UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
[ ] 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
--------------
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
-
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of April 30, 2004, 14,575,167 shares of the registrant's Common Stock were
outstanding.
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................................................. 3
Item 2. Management's Discussion And Analysis of Financial Condition and Results of Operations............. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................ 30
Item 4. Controls And Procedures........................................................................... 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................................. 34
Item 6. Exhibits And Reports On Form 8-K.................................................................. 36
SIGNATURES .................................................................................................. 40
CERTIFICATIONS.................................................................................................. 41
SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Amounts in thousands, except per share amounts)
Quarter Ended March 31,
2004 2003
_________ _________
Operating revenues:
Local service $ 17,134 $ 14,996
Network access service 11,610 13,417
Directory advertising 4,101 3,838
Long distance service 1,217 1,253
Wireless service 7,420 6,503
Internet service 4,152 3,714
Residential broadband service 3,553 1,813
Business broadband service 1,270 750
Other 1,131 1,091
--------- ---------
Total operating revenues 51,588 47,375
Operating expenses:
Cost of services and products 18,611 15,984
Customer operations and selling 8,638 8,368
General and administrative 11,287 8,731
Depreciation and amortization 11,294 12,387
--------- ---------
Total operating expenses 49,830 45,470
--------- ---------
Income from operations 1,758 1,905
Other income (expense):
Interest income 59 83
Interest expense (1,085) (832)
Other, net (71) (27)
--------- ---------
Total other expense, net (1,097) (776)
--------- ---------
Income before income taxes 661 1,129
Income taxes 280 454
--------- ---------
Net income $ 381 $ 675
========= =========
Basic and diluted earnings per share (1) $ 0.03 $ 0.05
========= =========
Cash dividends per share (2) $ 0.25 $ 0.25
========= =========
Shares of common stock used to calculate earnings per share:
Basic 14,526 14,521
========= =========
Diluted 14,577 14,530
========= =========
(1) Shares used in the computation of basic earnings per share are based on the
weighted average number of common shares outstanding, excluding unvested
restricted common shares. Shares used in the computation of diluted
earnings per share are based on the weighted average number of common and
other potentially dilutive securities outstanding in each period.
(2) Cash dividends per share are based on the actual dividends per share, as
declared by the Company's Board of Directors.
See accompanying notes.
SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands)
March 31, December 31,
2004 2003
__________ ____________
ASSETS
Current assets:
Cash and cash equivalents $ 34,869 $ 39,008
Short-term investments 2,699 2,699
Accounts receivable, net 19,437 18,846
Deferred income tax asset 209 209
Inventories 5,804 5,537
Deferred directory costs 4,741 5,320
Prepaid expenses and other current assets 2,966 3,440
--------- -----------
Total current assets 70,725 75,059
Property, plant and equipment, net 347,335 342,967
Intangible and other assets:
Wireless spectrum licenses, net 13,566 13,566
Goodwill 2,171 2,171
Intangible asset relating to pension plans 125 125
Intangible asset relating to favorable operating leases, net 613 649
Deferred charges and other assets 658 672
--------- -----------
17,133 17,183
--------- -----------
$ 435,193 $ 435,209
========= ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 3,779 $ 3,779
Current portion of capital lease obligations 347 347
Accounts payable 2,913 2,206
Other accrued liabilities 15,847 14,727
Estimated shareable earnings obligations 12,712 13,389
Advance billings and deferred revenues 10,693 9,882
Accrued income taxes 1,142 1,908
Accrued compensation 6,013 4,860
--------- -----------
Total current liabilities 53,446 51,098
Long-term debt 92,834 92,870
Long-term capital lease obligations 179 265
Deferred income taxes 26,732 25,946
Other liabilities and deferred revenues 7,458 7,502
Commitments and contingencies
Shareholders' equity:
Common stock, without par value; 200,000 shares authorized,
14,580 and 14,578 shares issued and outstanding at
March 31, 2004 and December 31, 2003, respectively 160,968 160,911
Deferred stock-based compensation (1,197) (1,419)
Accumulated other comprehensive loss (261) (261)
Retained earnings 95,034 98,297
--------- -----------
Total shareholders' equity 254,544 257,528
--------- -----------
$ 435,193 $ 435,209
========= ===========
See accompanying notes.
SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(Unaudited)
(Amounts in thousands)
Three Months Ended
March 31,
2004 2003
_________ _________
Net cash provided by operating activities $ 15,636 $ 20,979
Cash flows from investing activities:
Capital expenditures for property, plant and equipment, including network
parts inventory (15,978) (11,943)
Purchases of held-to-maturity investments - (5,976)
Changes in deferred charges and other assets (31) (31)
--------- ---------
Net cash used in investing activities (16,009) (17,950)
Cash flows from financing activities:
Repayment of short-term borrowings - (15,000)
Proceeds from long-term debt - 60,000
Principal payments of long-term debt and capital lease obligations (122) (606)
Debt issuance costs - (367)
Dividends paid (3,644) (3,634)
--------- ---------
Net cash provided by (used in) financing activities (3,766) 40,393
--------- ---------
Increase (decrease) in cash and cash equivalents (4,139) 43,422
Cash and cash equivalents at beginning of period 39,008 20,385
--------- ---------
Cash and cash equivalents at end of period $ 34,869 $ 63,807
========= =========
See accompanying notes.
SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except share and per share amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The condensed consolidated financial statements of SureWest Communications (the
"Company") have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and pursuant to
the rules and regulations of the Securities and Exchange Commission (the "SEC").
In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) considered necessary for a fair presentation of the
results for the interim periods shown have been included. Certain information
and footnote disclosures normally included in annual financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted pursuant to such SEC rules and
regulations and accounting principles applicable for interim periods. Management
believes that the disclosures made are adequate to make the informatihon
presented not misleading. These condensed consolidated financial statements
should be read in conjunction with the consolidated financial statements and
notes thereto included in the Company's 2003 Annual Report on Form 10-K filed
with the SEC.
The Company is a holding company with wholly-owned subsidiaries that provide
integrated communications services 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.
Stock-based Compensation
The Company has two stock-based compensation plans. Effective January 1, 2003,
the Company adopted the fair value recognition provisions of Statement of
Financial Accounting Standards ("SFAS") 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. The
adoption of the fair value recognition provisions' of SFAS No. 123 did not have
a material effect on the Company's condensed consolidated financial statements
for the quarter ended March 31, 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 the quarters ended March 31, 2004 and 2003:
Quarter Ended March 31,
2004 2003
____ ____
Risk-free Interest Rate - 2.11%
Expected Dividend Yield - 2.50%
Expected Volatility - 41.22%
Expected Lives - 4.0 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
periods.
SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The expense related to stock-based employee compensation included in the
determination of net income 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 and earnings per share would be as follows:
Quarter Ended March 31,
2004 2003
---------------- ---------------
Net income, as reported $ 381 $ 675
Add: Stock-based employee compensation expense included
in reported net income, net of related tax effects 161 41
Deduct: Total stock-based employee compensation expense
determined using the fair value method for all
awards, net of related tax effects (465) (399)
---------------- ---------------
$ 77 $ 317
Pro forma net income ================ ===============
Earnings per share:
Basic--as reported $ 0.03 $ 0.05
Basic--pro forma $ 0.01 $ 0.02
Diluted--as reported $ 0.03 $ 0.05
Diluted--pro forma $ 0.01 $ 0.02
There were no options granted to employees during the quarter ended March 31,
2004. The weighted-average grant date fair value of options granted to employees
was $8.43 per share during the quarter ended March 31, 2003.
Other Comprehensive Income (Loss)
Significant components of the Company's comprehensive income (loss) are as
follows:
Quarter Ended March 31,
2004 2003
---------------- ---------------
Net income $ 381 $ 675
Minimum pension and post-retirement benefit liability
adjustment, net of income taxes - -
---------------- ---------------
Other comprehensive income $ 381 $ 675
================ ===============
As of March 31, 2004 and 2003, 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.
Cumulative Effect of Change in Accounting Principle
The Company adopted SEC Staff Accounting Bulletin ("SAB") No. 101, "Revenue
Recognition in Financial Statements," effective January 1, 2000, which requires
non-recurring revenues associated with service and activation charges to be
deferred. The cumulative effect of this change in accounting principle was
$3,273, net of tax, ($0.21 per share) in 2000. Activation revenue previously
deferred in connection with the cumulative effect adjustment as of January 1,
2000 recognized for the quarters ended March 31, 2004 and 2003 was $56 and $128,
respectively. The net effect of these revenues was to increase net income for
the quarters ended March 31, 2004 and 2003 by $32 (no effect on earnings per
share) and $75 ($0.01 per share), respectively.
SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Adjustments and Reclassifications
During the Company's financial statement closing process for the quarter ended
December 31, 2003, certain matters were identified related to prior financial
reporting periods that necessitated the recording of adjustments to the
Company's condensed 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 interim periods based on both quantitative and qualitative
factors, including the trend of operating results. Accordingly, the Company
prospectively corrected these errors during the fourth quarter of 2003. Certain
of the aforementioned amounts relating to prior periods would have reduced the
Company's first quarter 2003 condensed consolidated net income by $233, or $0.02
per basic and diluted share, had such errors been corrected in the period in
which they originated.
Certain amounts in the Company's 2003 condensed consolidated financial
statements have been reclassified to conform to the presentation of the
Company's 2004 condensed consolidated financial statements.
2. CORPORATE 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 of the Board of Directors, 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 was 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 2004, 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 been advised that one of the individuals has
entered a plea of guilty. 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.
3. CHANGE IN ESTIMATE
The Company recently revised its long-term network operating plan for its
Telecommunications ("Telecom") and Wireless segments as a result of the
successful adoption of certain new technologies that enable the Company to
maximize the return on existing network facilities and migrate to other new
technologies at the point in time in which the benefit to do so exceeds the cost
of conversion. As a result of this change in strategic direction, which was
formally approved by the Company's Board of Directors in December 2003, the
Company has examined the appropriateness of its estimated useful lives of
certain property, plant and equipment at both the Telecom and Wireless segments.
As a result, effective January 1, 2004, the Company increased the estimated
useful lives of Telecom's digital switching, circuit and cable equipment by one
to three years and Wireless' base stations, towers and network software by one
to eight years. The Company also decreased the estimated useful lives of certain
other Telecom assets, including certain other switching and voicemail equipment.
This change in estimate resulted in a decrease to consolidated depreciation
expense of $3,277 and an increase to consolidated net income of $1,887 ($0.13
per share) during the quarter ended March 31, 2004. This change in accounting
estimate resulted in a decrease of Telecom depreciation expense and an increase
in net income by approximately $1,969 and $1,134, respectively, for the quarter
ended March 31, 2004. In addition, Wireless depreciation expense and net loss
decreased by approximately $1,308 and $753, respectively, for the quarter ended
March 31, 2004.
SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
4. BUSINESS SEGMENTS
The Company has three reportable business segments: Telecom, Broadband and
Wireless. The Telecom segment includes SureWest Telephone, SureWest Directories
and SureWest Long Distance, 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 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
area. SureWest Long Distance a reseller of long distance services.
The Broadband segment provides various services, including high-speed and
dial-up Internet, digital video, local, 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 fiber-to-the-premise ("FTTP") (previously
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 voice services, sales of handsets and related
communication equipment, 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.
Corporate Operations are allocated to the appropriate segments, except for cash,
investments, certain property, plant, and equipment and miscellaneous other
assets. 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.
SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
These segments are strategic business units that offer different products and
services. The Company accounts for intersegment revenues and expenses at
prevailing market rates. The Company's business segment information is as
follows:
Corporate Intercompany
Telecom Broadband Wireless Operations Eliminations Consolidated
_________ __________ __________ ___________ _____________ ____________
As of and for the three months
ended March 31, 2004:
Operating revenues from external
customers $ 35,193 $ 8,975 $ 7,420 $ - $ - $ 51,588
Intersegment revenues 6,216 452 311 - (6,979) -
Operating expenses 22,817 13,934 8,764 - (6,979) 38,536
Depreciation and amortization 6,179 2,018 3,097 - - 11,294
Income (loss) from operations 12,413 (6,525) (4,130) - - 1,758
Net income (loss) 7,271 (4,191) (2,699) - - 381
Total assets $ 580,764 $ 122,048 $ 82,829 $ 85,060 $ (435,508) $ 435,193
As of and for the three months
ended March 31, 2003:
Operating revenues from external
customers $ 34,595 $ 6,277 $ 6,503 $ - $ - $ 47,375
Intersegment revenues 5,523 528 156 - (6,207) -
Operating expenses 21,475 10,101 7,714 - (6,207) 33,083
Depreciation and amortization 7,759 849 3,779 - - 12,387
Income (loss) from operations 10,884 (4,145) (4,834) - - 1,905
Net income (loss) 6,369 (2,594) (3,100) - - 675
Total assets $ 544,281 $ 57,303 $ 93,956 $ 66,157 $ (313,494) $ 448,203
5. 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.
During the quarter ended March 31, 2004, SureWest Telephone changed its
estimates for a portion of its interstate and intrastate shareable earnings
obligations as a result of periodic cost separation studies. For the monitoring
periods prior to 2004, these changes in accounting estimates increased the
Company's consolidated revenues by $539 and net income by $310 ($0.02 per
share).
SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
During the quarter ended March 31, 2003, SureWest Telephone changed its
estimates for a portion of its interstate and intrastate shareable earnings
obligations and certain NECA Carrier Common Line ("CCL") accounts receivable
balances as a result of periodic cost separation studies. For the monitoring
periods prior to 2003, these changes in accounting estimates decreased the
Company's consolidated revenues by $277 and net income by $166 ($0.01 per
share).
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 during the quarters ended March 31, 2004 or 2003. On June 26,
2003, the Company entered into a Final Settlement Agreement (the "Settlement
Agreement") to recover $1,950 of the amount paid to a telecommunications company
in 2001. Therefore, the Company recognized a receivable from this
telecommunications company in the amount of $1,950 as of June 30, 2003 through a
credit to network access service revenues for the three months ended June 30,
2003. The Company received the funds pursuant to the Settlement Agreement on
July 8, 2003. The Company is currently seeking a similar refund from another
telecommunications company. However, the recoverability of the remaining funds
cannot presently be determined because the bankruptcy proceeding relating to the
telecommunications company from which the Company is seeking a refund has not
been completed.
Beginning in January 2002, SureWest Telephone began paying a consumer dividend
for intrastate overearnings relating to the years 1998 and 1999. A portion of
the consumer's intrastate service charges was returned in the form of a
surcredit beginning in January 2002 and ending in January 2003, totaling
approximately $4,605 (of which $294 was returned during January 2003).
Beginning in November 2003, SureWest Telephone began paying a consumer dividend
for intrastate overearnings relating to the year 2002. A portion of the
consumer's intrastate service charges was returned to the consumers in the form
of a surcredit beginning in November 2003 and ending in February 2004, totaling
$483 (of which $208 was returned during the first quarter of 2004).
As of March 31, 2004, the Company's condensed consolidated balance sheet
reflected aggregate liabilities of $12,712 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.
6. PENSION AND OTHER POST-RETIREMENT BENEFITS
Components of Net Periodic Benefit Cost
Net periodic pension cost recognized in the condensed consolidated statements of
income for the quarters ended March 31, 2004 and 2003 under the defined benefit
pension plan ("Pension Plan"), Supplemental Executive Retirement Plan ("SERP")
and post-retirement benefits other than pensions ("Other Benefits") plan
included the following components:
Pension Plan & SERP Other Benefits
____________________________ __________________________
Quarter Ended March 31, 2004 2003 2004 2003
____________________________ __________________________
Service cost-benefits earned during
the period $ 1,340 $ 1,262 $ 109 $ 88
Interest cost on projected benefit
obligation 1,774 1,791 88 81
Expected return on plan assets (2,008) (1,588) (44) (27)
Amortization of prior service cost 86 277 10 7
Recognized net actuarial loss 120 70 - -
_____________ _____________ ______________ _______________
Net pension cost $ 1,312 $ 1,812 $ 163 $ 149
============= ============= ============== ===============
SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Employer Contributions
The Company expects to contribute $5,500 and $460 to the Pension Plan and Other
Benefits plan, respectively, in 2004. As of March 31, 2004, no contributions
have been made to the Pension Plan and Other Benefits plan.
7. COMMITMENTS AND CONTINGENCIES
The Company has entered into various cable television franchise agreements with
associated letters of credit totaling $150 in the aggregate as of March 31,
2004.
The Company is subject to certain legal and regulatory proceedings and
examinations, Internal Revenue Service examinations and other 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.
PART I
ITEM 2. 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 quarterly report on Form 10-Q,
including that which relates to the impact on future revenue sources and
potential sharing obligations of pending and future regulatory orders, continued
expansion of the telecommunications network and expected changes in the sources
of the Company's revenue and its cost structure resulting from 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.
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 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 area. SureWest Long Distance is a reseller of long
distance services.
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 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 fiber-to-the-premise ("FTTP")
(previously referred to as "Triple Play"). 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 services. SureWest Wireless derives its revenue from the
provision of wireless voice services, sales of handsets and related
communication equipment, 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 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.
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
were 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 March 31, 2004, the Company instituted additional
processes and procedures to improve internal control. Subsequent to the
discovery of the unauthorized wire transactions, the Company implemented a
number of internal controls with respect to banking and investment activities.
The Audit Committee made a number of additional recommendations to the Company's
Board of Directors for further review and consideration, which were formally
acted upon beginning early in the second quarter of 2004, and contemplate
additional actions in 2004. 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. The
assessment is to be conducted by the Chief Financial Officer and, if
deemed appropriate, with the assistance of a third party, in
continuing consultation with the Board;
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 anticipated retention
in May 2004 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 (the "SEC");
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 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).
On April 15, 2004, Michael D. Campbell, the Company's Executive Vice President
and Chief Financial Officer announced his immediate retirement. Brian H. Strom,
President and Chief Executive Officer of the Company, is serving as interim
Chief Financial Officer, while the Company undertakes the search for a new Chief
Financial Officer.
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. One of the
individuals has pleaded guilty. 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 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 it will provide additional information in response to future
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 quarters ended March 31, 2004 and 2003. Both the financial data and the
selected operating metrics demonstrate the increasing importance of the
Company's Broadband and Wireless segments.
Financial Data
Quarter Ended March 31,
2004 2003 $ Change % Change
------------ ------------ ------------ ------------
Operating revenues (1)
Telecom $ 35,193 $ 34,595 $ 598 2%
Broadband 8,975 6,277 2,698 43
Wireless 7,420 6,503 917 14
Total operating revenues 51,588 47,375 4,213 9
Operating income (loss)
Telecom 12,413 10,884 1,529 14
Broadband (6,525) (4,145) (2,380) 57
Wireless (4,130) (4,834) 704 (15)
Total operating income 1,758 1,905 (147) (8)
Net income (loss)
Telecom 7,271 6,369 902 14
Broadband (4,191) (2,594) (1,597) 62
Wireless (2,699) (3,100) 401 (13)
Total net income $ 381 $ 675 $ (294) (44)%
(1) External customers only
Selected Operating Metrics
Quarter Ended March 31,
2004 2003 Change % Change
------------ ------------ ------------ ------------
Telecom
ILEC access lines 135,571 136,959 (1,388) (1)%
Long distance lines 43,461 40,676 2,785 7
Broadband
DSL subscribers (1) 20,317 16,843 3,474 21
FTTP subscribers (2) 11,904 6,409 5,495 86
Revenue-generating units (3) 27,603 14,989 12,614 84
Wireless
Subscribers 47,279 42,925 4,354 10%
(1) DSL subscribers are customers who receive data services within SureWest
Telephone's service area.
(2) FTTP subscribers are customers who receive digital video, voice and/or data
services from SureWest Broadband/Residential Services.
(3) The Broadband segment can deliver multiple services to a customer.
Accordingly, the Company maintains statistical data regarding
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 $2,698 during the first quarter of 2004
compared to the same period in 2003. The Broadband segment experienced a 21%
increase in the aggregate number of DSL subscribers at March 31, 2004, as
compared to March 31, 2003. More significantly, this segment reported 11,904
FTTP subscribers and 27,603 Revenue-generating units, representing increases of
86% and 84%, respectively, at March 31, 2004 as compared to March 31, 2003,
within the SureWest Broadband/Residential Services business. 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 quarter-over-quarter
operating and net losses.
The Wireless segment reported an increase in operating revenues of $917 during
the first quarter of 2004 as compared to the same period in 2003. The number of
wireless subscribers increased to 47,279 at March 31, 2004, representing a 10%
increase from March 31, 2003. SureWest Wireless established its market share in
the Sacramento market in large part by promoting an unlimited flat rate regional
calling plan. Throughout 2003 and during the first quarter of 2004, SureWest
Wireless initiated a number of new service options for customers, including new
regional plans and a family plan, which have attracted new customers. During
2004, Wireless also plans to launch new vertical services, such as wireless data
capabilities. Evolution of the marketplace has prompted 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, while seeking to reduce
customer churn and increasing the revenue it derives from each customer.
Operating revenues from external customers in the Telecom segment increased $598
for the quarter ended March 31, 2004 compared to the same period in 2003. While
the Company continues to experience growth from the Broadband and Wireless
segments, the Telecom segment continues to be subjected to the competitive and
regulatory challenges faced by incumbent local exchange carriers ("ILEC's") both
nationally and in California. As a result of competitive pressures, this segment
experienced decreases in local and network access revenues due to (i) a decrease
in access lines of approximately 1%, resulting from increased competition from
wireless services, (ii) decreases in zone and toll calls and (iii) decreases in
local switching access rates.
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 within the Broadband and Wireless segments. Customer operations and
selling expenses remained relatively flat due primarily to internal efficiencies
resulting from integrated customer support systems and productivity gains.
General and administrative expenses increased as a result of increases in (i)
professional fees and legal expense due to the Treasury investigation and an
increase in audit services, (ii) medical and liability insurance costs, (iii)
information management expense due to an increase in headcount and (iv)
maintenance and support expenses due to software implementation and overall
growth of the Company.
The Company's depreciation and amortization expense decreased $1,093 during the
first quarter of 2004 as compared to the same period in the 2003. This decrease
is due primarily to a change in accounting estimate during the first quarter of
2004, resulting from the adoption of new technology which increased the
estimated useful lives of Telecom's switching, circuit and cable equipment by
one to three years and Wireless' base stations, towers and network software by
one to eight years. The Company also decreased the estimated useful lives of
certain other Telecom assets, including certain other switching and voicemail
equipment. This change in estimate resulted in a decrease to consolidated
depreciation expense of $3,277 and an increase to consolidated net income of
$1,887 during the quarter ended March 31, 2004. For the remainder of 2004, the
Company expects this change in estimate to decrease Telecom's depreciation
expense and increase net income by $5,942 and $3,423, respectively, and decrease
Wireless' depreciation expense and net loss by $3,388 and $1,951, respectively.
This decrease was offset by an increase in depreciation expense resulting from
the continuing additions to property, plant and equipment and amortization of
internal-use software, primarily within the Broadband segment.
Adjustments and Reclassifications
During the Company's financial statement closing process for the quarter 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
interim periods based on both quantitative and qualitative factors, including
the trend of operating results. Accordingly, the Company prospectively corrected
these errors during the fourth quarter of 2003. Certain of the aforementioned
amounts relating to prior periods would have reduced the Company's first quarter
condensed consolidated net income by $233, or $0.02 per basic and diluted share,
had such errors been corrected in the period in which they originated.
Certain amounts in the Company's 2003 condensed consolidated financial
statements have been reclassified to conform to the presentation of the
Company's 2004 condensed consolidated financial statements.
Segment Results of Operations
Telecom
Quarter Ended March 31,
2004 2003 $Change %Change
__________ __________ __________ _______
Local service $ 17,134 $ 14,996 $ 2,138 14%
Network access service 11,610 13,417 (1,807) (13)
Directory advertising 4,101 3,838 263 7
Long distance service 1,217 1,253 (36) (3)
Other 1,131 1,091 40 4
Total operating revenues from external
customers 35,193 34,595 598 2
Intersegment revenues 6,216 5,523 693 13
Operating expenses 22,817 21,475 1,342 6
Depreciation and amortization 6,179 7,759 (1,580) (20)
Operating income 12,413 10,884 1,529 14
Net income $ 7,271 $ 6,369 $ 902 14%
Operating Revenues
Operating revenues from external customers in the Telecom segment increased $598
for the quarter ended March 31, 2004, compared to the same period in 2003. The
Telecom segment is encountering the competitive and regulatory challenges faced
by ILEC's both nationally and in California. As a result of competitive
pressures, the Telecom segment experienced decreases in local and network access
revenues due to (i) a decrease in access lines of approximately 1%, resulting
from increased competition from wireless services, (ii) decreases in zone and
toll calls and (iii) decreases in local switching access rates.
Revenues within the Telecom segment are also affected by the Company's shareable
earnings obligations. As a result of decreased revenues subject to regulation
and increased expenses, as described below, SureWest Telephone decreased its
provision for its estimated interstate and intrastate shareable earnings
obligations by $883 in 2004 as compared to the same period in 2003. In addition,
SureWest Telephone had changes in estimates for shareable earnings obligations
as a result of periodic cost separation studies. For the quarter ended March 31,
2004, changes in estimates pertaining to the Company's estimated interstate and
intrastate shareable earnings obligations increased the Telecom segments
consolidated revenues and net income by $539 and $310 ($0.02 per share),
respectively. For the quarter ended March 31, 2003, changes in estimates
pertaining to the Company's estimated interstate and intrastate shareable
earnings obligations and certain National Exchange Carrier Association ("NECA")
Carrier Common Line ("CCL") accounts receivable balances decreased the Telecom
segments' revenues and net income by $277 and $166 ($0.01 per share),
respectively.
The Company adopted SEC Staff Accounting Bulletin ("SAB") No. 101, "Revenue
Recognition in Financial Statements," effective January 1, 2000, which requires
non-recurring revenues associated with service and activation charges to be
deferred. The cumulative effect of this change in accounting principle was
$3,273, net of tax, ($0.21 per share) in 2000. Activation revenue previously
deferred in connection with the cumulative effect adjustment as of January 1,
2000 recognized for the quarters ended March 31, 2004 and 2003 was $56 and $128,
respectively. The net effect of these revenues was to increase net income for
the quarters ended March 31, 2004 and 2003 by $32 (no effect on earnings per
share) and $75 ($0.01 per share), respectively.
Directory advertising revenues increased $263 for the quarter ended March 31,
2004, compared to the same period in 2003 due to an increase in advertising
sales.
Operating Expenses
Operating expenses for the Telecom segment increased $1,342 for the quarter
ended March 31, 2004, compared to the same period in 2003. Customer operations
and selling expense decreased $147 for the quarter ended March 31, 2004,
compared to the same period in 2003 due primarily to an increase in the
allocation of resources provided to other affiliates. General and administrative
expenses increased $1,303 for the quarter ended March 31, 2004 compared to the
same period in 2003. This increase was due primarily to increases in (i)
professional fees and legal expense due to the Treasury investigation and an
increase in audit services, (ii) medical and liability insurance costs, (iii)
information management expense due to increase in headcount and (iv) maintenance
and support expenses due to software implementation and overall growth of the
Company.
Depreciation and amortization decreased $1,580 for the quarter ended March 31,
2004, compared to the same period in 2003. This decrease is due primarily to a
change in accounting estimate during the first quarter of 2004, resulting from
the adoption of new technology which increased the estimated useful lives of
Telecom's switching, circuit and cable equipment by one to three years and
decreased the estimated useful lives of certain other Telecom assets, including
certain switching and voicemail equipment. This change in accounting estimate
resulted in a decrease to depreciation expense of $1,969 for the quarter ended
March 31, 2004. This decrease was partially offset by the effects of continuing
additions of circuit equipment, 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. With respect to
post-petition obligations, WorldCom had proposed, pursuant to a provision of the
Bankruptcy Code, and the Bankruptcy Court has agreed, that utilities are
entitled to "adequate assurances" that WorldCom will satisfy its obligations for
post-petition services. In its original filings, WorldCom proposed its own set
of assurances to utilities, but such assurances did not include either deposits
or advance payments. Although the Bankruptcy Court did not require WorldCom to
provide any deposits or advance payments as adequate assurance of payment, it
did provide, with respect to any post-petition services provided after August
14, 2002, that all utilities will have a junior superiority administrative claim
senior to other administrative claims and junior only to the claims of
WorldCom's post-petition lenders. If WorldCom fails to pay for post-petition
services, a utility can either take appropriate action under any applicable
tariff or regulation, or seek, on an expedited basis, an order from the
Bankruptcy Court requiring immediate payment or other relief. Through March 31,
2004, 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, which include local and network
access services, constituted approximately 56% and 60% of the Company's total
operating revenues for the quarters ended March 31, 2004 and 2003, respectively.
Such revenues 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 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, the Company recognized liabilities relating to SureWest
Telephone's estimated interstate shareable earnings obligations of $86 for the
quarter ended March 31, 2003 through reductions of revenues (none for the
quarter ended March 31, 2004). 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 during the quarter ended March
31, 2004 or 2003. On June 26, 2003, SureWest Telephone entered into a Final
Settlement Agreement (the "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 because the bankruptcy proceeding relating to the telecommunications
company from which the Company is seeking a refund has not been completed.
Prior to January 1, 2002, SureWest Telephone billed SBC Communications ("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 March 31, 2004 and 2003 or results of
operations for the quarters 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 reductions 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 reductions of revenues of $70
and $867 relating to estimated intrastate shareable earnings obligation during
the quarters ended March 31, 2004 and 2003, respectively. The decrease in the
provision for its estimated intrastate shareable earnings obligation is
primarily due to decreased revenues subject to regulation and increased
expenses.
Beginning in January 2002, SureWest Telephone began paying a customer refund for
intrastate overearnings 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).
Beginning in November 2003, SureWest Telephone began paying a consumer refund
for intrastate overearnings relating to the year 2002. A portion of the
consumer's intrastate service charges was returned to the consumers in the form
of a surcredit beginning in November 2003 and ending in February 2004, totaling
$483 (of which $208 was returned during the first quarter of 2004).
During the quarter ended March 31, 2004, SureWest Telephone changed its
estimates for a portion of its interstate and intrastate shareable earnings
obligations as a result of periodic cost separation studies. For the monitoring
periods prior to 2004, these changes in accounting estimates increased the
Company's consolidated revenues by $539 and net income by $310 ($0.02 per
share).
During the quarter ended March 31, 2003, SureWest Telephone changed its
estimates for a portion of its interstate and intrastate shareable earnings
obligations and certain NECA CCL accounts receivable balances as a result of
periodic cost separation studies. For the monitoring periods prior to 2003,
these changes in accounting estimates decreased the Company's consolidated
revenues by $277 and net income by $166 ($0.01 per share).
As of March 31, 2004, the Company's consolidated balance sheet reflected
aggregate liabilities of $12,712 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.
Broadband
Quarter Ended March 31,
2004 2003 $Change %Change
________ ________ ________ ________
Internet service $ 4,152 $ 3,714 $ 438 12%
Residential Broadband service 3,553 1,813 1,740 96
Business Broadband service 1,270 750 520 69
Total operating revenues from
external customers 8,975 6,277 2,698 43
Intersegment revenues 452 528 (76) (14)
Operating expenses 13,934 10,101 3,833 38
Depreciation and amortization 2,018 849 1,169 138
Operating loss (6,525) (4,145) (2,380) 57
Net loss $ (4,191) $ (2,594) $ (1,597) 62%
Operating Revenues
Operating revenues from external customers in the Broadband segment increased
$2,698 for the quarter ended March 31, 2004, compared to the same period in
2003. The increase in Broadband revenues is due to the combined effects of (i) a
21% increase in residential and business DSL subscriber customer base, (ii) an
86% increase in the number of FTTP subscribers of SureWest Broadband/Residential
Services and (iii) the continued expansion of the Business Broadband services,
including several new customers in the current year quarter who were not
customers in the prior year quarter. These increases were offset by a decrease
to monthly access fees for Internet services as a result of competition and an
increase in contract customers.
Operating Expenses
Total operating expenses for the Broadband segment increased $3,833 for the
quarter ended March 31, 2004, compared to the same period in 2003. Cost of
services and products increased $2,306 during the quarter ended March 31, 2004,
compared to the same period in 2003 due primarily to (i) an increase in
programming and transport costs related to the 86% increase in FTTP subscriber
growth of SureWest Broadband/Residential Services, (ii) an increase in repairs
and maintenance expense resulting from an increase in outside plant-in-service
and (iii) an increase in personnel to support the outside plant and engineering
functions. These increases were partially offset by a decrease in the number of
modems expensed in the first quarter of 2004 due to a leasing program
implemented at the end of the first quarter of 2003.
Customer operations expense increased $468 for the quarter ended March 31, 2004,
as compared to the same period in 2003 primarily due to increases in (i)
advertising costs due to an increase in marketable homes passed and expansion of
bundled services into Roseville, California and (ii) customer service expense
due to an increase in headcount to support the increased subscriber base.
General and administrative expense increased $1,059 for the quarter ended March
31, 2004 compared to the same period in 2003 due primarily to increases in (i)
professional fees and legal expense due to the Treasury investigation and an
increase in audit services and (ii) medical and liability insurance costs.
Depreciation and amortization expense increased $1,169 primarily due to an
increase in property, plant and equipment additions at SureWest
Broadband/Residential Services.
Wireless
Quarter Ended March 31,
2004 2003 $Change %Change
________ ________ ________ ________
Wireless revenues from
external customers $ 7,420 $ 6,503 $ 917 14%
Intersegment revenues 311 156 155 99
Operating expenses 8,764 7,714 1,050 14
Depreciation and
amortization 3,097 3,779 (682) (18)
Operating loss (4,130) (4,834) 704 (15)
Net loss $ (2,699) $ (3,100) $ 401 (13)%
Operating Revenues
Operating revenues from external customers in the Wireless segment increased
$917 for the quarter ended March 31, 2004, compared to the same period in 2003.
The increase in Wireless revenues was due primarily to (i) continued additions
to the customer base, with a 10% overall increase in wireless subscribers based
on subscriber counts at March 31, 2004 compared to March 31, 2003, (ii) an
increase in roaming revenues and (iii) the introduction of bundled features,
including voicemail and text messaging.
Operating Expenses
Total operating expenses for the Wireless segment increased $1,050 for the
quarter ended March 31, 2004, compared to the same period in 2003. Cost of
services and products increased $801 during the quarter ended March 31, 2004,
compared to the same period in 2003. This increase was due primarily to (i) an
increase to phone subsidy and interconnect expense due to an increase in
subscriber base, (ii) an increase in maintenance expense, resulting from an
increase in plant-in-service and (iii) an increase in tower rent due to an
increase in cell sites. This increase was offset by a 7% decrease in the average
unit cost per handset. General and administrative expense increased $198 for the
quarter ended March 31, 2004 compared to the same period in 2003 due primarily
to (i) increases in professional fees and legal expense due to the Treasury
investigation and an increase in audit services and (ii) increases in medical
and liability insurance costs.
Depreciation and amortization decreased $682 for the quarter ended March 31,
2004, compared to the same period in 2003. This decrease is due primarily to a
change in accounting estimate during the first quarter of 2004, resulting from
the adoption of new technology which increased the estimated useful lives of
Wireless' base stations, towers and network software by one to eight years. This
change in accounting estimate resulted in a decrease to depreciation expense of
$1,308 for the quarter ended March 31, 2004. This decrease was offset by the
effects of continuing additions of property, plant and equipment and
amortization of internal-use software.
Local Number Portability
Effective November 24, 2003, the FCC has 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
Other Income and Expense, Net
Interest expense increased $253 during the quarter ended March 31, 2004,
compared to the same period in 2003 due to an increase in debt outstanding
related to the Company's issuance in March 2003 of its unsecured Series B Senior
Notes ("Series B Notes").
Income Taxes
Income taxes for the quarter ended March 31, 2004, decreased $174, compared to
the same period in 2003, due primarily to corresponding decreases in income
subject to tax. The effective federal and state income tax rates were
approximately 42.4% and 40.2% for the quarters ended March 31, 2004 and 2003,
respectively.
Liquidity and Capital Resources
As reflected in the Condensed Consolidated Statements of Cash Flows, net cash
provided by operating activities was $15,636 and $20,979 for the quarters ended
March 31, 2004 and 2003, respectively. The decrease in cash provided by
operating activities for the current year compared to the same period in the
prior year was due primarily to decreases in (i) liabilities related to the
Company's pension obligation, (ii) liabilities related to the Company's
estimated shareable earnings obligations and (iii) accrued liabilities. Net cash
provided by operating activities during the three-month period ended March 31,
2004 was greater than net income of $381 due to (i) non-cash charges consisting
principally of depreciation and amortization, (ii) decreases in accrued
liabilities and (iii) decreases in liabilities related to estimated shareable
earnings obligations. During the quarter ended March 31, 2004, the Company used
cash flows from operations and existing cash and cash equivalents to fund (i)
capital expenditures of $15,978 pertaining to ongoing plant construction
projects and (ii) dividends of $3,644.
The Company's most significant use of funds for the remainder of 2004 is
expected to be for (i) budgeted capital expenditures of approximately $61,984,
(ii) scheduled payments of long-term debt of $3,743, (iii) support of the
operations of SureWest Broadband/Residential Services up to an anticipated
$7,991 and (iv) support of the operations of SureWest Wireless up to an
anticipated $2,524. 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, which totaled $150 in aggregate, to continue its build-out in the
franchise areas.
In March 2003, the Company completed a note purchase agreement for the issuance
of its 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. In March 2004, the bank further amended the credit facility extending
the expiration date until June 1, 2005 and revising certain covenants. 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 March 31, 2004, nor since
the issuance of the Series B Notes.
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 March 31, 2004, approximately 1 million shares of common stock have been
repurchased through these programs. The Company has remaining authorization from
the Board of Directors to repurchase an additional 469 thousand outstanding
shares as of March 31, 2004.
The Company had cash, cash equivalents and short-term investments at March 31,
2004, of $37,568. The Company believes that its working capital position,
operating cash flows and borrowing capacity are more than sufficient to satisfy
its liquidity requirements for the remainder of 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.
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 March 31, 2004 and 2003, the entire amount of
retained earnings was unrestricted.
Critical Accounting Policies and Estimates
Below is a summary of the Company's critical accounting policies and estimates.
Management has discussed development and selection of critical accounting
policies and estimates with the Company's Audit Committee.
o 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 The Company recognizes revenue when (i) persuasive evidence of an
arrangement between the Company and the customer exists, (ii) delivery of
the product to the customer has occurred or service has been provided to
the customer, (iii) the price to the customer is fixed or determinable and
(iv) collectibility of the sales price is reasonably assured.
o The Company maintains allowances for doubtful accounts for estimated losses
resulting from the potential inability of its customers to make required
payments. If the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
o The Company states its inventories 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 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 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
March 31, 2004 or 2003 because it believes it is more likely than not that
such deferred tax asset will be realized. Should the Company determine that
it would not be able to realize all or part of its deferred tax asset in
the future, an adjustment to the deferred tax asset would be charged to
income in the period in which the determination was made.
o The Company has pension and post-retirement benefit costs and obligations.
The Company's pension and post-retirement benefit obligations are
actuarially determined based on estimates of discount rates, long-term
rates of return on plan assets and increases in future compensation levels.
Changes in these estimates and other factors could significantly impact the
Company's pension and post-retirement benefit costs and obligations.
o The Company is a party to a variety of litigation, regulatory proceedings
and other contingencies that arise in the ordinary course of business. The
Company is required to assess the likelihood of any adverse judgments or
outcomes to these matters, as well as potential ranges of probable losses
for certain of these matters. The determination of the liabilities
required, if any, for loss contingencies is made after careful analysis of
each individual issue. In the opinion of management, the ultimate outcome
of these matters will not materially affect the Company's consolidated
financial position and results of operations.
o The Company 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.
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.
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 Western Integrated Networks, LLC and certain affiliates 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 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's 2003 Annual Report on Form 10-K contains certain disclosures about
the Company's limited exposure to market risk for changes in interest rates.
There have been no material changes to the information provided which would
require additional disclosures as of the date of this filing.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Company management, including the chief executive officer and controller, 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 Quarterly Report on Form
10-Q. Based upon that evaluation, the chief executive officer and controller
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 March 31, 2004, 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 procedures,
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 made a number of additional recommendations to the Company's
Board of Directors for further review and consideration, which were formally
acted upon beginning early in the second quarter of 2004, and contemplate
additional actions in 2004. 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. The assessment is to be
conducted by the Chief Financial Officer and, if deemed appropriate,
with the assistance of a third party, in continuing consultation with
the Board.
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 anticipated retention
in May 2004 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 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).
On April 15, 2004, Michael D. Campbell, the Company's Executive Vice President
and Chief Financial Officer announced his immediate retirement. Brian H. Strom,
President and Chief Executive Officer of the Company, is serving as interim
Chief Financial Officer, while the Company undertakes the search for a new Chief
Financial Officer.
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 II
ITEM 1. LEGAL PROCEEDINGS
Except for the proceedings described below, the Company is not aware of any
material pending legal proceedings, other than ordinary routine litigation
incidental to its business, to which it is a party or to which any of its
property is subject.
In 1996, the California Public Utilities Commission ("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.
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.
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 the current reserve in 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 ORA recommends 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
2003. 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 Federal
Communications Commission ("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 jurisdictional separations process, the interstate universal service
fund, access charge reform and the regulation of local exchange carriers. 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) See Index to Exhibits.
b) Reports on Form 8-K:
The Company filed a report on Form 8-K on January 9, 2004 announcing
the Change of Independent Auditors for the SureWest KSOP from Ernst &
Young LLP to Moss Adams LLP.
The Company filed a report on Form 8-K on January 14, 2004 relating to
the disclosure of the investigation of certain irregularities by a
former employee in the cash management and investment function.
The Company filed a report on Form 8-K on January 29, 2004 announcing
the election of Steven Oldham to its Board Of Directors
The Company filed a report on Form 8-K on February 5, 2004 relating to
the multiple arrests by federal authorities, including a former
Company employee.
The Company filed a report on Form 8-K on February 6, 2004 announcing
the conference call regarding the multiple arrests announced on
February 5, 2004.
The Company filed a report on Form 8-K on February 9, 2004 relating to
the commencement of civil litigation relating to the Company's
previously reported missing treasury funds.
The Company filed a report on Form 8-K on February 26, 2004 relating
to the indictments against a former employee and other individuals,
and the ongoing investigation.
The Company filed a report on Form 8-K on March 15, 2004 announcing
that the Company has filed a notice with the Securities and Exchange
Commission to extend the period in which to file its 2003 Annual
Report on Form 10-K.
The Company filed a report on Form 8-K on March 24, 2004 relating to
its forthcoming earnings announcement and the resignation of a
director.
The Company filed a report on Form 8-K on March 29, 2004 relating to
the announcement of fourth quarter and full year 2003 financial
results.
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 6 (a))
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)
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 6 (a))
Method
Exhibit No. Description of Filing Page
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, 2002 (Filed
as Exhibit 10(l) to Form 10-Q Quarterly Report of
Registrant for the Quarter ended June 30, 2002)
10.5 Amendment No. 5 to Business Loan Agreement dated February Incorporated by -
26, 2003 (Filed as Exhibit 10(e) to Form 10-K Annual Report reference
of Registrant for the year ended December 31, 2002)
10.6 Amendment No. 6 to Business Loan Agreement dated as of Incorporated by -
January 13, 2004 (Filed as Exhibit 10.6 to Form 10-K Annual reference
Report of Registrant for year ended December 31, 2003)
10.7 Amendment No. 7 to Business Loan Agreement dated as of Incorporated by -
March 25, 2004 (Filed as Exhibit 10.7 to Form 10-K Annual reference
Report of Registrant for year ended December 31, 2003)
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 as Incorporated -
Exhibit 10.9 to Form 10-K Annual Report of Registrant for by reference
the year ended December 31, 2003)
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 Incorporated by -
between Registrant and Brian H. Strom (Filed as Exhibit 10 reference
(g) to Form 10-K Annual Report of Registrant for the year
ended December 31, 2000)
10.12 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)
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 6 (a))
Method
Exhibit No. Description of Filing Page
10.13 Letter agreement dated January 16, 2001 Incorporated by -
between Registrant and Jay B. Kinder (Filed as Exhibit 10 reference
(i) to Form 10-K Annual Report of Registrant for the year
ended December 31, 2000)
10.14 Letter agreement dated January 16, 2001 Incorporated by -
between Registrant and Bill M. DeMuth (Filed as Exhibit reference
10.14 to Form 10-K Annual Report of Registrant for the year
ended December 31, 2003)
10.15 Letter agreement dated January 16, 2001 Incorporated by -
between Registrant and Fred A. Arcuri (Filed as Exhibit reference
10.15 to Form 10-K Annual Report of Registrant for the year
ended December 31, 2003)
31.1 Certification of Brian H. Strom, President and Chief Filed herewith 41
Executive Officer, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of Dan T. Bessey, Controller, as adopted Filed herewith 42
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Brian H. Strom, President and Chief Filed herewith 43
Executive Officer, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
32.2 Certification of Dan T. Bessey, Controller, pursuant to 18 Filed herewith 44
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SUREWEST COMMUNICATIONS
(Registrant)
By: /s/ BRIAN H. STROM
-------------------------------
Brian H. Strom,
President and Chief
Executive Officer
(Duly Authorized Signatory
and Principal Financial Officer)
Date: May 7, 2004
EXHIBIT 31.1
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Brian Strom, President and Chief Executive Officer and Chief Financial
Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SureWest
Communications;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e)):
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 7, 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, Dan T. Bessey, Controller, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SureWest
Communications;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e)):
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 7, 2004
By: /s/ DAN T. BESSEY
--------------------
Dan T. Bessey,
Controller
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 Quarterly Report of SureWest Communications (the
"Company"), on Form 10-Q for the period ended March 31, 2004 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: May 7, 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 Quarterly Report of SureWest Communications (the
"Company"), on Form 10-Q for the period ended March 31, 2004 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), the
undersigned, as the Controller 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: May 7, 2004
By: /s/ DAN T. BESSEY
--------------------
Dan T. Bessey,
Controller
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.