The Company currently divides its business into three reportable business
segments: Telecommunications ("Telecom"), Broadband and Wireless. The table that
follows reflects the percentage of total operating revenues of the Company
generated by each of its three reporting segments for the last three fiscal
years:
% of Total Operating Revenues
Reporting Segment 2003 2002 2001
---- ---- ----
Telecom 71% 81% 87%
Broadband 15% 7% 3%
Wireless 14% 12% 10%
_____ _____ _____
Total operating revenues 100% 100% 100%
===== ===== =====
The Company's products or services that generated 10% or more of its total
operating revenues in any of the last three years are as follows:
2003 2002 2001
---- ---- ----
(Amounts in thousands)
Local service $ 63,363 $ 66,283 $ 63,816
Network access service $ 51,286 $ 58,426 $ 49,030
Wireless service $ 27,146 $ 23,225 $ 16,056
The Company currently generates the majority of its revenues from services that
are subject to regulation by either or both of the California Public Utilities
Commission ("CPUC") and the Federal Communications Commission ("FCC"). Revenues
from services subject to comprehensive regulation include local service, network
access service and toll service revenues. The Company expects that the
proportion of its revenues that comes from nonregulated or lightly regulated
businesses will increase in future years because of the successful execution of
its business strategy and the impact of competition on its existing regulated
operations. The table that follows reflects the percentage of total operating
revenues of the Company contributed by various sources.
% of Total Operating Revenues
Revenues 2003 2002 2001
---- ---- ----
Revenues from services subject to regulation 59% 67% 69%
Other revenues 41% 33% 31%
____ ____ ____
Total operating revenues 100% 100% 100%
==== ==== ====
There continues to be increased competition facing telecommunications providers.
As a result of technology change and industry, legislative and regulatory
developments, the Company continues to face new competitive challenges. These
developments, however, have also provided the Company with significant growth
opportunities. The Company believes that growth from its entry into newer
businesses in recent years will offset flat or slowing growth in customers in
its other businesses, and that the newer businesses provide significant revenue
opportunities that were not present before. Competitive issues facing individual
operating units are addressed in connection with the individual segment
discussions below.
As of December 31, 2003, the Company, including all of its operating
subsidiaries, had 997 employees. This reflects an increase of 6% over the number
of employees at December 31, 2002. None of the Company's employees are
represented by a union. The Company considers its employee relations to be
positive.
Telecom
General
The Telecom segment includes SureWest Telephone, SureWest Directories and
SureWest Long Distance, which provide landline telecommunications services,
digital subscriber line ("DSL") services, directory advertising services, long
distance services and certain related non-regulated services. The Telecom
segment accounted for approximately 71%, 81% and 87% of the Company's operating
revenue in the years 2003, 2002 and 2001, respectively. Although revenues from
this segment have decreased as a percentage of all Company revenues over the
past several years, the Company expects this segment to continue to provide the
largest proportion of its revenues and earnings in 2004.
SureWest Telephone operates as an incumbent local exchange carrier ("ILEC") with
a service area of approximately 83 square miles, covering Roseville and Citrus
Heights, California, and adjacent areas in Placer and Sacramento Counties. The
Company holds a non-exclusive perpetual franchise granted by section 7901 of the
California Public Utilities Code. The area served by SureWest Telephone has been
one of the most rapidly growing areas in California during the past decade, but
the pace of growth has slowed in recent years as the area has become more fully
developed. The rapid growth has also attracted new competitors to the area.
SureWest Telephone's primary services are local telephone service, network
access services, toll services and certain vertical and non-regulated services.
Toll services and access to SureWest Telephone's network are provided through
connections with other carriers serving adjacent areas, including SBC
Communications ("SBC"), and also through serving agreements with numerous
interexchange carriers, including national interexchange carriers.
SureWest Telephone provides services to residential, business and carrier
customers. As of December 31, 2003, SureWest Telephone served 136,365 access
lines within its service area. Total access lines declined by 1% from December
31, 2002 to December 31, 2003. The Company believes that economic conditions in
the area in 2003, expanding competition, and service substitution have impacted,
and will continue to impact, the number of access lines provided by SureWest
Telephone.
This segment also includes the operations of two other businesses, SureWest
Directories and SureWest Long Distance.
SureWest Directories publishes and distributes the SureWest Telephone local and
Yellow Pages directories, directories for greater Sacramento and directories for
the areas to the immediate northeast of the SureWest Telephone service area. The
SureWest Directories' business faces significant competition from national
directory publishers and other local businesses, including SBC. SureWest
Directories' business has expanded into electronic and on-line formats. The
directory business is not regulated by the FCC or CPUC; however, the revenues
from publishing rights licensed by SureWest Telephone under its contractual
arrangement with SureWest Directories are taken into account by the CPUC with
respect to SureWest Telephone's operations.
SureWest Long Distance offers intrastate, interstate, and international long
distance services, including calling card and 800 services. SureWest Long
Distance is a resale business that utilizes other national and international
carriers for wholesale transport, switching and other capabilities. SureWest
Long Distance maintains agreements with Sprint and Global Crossing to diversify
its risks related to its wholesale providers. The rates offered to SureWest Long
Distance by these companies are competitive; however, changes in the wholesale
marketplace in the recent past have provided recurring opportunities to long
distance resellers to reduce their costs further. The agreements with both of
these providers will be open to renegotiation in 2004, and there are other
interexchange providers who could provide wholesale service to SureWest Long
Distance in the future.
As of December 31, 2003, 42,911, or 31%, of the customers of SureWest Telephone
have elected to choose SureWest Long Distance as their presubscribed long
distance provider.
Competition
In recent years, competition to serve the customers of SureWest Telephone has
increased significantly. Changes in technology have made it possible for
customers to receive services in new ways at competitive rates. To meet the
competition, SureWest Telephone has responded in part by introducing new
services and service "bundles," offering services in convenient groupings with
package discounts and billing advantages, and by investing in its network and
business operations. Changing technology requires that the Company continue to
adapt its network and the manner in which it provides service. Within its
telephone service area, services are provided over an integrated network making
extensive use of optical fiber. SureWest Telephone deploys fiber optic
facilities closer to an end user's premises to broaden the reach and capacity of
Company services requiring additional bandwidth. In some instances, fiber optics
is deployed directly to a customer's premises. Because bandwidth is limited by
distance when utilizing copper facilities, the Company also deploys equipment
throughout its service area to enable the improved provision of services.
Certain of the Company's facilities take advantage of IP (Internet protocol),
which allows for more efficient use of bandwidth.
See "Item 3 - Legal Proceedings" and "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations" for further
discussion regarding SureWest Telephone's revenues that are subject to the
competitive environment in which SureWest Telephone operates.
The Company anticipates that its businesses will continue to experience
competition and that the nature and extent of such competition will increase.
Competitors to the SureWest Telephone business include competitive local
exchange carriers, interexchange carriers (including interexchange carriers who
directly serve customers without using facilities of local exchange carriers),
customers who are telecommunications self-providers, and a range of other
providers who specialize in certain niche areas of telecommunications.
Technology change has accelerated the pressure on established carriers,
including SureWest Telephone, by virtue of software-defined businesses, and
innovations related to packet switching and use of the Internet.
Regulation
SureWest Telephone's revenues are influenced greatly by the actions of the CPUC
and the FCC.
All intrastate service rates of SureWest Telephone are subject to comprehensive
regulation by the CPUC. The provision of access to the networks of interexchange
carriers for long distance calling is governed by access tariffs and by
intercarrier agreements which are subject to the jurisdiction of the CPUC or
FCC, or both, depending upon the nature of the transmissions that are made.
SureWest Telephone has a tariff on file with the FCC for all elements of
interstate access services except carrier common line charges, for which
SureWest Telephone concurs with the tariff of the National Exchange Carrier
Association ("NECA").
In February 1996, Congress passed the Telecommunications Act of 1996 (the "Act")
which was intended to expand the opportunities for competition in a range of
telecommunications businesses, and which has significantly changed the
regulatory environment. See "Item 3 - Legal Proceedings" and "Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations" for further discussion regarding the impact of the Act. The
application of the Act in particular circumstances continues to present
contentious issues for carriers and others, and a number of court appeals were
pending as of December 31, 2003 that would affect the application of the Act to
the Company.
The FCC monitors SureWest Telephone's interstate earnings through the use of
annual cost separation studies that are prepared and submitted by SureWest
Telephone in accordance with rules governing the preparation of such studies.
SureWest Telephone utilizes actual and estimated cost information and actual and
projected demand usage.
The characterization of traffic as interstate or intrastate, and as a
telecommunications or information service has been a significant source of
dispute among carriers and others in recent years, as such characterizations can
impact the regulatory treatment of such traffic and the payment of obligations
of the providers who are involved. The characterization of: (i) traffic involved
in intercarrier interconnection, (ii) Internet traffic, and (iii) traffic that
makes use of Internet protocol ("IP") and other transmission technologies are
examples of issues that are currently subject to analysis on the state and
federal levels, and that are expected to be subject to regulatory action in the
near future. The FCC and CPUC initiated a major rulemaking in early 2004 that is
intended to evaluate and establish the appropriate regulatory regime for
IP-enabled services.
With respect to regulation administered by the CPUC, in 1996, the CPUC issued a
decision in connection with SureWest Telephone's general rate proceeding, which
authorized SureWest Telephone to implement a New Regulatory Framework ("NRF")
for services furnished within SureWest Telephone's service area in order to
accommodate increased competition and to afford greater pricing flexibility.
Under the NRF, SureWest Telephone is subject to ongoing monitoring and reporting
requirements, including a sharing mechanism whereby SureWest Telephone is
required to share earnings with customers through a reduction of revenues if its
earned annual intrastate rate-of-return exceeds that authorized by the CPUC. In
accordance with the requirements of its general rate case order, SureWest
Telephone filed an application for review of its NRF in 1999 and requested that
the sharing mechanism be suspended, consistent with past CPUC decisions for
other incumbent local exchange carriers in California. After a verification
audit by the CPUC's Office of Ratepayer Advocate, the CPUC issued a decision in
June 2001 that failed to suspend the sharing mechanism, and required certain new
changes in the method used to allocate costs for services provided by SureWest
Telephone to its affiliates, the treatment of certain directory revenues and the
treatment of internal-use software costs. Since that time, SureWest Telephone
has been engaged in proceedings to modify that decision and to implement a NRF
that is consistent with that applicable to other ILECs within the state. As
discussed in "Item 3 - Legal Proceedings", the proceeding remains pending. In
addition to its regulatory authority with respect to SureWest Telephone's rates,
the CPUC also has the power, among other things, to establish terms and
conditions of service, to prescribe uniform systems of accounts and to regulate
the mortgaging or disposition of public utility properties.
In November 2000, the CPUC authorized SBC to terminate its approximate annual
$11,500 extended area service payments to SureWest Telephone effective November
30, 2000 and authorized replacement funding on an interim basis from the
California High Cost Fund ("CHCF"). In addition, the CPUC ordered a separate
proceeding for the purpose of determining whether future recovery of all, none
or a portion of the approximate $11,500 should come from SureWest Telephone's
ratepayers or other regulatory recovery mechanisms. As discussed further in
"Item 3 - Legal Proceedings," a decision in this matter is expected from the
CPUC during 2004.
These actions of the CPUC and of the FCC, as noted above, can affect the rates
charged for access and interconnection, and, as a result, the revenues derived
by the Company from access and related services. SureWest Telephone's future
operations also may be impacted by other proceedings at the FCC and CPUC,
including proceedings that address interstate access and other rates and
charges, the nature of interconnection between incumbent local exchange carriers
and others, the collection and distribution of support payments required to
assure universal access to basic telephone services, and the charges that can be
assessed for new forms of service that directly or indirectly utilize carrier
networks.
Substantially all of the interstate long distance business was detariffed after
a transition period that started on May 1, 2000 and ended in 2001, after the FCC
issued a detariffing order on January 31, 1996 and all related appeals were
exhausted. The long distance business is recognized as being fully competitive,
and there are many providers of long distance services. The emergence from
bankruptcy reorganization proceedings of some larger interexchange and
competitive local exchange carriers has created new competitive pressures in the
sector for both wholesale and retail providers. Because of the level of
competition, regulation of this area of the telecommunications business is light
or has been removed altogether. Where it exists, regulation is focused on
specific public policy concerns, such as customer account slamming, rather than
the rates, terms and conditions of service.
Broadband
General
The Broadband segment includes SureWest Broadband, SureWest Internet, SureWest
Custom Data Services and SureWest Broadband/Residential Services. The Broadband
segment also includes a competitive local exchange carrier ("CLEC"), which was
authorized by the CPUC in 1998 to provide telecommunications services in areas
outside the telephone service area of SureWest Telephone. As of January 1, 2003,
the Company consolidated the operations of SureWest Internet and SureWest Custom
Data Services into the operations of SureWest Broadband for financial reporting
purposes, though they remain separate legal entities.
The Broadband segment provides services to residential, business and carrier
customers. The services include: high-speed and dial-up Internet service,
digital video, local and network access, toll telephone and managed services.
These services are offered in the greater Sacramento area, principally to
customers residing outside of SureWest Telephone's service area. However,
commencing in December 2003, the Company began providing digital video and
high-speed Internet services to customers within SureWest Telephone's service
area. Certain of the Company's affiliates possess cable television licenses or
franchises in Sacramento County, and the cities of Roseville and Lincoln.
The Broadband segment accounted for approximately 15%, 7% and 3% of the
Company's operating revenues in the years 2003, 2002 and 2001, respectively. As
of December 31, 2003, the Broadband segment had 34,502 customers.
The Broadband segment's backbone network is comprised primarily of optical fiber
and is subject to continual expansion and diversification in response to
business growth.
The Broadband segment provides dial-up and high-speed Internet services and
custom data solutions, including collocation, fixed and burstable bandwidth,
managed services and network monitoring services. The Company provides DSL based
Internet services to residential and business customers in the SureWest
Telephone service area as well as high-speed Internet services to business
customers outside of SureWest Telephone's service area, primarily in the greater
Sacramento region. SureWest Broadband had 19,805 DSL customers as of December
31, 2003.
SureWest Broadband/Residential Services commenced operations in July 2002, when
the Company acquired the assets formerly held by Western Integrated Networks,
LLC. SureWest Broadband/Residential Services provides a "triple play" bundled
offering consisting of digital video, high-speed Internet, and telephone
services to residential customers in the greater Sacramento area. Substantially
all of the services provided by SureWest Broadband/Residential Services utilize
digital fiber network capability. SureWest Broadband/Residential Services
utilizes the SureWest Broadband brand. From its original base in July 2002 of
approximately 5,000 subscribers, the SureWest Broadband/Residential Services
subsidiary reached a triple play subscriber level of 11,084 as of December 31,
2003.
In 2003, SureWest Broadband/Residential Services obtained a cable television
franchise in Roseville, California, and began offering services to residential
customers in December 2003. SureWest Broadband/Residential Services procures
digital transport capability from its affiliate SureWest Telephone, and has
developed an advanced method of delivering video services to subscribers using
Internet protocol, or IP-video capability. The Company expects that SureWest
Broadband/Residential Services will compete more aggressively in the City of
Roseville to get and to retain its telecommunications and Internet customers as
well as digital video customers. SureWest Broadband/Residential Services
acquired a new franchise in Lincoln, California in early 2004, and expects to
expand its services in 2004 to already-licensed areas of Elk Grove and Natomas,
California as well as other areas within its service area footprint.
Competition
Except as noted below, the businesses in the Broadband segment are subject to
extensive competition. Competition is highly fragmented, and has grown
dramatically in recent years. Except for the digital video delivery business,
which requires significant capital investment, there are few significant
barriers to entry, and technology changes force rapid competitive adjustments.
SureWest Broadband competes regularly against SBC, which is the incumbent local
exchange carrier in Sacramento and most of its surrounding areas. The Broadband
segment also competes against Frontier Communications in southern Sacramento
County. Numerous CLECs and others offer telecommunications and related services
on a flexible and highly specialized basis in the Sacramento area. The Company
has found that it can be successful by constantly seeking out new sales
opportunities in attractive segments of the market, by maintaining a highly
reliable network that is accessible to new customers, and by focusing on the
provision of excellent service to its customers. To the extent permitted by law
and regulatory requirements, the Company seeks to operate its business across
the Broadband segment in an integrated manner, and its network as a single
integrated facility. The operating units in this segment benefit within the
region from the name recognition and reputation of SureWest, and from the active
participation of Company executives and employees in civic and other groups.
During 2003, the Company was able to obtain approval from the Sacramento county
Cable Commission to activate service for customers in "green field" areas that
were previously outside the Company's approved build-out and activation
schedules. It now anticipates that it will achieve a highly competitive market
share in the provision of telephone, digital video and Internet services in many
of these areas around Sacramento. It is important to the Company that its
operations in this segment be able to deliver services to customers in
developing areas as they grow.
The Broadband segment has assumed the responsibility for much of the Company's
DSL and high-speed Internet retail customer base. The emergence of cable modems,
wireless Internet access and other avenues to reach the Internet provide
significant competition. The presence of other broadband Internet access
providers has begun to have an impact on pricing, which has been under downward
pressure in the region.
The market among multichannel video providers is very competitive. The main
competitors of SureWest Broadband/Residential Services are Comcast and various
satellite television providers. Sacramento County promotes competition in the
provision of cable service, and has a straightforward franchise and licensing
ordinance that accommodates new entrants rapidly, and allows them flexibility in
defining service territories. SureWest has entered the Sacramento, Roseville and
Lincoln cable service markets as the second (or subsequent) franchisee, and
while it will therefore benefit from the somewhat reduced regulation that such
entrants enjoy, it will nevertheless face the challenge of drawing customers
away from the incumbent provider. The provision of cable television over a
closed transmission path has been recognized as possessing certain monopoly
characteristics, and therefore the ability of a second or subsequent provider to
succeed in the marketplace is not assured.
Regulation
Like SureWest Telephone, SureWest Broadband must comply with various rules of
the CPUC governing tariffs, access to information, consumer protection and
similar matters for a telecommunication service provider. The FCC has
jurisdiction over the SureWest Broadband interstate services, such as access
service. In 2001, the FCC adopted rules that will cause CLEC interstate switched
access charges to decline over time, and that have also caused a decline in the
amount of compensation that can be derived from Internet Service Provider
dial-up traffic. SureWest Broadband is only minimally affected by these actions,
and has already modified its rates to comply with the FCC requirements.
In late 2001, the FCC began a triennial review of its policies on unbundled
network elements ("UNE") and other regulations that affect the nature of
competition between ILECs and CLECs. The FCC concluded its Triennial Review in
early 2003, and its action was appealed by a number of parties. The appellate
court reversed the FCC and vacated significant portions of the FCC rules in a
decision that was released in early March 2004, but stayed its mandate for a
short time. SureWest Broadband does not rely to any significant degree on
unbundled network elements or other offerings that would be affected by these
appeals, and it does not rely generally on the availability of discounted
incremental cost pricing of service elements from the incumbent local exchange
carrier to serve retail customers. However, the position of SureWest Broadband
in the Sacramento market could be affected by a change in law or regulation that
granted unrestricted pricing flexibility to the incumbent local exchange carrier
in Sacramento or that denies competitors the ability to assure that pricing
concessions given to customers are nondiscriminatory and offered on a consistent
basis.
The cable television business is governed by federal, state and local laws and
regulation, but is most substantially controlled by the mechanisms in Title VI
of the Communications Act of 1934, as amended. While closely regulated in some
areas, providers of cable services are generally free from rate regulation, and
have wide leeway to select and package the content that they deliver. In
exchange for their use of local streets and rights of way, cable providers are
required to pay franchise fees, and to deliver public, educational and
governmental channels for use by the community, among other things.
Wireless
The Wireless segment consists of the Company's subsidiary SureWest Wireless,
which provides wireless services.
SureWest Wireless was formed for the purpose of providing wireless personal
communications services, or PCS. PCS is viewed generally as involving the
capability to deliver a more advanced set of features and capabilities than the
basic form of cellular mobile service.
During 1997, SureWest Wireless purchased from the FCC spectrum licenses that
allow it to offer wireless services in four Basic Trading Areas, representing 16
counties located in central California. These areas include the cities of
Sacramento, Stockton, Modesto and Yuba City. Each license represents 10
megahertz of spectrum, and accommodates digital wireless technology that is
capable of providing both voice and data transmission. SureWest Wireless
commenced deployment of the network infrastructure in 1998 and initiated
wireless telecommunications services with telephone, paging and voicemail
capabilities in June 1999.
SureWest Wireless derives its revenue from the provision of wireless PCS, and
the sale of handsets and related communications equipment. In addition, SureWest
Wireless generates revenue from long distance calls, roaming service, custom
calling and other features, and handset insurance.
SureWest Wireless established its market share in the Sacramento market in large
part by promoting an unlimited flat rate regional calling plan. Wireless
customer acquisition has historically been most active during the December
holiday season, and the Company has always been active in sales and marketing at
this time. During 2003, SureWest Wireless initiated a number of new service
options for customers, including new regional plans and in 2004 will launch a
family plan and new vertical services such as wireless data capabilities.
Evolution of the marketplace has caused SureWest Wireless to open four retail
stores in its service area. It is also seeking to expand its service penetration
among major accounts in 2004. SureWest Wireless will seek to reduce customer
churn and to increase the amount of revenue it derives from each customer in
2004.
As of December 31, 2003, SureWest Wireless had 46,724 subscribers. The Wireless
segment accounted for approximately 14%, 12% and 10% of the Company's operating
revenue in the years 2003, 2002 and 2001, respectively.
The wireless business requires capital investment to build new cell sites and to
deploy digital and other advanced service capabilities. Most of SureWest
Wireless' planned cell site construction has been completed, but SureWest
Wireless will seek to expand its capability to handle wireless data services in
2004.
Certain operations of the Company are reliant upon the services provided by
WorldCom, Inc. ("WorldCom"), which filed for bankruptcy protection on July 21,
2002, but which is expected to emerge from bankruptcy in 2004. If SureWest
Wireless is unable to procure the services it needs from Worldcom in the future,
it expects to be able to procure services from other telecommunication
providers, if necessary.
Competition
The market for wireless services is highly competitive. There are numerous
facilities-based wireless providers in the Sacramento market, including all of
the major national providers, and additional wireless resellers. Most of these
competitors have a national presence, and therefore have the ability to leverage
national advertising budgets and name recognition. In addition, many of the
competitors have access to additional spectrum in the geographic markets in
which SureWest Wireless competes. In order for SureWest to succeed in this
geographic market, it has established a marketing niche, such as its unlimited
flat rate service package, and it sought to leverage the SureWest name and
reputation. However, competition is expected to remain intense.
Regulation
Because of their use of valuable spectrum resources, wireless services are
subject to regulation. The construction, operation, management and transfer of
digital wireless systems in the United States are regulated by the FCC and CPUC.
However, regulators do not interfere with price plans offered to wireless
customers.
On November 24, 2003, the FCC implemented its mandate that wireless carriers
provide for local number portability ("LNP"). LNP allows wireless subscribers to
keep their wireless phone numbers while switching to a different wireless
service provider. In addition, LNP allows a person to move a telephone number
associated with a wired telephone to a wireless provider in the largest markets
in the United States, including the Sacramento market. As of December 31, 2003,
SureWest Wireless experienced a net gain of wireless customers from LNP
implementation. At the same time, the Company's SureWest Telephone subsidiary
experienced only an incidental loss of local telephone customers to wireless
providers as a result of LNP implementation.
Significant Events
Sale of Alarm Monitoring Division
In January 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 December 31, 2003, the Company has received cash proceeds of
$4,995, of which $4,495 and $500 were received during 2002 and the fourth
quarter of 2001, respectively, 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 as of the
date of the sale. The purchaser of the assets commenced litigation against the
Company relating to claims under the asset purchase agreement, generally in
connection with certain contracts assigned to the purchaser. In July 2003, the
Company and the purchaser settled the litigation and the parties released all
claims in exchange for payment by the Company to the purchaser of $375, which
was paid during 2003. Total operating revenues attributable to the Company's
alarm monitoring division during 2002 were $279 (none in 2003).
Acquisition of the Assets of Western Integrated Networks, LLC
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 assets of WIN acquired by the Company, consisted principally of
accounts receivable and property, plant and equipment located in Sacramento
County, California. The purchase price for the assets of WIN consisted of (i)
$12,000 in cash, (ii) direct acquisition related costs of $622, and (iii) the
assumption of certain liabilities aggregating $4,717 relating principally to
executory contracts and capital lease obligations. Under the terms of the asset
purchase agreement, $1,200 of the aggregate purchase price was held in an escrow
account to protect the Company in the event of any claims available to the
Company. On January 28, 2003, $150 was released to the Company, and the balance
remains in the escrow account. The Company has entered into a tentative
agreement to resolve all differences in connection with the amounts held in
escrow, and the disputes that led to the establishment of the escrow, which has
been submitted to the Bankruptcy Court for approval. Under the terms of the
tentative settlement no additional funds will be paid by or released to the
Company.
Factors That Could Affect Future Results
The Company advises of numerous risk factors that should be taken into account
in evaluating any investment in SureWest securities. Representative examples of
these factors include (without limitation) the following:
We expect to continue to face significant competition in all parts of our
business and the level of competition is expected to intensify. The
telecommunications industry is highly competitive. We face actual or
potential competition from many existing and emerging companies, including
other incumbent and competitive local telephone companies, long-distance
carriers and resellers, wireless telephone companies, Internet service
providers, satellite companies and cable television companies. We may not
be able to successfully anticipate and respond to various competitive
factors affecting the industry, including regulatory changes that may
affect our competitors and us differently, new technologies and services
that may be introduced, changes in consumer preferences, demographic trends
and discount pricing strategies by competitors. As the incumbent carrier in
Sacramento, SBC enjoys certain business advantages, including its size,
financial resources, favorable regulatory position, brand recognition and
connection to virtually all of our customers and potential customers there.
As the largest cable operator in Sacramento and Placer County, Comcast
enjoys certain business advantages, including its size, financial
resources, ownership or superior access to programming and other content,
brand recognition, and first-in-the-field advantages with a customer base
that generates positive cash flow for its operations. We face intense
competition in our markets for long-distance, Internet access and other
ancillary services that are important to our business and to our growth
strategy.
We must adapt to rapid technological change. Technological developments
could increase our costs and cause a decline in demand for our services. In
addition, technology changes can give competitors significant new
advantages. If we do not replace or upgrade technology and equipment that
becomes obsolete, we will be unable to compete effectively because we will
not be able to meet the needs or expectations of our customers.
Additionally, replacing or upgrading our infrastructure in the future could
result in significant capital expenditures.
We are subject to a complex and uncertain regulatory environment. Some
parts of our business are extensively regulated, and the nature of
regulation continues to undergo fundamental change and reinterpretation.
Our operations have undergone material changes, and our actual operating
results can be expected to differ from the results indicated in our
historical financial statements. As a result of our acquisition of assets
from WIN in 2002, our mix of operating assets differs from those operations
upon which our historical financial statements are based. Consequently, our
historical financial statements may not be reliable as an indicator of
future results.
Our success depends upon our ability to manage our growth and expansion. If
our acquisitions and growth initiatives are not successful, we could suffer
an adverse effect on our business and results of operations. Our growth
strategy will require us to invest significant capital in services that may
not achieve the desired returns. Our future success depends, in part, upon
our ability to manage our growth, including our ability to build network
and related facilities to serve new customers, integrate our operations to
take advantage of new capabilities and systems; attract and retain skilled
personnel across the Company, effectively manage the demands of day to day
operations in new areas while attempting to execute our business strategy,
and realize the projected growth and revenue targets developed by Company
management.
We have more indebtedness now than at December 31, 2002. In March 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, which had an
aggregate outstanding principal balance of $15,000. A substantial intended
use of the Series B Notes proceeds was and continues to be the funding of
capital expenditures for the Company's SureWest Broadband/Residential
Services business.
We are reliant on support funds provided under federal and state laws. We
receive revenues from various federal or state support funds: long term
support from the Universal Service Program, California High Cost Fund-B and
Universal Lifeline Service Fund. These governmental programs are reviewed
and amended from time to time, and are likely to change in the near future.
The outcome and impact on the Company's operations resulting from future
changes to these governmental programs cannot be determined at this time.
We could be harmed by the recent adverse developments affecting other
communications companies. There have been numerous bankruptcies and other
financial difficulties experienced by other carriers and suppliers in the
telecommunications and Internet sectors. Similar situations with our
suppliers, some of whom provide products and services for which there are
few substitutes, could cause us to experience delays, service interruptions
or additional expenses.
We depend on third parties, over whom we have no control, to deliver our
services. Because of the interconnected nature of the telecommunications
industry, we depend heavily on other local telephone companies,
long-distance carriers, and numerous other third parties to deliver our
services. In addition, we are dependent on easements, franchises and
licenses from various private parties such as established telephone
companies and other utilities, railroads, long-distance companies, state
highway authorities, local governments and transit authorities for access
to aerial pole space, underground conduits and other rights-of-way in order
to construct and operate our networks. The failure to maintain in effect
the necessary third party arrangements on acceptable terms would have an
adverse effect on our ability to conduct our business.
If we are unable to effectively and efficiently implement the necessary
initiatives to eliminate the material weaknesses identified in our internal
controls and procedures, there could be an adverse affect on our operations
or financial results. Our auditors, Ernst & Young LLP, in connection with
the audit of the Company's consolidated financial statements for the year
ended December 31, 2003, advised us that they had concluded that material
weaknesses in the Company's internal control existed, including with
respect to issues identified as a result of a special investigation
instituted by the Audit Committee. The specific matters identified by Ernst
& Young LLP encompassed (i) control of cash and investments, (ii)
accounting personnel, policies and procedures and (iii) accounting for
property, plant and equipment. We performed substantial additional
procedures designed to ensure that the internal control deficiencies did
not lead to material misstatements in our consolidated financial
statements.
We have already implemented various initiatives, and are considering
additional initiatives to improve our internal controls, and address the
matters identified by Ernst & Young LLP. The implementation of the
initiatives and the consideration of additional necessary improvements are
among our highest priorities. The Board of Directors, under the direction
of the Audit Committee, will continually assess the progress of the
initiatives and the improvements, and take further actions as deemed
necessary. Until all of the identified material weaknesses are eliminated,
there is a risk of an adverse affect on our operations or financial
results. In addition, we anticipate that the initiatives will require the
hiring of additional employees and the incurrence of fees and expenses of
third parties necessary to improve the internal controls, likely resulting
in increased operating expenses.
Available Information
The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and amendments to reports filed pursuant to Sections
13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are
available on our website at www.surewest.com/corporate/ir/, when such reports
are available on the Securities and Exchange Commission website. Copies are also
available free of charge upon request to SureWest Communications, P.O. Box 969,
Roseville, CA 95678, Attn: Investor Relations Manager.
Item 2. Properties.
The Company owns and leases office facilities and related equipment for
executive headquarters, administrative personnel, central office buildings, and
operations in Roseville, Citrus Heights, Granite Bay, and other locations in
Sacramento and Placer Counties. The Company's executive headquarters, principal
business and administrative office, and operations facility, which are located
in Roseville, consist of 262,657 square feet. The Company leases a 233,167
square foot facility in McClellan Park (Sacramento County), which is used by all
of its segments. The Company has appropriate easements, rights of way and other
arrangements for the accommodation of its pole lines, underground conduits,
aerial and underground cables and wires, and wireless towers and antennas. See
Note 10 in the Notes to Consolidated Financial Statements for information and
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations" regarding the Company's lease obligations.
In addition to land and structures, the Company's property consists of equipment
necessary for the provision of communication services. This includes central
office equipment, customer premises equipment and connections, radio and
wireless antennas, towers, pole lines, video head-end, remote terminals, aerial
and underground cable and wire facilities, vehicles, furniture and fixtures,
computers and other equipment. The Company also owns certain other
communications equipment held as inventory for sale or lease.
In addition to plant and equipment that it wholly-owns, the Company utilizes
poles, towers and cable and conduit systems jointly-owned with other entities,
and leases space on facilities to other entities. These arrangements are in
accordance with written agreements customary in the industry.
Item 3. 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.
Regulatory Matters
As indicated in Item 1 above, SureWest Telephone is subject to regulation by the
FCC and CPUC. In the past, there have been various proceedings before these
agencies to which SureWest Telephone has been a party. Reference is made to Item
1 for further information regarding the nature of the jurisdiction of the FCC
and CPUC over the business and operations of SureWest Telephone.
In 1996, the CPUC issued a decision in connection with SureWest Telephone's
general rate proceeding, which authorized SureWest Telephone to implement a New
Regulatory Framework ("NRF") for services furnished within SureWest Telephone's
service area in order to accommodate market and regulatory movement toward
competition and greater pricing flexibility. Under the NRF, SureWest Telephone
is subject to ongoing monitoring and reporting requirements, including a sharing
mechanism whereby SureWest 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 CPUC.
In accordance with the requirements of its general rate case order, SureWest
Telephone filed an application for review of its NRF in 1999. In connection with
this proceeding, the CPUC's Office of Ratepayer Advocates ("ORA") undertook a
verification audit of SureWest Telephone's non-regulated and affiliated
transactions pursuant to the general rate case and other CPUC orders. In June
2001, the CPUC adopted its decision in this matter (the "Decision"). The
Decision did not suspend the sharing mechanism as SureWest Telephone had
requested, and further provided that SureWest Telephone must change the method
used to allocate costs for services provided by SureWest 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. On May
2, 2002, SureWest Telephone filed a petition for modification of D. 01-06-077
requesting that the Commission modify the sharing mechanism to eliminate the
requirement that fifty percent of Roseville's earnings between the benchmark
rate of return and the ceiling rate of return (known as the "50/50 sharing
band") be returned to ratepayers. Evidentiary hearings on the pending petition
for modification are scheduled for mid-2004 and a draft decision for
consideration by the CPUC is scheduled for August 2004.
Prior to January 1, 2002, SureWest Telephone billed SBC various charges for
certain local service and network access service revenues in accordance with
certain agreements as described below. Of the Company's total revenues for the
years ended December 31, 2002 and 2001, less than 10% were recorded under these
agreements in each period. In 1999, SBC expressed interest in withdrawing from
the designated carrier plan ("DCP") for SureWest Telephone's toll traffic. The
DCP was a compensation arrangement between SureWest Telephone and SBC for
certain intrastate toll services. SureWest 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
December 31, 2002 or results of operations for the year 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 SureWest Telephone $11.5 million per year for EAS pursuant to a
Settlement Transition Agreement. In November 2000, the CPUC authorized SBC to
terminate its annual EAS payments to SureWest Telephone effective November 30,
2000. The CPUC authorized replacement funding to SureWest Telephone on an
interim basis using funds from the California High Cost Fund ("CHCF"). In
addition, the CPUC 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
SureWest 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 recommended
that the CPUC discontinue SureWest Telephone's present interim EAS funding from
the CHCF without replacement revenues from ratepayers. The CPUC's decision in
this matter is expected during 2004. The CPUC 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 SureWest Telephone cannot yet
be determined.
SureWest 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 FCC
conducted proceedings and adopted orders implementing the Act's provisions to
open local exchange service markets, such as the market of SureWest Telephone,
to competition. These proceedings and orders address interconnection, access
charges and universal service.
Given the ongoing activities of the FCC 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 FCC orders, it is
not yet possible to determine fully the impact of the Act and related FCC
regulations on SureWest 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 SureWest Telephone. These
regulatory proceedings include, but are not limited to, consideration of changes
to the interstate universal service fund, intercarrier compensation (including
access charges) reform and the regulation of local exchange carriers, and
regulation of IP-enabled services. The outcomes and impact on SureWest
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 SureWest Telephone, the effects of which on SureWest Telephone
cannot yet be determined.
Corporate Treasury Investigation
On January 14, 2004, the Company announced that the results of a preliminary
investigation, triggered by the December 17, 2003 resignation of a Senior
Treasury Analyst in the Company's Corporate Finance Department, indicated
irregularities in the Company's cash management and investment functions, and
that approximately $2,000 of the Company's funds were outstanding without proper
documentation. The Audit Committee of the Company's Board of Directors commenced
a formal internal investigation and retained independent legal counsel to
conduct the inquiry with the assistance of forensic accountants. In January
2004, the Federal Bureau of Investigation also began its own probe of the
matter, culminating with the February 5, 2004 arrest of the former Company
employee, the father of the former employee, and a business associate of the
former employee's father, and the subsequent return of federal grand jury
indictments against the three individuals. In early February 2004, the Company
announced that its investigation suggested that $25,000 of the Company's funds
were involved in the scheme, and that approximately $23,000 had been restored to
the Company by the time of the former employee's resignation.
On February 9, 2004, the company initiated civil litigation in Placer County
Superior Court, seeking to recover $2,000 and other costs from five individuals
and a private company in connection with the fraudulent scheme. The defendants
include the three individuals who are the subjects of the federal indictments,
together with a partnership believed to be controlled by certain of the
individual defendants.
In February 2004, the Company also filed a fidelity claim with it insurance
carrier to recover the missing funds, and has subsequently met with the
insurance carrier's representatives, and will be providing additional
information as requested by the carrier and its representatives.
The Company's independent legal counsel, with the assistance of the forensic
accountants, undertook an extensive process to (i) investigate the facts and
circumstances giving rise to the misappropriation of the Company funds, (ii)
determine whether there were any similar or other related transactions, and any
Company employees involved in the previously-identified transactions other than
those known to the Company at the commencement of the investigation, (iii)
determine the underlying mechanics in the origination of the transactions and
the circumstances under which detection failed to occur, and (iv) evaluate
internal controls relating to the affected portion of the Company's business.
The Audit Committee of the Board of Directors has been advised by independent
legal counsel that:
o All of the unauthorized transactions occurred in 2003 and
remained undetected until December 2003;
o The unauthorized transactions were actively concealed by the
Company's former employee in the Company's books and records; and
o Independent legal counsel did not uncover any other similar
transactions nor any evidence that any other Company employee
intentionally participated in the unauthorized transactions.
The Company, beginning in early January 2004, has already developed and
implemented a number of internal controls in response to the facts and
circumstances then known. The Board of Directors is considering further actions
in response to the investigation, and reference is made to "Item 9A-Controls and
Procedures" for further information.
The Company has engaged in informal discussion with the Securities and Exchange
Commission (the "SEC"), which has been in possession of certain background
information, regarding the facts and circumstances of the unauthorized funds
transfers. The Company has provided supplemental information to the SEC
regarding the results of the investigation, including with respect to the report
by independent legal counsel to the Audit Committee, and anticipates it will be
providing additional information in response to further requests.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth
quarter of 2003.
EXECUTIVE OFFICERS of the registrant
The names, ages and positions of the executive officers of the Company and its
subsidiaries as of March 1, 2004 are as follows:
Name Age Positions and Offices
Kirk C. Doyle 50 Chairman of the Board of Directors (since 2003)
Brian H. Strom 61 President and Chief Executive Officer (since 1993)
Michael D. Campbell 55 Executive Vice President (since 1996), Chief Financial Officer (since
1994) and Treasurer (since 2000)
Fred A. Arcuri 51 Senior Vice President and Chief Operating Officer - SureWest Broadband
(since 2001)
Robert M. Burger 47 Senior Vice President and Chief Operating Officer - SureWest Wireless
(since 2000)
Jay B. Kinder 59 Senior Vice President and Chief Operating Officer - SureWest Telephone
and SureWest Directories (since 2000)
Scott K. Barber 43 Vice President, Network Operations - SureWest Telephone (since 2003)
Bill M. DeMuth 54 Vice President and Chief Technology Officer (since 2000)
Peter C. Drozdoff 48 Vice President, Marketing (since 2002)
Philip D. Germond 54 Vice President, Customer Operations - SureWest Telephone and SureWest
Long Distance (since 2002)
Barbara J. Nussbaum 54 Vice President, Administration (since 2002)
Darla J. Yetter 43 Secretary (since 2003)
Laurel R. Dismukes 56 Assistant Secretary (since 2003)
Martin T. McCue 53 Assistant Secretary (since 2003)
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
The Company's common stock is traded on the Nasdaq National Market ("NASDAQ")
under the symbol "SURW". As of March 22, 2004, there were approximately 10,300
beneficial owners of Company common stock. The following table indicates the
range of stock closing prices of the Company's common stock as reported on the
NASDAQ, for each of the quarters indicated:
NASDAQ National Market
High Low
March 31, 2002 $56.59 $48.08
June 30, 2002 $57.25 $42.00
September 30, 2002 $53.80 $29.03
December 31, 2002 $40.99 $21.45
March 31, 2003 $38.98 $22.66
June 30, 2003 $32.59 $26.43
September 30, 2003 $39.99 $29.44
December 31, 2003 $41.05 $37.20
The Company paid cash dividends on its common stock of $0.25 per share for each
quarter of 2003 and 2002.
During the year ended December 31, 2003, no equity securities of the Company
were sold by the Company which were not registered under the Securities Act of
1933, as amended.
Equity Compensation Plan Information
Information regarding the Company's equity compensation plans is incorporated
herein by reference from the proxy statement for the annual meeting of the
Company's shareholders, to be filed pursuant to Regulation 14A within 120 days
after the Company's fiscal year-end of December 31, 2003.
Item 6. Selected Financial Data
2003 2002 2001 2000 1999
__________ __________ __________ __________ _________
(Amounts in thousands, except per share amounts)
Total operating revenues (1) $ 195,337 $ 185,955 $ 163,485 $ 143,194 $ 140,801
Gain on sale of investment in
cellular partnership (2) $ - $ - $ - $ 201,294 $ -
Net income $ 645 $ 11,249 $ 10,317 $ 125,793 $ 31,750
Basic earnings per share (3) $ 0.04 $ 0.76 $ 0.67 $ 8.06 $ 2.01
Diluted earnings per share (3) $ 0.04 $ 0.76 $ 0.67 $ 8.05 $ 2.01
Extraordinary loss, net of tax (4) $ - $ - $ - $ (10,932) $ -
Cumulative effect of change in
accounting principle, net of
tax (5) $ - $ - $ - $ (3,273) $ -
2003 2002 2001 2000 1999
___________ ___________ ___________ ___________ ___________
(Amounts in thousands, except per share amounts)
Extraordinary loss, net of tax, per
share (basic and diluted) $ - $ - $ - $ (0.70) $ -
Cumulative effect of change in
accounting principle, net of tax,
per share, (basic and diluted) $ - $ - $ - $ (0.21) $ -
Pro forma amounts assuming the accounting
change is applied retroactively:
Income before extraordinary loss and
cumulative effect of change in
accounting principle $ 645 $ 11,249 $ 10,317 $ 139,998 $ 31,926
Net income $ 645 $ 11,249 $ 10,317 $ 129,066 $ 31,926
Basic per share amounts:
Income before extraordinary loss
and cumulative effect of change
in accounting principle $ 0.04 $ 0.76 $ 0.67 $ 8.97 $ 2.02
Net income $ 0.04 $ 0.76 $ 0.67 $ 8.27 $ 2.02
Diluted per share amounts:
Income before extraordinary loss
and cumulative effect of change
in accounting principle $ 0.04 $ 0.76 $ 0.67 $ 8.96 $ 2.02
Net income $ 0.04 $ 0.76 $ 0.67 $ 8.26 $ 2.02
Cash dividends per share(6) $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Property, plant and equipment, at cost $ 646,740 $ 576,579 $ 524,505 $ 469,389 $ 383,896
Total assets $ 435,209 $ 396,516 $ 412,343 $ 528,942 $ 333,187
Long-term obligations $ 93,135 $ 52,252 $ 42,142 $ 44,285 $ 46,428
Shares of common stock used to calculate:
Basic earnings per share(3) 14,522 14,728 15,326 15,610 15,815
Diluted earnings per share(3) 14,539 14,795 15,387 15,630 15,822
(1) The Company's 2000 and 1999 consolidated operating revenues have been
adjusted to eliminate certain intercompany balances that were not
previously eliminated. However, such adjustments had no effect on the
Company's consolidated net income for such years.
(2) On November 3, 2000, two of the Company's subsidiaries sold their
collective 24% cellular partnership interest in Sacramento-Valley Limited
Partnership to Verizon Wireless for approximately $236,150, resulting in a
pre-tax gain of $201,294.
(3) 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.
(4) In December 2000, the Company recognized an extraordinary loss due to the
discontinuation of accounting under SFAS No. 71, "Accounting for the
Effects of Certain Types of Regulation." The Company recorded an
extraordinary non-cash charge of $10,932, which is net of related tax
benefits of $7,631.
(5) The Company changed its method of accounting, retroactive to January 1,
2000, for up-front fees associated with telecommunications service
activation in accordance with Staff Accounting Bulletin ("SAB") No. 101.
The cumulative effect of the change in prior years resulted in a charge to
2000 net income of $3,273 (net of income taxes of $2,250).
(6) Cash dividends per share are based on the actual dividends per share, as
declared by the Company's Board of Directors.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
(Amounts in thousands, except selected operating metrics and per share amounts)
Certain information included in the Company's annual report on Form 10-K,
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 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, internal control weaknesses and unanticipated
changes in the growth of the Company's emerging businesses, including the
wireless, Internet, digital 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. Prior to 2003, the Company reported its operating results in
two segments - Telecom and Wireless. Beginning in 2003, the Company began
reporting its operations in segments as previously defined. The Company's 2002
and 2001 business segment information has been restated to conform to the
Company's organizational structure change in 2003.
The Telecom segment includes SureWest Telephone (formerly known as Roseville
Telephone Company), SureWest Directories, and SureWest Long Distance (formerly
known as Roseville Long Distance Company), which provide landline
telecommunications services, directory advertising, Digital Subscriber Line
("DSL") service, long distance services and certain non-regulated services.
SureWest 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 SureWest 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 SureWest Telephone's service areas.
SureWest Long Distance is a reseller of long distance services.
The Broadband segment provides various services including: high-speed and
dial-up Internet, digital video, local and network access, toll telephone and
managed services in the greater Sacramento area, principally to customers
residing outside of SureWest Telephone's service area. The Company offers
high-speed Internet, digital video and local and long distance phone service as
a bundled package referred to as Triple Play. The Broadband segment includes the
Company's subsidiaries SureWest Broadband and SureWest Broadband/Residential
Services. On July 12, 2002, the Company purchased substantially all of the
assets of Western Integrated Networks, LLC, and certain affiliates to commence
the SureWest Broadband/Residential Services business. For further discussion of
the acquisition of the assets see "Segment Results of Operations-Broadband"
below. SureWest Broadband is comprised, in part, of a division of SureWest
Telephone operating as a Competitive Local Exchange Carrier. In December 2003,
SureWest Broadband/Residential Services began offering digital video services to
customers inside SureWest Telephone's service area.
The Wireless segment consists of the Company's subsidiary SureWest Wireless,
which provides wireless personal communication services. SureWest Wireless
derives its revenue from the provision of wireless voice services, sales of
handsets and related accessories, long distance, handset insurance, roaming
service and custom calling features. Wireless services are provided on a
month-to-month basis and are generally billed in advance for non-contract
subscribers and in arrears for contract subscribers.
The Company's shareholders have previously 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
date on which the Company will reincorporate is at the discretion of the
Company's Board of Directors.
Effective October 27, 2003, the Company changed the names of the remaining
subsidiaries that did not bear the SureWest name. The name change effected
Roseville Telephone Company, now SureWest Telephone, and Roseville Long Distance
Company, now SureWest Long Distance.
The Company expects that the sources of its revenues and its cost structure may
be different in future periods, both as a result of its entry into new
communications markets and competitive forces in each of the markets in which
the Company has operations.
Revenue Recognition
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. Revenues based on a flat fee, derived
principally from local telephone, dedicated network access, data communications,
internet access service, residential/business broadband service and non-contract
wireless services, are billed in advance and recognized in subsequent periods
when the services are provided. Contract wireless services are billed in
arrears. Revenues based on usage, derived primarily from network access, roaming
and long distance services, are recognized monthly as services are provided.
Incremental direct costs of telecommunications service activation are charged to
expense in the period in which they are incurred.
Directory advertising revenues and costs related to publishing and distributing
directories are recognized using the "circulation period" method, under which
revenues and related costs are recognized ratably over the expected useful life
of the directory, generally one year from the date of publication. For all other
operations, revenue is recognized when products are delivered or services are
rendered to customers.
Effective July 1, 2003, the Company began applying the Financial Accounting
Standards Board's ("FASB") Emerging Issues Task Force ("EITF") Issue No. 00-21
to all wireless handset sales below cost, which approximates fair value in the
absence of an activation "subsidy," when it receives an up-front fee of any kind
(e.g., a service activation fee). The application of EITF Issue No. 00-21
resulted in the immediate recognition of all or a portion of such up-front fees
as equipment sales revenue. Additionally, when the Company activates wireless
service for a customer, but does not concurrently provide the customer with a
handset, any up-front fees received continue to be deferred and amortized over
the expected term of the customer relationship. The Company provides a general
right of return within the first 30 days of service for a 100% refund of the
handset cost. The estimated equipment return allowance associated with this
right of return is estimated based on historical experience. The adoption of
EITF Issue No. 00-21 did not have a material impact on the Company's 2003
consolidated financial statements.
Treasury Investigation and Internal Control Matters
In January 2004, the Audit Committee of the Board of Directors launched a formal
investigation and retained independent legal counsel to conduct the
investigation with the assistance of forensic accountants. The investigation
resulted from a preliminary investigation by Company management, triggered by
the abrupt resignation in December 2003 of an employee in the Company's
Corporate Finance Department. The investigation indicated irregularities by the
former employee in the Company's cash management and investment functions, and
violations of the Company's investment policies. At the time of the commencement
of the special investigation, approximately $2,000 of Company funds were
outstanding without proper documentation, and such funds remain outstanding, and
have been reflected as a non-operating loss in the Company's 2003 consolidated
financial statements.
The independent legal counsel, with the assistance of the forensic accountants,
undertook an extensive process to (i) investigate the facts and circumstances
giving rise to the misappropriation of Company funds, (ii) determine whether
there were any similar or related transactions, and any Company employees
involved in the previously-identified transactions other than those known to the
Company at the commencement of the investigation, (iii) determine the underlying
mechanics in the origination of the transactions and the circumstances under
which detection failed to occur, and (iv) evaluate internal controls relating to
the affected portion of the Company's business.
The Audit Committee of the Board of Directors has been advised by independent
legal counsel that:
o All of the unauthorized transactions occurred in 2003 and remained
undetected until December 2003;
o The unauthorized transactions were actively concealed by the Company's
former employee in the Company's books and records; and
o Independent legal counsel did not uncover any other similar transactions
nor any evidence that any other Company employees intentionally
participated in the unauthorized transactions.
The independent legal counsel further reported to the Audit Committee, (i) its
view that existing Company control procedures prior to the discovery of the
unauthorized transactions were either circumvented or ignored, and the control
procedures existing at the time of the unauthorized transactions were not
adequate, and (ii) the Company, subsequent to the discovery of the unauthorized
transactions, had developed and implemented a number of key internal controls.
In addition, the independent legal counsel provided additional control
recommendations to the Audit Committee for review and consideration.
In connection with the audit of the Company's consolidated financial statements
for the year ended December 31, 2003, Ernst & Young LLP, the Company's
independent auditors, advised the Company that it had concluded that material
weaknesses in the Company's internal control existed, including with respect to
certain of the issues identified as a result of the Audit Committee's special
investigation. The Company has performed substantial additional procedures
designed to ensure that the internal control deficiencies did not lead to
material misstatements in its consolidated financial statements, notwithstanding
the presence of the noted internal control weaknesses.
Both before and after December 31, 2003, the Company instituted additional
processes and procedures to improve internal control. Subsequent to the
discovery of the unauthorized wire transactions in 2003, the Company implemented
a number of internal controls with respect to banking and investment activities.
The Audit Committee has made a number of additional recommendations to the
Company's Board of Directors for further review and consideration, which the
Company believes will be formally acted upon beginning early in the second
quarter of 2004, and thereafter. Such initiatives relate to:
o An assessment to be conducted with respect to the Company's Corporate
Finance Department, which encompasses the Company's accounting and finance
personnel, including specifically relating to the number of personnel, and
the collective mix and technical skills of such personnel, and the addition
of new personnel if necessary;
o An internal audit process, with tasks to be performed either by Company
personnel or a third party, with reporting duties to the Chairman of the
Company's Audit Committee;
o A more significant effort devoted to internal controls training for all
affected personnel, and an increased emphasis on the completion of internal
controls documentation, including as required by Section 404 of the
Sarbanes-Oxley Act of 2002 (including the possible retention of a
third-party to assist in performing internal control reviews of all of the
Company's accounting systems, and to assist in expediting the completion of
the internal controls documentation); and
o The preparation and implementation of a formal accounting policies and
procedures manual or electronic database to serve as a reference tool for
Company personnel and to establish uniformity and consistency throughout
the Company.
The Company has previously taken actions that it believes have improved internal
controls, including:
o The establishment of a Disclosure Committee comprised of Management
personnel and senior representatives of the Company's Corporate Finance
Department, which undertakes reviews prior to significant filings with the
Securities and Exchange Commission;
o The modification of written ethics and compliance materials provided to
Company employees, and the formal adoption of a Code of Ethics and Business
Conduct, and the related establishment of confidential procedures which
permit Company employees to communicate anonymously in the event of
suspected violations of laws or Company standards (together with upcoming
mandatory classes in 2004 for all Company employees to review the Code of
Ethics and Business Conduct); and
o The implementation in 2003 of new enterprise resource planning and
accounting software, which likely assisted in identifying certain of the
accounting deficiencies noted above relating to property, plant and
equipment. (The Company in 2004 also anticipates improving modules in its
new software and undertaking revised physical verification and other
procedures to improve its accounting for property, plant and equipment).
The Company has filed an insurance claim to recover the missing funds and has
filed a civil lawsuit seeking to recover $2,000 and other costs from five
individuals and a private company allegedly associated with the fraudulent
scheme to illegally transfer the Company's funds to outside accounts. The
Company will recognize a recovery of funds in future periods to the extent of
its insurance and litigation recoveries.
The Company has engaged in informal discussion with the Securities and Exchange
Commission, which has been in possession of certain background information,
regarding the facts and circumstances of the unauthorized funds transfers. The
Company has provided supplemental information to the Securities and Exchange
Commission regarding the results of the investigation, including with respect to
the report by independent legal counsel to the Audit Committee, and anticipates
it will be providing additional information in response to further requests.
Results of Operations
Consolidated Overview
The tables below reflect certain financial data (on a consolidated and segment
basis) and selected operating metrics for each reportable segment as of and for
the years ended December 31, 2003, 2002 and 2001. Both the financial data and
the selected operating metrics demonstrate the increasing importance of the
Company's Broadband and Wireless segments.
Financial Data
Percent Change
--------------
2003 vs. 2002 vs.
2003 2002 2001 2002 2001
___________ ____________ ____________ ________ ________
Operating revenues (1)
Telecom $ 138,924 $ 149,679 $ 142,780 (7)% 5%
Broadband 29,267 13,051 4,649 124 181
Wireless 27,146 23,225 16,056 17 45
Total operating revenues 195,337 185,955 163,485 5 14
Operating income (loss)
Telecom 47,598 51,839 45,685 (8) 13
Broadband (16,312) (11,180) (4,005) 46 179
Wireless (23,539) (24,969) (28,917) (6) (14)
Total operating income 7,747 15,690 12,763 (51) 23
Net income (loss)
Telecom 26,565 33,634 30,724 (21) 9
Broadband (10,983) (6,715) (2,283) 64 194
Wireless (14,937) (15,670) (18,124) (5) (14)
Total net income $ 645 $ 11,249 $ 10,317 (94)% 9%
(1) External customers only
Selected Operating Metrics
Percent Change
--------------
2003 vs. 2002 vs.
2003 2002 2001 2002 2001
_______ ________ ________ _______ ________
Telecom
ILEC access lines 136,365 137,240 134,877 (1)% 2%
Long distance lines 42,911 39,654 32,958 8 20
Broadband
DSL subscribers (1) 19,805 15,648 11,307 27 38
Triple Play subscribers (2) 11,084 5,646 N/A 96 N/A
Revenue-generating units (3) 25,469 13,271 N/A 92 N/A
Wireless
Subscribers 46,724 40,454 31,649 15 % 28%
(1) DSL subscribers are customers who receive data services within SureWest
Telephone's service area.
(2) Triple Play subscribers are customers who receive digital video, voice
and/or data services from the SureWest Broadband/Residential Services.
(3) The Broadband segment can deliver multiple services to a customer.
Accordingly, the Company maintains statistical data regarding the latest
number of various revenue generating units for digital video, voice and
data, in addition to the number of customers. For example, a single
customer who purchases digital video, voice and data services would be
reflected as three Revenue-generating units.
Broadband operating revenues increased $16,216 and $8,402 in 2003 and 2002,
respectively, as compared to each prior year period. During 2003 and 2002, the
Broadband segment experienced substantial increases in the number of DSL
subscribers and ISP and Custom Data subscribers. More significantly, this
segment had 11,084 Triple Play subscribers and 25,469 Revenue-Generating Units
at December 31, 2003 within the Company's SureWest Broadband/Residential
Services business, which commenced in July 2002 as a result of the acquisition
of assets from Western Integrated Networks, LLC and affiliated companies. While
continuing to produce significant revenue increases, the expansion of the
broadband business has and will continue to require significant capital and
expense commitments. Accordingly, the Broadband segment incurred larger
year-over-year operating and net losses in the years 2003 and 2002.
The Wireless segment also reported increases in operating revenues of $3,921 and
$7,169 in 2003 and 2002, respectively, as compared to each prior year period.
The number of wireless subscribers increased to 46,724 at December 31, 2003,
representing a 15% increase for the years 2003. SureWest Wireless established
its market share in the Sacramento market in large part by promoting an
unlimited flat rate regional calling plan. Wireless customer acquisition has
historically been most active during the December holiday season, and the
Company has always been active in sales and marketing at this time. During 2003,
SureWest Wireless initiated a number of new service options for customers,
including new regional plans and in 2004 will launch a family plan and new
vertical services such as wireless data capabilities. Evolution of the
marketplace has caused SureWest Wireless to open four retail stores in its
service area. It is also seeking to expand its service penetration among major
accounts in 2004. SureWest Wireless will seek to reduce customer churn and to
increase the amount of revenue it derives from each customer in 2004.
While the Company continues to experience growth from the Broadband and Wireless
segments, the Company's Telecom segment operations are facing the competitive
and regulatory challenges now faced by incumbent local exchange carriers
("ILEC's") both nationally and in California. For the first time in recent
history, SureWest Telephone had a decline in access lines, primarily due to
increased competition from wireless services. Telecom's operating revenues
decreased $10,755 in 2003 as compared to 2002, and were also below 2001 reported
revenues. Operating and net income also declined $4,241 and $7,069,
respectively, in 2003 as compared to 2002.
While the Telecom operating revenues continue to generate a majority of the
Company's revenues and yield significant cash flows and net income, the Company
believes that the Telecom segments results in recent years support the Company's
decision to enter and commit resources to newer businesses, particularly in the
Broadband segment.
The Company's operating expenses increased due to an increase in cost of
services and products expense associated with a larger number of subscribers and
services, including a full year of expense in 2003 from SureWest
Broadband/Residential Services, as described above. General and administrative
expenses increased as a result of (i) an increase in employee headcount
necessary to provide the Company's services, including a full year of expense in
2003 from SureWest Broadband/Residential Services business, (ii) an increase in
medical insurance costs, resulting from an increase in the number of employees
and higher per employee cost and (iii) an increase in corporate insurance costs.
Depreciation and amortization expense increased $7,344 in 2003 and $5,285 in
2002 . A substantial portion of this increase results from additions to
property, plant and equipment, primarily within the Broadband and Wireless
segments. The increase in depreciation expense was offset in part by 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 mail equipment. This change in accounting estimate resulted in
decreased depreciation expense of $930 and $206 in 2003 and 2002, respectively.
Adjustments and Eliminations
During the Company's financial statement closing process for the year ended
December 31, 2003, certain matters were identified related to prior financial
reporting periods that necessitated the recording of adjustments to the
Company's consolidated financial statements. Such adjustments pertained
principally to property, plant and equipment, and management believes that
weaknesses in the Company's internal controls caused the errors that resulted in
these adjustments. The Company does not believe any of the aforementioned
amounts are material, individually or in the aggregate, to the respective prior
annual periods based on both quantitative and qualitative factors, including the
trend of operating results, nor does it believe the prospective correction of
such amounts during the quarter ended December 31, 2003 is material to the
Company's 2003 consolidated results of operations based on both quantitative and
qualitative factors, including the trend of operating results. (The prospective
correction of the aforementioned amounts relating to prior periods reduced the
Company's 2003 consolidated net income by $1,603, or $0.11 per basic and diluted
share, and would have reduced the Company's 2002 and 2001 consolidated net
income by $796, or $0.05 per basic and diluted share, and $217, or $0.01 per
basic and diluted share, respectively, had such errors been corrected in the
periods in which they originated.)
The Company's 2002 and 2001 consolidated financial statements have been adjusted
to eliminate certain intercompany balances that were not previously eliminated.
These adjustments pertained to (i) the Company's December 31, 2002 intercompany
accounts receivable and accounts payable balances aggregating $1,381 and (ii)
certain of the Company's 2002 and 2001 intercompany revenue and operating
expense balances aggregating $2,955 and $3,480, respectively. However, such
adjustments had no effect on the Company's consolidated working capital and
shareholders' equity balances as of December 31, 2002, or consolidated income
from operations or net income for the years ended December 31, 2002 and 2001.
2003 versus 2002
Segment Results of Operations
Telecom
2003 2002 $Change %Change
__________ __________ ___________ _______
Local service $ 63,363 $ 66,283 $ (2,920) (4)%
Network access service 51,286 58,426 (7,140) (12)
Directory advertising 15,087 14,824 263 2
Long distance service 5,098 5,368 (270) (5)
Other 4,090 4,778 (688) (14)
Total operating revenues from
external customers 138,924 149,679 (10,755) (7)
Intersegment revenues 23,576 16,826 6,750 40
Operating expenses 83,645 86,417 (2,772) (3)
Depreciation and amortization 31,257 28,249 3,008 11
Operating income 47,598 51,839 (4,241) (8)
Net income $ 26,565 $ 33,634 $ (7,069) (21)%
Operating Revenues
Operating revenues from external customers in the Telecom segment decreased
$10,755 compared to 2002. Revenues from services subject to regulation, which
include local and network access services, decreased $10,060 compared to 2002.
The decrease in operating revenues was primarily due to the combined effects of
(i) decreased zone and toll calls resulting from increased competition from
wireless service, (ii) a $1,535 increase in SureWest Telephone's provision for
its estimated intrastate shareable earnings obligations compared to the same
period in 2002 and (iii) a change in accounting estimate during 2002 for a
portion of SureWest Telephone's interstate and intrastate shareable earnings
obligations related to the 1999 through 2001 monitoring periods, resulting in an
increase to the Telecom segment's revenues of $6,207 and net income of $3,724,
respectively (for a more detailed discussion refer to the Regulatory Matters
section).
These decreases to operating revenues during 2003 were partially offset by
continued growth and demand for dedicated access, the introduction of Ethernet
Service in mid-2002 and an increase in SureWest Telephone's billing surcharge.
The decrease in operating revenues in the Telecom segment was also offset, in
part, by a Final Settlement Agreement (the "Settlement Agreement") SureWest
Telephone entered into during 2003. As discussed in greater detail in the
Regulatory Matters section, the Settlement Agreement provided for a $1,950
refund from another telecommunications company for a payment made by the
SureWest Telephone in 2001 related to interstate shareable earnings obligations.
SureWest Telephone's operating revenues were also affected by the commencement
of a wholesaling arrangement in the fourth quarter of 2002 for its DSL service.
This wholesaling arrangement resulted in a decrease to network access revenues
of $5,142 for the year ended December 31, 2003 compared to 2002.
The Company adopted SEC Staff Accounting Bulletin 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 on the
Company was a decrease of $3,273, net of tax, ($0.21 per share) in 2000. For the
years ended December 31, 2003 and 2002, the Telecom segment recognized $413 and
$926, respectively, of revenues that were in the cumulative effect adjustment as
of January 1, 2000. The effect of those revenues was to increase income by $244
(net of income taxes of $169) and $555 (net of income taxes of $371) for the
years ended December 31, 2003 and 2002, respectively.
Operating Expenses
Operating expenses for the Telecom segment decreased $2,772 compared to 2002.
Cost of services and products decreased $1,170, or 2%, during 2003 due primarily
to an increase in allocation of resources provided to other affiliates.
Customer operations and selling expense decreased $1,925, or 10%, during 2003
due primarily to (i) internal efficiencies resulting from integrated customer
support systems and productivity gains and (ii) a decrease in brand advertising
expenses.
General and administrative expense increased $323, or 2%, due primarily to (i) a
$375 one-time settlement reached in connection with the litigation arising from
the agreement for the sale of alarm monitoring assets during 2002, (ii) an
increase in medical and liability insurance costs and (iii) an increase in costs
related to compliance with the requirements imposed by The Sarbanes-Oxley Act
and related regulations. This increase was offset in part by bad debt expense
recognized during 2002 associated with access charge billings to an
interexchange carrier that filed for bankruptcy protection as described in more
detail below.
Depreciation and amortization expenses increased $3,008 during 2003 due
primarily to additions to central office assets, cable and wire facilities 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 bad debt expense of approximately
$1,343 in 2002 relating to 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 (including ILEC's) are
entitled to "adequate assurances" that WorldCom will satisfy its obligations for
post-petition services. The Bankruptcy Court provided, 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 December 31, 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 59% of
the Company's total operating revenues in 2003. Such revenues, which include
local and network access services, are derived from various sources, including:
o business and residential subscribers, for basic exchange services
o surcharges, mandated by the California Public Utilities Commission
("CPUC")
o long distance carriers, for network access service
o competitive access providers and subscribers, for network access
services
o interstate pool settlements, from the National Exchange Carrier
Association ("NECA")
o support payments from the Universal Service Fund
o support payments from the California High Cost Fund ("CHCF"),
recovering costs of services including extended area service.
Revenues from certain telephone services are affected by rates authorized by
various regulatory agencies. Intrastate service rates are subject to regulation
by the CPUC. With respect to toll calls initiated by interexchange carriers'
customers, the interexchange carriers are assessed access charges based on
tariffs filed by SureWest Telephone. Interstate access rates and resulting
earnings are subject to regulation by the Federal Communications Commission
("FCC"). With respect to interstate services, SureWest Telephone has filed its
own tariff with the FCC for all elements of access services except carrier
common line charges, for which SureWest Telephone concurs with tariffs filed by
NECA.
The FCC monitors SureWest Telephone's interstate earnings through the use of
annual cost separation studies prepared by SureWest Telephone, which utilize
estimated cost information and projected demand usage. The FCC establishes rules
that carriers must follow in the preparation of the annual studies.
Additionally, under current FCC rules governing rate making, SureWest 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.
In January 2001, the FCC issued a Memorandum Opinion and Order to another
telephone company in which it clarified how Internet traffic, which the FCC had
prior to that date characterized as largely interstate in nature, should be
treated. During 2000 and 2001, Internet traffic and DSL service grew
substantially, far exceeding SureWest Telephone's estimates, which resulted in
actual earnings exceeding the levels allowed by the FCC. Based on preliminary
cost studies, SureWest Telephone recognized liabilities relating to its
estimated interstate shareable earnings obligations of $343, $650 and $3,231 for
the years ended December 31, 2003, 2002 and 2001, respectively, through
reductions of revenues. During the year ended December 31, 2001, SureWest
Telephone made payments to certain telecommunications companies aggregating
$6,800 related to interstate shareable earnings obligations for the monitoring
period 1999-2000. No similar payments were made in 2003 or 2002. On June 26,
2003, SureWest Telephone entered into a Settlement Agreement to recover $1,950
of the amount paid to a telecommunications company in 2001. The funds were
received pursuant to the Settlement Agreement on July 8, 2003. SureWest
Telephone 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 SureWest Telephone is
seeking a refund has filed for bankruptcy protection.
In May 2002, the D.C. Circuit Court of Appeals (the "Court") issued its decision
in a case involving ACS of Anchorage. The Court determined that a tariff filed
properly under Section 204 "streamlined" procedures and allowed to go into
effect without suspension is deemed lawful, and the carrier is not subsequently
obligated to pay refunds for earnings higher than the permitted rate of return
as prescribed by the FCC for that monitoring period. Subsequent to the Court's
decision, certain telecommunication companies filed a petition for rehearing. In
August 2002, the petitions for rehearing were denied by the Court, and later
that month the Court's order became effective. For the monitoring periods 1999
through 2001, SureWest Telephone filed tariffs pursuant to the streamlined
procedures and such tariffs were not suspended or investigated. Consequently,
during the third quarter of 2002, SureWest Telephone changed its estimate for a
portion of its interstate shareable earnings obligations related to those
monitoring periods. For the year ended December 31, 2002 this change in
accounting estimate increased the Company's revenues by $5,092 and net income by
$3,065 ($0.21 per share).
Prior to January 1, 2002, SureWest 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 SureWest Telephone's
toll traffic. The DCP was a compensation arrangement between SureWest Telephone
and SBC for certain intrastate toll services. SureWest 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 December 31, 2003 and 2002 or results of operations for the years
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 SureWest Telephone approximately $11,500 per year for EAS
pursuant to a Settlement Transition Agreement. In November 2000, the CPUC
authorized SBC to terminate its annual EAS payments to SureWest Telephone
effective November 30, 2000. The CPUC authorized replacement funding to SureWest
Telephone on an interim basis using funds from the CHCF. In addition, the CPUC
opened an Order Instituting Investigation ("OII") for the purpose of determining
whether future recovery of all, none, or a portion of the approximate $11,500
annual payments previously received from SBC should come from SureWest
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 CPUC discontinue SureWest Telephone's
present interim EAS funding from the CHCF without replacement revenues from
ratepayers. The CPUC's decision in this matter is expected during 2004. The CPUC
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
SureWest Telephone cannot yet be determined.
In 1996, the CPUC issued a decision in connection with SureWest Telephone's
general rate proceeding, which authorized SureWest Telephone to implement a New
Regulatory Framework ("NRF") for services furnished within SureWest Telephone's
service area in order to accommodate market and regulatory movement toward
competition and greater pricing flexibility. Under the NRF, SureWest Telephone
is subject to ongoing monitoring and reporting requirements, including a sharing
mechanism whereby SureWest 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 CPUC.
In accordance with the requirements of its general rate case order, SureWest
Telephone filed an application for review of its NRF in 1999. In connection with
this proceeding, the CPUC's ORA undertook a verification audit of SureWest
Telephone's non-regulated and affiliated transactions pursuant to the general
rate case and other CPUC orders. In June 2001, the CPUC adopted its decision in
this matter (the "Decision"). The Decision did not suspend the sharing mechanism
as SureWest Telephone had requested and the CPUC ruled that SureWest Telephone
must change the method used to allocate costs for services provided by SureWest
Telephone to its affiliates, the treatment of certain directory revenues and the
treatment of internal-use software costs. In accordance with the provisions of
the Decision, the Company recorded liabilities and reduction of revenues of
$3,285, $1,750 and $6,000 relating to estimated intrastate shareable earnings
obligations during the years ended December 31, 2003, 2002 and 2001,
respectively.
Beginning in January 2002, SureWest Telephone began paying a customer refund for
intrastate shareable earnings obligations relating to the years 1998 and 1999. A
portion of the customers' intrastate service charges was returned in the form of
a surcredit beginning in January 2002 and ending in January 2003, totaling
approximately $4,605 (of which $294 was returned during 2003).
In October 2003, the CPUC issued a resolution requiring SureWest Telephone to
pay a refund for intrastate overearnings totaling approximately $483 relating to
2002. A portion of the consumer's intrastate service charges are being returned
to the customers in the form of a surcredit over approximately three months
which began in November 2003. During the year ended December 31, 2003, $275 was
returned to customers.
As a result of periodic cost separation studies for the monitoring period
2002-2001, SureWest Telephone changed its estimates for a portion of its
interstate and intrastate shareable earnings obligations and certain NECA CCL
accounts receivable balances during the years ended December 31, 2003 and 2002.
For the year ended December 31, 2003, these changes in accounting estimates
decreased Telecom segment revenues by $29 and net income by $17, respectively.
For the year ended December 31, 2002, similar changes in accounting estimates
decreased Telecom segment revenues by $1,115 and net income by $671.
As of December 31, 2003, the Company's consolidated balance sheet reflected
aggregate liabilities of $13,389 relating to SureWest 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, SureWest
Telephone's interstate shareable earnings obligations lapse over time if
SureWest 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.
Significant Business Event
In January 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 December 31, 2003, the Company has received cash proceeds of
$4,995, of which $4,495 and $500 were received during 2002 and the fourth
quarter of 2001, respectively, 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 as of the
date of the sale. The purchaser of the assets commenced litigation against the
Company relating to claims under the asset purchase agreement, generally in
connection with certain contracts assigned to the purchaser. In July 2003, the
Company and the purchaser settled the litigation and the parties released all
claims in exchange for payment by the Company to the purchaser of $375, which
was paid during 2003. Total operating revenues attributable to the Company's
alarm monitoring division during 2002 were $279 (none in 2003).
Broadband
2003 2002 $Change %Change
__________ __________ __________ ________
Internet service $ 15,984 $ 7,578 $ 8,406 111%
Residential Broadband service 9,586 3,052 6,534 214
Business Broadband service 3,697 2,421 1,276 53
Total operating revenues from
external customers 29,267 13,051 16,216 124
Intersegment revenues 1,683 1,189 494 42
Operating expenses 42,754 23,448 19,306 82
Depreciation and amortization 4,508 1,972 2,536 129
Operating loss (16,312) (11,180) 5,132 46
Net loss $ (10,983) $ (6,715) $ 4,268 64%
Operating Revenues
Operating revenues from external customers in the Broadband segment increased
$16,216 compared to 2002. The increase in Broadband revenues is due in a large
part to (i) a 27% increase in residential and business DSL subscriber customer
base, (ii) an increase in operating revenues resulting from the commencement of
a wholesale DSL service arrangement with SureWest Telephone in the fourth
quarter of 2002, (iii) a 96% increase in the number of SureWest
Broadband/Residential Services subscribers and (iv) the continued expansion of
the Business Broadband Services, resulting in a 73% increase in ending access
lines.
Operating Expenses
Total operating expenses for the Broadband segment increased $21,842 compared to
2002. Cost of services and products increased $14,293, or 136%, compared to 2002
due primarily to (i) an increase in network administration due to a 27% increase
in DSL subscriber base (ii) an increase in expenses, including programming and
transport costs, from the expanded operations of SureWest Broadband/Residential
Services, (iii) the commencement of a wholesale DSL service arrangement with
SureWest Telephone in the fourth quarter of 2002 and (iv) increased transport
costs related to business Broadband services. These increases were partially
offset by a decrease in the number of DSL modems expensed in the 2003 periods
due to a leasing program implemented in the current year and a 65% decrease in
the cost of the DSL modems as compared to the same period in the prior year.
Customer operations expense, general and administrative expense and depreciation
and amortization expense increased $2,372, $2,641 and $2,536, respectively, for
the year ended December 31, 2003 compared to the same period in 2002. The
increases are primarily due to the expanded operations of SureWest
Broadband/Residential Services in 2003, the related significant increase in the
size of the Company's workforce, increased medical and liability insurance costs
and an increase in depreciation expense resulting from property, plant and
equipment additions at SureWest Broadband, including DSL modems leased to
customers.
Nonmonetary Transaction
During 2003, the Company entered into a 20-year nonmonetary transaction with a
third party involving the exchange of certain fiber optic capacity and
collocation rights. This transaction provides the Company with access and rights
to certain collocation facilities and cell site locations, which were previously
inaccessible due to unreasonably high entrance costs. The collocation rights
provide access to additional network connections to the Company while the cell
site locations strengthen the Company's existing cellular network in key areas.
Because this nonmonetary transaction did not represent the culmination of an
earnings process, no revenues or expenses have been, or will be, recorded by the
Company pursuant to this transaction. In addition, there was no indicated loss
on this exchange of productive rights.
Significant Business Event
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 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
------
Net assets acquired $ 12,622
======
The equipment purchased from WIN that was held for sale consisted primarily of
network assets located in Dallas, Texas. The Company completed the sale of such
equipment during the first quarter of 2003. The Company did not recognize a gain
or loss on the sale of these assets.
Wireless
2003 2002 $Change %Change
__________ __________ __________ _______
Wireless revenues from external
customers $ 27,146 $ 23,225 $ 3,921 17%
Intersegment revenues 744 507 237 47
Operating expenses 34,724 33,796 928 3
Depreciation and amortization 16,705 14,905 1,800 12
Operating loss (23,539) (24,969) (1,430) (6)
Net loss $ (14,937) $ (15,670) $ (733) (5)%
Operating Revenues
Operating revenues from external customers in the Wireless segment increased
$3,921 due primarily to (i) continued additions to the customer base, with a 15%
overall increase in wireless subscribers based on subscriber counts at December
31, 2003 compared to December 31, 2002, (ii) an increase in roaming revenues,
(iii) the introduction of new features and (iv) a decrease in uncollectible
revenues.
Operating Expenses
Total operating expenses for the Wireless segment increased $928 compared to
2002. Cost of services and products expense increased $882, or 5%, compared to
2002 primarily due to increased interconnect usage associated with the increase
in subscriber base and increased property taxes due to the addition of cell
cites. This increase was partially offset by (i) a reduction in roaming expenses
due to a lower roaming rate and (ii) decreased handset insurance costs due to
fewer claims submitted, outsourcing of the insurance function to a third party
and fewer customers selecting this feature. Customer operations and selling
expense decreased $311, or 3%, compared to 2002 due primarily to decreased sales
expense resulting from fewer dealer sales. This decrease was offset in part by
an increase in subscriber billing costs associated with the higher average
customer base. General and administrative expense increased $357, or 10%,
compared to 2002 due primarily to an increase in medical and liability insurance
costs.
Local Number Portability
Effective November 24, 2003, the FCC mandated that wireless carriers provide for
local number portability ("LNP"). LNP allows subscribers to keep their wireless
phone numbers while switching to a different service provider. Although the
Company has experienced favorable porting activity, the implementation of LNP
has not had a material effect on the Company's consolidated financial position
or results of operations.
Non-Operating Items
Interest Income and Expense, Net
Interest expense increased $2,371, or 126%, compared to 2002 due to the
Company's issuance in March 2003 of $60,000 of unsecured Series B Senior Notes,
$15,000 of the proceeds of which was used to retire certain short-term
borrowings.
Other Income (Expense), Net
In December 2003, the Company discovered certain irregular bank transactions and
deposits in a routine investigation following the abrupt resignation of the
Company's Treasury Analyst. Immediately following the Company's initial review
that uncovered these irregularities, the Company broadened its review of the
investment and cash operations, and a special corporate investigation was
launched by the Audit Committee and the Board of Directors, which engaged
independent legal counsel and forensic accountants. The investigations revealed
concealed illegal transfers in violation of the Company's investment and cash
management policies. The Company has concluded that the irregularities were
limited to the 2003 calendar year. The investigation suggests that as much as
$25,000 may have been involved in the scheme. Nearly all of the funds have been
recovered; however, as of March 26, 2004, approximately $2,000 remains
outstanding and has been reflected as a non-operating loss in the Company's 2003
consolidated financial statements. In January 2004, the Federal Bureau of
Investigation ("FBI") launched its own probe into the illegal funds transfer,
and in February 2004, indictments were returned against three individuals,
including the Company's former Treasury Analyst, on charges of mail fraud,
conspiracy and money laundering. The Company has filed an insurance claim to
recover the missing funds and has filed a civil lawsuit seeking to recover the
misappropriated funds and other costs from five individuals and a private
company allegedly associated with the fraudulent scheme to illegally transfer
the Company's funds to outside accounts. The Company will recognize a recovery
of the funds in future periods to the extent of its insurance and litigation
recoveries.
Income Taxes
Income taxes decreased $6,404, or 86%, compared to 2002 due to a corresponding
decrease in income subject to tax. The effective federal and state income tax
rate was 61.3% and 39.8% for the years ended 2003 and 2002, respectively. The
increase in the effective federal and state income tax rate is primarily due to
an increase in state income tax expense and an increase in permanent
differences.
As of December 31, 2003, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $19,434, which will expire in the
years 2018 through 2023, if not utilized. Deferred tax assets relating to net
operating loss carryforwards for federal purposes as of December 31, 2003
include approximately $463 associated with stock compensation activity for which
subsequent realized tax benefits, if any, will reduce income taxes payable in
the future. The Company also had net operating loss carryforwards for state
income tax purposes of approximately $218, which will expire in the years 2004
through 2011, if not utilized. The Company also had research and development tax
credit carryforwards of approximately $100 each for federal and state income tax
purposes. The federal credit will expire in 2022 if it is not utilized. The
state credits have no expiration date.
2002 versus 2001
Segment Results of Operations
Telecom
- -------
2002 2001 $Change %Change
__________ __________ __________ _______
Local service $ 66,283 $ 63,816 $ 2,467 4%
Network access service 58,426 49,030 9,396 19
Directory advertising 14,824 14,237 587 4
Long distance service 5,368 5,830 (462) (8)
Other 4,778 9,867 (5,089) (52)
Total operating revenues from
external customers 149,679 142,780 6,899 5
Intersegment revenues 16,826 12,877 3,949 31
Operating expenses 86,417 82,518 3,899 5
Depreciation and amortization 28,249 27,454 795 3
Operating income 51,839 45,685 6,154 13
Net income $ 33,634 $ 30,724 $ 2,910 9%
Operating Revenues
Operating revenues from external customers in the Telecom segment increased
$6,899 compared to 2001. Revenues from services subject to regulation, which
include local and network access services, increased $11,863, or 11%, compared
to 2001. The increase was primarily due to the combined effects of (i) increased
network access revenues due to expanded demand for DSL services and dedicated
access, (ii) access line growth of 2% and (iii) a $6,831 decrease in SureWest
Telephone's provision for its estimated interstate and intrastate shareable
earnings obligations. These increases were offset in part by the sale of the
Company's alarm monitoring division in January 2002 as described below in
Significant Business Event.
The Telecom segment operating revenues were also affected by SureWest
Telephone's wholesaling arrangement, commencing in the fourth quarter of 2002,
for its DSL service, resulting in a decrease to network access revenues of
$1,010 for the year ended December 31, 2002.
Directory advertising revenues increased $587 as compared to the same period in
2001 due to increased advertising sales.
The Company adopted SEC Staff Accounting Bulletin 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 years ended December 31,
2002 and 2001, the Company recognized $926 and $1,708, respectively, of revenues
that were in the cumulative effect adjustment as of January 1, 2000. The effect
of those revenues was to increase income by $555 (net of income taxes of $371)
and $1,025 (net of income taxes of $683) for the years ended December 31, 2002
and 2001, respectively.
Operating Expenses
Operating expenses for the Telecom segment increased $3,899 compared to 2001.
Cost of services and products increased $1,456, or 3% during 2002 due primarily
to (i) a favorable price adjustment to purchase fiber optic cable, (ii) an
increase in demand for DSL and (iii) an increase in the cost of producing and
printing the Roseville and Sacramento Telephone Directories. General and
administrative expenses increased $1,766, or 9%, compared to 2001. This increase
was due primarily to bad debt expense recognized during 2002 associated with
access charge billings to an interexchange carrier that filed for bankruptcy
protection. In addition, there were moderate increases to the size of the
Company's workforce, legal expenses and consulting fee's related to internal-use
software. These increases were partially offset by increased expenses in 2001
related to the Company's name change.
Depreciation and amortization expense increased $795 during 2002 due primarily
to additions to central office assets, cable and wire facilities 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 bad debt expense of approximately
$1,343 in 2002 relating to 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 (including ILEC's) are
entitled to "adequate assurances" that WorldCom will satisfy its obligations for
post-petition services. The Bankruptcy Court provided, 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 December 31, 2002, obligations owed by WorldCom to the
Company for post-petition services were paid on a timely basis.
Significant Business Event
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 December 31, 2003 the Company had received cash proceeds of
$4,995, of which $500 was received during 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 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 parties released all claims in exchange for payment by the
Company to the purchaser of $375, which was paid during 2003. Total operating
revenues attributable to the Company's alarm monitoring division during the
years ended 2002 and 2001 were $279 and $2,530, respectively.
Broadband
2002 2001 $Change %Change
_________ __________ __________ _______
Internet service $ 7,578 $ 3,722 $ 3,856 104%
Residential Broadband service 3,052 - 3,052 -
Business Broadband service 2,421 927 1,494 161
Total operating revenues from
external customers 13,051 4,649 8,402 181
Intersegment revenues 1,189 77 1,112 1,444
Operating expenses 23,448 8,178 15,270 187
Depreciation and amortization 1,972 553 1,419 257
Operating loss (11,180) (4,005) 7,175 179
Net loss $ (6,715) $ (2,283) $ 4,432 194%
Operating Revenues
Operating revenues from external customers in the Broadband segment increased
$8,402 compared to 2001. The increase in Broadband revenues is due in large part
to (i) continued additions to the residential and business DSL subscriber
customer base, with a 38% increase in Broadband subscribers based on subscriber
counts at December 31, 2002 compared to December 31, 2001, (ii) continued
expansion of the Business Broadband services and (iii) increased revenues
associated with the purchase of the Custom Data Services assets during the third
quarter of 2001 and SureWest Broadband/Residential Services assets during the
third quarter of 2002. In addition, there was an increase in operating revenues
resulting from the commencement of a wholesale DSL service arrangement with
SureWest Telephone in the fourth quarter of 2002.
Operating Expenses
Total operating expenses, including depreciation and amortization, in the
Broadband segment increased $16,689 compared to 2001. Cost of services and
products increased $5,952, or 130%, compared to 2001 due primarily to (i)
increased expenses associated with the purchase of the Custom Data Services
assets in the third quarter of 2001 and the SureWest Broadband/Residential
Services assets during the third quarter of 2002, (ii) increased transport costs
related to growth of CLEC operations and (iii) the commencement of a wholesale
DSL service arrangement with SureWest Telephone in the fourth quarter of 2002.
Customer operations expense, general and administrative expense and depreciation
and amortization increased $3,347, $5,971 and $1,419, respectively, for the year
ended December 31, 2002 compared to the same period in 2001. The increases are
primarily due to the asset purchases described above during the third quarter of
2002 and 2001, increase in customer service and billing expenses due to 38%
increase in Broadband subscribers based on subscriber counts, growth in CLEC
operations and an increase in depreciation expense resulting from property,
plant and equipment additions at SureWest Broadband and assets acquired from
purchase of Custom Data Services and SureWest Broadband/Residential Services.
Significant Business Events
Asset Purchase
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) acquisition related costs of $560 and (iii) the assumption
of certain current liabilities aggregating $4,579 relating principally to
executory contracts and capital lease obligations. Under the terms of the asset
purchase agreement, $1,200 of the aggregate purchase price was held in an escrow
account to protect the Company in the event of any claims available to the
Company. On January 28, 2003, $150 was released to the Company, and the balance
remains in the escrow account. The Company has entered into a tentative
agreement to resolve all differences in connection with the amounts held in
escrow, and the disputes that led to the establishment of the escrow. Under the
terms of the tentative settlement no additional funds will be paid by or
released to the Company. Prior to December 31, 2002, the Company sold certain
equipment acquired in the transaction for $2,157, which equaled its aggregate
carrying value at the date of sale.
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 preliminary allocation of the aforementioned purchase price:
Accounts receivable, net $ 615
Equipment held for sale 2,157
Other current assets 943
Property, plant and equipment 12,064
Intangible asset relating to favorable operating leases 1,360
------
Total assets acquired 17,139
Current liabilities assumed under executory contracts 3,345
Liabilities assumed under capital lease obligations 1,064
Other liabilities 170
------
Total liabilities assumed 4,579
------
Net assets acquired $ 12,560
======
Acquisition of SureWest Custom Data Services
Effective July 31, 2001, the Company acquired all of the outstanding common
stock of SureWest Custom Data Services for $2,100 in cash. The acquisition was
accounted for as a purchase in accordance with SFAS No. 141 "Business
Combinations." The assets of SureWest Custom Data Services acquired by the
Company, which had an aggregate fair value of $491, consisted principally of
cash, accounts receivable and property, plant and equipment. The liabilities of
SureWest Custom Data Services assumed by the Company, which had an aggregate
fair value of $534, consisted principally of accounts payable and long-term
debt. As a result of this acquisition, the Company recorded $2,171 of goodwill,
which was assigned to the Telecom Segment. As of January 1, 2003, SureWest
Custom Data Services operates as part of Internet Services within SureWest
Broadband.
Wireless
2002 2001 $Change %Change
---- ---- ------- -------
Wireless revenues from external
customers $ 23,225 $ 16,056 $ 7,169 45%
Intersegment revenues 507 245 262 107
Operating expenses 33,796 33,384 412 1
Depreciation and amortization 14,905 11,834 3,071 26
Operating loss (24,969) (28,917) (3,948) (14)
Net loss $ (15,670) $ (18,124) $ (2,454) (14)%
Operating Revenues
Operating revenues from external customers in the Wireless segment increased
$7,169 compared to 2001. The increase in Wireless revenues is due primarily to
continued additions to the customer base, with a 28% overall increase in
wireless subscribers based on subscriber counts at December 31, 2002 compared to
December 31, 2001. This increase resulted in increased feature, long distance,
directory assistance and activation revenues. Wireless revenues in 2001 were
negatively impacted by billings to certain customers of $2,200 that did not meet
all of the criteria for revenue recognition due to collection concerns.
Operating Expenses
Total operating expenses for the Wireless segment increased $412 compared to
2001. Cost of services and products increased $3,826, or 27%, compared to 2001.
This increase was due primarily to increased costs in tower rents, wireless
phone handset subsidies and roaming charges related to the continuing expansion
of the coverage area and increased demand for wireless service. Customer
operations and selling expense decreased $1,464 compared to 2001. The decrease
was primarily due to a decrease in dealer commissions resulting from customer
churn charge backs and $1,200 of bad debt expense recorded in 2001. These
decreases were partially offset by increased subscriber billing, product
advertising and marketing associated with the subscriber growth.
Depreciation and amortization increased $3,071 compared to 2001 due primarily to
increased in wireless property, plant and equipment and amortization of
internal-use software. This increase was partially offset by a decrease in
amortization relating to the Company's wireless licenses due to the adoption of
SFAS No. 142 as described below. In addition, during the fourth quarter of 2002,
the Company increased the estimated useful lives primarily to wireless switching
and voice mail equipment from five to ten years. This change in accounting
estimate resulted in decreased depreciation expense of $206 for the year ended
December 31, 2002.
Significant Business Event
During the second quarter of 2001, the Company acquired from Foresthill
Telephone Co. ("FHT") its 1.8% interest in SureWest Wireless for $2,500 in cash.
As a result of the acquisition, the Company now owns 100% of SureWest Wireless.
A former member of the Company's Board of Directors was, at the time of the
acquisition, the President and sole shareholder of FHT.
Non-Operating Items
Interest Income and Expense, Net
Other income (expense), net, decreased $1,438, or 33%, compared to 2001 due
primarily to (i) reduced interest income resulting from lower average invested
balances and (ii) increased interest expense resulting from higher average
short-term borrowings during 2002. This decrease was partially offset by the
gain from the sale of the Company's alarm monitoring division in January 2002.
Income Taxes
Income taxes increased $557, as compared to 2001, due primarily to an increase
in income subject to tax. The effective federal and state income tax rate was
39.8% and 40.0% for the years ended 2002 and 2001, respectively.
Liquidity and Capital Resources
As reflected in the Consolidated Statements of Cash Flows, net cash provided by
operating activities was $73,108 and $46,802 in 2003 and 2002, respectively. Net
cash used in operating activities was $32,896 in 2001. The increase in cash
provided by operating activities for the current year compared to the prior year
was due primarily to (i) increases in liabilities related to the Company's
estimated shareable earnings obligations, (ii) a decrease in provision for
deferred income taxes and (iii) increases in accrued liabilities. Net cash
provided by operating activities during 2003 was greater than net income of $645
due primarily to (i) non-cash charges consisting principally of depreciation and
amortization, (ii) increases in accrued liabilities and (iii) increase in
liabilities related to estimated shareable earnings obligations. During 2003,
the Company used cash flows from operations, proceeds from the issuance of its
Series B Senior Notes and existing cash and cash equivalents to fund (i) capital
expenditures of $76,105 pertaining to ongoing plant construction projects, (ii)
dividends of $14,539, (iii) principal payments of $5,780 to retire long-term
debt and (iv) $15,000 to retire short-term borrowings.
The Company's most significant use of funds in 2004 is expected to be for (i)
budgeted capital expenditures of approximately $82,556 (ii) scheduled payments
of long-term debt of $3,779, (iii) support of the operations of SureWest
Broadband/Residential Services up to an anticipated $8,691 and (iv) support of
the operations of SureWest Wireless up to an anticipated $2,847. A substantial
portion of the 2004 budgeted capital expenditures are at the discretion of the
Company, and are dependent upon the Company's working capital position,
operating cash flows and ability to borrow, as described below. The Company is
required to comply with its cable franchise agreements to continue its build-out
in the franchise areas.
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, which had an aggregate
outstanding principal balance of $15,000. A substantial intended use of the
Series B Notes proceeds was and continues to be the funding of capital
expenditures for the Company's SureWest Broadband/Residential Services business.
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. Interest on this credit facility is based on a
LIBOR-based pricing formula. While the Company has borrowed previously under
this credit facility, there were no amounts outstanding under this credit
facility as of December 31, 2003, nor since the issuance of the Series B Notes.
The Company obtained a waiver as of December 31, 2003 with respect to a
technical violation of the business loan agreement; however, the Company does
not believe the violation to be of any consequence since (i) there were no
amounts outstanding as of the time of the technical violation nor thereafter and
(ii) subsequent to December 31, 2003, the Company and the bank executed an
amendment to the business loan agreement extending the expiration date until
June 1, 2005 and revising certain covenants.
In April 2003, the Company sold a short-term investment prior to its maturity
date. The investment was sold without the consent of the Company's Management
and was a part of the irregular transactions discovered in connection with the
Corporate Treasury Investigation described in "2003 versus 2002 - Non-Operating
Items," above. The Company incurred a nominal penalty for the premature
redemption of this investment. The redemption did not have a material effect on
the Company's consolidated 2003 financial statements.
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.
Through December 31, 2003, approximately 1 million shares of common stock have
been repurchased through the programs. The Company has remaining authorization
from the Board of Directors to repurchase an additional 469 thousand outstanding
shares. The purchase of common shares resulted in a decrease in the average
number of common shares outstanding used in calculating both basic and diluted
earnings per share by 3% and 1% for 2002 and 2001, respectively (none in 2003).
The effects on the average number of common shares outstanding resulting from
the repurchase of stock resulted in an increase in basic earnings per share of
$0.02 for the year ended 2002 (no effect in 2003 or 2001). The effects on the
average number of common shares outstanding resulting from the repurchase of
stock resulted in an increase in diluted earnings per share of $0.02 and $0.01
for 2002 and 2001, respectively (no effect in 2003).
The Company had cash, cash equivalents and short-term investments at December
31, 2003, of $41,707. The Company believes that its working capital position,
operating cash flows and borrowing capacity are more than sufficient to satisfy
its liquidity requirements in 2004. The Company's forecast indicates it is
likely that the Company will borrow additional funds in the second-half of 2004
to fund operations and planned capital expenditures, while maintaining adequate
cash and cash equivalents. Such borrowing might be undertaken under the newly
extended credit facility or by the incurrence of additional long-term
indebtedness, or a combination of short and long-term borrowing. The Company
believes, given its financial position and debt-to-equity position, it has
substantial additional short and long-term borrowing capacity. As indicated
above, a substantial portion of the Company's 2004 budgeted capital expenditures
is at the discretion of the Company. Accordingly, the Company also believes that
it could modify its planned construction and commitments if the results of
operations or borrowing opportunities so require.
As of December 31, 2003, the Company's contractual obligations were as follows:
2004 2005-2006 2007-2008 Thereafter Total
---- --------- --------- ---------- -----
Long-term debt $ 3,779 $ 7,273 $ 7,273 $ 78,181 $ 96,506
Capital leases $ 347 $ 246 $ 12 $ 7 $ 612
Operating leases $ 4,815 $ 6,656 $ 4,748 $ 6,103 $ 22,322
Unconditional purchase obligations $ 2,527 $ - $ - $ - $ 2,527
Dividends are declared at the discretion of the Company's Board of Directors.
However, unsecured Series A Senior Notes, unsecured Series B Notes and other
unsecured credit arrangements contain provisions that could restrict the payment
of dividends in certain circumstances. These restrictions include various
positive and negative covenants with respect to cash flow coverage, tangible net
worth and leverage ratio. At December 31, 2003 and 2002, the entire amount of
retained earnings was unrestricted.
Other Related Party Transactions
An officer of the Company is also a member of the Board of Directors of a local
banking institution. As of December 31, 2000, the Company had a $15,000
certificate of deposit with a term greater than one year with such banking
institution. In the fourth quarter of 2001, the Company redeemed this
certificate of deposit for an amount equal to its historical carrying value,
including accrued interest. In addition, for the years ended December 31, 2003,
2002 and 2001 the Company provided $45, $17 and $18, respectively, in
telecommunications services to the banking institution.
During 2002, the Company repurchased 300 thousand shares of its common stock
from one of its employee benefit plans. The Company utilized two separate
independent third party entities for the purpose of providing fairness opinions
in connection with the transaction. The shares were repurchased at a price of
$50 per share and were retired upon repurchase.
Critical Accounting Policies and Estimates
Below is a summary of the Company's critical accounting policies and estimates,
which are more fully described in the referenced Notes to the Company's
Consolidated Financial Statements. Management has discussed development and
selection of critical accounting policies and estimates with the Company's Audit
Committee.
o As discussed more fully in Note 1, total revenues from telephone services
are affected by rates authorized by various regulatory agencies. The FCC
monitors SureWest Telephone's interstate earnings through the use of annual
cost separation studies prepared by SureWest Telephone, which utilize
estimated cost information and projected demand usage. The FCC establishes
rules that carriers must follow in the preparation of the annual studies.
In addition, under NRF, SureWest Telephone is subject to ongoing monitoring
and reporting requirements by the CPUC, including a sharing mechanism
whereby SureWest 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 SureWest Telephone's shareable
earnings obligations could change in the near term, and the amounts
involved could be material.
o As discussed more fully in Note 2, 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 As discussed more fully in Note 1, 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 As discussed more fully in Note 1, the Company states its inventories held
for sale 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 As discussed more fully in Note 1, 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 is depreciated or amortized using the straight-line method
over their estimated economic lives. The economic lives are estimated at
the time the assets are acquired and are based on historical experience
with similar assets, as well as anticipated technological or other changes.
If technological changes were to occur more rapidly than anticipated or
differently than anticipated, the economic lives assigned to these assets
may need to be shortened, resulting in the recognition of increased
depreciation and amortization expense in future periods. Likewise, if the
anticipated technological or other changes occur more slowly than
anticipated, the life of the asset group could be extended based on the
life assigned to new assets added to the group. This could result in a
reduction of depreciation and amortization expense in future periods. The
Company reviews these types of assets annually, or when events or
circumstances indicate that the carrying amount may not be recoverable over
the remaining lives of the assets. In assessing the recoverability of the
Company's property, plant and equipment and intangible assets, which
consist principally of wireless spectrum 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 As discussed more fully in Notes 1 and 8, 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 bases 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 December 31, 2003 or 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. However, the Company believes it will generate
sufficient taxable income to realize the deferred tax asset of $20,573 as
of December 31, 2003.
o As discussed more fully in Note 9, 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. Assumed health care cost
trend rates have a significant effect on the amounts reported for the
health care plans. A one-percentage-point change in assumed health care
cost trend rates would have the following effects:
1-Percentage- 1-Percentage-
Point Increase Point Decrease
-------------- --------------
Effect on total 2003 service and interest cost $ 56 $ (47)
Effect on post-retirement benefit obligation
as of December 31, 2003 $ 274 $ (239)
The discount rate is determined based on the current yields on high quality
corporate fixed-income investments with maturities corresponding to the
expected duration of the benefit obligations. As of December 31, 2002, the
Company reduced the discount rate by 25 basis points to 6.75%. This change
in the discount rate did not have a material impact on the Company's 2003
consolidated results of operations.
In 2003, the Company used an expected long-term rate of return of 8.5%. For
2004, the Company does not believe the expected long-term rate will change
significantly. The expected long-term rate of return on plan assets is
determined based on the current and projected investment portfolio mix and
estimated long-term investment returns for each asset class. The projected
portfolio mix of the plan assets is developed in consideration of the
expected duration of related plan obligations and private equity positions.
The expected return on plan assets is determined by applying the expected
long-term rate of return to the market-value of plan assets.
The future compensation levels are based on recent experience as well as
future expectations. As of December 31, 2002, the Company reduced the
future compensation level by 100 basis points to 5.00% and it remains at
that level. This change in the future compensation level did not have a
material impact on the Company's 2003 consolidated results of operations.
o As discussed more fully in Notes 1 and 10, 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 currently sponsors two Equity Incentive Plans (the "Plans") for
certain employees, outside directors and consultants of the Company, which
were approved by the Company's shareholders. The Plans permit issuance by
the Company of awards in the form of restricted shares, stock units,
performance shares, stock options and stock appreciation rights. Prior to
2003, the Company accounted for those plans under the recognition and
measurement provisions of Accounting Principles Board Opinion ("APB") No.
25, "Accounting for stock issued to employees," and related
interpretations. No stock based compensation expense for stock options was
reflected in net income for the years ended December 31, 2002 and 2001, as
all stock options granted under those plans had an exercise price equal to
the fair value of the underlying common stock on the date of grant.
Effective January 1, 2003, the Company adopted the preferable fair value
recognition provisions of Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation Transition and
Disclosure." Under the prospective transition method selected by the
Company, as described in SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure," compensation expense was
recognized in 2003 for all employee awards granted, modified or settled
after January 1, 2003. This change in accounting for stock-based
compensation resulted in increased compensation expense of $47, which
decreased net income by $28 (no effect on earnings per share) for the year
ended December 31, 2003.
The Company voluntarily made the choice to change to the preferable method
of accounting for employee stock options in accordance with SFAS No. 123.
The Company concluded that stock options are a form of employee
compensation expense and, therefore, it is appropriate that these expenses
be recorded in the results of operations to more clearly reflect economic
reality.
The Black-Scholes option pricing model includes assumptions regarding
dividend yields, expected volatility, expected lives and risk-free interest
rates. These assumptions reflect management's best estimates, but these
items involve inherent uncertainties based on market conditions generally
outside of the control of the Company. As a result, if other assumptions
had been used in the current period, stock-based compensation expense could
have been materially different. If management uses different assumptions in
future periods, stock-based compensation expense could be materially
impacted in future years.
Recent Accounting Pronouncements
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
establishes standards for classifying and measuring as liabilities certain
financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity, such as mandatorily redeemable
equity instruments. The adoption of SFAS No. 150 had no effect on the Company's
2003 consolidated financial statements.
In January 2003, the FASB issued Interpretation ("FIN") No. 46, "Consolidation
of Variable Interest Entities," an interpretation of Accounting Research
Bulletin ("ARB") No. 51, "Consolidated Financial Statements." FIN No. 46 applies
to any business enterprise that has a controlling interest, contractual
relationship or other business relationship with a variable interest entity
("VIE") and establishes guidance for the consolidation of VIEs that function to
support the activities of the primary beneficiary. The Company believes it has
no investments in, or contractual or other business relationships with, VIEs.
The adoption of FIN No. 46 had no effect on the Company's consolidated financial
statements as of and for the year ended December 31, 2003.
In July 2002, the 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 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
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 consolidated financial statements as of
and for the year ended December 31, 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. The Company changed its method of accounting on a
prospective basis for stock-based employee compensation to the fair value method
during the fourth quarter of 2003. The adoption of this new standard did not
have a material effect on the Company's consolidated financial statements as of
and for the year ended December 31, 2003.
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
consolidated financial statements as of and for the year ended December 31,
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 adopted EITF Issue No. 00-21 on a prospective basis for arrangements
entered into after June 30, 2003. The Company has determined that the sale of
its wireless handsets and the associated phone service provided by the Wireless
segment should be considered separate units of accounting under EITF Issue No.
00-21. Accordingly, beginning on July 1, 2003, the Company began applying EITF
Issue No. 00-21 to all wireless handset sales below cost, which approximates
fair value in the absence of an activation "subsidy," when it receives an
up-front fee of any kind (e.g., a service activation fee). The application of
EITF Issue No. 00-21 resulted in the immediate recognition of all or a portion
of such up-front fees as equipment sales revenue. Additionally, when the Company
activates wireless service for a customer, but does not concurrently provide the
customer with a handset, any up-front fees received continue to be deferred and
amortized over the expected term of the customer relationship. The Company
provides a general right of return within the first 30 days of service for a
100% refund of the handset cost. The estimated equipment return allowance
associated with this right of return is estimated based on historical
experience. The adoption of EITF Issue No. 00-21 did not have a material effect
on the Company's 2003 consolidated financial statements.
In November 2002, the FASB issued 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 consolidated financial
statements as of and for year ended December 31, 2003.
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," on
January 1, 2002. SFAS No. 142 addresses accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
"Intangible Assets." Under the provisions of SFAS No. 142, goodwill is not
amortized but instead evaluated at least annually for impairment in a two-step
process. In the first step, the fair value of each reporting unit is compared
with the carrying amount of the reporting unit, including goodwill. The Company
has determined that the reporting units are equal to its reportable business
segments since the business units within the reportable segments have similar
economic characteristics. Goodwill was allocated to the reporting unit that
received economic benefit from the acquisition. The estimated fair value of the
reporting unit is generally determined on the basis of discounted future cash
flows. The assumptions used in the estimate of fair value are generally
consistent with the past performance of each reporting unit and are also
consistent with the forecast and assumptions that are used in current operating
plans. Such assumptions are subject to change as a result of changing economic
and competitive conditions. If the estimated fair value of the reporting unit is
less than the carrying amount of the reporting unit, then a second step must be
completed in order to determine the amount of the goodwill impairment that
should be recorded. In the second step, the implied fair value of the reporting
unit's goodwill is determined by allocating the reporting unit's fair value to
all of its assets and liabilities other than goodwill in a manner similar to a
purchase price allocation. The resulting implied fair value of the goodwill that
results from the application of this second step is then compared to the
carrying amount of the goodwill and an impairment charge is recorded for the
difference
The Company believes its wireless spectrum licenses have indefinite lives
because such licenses can be renewed indefinitely at little cost. Accordingly,
the Company has applied the nonamortization provision of SFAS No. 142 to the
Company's wireless spectrum licenses effective January 1, 2002, which resulted
in an increase in the Company's consolidated net income of $305 ($0.02 per
share) for the years ended December 31, 2003 and 2002. The Company's operating
results for the year ended December 31, 2001 included $483 of amortization
expense related to the Company's wireless spectrum licenses. In the absence of
such amortization, the Company's adjusted net income for the year ended December
31, 2001 would have been $10,600 ($0.69 per share). Beginning in the first
quarter of 2002, the Company's wireless spectrum licenses are carried at the
lower of cost or fair value, which is evaluated at least annually and determined
based on transactions involving sales of comparable wireless spectrum licenses
in the aftermarket or independent valuations.
The goodwill recognized by the Company in connection with the acquisition of
SureWest Custom Data Services in July 2001 has been allocated to the Telecom
segment and is not being amortized based on the provisions of SFAS No's. 141 and
142.
The Company tests for impairment annually during the fourth quarter. The Company
completed its annual impairment tests during the fourth quarters of 2003 and
2002 and did not identify any impairment of its goodwill or wireless spectrum
licenses.
On January 1, 2002, the Company adopted the provision of EITF Issue No. 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)," dealing with consideration from a vendor to
a reseller under cooperative advertising and other arrangements. This provision
of EITF Issue No. 01-9 states that consideration from a vendor to a resel1er of
the vendor's products or services is presumed to be a reduction of the selling
price of the vendor's products or services, unless the vendor (i) receives an
identifiable benefit in return for the consideration and (ii) can reasonably
estimate the fair value of the benefit received. If the amount of consideration
paid by the vendor exceeds the estimated fair value of the benefit received, the
excess amount is to be recorded by the vendor as a reduction of revenues. The
application of this new guidance did not have a material effect on the Company's
2003 and 2002 consolidated financial statements.
On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-lived Assets to
Be Disposed Of," and provides a single accounting model for long-lived assets to
be disposed of. The adoption of SFAS No. 144 did not have a material effect on
the Company's 2002 consolidated financial statements.
Factors That Could Affect Future Results
As a result of the following factors, as well as other variables affecting our
operating results, past financial performance may not be a reliable indicator of
future performance, and historical trends should not necessarily be used to
anticipate results or trends in future periods.
Representative examples of these factors include (without limitation) the
following:
We expect to continue to face significant competition in all parts of our
business and the level of competition is expected to intensify. The
telecommunications industry is highly competitive. We face actual or
potential competition from many existing and emerging companies, including
other incumbent and competitive local telephone companies, long-distance
carriers and resellers, wireless telephone companies, Internet service
providers, satellite companies and cable television companies. We may not
be able to successfully anticipate and respond to various competitive
factors affecting the industry, including regulatory changes that may
affect our competitors and us differently, new technologies and services
that may be introduced, changes in consumer preferences, demographic trends
and discount pricing strategies by competitors. As the incumbent carrier in
Sacramento, SBC Communications enjoys certain business advantages,
including its size, financial resources, favorable regulatory position,
brand recognition and connection to virtually all of our customers and
potential customers there. As the largest cable operator in Sacramento and
Placer County, Comcast enjoys certain business advantages, including its
size, financial resources, ownership or superior access to programming and
other content, brand recognition, and first-in-the-field advantages with a
customer base that generates positive cash flow for its operations. We face
intense competition in our markets for long-distance, Internet access and
other ancillary services that are important to our business and to our
growth strategy.
We must adapt to rapid technological change. Technological developments
could increase our costs and cause a decline in demand for our services. In
addition, technology changes can give competitors significant new
advantages. If we do not replace or upgrade technology and equipment that
becomes obsolete, we will be unable to compete effectively because we will
not be able to meet the needs or expectations of our customers.
Additionally, replacing or upgrading our infrastructure in the future could
result in significant capital expenditures.
We are subject to a complex and uncertain regulatory environment. Some
parts of our business are extensively regulated, and the nature of
regulation continues to undergo fundamental change and reinterpretation.
Our operations have undergone material changes, and our actual operating
results can be expected to differ from the results indicated in our
historical financial statements. As a result of our acquisition of assets
from WIN in 2002, our mix of operating assets differs from those operations
upon which our historical financial statements are based. Consequently, our
historical financial statements may not be reliable as an indicator of
future results.
Our success depends upon our ability to manage our growth and expansion. If
our acquisitions and growth initiatives are not successful, we could suffer
an adverse effect on our business and results of operations. Our growth
strategy will require us to invest significant capital in services that may
not achieve the desired returns. Our future success depends, in part, upon
our ability to manage our growth, including our ability to build network
and related facilities to serve new customers, integrate our operations to
take advantage of new capabilities and systems; attract and retain skilled
personnel across the Company, effectively manage the demands of day to day
operations in new areas while attempting to execute our business strategy,
and realize the projected growth and revenue targets developed by Company
management.
We have more indebtedness now than at December 31, 2002. In March 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, which had an
aggregate outstanding principal balance of $15,000. A substantial intended
use of the Series B Notes proceeds was and continues to be the funding of
capital expenditures for the Company's SureWest Broadband/Residential
Services business.
We are reliant on support funds provided under federal and state laws. We
receive revenues from various federal or state support funds: long term
support from the Universal Service Program, CHCF-B and Universal Lifeline
Service Fund. These governmental programs are reviewed and amended from
time to time, and are likely to change in the near future. The outcome and
impact on the Company's operations resulting from future changes to these
governmental programs cannot be determined at this time.
We could be harmed by the recent adverse developments affecting other
communications companies. There have been numerous bankruptcies and other
financial difficulties experienced by other carriers and suppliers in the
telecommunications and Internet sectors. Similar situations with our
suppliers, some of whom provide products and services for which there are
few substitutes, could cause us to experience delays, service interruptions
or additional expenses.
We depend on third parties, over whom we have no control, to deliver our
services. Because of the interconnected nature of the telecommunications
industry, we depend heavily on other local telephone companies,
long-distance carriers, and numerous other third parties to deliver our
services. In addition, we are dependent on easements, franchises and
licenses from various private parties such as established telephone
companies and other utilities, railroads, long-distance companies, state
highway authorities, local governments and transit authorities for access
to aerial pole space, underground conduits and other rights-of-way in order
to construct and operate our networks. The failure to maintain in effect
the necessary third party arrangements on acceptable terms would have an
adverse effect on our ability to conduct our business.
If we are unable to effectively and efficiently implement the necessary
initiatives to eliminate the material weaknesses identified in our internal
controls and procedures, there could be an adverse affect on our operations
or financial results. Our auditors, Ernst & Young LLP, in connection with
the audit of the Company's consolidated financial statements for the year
ended December 31, 2003, advised us that they had concluded that material
weaknesses in the Company's internal control existed, including with
respect to issues identified as a result of the special investigation
instituted by the Audit Committee. The specific matters identified by Ernst
& Young LLP encompassed (i) control of cash and investments, (ii)
accounting personnel, policies and procedures and (iii) accounting for
property, plant and equipment. We performed substantial additional
procedures designed to ensure that the internal control deficiencies did
not lead to material misstatements in our consolidated financial
statements.
We have already implemented various initiatives, and are considering
additional initiatives to improve our internal controls, and address the
matters identified by Ernst & Young LLP. The implementation of the
initiatives and the consideration of additional necessary improvements are
among our highest priorities. The Board of Directors, under the direction
of the Audit Committee, will continually assess the progress of the
initiatives and the improvements, and take further actions as deemed
necessary. Until all of the identified material weaknesses are eliminated,
there is a risk of an adverse affect on our operations or financial
results. In addition, we anticipate that the initiatives will require the
hiring of additional employees and the incurrence of fees and expenses of
third parties necessary to improve the internal controls, likely resulting
in increased operating expenses.
Regulatory and Legal Matters
SureWest Telephone is subject to regulation by the FCC and CPUC. In the past,
there have been various proceedings before these agencies to which SureWest
Telephone has been a party. In 1996, Congress passed the Telecommunications Act
of 1996 (the "Act"), which significantly changed the regulatory environment for
telecommunications companies. Beginning in 1996, the FCC conducted proceedings
and adopted orders implementing the Act's provisions to open local exchange
service markets, such as the market of SureWest Telephone, to competition. These
proceedings and orders address interconnection, access charges and universal
service. With respect to local competition, the FCC rules outline pricing
methodologies for the states to follow when setting rates for incumbent carriers
(such as SureWest Telephone) to charge competitors for resale, interconnection
and unbundled network elements.
Given the Act's relatively recent enactment, the ongoing actions taken by the
FCC 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 FCC orders, it is not yet possible to determine fully the
impact of the Act and related FCC regulations on SureWest Telephone's
operations.
The Company's financial condition and results of operations have been and will
be affected by recent and future proceedings before the CPUC and FCC. Pending
before the FCC and CPUC are proceedings which are considering:
o additional rules governing the opening of markets to competition;
o the goals and definition of universal telephone service in a changing
environment, including examination of subsidy support mechanisms for
subscribers of different carriers (including incumbent carriers) and
in various geographic areas;
o rules that will provide non-discriminatory access by competing service
providers to the network capabilities of local exchange carriers and
o the regulated rates and earnings of SureWest Telephone.
There are a number of pending and anticipated other regulatory proceedings
occurring at the federal and state levels that may have a material impact on
SureWest Telephone. These regulatory proceedings include, but are not limited
to, consideration of changes to the interstate universal service fund,
intercarrier compensation (including access charges) reform and the regulation
of local exchange carriers, and regulation of IP-enabled services. The outcomes
and impact on SureWest Telephone's operations of these proceedings and related
court matters cannot be determined at this time.
The eventual impact on the Company of the effect of all the proceedings
described above cannot presently be determined.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company's limited exposure to market risk for changes in interest rates
relates primarily to its long-term debt obligations. The Company primarily
enters into debt obligations to support capital expenditures. The Company
currently has no cash flow exposure due to rate changes for long-term debt
obligations, as all obligations are at fixed rates. As of December 31, 2003, the
Company had debt obligations of $96.4 million with an average interest rate of
5.3%. Based on borrowing rates currently available for loans with similar terms
and maturities, the estimated fair value of long-term debt as of December 31,
2003 was $101.3 million. The Company does not use derivative financial
instruments in its investment portfolio or for any other purposes
Item 8. Financial Statements and Supplementary Data.
Page
Report of Independent Auditors ........................................................................... 52
Consolidated Balance Sheets as of December 31, 2003 and 2002 ............................................. 53
Consolidated Statements of Income for each of the three years in the period ended
December 31, 2003......................................................................................... 55
Consolidated Statements of Shareholders' Equity for each of the three years in the
period ended December 31, 2003............................................................................ 56
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 2003................................................................................... 57
Notes to Consolidated Financial Statements ............................................................... 59
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
SureWest Communications
We have audited the accompanying consolidated balance sheets of SureWest
Communications as of December 31, 2003 and 2002, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of SureWest
Communications at December 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, in 2003 the
Company adopted the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation, using the
prospective adoption method under the provisions of Statement of Financial
Accounting Standards No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure. As discussed in Note 1 to the consolidated financial
statements, in 2003 the Company changed its method of accounting for revenue
recognition upon the prospective adoption of Emerging Issues Task Force Issue
No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. As
discussed in Note 1 to the consolidated financial statements, in 2002 the
Company discontinued the amortization of certain indefinite-lived intangible
assets in accordance with Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets.
/s/ Ernst & Young LLP
Sacramento, California
March 19, 2004
SUREWEST COMMUNICATIONS
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
December 31,
ASSETS 2003 2002
---- ----
Current assets:
Cash and cash equivalents $ 39,008 $ 20,385
Short-term investments 2,699 -
Accounts receivable (less allowances of $2,665 and $1,705 at
December 31, 2003 and 2002, respectively) 18,846 19,747
Refundable income taxes - 6,868
Deferred income tax asset 209 -
Inventories 5,537 3,651
Deferred directory costs 5,320 3,657
Prepaid expenses and other current assets 3,440 2,102
---------- ----------
Total current assets 75,059 56,410
Property, plant and equipment, net 342,967 321,259
Intangible and other assets:
Wireless spectrum licenses, net 13,566 13,566
Goodwill 2,171 2,171
Intangible asset relating to pension plans 125 1,507
Intangible asset relating to favorable operating leases, net 649 1,260
Deferred charges and other assets 672 343
---------- ----------
17,183 18,847
---------- ----------
$ 435,209 $ 396,516
========== ==========
See accompanying notes.
SUREWEST COMMUNICATIONS
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(amounts in thousands)
December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2003 2002
---- ----
Current liabilities:
Current portion of long-term debt $ 3,779 $ 5,920
Current portion of capital lease obligations 347 309
Accounts payable 2,206 605
Other accrued liabilities 14,727 6,085
Estimated shareable earnings obligations 13,389 9,350
Advance billings and deferred revenues 9,882 7,919
Accrued income taxes 1,908 -
Accrued pension benefits - 5,613
Accrued compensation 4,860 4,902
---------- ----------
Total current liabilities 51,098 40,703
Short-term borrowings refinanced on a long-term basis - 15,000
Long-term debt 92,870 36,645
Long-term capital lease obligations 265 607
Deferred income taxes 25,946 26,552
Other liabilities and deferred revenues 7,502 8,004
Commitments and contingencies
Shareholders' equity:
Common stock, without par value; 200,000 authorized,
14,578 and 14,529 shares issued and outstanding at
December 31, 2003 and 2002, respectively 160,911 158,567
Deferred stock-based compensation (1,419) (116)
Accumulated other comprehensive loss (261) (1,637)
Retained earnings 98,297 112,191
---------- ----------
Total shareholders' equity 257,528 269,005
---------- ----------
$ 435,209 $ 396,516
========== ==========
See accompanying notes.
SureWest Communications
consolidated statements of income
(amounts in thousands, except per share amounts)
Years Ended December 31,
2003 2002 2001
---- ---- ----
Operating revenues:
Local service $63,363 $ 66,283 $ 63,816
Network access service 51,286 58,426 49,030
Directory advertising 15,087 14,824 14,237
Long distance service 5,098 5,368 5,830
Wireless service 27,146 23,225 16,056
Internet service 15,984 7,578 3,722
Residential broadband service 9,586 3,052 -
Business broadband service 3,697 2,421 927
Other 4,090 4,778 9,867
-------- -------- --------
Total operating revenues 195,337 185,955 163,485
Operating expenses:
Cost of services and products 66,890 61,220 53,075
Customer operations and selling 34,094 34,271 32,852
General and administrative 34,136 29,648 24,954
Depreciation and amortization 52,470 45,126 39,841
-------- -------- --------
Total operating expenses 187,590 170,265 150,722
Income from operations 7,747 15,690 12,763
Other income (expense):
Interest income 306 739 4,803
Interest expense (4,247) (1,876) (1,314)
Gain on sale of alarm monitoring assets - 4,435 -
Corporate treasury loss (1,828) - -
Other, net (311) (313) 934
-------- -------- --------
Total other income (expense), net (6,080) 2,985 4,423
-------- -------- --------
Income before income taxes 1,667 18,675 17,186
Income taxes 1,022 7,426 6,869
-------- -------- --------
Net income $ 645 $ 11,249 $ 10,317
======== ======== ========
Basic and diluted earnings per share $ 0.04 $ 0.76 $ 0.67
======== ======== ========
Dividends per share $ 1.00 $ 1.00 $ 1.00
======== ======== ========
Shares of common stock used to calculate earnings per share:
Basic 14,522 14,728 15,326
======== ======== ========
Diluted 14,539 14,795 15,387
======== ======== ========
See accompanying notes.
SUREWEST COMMUNICATIONS
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(amounts in thousands)
Common Stock
------------
Deferred Other
Number of Stock-Based Comprehensive Retained
Shares Amount Compensation Loss Earnings Total
------ ------ ------------ ---- -------- -----
Balance at December 31, 2000 15,510 $ 181,547 $ - $ - $ 143,455 $ 325,002
Issuance of common stock upon exercise
of options 7 288 - - - 288
Issuance of restricted common stock 8 363 (363) - - -
Repurchase of common stock (415) (10,115) - - (8,417) (18,532)
Amortization of deferred stock-based
compensation - - 60 - - 60
Cash dividends - - - - (15,342) (15,342)
Net income - - - - 10,317 10,317
------ ------- ----- ------ ------- -------
Balance at December 31, 2001 15,110 172,083 (303) - 130,013 301,793
Issuance of common stock upon exercise
of options 23 896 - - - 896
Issuance of restricted common stock 2 46 - - - 46
Repurchase of common stock (606) (15,149) - - (14,318) (29,467)
Amortization of deferred stock-based
compensation - - 187 - - 187
Tax benefits from stock plans - 691 - - - 691
Minimum pension and post-retirement
benefit obligation adjustment, net of
income taxes - - - (1,637) - (1,637)
Cash dividends - - - - (14,753) (14,753)
Net income - - - - 11,249 11,249
------ ------- ----- ------ ------- -------
Balance at December 31, 2002 14,529 158,567 (116) (1,637) 112,191 269,005
Issuance of common stock upon exercise
of options 5 164 - - - 164
Issuance of stock options to employees - 47 - - - 47
Issuance of restricted common stock 44 1,594 (1,594) - - -
Repurchase of common stock - - - - - -
Amortization of deferred stock-based
compensation - - 291 - - 291
Tax benefits from stock plans - 539 - - - 539
Minimum pension and post-retirement
benefit obligation adjustment, net of
income taxes - - - 1,376 - 1,376
Cash dividends - - - - (14,539) (14,539)
Net income - - - - 645 645
------ ------- ------- ------ ------- -------
Balance at December 31, 2003 14,578 $ 160,911 $ (1,419) $ (261) $ 98,297 $ 257,528
====== ======= ======= ====== ======= =======
See accompanying notes.
SUREWEST COMMUNICATIONS
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(amounts in thousands)
Years ended December 31,
2003 2002 2001
---- ---- ----
Cash flows from operating activities:
Net income $ 645 $ 11,249 $ 10,317
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 52,470 45,126 39,841
Provision for deferred income taxes (1,309) 17,128 10,381
Gain on sale of alarm monitoring assets - (4,435) -
Provision (benefit) for doubtful accounts 3,381 3,811 2,896
Stock-based compensation 338 202 60
Other, net 307 (4) 838
Net changes in:
Receivables (2,480) (3,624) 2,110
Refundable and accrued income taxes, net 8,852 (3,558) (94,669)
Inventories, prepaid expenses and other
current assets (1,926) (155) (774)
Accounts payable 1,601 (2,777) 476
Accrued liabilities and other deferred
credits 11,229 (16,161) (4,372)
------ -------- -------
Net cash provided by (used in) operating
activities 73,108 46,802 (32,896)
Cash flows from investing activities:
Purchase of substantially all of the assets
from Western Integrated Networks, LLC (62) (12,529) -
Proceeds from the sale of alarm monitoring
assets - 4,495 500
Purchase of business, net of cash acquired - - (2,091)
Purchase of minority interest in subsidiary - - (2,500)
Capital expenditures for property, plant and
equipment (76,105) (44,352) (69,556)
Purchases of held-to-maturity investments (25,351) - (8,843)
Maturities of held-to-maturity investments 20,652 1,723 14,555
Sale of held-to-maturity investment prior to
maturity 2,000 - -
Return of investment in cellular partnership - - 5,513
Redemption of long-term certificate of deposit
with related party - - 15,000
Other, net 33 192 691
------- -------- --------
Net cash used in investing activities (78,833) (50,471) (46,731)
Years ended December 31,
2003 2002 2001
---- ---- ----
Cash flows from financing activities:
Principal payments of long-term debt $ (5,921) $ (2,142) $ (2,143)
Proceeds from issuance of long-term debt 60,000 - -
Payment of debt issuance costs (356) - -
Increase (decrease) in short-term borrowings (15,000) 15,000 -
Dividends paid (14,539) (14,753) (15,342)
Proceeds from exercise of stock options 164 896 288
Repurchase of common stock - (29,467) (18,532)
Other, net - - (79)
------- ------- -------
Net cash provided by (used in)
financing activities 24,348 (30,466) (35,808)
------- ------- -------
Increase (decrease) in cash and cash equivalents 18,623 (34,135) (115,435)
Cash and cash equivalents at beginning of year 20,385 54,520 169,955
------- ------- -------
Cash and cash equivalents at end of year $ 39,008 $ 20,385 $ 54,520
======= ======= =======
See accompanying notes.
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and per share amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business and Basis of Accounting
SureWest Communications (the "Company") is a holding company with wholly-owned
subsidiaries that provide integrated communications services in Northern
California. The Company's principal operating subsidiary is SureWest Telephone
(formerly known as Roseville Telephone Company). SureWest Directories, SureWest
Long Distance (formerly known as Roseville Long Distance Company), 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, both as a result of its entry into new
communications markets and competitive forces in each of the markets in which
the Company has operations.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results may differ materially from
those estimates. The Company's critical accounting estimates include (i) revenue
recognition and the establishment of estimated shareable earnings obligations
and accounts receivable allowances (Notes 1 and 2), (ii) inventory valuation
(Note 1), (iii) useful life assignments and impairment evaluations associated
with property, plant and equipment and intangible assets (Note 1), (iv)
valuation allowances associated with deferred tax assets (Notes 1 and 8), (v)
pension and post-retirement benefit costs and obligations (Note 9), (vi)
anticipated outcomes of litigation, regulatory proceedings and other
contingencies (Notes 1 and 10) and (vii) employee stock-based compensation
(Notes 1 and 11).
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany transactions have
been eliminated.
Adjustments and Eliminations
During the Company's financial statement closing process for the year ended
December 31, 2003, certain matters were identified related to prior financial
reporting periods that necessitated the recording of adjustments to the
Company's consolidated financial statements. Such adjustments pertained
principally to property, plant and equipment, and management believes that
weaknesses in the Company's internal controls caused the errors that resulted in
these adjustments. The Company does not believe any of the aforementioned
amounts are material, individually or in the aggregate, to the respective prior
annual periods based on both quantitative and qualitative factors, including the
trend of operating results, nor does it believe the prospective correction of
such amounts during the quarter ended December 31, 2003 is material to the
Company's 2003 consolidated results of operations based on both quantitative and
qualitative factors, including the trend of operating results. (The prospective
correction of the aforementioned amounts relating to prior periods reduced the
Company's 2003 consolidated net income by $1,603, or $0.11 per basic and diluted
share, and would have reduced the Company's 2002 and 2001 consolidated net
income by $796, or $0.05 per basic and diluted share, and $217, or $0.01 per
basic and diluted share, respectively, had such errors been corrected in the
periods in which they originated.)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company's 2002 and 2001 consolidated financial statements have been adjusted
to eliminate certain intercompany balances that were not previously eliminated.
These adjustments pertained to (i) the Company's December 31, 2002 intercompany
accounts receivable and accounts payable balances aggregating $1,381 and (ii)
certain of the Company's 2002 and 2001 intercompany revenue and operating
expense balances aggregating $2,955 and $3,480, respectively. However, such
adjustments had no effect on the Company's consolidated working capital and
shareholders' equity balances as of December 31, 2002, or consolidated income
from operations or net income for the years ended December 31, 2002 and 2001.
Certain amounts in the 2002 and 2001 consolidated financial statements have been
reclassified to conform with the presentation of the Company's 2003 consolidated
financial statements.
Regulation and Estimated Shareable Earnings Obligations
Certain of the Company's rates are subject to regulation by the Federal
Communications Commission ("FCC") and the California Public Utilities Commission
("CPUC"). Pending and future regulatory actions may have a material impact on
the Company's consolidated financial position and results of operations.
Revenues from certain telephone services are affected by rates authorized by
various regulatory agencies. Intrastate service rates are subject to regulation
by the CPUC. With respect to toll calls initiated by interexchange carriers'
customers, the interexchange carriers are assessed access charges based on
tariffs filed by SureWest Telephone. Interstate access rates and resulting
earnings are subject to regulation by the FCC. With respect to interstate
services, SureWest Telephone has filed its own tariff with the FCC for all
elements of access services except carrier common line charges, for which
SureWest Telephone concurs with tariffs filed by the National Exchange Carrier
Association ("NECA").
The FCC monitors SureWest Telephone's interstate earnings through the use of
annual cost separation studies prepared by SureWest Telephone, which utilize
estimated cost information and projected demand usage. The FCC establishes rules
that carriers must follow in the preparation of the annual studies.
Additionally, under current FCC rules governing rate making, SureWest 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.
In January 2001, the FCC issued a Memorandum Opinion and Order to another
telephone company in which it clarified how Internet traffic, which the FCC had
prior to that date characterized as largely interstate in nature, should be
treated. During 2000 and 2001, Internet traffic and digital subscriber line
("DSL") service grew substantially, far exceeding SureWest Telephone's
estimates, which resulted in actual earnings exceeding the levels allowed by the
FCC. Based on preliminary cost studies, SureWest Telephone recognized
liabilities relating to its estimated interstate shareable earnings obligations
of $343, $650 and $3,231 for the years ended December 31, 2003, 2002, and 2001,
respectively, through reductions of revenues. During the year ended December 31,
2001, SureWest Telephone made payments to certain telecommunications companies
aggregating $6,800 related to interstate shareable earnings obligations for the
monitoring period 1999-2000. No similar payments were made in 2003 or 2002. On
June 26, 2003, SureWest Telephone entered into a Settlement Agreement to recover
$1,950 of the amount paid to a telecommunications company in 2001. The funds
were received pursuant to the Settlement Agreement on July 8, 2003. SureWest
Telephone 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 SureWest Telephone
is seeking a refund has filed for bankruptcy protection. In addition, during the
fourth quarter of 2001, SureWest Telephone changed its estimate relating to a
portion of its interstate shareable earnings obligations, principally due to the
closing of the 1997 through 1998 monitoring period. This change in accounting
estimate increased the Company's 2001 revenues and net income by $2,150 and
$1,290 ($0.08 per share), respectively. In May 2002, the D.C. Circuit Court of
Appeals (the "Court") issued its decision in a case involving ACS of Anchorage.
The Court determined that a tariff filed properly under Section 204
"streamlined" procedures and allowed to go into effect without suspension is
deemed lawful, and the carrier is not subsequently obligated to pay refunds for
earnings higher than the permitted rate of return as prescribed by the FCC for
that monitoring period. Subsequent to the Court's decision, certain
telecommunication companies filed a petition for rehearing. In August 2002, the
petitions for rehearing were denied by the Court, and later that month the
Court's order became effective. For the monitoring periods 1999 through 2001,
SureWest Telephone filed tariffs pursuant to the streamlined procedures and such
tariffs were not suspended or investigated. Consequently, during the third
quarter of 2002, SureWest Telephone changed its estimate for a portion of its
interstate shareable earnings obligations related to those monitoring periods.
For the year ended December 31, 2002, this change in accounting estimate
increased the Company's 2002 revenues by $5,092 and net income by $3,065 ($0.21
per share).
Prior to January 1, 2002, SureWest Telephone billed SBC Communications Inc.
("SBC") (formerly Pacific Bell) 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 SureWest Telephone's toll traffic. The DCP
was a compensation arrangement between SureWest Telephone and SBC for certain
intrastate toll services. SureWest 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
December 31, 2003 and 2002 or results of operations for the years 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 SureWest Telephone approximately $11,500 per year for EAS
pursuant to a Settlement Transition Agreement. In November 2000, the CPUC
authorized SBC to terminate its annual EAS payments to SureWest Telephone
effective November 30, 2000. The CPUC authorized replacement funding to SureWest
Telephone on an interim basis using funds from the California High Cost Fund
("CHCF"). In addition, the CPUC opened an Order Instituting Investigation
("OII") for the purpose of determining whether future recovery of all, none, or
a portion of the approximate $11,500 annual payments previously received from
SBC should come from SureWest 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 CPUC
discontinue SureWest Telephone's present interim EAS funding from the CHCF
without replacement revenues from ratepayers. The CPUC's decision in this matter
is expected during 2004. The CPUC 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 SureWest Telephone cannot yet be
determined.
In 1996, the CPUC issued a decision in connection with SureWest Telephone's
general rate proceeding, which authorized SureWest Telephone to implement a New
Regulatory Framework ("NRF") for services furnished within SureWest Telephone's
service area in order to accommodate market and regulatory movement toward
competition and greater pricing flexibility. Under the NRF, SureWest Telephone
is subject to ongoing monitoring and reporting requirements, including a sharing
mechanism whereby SureWest 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 CPUC.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In accordance with the requirements of its general rate case order, SureWest
Telephone filed an application for review of its NRF in 1999. In connection with
this proceeding, the CPUC's ORA undertook a verification audit of SureWest
Telephone's non-regulated and affiliated transactions pursuant to the general
rate case and other CPUC orders. In June 2001, the CPUC adopted its decision in
this matter (the "Decision"). The Decision did not suspend the sharing mechanism
as SureWest Telephone had requested and the CPUC ruled that SureWest Telephone
must change the method used to allocate costs for services provided by SureWest
Telephone to its affiliates, the treatment of certain directory revenues and the
treatment of internal-use software costs. In accordance with the provisions of
the Decision, the Company recorded certain liabilities and reductions of
revenues of $3,285, $1,750 and $6,000 relating to its estimated intrastate
shareable earnings obligations during the years ended December 31, 2003, 2002
and 2001, respectively.
Beginning in January 2002, SureWest Telephone began paying a customer refund for
intrastate shareable earnings obligations relating to the years 1998 and 1999. A
portion of the customers' intrastate service charges was returned in the form of
a surcredit beginning in January 2002 and ending in January 2003, totaling
approximately $4,605 (of which $294 was returned during 2003).
In October 2003, the CPUC issued a resolution requiring SureWest Telephone to
pay a customer dividend for intrastate overearnings totaling approximately $483
relating to 2002. A portion of the customers' intrastate service charges will be
returned to the customers in the form of a surcredit over approximately three
months, which began in November 2003. During the year ended December 31, 2003,
$275 was returned to customers.
As a result of periodic cost separation studies for the monitoring period
2002-2001, SureWest Telephone changed its estimates for a portion of its
interstate and intrastate shareable earnings obligations and certain NECA CCL
accounts receivable balances during the years ended December 31, 2003 and 2002.
For the year ended December 31, 2003, these changes in accounting estimates
decreased the Company's revenues by $29 and net income by $17 (no effect on
earnings per share), respectively. For the year ended December 31, 2002, similar
changes in accounting estimates decreased Telecom segment revenues by $1,115 and
net income by $671 ($0.05 per share).
As of December 31, 2003, the Company's consolidated balance sheet reflected
aggregate liabilities of $13,389 relating to SureWest 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, SureWest
Telephone's interstate shareable earnings obligations lapse over time if
SureWest 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 SureWest Telephone's liabilities for interstate and
intrastate shareable earnings obligations could change in the near term, and the
amounts involved could be material.
Cash Equivalents and Short-term Investments
The Company invests its excess cash in high-quality debt instruments and money
market mutual funds. The Company considers highly liquid investments with
maturities of three months or less from the acquisition date of the instrument
to be cash equivalents. Short-term investments at December 31, 2003 had
maturities ranging from greater than 90 days to less than one year. There were
no short-term investments at December 31, 2002. Management determines the
appropriate classification of securities at the time of purchase and reevaluates
such designation as of each balance sheet date. At December 31, 2003 and 2002,
all securities are designated as held-to-maturity because management has the
positive intent and ability to hold the securities until maturity.
Held-to-maturity securities are stated at cost, adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization and
accretion, as well as any interest on the securities, is included in interest
income.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In April 2003, the Company sold a short-term investment prior to its maturity
date. The investment was sold without the consent of the Company's Management
and was a part of the irregular transactions discovered in connection with the
Company's treasury investigation (refer to Note 3 for a more detailed discussion
about the Company's treasury investigation). The Company incurred a nominal
penalty for the premature redemption of this investment. The redemption did not
have a material effect on the Company's 2003 consolidated financial statements.
The following is a summary of the Company's cash equivalents and short-term
investments as of December 31, 2003 and 2002 at amortized cost, which
approximates fair market value:
2003 2002
---- ----
Money market mutual funds $ 15,726 $ 2,112
United States Government Agency Securities 999 -
Auction rate securities 1,700 -
------ ------
$ 18,425 $ 2,112
====== ======
Fair Values of Financial Instruments
As of December 31, 2003 and 2002, the Company's financial instruments consist of
cash, cash equivalents, short-term investments, short-term borrowings, long-term
debt and capital lease obligations. Management believes the carrying values of
cash equivalents and short-term investments at December 31, 2003 and 2002, which
are at amortized cost, approximated their fair values at such dates. The
aggregate fair value of the Company's long-term debt (including current
maturities) was approximately $101,288 and $43,728 at December 31, 2003 and
2002, respectively. The aggregate fair value of the Company's short-term
borrowings was $15,000 as of December 31, 2002 (none as of December 31, 2003).
The aggregate fair value of the Company's capital lease obligations was $581 and
$862 as of December 31, 2003 and 2002, respectively. Fair values for cash
equivalents and short-term investments were determined by quoted market prices.
Fair values for the long-term debt, short-term borrowings and capital lease
obligations were determined through discounted cash flow analyses based on the
Company's current incremental interest rates for similar instruments.
Allowance for Doubtful Accounts
An allowance for doubtful accounts is maintained for estimated losses, which
result from the inability of customers to make required payments. Allowances are
based on the likelihood of recoverability of accounts receivable based on past
experience and management's best estimates of current bad debt exposures. The
Company performs ongoing credit evaluations of its customers' financial
condition and management believes that adequate allowances for doubtful accounts
have been provided. Accounts determined to be uncollectable are charged against
the allowance for doubtful accounts and removed from the accounts receivable
balances.
Inventories
Telephone network inventories consist of materials and supplies, which are
stated at average cost. Nonregulated wireline equipment inventory held for sale
is stated at the lower of average cost or market value. Wireless handset and
accessory inventories are stated at the lower of average cost or market value.
Inventories at SureWest Broadband are comprised of modems, which are stated at
the lower of average cost or market value, and network materials and supplies,
which are stated at average cost.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Additions and substantial
improvements are capitalized. Repairs and maintenance costs are expensed as
incurred. Retirements and other reductions of regulated telephone plant and
equipment with a cost of approximately $4,079, $6,470 and $14,696 in 2003, 2002
and 2001, respectively, were 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 consists of the following as of December 31, 2003
and 2002:
2003 2002
---- ----
Land $ 4,198 $ 4,189
Buildings 79,286 78,553
Central office equipment 156,355 140,551
Outside plant equipment 282,789 245,133
Internal-use software 46,531 29,075
Other 62,474 56,243
------- -------
Property, plant and equipment 631,633 553,744
Less accumulated depreciation 303,773 255,320
------- -------
Total plant in service 327,860 298,424
Plant under construction 15,107 22,835
------- -------
Property plant and equipment, net $ 342,967 $ 321,259
======= =======
Property, plant and equipment is depreciated using the straight-line method over
their estimated economic lives, which range from 3 to 40 years. The useful lives
of property, plant and equipment are estimated in order to determine the amount
of depreciation and amortization expense to be recorded. The useful lives are
estimated at the time the assets are acquired and are based on historical
experience with similar assets, as well as taking into account anticipated
technological or other changes. Average annual composite depreciation rates were
7.6%, 7.1% and 7.48% in 2003, 2002 and 2001, respectively.
Effective November 1, 2002, the Company increased the estimated useful lives
primarily related to its wireless switching and voice mail equipment from five
to ten years. This change in accounting estimate decreased the Company's 2003
and 2002 depreciation expense by $930 and $206, respectively, and increased the
Company's 2003 and 2002 consolidated net income by $360 and $124, respectively
($0.02 and $0.01 per share, respectively).
Intangible Assets
Wireless spectrum licenses are stated at cost. Accumulated amortization was
$1,195 at December 31, 2003 and 2002. As described below in "Recent accounting
pronouncements," the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 142, "goodwill and Other Intangible Assets," on January 1, 2002.
Under the provisions of SFAS No. 142, goodwill is not amortized but instead
evaluated at least annually for impairment in a two-step process. In the first
step, the fair value of each reporting unit is compared with the carrying amount
of the reporting unit, including goodwill. The Company has determined that the
reporting units are equal to its reportable business segments since the business
units within the reportable segments have similar economic characteristics.
Goodwill was allocated to the reporting unit that received economic benefit from
the acquisition. The estimated fair value of the reporting unit is generally
determined on the basis of discounted future cash flows. The assumptions used in
the estimate of fair value are generally consistent with the past performance of
each reporting unit and are also consistent with the forecast and assumptions
that are used in current operating plans. Such assumptions are subject to change
as a result of changing economic and competitive conditions. If the estimated
fair value of the reporting unit is less than the carrying amount of the
reporting unit, then a second step must be completed in order to determine the
amount of the goodwill impairment that should be recorded. In the second step,
the implied fair value of the reporting unit's goodwill is determined by
allocating the reporting unit's fair value to all of its assets and liabilities
other than goodwill in a manner similar to a purchase price allocation. The
resulting implied fair value of the goodwill that results from the application
of this second step is then compared to the carrying amount of the goodwill and
an impairment charge is recorded for the difference. The Company believes its
wireless spectrum licenses have indefinite lives because such licenses can be
renewed indefinitely at little cost. Accordingly, the Company has applied the
nonamortization provision of SFAS No. 142 to the Company's wireless spectrum
licenses effective January 1, 2002., Beginning in the first quarter of 2002, the
Company's wireless spectrum licenses are carried at the lower of cost or fair
value, which is evaluated at least annually and determined based on transactions
involving sales of comparable wireless spectrum licenses in the aftermarket or
independent valuations.
The goodwill recognized by the Company in connection with the acquisition of
SureWest Custom Data Services in July 2001 has been allocated to the Telecom
segment and is not being amortized based on the provisions of SFAS No's. 141 and
142.
The Company tests for impairment annually during the fourth quarter. The Company
completed its annual impairment tests during the fourth quarters of 2003 and
2002 and did not identify any impairment of its goodwill or wireless spectrum
licenses.
Nonmonetary Transaction
During 2003, the Company entered into a 20-year nonmonetary transaction with a
third party involving the exchange of certain fiber optic capacity and
collocation rights. This transaction provides the Company with access and rights
to certain collocation facilities and cell site locations, which were previously
inaccessible due to unreasonably high entrance costs. The collocation rights
provide access to additional network connections to the Company while the cell
site locations strengthen the Company's existing cellular network in key areas.
Because this nonmonetary transaction did not represent the culmination of an
earnings process, no revenues or expenses have been, or will be, recorded by the
Company pursuant to this transaction. In addition, there was no indicated loss
on this exchange of productive rights.
Stock-based Compensation
The Company has two stock-based compensation plans, which are described more
fully in Note 11. Prior to 2003, the Company accounted for employee stock
options issued under these plans using the intrinsic value method pursuant to
Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued
to Employees," and related Interpretations. No stock-based employee compensation
expense pertaining to employee stock options was recognized in the Company's
2002 or 2001 consolidated financial statements because all such options had an
exercise price equal to the market value of underlying common stock on the date
of grant. Effective January 1, 2003, the Company adopted the fair value
recognition provisions of SFAS No. No. 123, "Accounting for Stock-Based
Compensation." Under the prospective method of adoption selected by the Company
under the provisions of SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," the fair value method of accounting was applied to
all employee awards granted, modified, or settled after January 1, 2003.
Stock-based compensation associated with employee stock options is recognized
over the vesting periods (which range from 1 to 5 years) using the graded
vesting method.
The fair value of the Company's employee stock options was estimated at the date
of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions for 2003, 2002 and 2001:
2003 2002 2001
---- ---- ----
Risk-free Interest Rate 1.79% 2.54% 4.24%
Expected Dividend Yield 2.5% 2.13% 1.76%
Expected Volatility 42.48% 39.95% 26.7%
Expected Lives 4 years 4 years 5 years
The Black-Scholes option pricing model includes assumptions regarding dividend
yields, expected volatility, expected lives and risk-free interest rates. These
assumptions reflect management's best estimates, but these items involve
inherent uncertainties based on market conditions generally outside of the
control of the Company. As a result, if other assumptions had been used in the
current period, actual and pro forma stock-based compensation expense could have
been materially different. If management uses different assumptions in future
periods, stock-based compensation expense could be materially impacted in future
years.
The expense related to stock-based employee compensation included in the
determination of net income for 2003 is less than that which would have been
recognized if the fair value method had been applied to all awards granted after
the original effective date of SFAS No. 123. If the Company had elected to adopt
the fair value recognition provisions of SFAS No. 123 as of its original
effective date, pro forma net income (loss) and earnings (loss) per share would
be as follows:
Years ended December 31,
------------------------
2003 2002 2001
--------- --------- ---------
Net income, as reported $ 645 $ 11,249 $ 10,317
Add: Stock-based employee compensation expense included
in reported net income, net of related tax effects 200 122 36
Deduct: Total stock-based employee compensation expense
determined using the fair value method for all
awards, net of related tax effects (1,522) (1,421) (857)
---------------- ----------------- ---------------
Pro forma net income (loss) $ (677) $ 9,950 $ 9,496
================ ================= ===============
Earnings (loss) per share:
Basic--as reported $ 0.04 $ 0.76 $ 0.67
Basic--pro forma $ (0.05) $ 0.68 $ 0.62
Diluted--as reported $ 0.04 $ 0.76 $ 0.67
Diluted--pro forma $ (0.05) $ 0.68 $ 0.62
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company uses the Black-Scholes option-pricing model to determine the fair
value of each option grant. The Black-Scholes model includes assumptions
regarding dividend yields, expected volatility, expected lives and risk-free
interest rates. These assumptions reflect management's best estimates, but these
items involve inherent uncertainties based on market conditions generally
outside of the control of the Company. As a result, if other assumptions had
been used in the current period, actual and pro forma stock-based compensation
expense could have been materially different. If management uses different
assumptions in future periods, stock-based compensation expense could be
materially impacted in future years.
During the years ended December 31, 2003, 2002 and 2001, the weighted-average
grant date fair value of options granted to employees was $8.75, $11.42 and
$12.24 per share, respectively.
Advertising Costs
The costs of advertising are charged to expense as incurred. Advertising expense
was $4,339, $3,659 and $3,364 in 2003, 2002 and 2001, respectively.
The Company makes market development funds ("MDF") available to certain
retailers that serve as agents for SureWest Wireless for the reimbursement of
co-branded advertising expenses. To the extent that MDF is used by the Company's
customers for co-branded advertising, and (i) the agents provide the Company
with third-party evidence of such co-branded advertising as prescribed by
Company policy and (ii) the Company can reasonably estimate the fair value of
its portion of the advertising, such amounts are charged to advertising expense
as incurred.
Income Taxes
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 bases 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.
Per Share Amounts
Basic per share amounts are computed using the weighted average number of shares
of the Company's common stock outstanding, less the weighted average number of
unvested restricted common shares outstanding during the period.
Diluted per share amounts are determined in the same manner as basic per share
amounts, except the number of weighted average common shares used in the
computations (i) includes unvested restricted common shares outstanding and (ii)
is increased assuming the exercise of dilutive stock options using the treasury
stock method.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table presents the calculations of weighted average common shares
used in the computations of basic and diluted per share amounts presented in the
accompanying consolidated statements of income:
Years ended December 31,
2003 2002 2001
---- ---- ----
Basic:
Weighted average shares of common stock outstanding 14,539 14,737 15,338
Less weighted average shares of restricted
common stock 17 9 12
---------------- -------------------- -----------
Weighted average common shares used in computing
basic per share amounts 14,522 14,728 15,326
================ ==================== ===========
Diluted:
Weighted average shares of common stock outstanding 14,539 14,737 15,338
Plus weighted average shares of common stock from
the assumed exercise of dilutive stock options - 58 49
---------------- -------------------- -----------
Weighted average common shares used in computing
diluted per share amounts 14,539 14,795 15,387
================ ==================== ==========
Statements of Cash Flows Information
During 2003, 2002 and 2001, the Company made payments for interest and income
taxes as follows:
2003 2002 2001
---- ---- ----
Interest, net of amounts capitalized ($1,095 in
2003, $1,074 in 2002 and $1,708 in 2001) $ 3,758 $ 2,485 $ 1,285
Income taxes $ - $ 2,812 $ 93,466
Other Comprehensive Income (loss)
Significant components of the Company's other comprehensive income (loss) are as
follows:
Years ended December 31,
2003 2002 2001
---- ---- ----
Net Income $ 645 $ 11,249 $ 10,317
Minimum pension and post-retirement
benefit liability adjustment, net
of income taxes of $934 and $1,138
in 2003 and 2002 (none in 2001) 1,376 (1,637) -
------- ------- -------
Other comprehensive income $ 2,021 $ 9,612 $ 10,317
====== ======== =======
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
As of December 31, 2003 and 2002, the accumulated other comprehensive loss was
$261 and $1,637, respectively, which consisted of minimum pension and
post-retirement benefit liability adjustments, net of income taxes.
Recent Accounting Pronouncements
On May 15, 2003, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 150, "Accounting for Certain Financial Instruments with Characteristics of
Both Liabilities and Equity." SFAS No. 150 establishes standards for classifying
and measuring as liabilities certain financial instruments that embody
obligations of the issuer and have characteristics of both liabilities and
equity, such as mandatorily redeemable equity instruments. The adoption of SFAS
No. 150 had no effect on the Company's 2003 consolidated financial statements.
In January 2003, the FASB issued Interpretation ("FIN") No. 46, "Consolidation
of Variable Interest Entities," an interpretation of Accounting Research
Bulletin ("ARB") No. 51, "Consolidated Financial Statements." FIN No. 46 applies
to any business enterprise that has a controlling interest, contractual
relationship or other business relationship with a variable interest entity
("VIE") and establishes guidance for the consolidation of VIEs that function to
support the activities of the primary beneficiary. The Company believes it has
no investments in, or contractual or other business relationships with, VIEs.
The adoption of FIN No. 46 had no effect on the Company's consolidated financial
statements as of and for the year ended December 31, 2003.
In July 2002, the 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 will
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 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 2003 consolidated financial statements.
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. The Company changed its method of accounting on a
prospective basis for stock-based employee compensation to the fair value method
during the fourth quarter of 2003. The adoption of this new standard did not
have a material effect on the Company's consolidated financial statements as of
and for the year ended December 31, 2003.
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
consolidated financial statements as of and for the year ended December 31,
2003.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 adopted EITF Issue No. 00-21 on a prospective basis for arrangements
entered into after June 30, 2003. The Company has determined that the sale of
its wireless handsets and the associated phone service provided by the Wireless
segment should be considered separate units of accounting under EITF Issue No.
00-21. Accordingly, beginning on July 1, 2003, the Company began applying EITF
Issue No. 00-21 to all wireless handset sales below cost, which approximates
fair value in the absence of an activation "subsidy," when it receives an
up-front fee of any kind (e.g., a service activation fee). The application of
EITF Issue No. 00-21 resulted in the immediate recognition of all or a portion
of such up-front fees as equipment sales revenue. Additionally, when the Company
activates wireless service for a customer, but does not concurrently provide the
customer with a handset, any up-front fees received continue to be deferred and
amortized over the expected term of the customer relationship. The Company
provides a general right of return within the first 30 days of service for a
100% refund of the handset cost. The estimated equipment return allowance
associated with this right of return is estimated based on historical
experience. The adoption of EITF Issue No. 00-21 did not have a material effect
on the Company's 2003 consolidated financial statements.
In November 2002, the FASB issued 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 consolidated financial
statements as of and for year ended December 31, 2003.
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," on
January 1, 2002. SFAS No. 142 addresses accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
"Intangible Assets." The Company believes its wireless spectrum licenses have
indefinite lives because such licenses can be renewed indefinitely at little
cost. Accordingly, the Company has applied the non-amortization provision of
SFAS No. 142 to the Company's wireless spectrum licenses effective January 1,
2002, which resulted in an increase in the Company's consolidated net income of
$305 ($0.02 per share) for the years ended December 31, 2003 and 2002. The
Company's operating results for the year ended December 31, 2001 included $483
amortization expense related to the Company's wireless spectrum licenses. In the
absence of such amortization, the Company's adjusted net income for the year
ended December 31, 2001 would have been $10,600 ($0.69 per share). Beginning in
the first quarter of 2002, the Company's wireless spectrum licenses are carried
at the lower of cost or fair value (the application of this provision of SFAS
No. 142 had no effect on the Company's consolidated financial statements as of
and for the years ended December 31, 2003 and 2002). The goodwill recognized by
the Company in connection with the acquisition of SureWest Custom Data Services
in July 2001 is not being amortized based on the provisions of SFAS Nos. 141 and
142. Instead, under the provisions of SFAS No. 142, goodwill is evaluated at
least annually for impairment in a two-step process. The first step screens for
potential impairment and the second step measures any impairment loss resulting
from step one. The Company tests for impairment annually during the fourth
quarter. The Company completed its annual impairment tests during the fourth
quarters of 2003 and 2002 and did not identify any impairment. The goodwill is
allocated to the Telecom segment in accordance with the provisions of SFAS No.
142.
On January 1, 2002, the Company adopted the provision of EITF Issue No. 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)," dealing with consideration from a vendor to
a reseller under cooperative advertising and other arrangements. This provision
of EITF Issue No. 01-9 states that consideration from a vendor to a resel1er of
the vendor's products or services is presumed to be a reduction of the selling
price of the vendor's products or services, unless the vendor (i) receives an
identifiable benefit in return for the consideration and (ii) can reasonably
estimate the fair value of the benefit received. If the amount of consideration
paid by the vendor exceeds the estimated fair value of the benefit received, the
excess amount is to be recorded by the vendor as a reduction of revenues. The
application of this new guidance did not have a material effect on the Company's
2003 and 2002 consolidated financial statements.
On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and provides a single accounting model for long-lived assets to
be disposed of. The adoption of SFAS No. 144 did not have a material effect on
the Company's 2002 consolidated financial statements.
2. REVENUE RECOGNITION
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. Revenues based on a flat fee, derived
principally from local telephone, dedicated network access, data communications,
Internet access service, residential/business broadband service and non-contract
wireless services, are billed in advance and recognized in subsequent periods
when the services are provided. Contract wireless services are billed in
arrears. Revenues based on usage, derived primarily from network access and long
distance services, are recognized monthly as services are provided. Incremental
direct costs of telecommunications service activation are charged to expense in
the period in which they are incurred. Directory advertising revenues and costs
related to publishing and distributing directories are recognized using the
"circulation period" method, under which revenues and related costs are
recognized ratably over the expected useful life of the directory, generally one
year from the date of publication. For all other operations, revenue is
recognized when products are delivered or services are rendered to customers.
Effective July 1, 2003, the Company began applying the FASB EITF Issue No. 00-21
to all wireless handset sales below cost, which approximates fair value in the
absence of an activation "subsidy," when it receives an up-front fee of any kind
(e.g., a service activation fee). The application of EITF Issue No. 00-21
resulted in the immediate recognition of all or a portion of such up-front fees
as equipment sales revenue. Additionally, when the Company activates wireless
service for a customer, but does not concurrently provide the customer with a
handset, any up-front fees received continue to be deferred and amortized over
the expected term of the customer relationship. The Company provides a general
right of return within the first 30 days of service for a 100% refund of the
handset cost. The estimated equipment return allowance associated with this
right of return is estimated based on historical experience. The adoption of
EITF Issue No. 00-21 did not have a material impact on the Company's 2003
consolidated financial statements.
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 bad debt expense of approximately
$1,343 in 2002 relating to 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 (including Incumbent
Local Exchnage Carriers) are entitled to "adequate assurances" that WorldCom
will satisfy its obligations for post-petition services. The Bankruptcy Court
provided, 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 December 31,
2003, obligations owed by WorldCom to the Company for post-petition services
have been paid on a timely basis.
During the fourth quarter of 2000, the Company changed its method of accounting,
retroactive to January 1, 2000, for up-front fees associated with
telecommunications service activation in accordance with the guidance contained
in the Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements." Previously, the Company had
recognized such up-front fees as revenues upon activation of service. Under the
new accounting method, the Company now recognizes up-front fees associated with
service activation over the expected duration of the customer relationships,
which presently ranges from one to five years, using the straight-line method.
The cumulative effect of the change on prior years resulted in a charge to
income of $3,273 (net of income taxes of $2,250), which was included in net
income for the year ended December 31, 2000. For the years ended December 31,
2003, 2002 and 2001, the Company recognized $413, $926 and $1,708, respectively,
of revenues that were in the cumulative effect adjustment as of January 1, 2000.
The effect of those revenues was to increase income by $244 (net of income taxes
of $169), $555 (net of income taxes of $371) and $1,025 (net of income taxes of
$683) for the years ended December 31, 2003, 2002 and 2001, respectively.
3. CORPORTATE TREASURY INVESTIGATION
In December 2003, the Company discovered certain irregular bank transactions and
deposits in a routine investigation following the abrupt resignation of the
Company's Treasury Analyst. Immediately following the Company's initial review
that uncovered suspect transfers, the Company broadened its review of the
investment and cash operations, and a special corporate investigation was
launched by the Audit Committee, which engaged outside counsel and forensic
auditors. The investigations revealed concealed illegal transfers in violation
of the Company's investment and cash management policies. The Company believes
that the irregularities were limited to the 2003 calendar year. The
investigation suggests that as much as $25,000 may have been involved in the
scheme. Nearly all of the funds have been recovered; however, at present,
approximately $1,828 remains outstanding and has been reflected as a
non-operating loss in the Company's 2003 consolidated financial statements. The
Company has filed an insurance claim to recover the missing funds. In January,
the Federal Bureau of Investigation ("FBI") launched its own probe into the
illegal funds transfer. On February 5, 2004, the FBI made three arrests,
including the Company's former Treasury Analyst, on charges of mail fraud,
conspiracy and money laundering. The Company has filed a civil lawsuit seeking
to recover the misappropriated funds and other costs from five individuals and a
private company allegedly associated with the fraudulent scheme to illegally
transfer the Company's funds to outside accounts. Should the insurance claim be
perfected or the civil lawsuit successful, the Company will recognize a recovery
of the funds at that time.
4. ASSET PURCHASE
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.
The Company does not believe the assets acquired from WIN constitute a
self-sustaining, integrated set of activities and assets that would constitute a
business, principally due to the absence of an established customer base at WIN
or significant revenue generating activities as of July 12, 2002. Since July 12,
2002, the Company has been utilizing the assets acquired from WIN to offer
bundled high-speed Internet, digital cable and telephone services under the
SureWest Broadband/Residential Services name in the Sacramento metropolitan
area.
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 prospectively adjusted the preliminary purchase price
allocation in connection with the preparation of its 2003 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
------
Net assets acquired $ 12,622
======
The equipment purchased from WIN that was held for sale consisted primarily of
network assets located in Dallas, Texas. The Company completed the sale of such
equipment during the first quarter of 2003. The Company did not recognize a gain
or loss on the sale of these assets.
The property, plant and equipment acquired from WIN consisted principally of a
primary processing center, video head end equipment, a fiber-coaxial cable
network located in the Sacramento metropolitan area, software licenses and
office furniture and equipment. The Company is depreciating these assets on a
straight-line basis over estimated useful lives ranging from three to fifteen
years.
In addition, the Company recognized an intangible asset related to favorable
operating leases assumed from WIN. This intangible asset is being amortized to
rent expense over the remaining lease terms, which range from two to ten years.
As of December 31, 2003 and 2002, accumulated amortization associated with this
intangible asset was $711 and $100, respectively.
Under the terms of the asset purchase agreement, $1,200 of the aggregate
purchase price was held in an escrow account to protect the Company in the event
of any claims available to the Company. On January 28, 2003, $150 was released
to the Company, and the balance remains in the escrow account. The Company has
entered into a tentative agreement to resolve all differences in connection with
the amounts held in escrow, and the disputes that led to the establishment of
the escrow, which has been submitted to the Bankruptcy Court for approval. Under
the terms of the tentative settlement, no additional funds will be paid by or
released to the Company.
5. SALE OF ALARM MONITORING DIVISION
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 December 31, 2003, the Company has received cash proceeds of
$4,995, of which $4,495 and $500 were received during 2002 and the fourth
quarter of 2001, respectively, 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 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 parties released all claims in
exchange for payment by the Company to the purchaser of $375, which was paid
during 2003. Total operating revenues attributable to the Company's alarm
monitoring division during 2002 and 2001 were $279 and $2,530, respectively
(none in 2003).
6. ACQUISITION OF BUSINESS AND MINORITY INTEREST
Effective July 31, 2001, the Company acquired all of the outstanding common
stock of SureWest Custom Data Services for $2,100 in cash. The acquisition was
accounted for as a purchase in accordance with SFAS No. 141 "Business
Combinations." The assets of SureWest Custom Data Services acquired by the
Company, which had an aggregate fair value of $491, consisted principally of
cash, accounts receivable and property, plant and equipment. The liabilities of
SureWest Custom Data Services assumed by the Company, which had an aggregate
fair value of $534, consisted principally of accounts payable and long-term
debt. As a result of this acquisition, the Company recorded $2,171 of goodwill,
which was assigned to the Telecom Segment. None of this goodwill is deductible
for tax purposes. As of January 1, 2004, SureWest Custom Data Services operates
as SureWest Broadband.
During the second quarter of 2001, the Company acquired from Foresthill
Telephone Co. ("FHT") its 1.8% interest in SureWest Wireless for $2,500 in cash.
As a result of the acquisition, the Company now owns 100% of SureWest Wireless.
A former member of the Company's Board of Directors was, at the time of the
acquisition, the President and sole shareholder of FHT.
7. CREDIT ARRANGEMENTS
Long-term debt outstanding as of December 31, 2003 and 2002 consisted of the
following:
2003 2002
---- ----
Unsecured Series A Senior Notes, with interest payable semiannually at a
fixed rate of 6.3%; principal payments are due in equal annual
installments of approximately $3,636,
commencing in December 2003 and ending in December 2013 $ 36,363 $ 40,000
Unsecured Series B Senior Notes, with interest payable semiannually at a
fixed rate of 4.74%; principal payments are due in equal annual
installments of approximately $12,000,
commencing in March 2009 and ending in March 2013 60,000 -
Unsecured term loan with a bank, with interest payable quarterly at a
fixed rate of 6.22%; principal payments are due in equal quarterly
installments of approximately $536, through December
2003 - 2,143
Note payable, with interest payable quarterly at a fixed rate of 8.00%;
principal payments are due in equal quarterly
installments of approximately $36, through November 2005 286 422
------ ------
Total long-term debt 96,649 42,565
Less current portion 3,779 5,920
------ ------
Total long-term debt, net of current portion $ 92,870 $ 36,645
======= ======
At December 31, 2003, the aggregate maturities of long-term debt were (i) $3,636
annually through 2008, (ii) $15,636 annually from 2009 through 2013 and (iii)
$143 annually through 2005 for a total of $92,870.
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 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 $15,000 as
of December 31, 2002. Consequently, such short-term borrowings have been
presented as a long-term liability in the accompanying consolidated balance
sheet as of December 31, 2002.
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. Interest on this credit facility is based on a
LIBOR-based pricing formula. While the Company has borrowed previously under
this credit facility, there were no amounts outstanding under this credit
facility as of December 31, 2003, nor since the issuance of the Series B Notes.
The Company obtained a waiver as of December 31, 2003 with respect to a
technical violation of the business loan agreement; however, the Company does
not believe the violation to be of any consequence since (i) there were no
amounts outstanding as of the time of the technical violation nor thereafter and
(ii) subsequent to December 31, 2002, the Company and the Bank executed an
amendment to the business loan agreement extending the expiration date until
June 1, 2005 and revising certain covenants. (see Note 17).
Certain of the aforementioned credit arrangements contain various positive and
negative covenants with respect to cash flow coverage, tangible net worth and
leverage ratio. These provisions could restrict the payment of dividends in
certain circumstances; however, the entire amount of retained earnings at
December 31, 2003 and 2002 was unrestricted.
8. INCOME TAXES
Income tax expense consists of the following components:
2003 2002 2001
---- ---- ----
Current expense (benefit):
Federal $ 782 $ (9,095) $ (4,613)
State 1,549 (607) 1,101
------ ------ ------
Total current expense (benefit) 2,331 (9,702) (3,512)
Deferred expense (benefit):
Federal 75 15,010 10,050
State (1,384) 2,118 331
------ ------ ------
Total deferred expense (benefit) (1,309) 17,128 10,381
------ ------ ------
Total income tax expense $ 1,022 $ 7,426 $ 6,869
====== ====== ======
8. INCOME TAXES (CONTINUED)
Income tax expense differs from that computed by using the statutory
federal tax rate (35% in all years presented) due to the following:
2003 2002 2001
---- ---- ----
Computed at statutory rates $ 583 $ 6,536 $ 6,015
Increase (decrease):
State taxes, net of federal benefit 108 982 930
Other, net 331 (92) (76)
------ ------ ------
Income tax expense $ 1,022 $ 7,426 $ 6,869
====== ====== ======
Effective federal and state tax rate 61.3% 39.8% 40.0%
====== ====== ======
The significant components of the Company's deferred income tax assets and
liabilities were as follows at December 31, 2003 and 2002:
Deferred Income Taxes
---------------------
2003 2002
---- ----
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Property, plant and equipment-primarily
due to depreciation differences $ - $ 37,820 $ - $ 32,128
Differences in the timing of recognition
of revenues 9,838 - 7,182 -
State franchise taxes 209 - - -
Other, net 10,526 8,490 6,432 8,038
------ ----- ----- -----
Total 20,573 46,310 13,614 40,166
Less current portion 209 - - -
------ ----- ----- -----
Total deferred income taxes $ 20,364 $ 46,310 $ 13,614 $ 40,166
====== ====== ====== ======
Net long-term deferred income tax liability $ 25,946 $ 26,552
====== ======
As of December 31, 2003, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $19,434, which will expire
in the years 2018 through 2023, if not utilized. Deferred tax assets
relating to net operating loss carryforwards for federal purposes as of
December 31, 2003 include approximately $463 associated with stock
compensation activity for which subsequent realized tax benefits, if any,
will reduce income taxes payable in the future. The Company also had net
operating loss carryforwards for state income tax purposes of approximately
$218, which will expire in the years 2004 through 2011, if not utilized.
The Company also had research and development tax credit carryforwards of
approximately $100 both for federal and state income tax purposes. The
federal credit will expire in 2022 if it is not utilized. The state credits
have no expiration date.
9. PENSION AND OTHER POST-RETIREMENT BENEFITS
The Company sponsors a noncontributory defined benefit pension plan (the
"Pension Plan") covering substantially all of its employees. In December 2003,
the Company approved an amendment to the Pension Plan that essentially provided
for the adoption of the Pension Plan by all subsidiaries, thereby extending the
pension benefit to all employees of the Company, effective January 1, 2004.
Benefits are based on years of service and the employee's average compensation
during the five highest consecutive years of the last ten years of credited
service. The Company's funding policy is to contribute annually an actuarially
determined amount consistent with applicable federal income tax regulations.
Contributions are intended to provide for benefits attributed to service to
date. Pension Plan assets are primarily invested in collective trust accounts,
government and government agency obligations, publicly traded stocks and bonds
and mortgage-related securities.
The Company also has an unfunded Supplemental Executive Retirement Plan
("SERP"), which provides supplemental retirement benefits to certain executives
of the Company. The SERP provides for incremental pension payments partially to
offset the reduction in amounts that would have been payable under the Pension
Plan if it was not for limitations imposed by federal income tax regulations.
In addition, the Company provides certain post-retirement benefits other than
pensions ("Other Benefits") to substantially all employees, including life
insurance benefits and a stated reimbursement for Medicare supplemental
insurance.
The Company uses a measurement date of December 31 for the majority of its
pension and other post retirement benefit plans.
The following table sets forth the change in benefit obligation, change in plan
assets and funded status of the Pension Plan, SERP and Other Benefits as of
December 31, 2003 and 2002:
Pension Plan & SERP Other Benefits
------------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
Change in benefit obligation:
Benefit obligation at beginning of year $ 98,853 $ 95,460 $ 4,554 $ 3,993
Service cost 4,557 4,552 353 319
Interest cost 6,841 6,866 326 297
Plan participants' contributions - - 228 -
Plan amendments - - 175 -
Actuarial losses (gain) 4,521 (4,026) (180) 312
Benefits paid (4,419) (3,999) (420) (367)
------- ------- ------- -------
Benefit obligation at end of year $ 110,353 $ 98,853 $ 5,036 $ 4,554
======= ======= ======= =======
Change in plan assets:
Fair value of plan assets at beginning of
year 73,806 74,019 1,347 1,450
Actual return on plan assets 15,453 (8,157) 289 (164)
Company contribution 9,109 11,943 446 428
Participant contributions - - 228 -
Benefits paid (4,419) (3,999) (420) (367)
------- ------ ------ ------
Fair value of plan assets at end of year $ 93,949 $ 73,806 $ 1,890 $ 1,347
======= ======= ====== ======
9. PENSION AND OTHER POST-RETIREMENT BENEFITS (CONTINUED)
Pension Plan & SERP Other Benefits
Funded status: 2003 2002 2003 2002
Unfunded status of plan at end of year (16,404) (25,048) (3,146) (3,207)
Unrecognized actuarial loss (gain) 16,784 22,210 (142) 220
Unrecognized prior service cost 575 667 408 259
Unrecognized net transition obligation 573 840 - -
------- ------- ------- ------
Prepaid (accrued) benefits $ 1,528 $ (1,331) $ (2,880) $ (2,728)
======= ======= ======= ======
Amounts recognized in the consolidated balance sheets at December 31, 2003 and
2002 consist of:
Prepaid benefit cost $ 3,009 $ - $ - $ -
Accrued benefit cost (1,481) (1,331) (2,880) (2,728)
Additional minimum liability (568) (4,282) - -
Intangible assets 126 1,507 - -
Accumulated other comprehensive income 442 2,775 - -
------- ------- ------- ------
Prepaid (accrued) benefits $ 1,528 $ (1,331) $ (2,880) $ (2,728)
======= ======= ======= ======
Information for the Pension Plan and SERP, which have with an accumulated
benefit obligations in excess of plan assets as of December 31, 2003 are as
follows:
2003 2002
---- ----
Projected benefit obligation $ 110,353 $ 98,853
Accumulated benefit obligation $ 91,375 $ 79,419
Fair value of plan assets $ 93,949 $ 73,806
Net periodic pension cost recognized in the consolidated statements of income
for the years ended December 31, 2003, 2002 and 2001 under the Pension Plan,
SERP and Other Benefits plan included the following components:
Pension Plan & SERP Other Benefits
------------------- --------------
2003 2002 2001 2003 2002 2001
---- ---- ---- ---- ---- ----
Service cost-benefits earned during
the period $ 4,557 $ 4,552 $ 4,060 $ 353 $ 320 $ 237
Interest cost on projected benefit
obligation 6,841 6,866 6,394 326 297 233
Expected return on plan assets (6,305) (6,368) (6,487) (108) (117) (118)
Amortization of prior service cost 92 92 71 26 26 27
Recognized net actuarial loss 798 151 47 - (6) (58)
Amortization of transition obligation 267 267 267 - - -
------ ----- ------ ------ ------ ------
Net pension cost $ 6,250 $ 5,560 $ 4,352 $ 597 $ 520 $ 321
====== ====== ====== ====== ====== ======
9. PENSION AND OTHER POST-RETIREMENT BENEFITS (CONTINUED)
The weighted-average assumptions used to determine projected benefit obligations
as of December 31, 2003 and 2002 are as follows:
Pension Plan & SERP Other Benefits
------------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
Discount rate 6.25% 6.75% 6.25% 6.75%
Rate of compensation increase 5.00% 5.00% 5.00% 5.00%
Weighted-average assumptions used to determine net periodic benefit cost as of
December 31, 2003 and 2002 are as follows:
Pension Plan & SERP Other Benefits
------------------- --------------
2003 2002 2001 2003 2002 2001
---- ---- ---- ---- ---- ----
Discount rate 6.75% 7.00% 7.25% 6.75% 7.00% 7.25%
Expected long-term return on plan assets 8.50% 8.50% 8.50% 8.50% 8.50% 8.50%
Rate of compensation increase 5.00% 6.00% 6.00% 5.00% 6.00% 6.00%
The expected rate of return on plan assets is the weighted average of expected
long-term asset return assumptions.
Assumed health care cost trend rates at December 31, 2003 and 2002 are as
follows:
2003 2002
---- ----
Health care cost trend assumed for the next year 9.00% 10.00%
Rate to which the cost trend is assumed to decline (the ultimate
trend rate) 6.00% 6.00%
Year that the rate reaches the ultimate trend rate 2007 2007
Assumed health care cost trend rates have a significant effect on the amounts
reported for the Other Benefits plan. A one-percentage-point change in assumed
health care cost trend rates would have the following effects:
1-Percentage-Point 1-Percentage-Point
Increase Decrease
------------------ ------------------
Effect on total 2003 service and interest costs $ 56 $ (47)
Effect on Other Benefits obligation as of December 31, 2003 $ 274 $ (239)
The assets of the Pension Plan and Other Benefits are combined in a single trust
and invested in the aggregate. The SERP benefit obligation is funded through
current Company assets. The allocation for the plan assets at the end of 2003
and 2002, and the target allocation for 2004, by asset category is as follows:
Target Allocation Percentage of Plan Assets at December 31,
----------------- -----------------------------------------
Asset Category 2004 2003 2002
- -------------- ---- ---- ----
Equity securities 35-45% 39.6% 53.2%
Government/credit
securities 35-45% 38.6% 30.9%
International stocks 15-25% 20.9% 14.1%
Cash equivalents 0-2% 0.9% 1.8%
----- -----
Total 100% 100% 100%
===== ====
9. PENSION AND OTHER POST-RETIREMENT BENEFITS (CONTINUED)
The fair value of plan assets for these plans is $95,839 and $75,153 at December
31, 2003 and 2002, respectively. The expected long-term rate of return on these
plan assets for 2003 and 2002 was 8.5%.
Revised in mid-2003, the Company's investment strategy is designed to provide a
stable environment to secure participant retirement benefits and minimize the
reliance on contributions as a source of benefit security. As such, plan assets
are invested to maximize the plan's funded ratios over the long-term while
managing the downside risk that funded ratios fall below some specified
threshold level. The asset return objective is to achieve, as a minimum over
time, the passively managed return earned by managed index funds, weighted in
the proportions outlined by the asset class exposures identified in the plan's
strategic allocation.
The Company expects to contribute $5,500 and $460 to the Pension Plan and Other
Benefits plan, respectively, in 2004.
Estimated Future Benefit Payments
Information about the expected cash flows for the Pension Plan, SERP and Other
Benefits plan is as follows :
Pension Plan & SERP Other Benefits
------------------- --------------
Expected benefit payments:
2004 $ 4,475 $ 187
2005 4,687 222
2006 4,972 258
2007 5,383 296
2008 5,741 333
2009 - 2013 36,123 2,336
The above table reflects the total benefits expected to be paid from the plans
or from the Company's assets, including both the Company's share of the benefit
cost and the participants' share of the cost, which is funded by participant
contributions to the plans. Expected contributions reflect amounts expected to
be contributed to funded plans.
Prior to December 31, 2001, the Company maintained two defined contribution
retirement plans, the Employee Stock Ownership Plan ("ESOP") and the Retirement
Supplement Plan ("RSP"), which together provided retirement and savings features
for substantially all employees. The Company approved an amendment to merge the
RSP into the ESOP as of December 31, 2001 and to change the structure of the
Company's provision to match employee contributions to the ESOP from one-half of
an employee's contributions, to a dollar-for-dollar match up to six percent of
an employee's salary.
In addition, effective June 1, 2002, the Company approved an amendment to
establish the SureWest KSOP (the "KSOP"), replacing the ESOP, in order to allow
its participants an opportunity to diversify their retirement holdings. All of
the assets held in the ESOP were transferred to the KSOP. The Company has
retained an investment management company to be the record keeper and fund
manager of the KSOP. Employees may choose from eleven investment options,
including the Company's Stock Fund. The KSOP will continue to have both a
retirement and savings feature. The retirement feature allows for qualified tax
deferred contributions by employees under Section 401(k) of the Internal Revenue
Code. The KSOP provides for voting rights as to the participant's share of the
Company's common stock held by the KSOP and for certain diversification rights
of the participant's account balances. Aggregate matching contributions made by
the Company and charged to expense under the KSOP, RSP and ESOP were $2,204,
$1,962 and $1,725 in 2003, 2002 and 2001, respectively. The KSOP held 1,211,000
1,263,000 and 1,633,000 shares of the Company's common stock and received
dividends of $1,275, $1,410 and $1,729, respectively, during the years ended
December 31, 2003, 2002 and 2001, respectively. The Company's earnings per share
calculations includes the issued and outstanding shares held by the KSOP.
10. COMMITMENTS AND CONTINGENCIES
Capital and Operating Leases
As a result of the acquisition by SureWest Televideo of certain WIN assets in
July 2002 (Note 4) the Company assumed capital leases for certain vehicles.
These leases bear interest at imputed rates of 6.3% to 16.2% per annum and
expire through December 2010. The capitalized costs related to assets under
capital leases were $1,064 as of December 31, 2003 and 2002. The amortization of
assets under capital leases is included in depreciation and amortization expense
in the accompanying consolidated financial statements. As of December 31, 2003
and 2002, the accumulated amortization for these assets was $315 and $105,
respectively.
The Company leases certain facilities and equipment used in its operations under
arrangements accounted for as operating leases. The facility leases generally
require the Company to pay operating costs, including property taxes, insurance
and maintenance, and certain of them contain scheduled rent increases and
renewal options. The Company recognizes rent expense on a straight-line basis
over the term of each lease. Total rent expense for all operating leases was
$5,032, $4,238 and $2,999 in 2003, 2002 and 2001, respectively.
As of December 31, 2003, the Company had various non-cancelable operating and
capital leases with terms greater than one year. Future minimum lease payments
for all non-cancelable operating and capital leases at December 31, 2003 are as
follows:
Operating Capital
Leases Leases
------ ------
2004 $ 4,815 $ 417
2005 3,695 230
2006 2,961 32
2007 2,495 7
2008 2,253 7
Thereafter 6,103 14
------ ---
$ 22,322 707
======
Less: amount representing interest 95
---
Present value of net minimum lease payments 612
Less: current portion 347
---
$ 265
===
Other Commitments
As of December 31, 2003, binding commitments for future capital expenditures
were approximately $2,000 in the aggregate.
SureWest Long Distance provides long distance services under resale arrangements
with two interexchange carriers, Global Crossing Ltd. ("Global Crossing") and
Sprint Communications Company L.P. ("Sprint"). The agreement with Global
Crossing is due to expire in July 2004. The Company's 2-year non-exclusive
agreement with Sprint will expire in December 2004. The Company's minimum usage
requirements for Global Crossing and Sprint for 2004 are $255 and $275,
respectively. For the years ended December 31, 2003, 2002 and 2001, the Company
paid $1,183, $1,343 and $1,254, respectively, for long distance resale
arrangements.
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company executed a surety and indemnification agreement in the amount of
$500 related to a Facility License Agreement entered into during the third
quarter of 2003. In addition, the Company has certain other guarantees
surrounding its cable franchise licenses.
Litigation, Regulatory Proceedings and Other Contingencies
The Company is subject to certain legal and regulatory proceedings, Internal
Revenue Service examinations and other income tax exposures, and other claims
arising in the ordinary course of its business. In the opinion of management,
the ultimate outcome of these matters will not materially affect the
consolidated financial position or results of operations of the Company.
11. EQUITY INCENTIVE PLANS
The Company has two Equity Incentive Plans (the "Plans") for certain employees,
outside directors and consultants of the Company, which were approved by
shareholders. The Company authorized for future issuance under the Plans 1
million shares (subject to upward adjustment based upon the Company's issued and
outstanding shares) of authorized, but unissued, common stock. As of December
31, 2003, 360,159 shares were available for grant. The Plans permit issuance by
the Company of awards in the form of restricted shares, stock units, performance
shares, stock options and stock appreciation rights. The exercise price per
share of the Company's common stock purchasable under any stock option shall not
be less than 100% of the fair market value of a share of the Company's common
stock on the date of the grant, and the exercise price under a non-qualified
stock option shall not be less than 85% of the fair market value of the
Company's common stock in the date of the grant.
The following table summarizes stock option activity for the years ended
December 31, 2003, 2002 and 2001, along with options exercisable at the end of
each year:
2003 2002 2001
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Options Price Options Price Options Price
------- ----- ------- ----- ------- -----
Outstanding-January 1, 865,122 $40.87 739,887 $41.28 612,500 $39.46
Granted 12,750 30.26 180,250 38.83 169,800 47.37
Exercised (5,344) 30.77 (22,805) 39.28 (6,678) 39.86
Cancelled (48,054) 41.74 (32,210) 39.91 (35,735) 39.27
-------- ------ -------- ------ ------- ------
Outstanding-December 31, 824,474 $40.72 865,122 $40.87 739,887 $41.28
======== ====== ======== ====== ======= ======
Exercisable at end of year 448,471 262,091 111,957
======= ======= =======
11. EQUITY INCENTIVE PLANS (CONTINUED)
The following is a summary of the status of the stock options outstanding at
December 31, 2003:
Options Outstanding Options Exercisable
----------------------------------------------- -----------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Number of Remaining Exercise Number of Exercise
Prices Shares Contractual Life Price Shares Price
------------------------ ---------------- ----------------- ------------ -------------- --------------
$26.51 - $39.00 197,303 8.24 $36.69 87,024 $38.02
$39.25 - $39.25 316,221 6.53 $39.25 222,927 $39.25
$39.50 - $50.50 301,950 7.51 $44.47 135,520 $47.06
$53.37 - $55.74 9,000 8.30 $55.35 3,000 $55.35
---------------- --------------
824,474 7.32 $40.72 448,471 $41.48
================ ==============
During the year ended December 31, 2003, the Company issued 43,491 shares of the
Company's restricted common stock, which had a fair market value ranging from
$26.40 to $39.00 per share at the dates of grant, to certain employees, members
of management and outside counsel. Deferred stock-based compensation of $1,594
was recorded as a result of the issuance of these shares of restricted common
stock. During the year ended December 31, 2002, the Company issued 1,500 shares
of the Company's restricted common stock, which had a fair market value of $46
as of the date of grant, to certain members of management and outside counsel.
For the year ended December 31, 2001, the Company recorded deferred stock-based
compensation of $363 as a result of issuing 8,450 shares of the Company's
restricted common stock to members of the Company's Board of Directors and
certain members of management. These amounts were determined based on the fair
market value of such common shares at the date of grant and are being amortized
to operations over the vesting periods (which range from 2 - 5 years) using the
graded vesting method. Stock-based compensation expense related to these
restricted stock issuances was $291, $202, and $60 for the years ended December
31, 2003, 2002 and 2001, respectively.
12. STOCK REPURCHASE
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 December 31, 2003, approximately 1 million shares of common stock have
been repurchased through the programs. The Company has remaining authorization
from the Board of Directors to repurchase an additional 469 thousand outstanding
shares as of December 31, 2003.
13. SHAREHOLDER RIGHTS PLAN AND CHANGE IN CONTROL AGREEMENT
The Company has a Shareholder Rights Plan wherein shareholders of the Company
receive rights to purchase the Company's common stock, or an acquirer's common
stock, at a discount in certain events involving an acquisition of 20% or more
of the Company's common stock by any person or group in a transaction not
approved by the Company's Board of Directors. The rights expire in March 2008.
The Company has change in control agreements with approximately 20 employees,
which provide upon (i) a change in control of the Company and (ii) a
constructive termination of employment, the payment of a severance benefit
approximately equal to twice the employee's annual compensation.
14. BUSINESS SEGMENTS
The Company has three reportable business segments: Telecommunications
("Telecom"), Broadband and Wireless. The Telecom segment includes SureWest
Telephone, SureWest Directories and SureWest Long Distance, which provide
landline telecommunications services, directory advertising, DSL service, long
distance services and certain non-regulated services. SureWest Telephone, which
is the principal operating subsidiary of the Telecom segment, provides local and
toll telephone services, network access services and certain non-regulated
services. SureWest Directories publishes and distributes SureWest 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 SureWest
Telephone's service areas. SureWest Long Distance provides long distance
services.
The Broadband segment provides various services including: high-speed and
dial-up Internet, digital video, local, network access and toll telephone and
managed services in the greater Sacramento area, principally to customers
residing outside of SureWest Telephone's service area. The Company offers
high-speed Internet, digital video and local and long distance phone service as
a bundled package referred to as Triple Play. The Broadband segment includes the
Company's subsidiaries SureWest Broadband and SureWest Broadband/Residential
Services. SureWest Broadband is comprised, in part, of a division of SureWest
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, handset insurance, roaming
service and custom calling features. Non-contract wireless services are billed
in advance and recognized in subsequent periods when the services are provided.
Contract wireless services are billed in arrears.
Corporate Operations are allocated to the appropriate segment, except for: cash;
investments; certain property, plant, and equipment and miscellaneous other
assets which are 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. The Company evaluates
the performance of its segments based on income (loss) from operations.
These segments are strategic business units that offer different products and
services. The accounting policies of these segments are the same as those
described in Notes 1 and 2. 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 and 2001 business segment information has been
restated to conform to the Company's organizational structure in 2003):
14. BUSINESS SEGMENTS (CONTINUED)
Corporate Intercompany
2003 Telecom Broadband Wireless Operations Eliminations Consolidated
---------------------------------------------------------------------------------------------------------------------
Operating revenues from
external customers $ 138,924 $ 29,267 $ 27,146 $ - $ - $ 195,337
Intersegment revenues 23,576 1,683 744 - (26,003) -
Operating expenses 83,645 42,754 34,724 - (26,003) 135,120
Depreciation and amortization 31,257 4,508 16,705 - - 52,470
Income (loss) from operations 47,598 (16,312) (23,539) - - 7,747
Interest income 322 2 (18) - - 306
Interest expense, net of
capitalized interest (452) (1,890) (1,905) - - (4,247)
Corporate treasury loss 1,263 347 218 - - 1,828
Income tax expense (benefit) 19,327 (7,551) (10,754) - - 1,022
Net income (loss) $ 26,565 $ (10,983) $(14,937) $ - $ - $ 645
Total assets $ 569,574 $ 104,522 $ 80,217 $ 53,025 $ (372,129) $ 435,209
Capital expenditures $ 15,675 $ 47,626 $ 5,224 $ 7,580 $ - $ 76,105
Corporate Intercompany
2002 Telecom Broadband Wireless Operations Eliminations Consolidated
- ---------------------------------------------------------------------------------------------------------------------
Operating revenues from
external customers $ 149,679 $ 13,051 $ 23,225 $ - $ - $ 185,955
Intersegment revenues 16,826 1,189 507 - (18,522) -
Operating expenses 86,417 23,448 33,796 - (18,522) 125,139
Depreciation and amortization 28,249 1,972 14,905 - - 45,126
Income (loss) from operations 51,839 (11,180) (24,969) - - 15,690
Interest income 738 - 1 - - 739
Interest expense, net of
capitalized interest 366 85 1,425 - - 1,876
Income tax expense (benefit) 22,762 (4,585) (10,751) - - 7,426
Net income (loss) $ 33,634 $ (6,715) $ (15,670) $ - $ - $ 11,249
Total assets $ 524,913 $ 64,654 $132,483 $ 15,085 $(340,619) $ 396,516
Capital expenditures $ 16,460 $ 10,125 $ 10,650 $ 7,117 $ - $ 44,352
Corporate Intercompany
2001 Telecom Broadband Wireless Operations Eliminations Consolidated
- ---------------------------------------------------------------------------------------------------------------------
Operating revenues from
external customers $ 142,780 $ 4,649 $ 16,056 $ - $ - $ 163,485
Intersegment revenues 12,877 77 245 - (13,199) -
Operating expenses 82,518 8,178 33,384 - (13,199) 110,881
Depreciation and amortization 27,454 553 11,834 - - 39,841
Income (loss) from operations 45,685 (4,005) (28,917) - - 12,763
Interest income 4,803 - - - - 4,803
Interest expense, net of
capitalized interest (320) (126) 1,760 - 1,314
Income tax benefit (expense) 20,921 (1,597) (12,455) - - 6,869
Net income (loss) $ 30,724 $ (2,283) $ (18,124) $ - $ - $ 10,317
Total assets $ 486,581 $ 27,559 $ 123,453 $ 50,694 $ (276,680) $ 411,607
Capital expenditures $ 30,957 $ 9,754 $ 28,845 $ - $ - $ 69,556
15. OTHER RELATED PARTY TRANSACTIONS
An officer of the Company is also a member of the Board of Directors of a local
banking institution. As of December 31, 2000, the Company had a $15,000
certificate of deposit with a term greater than one year with such banking
institution. In the fourth quarter of 2001, the Company redeemed this
certificate of deposit for an amount equal to its historical carrying value,
including accrued interest. In addition, during the years ended December 31,
2003, 2002 and 2001, the Company provided $45, $17 and $18, respectively, in
telecommunications services to this banking institution.
A member of the Company's Board of Directors as of December 31, 2003 was also an
executive officer and director of a certain entity from which the Company
purchased approximately $545 in telecommunications equipment during 2001 (no
similar purchases were made during 2002 and 2003).
On May 31, 2002, the company repurchased 300 thousand shares of its common stock
from one of its employee benefit plans. The Company utilized two separate
independent third party entities for the purpose of providing fairness opinions
in connection with the transaction. The shares were repurchased at a price of
$50 per share and were retired upon purchase.
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
During the Company's financial statement closing process for the quarter ended
December 31, 2003, certain matters were identified related to prior interim
financial reporting periods that necessitated the recording of adjustments to
the Company's condensed consolidated financial information. Such adjustments
pertained principally to (i) property, plant and equipment and (ii) cash, and
management believes that weaknesses in the Company's internal controls caused
the errors that resulted in these adjustments. The Company does not believe any
of the aforementioned amounts are material, individually or in the aggregate, to
the respective prior interim periods based on both quantitative and qualitative
factors, including the trend of operating results, nor does it believe the
prospective correction of such amounts during the quarter ended December 31,
2003 is material to the Company's fourth quarter 2003 condensed consolidated
results of operations based on both quantitative and qualitative factors,
including the trend of operating results. (The prospective correction of the
aforementioned amounts relating to prior periods increased the Company's fourth
quarter 2003 condensed consolidated net loss by $3,157, or $0.22 per basic and
diluted share, and would have reduced the Company's (i) first, second and third
quarter 2003 condensed consolidated net income by $223, or $0.02 per basic and
diluted share, $119, or $0.01 per basic and diluted share, and $1,250, or $0.09
per basic and diluted share and (ii) first, second, third and fourth quarter
2002 condensed consolidated net income by $54, or $0.00 per basic and diluted
share, $61 or $0.00 per basic and diluted share, $86, or $0.01 per basic and
diluted share, and $595, or $0.04 per basic and diluted share, respectively, had
such errors been corrected in the periods in which they originated.)
The Company's fourth quarter 2002 condensed consolidated financial information
has been adjusted to eliminate certain intercompany balances that were not
previously eliminated. These adjustments pertained to certain of the Company's
fourth quarter 2002 intercompany revenue and operating expense balances
aggregating $1,021. However, such adjustments had no effect on the Company's
condensed consolidated income from operations or net income for the quarter
ended December 31, 2002.
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (CONTINUED)
2003 March 31 June 30 September 30 December 31
- -------------------------------------------------------------------------------------------------------------------
Operating revenues $ 47,429 $ 50,289 $ 48,902 $ 48,717
Income from operations 1,905 5,567 3,677 (3,402)
Net income $ 675 $ 2,713 $ 1,502 $ (4,245)
Basic earnings (loss) per share $ 0.05 $ 0.19 $ 0.10 $ (0.30)
Diluted earnings (loss) per share $ 0.05 $ 0.19 $ 0.10 $ (0.30)
2002 March 31 June 30 September 30 December 31
- -------------------------------------------------------------------------------------------------------------------
Operating revenues $ 43,451 $ 43,118 $ 51,600 $ 47,786
Income from operations 5,129 3,047 7,026 488
Net income $ 5,609 $ 1,703 $ 3,852 $ 85
Basic earnings per share $ 0.37 $ 0.12 $ 0.26 $ 0.01
Diluted earnings per share $ 0.37 $ 0.12 $ 0.26 $ 0.01
As a result of the Company's annual cost separation studies for monitoring
periods 2002-2001, the Company changed its estimate for a portion of its
interstate and intrastate shareable earnings obligations during the fourth
quarter of 2002. This change in accounting estimate increased the Company's
revenues by $1,115 and net income by $671 ($0.05 per share) for the quarter
ended December 31, 2002.
Effective November 1, 2002, the Company increased the estimated useful lives
primarily related to its wireless switching and voice mail equipment from five
to ten years. This change in accounting estimate decreased the Company's
depreciation expense by $206 and increased the Company's consolidated net income
by $124 ($0.01 per share) for the quarter ended December 31, 2002.
The Company adopted SEC Staff Accounting Bulletin 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, June 30, September 30 and December
31, 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
September 30, 2003 $ 96
December 31, 2003 $ 75
March 31, 2002 $ 298
June 30, 2002 $ 251
September 30, 2002 $ 212
December 31, 2002 $ 165
The net effect of these revenues in 2003 was to increase net income in the
three-month periods ended March 31, June 30, September 30 and December 31 by
$75, $68, $57 and $44, respectively.
The net effect of these revenues in 2002 was to increase net income in the
three-month periods ended March 31, June 30, September 30 and December 31 by
$178, $150, $127 and $100, respectively.
17. EVENT (UNAUDITED) SUBSEQUENT TO THE DATE OF THE REPORT OF INDEPENDENT
AUDITORS
On March 25, 2004, the Company and the bank executed an amendment to the
business loan agreement (Note 7), extending the expiration date until June 1,
2005 and revising certain covenants.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
Item 9A. 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 Rule 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 Annual Report
on Form 10-K. Based upon that evaluation, the chief executive officer and chief
financial officer have concluded that the Company's disclosure controls and
procedures are effective, except as discussed below, 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. Notwithstanding management's
conclusions, the effectiveness of a system of disclosure controls and procedures
is subject to certain inherent limitations, including cost limitations,
judgments used in decision making, assumptions regarding the likelihood of
future events, soundness of internal controls, and fraud. Due to the
limitations, there can be only be reasonable, not absolute assurance that any
system of disclosure controls and procedures will be successful in preventing
all errors or fraud, or in making all material information known in a timely
manner to the appropriate management.
In January 2004, The Audit Committee of the Board of Directors launched a formal
investigation, and retained independent legal counsel to conduct the
investigation with the assistance of forensic accountants. The investigation
resulted from a preliminary investigation by Company management, triggered by
the abrupt resignation of an employee in the Company's Corporate Finance Group,
indicating irregularities by the former employee in the Company's cash
management and investment functions, and violations of the Company's investment
policies. At the time of the commencement of the special investigation,
approximately $2 million of Company funds were outstanding without proper
documentation and remain outstanding.
The independent legal counsel, with the assistance of the forensic accountants,
undertook an extensive process to (i) investigate the facts and circumstances
giving rise to the misappropriation of Company funds, (ii) determine whether
there were any similar or related transactions, and any Company employees
involved in the previously-identified transactions other than those known to the
Company at the commencement of the investigation, (iii) determine the underlying
mechanics in the origination of the transactions and the circumstances under
which detection failed to occur, and (iv) evaluate internal controls relating to
the affected portion of the Company's business.
The Audit Committee of the Board of Directors has been advised by independent
legal counsel that:
o All of the unauthorized transactions occurred in 2003 and remained
undetected until December 2003;
o The unauthorized transactions were actively concealed by the Company's
former employee in the Company's books and records; and
o Independent legal counsel did not uncover any other similar
transactions nor any evidence that any other Company employees
intentionally participated in the unauthorized transactions.
The independent legal counsel further reported to the Audit Committee, (i) its
view that existing Company control procedures prior to the discovery of the
unauthorized transactions were either circumvented or ignored, and the control
procedures existing at the time of the unauthorized transactions were not
adequate, and (ii) the Company, subsequent to the discovery of the unauthorized
transactions, had developed and implemented a number of key internal controls.
In addition, the independent legal counsel provided additional control
recommendations to the Audit Committee for review and consideration.
In connection with the audit of the Company's consolidated financial statements
for the year ended December 31, 2003, Ernst & Young LLP, the Company's
independent auditors, advised the Company that it had concluded that material
weaknesses in the Company's internal control existed, including with respect to
certain of the issues identified as a result of the Audit Committee's special
investigation. The Company has performed substantial additional procedures
designed to ensure that the internal control deficiencies did not lead to
material misstatements in its consolidated financial statements, notwithstanding
the presence of the noted internal control weaknesses. The specific matters
identified by Ernst & Young LLP involving internal control and its operation
considered to be material weaknesses encompassed:
o Control of cash and investments, including with respect control of
cash disbursements, reconciliation procedures, segregation of duties
and investment policy compliance;
o Accounting personnel, policies and procedures; and
o Accounting for property, plant and equipment.
Both before and after December 31, 2003, the Company instituted additional
processes and procedures to improve internal control. Subsequent to the
discovery of the unauthorized wire transactions in 2003, the Company implemented
a number of internal controls with respect to banking activities, including:
o An improved process with respect to bank reconciliation policies,
including secondary reviews performed by Company personnel with
appropriate segregation of duties;
o Revised procedures for the initiation of modifications to the
Company's instructions to its bank relating to authorizations; and
o Weekly reviews of the Company's wire transfer activity by the Chief
Financial Officer or Controller.
The Company has also implemented new controls with respect to its investment
activities, including:
o Standardizing supporting documentation for investment activity and
approvals;
o Revisions to the journal entry process for investment transactions,
and related segregation of duty modifications;
o The preparation of investment schedules by properly segregated
personnel; and
o Monthly investment compliance testing.
The Audit Committee has made a number of additional recommendations to the
Company's Board of Directors for further review and consideration, which the
Company believes will be formally acted upon beginning early in the second
quarter of 2004, and thereafter. Such initiatives relate to:
o An assessment to be conducted with respect to the Company's Corporate
Finance Group, which encompasses the Company's accounting and finance
personnel, including specifically relating to the number of personnel,
and the collective mix and technical skills of such personnel, and the
addition of new personnel if necessary.
o An internal audit process, with tasks to be performed either by
Company personnel or a third party, with reporting duties to the
Chairman of the Company's Audit Committee.
o A more significant effort devoted to internal controls training for
all affected personnel, and an increased emphasis on the completion of
internal controls documentation, including as required by Section 404
of the Sarbanes-Oxley Act of 2002 (including the possible retention of
a third-party to assist in performing internal control reviews of all
of the Company's accounting systems, and to assist in expediting the
completion of the internal controls documentation).
o The preparation and implementation of a formal accounting policies and
procedures manual or electronic database to serve as a reference tool
for Company personnel and to establish uniformity and consistency
throughout the Company.
The Company has previously taken actions that it believes have improved internal
controls, including:
o The establishment of a Disclosure Committee comprised of Management
personnel and senior representatives of the Company's Corporate
Finance Group, which undertakes reviews prior to significant filings
with the Securities and Exchange Commission;
o The modification of written ethics and compliance materials provided
to Company employees, and the formal adoption of a Code of Ethics and
Business Conduct, and the related establishment of confidential
procedures which permit Company employees to communicate anonymously
in the event of suspected violations of laws or Company standards
(together with upcoming mandatory classes in 2004 for all Company
employees to review the Code of Ethics and Business Conduct); and
o The implementation in 2003 of new enterprise resource planning and
accounting software, which likely assisted in identifying certain of
the accounting deficiencies noted above relating to property, plant
and equipment. (The Company in 2004 also anticipates improving modules
in its new software and undertaking revised physical verification and
other procedures to improve its accounting for property, plant and
equipment).
The Company will continue to evaluate the effectiveness of its disclosure
controls and internal controls and procedures on an ongoing basis, and will take
further action as appropriate.
With the exception of the items noted above, there has been no change in the
Company's internal control over financial reporting during the period covered by
the report, that has materially affected or is reasonably likely to materially
affect the Company's internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant.
For information regarding the executive officers of the Company, see "Executive
Officers of the Registrant" at the end of Part I of this report. Other
information required by this item is incorporated herein by reference from the
proxy statement for the annual meeting of the Company's shareholders to be filed
pursuant to Regulation 14A within 120 days after the Company's fiscal year-end
of December 31, 2003.
Code of Ethics
The Company has adopted a Code of Ethics and Business Conduct applicable to all
employees and members of the Board of Directors. The Code of Ethics and Business
Conduct is available on the Company's website at
http://www.surewest.com/corporate/ir/corpgov/Code_of_Ethics_Business_
Conduct.php.
Shareholders may request a free copy of the Code of Ethics and Business Conduct
from:
SureWest Communications
P.O. Box 969
Roseville, California 95678
Attention: Investor Relations
Item 11. Executive Compensation.
Incorporated herein by reference from the proxy statement for the annual meeting
of the Company's shareholders to be filed pursuant to Regulation 14A within 120
days after the Company's fiscal year-end of December 31, 2003.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
Equity Compensation Plan Information
The Company maintains the 1999 Restricted Stock Bonus Plan (the "1999 Plan") and
the 2000 Equity Incentive Plan (the "2000 Plan"), pursuant to which it may grant
equity awards to eligible persons. The 1999 Plan and the 2000 Plan were approved
by the Company's shareholders.
The following table provides information about equity awards under the 1999 Plan
and the 2000 Plan.
Number of securities
remaining available for
future issuance under
Number of securities to Weighted-average equity compensation
be issued upon exercise exercise price of plans (excluding
of outstanding options, outstanding options securities reflected in
Plan category warrants and rights warrants and rights column (a)
------------- ------------------------ ------------------- -----------------------
(a) (b) (c)
Equity compensation plans
approved by security holders
824,474 $40.72 359,364
Equity compensation plans not
approved by security holders
- -
------- -------
Total 824,474 $40.72 359,364
======= =======
(1) The 1999 Plan permits only the issuance of Restricted Shares. As of
December 31, 2003, the Company had made Restricted Share grants in
respect of 77,759 shares of the Company's common stock, and 166,107
shares of the Company's common stock remain available under the 1999
Plan.
(2) The 2000 Plan, as originally approved by the Company's shareholders,
contemplated the issuance of up to 800,000 shares of the Company's
common stock. Thereafter, the Company's shareholders approved an
increase to 950,000 shares and the incorporation of an evergreen
provision pursuant to which the number of shares of the Company stock
which shall be made available under the 2000 Plan shall be 950,000
shares plus an annual increase to be added on January 1 of each year
beginning January 1, 2003 equal to the lesser of (i) 149,035 shares,
or (ii) 1% of the outstanding shares.
Additional information required by Item 12 is incorporated herein by reference
from the proxy statement for the annual meeting of the Company's shareholders to
be filed pursuant to Regulation 14A within 120 days after the Company's fiscal
year-end of December 31, 2003.
Item 13. Certain Relationships and Related Transactions.
Incorporated herein by reference from the proxy statement for the annual meeting
of the Company's shareholders to filed pursuant to Regulation 14A within 120
days after the Company's fiscal year-end of December 31, 2003.
Item 14. Principal Accountant Fees and Services
Incorporated herein by reference from the proxy statement for the annual meeting
of the Company's shareholders to be filed pursuant to Regulation 14A within 120
days after the Company's fiscal year-end of December 31, 2003.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) 1 and 2. Financial Statements Schedules
None
3. Exhibits
The exhibits listed on the accompanying Index to Exhibits
are filed as part of this annual report.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on November 4, 2003
relating to the announcement of third quarter 2003 financial
results.
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 15 (A) 3)
Method
Exhibit No. Description of Filing Page
3.1 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)
3.2 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)
3.3 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)
4.1 Shareholder Rights Plan (Filed as Exhibit 2.1 to Form 8-A Incorporated by -
Registration Statement under the Securities Act of 1934) reference
10.1 Credit Agreement of SureWest Telephone Company with Bank of Incorporated by -
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)
10.2 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)
10.3 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)
10.4 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, 2000 (Filed
as Exhibit 10(l) to Form 10-Q Quarterly Report of
Registrant for the Quarter ended June 30, 2002)
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 15 (A) 3)
Method
Exhibit No. Description of Filing Page
10.5 Amendment No. 5 to Business Loan Agreement dated Incorporated by -
February 26, 2003 (filed as Exhibit 10(e) to Form 10-K reference
Annual Report of Registrant for the year ended December
31, 2002)
10.6 Amendment No. 6 to Business Loan Agreement dated Filed herewith 102
As of January 13, 2004
10.7 Amendment No. 7 to Business Loan Agreement dated Filed herewith 104
As of March 25, 2004
10.8 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)
10.9 2000 Equity Incentive Plan, as amended Filed herewith 106
10.10 SureWest KSOP (filed as Exhibit 4.1 to Registration Incorporated by -
Statement on Form S-8 [No. 333-87222]) reference
10.11 Letter agreement dated January 16, 2001 between Registrant Incorporated by -
and Brian H. Strom (Filed as Exhibit 10 (g) to Form 10-K reference
Annual Report of Registrant for the year ended December 31,
2000)
10.12 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)
10.13 Letter agreement dated January 16, 2001 between Registrant Incorporated by -
and Jay B. Kinder (Filed as Exhibit 10 (i) to Form 10-K reference
Annual Report of Registrant for the year ended December 31,
2000)
10.14 Letter agreement dated January 16, 2001 Filed herewith 124
between Registrant and Bill M. DeMuth
10.15 Letter agreement dated January 16, 2001 Filed herewith 129
between Registrant and Fred A. Arcuri
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 15 (A) 3)
Method
Exhibit No. Description of Filing Page
21.1 List of Subsidiaries Filed herewith 134
23.1 Consent of Ernst & Young LLP, Independent Auditors Filed herewith 135
31.1 Certification of Brian H. Strom, President and Chief Filed herewith 136
Executive Officer, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of Michael D. Campbell, Executive Vice Filed herewith 137
President and Chief Financial Officer, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Brian H. Strom, President and Chief Filed herewith 138
Executive Officer, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
32.2 Certification of Michael D. Campbell, Executive Vice Filed herewith 139
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 Section 13 or 15(d) 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: March 29, 2004 By: /s/ Brian H. Strom
Brian H. Strom,
President and Chief
Executive Officer
Date: March 29, 2004 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, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ Kirk C. Doyle
Kirk C. Doyle,
Chairman of the Board
/s/ Brian H. Strom
Brian H. Strom,
President and Chief
Executive Officer; Director
/s/ Michael D. Campbell
Michael D. Campbell,
Executive Vice President
and Chief Financial Officer
/s/ Neil J. Doerhoff
Neil J. Doerhoff,
Director
/s/ Guy R. Gibson
Guy R. Gibson,
Director
/s/ Steven C. Oldham
Steven C. Oldham,
Director
/s/ John R. Roberts III
John R. Roberts III,
Director
/s/ Timothy D. Taron
Timothy D. Taron,
Director
Date: March 29, 2004
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
By:
----------------------------
Brian H. Strom,
President and Chief
Executive Officer
By:
----------------------------
Michael D. Campbell,
Executive Vice President
and Chief Financial Officer
Date: March 29, 2003
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Date: March 29, 2004
-----------------------------
Kirk C. Doyle,
Chairman of the Board
Date: March 29, 2004
-----------------------------
Brian H. Strom,
President and Chief
Executive Officer; Director
Date: March 29, 2004
-----------------------------
Michael D. Campbell,
Executive Vice President
and Chief Financial Officer
Date: March 29, 2004
-----------------------------
Neil J. Doerhoff,
Director
Date: March 29, 2004
-----------------------------
Guy R. Gibson,
Director
Date: March 29, 2004
-----------------------------
Steven C. Oldham,
Director
Date: March 29, 2004
-----------------------------
John R. Roberts III,
Director
Date: March 29, 2004
-----------------------------
Timothy D. Taron,
Director
Exhibit 10.6
AMENDMENT NO. 6 TO LOAN AGREEMENT
This Amendment No. 6 (the "Amendment") dated as of January 13, 2004 is
between Bank of America, N.A. (the "Bank") and SureWest Communications (the
"Borrower"), formerly known as Roseville Communications Company.
RECITALS
A. The Bank and the Borrower entered into a certain Business Loan Agreement
dated as of March 15, 2000 (together with any previous amendments, the
"Agreement'").
B. The Bank and the Borrower desire to amend the Agreement.
AGREEMENT
1. Definitions. Capitalized terms used but not defined in this Amendment
shall have the meaning given to them in the Agreement.
2. Amendments. The Agreement is hereby amended as follows:
(a) Paragraph number 1.7(a)(i) is hereby amended to read in its
entirety as follows:
(i) standby letters of credit with a maximum maturity not to extend
365 days beyond the Expiration Date. The standby letters of
credit may include a provision providing that the maturity date
will be automatically extended each year for an additional year
unless the Bank gives written notice to the contrary; provided,
however, that each letter of credit must include a final maturity
date which will not be subject to automatic extension.
3. Representations and Warranties. When the Borrower signs this Amendment,
the Borrower represents and warrants to the Bank that: (a) there is no event
which is, or with notice or lapse of time or both would be, a default under the
Agreement except those events, if any, that have been disclosed in writing to
the Bank or waived in writing by the Bank, (b) the representations and
warranties in the Agreement are true as of the date of this Amendment as if made
on the date of this Amendment, (c) this Amendment does not conflict with any
law, agreement, or obligation by which the Borrower is bound, and (d) this
Amendment is within the Borrower's powers, has been duly authorized, and does
not conflict with any of the Borrower's organizational papers.
4. Effect of Amendment. Except as provided in this Amendment, all of the
terms and conditions of the Agreement shall remain in full force and effect.
5. Counterparts. This Amendment may be executed in counterparts, each of
which when so executed shall be deemed an original, but all such counterparts
together shall constitute but one and the same instrument.
6. FINAL AGREEMENT. THIS WRITTEN AMENDMENT REPRESENTS THE FINAL AGREEMENT
BETWEEN AND AMONG THE PARTIES HERETO AND MAY NOT BE CONTRADICTED BY EVIDENCE OF
PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS BETWEEN OR AMONG THE
PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN OR AMONG THE PARTIES.
This Amendment is executed as of the date stated at the beginning
of this Amendment.
Borrower: Bank:
SureWest Communications Bank of America, N.A.
By_________________________ By________________________________
Michael D. Campbell, EVP-CFO Robert L. Munn, Jr.,
Senior Vice President
Exhibit 10.7
AMENDMENT NO. 7 TO LOAN AGREEMENT
This Amendment No. 7 (the "Amendment") dated as of March 25, 2004, is between
Bank of America, N.A. (the "Bank") and SureWest Communications (the "Borrower"),
formerly known as Roseville Communications Company.
RECITALS
A. The Bank and the Borrower entered into a certain Business Loan Agreement
dated as of March 15, 2000 (together with any previous amendments, the
"Agreement").
B. The Bank and the Borrower desire to amend the Agreement.
AGREEMENT
1. Definitions. Capitalized terms used but not defined in this Amendment
shall have the meaning given to them in the Agreement.
2. Amendments. The Agreement is hereby amended as follows:
2.1 In Paragraph 1.2, the date "June 1, 2005" is substituted for the date
"June 1, 2004."
2.2 Paragraph 7.5 is amended to read in its entirety as follows:
7.5 Interest Coverage Ratio. To maintain on a consolidated basis on
Interest Coverage Ratio of at least the ratios indicated for each period
specified below:
Periods Ratios
Fiscal quarters ending March 1.50 : 1.0
31, 2004, June 30, 2004, and
September 30, 2004
Fiscal quarter and fiscal year 2.0 : 1.0
ending December 31,2004,
and thereafter
"Interest Coverage Ratio" means the ratio of EBIT to interest expense.
"EBIT" means net income, less income or plus loss from discontinued
operations and extraordinary items, plus income taxes, plus interest
expense. This ratio will be calculated at the end of each reporting period
for which the Bank requires financial statements, using the results of the
twelve-month period ending with that reporting period. Further, in
calculating this ratio for the reporting periods ending March 31,2004, June
30, 2004, and September 30, 2004, the amount Two Million Dollars
($2,000,000) shall be added to EBIT.
3. Representations and Warranties. When the Borrower signs this Amendment,
the Borrower represents and warrants to the Bank that: (a) there is no event
which is, or with notice or lapse of time or both would be, a default under the
Agreement except those events, if any, that have been disclosed in writing to
the Bank or waived in writing by the Bank, (b) the. representations and
warranties in the Agreement are true as of the date of this Amendment as if made
on the date of this Amendment, (c) this Amendment does not conflict with any
law, agreement, or obligation by which the Borrower is bound, and (d) this
Amendment is within the
1
Borrower's powers, has been duly authorized, and does not conflict with any of
the Borrower's organizational papers.
4. Effect of Amendment. Except as provided in this Amendment, all of the
terms and conditions of the Agreement shall remain in full force and effect.
5. Counterparts. This Amendment may be executed in counterparts, each of
which when so executed shall be deemed an original, but all such counterparts
together shall constitute but one and the same instrument.
6. FINAL AGREEMENT. BY SIGNING THIS DOCUMENT EACH PARTY REPRESENTS AND
AGREES THAT: (A) THIS DOCUMENT REPRESENTS THE FINAL AGREEMENT BETWEEN PARTIES
WITH RESPECT TO THE SUBJECT MATTER HEREOF, (B) THIS DOCUMENT SUPERSEDES ANY
COMMITMENT LETTER, TERM SHEET OR OTHER WRITTEN OUTLINE OF TERMS AND CONDITIONS
RELATING TO THE SUBJECT MATTER HEREOF, UNLESS SUCH COMMITMENT LETTER, TERM SHEET
OR OTHER WRITTEN OUTLINE OF TERMS AND CONDITIONS EXPRESSLY PROVIDES TO THE
CONTRARY, (C) THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES, AND
(D) THIS DOCUMENT MAY NOT BE CONTRADICTED BY EVIDENCE OF ANY PRIOR,
CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OR UNDERSTANDINGS OF THE PARTIES.
This Amendment is executed as of the date stated at the beginning of this
Amendment.
Bank of America, N.A.
By /s/
-----------------------------------------
Robert L. Munn, Jr.
Senior Vice President
SureWest Communications
By /s/
-----------------------------------------
Michael D. Campbell
Executive Vice President, Chief FinanciaI
Officer and Treasurer
By /s/
-----------------------------------------
Brian H. Strom
President and Chief Executive Officer
Exhibit 10.9
SUREWEST COMMUNICATIONS
2000 EQUITY INCENTIVE PLAN
(As ADOPTED EFFECTIVE JANUARY 31, 2000)
(As AMENDED EFFECTIVE MAY 17, 2002)
TABLE OF CONTENTS
Page
ARTICLE 1. INTRODUCTION..........................................................................1
ARTICLE 2. DEFINITIONS...........................................................................1
ARTICLE 3. ADMINISTRATION........................................................................4
3.1 Committee Composition...........................................................................4
3.2 Committee Responsibilities......................................................................5
3.3 Committee for Non-Officer Grants................................................................5
ARTICLE 4. SHARES AVAILABLE FOR GRANTS...........................................................5
4.1 Basic Limitation................................................................................5
4.2 Annual Increase in Shares.......................................................................5
4.4 Dividend Equivalents............................................................................6
ARTICLE 5. ELIGIBILITY...........................................................................6
5.1 Incentive Stock Options.........................................................................6
5.2 Other Grants....................................................................................6
ARTICLE 6. OPTIONS...............................................................................6
6.1 Stock Option Agreement..........................................................................6
6.2 Number of Shares................................................................................7
6.3 Exercise Price..................................................................................7
6.4 Exercisability and Term.........................................................................7
6.5 Effect of Change in Control.....................................................................7
6.6 Modification or Assumption of Options...........................................................7
6.7 Buyout Provisions...............................................................................8
ARTICLE 7. PAYMENT FOR OPTION SHARES.............................................................8
7.1 General Rule....................................................................................8
7.2 Surrender of Stock..............................................................................8
7.3 Exercise/Sale...................................................................................8
7.4 Exercise/Pledge.................................................................................8
7.5 Promissory Note.................................................................................9
7.6 Other Forms of Payment..........................................................................9
ARTICLE 8. AUTOMATIC OPTION GRANTS TO
OUTSIDE DIRECTORS.....................................................................9
8.1 Annual Grants...................................................................................9
8.2 Accelerated Exercisability......................................................................9
8.3 Exercise Price..................................................................................9
8.4 Term............................................................................................9
ARTICLE 9. STOCK APPRECIATION RIGHTS............................................................10
9.1 SAR Agreement..................................................................................10
9.2 Number of Shares...............................................................................10
9.3 Exercise Price.................................................................................10
9.4 Exercisability and Term........................................................................10
9.5 Effect of Change in Control....................................................................10
9.6 Exercise of SARs...............................................................................10
9.7 Modification or Assumption of SARs.............................................................11
ARTICLE 10. RESTRICTED SHARES.....................................................................11
10.1 Restricted Stock Agreement.....................................................................11
10.2 Payment for Awards.............................................................................11
10.3 Vesting Conditions.............................................................................11
10.4 Voting and Dividend Rights.....................................................................11
ARTICLE 11. STOCK UNITS...........................................................................12
11.1 Stock Unit Agreement...........................................................................12
11.2 Payment for Awards.............................................................................12
11.3 Vesting Conditions.............................................................................12
11.4 Voting and Dividend Rights.....................................................................12
11.5 Form and Time of Settlement of Stock Units.....................................................12
11.6 Death of Recipient.............................................................................13
11.7 Creditors' Rights..............................................................................13
ARTICLE 12. PERFORMANCE SHARES....................................................................13
12.1 Performance Share Agreement....................................................................13
12.2 Grant of Performance Shares....................................................................13
12.3 Modification of Grant..........................................................................14
12.4 Terms of the Grant.............................................................................14
12.5 Payment of Performance Shares..................................................................14
ARTICLE 13. PROTECTION AGAINST DILUTION...........................................................15
13.1 Adjustments....................................................................................15
13.2 Dissolution or Liquidation.....................................................................16
13.3 Reorganizations................................................................................16
ARTICLE 14. DEFERRAL OF AWARDS....................................................................16
ARTICLE 15. AWARDS UNDER OTHER PLANS..............................................................17
ARTICLE 16. PAYMENT OF DIRECTOR'S FEES IN SECURITIES..............................................17
16.1 Effective Date.................................................................................17
16.2 Elections to Receive NSOs, Restricted Shares or Stock Units....................................18
16.3 Number and Terms of NSOs, Restricted Shares or Stock Units.....................................18
ARTICLE 17. LIMITATION ON RIGHTS..................................................................18
17.1 Retention Rights...............................................................................18
17.2 Shareholders' Rights...........................................................................18
17.3 Regulatory Requirements........................................................................18
ARTICLE 18. WITHHOLDING TAXES.....................................................................19
18.1 General........................................................................................19
18.2 Share Withholding..............................................................................19
ARTICLE 19. FUTURE OF THE PLAN....................................................................19
19.1 Term of the Plan...............................................................................19
19.2 Amendment or Termination.......................................................................19
ARTICLE 20. LIMITATION ON PARACHUTE PAYMENTS......................................................19
20.1 Scope of Limitation............................................................................19
20.2 Basic Rule.....................................................................................20
20.3 Reduction of Payments..........................................................................20
20.4 Overpayments and Underpayments.................................................................21
20.5 Related Corporations...........................................................................21
ARTICLE 21. EXECUTION...........................................................................................22
SUREWEST COMMUNICATIONS
2000 EQUITY INCENTIVE PLAN
ARTICLE 1. INTRODUCTION.
The Plan was adopted by the Board effective January 31, 2000 and amended by
the Board on December 13, 2001. The purpose of the Plan is to promote the
long-term success of the Company and creation of shareholder value by (a)
encouraging Employees, Outside Directors and Consultants to focus on critical
long-range objectives, (b) encouraging the attraction and retention of
Employees, Outside Directors and Consultants with exceptional qualifications and
(c) linking Employees, Outside Directors and Consultants directly to shareholder
interests through increased share ownership. The Plan seeks to achieve this
purpose by providing for Awards in the form of Restricted Shares, Stock Units,
Performance Shares, Options (which may constitute incentive stock options or
nonstatutory stock options) or stock appreciation rights.
The Plan shall be governed by, and construed in accordance with, the laws
of the State of California (except their choice-of-law provisions).
ARTICLE 2. DEFINITIONS.
2.1 "Affiliate" means any entity other than a Subsidiary, if the Company
and/or one or more Subsidiaries own not less than 50% of such entity.
2.2 "'Award" means any award of an Option, an SAR, a Restricted Share, a
Stock Unit or a Performance Share under the Plan.
2.3 "Board" means the Company's Board of Directors, as constituted from
time to time.
2.4 A "Change in Control" shall be deemed to have occurred if (A) any
"person" (as such term is used in Section 13(d) and 14(d) of the Exchange Act),
other than a trustee or other fiduciary holding securities under an employee
benefit plan of the Company, is or becomes the "beneficial owner" (as defined in
Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the
Company representing Twenty percent (20%) or more of the combined voting power
of the Company's then outstanding voting securities; (B) there is a merger or
consolidation of the Company in which the Company does not survive as an
independent public company; or (C) the business or businesses of the Company for
which a Participant's services are principally performed are disposed of by the
Company pursuant to a partial or complete liquidation of the Company, a sale of
assets (including stock of a Subsidiary) of the Company, or otherwise. A
transaction shall not constitute a Change in Control if its sole purpose is to
change the state of the Company's incorporation or to create a holding company
that will be owned in substantially the same proportions by the persons who held
the Company's securities immediately before such transaction.
2.5 "Code" means the Internal Revenue Code of 1986, as amended.
2.6 "Committee" means the Compensation Committee of the Board, as described
in Article 3.
2.7 "Company" means SureWest Communications, a California corporation.
2.8 "Consultant" means a consultant or adviser who provides bona fide
services to the Company, a Parent, a Subsidiary or an Affiliate as an
independent contractor. Service as a Consultant shall be considered employment
for all purposes of the Plan, except as provided in Section 5.1.
2.9 "Employee" means a common law employee of the Company, a Parent, a
Subsidiary or an Affiliate.
2.10 "Exchange Act" means the Securities Exchange Act of 1934, as amended.
2.11 "Exercise Price," in the case of an Option, means the amount for which
one Share may be purchased upon exercise of such Option, as specified in the
applicable Stock Option Agreement. "Exercise Price," in the case of an SAR,
means an amount, as specified in the applicable SAR Agreement, which is
subtracted from the Fair Market Value of one Share in determining the amount
payable upon exercise of such SAR.
2.12 "Fair Market Value" means the market price of Shares, determined by
the Committee in good faith on such basis as it deems appropriate. Fair Market
Value may mean (i) if the Company's common stock is listed on a securities
exchange or is traded over the NASDAQ National Market System, the closing sales
price of one Share on such exchange or other such system on an applicable date
or, in the absence of reported sales on such date, the closing sales price on
the immediately preceding date on which sales were reported, or (ii) if the
Company's common stock is not listed on a securities exchange or traded over the
NASDAQ National Market System, the mean between the bid and offered prices of
the Share as quoted by the National Association of Securities Dealer through
NASDAQ, provided, that if the Committee determines that the fair market value is
not properly reflected by such NASDAQ quotations, the Fair Market Value will
mean the fair market value as determined by such other method as the Committee
determines in good faith to be reasonable. Such determination shall be
conclusive and binding on all persons.
2.13 "ISO" means an incentive stock option described in Section 422(b) of
the Code.
2.14 "NSO" means a stock option not described in Sections 422 or 423 of the
Code.
2.15 "Option" means an ISO or NSO granted under the Plan and entitling the
holder to purchase Shares.
2.16 "Optionee" means an individual or estate who holds an Option or SAR.
2.17 "Outside Director" means a member of the Board who is not an Employee.
Service as an Outside Director shall be considered employment for all purposes
of the Plan, except as provided in Section 5.1.
2.18 "Parent" means any corporation (other than the Company) in an unbroken
chain of corporations ending with the Company, if each of the corporations other
than the Company owns stock possessing 50% or more of the total combined voting
power of all classes of stock in one of the other corporations in such chain. A
corporation that attains the status of a Parent on a date after the adoption of
the Plan shall be considered a Parent commencing as of such date.
2.19 "Participant" means an individual or estate who holds an Award.
2.20 "Performance Share" means an Award to a Participant under Article 12.
2.21 "Performance Share Agreement" means the agreement between the Company
and a Participant which contains the terms, conditions and restrictions
pertaining to such Performance Share.
2.22 "Plan" means this SureWest Communications 2000 Equity Incentive Plan,
as amended from time to time.
2.23 "Restricted Share" means a Share awarded under the Plan.
2.24 "Restricted Stock Agreement" means the agreement between the Company
and the recipient of a Restricted Share which contains the terms, conditions and
restrictions pertaining to such Restricted Share.
2.25 "SAR" means a stock appreciation right granted under the Plan.
2.26 "SAR Agreement" means the agreement between the Company and an
Optionee which contains the terms, conditions and restrictions pertaining to his
or her SAR.
2.27 "Share" means one share of the common stock of the Company.
2.28 "Stock Option Agreement" means the agreement between the Company and
an Optionee that contains the terms, conditions and restrictions pertaining to
his or her Option.
2.29 "Stock Unit" means a bookkeeping entry representing the equivalent of
one Share, as awarded under the Plan.
2.30 "Stock Unit Agreement" means the agreement between the Company and the
recipient of a Stock Unit which contains the terms, conditions and restrictions
pertaining to such Stock Unit.
2.31 "Subsidiary" means any corporation (other than the Company) in an
unbroken chain of corporations beginning with the Company, if each of the
corporations other than the last corporation in the unbroken chain owns stock
possessing 50% or more of the total combined voting power of all classes of
stock in one of the other corporations in such chain. A corporation that attains
the status of a Subsidiary on a date after the adoption of the Plan shall be
considered a Subsidiary commencing as of such date.
ARTICLE 3. ADMINISTRATION.
3.1 Committee Composition. The Plan shall be administered by the Committee.
The Committee shall consist exclusively of two or more directors of the Company,
who shall be appointed by the Board. In addition, the composition of the
Committee shall satisfy:
(a) Such requirements as the Securities and Exchange Commission may
establish for administrators acting under plans intended to quality for
exemption under Rule 16b-3 (or its successor) under the Exchange Act; and
(b) Such requirements as the Internal Revenue Service may establish
for Outside Directors acting under plans intended to qualify for exemption
under section 162(m)(4)(C) of the Code.
3.2 Committee Responsibilities. The Committee shall (a) select the
Employees, Outside Directors and Consultants who are to receive Awards under the
Plan, (b) determine the type, number, vesting requirements and other features
and conditions of such Awards, (c) interpret the Plan and (d) make all other
decisions relating to the operation of the Plan. The Committee may adopt such
rules or guidelines as it deems appropriate to implement the Plan. The
Committee's determinations under the Plan shall be final and binding on all
persons.
3.3 Committee for Non-Officer Grants. The Board may also appoint a
secondary committee of the Board, which shall be composed of two or more
directors of the Company who need not satisfy the requirements of Section 3.1.
Such secondary committee may administer the Plan with respect to Employees and
Consultants who are not considered officers or directors of the Company under
Section 16 of the Exchange Act, may grant Awards under the Plan to such
Employees and Consultants and may determine all features and conditions of such
Awards. Within the limitations of this Section 3.3, any reference in the Plan to
the Committee shall include such secondary committee.
ARTICLE 4. SHARES AVAILABLE FOR GRANTS.
4.1 Basic Limitation. Shares issued pursuant to the Plan shall be
authorized but unissued shares. The aggregate number of Options, SARs, Stock
Units, Restricted Shares and Performance Shares awarded under the Plan shall not
exceed Nine Hundred Fifty Thousand (950,000) Shares until December 31, 2002, and
commencing with the first business day of each calendar year thereafter
beginning with January 2, 2003, such maximum number of Shares shall be increased
by a number equal to one percent (1%) of the number of Shares outstanding as of
December 31 of the immediately preceding calendar year. The limitation of this
Section 4.1 shall be subject to adjustment pursuant to Article 13.
4.2 Forfeited Shares. If Restricted Shares, Performance Shares or Shares
issued upon the exercise of Options are forfeited, then such Shares shall again
become available for Awards under the Plan. If Stock Units, Options or SARs are
forfeited or terminate for any other reason before being exercised, then the
corresponding Shares shall again become available for Awards under the Plan. If
Stock Units are settled, then only the number of Shares (if any) actually issued
in settlement of such Stock Units shall reduce the number available under
Section 4.1 and the balance shall again become available for Awards under the
Plan. If SARs are exercised, then only the number of Shares (if any) actually
issued in settlement of such SARs shall reduce the number available under
Section 4.1 and the balance shall again become available for Awards under the
Plan. The foregoing notwithstanding, the aggregate number of Shares that may be
issued under the Plan upon the exercise of ISOs shall not be increased when
Restricted Shares, Performance Shares or other Shares are forfeited.
4.3 Dividend Equivalents. Any dividend equivalents paid or credited under
the Plan shall not be applied against the number of Restricted Shares,
Performance Shares, Stock Units, Options or SARs available for Awards, whether
or not such dividend equivalents are converted into Stock Units.
ARTICLE 5. ELIGIBILITY.
5.1 Incentive Stock Options. Only Employees who are common-law employees of
the Company, a Parent or a Subsidiary shall be eligible for the grant of ISOs.
In addition, an Employee who owns more than 10% of the total combined voting
power of all classes of outstanding stock of the Company or any of its Parents
or Subsidiaries shall not be eligible for the grant of an ISO unless the
requirements set forth in section 422(c)(6) of the Code are satisfied.
5.2 Other Grants. Only Employees, Outside Directors and Consultants shall
be eligible for the grant of Restricted Shares, Performance Shares, Stock Units,
NSOs or SARs.
ARTICLE 6. OPTIONS.
6.1 Stock Option Agreement. Each grant of an Option under the Plan shall be
evidenced by a Stock Option Agreement between the Optionee and the Company. Such
Option shall be subject to all applicable terms of the Plan and may be subject
to any other terms that are not inconsistent with the Plan. The Stock Option
Agreement shall specify whether the Option is an ISO or an NSO. The provisions
of the various Stock Option Agreements entered into under the Plan need not be
identical. Options may be granted in consideration of a reduction in the
Optionee's other compensation. A Stock Option Agreement may provide that a new
Option will be granted automatically to the Optionee when he or she exercises a
prior Option and pays the Exercise Price in the form described in Section 7.2.
6.2 Number of Shares. Each Stock Option Agreement shall specify the number
of Shares subject to the Option and shall provide for the adjustment of such
number in accordance with Article 13. Options granted to any Optionee in a
single fiscal year of the Company shall not cover more than 200,000 Shares,
except that Options granted to a new Employee in the fiscal year of the Company
in which his or her service as an Employee first commences shall not cover more
than 25,000 Shares. The limitations set forth in the preceding sentence shall be
subject to adjustment in accordance with Article 13.
6.3 Exercise Price. Each Stock Option Agreement shall specify the Exercise
Price; provided that the Exercise Price under an ISO shall in no event be less
than 100% of the Fair Market Value of a Share on the date of grant and the
Exercise Price under an NSO shall in no event be less than 85% of the Fair
Market Value of a Share on the date of grant. In the case of an NSO, a Stock
Option Agreement may specify an Exercise Price that varies in accordance with a
predetermined formula while the NSO is outstanding.
6.4 Exercisability and Term. Each Stock Option Agreement shall specify the
date or event when all or any installment of the Option is to become
exercisable. The Stock Option Agreement shall also specify the term of the
Option; provided that the term of an ISO shall in no event exceed 10 years from
the date of grant. A Stock Option Agreement may provide for accelerated
exercisability in the event of the Optionee's death, disability or retirement or
other events and may provide for expiration prior to the end of its term in the
event of the termination of the Optionee's service. Options may be awarded in
combination with SARs, and such an Award may provide that the Options will not
be exercisable unless the related SARs are forfeited.
6.5 Effect of Change in Control. The Committee may determine, at the time
of granting an Option or thereafter, that such Option shall become exercisable
as to all or part of the Shares subject to such Option in the event that a
Change in Control occurs with respect to the Company, subject to the limitations
that, in the case of an ISO, the acceleration of exercisability shall not occur
without the Optionee's written consent.
6.6 Modification or Assumption of Options. Within the limitations of the
Plan, the Committee may modify, extend or assume outstanding options or may
accept the cancellation of outstanding options (whether granted by the Company
or by another issuer) in return for the grant of new options for the same or a
different number of shares and at the same or a different exercise price. The
foregoing notwithstanding, no modification of an Option shall, without the
consent of the Optionee, alter or impair his or her rights or obligations under
such Option.
6.7 Buyout Provisions. The Committee may at any time (a) offer to buy out
for a payment in cash or cash equivalents an Option previously granted or (b)
authorize an Optionee to elect to cash out an Option previously granted, in
either case at such time and based upon such terms and conditions as the
Committee shall establish.
ARTICLE 7. PAYMENT FOR OPTION SHARES.
7.1 General Rule. The entire Exercise Price of Shares issued upon exercise
of Options shall be payable in cash or cash equivalents at the time when such
Shares are purchased, except as follows:
(a) In the case of an ISO granted under the Plan, payment shall be
made only pursuant to the express provisions of the applicable Stock Option
Agreement. The Stock Option Agreement may specify that payment may be made
in any form(s) described in this Article 7.
(b) In the case of an NSO, the Committee may at any time accept
payment in any form(s) described in this Article 7.
7.2 Surrender of Stock. To the extent that this Section 7.2 is applicable,
all or any part of the Exercise Price may be paid by surrendering, or attesting
to the ownership of, Shares that are already owned by the Optionee. Such Shares
shall be valued at their Fair Market Value on the date when the new Shares are
purchased under the Plan. The Optionee shall not surrender, or attest to the
ownership of, Shares in payment of the Exercise Price if such action would cause
the Company to recognize compensation expense (or additional compensation
expense) with respect to the Option for financial reporting purposes.
7.3 Exercise/Sale. To the extent that this Section 7.3 is applicable, all
or any part of the Exercise Price and any withholding taxes may be paid by
delivering (on a form prescribed by the Company) an irrevocable direction to a
securities broker approved by the Company to sell all or part of the Shares
being purchased under the Plan and to deliver all or part of the sales proceeds
to the Company.
7.4 Exercise/Pledge. To the extent that this Section 7.4 is applicable, all
or any part of the Exercise Price and any withholding taxes may be paid by
delivering (on a form prescribed by the Company) an irrevocable direction to
pledge all or part of the Shares being purchased under the Plan to a securities
broker or lender approved by the Company, as security for a loan, and to deliver
all or part of the loan proceeds to the Company.
7.5 Promissory Note. To the extent that this Section 7.5 is applicable, all
or any part of the Exercise Price and any withholding taxes may be paid by
delivering (on a form prescribed by the Company) a full-recourse promissory
note.
7.6 Other Forms of Payment. To the extent that this Section 7.6 is
applicable, all or any part of the Exercise Price and any withholding taxes may
be paid in any other form that is consistent with applicable laws, regulations
and rules.
ARTICLE 8. AUTOMATIC OPTION GRANTS TO OUTSIDE DIRECTORS.
8.1 Annual Grants. Upon the conclusion of each regular annual meeting of
the Company's stockholders held in the year 2000 or thereafter, each Outside
Director who will continue serving as a member of the Board thereafter shall
receive an NSO covering 1,250 Shares (subject to adjustment under Article 13).
NSOs granted under this Section 8.1 shall become exercisable in full on the
first anniversary of the date of grant.
8.2 Accelerated Exercisability. All NSOs granted to an Outside Director
under this Article 8 shall also become exercisable in full in the event of:
(a) The termination of such Outside Director's service because of
death, total and permanent disability or retirement at or after age 70 and
1/2 ; or
(b) A Change in Control with respect to the Company.
8.3 Exercise Price. The Exercise Price under all NSOs granted to an Outside
Director under this Article 8 shall be equal to 100% of the Fair Market Value of
a Share on the date of grant, payable in one of the forms described in Sections
7.1, 7.2, 7.3 and 7.4.
8.4 Term. All NSOs granted to an Outside Director under this Article 8
shall terminate on the earliest of (a) the 10th anniversary of the date of
grant, (b) the date three (3) months after the termination of such Outside
Director's service for any reason other than death or total and permanent
disability or (c) the date six (6) months after the termination of such Outside
Director's service because of death or total and permanent disability.
ARTICLE 9. STOCK APPRECIATION RIGHTS.
9.1 SAR Agreement. Each grant of an SAR under the Plan shall be evidenced
by an SAR Agreement between the Optionee and the Company. Such SAR shall be
subject to all applicable terms of the Plan and may be subject to any other
terms that are not inconsistent with the Plan. The provisions of the various SAR
Agreements entered into under the Plan need not be identical. SARs may be
granted in consideration of a reduction in the Optionee's other compensation.
9.2 Number of Shares. Each SAR Agreement shall specify the number of Shares
to which the SAR pertains and shall provide for the adjustment of such number in
accordance with Article 13. SARs granted to any Optionee in a single calendar
year shall in no event pertain to more than 200,000 Shares, except that SARs
granted to a new Employee in the fiscal year of the Company in which his or her
service as an Employee first commences shall not pertain to more than 25,000
Shares. The limitations set forth in the preceding sentence shall be subject to
adjustment in accordance with Article 13.
9.3 Exercise Price. Each SAR Agreement shall specify the Exercise Price. An
SAR Agreement may specify an Exercise Price that varies in accordance with a
predetermined formula while the SAR is outstanding.
9.4 Exercisability and Term. Each SAR Agreement shall specify the date when
all or any installment of the SAR is to become exercisable. The SAR Agreement
shall also specify the term of the SAR. An SAR Agreement may provide for
accelerated exercisability in the event of the Optionee's death, disability or
retirement or other events and may provide for expiration prior to the end of
its term in the event of the termination of the Optionee's service. SARs may be
awarded in combination with Options, and such an Award may provide that the SARs
will not be exercisable unless the related Options are forfeited. An SAR may be
included in an ISO only at the time of grant but may be included in an NSO at
the time of grant or thereafter. An SAR granted under the Plan may provide that
it will be exercisable only in the event of a Change in Control.
9.5 Effect of Change in Control. The Committee may determine, at the time
of granting an SAR or thereafter, that such SAR shall become fully exercisable
as to all Shares subject to such SAR in the event that a Change in Control
occurs with respect to the Company.
9.6 Exercise of SARs. Upon exercise of an SAR, the Optionee (or any person
having the right to exercise the SAR after his or her death) shall receive from
the Company (a) Shares, (b) cash or (c) a combination of Shares and cash, as the
Committee shall determine. The amount of cash and/or the Fair Market Value of
Shares received upon exercise of SARs shall, in the aggregate, be equal to the
amount by which the Fair Market Value (on the date of surrender) of the Shares
subject to the SARs exceeds the Exercise Price. If, on the date when an SAR
expires, the Exercise Price under such SAR is less than the Fair Market Value on
such date but any portion of such SAR has not been exercised or surrendered,
then such SAR shall automatically be deemed to be exercised as of such date with
respect to such portion.
9.7 Modification or Assumption of SARs. Within the limitations of the Plan,
the Committee may modify, extend or assume outstanding SARs or may accept the
cancellation of outstanding SARs (whether granted by the Company or by another
issuer) in return for the grant of new SARs for the same or a different number
of shares and at the same or a different exercise price. The foregoing
notwithstanding, no modification of an SAR shall, without the consent of the
Optionee, alter or impair his or her rights or obligations under such SAR.
ARTICLE 10. RESTRICTED SHARES.
10.1 Restricted Stock Agreement. Each grant of Restricted Shares under the
Plan shall be evidenced by a Restricted Stock Agreement between the recipient
and the Company. Such Restricted Shares shall be subject to all applicable terms
of the Plan and may be subject to any other terms that are not inconsistent with
the Plan. The provisions of the various Restricted Stock Agreements entered into
under the Plan need not be identical.
10.2 Payment for Awards. Restricted Shares may be sold or awarded under the
Plan for such consideration as the Committee may determine, including (without
limitation) cash, cash equivalents, full-recourse promissory notes, past
services and future services.
10.3 Vesting Conditions. Each Award of Restricted Shares may or may not be
subject to vesting. Vesting shall occur, in full or in installments, upon
satisfaction of the conditions specified in the Restricted Stock Agreement. A
Restricted Stock Agreement may provide for accelerated vesting in the event of
the Participant's death, disability or retirement or other events. The Committee
may determine, at the time of granting Restricted Shares or thereafter, that all
or part of such Restricted Shares shall become vested in the event that a Change
in Control occurs with respect to the Company.
10.4 Voting and Dividend Rights. The holders of Restricted Shares awarded
under the Plan shall have the same voting, dividend and other rights as the
Company's other shareholders. A Restricted Stock Agreement, however, may require
that the holders of Restricted Shares invest any cash dividends received in
additional Restricted Shares. Such additional Restricted Shares shall be subject
to the same conditions and restrictions as the Award with respect to which the
dividends were paid.
ARTICLE 11. STOCK UNITS.
11.1 Stock Unit Agreement. Each grant of Stock Units under the Plan shall
be evidenced by a Stock Unit Agreement between the recipient and the Company.
Such Stock Units shall be subject to all applicable terms of the Plan and may be
subject to any other terms that are not inconsistent with the Plan. The
provisions of the various Stock Unit Agreements entered into under the Plan need
not be identical. Stock Units may be granted in consideration of a reduction in
the recipient's other compensation.
11.2 Payment for Awards. To the extent that an Award is granted in the form
of Stock Units, no cash consideration shall be required of the Award recipients.
11.3 Vesting Conditions. Each Award of Stock Units may or may not be
subject to vesting. Vesting shall occur, in full or in installments, upon
satisfaction of the conditions specified in the Stock Unit Agreement. A Stock
Unit Agreement may provide for accelerated vesting in the event of the
Participant's death, disability or retirement or other events. The Committee may
determine, at the time of granting Stock Units or thereafter, that all or part
of such Stock Units shall become vested in the event that a Change in Control
occurs with respect to the Company.
11.4 Voting and Dividend Rights. The holders of Stock Units shall have no
voting rights. Prior to settlement or forfeiture, any Stock Unit awarded under
the Plan may, at the Committee's discretion, carry with it a right to dividend
equivalents. Such right entitles the holder to be credited with an amount equal
to all cash dividends paid on one Share while the Stock Unit is outstanding.
Dividend equivalents may be converted into additional Stock Units. Settlement of
dividend equivalents may be made in the form of cash, in the form of Shares, or
in a combination of both. Prior to distribution, any dividend equivalents which
are not paid shall be subject to the same conditions and restrictions as the
Stock Units to which they attach.
11.5 Form and Time of Settlement of Stock Units. Settlement of vested Stock
Units may be made in the form of (a) cash, (b) Shares or (c) any combination of
both, as determined by the Committee. The actual number of Stock Units eligible
for settlement may be larger or smaller than the number included in the original
Award, based on predetermined performance factors. Methods of converting Stock
Units into cash may include (without limitation) a method based on the average
Fair Market Value of Shares over a series of trading days. Vested Stock Units
may be settled in a lump sum or in installments. The distribution may occur or
commence when all vesting conditions applicable to the Stock Units have been
satisfied or have lapsed, or it may be deferred to any later date. The amount of
a deferred distribution may be increased by an interest factor or by dividend
equivalents. Until an Award of Stock Units is settled, the number of such Stock
Units shall be subject to adjustment pursuant to Article 13.
11.6 Death of Recipient. Any Stock Units Award that becomes payable after
the recipient's death shall be distributed to the recipient's beneficiary or
beneficiaries. Each recipient of a Stock Units Award under the Plan shall
designate one or more beneficiaries for this purpose by filing the prescribed
form with the Company. A beneficiary designation may be changed by filing the
prescribed form with the Company at any time before the Award recipient's death.
If no beneficiary was designated or if no designated beneficiary survives the
Award recipient, then any Stock Units Award that becomes payable after the
recipient's death shall be distributed to the recipient's estate.
11.7 Creditors' Rights. A holder of Stock Units shall have no rights other
than those of a general creditor of the Company. Stock Units represent an
unfunded and unsecured obligation of the Company, subject to the terms and
conditions of the applicable Stock Unit Agreement.
ARTICLE 12. PERFORMANCE SHARES
12.1 Performance Share Agreement. Each grant of Performance Shares under
the Plan shall be evidenced by a Performance Share Agreement between the
Participant and the Company. Such Performance Shares shall be subject to all
applicable terms of the Plan and may be subject to any other terms that are not
inconsistent with the Plan. The provisions of the various Performance Share
Agreements entered into under the Plan need not be identical.
12.2 Grant of Performance Shares. Before the grant of Performance Shares,
the Committee shall:
(a) determine objective performance goals, which may consist of any
one or more of the following goals deemed appropriate by the Committee:
earnings (either in the aggregate or on a per-share basis), operating
income, cash flow, including EBITDA (earnings before interest, taxes,
depreciation and amortization), return on equity, per share rate of return
on the Shares (including dividends), general indices relative to levels of
general customer service satisfaction, as measured through various
randomly-generated customer service surveys, market share (in one or more
markets), customer retention rates, market penetration rates, revenues,
reductions in expense levels, and the attainment by the Shares of a
specified market value for a specified period of time, in each case where
applicable to be determined either on a Company-wide basis or in respect of
any one or more business units, and the amount of compensation under the
goals applicable to such grant;
(b) designate a period for the measurement of the extent to which
performance goals are attained, which may begin prior to the date of grant
(the "Performance Period"); and
(c) assign a "Performance Percentage" to each level of attainment of
performance goals during the Performance Period, with the percentage
applicable to minimum attainment being zero percent and the percentage
applicable to maximum attainment to the determined by the Committee from
time to time, but not in excess of 250%.
12.3 Modification of Grant. If a Participant is promoted, demoted, or
transferred to a different business unit of the Company during a Performance
Period, then, to the extent the Committee determines any one or more of the
performance goals, Performance Period, or Performance Percentage are no longer
appropriate, the Committee may make any changes thereto as it deems appropriate
in order to make them appropriate.
12.4 Terms of the Grant. When granted, Performance Shares may, but need
not, be identified with Shares subject to a specific Option, specific Restricted
Shares, or specific SARs of the Participant granted under the Plan in a number
equal to or different from the number of the Performance Shares so granted. If
Performance Shares are so identified, then, unless otherwise provided in the
applicable Award, the Participant's associated Performance Shares shall
terminate upon (a) the expiration, termination, forfeiture, or cancellation of
the Option, Restricted Shares, or SARs with which the Performance Shares are
identified, (b) the exercise of such Option or SARs, or (c) the date Restricted
Shares become nonforfeitable.
12.5 Payment of Performance Shares. Unless otherwise provided in the
Performance Share Agreement, if the minimum performance goals applicable to such
Performance Shares have been achieved during the applicable Performance Period,
then the Company shall pay to the Participant that number of Shares equal to the
product of:
(a) the sum of (i) number of Performance Shares specified in the
applicable Award agreement and (ii) the number of Shares that would have
been issuable if such Performance Shares had been Shares outstanding
throughout the Performance Period and the stock dividends, cash dividends
(except as otherwise provided in the Performance Share Agreement) and other
property paid in respect of such shares had been reinvested in additional
Shares as of each dividend payment date,
multiplied by
(b) the Performance Percentage achieved during such Performance
Period.
The Committee may, in its discretion, determine that cash be paid in lieu of
some or all of such Shares. The amount of cash payable in lieu of a Share shall
be determined by valuing such shares at its Fair Market Value on the business
day next preceding the date such cash is to be paid. Payments pursuant to this
Section shall be made as soon as administratively practical after the end of the
applicable Performance Period. Any Performance Shares with respect to which the
performance goals shall not have been achieved by the end of the applicable
Performance period shall expire.
ARTICLE 13. PROTECTION AGAINST DILUTION.
13.1 Adjustments. In the event of a subdivision of the outstanding Shares,
a declaration of a dividend payable in Shares, a declaration of a dividend
payable in a form other than Shares in an amount that has a material effect on
the price of Shares, a combination or consolidation of the outstanding Shares
(by reclassification or otherwise) into a lesser number of Shares, a
recapitalization, a spin-off or a similar occurrence, the Committee shall make
such adjustments as it, in its sole discretion, deems appropriate in one or more
of:
(a) The number of Options, SARs, Restricted Shares, Performance Shares
and Stock Units available for future Awards under Article 4;
(b) The limitations set forth in Sections 6.2 and 9.2;
(c) The number of NSOs to be granted to Outside Directors under
Article 8;
(d) The number of Shares covered by each outstanding Option and SAR;
(e) The Exercise Price under each outstanding Option and SAR; or
(f) The number of Stock Units included in any prior Award which has
not yet been settled.
Except as provided in this Article 13, a Participant shall have no rights by
reason of any issue by the Company of stock of any class or securities
convertible into stock of any class, any subdivision or consolidation of shares
of stock of any class, the payment of any stock dividend or any other increase
or decrease in the number of shares of stock of any class.
13.2 Dissolution or Liquidation. To the extent not previously exercised or
settled, Options, SARs and Stock Units shall terminate immediately prior to the
dissolution or liquidation of the Company.
13.3 Reorganizations. In the event that the Company is a party to a merger
or other reorganization, outstanding Awards shall be subject to the agreement of
merger or reorganization Such agreement shall provide for:
(a) The continuation of the outstanding Awards by the Company, if the
Company is a surviving corporation;
(b) The assumption of the outstanding Awards by the surviving
corporation or its parent or subsidiary;
(c) The substitution by the surviving corporation or its parent or
subsidiary of its own awards for the outstanding Awards;
(d) Full exercisability or vesting and accelerated expiration of the
outstanding Awards; or
(e) Settlement of the full value of the outstanding Awards in cash or
cash equivalents followed by cancellation of such Awards.
ARTICLE 14. DEFERRAL OF AWARDS.
The Committee (in its sole discretion) may permit or require a Participant
to:
(a) Have cash that otherwise would be paid to such Participant as a
result of the exercise of an SAR or the settlement of Stock Units credited
to a deferred compensation account established for such Participant by the
Committee as an entry on the Company's books;
(b) Have Shares that otherwise would be delivered to such Participant
as a result of the exercise of an Option or SAR converted into an equal
number of Stock Units; or
(c) Have Shares that otherwise would be delivered to such Participant
as a result of the exercise of an Option or SAR or the settlement of Stock
Units converted into amounts credited to a deferred compensation account
established for such Participant by the Committee as an entry on the
Company's books. Such amounts shall be determined by reference to the Fair
Market Value of such Shares as of the date when they otherwise would have
been delivered to such Participant.
A deferred compensation account established under this Article 14 may be
credited with interest or other forms of investment return, as determined by the
Committee. A Participant for whom such an account is established shall have no
rights other than those of a general creditor of the Company. Such an account
shall represent an unfunded and unsecured obligation of the Company and shall be
subject to the terms and conditions of the applicable agreement between such
Participant and the Company. If the deferral or conversion of Awards is
permitted or required, the Committee (in its sole discretion) may establish
rules, procedures and forms pertaining to such Awards, including (without
limitation) the settlement of deferred compensation accounts established under
this Article 14.
ARTICLE 15. AWARDS UNDER OTHER PLANS.
The Company may grant awards under other plans or programs. Such awards may
be settled in the form of Shares issued under this Plan. Such Shares shall be
treated for all purposes under the Plan like Shares issued in settlement of
Stock Units and shall, when issued, reduce the number of Shares available under
Article 4.
ARTICLE 16. PAYMENT OF DIRECTOR'S FEES IN SECURITIES.
16.1 Effective Date. No provision of this Article 16 shall be effective
unless and until the Board has determined to implement such provision.
16.2 Elections to Receive NSOs, Restricted Shares or Stock Units. An
Outside Director may elect to receive his or her annual retainer payments and/or
meeting fees from the Company in the form of cash, NSOs, Restricted Shares or
Stock Units, or a combination thereof, as determined by the Board. Such NSOs,
Restricted Shares and Stock Units shall be issued under the Plan. An election
under this Article 16 shall be filed with the Company on the prescribed form.
16.3 Number and Terms of NSOs, Restricted Shares or Stock Units. The number
of NSOs, Restricted Shares or Stock Units to be granted to Outside Directors in
lieu of annual retainers and meeting fees that would otherwise be paid in cash
shall be calculated in a manner determined by the Board. The terms of such NSOs,
Restricted Shares or Stock Units shall also be determined by the Board.
ARTICLE 17. LIMITATION ON RIGHTS.
17.1 Retention Rights. Neither the Plan nor any Award granted under the
Plan shall be deemed to give any individual a right to remain an Employee,
Outside Director or Consultant. The Company and its Parents, Subsidiaries and
Affiliates reserve the right to terminate the service of any Employee, Outside
Director or Consultant at any time, with or without cause, subject to applicable
laws, the Company's articles of incorporation and bylaws and a written
employment agreement (if any).
17.2 Shareholders' Rights. A Participant shall have no dividend rights,
voting rights or other rights as a shareholder with respect to any Shares
covered by his or her Award prior to the time when a stock certificate for such
Shares is issued or, if applicable, the time when he or she becomes entitled to
receive such Shares by filing any required notice of exercise and paying any
required Exercise Price. No adjustment shall be made for cash dividends or other
rights for which the record date is prior to such time, except as expressly
provided in the Plan.
17.3 Regulatory Requirements. Any other provision of the Plan
notwithstanding, the obligation of the Company to issue Shares under the Plan
shall be subject to all applicable laws, rules and regulations and such approval
by any regulatory body as may be required. The Company reserves the right to
restrict, in whole or in part, the delivery of Shares pursuant to any Award
prior to the satisfaction of all legal requirements relating to the issuance of
such Shares, to their registration, qualification or listing or to an exemption
from registration, qualification or listing.
ARTICLE 18. WITHHOLDING TAXES.
18.1 General. To the extent required by applicable federal, state, local or
foreign law, a Participant or his or her successor shall make arrangements
satisfactory to the Company for the satisfaction of any withholding tax
obligations that arise in connection with the Plan. The Company shall not be
required to issue any Shares or make any cash payment under the Plan until such
obligations are satisfied.
18.2 Share Withholding. The Committee may permit a Participant to satisfy
all or part of his or her withholding or income tax obligations by having the
Company withhold all or a portion of any Shares that otherwise would be issued
to his or her or by surrendering all or a portion of any Shares that he or she
previously acquired. Such Shares shall be valued at their Fair Market Value on
the date when taxes otherwise would be withheld in cash.
ARTICLE 19. FUTURE OF THE PLAN.
19.1 Term of the Plan. The Plan, as set forth herein, shall become
effective on January 31, 2000. The Plan shall remain in effect until it is
terminated under Section 19.2, except that no ISOs shall be granted on or after
the 10th anniversary of the later of (a) the date when the Board adopted the
Plan or (b) the date when the Board adopted the most recent increase in the
number of Shares available under Article 4 which was approved by the Company's
shareholders.
19.2 Amendment or Termination. The Board may, at any time and for any
reason, amend or terminate the Plan. An amendment of the Plan shall be subject
to the approval of the Company's shareholders only to the extent required by
applicable laws, regulations or rules. No Awards shall be granted under the Plan
after the termination thereof. The termination of the Plan, or any amendment
thereof, shall not affect any Award previously granted under the Plan.
ARTICLE 20. LIMITATION ON PARACHUTE PAYMENTS.
20.1 Scope of Limitation. This Article 20 shall apply to an Award only if:
(a) The independent auditors most recently selected by the Board (the
"Auditors") determine that the after-tax value of such Award to the
Participant, taking into account the effect of all federal, state and local
income taxes, employment taxes and excise taxes applicable to the
Participant (including the excise tax under section 4999 of the Code), will
be greater after the application of this Article 20 than it was before the
application of this Article 20, or
(b) The Committee, at the time of making an Award under the Plan or at
any time thereafter, specifies in writing that such Award shall be subject
to this Article 20 (regardless of the after-tax value of such Award to the
Participant).
If this Article 20 applies to an Award, it shall supersede any contrary
provision of the Plan or of any Award granted under the Plan.
20.2 Basic Rule. In the event that the independent auditors most recently
selected by the Board (the "Auditors") determine that any payment or transfer by
the Company under the Plan to or for the benefit of a Participant (a "Payment")
would be nondeductible by the Company for federal income tax purposes because of
the provisions concerning "excess parachute payments" in Section 28OG of the
Code, then the aggregate present value of all Payments shall be reduced (but not
below zero) to the Reduced Amount. For purposes of this Article 20, the "Reduced
Amount" shall be the amount, expressed as a present value, which maximizes the
aggregate present value of the Payments without causing any Payment to be
nondeductible by the Company because of Section 28OG of the Code.
20.3 Reduction of Payments. If the Auditors determine that any Payment
would be nondeductible by the Company because of Section 28OG of the Code, then
the Company shall promptly give the Participant notice to that effect and a copy
of the detailed calculation thereof and of the Reduced Amount, and the
Participant may then elect, in his or her sole discretion, which and how much of
the Payments shall be eliminated or reduced (as long as after such election the
aggregate present value of the Payments equals the Reduced Amount) and shall
advise the Company in writing of his or her election within 10 days of receipt
of notice. If no such election is made by the Participant within such 10-day
period, then the Company may elect which and how much of the Payments shall be
eliminated or reduced (as long as after such election the aggregate present
value of the Payments equals the Reduced Amount) and shall notify the
Participant promptly of such election. For purposes of this Article 20, present
value shall be determined in accordance with Section 28OG(d)(4) of the Code. All
determinations made by the Auditors under this Article 20 shall be binding upon
the Company and the Participant and shall be made within 60 days of the date
when a Payment becomes payable or transferable. As promptly as practicable
following such determination and the elections hereunder, the Company shall pay
or transfer to or for the benefit of the Participant such amounts as are then
due to him or her under the Plan and shall promptly pay or transfer to or for
the benefit of the Participant in the future such amounts as become due to him
or her under the Plan.
20.4 Overpayments and Underpayments. As a result of uncertainty in the
application of Section 28OG of the Code at the time of an initial determination
by the Auditors hereunder, it is possible that Payments will have been made by
the Company that should not have been made (an "Overpayment") or that additional
Payments that will not have been made by the Company could have been made (an
"Underpayment"), consistent in each case with the calculation of the Reduced
Amount hereunder. In the event that the Auditors, based upon the assertion of a
deficiency by the Internal Revenue Service against the Company or the
Participant that the Auditors believe has a high probability of success,
determine that an Overpayment has been made, such Overpayment shall be treated
for all purposes as a loan to the Participant which he or she shall repay to the
Company, together with interest at the applicable federal rate provided in
Section 7872(f)(2) of the Code; provided, however, that no amount shall be
payable by the Participant to the Company if and to the extent that such payment
would not reduce the amount subject to taxation under Section 4999 of the Code.
In the event that the Auditors determine that an Underpayment has occurred, such
Underpayment shall promptly be paid or transferred by the Company to or for the
benefit of the Participant, together with interest at the applicable federal
rate provided in Section 7872(f)(2) of the Code.
20.5 Related Corporations. For purposes of this Article 20, the term
"Company" shall include affiliated corporations to the extent determined by the
Auditors in accordance with Section 28OG(d)(5) of the Code.
ARTICLE 21. EXECUTION.
To record the adoption of the Plan by the Board, the Company has caused its
duly authorized officer to execute this document in the name of the Company.
SUREWEST COMMUNICATIONS
By:
-----------------------------------------------
Title:
--------------------------------------------
Exhibit 10.14
Roseville Communications Company
P.O. Box 969
Roseville, California 95678
January 16, 2001
Bill M. DeMuth
Vice President, Chief Technology Officer
Roseville Communications Company
P.O. Box 969 Roseville, California 95678
Dear Bill:
Roseville Communications Company (the "Company") considers it essential to
the best interests of the Company and its shareholders to foster the continued
employment of key management personnel in a period of uncertainty regarding the
Company's future in light of the consolidation in the telecommunications
industry. In this connection, the Board of Directors of the Company (the
"Board") recognizes that the possibility of a change in control exists and that
such possibility, and the uncertainty and questions which it necessarily raises
among management, may result in the departure or distraction of management
personnel to the detriment of the Company and its shareholders when their
undivided attention and commitment to the best interests of the Company and its
shareholders are particularly important.
Accordingly, the Board has determined that appropriate steps should be
taken to reinforce and encourage the continued attention and dedication of
members of the Company's management, including you, to their assigned duties
without distraction in the face of potentially disturbing circumstances arising
from the possibility of a change in control of the Company.
In order to induce you to remain in the employ of the Company and in
consideration of your agreement set forth in Section 2 hereof, the Company
agrees that you shall receive the benefits set forth in this letter agreement
("Agreement") in the event of a "change in control of the Company" and a
"constructive termination" (each as defined in Section 2 hereof) under the
circumstances described below.
1. Term of Agreement. This Agreement shall commence on the date hereof and
shall continue in effect through December 31, 2001; provided, however, that
commencing on January 1, 2001 and each January 1 thereafter, the term of this
Agreement shall automatically be extended for one additional year unless, not
later than by November 30 of the preceding year, the Company shall have given
notice that it does not wish to extend this Agreement; provided, further, that
following a change in control of the Company (as hereinafter defined) the term
of this Agreement shall automatically extend to the date which is two (2) years
following such change in control.
2. Change in Control and Constructive Termination. No benefits shall be
payable hereunder unless there shall have been a change in control of the
Company and thereafter a constructive termination, as set forth below. For
purposes of this Agreement, a "change in control of the Company" shall be deemed
to have occurred if (A) any "person" (as such term is used in Section 13(d) and
14(d) of the Exchange Act), other than a trustee or other fiduciary holding
securities under an employee benefit plan of the Company, is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly
or indirectly, of securities of the Company representing Twenty percent (20%) or
more of the combined voting power of the Company's then outstanding voting
securities; (B) there is a merger or consolidation of the Company in which the
Company does not survive as an independent public company; or (C) the business
or businesses of the Company for which your services are principally performed
are disposed of by the Company pursuant to a partial or complete liquidation of
the Company, a sale of assets (including stock of a subsidiary) of the Company,
or otherwise. For purposes of this Agreement, "constructive termination" shall
mean a change in control of the company, as well as, and as a direct result
thereof, (i) a decrease in the total amount of your base salary below its level
in effect on the date hereof or as the same may be increased from time to time,
or a decrease in the bonus percentage to which you are entitled, without your
consent, provided, however, nothing herein shall be construed to guarantee your
bonus award if performance is below target, or (ii) a reduction in the
importance of your job responsibilities without your consent, with the
determination of whether a reduction in job responsibility has taken place to be
in your discretion or, (iii) your geographical relocation without your consent.
Absent written consent, after a change in control of the Company, no action or
inaction by you within ninety (90) days following the occurrence of the events
described in (i), (ii) or (iii) hereof shall be deemed consent to such events.
3. Compensation Following Change of Control and Constructive Termination.
Subject to the terms and conditions of this Agreement, following a change in
control of the Company and constructive termination, as defined in Section 2,
the Company shall pay you a lump sum payment, within ten (10) days after the
constructive termination, in the amount equal to the sum of:
(A) The sum of your then effective annual base salary through the
termination date and any accrued vacation pay, plus
(B) two times the sum of (I) your full annual base salary on the date
of the constructive termination, plus (II) the greater of your target bonus
or the most recent annual bonus paid to you.
In addition, the Company shall continue to provide to you and your family at the
Company's expense, for twenty-four (24) months following the change in control
and the constructive termination, the life insurance, medical, dental and other
benefits provided to you and your family immediately prior to the change in
control and constructive termination. The Company also shall pay to you all
legal fees and expenses incurred by you in seeking to obtain or enforce any
right or benefit provided by this Agreement. You shall not be required to
mitigate the amount of any payment provided for in this Section 3 by seeking
other employment or otherwise, nor shall the amount of any payment or benefit
provided for in this Section 3 be reduced by any compensation earned by you as
the result of employment by another employer or by retirement benefits after the
date of termination, or otherwise.
4. Certain Additional Payments by the Company.
(i) Anything in this Agreement to the contrary notwithstanding, in the
event it shall be determined that any payment or distribution by the Company to
or for your benefit (whether paid or payable or distributed or distributable
pursuant to the terms of this Agreement or otherwise, but determined without
regard to any additional payments required under this Section 4) (a "Payment")
would be subject to the excise tax imposed by Section 4999 of the Internal
Revenue Code of 1986, as amended (the "Code") or any corresponding provisions of
state or local tax laws, or any interest or penalties are incurred by you with
respect to such excise tax (such excise tax, together with any such interest and
penalties, are hereinafter collectively referred to as the "Excise Tax"), then
you shall be entitled to receive an additional payment (a "Gross-Up Payment") in
an amount such that after your payment of all taxes (including any interest or
penalties imposed with respect to such taxes), including, without limitation,
any income taxes (and any interest and penalties imposed with respect thereto)
and Excise Tax imposed upon the Gross-Up Payment, you retain an amount of the
Gross-Up Payment equal to the Excise Tax imposed upon the Payments.
(ii) Subject to the provisions of Section 4(iii), all determinations
required to be made under this Section 4, including whether and when a Gross-Up
Payment is required and the amount of such Gross-Up Payment and the assumptions
to be utilized in arriving at such determination, shall be made by Ernst & Young
LLP or such other certified public accounting firm as may be designated by you
(the "Accounting Firm"), which shall provide detailed supporting calculations
both to the Company and you within 15 business days of the receipt of notice
from you that there has been a Payment, or such earlier time as is requested by
the Company. In the event that the Accounting Firm is serving as accountant or
auditor for the individual, entity or group effecting the change of control, you
shall appoint another nationally recognized accounting firm to make the
determinations required hereunder (which accounting firm shall then be referred
to as the Accounting Firm hereunder). All fees and expenses of the Accounting
Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined
pursuant to this Section 4, shall be paid by the Company to you within five days
of the receipt of the Accounting Firm's determination. Any determination by the
Accounting Firm shall be binding upon the Company and you. As a result of the
uncertainty in the application of Section 4999 of the Code at the time of the
initial determination by the Accounting Firm hereunder, it is possible that
Gross-Up Payments which will not have been made by the Company should have been
made ("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that the Company exhausts its remedies pursuant to
Section 4(iii) and you thereafter are required to make a payment of any Excise
Tax, the Accounting Firm shall determine the amount of the Underpayment that has
occurred and any such Underpayment shall be promptly paid by the Company to or
for your benefit.
(iii) You shall notify the Company in writing of any claim by the Internal
Revenue Service that, if successful, would require the payment by the Company of
the Gross-Up Payment. Such notification shall be given as soon as practicable
but no later than ten business days after you are informed in writing of such
claim and shall apprise the Company of the nature of such claim and the date on
which such claim is requested to be paid. You shall not pay such claim prior to
the expiration of the 30-day period following the date on which you give such
notice to the Company (or such shorter period ending on the date that any
payment of taxes with respect to such claim is due). If the Company notifies you
in writing prior to the expiration of such period that it desires to contest
such claim, you shall:
(A) give the Company any information reasonably requested by the
Company relating to such claim,
(B) take such action in connection with contesting such claim as
the Company shall reasonably request in writing from time to time,
including, without limitation, accepting legal representation with
respect to such claim by an attorney reasonably selected by the
Company,
(C) cooperate with the Company in good faith in order effectively
to contest such claim, and
(D) permit the Company to participate in any proceedings relating
to such claim; provided, however, that the Company shall bear and pay
directly all costs and expenses (including additional interest and
penalties) incurred in connection with such contest and shall
indemnify and hold you harmless, on an after-tax basis, for any Excise
Tax or income tax (including interest and penalties with respect
thereto) imposed as a result of such representation and payment of
costs and expenses. Without limitation on the foregoing provisions of
this Section 4(iii), the Company shall control all proceedings taken
in connection with such contest and, at its sole option, may pursue or
forego any and all administrative appeals, proceedings, hearings and
conferences with the taxing authority in respect of such claim and
may, at its sole option, either direct you to pay the tax claimed and
sue for a refund or contest the claim in any permissible manner, and
you agree to prosecute such contest to a determination before any
administrative tribunal, in a court of initial jurisdiction and in one
or more appellate courts, as the Company shall determine; provided,
however, that if the Company directs you to pay such claim and sue for
a refund, the Company shall advance the amount of such payment to you,
on an interest-free basis and shall indemnify and hold you harmless,
on an after-tax basis, from any Excise Tax or income tax (including
interest or penalties with respect thereto) imposed with respect to
such advance or with respect to any imputed income with respect to
such advance; and further provided that any extension of the statute
of limitations relating to payment of taxes for your taxable year with
respect to which such contested amount is claimed to be due is limited
solely to such contested amount. Furthermore, the Company's control of
the contest shall be limited to issues with respect to which a
Gross-Up Payment would be payable hereunder and you shall be entitled
to settle or contest, as the case may be, any other issue raised by
the Internal Revenue Service or any other taxing authority.
(iv) If, after your receipt of an amount advanced by the Company pursuant
to Section 4(iii), you become entitled to receive any refund with respect to
such claim, you shall (subject to the Company's complying with the requirements
of Section 4(iii)) promptly pay to the Company the amount of such refund
(together with any interest paid or credited thereon after taxes applicable
thereto). If, after your receipt of an amount advanced by the Company pursuant
to Section 4(iii), a determination is made that you shall not be entitled to any
refund with respect to such claim and the Company does not notify you in writing
of its intent to contest such denial of refund prior to the expiration of 30
days after such determination, then such advance shall be forgiven and shall not
be required to be repaid and the amount of such advance shall offset, to the
extent thereof, the amount of Gross-Up Payment required to be paid.
5. Successors; Binding Agreement.
(i) The Company will require any successor (whether direct or indirect, by
merger, consolidation or otherwise) to all or substantially all of the business
and/or assets of the Company to expressly agree to perform this Agreement.
Failure of the Company to obtain such assumption and agreement prior to the
effectiveness of any such succession shall be a breach of this Agreement and
shall entitle you to compensation from the Company in the same amount and on the
same terms as you would be entitled hereunder following a change in control of
the Company and constructive termination, except that for purposes of
implementing the foregoing, the date on which any such succession becomes
effective shall be deemed the date on which you become entitled to such
compensation from the Company. As used in this Agreement, "Company" shall mean
the Company as hereinbefore defined and any successor to its business and/or
assets as aforesaid which assumes and agrees to perform this Agreement by
operation of law, or otherwise.
(ii) This Agreement shall inure to the benefit of and be enforceable by
your executors, administrators, successors, heirs, distributees, devisees and
legatees. If you should die while any amount would still be payable to you
hereunder if you had continued to live, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of this Agreement to
your devisee, legatee or other designee or, if there is no such designee, to
your estate.
6. Notice. For purposes of this Agreement, notices and all other
communications provided for in this Agreement shall be in writing and shall be
deemed to have been duly given when delivered or mailed by United States
registered mail, return receipt requested, postage prepaid, addressed to the
respective addresses set forth on the first page of this Agreement, provided
that all notices to the Company shall be directed to the attention of the Board
with a copy to the Secretary of the Company, or to such other address as either
party may have furnished to the other in writing in accordance herewith, except
that notice of a change of address shall be effective only upon receipt.
7. Miscellaneous. No provision of this Agreement may be modified, waived or
discharged unless such waiver, modification or discharge is agreed to in writing
and signed by you and such officer as may be specifically designated by the
Board. No waiver by either party hereto at any time of any breach by the other
party hereto of, or compliance with, any condition or provision of this
Agreement to be performed by such other party shall be deemed a waiver of
similar or dissimilar provisions or conditions at the same or at any prior or
subsequent time. No agreements or representations, oral or otherwise, express or
implied, with respect to the subject matter hereof have been made by either
party which are not expressly set forth in this Agreement. The validity,
interpretation, construction and performance of this Agreement shall be governed
by the laws of the State of California.
8. Validity. The invalidity or unenforceability of any provision of this
Agreement shall not affect the validity or enforceability of any other provision
of this Agreement, which shall remain in full force and effect.
9. Counterparts. This Agreement may be executed in several counterparts,
each of which shall be deemed to be an original but all of which together will
constitute one and the same instrument.
10. Supercedes Prior Agreements. The Company and you agree that this
Agreement supercedes all prior agreements, whether written or oral, relating to
the subject matter of this Agreement including, without limitation, any prior
letter agreements relating to payments in the event of a change in control of
the Company, or any provisions of any letters of offer of employment with the
Company."
If this letter sets forth our agreement on the subject matter hereof,
kindly sign and return to the Company the enclosed copy of this letter which
will then constitute our agreement on this subject.
Sincerely yours,
ROSEVILLE COMMUNICATIONS COMPANY
By
------------------------------------------
Thomas E. Doyle
Chairman
AGREED TO this _____ day
of ________________, 2001.
- -------------------------------
Bill M. DeMuth
Exhibit 10.15
Roseville Communications Company
P.O. Box 969
Roseville, California 95678
January 16, 2001
Fred A. Arcuri
Vice President - Emerging Businesses
Roseville Telephone Company
P.O. Box 969 Roseville, California 95678
Dear Fred:
Roseville Communications Company (the "Company") considers it essential to
the best interests of the Company and its shareholders to foster the continued
employment of key management personnel in a period of uncertainty regarding the
Company's future in light of the consolidation in the telecommunications
industry. In this connection, the Board of Directors of the Company (the
"Board") recognizes that the possibility of a change in control exists and that
such possibility, and the uncertainty and questions which it necessarily raises
among management, may result in the departure or distraction of management
personnel to the detriment of the Company and its shareholders when their
undivided attention and commitment to the best interests of the Company and its
shareholders are particularly important.
Accordingly, the Board has determined that appropriate steps should be
taken to reinforce and encourage the continued attention and dedication of
members of the Company's management, including you, to their assigned duties
without distraction in the face of potentially disturbing circumstances arising
from the possibility of a change in control of the Company.
In order to induce you to remain in the employ of the Company and in
consideration of your agreement set forth in Section 2 hereof, the Company
agrees that you shall receive the benefits set forth in this letter agreement
("Agreement") in the event of a "change in control of the Company" and a
"constructive termination" (each as defined in Section 2 hereof) under the
circumstances described below.
1. Term of Agreement. This Agreement shall commence on the date hereof and
shall continue in effect through December 31, 2001; provided, however, that
commencing on January 1, 2001 and each January 1 thereafter, the term of this
Agreement shall automatically be extended for one additional year unless, not
later than by November 30 of the preceding year, the Company shall have given
notice that it does not wish to extend this Agreement; provided, further, that
following a change in control of the Company (as hereinafter defined) the term
of this Agreement shall automatically extend to the date which is two (2) years
following such change in control.
2. Change in Control and Constructive Termination. No benefits shall be
payable hereunder unless there shall have been a change in control of the
Company and thereafter a constructive termination, as set forth below. For
purposes of this Agreement, a "change in control of the Company" shall be deemed
to have occurred if (A) any "person" (as such term is used in Section 13(d) and
14(d) of the Exchange Act), other than a trustee or other fiduciary holding
securities under an employee benefit plan of the Company, is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly
or indirectly, of securities of the Company representing Twenty percent (20%) or
more of the combined voting power of the Company's then outstanding voting
securities; (B) there is a merger or consolidation of the Company in which the
Company does not survive as an independent public company; or (C) the business
or businesses of the Company for which your services are principally performed
are disposed of by the Company pursuant to a partial or complete liquidation of
the Company, a sale of assets (including stock of a subsidiary) of the Company,
or otherwise. For purposes of this Agreement, "constructive termination" shall
mean a change in control of the company, as well as, and as a direct result
thereof, (i) a decrease in the total amount of your base salary below its level
in effect on the date hereof or as the same may be increased from time to time,
or a decrease in the bonus percentage to which you are entitled, without your
consent, provided, however, nothing herein shall be construed to guarantee your
bonus award if performance is below target, or (ii) a reduction in the
importance of your job responsibilities without your consent, with the
determination of whether a reduction in job responsibility has taken place to be
in your discretion or, (iii) your geographical relocation without your consent.
Absent written consent, after a change in control of the Company, no action or
inaction by you within ninety (90) days following the occurrence of the events
described in (i), (ii) or (iii) hereof shall be deemed consent to such events.
3. Compensation Following Change of Control and Constructive Termination.
Subject to the terms and conditions of this Agreement, following a change in
control of the Company and constructive termination, as defined in Section 2,
the Company shall pay you a lump sum payment, within ten (10) days after the
constructive termination, in the amount equal to the sum of:
(A) The sum of your then effective annual base salary through the
termination date and any accrued vacation pay, plus
(B) two times the sum of (I) your full annual base salary on the date
of the constructive termination, plus (II) the greater of your target bonus
or the most recent annual bonus paid to you.
In addition, the Company shall continue to provide to you and your family at the
Company's expense, for twenty-four (24) months following the change in control
and the constructive termination, the life insurance, medical, dental and other
benefits provided to you and your family immediately prior to the change in
control and constructive termination. The Company also shall pay to you all
legal fees and expenses incurred by you in seeking to obtain or enforce any
right or benefit provided by this Agreement. You shall not be required to
mitigate the amount of any payment provided for in this Section 3 by seeking
other employment or otherwise, nor shall the amount of any payment or benefit
provided for in this Section 3 be reduced by any compensation earned by you as
the result of employment by another employer or by retirement benefits after the
date of termination, or otherwise.
4. Certain Additional Payments by the Company.
(i) Anything in this Agreement to the contrary notwithstanding, in the
event it shall be determined that any payment or distribution by the Company to
or for your benefit (whether paid or payable or distributed or distributable
pursuant to the terms of this Agreement or otherwise, but determined without
regard to any additional payments required under this Section 4) (a "Payment")
would be subject to the excise tax imposed by Section 4999 of the Internal
Revenue Code of 1986, as amended (the "Code") or any corresponding provisions of
state or local tax laws, or any interest or penalties are incurred by you with
respect to such excise tax (such excise tax, together with any such interest and
penalties, are hereinafter collectively referred to as the "Excise Tax"), then
you shall be entitled to receive an additional payment (a "Gross-Up Payment") in
an amount such that after your payment of all taxes (including any interest or
penalties imposed with respect to such taxes), including, without limitation,
any income taxes (and any interest and penalties imposed with respect thereto)
and Excise Tax imposed upon the Gross-Up Payment, you retain an amount of the
Gross-Up Payment equal to the Excise Tax imposed upon the Payments.
(ii) Subject to the provisions of Section 4(iii), all determinations
required to be made under this Section 4, including whether and when a Gross-Up
Payment is required and the amount of such Gross-Up Payment and the assumptions
to be utilized in arriving at such determination, shall be made by Ernst & Young
LLP or such other certified public accounting firm as may be designated by you
(the "Accounting Firm"), which shall provide detailed supporting calculations
both to the Company and you within 15 business days of the receipt of notice
from you that there has been a Payment, or such earlier time as is requested by
the Company. In the event that the Accounting Firm is serving as accountant or
auditor for the individual, entity or group effecting the change of control, you
shall appoint another nationally recognized accounting firm to make the
determinations required hereunder (which accounting firm shall then be referred
to as the Accounting Firm hereunder). All fees and expenses of the Accounting
Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined
pursuant to this Section 4, shall be paid by the Company to you within five days
of the receipt of the Accounting Firm's determination. Any determination by the
Accounting Firm shall be binding upon the Company and you. As a result of the
uncertainty in the application of Section 4999 of the Code at the time of the
initial determination by the Accounting Firm hereunder, it is possible that
Gross-Up Payments which will not have been made by the Company should have been
made ("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that the Company exhausts its remedies pursuant to
Section 4(iii) and you thereafter are required to make a payment of any Excise
Tax, the Accounting Firm shall determine the amount of the Underpayment that has
occurred and any such Underpayment shall be promptly paid by the Company to or
for your benefit.
(iii) You shall notify the Company in writing of any claim by the Internal
Revenue Service that, if successful, would require the payment by the Company of
the Gross-Up Payment. Such notification shall be given as soon as practicable
but no later than ten business days after you are informed in writing of such
claim and shall apprise the Company of the nature of such claim and the date on
which such claim is requested to be paid. You shall not pay such claim prior to
the expiration of the 30-day period following the date on which you give such
notice to the Company (or such shorter period ending on the date that any
payment of taxes with respect to such claim is due). If the Company notifies you
in writing prior to the expiration of such period that it desires to contest
such claim, you shall:
(A) give the Company any information reasonably requested by the
Company relating to such claim,
(B) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time, including,
without limitation, accepting legal representation with respect to such
claim by an attorney reasonably selected by the Company,
(C) cooperate with the Company in good faith in order effectively to
contest such claim, and
(D) permit the Company to participate in any proceedings relating to
such claim; provided, however, that the Company shall bear and pay directly
all costs and expenses (including additional interest and penalties)
incurred in connection with such contest and shall indemnify and hold you
harmless, on an after-tax basis, for any Excise Tax or income tax
(including interest and penalties with respect thereto) imposed as a result
of such representation and payment of costs and expenses. Without
limitation on the foregoing provisions of this Section 4(iii), the Company
shall control all proceedings taken in connection with such contest and, at
its sole option, may pursue or forego any and all administrative appeals,
proceedings, hearings and conferences with the taxing authority in respect
of such claim and may, at its sole option, either direct you to pay the tax
claimed and sue for a refund or contest the claim in any permissible
manner, and you agree to prosecute such contest to a determination before
any administrative tribunal, in a court of initial jurisdiction and in one
or more appellate courts, as the Company shall determine; provided,
however, that if the Company directs you to pay such claim and sue for a
refund, the Company shall advance the amount of such payment to you, on an
interest-free basis and shall indemnify and hold you harmless, on an
after-tax basis, from any Excise Tax or income tax (including interest or
penalties with respect thereto) imposed with respect to such advance or
with respect to any imputed income with respect to such advance; and
further provided that any extension of the statute of limitations relating
to payment of taxes for your taxable year with respect to which such
contested amount is claimed to be due is limited solely to such contested
amount. Furthermore, the Company's control of the contest shall be limited
to issues with respect to which a Gross-Up Payment would be payable
hereunder and you shall be entitled to settle or contest, as the case may
be, any other issue raised by the Internal Revenue Service or any other
taxing authority.
(iv) If, after your receipt of an amount advanced by the Company pursuant
to Section 4(iii), you become entitled to receive any refund with respect to
such claim, you shall (subject to the Company's complying with the requirements
of Section 4(iii)) promptly pay to the Company the amount of such refund
(together with any interest paid or credited thereon after taxes applicable
thereto). If, after your receipt of an amount advanced by the Company pursuant
to Section 4(iii), a determination is made that you shall not be entitled to any
refund with respect to such claim and the Company does not notify you in writing
of its intent to contest such denial of refund prior to the expiration of 30
days after such determination, then such advance shall be forgiven and shall not
be required to be repaid and the amount of such advance shall offset, to the
extent thereof, the amount of Gross-Up Payment required to be paid.
5. Successors; Binding Agreement.
(i) The Company will require any successor (whether direct or indirect, by
merger, consolidation or otherwise) to all or substantially all of the business
and/or assets of the Company to expressly agree to perform this Agreement.
Failure of the Company to obtain such assumption and agreement prior to the
effectiveness of any such succession shall be a breach of this Agreement and
shall entitle you to compensation from the Company in the same amount and on the
same terms as you would be entitled hereunder following a change in control of
the Company and constructive termination, except that for purposes of
implementing the foregoing, the date on which any such succession becomes
effective shall be deemed the date on which you become entitled to such
compensation from the Company. As used in this Agreement, "Company" shall mean
the Company as hereinbefore defined and any successor to its business and/or
assets as aforesaid which assumes and agrees to perform this Agreement by
operation of law, or otherwise.
(ii) This Agreement shall inure to the benefit of and be enforceable by
your executors, administrators, successors, heirs, distributees, devisees and
legatees. If you should die while any amount would still be payable to you
hereunder if you had continued to live, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of this Agreement to
your devisee, legatee or other designee or, if there is no such designee, to
your estate.
6. Notice. For purposes of this Agreement, notices and all other
communications provided for in this Agreement shall be in writing and shall be
deemed to have been duly given when delivered or mailed by United States
registered mail, return receipt requested, postage prepaid, addressed to the
respective addresses set forth on the first page of this Agreement, provided
that all notices to the Company shall be directed to the attention of the Board
with a copy to the Secretary of the Company, or to such other address as either
party may have furnished to the other in writing in accordance herewith, except
that notice of a change of address shall be effective only upon receipt.
7. Miscellaneous. No provision of this Agreement may be modified, waived or
discharged unless such waiver, modification or discharge is agreed to in writing
and signed by you and such officer as may be specifically designated by the
Board. No waiver by either party hereto at any time of any breach by the other
party hereto of, or compliance with, any condition or provision of this
Agreement to be performed by such other party shall be deemed a waiver of
similar or dissimilar provisions or conditions at the same or at any prior or
subsequent time. No agreements or representations, oral or otherwise, express or
implied, with respect to the subject matter hereof have been made by either
party which are not expressly set forth in this Agreement. The validity,
interpretation, construction and performance of this Agreement shall be governed
by the laws of the State of California.
8. Validity. The invalidity or unenforceability of any provision of this
Agreement shall not affect the validity or enforceability of any other provision
of this Agreement, which shall remain in full force and effect.
9. Counterparts. This Agreement may be executed in several counterparts,
each of which shall be deemed to be an original but all of which together will
constitute one and the same instrument.
10. Supercedes Prior Agreements. The Company and you agree that this
Agreement supercedes all prior agreements, whether written or oral, relating to
the subject matter of this Agreement including, without limitation, any prior
letter agreements relating to payments in the event of a change in control of
the Company, or any provisions of any letters of offer of employment with the
Company."
If this letter sets forth our agreement on the subject matter hereof,
kindly sign and return to the Company the enclosed copy of this letter which
will then constitute our agreement on this subject.
Sincerely yours,
ROSEVILLE COMMUNICATIONS COMPANY
By
--------------------------------------
Thomas E. Doyle
Chairman
AGREED TO this _____ day
of ________________, 2001.
- -------------------------------
Fred A. Arcuri
Exhibit 21.1
List of Subsidiaries
SureWest Telephone
SureWest Broadband
SureWest Directories
SureWest Long Distance
SureWest Wireless
SureWest Internet
SureWest Custom Data Services
SureWest TeleVideo
SureWest TeleVideo of Roseville
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the (1) Registration Statement
(Form S-8 No. 333-42870) pertaining to the SureWest Communications 2000 Equity
Incentive Plan, (2) Registration Statement (Form S-8 No. 333-42868) pertaining
to the SureWest Communications 1999 Restricted Stock Bonus Plan and (3)
Registration Statement (Form S-8 No. 333-87222) pertaining to the SureWest KSOP
of our report dated March 19, 2004, with respect to the consolidated financial
statements of SureWest Communications included in the Annual Report (Form 10-K)
for the year ended December 31, 2003.
/s/ Ernst & Young LLP
Sacramento, California
March 25, 2004
Exhibit 31.1
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Brian H. Strom, President and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of SureWest
Communications;
2. Based on my knowledge, this annual 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 periods covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Rules 13a-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
annual 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 annual report based on such evaluation; and
c) Disclosed in this annual 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 the
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: March 29, 2004 By: /s/ Brian H. Strom
------------------
Brian H. Strom,
President and Chief
Executive Officer
Exhibit 31.2
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 annual report on Form 10-K of SureWest
Communications;
2. Based on my knowledge, this annual 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 periods covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Rules 13a-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
annual 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 annual report based on such evaluation; and
c) Disclosed in this annual 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 the
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: March 29, 2004 By: /s/ Michael D. Campbell
-----------------------
Michael D. Campbell,
Executive Vice President and
Chief Financial Officer
Exhibit 32.1
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 Annual Report of SureWest Communications (the "Company"),
on Form 10-K for the period ended December 31, 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: March 29, 2004 By: /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 32.2
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 Annual Report of SureWest Communications (the "Company"),
on Form 10-K for the period ended December 31, 2002 as filed with the Securities
and Exchange Commission of the date hereof (the "Report"), the undersigned, as
the 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: March 29, 2004 By: /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.