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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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[X]
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2004 |
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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)
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California
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68-0365195 |
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(State or Other Jurisdiction of
Incorporation or Organization) |
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(I.R.S. Employer
Identification No.) |
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200 Vernon Street, Roseville, California |
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95678 |
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(Address of Principal Executive Offices)
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(Zip Code) |
Registrant’s telephone number, including area code
(916) 772-2000
Securities to be registered pursuant to Section 12(b) of
the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock – Without Par Value
(Title of class)
Indicate by check mark whether the registrant: (1) has
filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past
90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Exchange Act Rule 12b-2).
Yes X No
On June 30, 2004, which was the last business day of the
registrant’s most recently completed second fiscal quarter,
the registrant had 14,579,401 shares of Common Stock
outstanding and the market value of shares held by
non-affiliates was approximately $416,070,027 (based on
13,166,773 shares of Common Stock then held by
non-affiliates and a closing price that day of $31.60 per
share of Common Stock on the Nasdaq National Market). The market
value calculations exclude shares held on the stated date by
registrant’s employee benefit plans, directors and officers
on the assumption such shares may be shares owned by affiliates.
(Exclusion from these public market value calculations does not
imply affiliate status for any other purpose).
On March 4, 2005, the registrant had 14,590,701 shares
of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Incorporated by reference into Part II, Item 5 and
Part III hereof are portions of the registrant’s
definitive proxy statement to be filed pursuant to
Regulation 14A within 120 days after the
Registrant’s fiscal year-end of December 31, 2004.
1
TABLE OF CONTENTS
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PART I
Item 1. Business.
General Development of Business
SureWest Communications (the “Company” or
“we”) is a California holding company whose operating
subsidiaries provide a wide range of telecommunications, digital
video, and other facilities-based communication services in
Northern California, primarily in the greater Sacramento region.
The Company was incorporated under the laws of the State of
California in 1995, and its predecessor, Roseville Telephone
Company, was incorporated in 1914.
As of December 31, 2004, the Company’s wholly-owned
subsidiaries included SureWest Telephone, SureWest Directories,
SureWest Long Distance, SureWest Wireless, SureWest Broadband,
SureWest TeleVideo and SureWest TeleVideo of Roseville
(“SureWest Broadband/ Residential Services”), SureWest
Internet, and SureWest Custom Data Services (formerly Quiknet,
Inc.).
The Company’s strategy is to become the first choice as a
dominant integrated communications provider in the Sacramento
region. It seeks to achieve this position by leveraging its
existing advanced fiber network to extend its operations
throughout Sacramento, Placer and adjacent counties, by
providing superior customer service and by integrating its
systems, products and operating functions.
No customer accounted for more than 10% of the Company’s
consolidated operating revenues during the years ended
December 31, 2004, 2003 and 2002.
The Company currently divides its business into three reportable
business segments: Telecommunications (“Telecom”),
Broadband and Wireless. The table that follows reflects the
percentage of total operating revenues of the Company generated
by each of its three reporting segments for the last three
fiscal years:
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% of Total Operating Revenues | |
| Reporting Segment |
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2002 | |
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Telecom
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67% |
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71% |
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81% |
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Broadband
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18% |
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15% |
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7% |
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Wireless
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15% |
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14% |
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12% |
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Total operating revenues
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100% |
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100% |
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100% |
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The Company’s products or services that generated 10% or
more of its total operating revenues in any of the last three
years are as follows:
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2004 | |
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2002 | |
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(Amounts in thousands) | |
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Local service
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$ |
69,560 |
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63,363 |
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66,283 |
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Network access service
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$ |
46,161 |
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51,286 |
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58,426 |
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Wireless service
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31,261 |
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27,146 |
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23,225 |
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The Company currently generates the majority of its revenues
from services that are subject to regulation by either or both
of the California Public Utilities Commission (“CPUC”)
and the Federal Communications Commission (“FCC”).
Revenues from services subject to comprehensive regulation
include local service, network access service and toll service
revenues. The Company expects that the proportion of its
revenues that comes from nonregulated or lightly regulated
businesses will increase in future years because of the
successful
3
execution of its business strategy and the impact of competition
on its existing regulated operations. The table that follows
reflects the percentage of total operating revenues of the
Company contributed by various sources.
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Rate Regulated Revenues as a % of | |
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Total Operating Revenues | |
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2004 | |
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2003 | |
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2002 | |
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Revenues from services subject to comprehensive regulation
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55% |
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59% |
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67% |
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Other revenues
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45% |
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41% |
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33% |
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Total operating revenues
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100% |
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100% |
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100% |
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There continues to be increased competition facing
telecommunications providers. As a result of technology change
and industry, legislative and regulatory developments, the
Company continues to face new competitive challenges. These
developments, however, have also provided the Company with
significant growth opportunities. The Company believes that
growth from its entry into newer businesses in recent years will
offset flat or slowing growth in customers in its other
businesses, and that the newer businesses provide significant
revenue opportunities not present before. Competitive issues
facing individual operating units are addressed in connection
with the individual segment discussions below.
As of December 31, 2004, the Company had 1,018 employees.
This reflects an increase of approximately 2% over the number of
employees at December 31, 2003. However, in November 2004,
the Company announced an early retirement offer, which was
accepted by 59 employees in December 2004 and an additional 13
employees during the first quarter of 2005. Such employees
ultimately retired in February 2005. None of the Company’s
employees are represented by a union. The Company considers its
employee relations to be positive.
Telecom
The Telecom segment includes SureWest Telephone, SureWest
Directories and SureWest Long Distance, which provide landline
telecommunications services, Digital Subscriber Line
(“DSL”) services, directory advertising services, long
distance services and certain related non-regulated services.
The Telecom segment accounted for approximately 67%, 71% and 81%
of the Company’s operating revenue in the years 2004, 2003
and 2002, respectively. Although revenues from this segment have
decreased as a percentage of all Company revenues over the past
several years, the Company expects this segment to continue to
provide the largest proportion of its revenues and earnings in
2005.
SureWest Telephone operates as an incumbent local exchange
carrier (“ILEC”) with a service area of approximately
83 square miles, covering Roseville and Citrus Heights,
California, and adjacent areas in Placer and Sacramento
Counties. The Company holds a non-exclusive perpetual franchise
granted by Section 7901 of the California Public Utilities
Code. The area served by SureWest Telephone has been one of the
most rapidly growing areas in California during the past decade,
but the pace of growth has slowed in recent years as the area
has become more developed. The rapid growth also attracted new
competitors to the area.
SureWest Telephone’s primary services are local telephone
service, network access services, toll services and certain
vertical and non-regulated services. Toll services and access to
SureWest Telephone’s network are provided through
connections with other carriers serving adjacent areas,
including SBC Communications (“SBC”), and also through
service agreements with numerous interexchange carriers,
including national interexchange carriers.
SureWest Telephone provides services to residential, business
and carrier customers, and continues to be subject to the
competitive and regulatory challenges faced by incumbent local
exchange carriers (“ILECs”) both nationally and in
California. As a result of competitive pressures, SureWest
Telephone experienced a 3%
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decrease in total access lines from December 31, 2003 to
December 31, 2004. As of December 31, 2004, SureWest
Telephone served 131,905 access lines. The Company believes that
economic conditions in the area in 2004, expanding competition,
and service substitution have impacted, and will continue to
impact, the number of access lines provided by SureWest
Telephone.
This segment also includes the operations of two other
businesses, SureWest Directories and SureWest Long Distance.
SureWest Directories publishes and distributes 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. The SureWest Directories’
business faces significant competition from national print and
on-line directory publishers and other local businesses,
including SBC. SureWest Directories’ business has expanded
into electronic and on-line formats in 2005. The directory
business is not regulated by the FCC or CPUC; however, the
revenues from publishing rights licensed by SureWest Telephone
under its contractual arrangement with SureWest Directories are
taken into account by the CPUC with respect to SureWest
Telephone’s operations.
SureWest Long Distance offers intrastate, interstate, and
international long distance services, including calling card and
800 services. SureWest Long Distance is a resale business that
utilizes other national and international carriers for wholesale
transport, switching and other capabilities. SureWest Long
Distance maintains agreements with Sprint and Global Crossing to
diversify its risks related to its wholesale providers. The
rates offered to SureWest Long Distance by these companies are
competitive; however, changes in the wholesale marketplace in
the recent past have provided recurring opportunities to long
distance resellers to reduce their costs further. During 2004,
SureWest Long Distance renegotiated its contract with Sprint,
entering into a two-year agreement. Through this new contract
with Sprint, SureWest Long Distance is experiencing an
approximate 20% cost savings over the prior year. SureWest Long
Distance maintains a month-to-month agreement with Global
Crossing.
As of December 31, 2004 and 2003, 36% and 31%,
respectively, of the customers of SureWest Telephone chose
SureWest Long Distance as their presubscribed long distance
provider.
In recent years, competition to serve the customers of SureWest
Telephone has increased significantly. Changes in technology
have made it possible for customers to receive services in new
ways at competitive rates. To meet the competition, SureWest
Telephone has responded in part by introducing new services and
service “bundles,” offering services in convenient
groupings with package discounts and billing advantages, and by
investing in its network and business operations. Changing
technology requires that the Company continue to adapt its
network and the manner in which it provides service. Within its
telephone service area, services are provided over an integrated
network making extensive use of optical fiber. SureWest
Telephone deploys fiber optic facilities closer to an end
user’s premises to broaden the reach and capacity of
Company services requiring additional bandwidth. In some
instances, fiber optics are deployed directly to a
customer’s premises. Because bandwidth is limited by
distance when utilizing copper facilities, the Company also is
deploying equipment throughout its service area to enable the
improved provision of services. Certain of the Company’s
facilities take advantage of Internet protocol (“IP”),
which allows for more efficient use of bandwidth.
See “Item 3 – Legal Proceedings” and
“Item 7 – Management’s Discussion and
Analysis of Financial Condition and Results of Operations”
for further discussion regarding SureWest Telephone’s
revenues that are subject to the competitive environment in
which SureWest Telephone operates.
The Company anticipates that its businesses will continue to
experience competition and that the nature and extent of such
competition will increase. Competitors to the SureWest Telephone
business include competitive local exchange carriers,
interexchange carriers (including interexchange carriers which
serve customers directly without using facilities of local
exchange carriers), wireless service providers, providers of
IP-based calling services, customers which are
telecommunications self-providers, and a range of other
providers that specialize in
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certain niche areas of telecommunications. Technology change has
accelerated the pressure on established carriers, including
SureWest Telephone, by virtue of software-defined businesses,
and innovations related to packet switching and use of the
Internet and IP capabilities.
SureWest Telephone’s revenues are influenced greatly by the
actions of the CPUC and the FCC.
All intrastate telecommunications service rates of SureWest
Telephone are subject to comprehensive regulation by the CPUC.
The provision of access to the networks of interexchange
carriers for long distance calling is governed by access tariffs
and by intercarrier agreements, which are subject to the
jurisdiction of the CPUC or FCC, or both, depending upon the
nature of the transmissions. SureWest Telephone has a tariff on
file with the FCC for all elements of interstate access services
except carrier common line charges, for which SureWest Telephone
concurs with the tariff of the National Exchange Carrier
Association (“NECA”).
In February 1996, Congress passed the Telecommunications Act of
1996 (the “Act”), which was intended to expand the
opportunities for competition in a range of telecommunications
businesses, and which has significantly changed the regulatory
environment. See “Item 3 – Legal
Proceedings” and “Item 7 –
Management’s Discussion and Analysis of Financial Condition
and Results of Operations” for further discussion regarding
the impact of the Act. The application of the Act in particular
circumstances continues to present contentious issues for
carriers and others, and a number of court appeals were pending
as of December 31, 2004 that would affect the application
of the Act to the Company.
The FCC monitors SureWest Telephone’s interstate earnings
through the use of annual cost separation studies that are
prepared and submitted by SureWest Telephone in accordance with
rules governing the preparation of such studies. SureWest
Telephone utilizes actual and estimated cost information and
actual and projected demand usage to prepare these studies.
The characterization of traffic as interstate or intrastate, and
as a telecommunications or information service has been a
significant source of dispute among carriers and others in
recent years, as such characterizations can impact the
regulatory treatment of such traffic and the payment obligations
of the providers who are involved. The characterization of:
(i) traffic involved in intercarrier interconnection,
(ii) Internet traffic, and (iii) traffic that makes
use of IP and other transmission technologies are examples of
issues that are currently subject to analysis on the state and
federal levels, and that are expected to be subject to
regulatory action in the near future. Both the FCC and CPUC have
initiated proceedings to evaluate the appropriate level of
regulation for providers of telecommunications services and for
IP-enabled services. In addition, various proceedings at the FCC
are pending that could lead to significant alteration of the
existing compensation arrangements among providers of
telecommunications services, and that could impact the amount of
the payments received by the Company from carriers and others
for use of the Company’s network.
With respect to regulation administered by the CPUC, in 1996,
the CPUC issued a decision in connection with SureWest
Telephone’s general rate proceeding, which authorized
SureWest Telephone to implement a New Regulatory Framework
(“NRF”) for services furnished within SureWest
Telephone’s service area in order to accommodate increased
competition and to afford greater pricing flexibility. Under the
NRF, SureWest Telephone is subject to ongoing monitoring and
reporting requirements, and it was initially required to share
earnings with customers through a reduction of revenues if its
earned annual intrastate rate-of-return exceeds that authorized
by the CPUC.
In accordance with the requirements of its general rate case
order, SureWest Telephone filed an application for review of its
NRF in 1999 and requested that the sharing mechanism be
suspended, consistent with past CPUC decisions for other
incumbent local exchange carriers in California. After a
verification audit by the CPUC’s Office of Ratepayer
Advocates (“ORA”), the CPUC issued a decision in June
2001 that failed to suspend the sharing mechanism, and required
certain new changes in the method used to allocate costs for
services provided by SureWest Telephone to its affiliates, the
treatment of certain directory revenues and the treatment of
internal-use software costs. Since that time, SureWest Telephone
has been engaged in proceedings to modify that
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decision and to implement a NRF that is consistent with that
applicable to other ILECs within the state. During 2004, the
Company was involved in a proceeding at the CPUC that considered
the continued need for the sharing requirements in the
intrastate jurisdiction. On July 27, 2004, the Company
entered into a settlement agreement with the other parties in
the proceeding, the ORA and The Utility Reform Network
(“TURN”), to resolve all issues in the proceeding. On
November 19, 2004, the CPUC approved this settlement
agreement resolving existing sharing obligations and related
earnings issues for the monitoring periods 2000-2004, and
putting into place a surcredit mechanism for the amount of the
settlement, and suspending the requirement for any intrastate
sharing for monitoring periods from January 1, 2005 through
at least December 31, 2010. The settlement agreement
resulted in SureWest Telephone recognizing an increase in local
revenues of $2.9 million due to a change in accounting
estimate. This increase in revenues resulted in a decrease of
the Company’s net loss by $2.0 million ($0.14 per
share) during 2004.
In accordance with the November 19, 2004 settlement
agreement, SureWest Telephone will return approximately
$6.5 million, plus interest at an annual contractual rate
of 2.34% and imputed rate of 3.15%, to its customers in the form
of a surcredit over a period of four years beginning
January 1, 2005 and will pay a one-time customer refund of
$2.6 million, which includes an annual imputed interest
rate of 3.15% (no stated contractual interest rate), in the form
of a surcredit over two years beginning January 1, 2005 to
settle the monitoring periods 2000 to 2004. At December 31,
2004, the aggregate contractual shareable earnings obligation
for these surcredits was $9.2 million, (which is net of an
unamortized discount pertaining to imputed interest of $524
thousand at such date). Future payments for these obligations
are $3.1 million in 2005 and 2006 and $1.8 million in
2007 and 2008. Further, commencing January 1, 2007,
SureWest Telephone shall implement a permanent annual consumer
dividend of $1.3 million to end-users receiving SureWest
Telephone services subject to sharing on or after that date;
however, this consumer dividend is subject to reduction based
upon the results of other pending regulatory proceedings.
In addition to its regulatory authority with respect to SureWest
Telephone’s rates, the CPUC also has the power, among other
things, to establish terms and conditions of service, to
prescribe uniform systems of accounts and to regulate the
mortgaging or disposition of public utility properties.
In November 2000, the CPUC authorized SBC to terminate its
approximate annual $11.5 million extended area service
payments to SureWest Telephone effective November 30, 2000
and authorized replacement funding on an interim basis from the
California High Cost Fund (“CHCF”). The CHCF is a
program designed by the CPUC to establish a fair and equitable
local rate structure and to reduce any disparity in the rates
charged by telephone companies serving high-cost areas. The CHCF
was due to expire on January 1, 2005. However, on
September 28, 2004, the Governor of California signed
SB1276 into law, which amended the existing legislation and
extended the expiration date to January 1, 2009. In
addition, the CPUC ordered a separate proceeding for the purpose
of determining whether future recovery of all, none or a portion
of the approximate $11.5 million should come from SureWest
Telephone’s ratepayers or other regulatory recovery
mechanisms. See “Item 3 – Legal
Proceedings,” for further discussion of these proceedings.
These actions of the CPUC and of the FCC, as noted above, can
affect the rates charged for access and interconnection, and, as
a result, the revenues derived by the Company from access and
related services. SureWest Telephone’s future operations
also may be impacted by other proceedings at the FCC and CPUC,
including proceedings that address interstate access and other
rates and charges, the nature of interconnection between
incumbent local exchange carriers and others, the collection and
distribution of support payments required to assure universal
access to basic telephone services, and the charges that can be
assessed for new forms of service that directly or indirectly
utilize carrier networks.
Substantially all of the interstate long distance business was
detariffed after a transition period that started on May 1,
2000 and ended in 2001, after the FCC issued a detariffing order
on January 31, 1996 and all related appeals were exhausted.
The long distance business is recognized as being fully
competitive, and there are many providers of long distance
services. The emergence from bankruptcy reorganization
proceedings of some larger interexchange and competitive local
exchange carriers has created new competitive pressures in the
sector for both wholesale and retail providers. Because of the
level of competition, regulation of this area of the
telecommunications business is light or has been removed
altogether. Where it exists, regulation is focused on
7
specific public policy concerns, such as customer account
slamming, rather than the rates, terms and conditions of service.
Broadband
The Broadband segment includes SureWest Broadband, SureWest
Internet, SureWest Custom Data Services and SureWest Broadband/
Residential Services. The Broadband segment also includes a
competitive local exchange carrier (“CLEC”), which was
authorized by the CPUC in 1998 to provide telecommunications
services in areas outside the telephone service area of SureWest
Telephone. As of January 1, 2003, the Company consolidated
the operations of SureWest Internet and SureWest Custom Data
Services into the operations of SureWest Broadband for financial
reporting purposes, though they remain separate legal entities.
In addition, as of January 1, 2004, the Company
consolidated the operations of SureWest Broadband, SureWest
TeleVideo and SureWest TeleVideo of Roseville for financial
reporting purposes, though they remain separate legal entities.
The Broadband segment provides services to residential, business
and carrier customers. The services include: high-speed and
dial-up Internet service, digital video, local and network
access, long distance and managed services. These services
initially were offered in the greater Sacramento area,
principally to customers residing outside of SureWest
Telephone’s service area. However, over time, Internet and
similar services have been made available to customers without
regard to service area boundaries, and commencing in December
2003, SureWest Broadband also began providing digital video and
high-speed Internet services to customers within SureWest
Telephone’s service area. Certain of the Company’s
affiliates possess cable television licenses or franchises in
Sacramento County, in Placer County and in the cities of
Roseville and Lincoln. The Company is now authorized to provide
video programming to all or substantially all of the residents
in the SureWest Telephone service area.
During 2000, SureWest Broadband purchased from the FCC two 39
Gigahertz (“GHz”) Local Multipoint Distribution System
(“LMDS”) spectrum licenses, which provide spectrum
coverage in parts of eleven different counties in the greater
Sacramento area. These spectrum licenses allow SureWest
Broadband to expand its network within these areas by using
wireless technology for extra transmission capacity backhaul.
During 2004, SureWest Broadband also began using these licenses
to offer a fixed wireless DSL service to customers outside of
SureWest Telephone’s service area in parts of Lincoln and
Rocklin, California. In 2005, SureWest Broadband plans to
further expand its fixed wireless DSL service by offering this
service to customers in other areas in Sacramento and Placer
Counties. In addition, SureWest Broadband will continue to use
this wireless spectrum for backhaul in cost effective areas.
The Broadband segment accounted for approximately 18%, 15% and
7% of the Company’s operating revenues in the years 2004,
2003 and 2002, respectively. As of December 31, 2004, the
Broadband segment had 42,119 customers.
The Broadband segment’s backbone network is comprised
primarily of optical fiber and is subject to continual expansion
and diversification in response to business growth.
The Broadband segment provides dial-up and high-speed Internet
services and custom data solutions, including collocation, fixed
and burstable bandwidth, managed services and network monitoring
services. SureWest Broadband provides DSL-based Internet
services to residential and business customers in the SureWest
Telephone service area as well as high-speed Internet services
to business customers outside of SureWest Telephone’s
service area, primarily in the greater Sacramento region.
SureWest Broadband had 22,442 DSL customers as of
December 31, 2004.
SureWest Broadband/ Residential Services commenced operations in
July 2002 when the Company acquired the assets formerly held by
Western Integrated Networks, LLC. SureWest Broadband/
Residential Services provides a bundled offering consisting of
digital video, high-speed Internet, and telephone services to
residential customers in the greater Sacramento area referred to
as fiber-to-the premise (“FTTP”) (previously referred
to as “Triple Play”). Substantially all of the
services provided by SureWest Broadband/ Residential Services
utilize digital
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fiber network capability. SureWest Broadband/ Residential
Services utilizes the SureWest Broadband brand. From its
original base in July 2002 of approximately 5,000 subscribers,
the SureWest Broadband/ Residential Services subsidiary reached
a fiber-to-the premise subscriber level of 15,689 as of
December 31, 2004.
In 2003, SureWest Broadband/ Residential Services obtained a
cable television franchise in Roseville, California, and it
began offering video programming services to residential
customers in December 2003. SureWest Broadband/ Residential
Services is also authorized to offer video programming services
to customers in other parts of the SureWest Telephone service
area, including Citrus Heights and areas within unincorporated
Placer County. SureWest Broadband/ Residential Services procures
digital transport capability from its affiliate, SureWest
Telephone, and has developed an advanced method of delivering
video services to subscribers using Internet protocol, or
IP-video capability. The Company expects that each of its
segments operating in Roseville and other parts of SureWest
Telephone’s service area should benefit from the Company
offerings of telecommunications, cable television and Internet
services. SureWest Broadband/ Residential Services acquired a
new franchise in Lincoln, California in early 2004, and one for
portions of Placer County in later 2004, and it has expanded its
services in 2004 to already-licensed areas of Elk Grove and
Natomas, California as well as other areas within its service
area footprint.
Except as noted below, the businesses in the Broadband segment
are subject to extensive competition. Competition is highly
fragmented, and has grown dramatically in recent years. Except
for the digital video delivery business, which requires
significant capital investment to serve designated service
territories, the barriers to entry are not high, and technology
changes force rapid competitive adjustments.
SureWest Broadband competes regularly against SBC, which is the
incumbent local exchange carrier in Sacramento and most of its
surrounding areas. The Broadband segment also competes against
Frontier Communications in southern Sacramento County. Numerous
CLECs and others offer telecommunications and related services
on a flexible and highly specialized basis in the Sacramento
area. The Company has found that it can be successful by
constantly seeking out new sales opportunities in attractive
segments of the market, by maintaining a highly reliable network
that is accessible to new customers, and by focusing on the
provision of excellent service to its customers. To the extent
permitted by law and regulatory requirements, the Company seeks
to operate its business across the Broadband segment in an
integrated manner, and its network as a single integrated
facility. The operating units in this segment benefit within the
region from the name recognition and reputation of SureWest, and
from the active participation of Company executives and
employees in civic and other groups. During 2003, the Company
was able to obtain approval from the Sacramento Metropolitan
Cable Television Commission to activate service for customers in
“green field” areas that were previously outside of
the Company’s approved build-out and activation schedules.
It now anticipates that it will achieve a competitive market
share in the provision of telephone, digital video and Internet
services in many of these areas around Sacramento. It is
important to the Company that its operations in this segment be
able to deliver services to customers in developing areas as
they grow. The Company is also considering whether a
modification or expansion of its service territory in Sacramento
County is appropriate.
The Broadband segment has assumed the responsibility for much of
the Company’s DSL and high-speed Internet retail customer
base. The emergence of cable modems, wireless Internet access
and other avenues to reach the Internet provide significant
competition. The presence of other broadband Internet access
providers has begun to have an impact on pricing, which has been
under downward pressure in the region.
The market faced by the Company among multichannel video
providers is very competitive. The main competitors of SureWest
Broadband/Residential Services are Comcast and various satellite
television providers. In the Company’s opinion, the Comcast
organization possesses significant market power in Sacramento
County. However, the governing Sacramento County Commission
promotes competition in the provision of cable service, and has
a straightforward franchise and licensing ordinance that
accommodates other new entrants rapidly, and allows them
flexibility in defining service territories. SureWest has
entered the Sacramento, Roseville and Lincoln cable service
markets as the second (or subsequent) franchisee, and while it
will, therefore, benefit from the somewhat reduced regulation
that such entrants enjoy, it will nevertheless face the
challenge of drawing
9
customers away from the incumbent provider. The provision of
cable television over a closed transmission path has been
recognized as possessing certain monopoly characteristics and,
therefore, the ability of a second or subsequent provider to
succeed in the marketplace is not assured. Similarly, the
possession of comparative size and scale can give a competitor
an advantage in both access to and pricing of the program
content needed to operate a cable television business, and
Comcast possesses significantly greater size and scale in
Sacramento than the Company.
Like SureWest Telephone, SureWest Broadband must comply with
various rules of the CPUC governing tariffs, access to
information, consumer protection and similar matters for a
telecommunication service provider. The FCC has jurisdiction
over the SureWest Broadband interstate services, such as access
service. In 2001, the FCC adopted rules that will cause CLEC
interstate switched access charges to decline over time, and
that have also caused a decline in the amount of compensation
that can be derived from Internet Service Provider dial-up
traffic. SureWest Broadband is only minimally affected by these
actions, and has already modified its rates to comply with the
FCC requirements.
In late 2001, the FCC began a triennial review of its policies
on unbundled network elements (“UNEs”) and other
regulations that affect the nature of competition between ILECs
and CLECs. The FCC concluded its Triennial Review in early 2003,
and its action was appealed by a number of parties. The
appellate court reversed the FCC and vacated significant
portions of the FCC rules in a decision that was released in
early March 2004, but stayed its mandate for a short time.
Subsequently, the FCC released a new decision with modified
rules. That new decision also has been appealed. SureWest
Broadband does not rely to any significant degree on UNEs or
other offerings that would be affected by these appeals, and it
does not rely generally on the availability of discounted
incremental cost pricing of service elements from the incumbent
local exchange carrier to serve retail customers. However, the
position of SureWest Broadband in the Sacramento market could be
affected by a change in law or regulation that granted
unrestricted pricing flexibility to the incumbent local exchange
carrier in Sacramento or that denies competitors the ability to
assure that pricing concessions given to customers are
nondiscriminatory and offered on a consistent basis.
The cable television business is governed by federal, state and
local laws and regulation, but is most substantially controlled
by the mechanisms in Title VI of the Communications Act of
1934, as amended. While closely regulated in some areas,
providers of cable services are generally free from rate
regulation, and have wide leeway to select and package the
content that they deliver. In exchange for their use of local
streets and rights of way, cable providers are required to pay
franchise fees, and to deliver public, educational and
governmental channels for use by the community, among other
things.
Wireless
The Wireless segment consists of the Company’s subsidiary
SureWest Wireless, which provides wireless services.
SureWest Wireless was formed for the purpose of providing
wireless personal communications services, or PCS. PCS is viewed
generally as involving the capability to deliver a more advanced
set of features and capabilities than the basic form of cellular
mobile service. SureWest Wireless derives its revenue from the
provision of wireless PCS, and the sale of handsets and related
communications equipment. In addition, SureWest Wireless
generates revenue from long distance calls, roaming service,
custom calling and other features.
During 1997, SureWest Wireless purchased from the FCC spectrum
licenses that allow it to offer wireless services in four Basic
Trading Areas, representing 16 counties located in central
California. These areas include the cities of Sacramento,
Stockton, Modesto and Yuba City. Each license represents 10
megahertz of spectrum, and accommodates digital wireless
technology that is capable of providing both voice and data
transmission. SureWest Wireless commenced deployment of the
network infrastructure in 1998 and initiated wireless
telecommunications services with telephone, paging and voicemail
capabilities in June 1999.
10
SureWest Wireless established its market share in the Sacramento
market in large part by promoting an unlimited flat rate
regional calling plan. Wireless customer acquisition has
historically been most active during the December holiday
season, and the Company has always been active in sales and
marketing at this time. During 2003 and 2004, SureWest Wireless
initiated a number of new service options for customers,
including additional regional plans, an unlimited national plan,
a family plan and new vertical services (such as wireless data
capabilities), which have attracted new customers. Evolution of
the marketplace has prompted SureWest Wireless to open five
retail stores in its service area, with plans to open a sixth
store in Lincoln, California in late 2005. SureWest Wireless is
working to reduce customer churn and to increase the amount of
revenue it derives from each customer in 2005.
As of December 31, 2004, SureWest Wireless had 52,657
subscribers. The Wireless segment accounted for approximately
15%, 14% and 12% of the Company’s operating revenue in the
years 2004, 2003 and 2002, respectively.
The wireless business requires capital investment to build new
cell sites and to deploy digital and other advanced service
capabilities. In 2005, capital investment in SureWest Wireless
will emphasize continued improvements in service levels and
de-emphasize network expansion.
The market for wireless services is highly competitive. There
are numerous facilities-based wireless providers in the
Sacramento market, including all of the major national
providers, and additional wireless resellers. Most of these
competitors have a national presence and, therefore, have the
ability to leverage national advertising budgets and name
recognition. In addition, many of the competitors have access to
additional spectrum in the geographic markets in which SureWest
Wireless competes. In order for SureWest Wireless to succeed in
this geographic market, it must establish innovative services,
such as its unlimited flat rate service package, and continue to
leverage the SureWest name and reputation. A trend toward
consolidation in this segment has begun to emerge, with the
announcement of merger agreements involving some of the largest
wireless providers. However, competition in this segment is
expected to remain intense.
Because of their use of valuable spectrum resources, wireless
services are subject to regulation. The construction, operation,
management and transfer of digital wireless systems in the
United States are regulated by the FCC and CPUC. However,
regulators do not interfere with price plans offered to wireless
customers.
Effective November 24, 2003, the FCC mandated that wireless
carriers provide for local number portability (“LNP”).
LNP allows subscribers to keep their wireless phone numbers
while switching to a different service provider. Although the
Company has experienced favorable porting activity, the
implementation of LNP has not had a material effect on the
Company’s consolidated financial position or results of
operations.
Other Significant Events
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Sale of Alarm Monitoring Division |
In January 2002, the Company sold substantially all of the
assets of its alarm monitoring division, which was a component
of the Telecom segment, for approximately $5.2 million.
This sale resulted in a pre-tax gain of $4.4 million during
2002. Through December 31, 2003, the Company had received
cash proceeds of $5.0 million, of which $4.5 million
and $500 thousand were received during 2002 and the fourth
quarter of 2001, respectively, related to the sale of the alarm
monitoring division assets. The alarm monitoring assets
consisted primarily of customer contracts and equipment, which
had a net book value of approximately $355 thousand as of the
date of the sale. The purchaser of the assets commenced
litigation against the Company relating to claims under the
asset purchase agreement, generally in connection with certain
contracts assigned to the purchaser. In July 2003, the Company
and the purchaser settled the litigation and the parties
released all claims in exchange for payment by the Company to
the purchaser of $375 thousand, which was paid during 2003.
Total operating revenues attributable to the Company’s
alarm monitoring division during 2002 were $279 thousand (none
in 2004 or 2003).
11
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Acquisition of the Assets of Western Integrated Networks,
LLC |
On July 12, 2002, the Company purchased substantially all
of the assets of Western Integrated Networks, LLC and certain
affiliates (collectively, “WIN”) in a transaction
supervised by the United States Bankruptcy Court for the
District of Colorado (the “Bankruptcy Court”). The
assets of WIN acquired by the Company, consisted principally of
accounts receivable and property, plant and equipment located in
Sacramento County, California. The purchase price for the assets
of WIN consisted of (i) $12.0 million in cash,
(ii) direct acquisition costs of $622 thousand, and
(iii) the assumption of certain liabilities aggregating
$4.7 million relating principally to executory contracts
and capital lease obligations. Under the terms of the asset
purchase agreement, $1.2 million of the aggregate purchase
price was held in an escrow account to protect the Company in
the event of any claims available to the Company. In January
2003, $150 thousand was released to the Company. During March
2004, the Company resolved the remaining issues related to the
escrow, and a settlement agreement was executed that gave the
Company undisputed rights to certain deposits held by a third
party in connection with WIN’s network construction. As a
result, in April 2004, the Bankruptcy Court signed an order that
allowed the remainder of the funds in escrow to be released to
the WIN estate. In November 2004, the third party refunded $695
thousand to the Company to cover all unused deposits through
April 1, 2004, which was recorded as a reduction of
property, plant and equipment.
Factors That Could Affect Future Results
The Company advises of numerous risk factors that should be
taken into account in evaluating any investment in SureWest
securities. Representative examples of these factors include
(without limitation) the following:
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We expect to continue to face significant competition in all
parts of our business and the level of competition is expected
to intensify. The telecommunications industry is highly
competitive. We face actual or potential competition from many
existing and emerging companies, including other incumbent and
competitive local telephone companies, long-distance carriers
and resellers, wireless telephone companies, Internet service
providers, satellite companies and cable television companies.
We may not be able to successfully anticipate and respond to
various competitive factors affecting the industry, including
regulatory changes that may affect our competitors and us
differently, new technologies and services that may be
introduced, changes in consumer preferences, demographic trends
and discount pricing strategies by competitors. As the incumbent
carrier in Sacramento, SBC enjoys certain business advantages,
including its size, financial resources, favorable regulatory
position, brand recognition and connection to virtually all of
our customers and potential customers there. As the largest
cable operator in Sacramento and Placer County, Comcast enjoys
certain business advantages, including its size, financial
resources, ownership or superior access to programming and other
content, brand recognition, and first-in-the-field advantages
with a customer base that generates positive cash flow for its
operations. We face intense competition in our markets for
long-distance, Internet access and other ancillary services that
are important to our business and to our growth strategy. |
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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 reduce the costs of entry for others and 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, and we may be
placed at a cost disadvantage in offering other services.
Additionally, replacing or upgrading our infrastructure in the
future could result in significant capital expenditures. |
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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. Many businesses that
compete with the Company are comparatively less regulated. Many
significant regulatory decisions have had to be accommodated in
recent years, and there are pending decisions on issues
affecting the Company that are of great importance. |
12
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Our operations have undergone material changes, and our
actual operating results can be expected to differ from the
results indicated in our historical financial statements. As
a result of our acquisition of assets from WIN in 2002, and the
subsequent expansion of our cable television business, 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. |
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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 continue
to require us to invest significant capital in facilities and
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. |
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We are reliant on support funds provided under federal and
state laws. We receive revenues from various federal or
state support funds: interstate common line support from the
Universal Service Program, California High Cost Fund-B and
Universal Lifeline Service Fund. These governmental programs are
reviewed and amended from time to time, and are likely to change
in the near future. As described in the Regulation
section above, the Company currently receives funding of
$11.5 million annually from the CHCF, a program designed by
the CPUC to establish a fair and equitable local rate structure
and to reduce any disparity in the rates charged by certain
telephone companies serving high-cost areas. The CHCF was due to
expire on January 1, 2005. On September 28, 2004, the
Governor of California signed SB1276 into law, which amended the
existing legislation and extended the expiration date to
January 1, 2009. The outcome and impact on the
Company’s operations resulting from future changes to these
governmental programs cannot be determined at this time. |
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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. Situations
with carriers and other customers could affect our ability to
collect for services that have been provided. |
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We often 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, and from 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. |
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We are subject to new corporate governance and internal
control reporting requirements, and our failure to comply with
existing and future requirements could adversely affect our
business. Pursuant to Section 404 of the Sarbanes-Oxley
Act of 2002 (“Section 404”) and related
Securities and Exchange Commission rules, we have furnished a
report of management’s assessment of the effectiveness of
our internal controls at December 31, 2004. In addition,
our Independent Registered Public Accounting Firm audited and
reported on, management’s assessment. Management concluded
that the Company’s internal control over financial
reporting was not effective at December 31, 2004. If our
deficiencies are not adequately addressed, we could experience
accounting errors that could result in misstatements of our
financial position and results of operations, potential
restatements of our financial statements or otherwise adversely
affect our business, reputation and results of operations.
Inferior internal controls could also cause investors to lose
confidence in our reported financial information, which could
have a negative effect on the trading price of our securities. |
13
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If we are unable to effectively and efficiently implement the
necessary initiatives to eliminate the material weakness
identified in our internal controls and procedures, there could
be an adverse affect on our operations or financial results.
In connection with the Management’s Report on Internal
Control over Financial Reporting, management identified a
material weakness in the Company’s internal control over
financial reporting relating to the accounting for property,
plant and equipment, which resulted from control weaknesses that
caused the following conditions: The Company was unable to
completely reconcile its plant in service and plant under
construction subsidiary ledgers to the corresponding general
ledger balances for periods throughout 2004 and as of
December 31, 2004. Management believes these unreconciled
differences are attributable principally to deficiencies in the
reliability of the Company’s information system interfaces
between the general ledger and the property, plant and equipment
subsidiary ledgers. In addition, during 2004, several errors
occurred in the Company’s periodic depreciation and
capitalized interest calculations that were more than
inconsequential. Additionally, as of December 31, 2004, the
Company did not have effective procedures with which to
determine the cost bases of property, plant and equipment that
had been retired. Moreover, certain manual internal controls
pertaining to property, plant and equipment implemented by the
Company during the third quarter of 2004 were not operating
effectively as of December 31, 2004. These matters required
the Company to record adjustments to both its annual and interim
2004 consolidated financial statements. The significant accounts
affected by this material weakness are property, plant and
equipment and related accumulated depreciation included in the
Company’s consolidated balance sheets, and depreciation
expense and interest expense included in the Company’s
consolidated statements of operations. Due to this material
weakness, management believes that as of December 31, 2004,
the Company’s internal control over financial reporting was
not effective based on the Committee of Sponsoring Organizations
of the Treadway Commission criteria. |
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During the year ended December 31, 2004, we implemented
various initiatives, and will be implementing additional
initiatives in 2005 to improve our internal controls, and
address the matters discussed in Management’s Report on
Internal Control over Financial Reporting. 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 the identified material weakness is eliminated, there is a
risk of an adverse affect on our operations or financial results. |
Available Information
The Company’s Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and
amendments to reports filed pursuant to Sections 13(a) and
15(d) of the Securities Exchange Act of 1934, as amended, are
available on our website at www.surw.com /ir/,
when such reports are available on the Securities and Exchange
Commission website. Copies are also available free of charge
upon request to SureWest Communications, P.O. Box 969,
Roseville, CA 95678, Attn: Investor Relations Manager.
The Company owns and leases office facilities and related
equipment for executive headquarters, administrative personnel,
central office buildings, and operations in Roseville, Citrus
Heights, Granite Bay, and other locations in Sacramento and
Placer Counties. The Company’s executive headquarters,
principal business and administrative office, and operations
facility, which are located in Roseville, consist of
262,411 square feet. The Company leases a
213,871 square foot facility in McClellan Park (Sacramento
County), which is used by all of its segments. The Company has
appropriate easements, rights of way and other arrangements for
the accommodation of its pole lines, underground conduits,
aerial and underground cables and wires, and wireless towers and
antennas. See Note 9 in the Notes to Consolidated Financial
Statements and “Item 7 – Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” for information regarding the Company’s
lease obligations.
In addition to land and structures, the Company’s property
consists of equipment necessary for the provision of
communication services. This includes central office equipment,
customer premises equipment and connections, radio and wireless
antennas, towers, pole lines, video head-end, remote terminals,
aerial and underground cable
14
and wire facilities, vehicles, furniture and fixtures, computers
and other equipment. The Company also owns certain other
communications equipment held as inventory for sale or lease.
In addition to plant and equipment that it wholly-owns, the
Company utilizes poles, towers and cable and conduit systems
jointly-owned with other entities, and leases space on
facilities to other entities. These arrangements are in
accordance with written agreements customary in the industry.
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Legal Proceedings. (Dollars in thousands) |
Except for the proceedings described below, the Company is not
aware of any material pending legal proceedings, other than
ordinary routine litigation incidental to its business, to which
it is a party or to which any of its property is subject.
As indicated in Item 1 above, SureWest Telephone is subject
to regulation by the Federal Communications Commission
(“FCC”) and the California Public Utilities Commission
(“CPUC”). In the past, there have been various
proceedings before these agencies to which SureWest Telephone
has been a party. Reference is made to Item 1 for further
information regarding the nature of the jurisdiction of the FCC
and CPUC over the business and operations of SureWest Telephone.
In 1996, the CPUC issued a decision in connection with SureWest
Telephone’s general rate proceeding, which authorized
SureWest Telephone to implement a New Regulatory Framework
(“NRF”) for services furnished within SureWest
Telephone’s service area in order to accommodate market and
regulatory movement toward competition and greater pricing
flexibility. Under the NRF, SureWest Telephone is subject to
ongoing monitoring and reporting requirements, and it was
initially 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.
The Company has been involved in a proceeding at the CPUC that
has considered the continued need for certain sharing
requirements in the intrastate jurisdiction, and in connection
with that review, has also considered the issues of whether the
Company overearned in the intrastate jurisdiction in recent
monitoring periods, and if so, the amount of such overearnings
that should be shared with customers. On July 27, 2004, the
Company entered into a settlement agreement with the other
parties in the proceeding, the ORA and The Utility Reform
Network (“TURN”), to resolve all issues in the
proceeding. On November 19, 2004, the CPUC approved the
settlement agreement. The settlement agreement resolves all
earnings issues for the monitoring periods 2000 through 2004,
put into place a surcredit mechanism for the amount of the
settlement, and suspends the requirement for any intrastate
sharing for later monitoring periods from January 1, 2005
through at least December 31, 2010.
Prior to January 1, 2002, SureWest Telephone billed SBC
various charges for certain local service and network access
service revenues in accordance with certain agreements as
described below. In 1999, SBC expressed interest in withdrawing
from the designated carrier plan (“DCP”) for SureWest
Telephone’s toll traffic. The DCP was a compensation
arrangement between SureWest Telephone and SBC for certain
intrastate toll services. SureWest Telephone and SBC agreed to
allow the DCP arrangement to expire in December 2001. The
15
termination of the DCP did not have a material impact on the
Company’s consolidated financial position as of
December 31, 2002 or results of operations for the year
then ended.
In 1999, SBC also expressed interest in entering into a new,
permanent compensation arrangement for extended area service
(“EAS”). At that time, SBC had been paying SureWest
Telephone approximately $11,500 per year for EAS pursuant
to a Settlement Transition Agreement. In November 2000, the CPUC
authorized SBC to terminate its annual EAS payments to SureWest
Telephone effective November 30, 2000. The CPUC authorized
replacement funding to SureWest Telephone on an interim basis
using funds from the California High Cost Fund
(“CHCF”). The CHCF is a program designed by the CPUC
to establish a fair and equitable local rate structure and to
reduce any disparity in the rates charged by telephone companies
serving high-cost areas. The CHCF was due to expire on
January 1, 2005. However, on September 28, 2004, the
Governor of California signed SB1276 into law, which amended the
existing legislation and extended the expiration date to
January 1, 2009. 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 recommended that the CPUC discontinue SureWest
Telephone’s present interim EAS funding from the CHCF
without replacement revenues from ratepayers. The CPUC has made
no indication as to what, if any, changes will be forthcoming
relating to EAS revenues. The results of these proceedings and
their potential effects on SureWest Telephone cannot yet be
determined.
SureWest Telephone’s operations may also be impacted by the
Telecommunications Act of 1996 (the “Act”). The Act
significantly changed the regulatory environment for
telecommunications companies. Beginning in 1996, the FCC
conducted proceedings and adopted orders implementing the
Act’s provisions to open local exchange service markets,
such as the market of SureWest Telephone, to competition. These
proceedings and orders address interconnection, access charges
and universal service.
Given the ongoing activities of the FCC to promulgate rules and
regulations on interconnection, access charges, and universal
service reform, and the various on-going legal challenges
considering the validity of these FCC orders, it is not yet
possible to determine fully the impact of the Act and related
FCC regulations on SureWest Telephone’s operations.
There are a number of other regulatory proceedings occurring at
the federal and state levels that may have a material impact on
SureWest Telephone. These regulatory proceedings include, but
are not limited to, consideration of changes to the
jurisdictional separations process, the interstate universal
service fund, intercarrier compensation access charge reform and
the regulation of local exchange carriers and IP-enabled
services. The outcomes and impact on SureWest Telephone’s
operations of these proceedings and related court matters cannot
be determined at this time.
The regulatory proceedings occurring at the state and federal
levels described above may also broaden the scope of competition
in the provision of regulated services and change the rates and
rate structure for regulated services furnished by SureWest
Telephone, the effects of which on SureWest Telephone cannot yet
be determined.
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Corporate Treasury Investigation |
On January 14, 2004, the Company announced that the results
of a preliminary investigation, triggered by the
December 17, 2003 resignation of a Senior Treasury Analyst
in the Company’s Corporate Finance Department, indicated
irregularities in the Company’s cash management and
investment functions, and that approximately $1,828 of the
Company’s funds were outstanding without proper
documentation as of December 31, 2003. The Audit Committee
of the Company’s Board of Directors commenced a formal
internal investigation and retained independent legal counsel to
conduct the inquiry with the assistance of forensic accountants.
In January 2004, the Federal Bureau of Investigation also began
its own probe of the matter, culminating with the
February 5, 2004 arrest of the former Company employee, the
father of the former employee, and a business associate of the
former employee’s father, and the subsequent return of
federal grand jury indictments against the three individuals. In
early February 2004, the Company announced that its
investigation suggested that $25,000 of the
16
Company’s funds were involved in the scheme, and that
approximately $23,000 had been restored to the Company by the
time of the former employee’s resignation.
On February 9, 2004, the Company initiated civil litigation
in Placer County Superior Court, seeking to recover $2,000 and
other costs from five individuals and a private company in
connection with the fraudulent scheme. The defendants include
the three individuals who are the subjects of the federal
indictments, together with a partnership believed to be
controlled by certain of the individual defendants.
In February 2004, the Company also filed a fidelity claim with
its insurance carrier to recover the missing funds. On
October 26, 2004, the Company executed a release and
partial assignment of claims with the insurance company and
received an insurance recovery in the amount of $1,803. The
recovery was recognized in the fourth quarter of 2004 as a
non-operating gain in the Company’s consolidated financial
statements. The Company will recognize additional recoveries of
funds, if any, in future periods to the extent of its litigation
recoveries.
The Company’s independent legal counsel, with the
assistance of the forensic accountants, undertook an extensive
process to (i) investigate the facts and circumstances
giving rise to the misappropriation of the Company funds,
(ii) determine whether there were any similar or other
related transactions, and any Company employees involved in the
previously-identified transactions other than those known to the
Company at the commencement of the investigation,
(iii) determine the underlying mechanics in the origination
of the transactions and the circumstances under which detection
failed to occur, and (iv) evaluate internal controls
relating to the affected portion of the Company’s business.
The Audit Committee of the Board of Directors was advised by
independent legal counsel that:
|
|
|
| |
• |
All of the unauthorized transactions occurred in 2003 and
remained undetected until December 2003, consisting of thirteen
distinct principal transfers to and from the company beginning
in January 10, 2003, with additional transfers occurring in
the months of March, April, July, August and December 2003; |
| |
| |
• |
The unauthorized transactions were actively concealed by the
Company’s former employee in the Company’s books and
records; and |
| |
| |
• |
Independent legal counsel did not uncover any other similar
transactions nor any evidence that any other Company employee
intentionally participated in the unauthorized transactions. |
The Company, beginning in early January 2004, developed and
implemented a number of internal controls in 2004 in response to
the facts and circumstances then known. See
Item 9A – “Controls and Procedures” for
more information regarding the Company’s actions in 2004.
In the first quarter of 2004, the Company engaged in informal
discussion with a Division of the Securities and Exchange
Commission (the “SEC”), which has been in possession
of certain background information, regarding the facts and
circumstances of the unauthorized funds transfers. The Company
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
will provide additional information in response to further
requests, although there has been no communication since March
2004 with the Division of the SEC with which the Company engaged
in informal discussions regarding the misappropriation.
17
Item 4. Submission of Matters to a Vote of Security
Holders.
No matters were submitted to a vote of security holders during
the fourth quarter of 2004.
18
EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages and positions of the executive officers of the
Company and its subsidiaries as of March 4, 2005 are as
follows:
| |
|
|
|
|
|
|
| Name |
|
Age | |
|
Positions and Offices |
| |
|
| |
|
|
|
Kirk C. Doyle
|
|
|
51 |
|
|
Chairman of the Board of Directors (since 2003) |
| |
|
Brian H. Strom
|
|
|
62 |
|
|
President and Chief Executive Officer (since 1993) |
| |
|
Philip A. Grybas
|
|
|
56 |
|
|
Senior Vice President and Chief Financial Officer (since 2004) |
| |
|
Fred A. Arcuri
|
|
|
52 |
|
|
Senior Vice President and Chief Operating Officer –
SureWest Broadband (since 2001) |
| |
|
Robert M. Burger
|
|
|
48 |
|
|
Senior Vice President and Chief Operating Officer –
SureWest Wireless (since 2000) |
| |
|
Jay B. Kinder
|
|
|
58 |
|
|
Senior Vice President and Chief Operating Officer –
SureWest Telephone and SureWest Directories (since 2000) |
| |
|
Scott K. Barber
|
|
|
44 |
|
|
Vice President, Network Operations – SureWest
Telephone (since 2003) |
| |
|
Bill M. DeMuth
|
|
|
55 |
|
|
Vice President and Chief Technology Officer (since 2000) |
| |
|
Peter C. Drozdoff
|
|
|
49 |
|
|
Vice President, Marketing (since 2002) |
| |
|
Philip D. Germond
|
|
|
55 |
|
|
Vice President, Customer Operations – SureWest
Telephone (since 2002) and Vice President SureWest Long Distance
(since 1998) |
| |
|
Barbara J. Nussbaum
|
|
|
55 |
|
|
Vice President, Administration (since 2002) |
| |
|
Darla J. Yetter
|
|
|
44 |
|
|
Corporate Secretary (since 2003) |
| |
|
Laurel R. Dismukes
|
|
|
57 |
|
|
Assistant Corporate Secretary (since 2003) |
| |
|
Martin T. McCue
|
|
|
54 |
|
|
Assistant Corporate Secretary (since 2003) |
19
PART II
|
|
| Item 5. |
Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities. |
The Company’s common stock is traded on the Nasdaq National
Market (“NASDAQ”) under the symbol “SURW.”
As of March 4, 2005, there were approximately 9,917
beneficial owners based on the number of record holders of the
Company’s common stock. The following table indicates the
range of stock closing prices of the Company’s common stock
as reported on the NASDAQ, for each of the quarters indicated:
| |
|
|
|
|
|
|
|
|
| |
|
NASDAQ National Market | |
| |
|
| |
| |
|
High | |
|
Low | |
| |
|
| |
|
| |
|
March 31, 2003
|
|
|
$ 38.98 |
|
|
|
$ 22.66 |
|
|
June 30, 2003
|
|
|
$ 32.59 |
|
|
|
$ 26.43 |
|
|
September 30, 2003
|
|
|
$ 39.99 |
|
|
|
$ 29.44 |
|
|
December 31, 2003
|
|
|
$ 41.05 |
|
|
|
$ 37.20 |
|
|
March 31, 2004
|
|
|
$ 40.00 |
|
|
|
$ 25.65 |
|
|
June 30, 2004
|
|
|
$ 32.23 |
|
|
|
$ 25.25 |
|
|
September 30, 2004
|
|
|
$ 31.28 |
|
|
|
$ 25.50 |
|
|
December 31, 2004
|
|
|
$ 30.12 |
|
|
|
$ 27.30 |
|
The Company paid cash dividends on its common stock of
$0.25 per share for each quarter of 2004 and 2003. See
“Part II, Item 7 – Management’s
Discussion and Analysis of Financial Condition and Results of
Operations – Liquidity and Capital Resources” for
a discussion regarding restrictions on the payment of dividends.
During the year ended December 31, 2004, no equity
securities of the Company were sold by the Company which were
not registered under the Securities Act of 1933, as amended.
|
|
|
Equity Compensation Plan Information |
Information regarding the Company’s equity compensation
plans is incorporated herein by reference from the proxy
statement for the annual meeting of the Company’s
shareholders, to be filed pursuant to Regulation 14A within
120 days after the Company’s fiscal year-end of
December 31, 2004.
20
Item 6. Selected Financial Data
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
2000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(Amounts in thousands, except per share amounts) | |
|
Total operating revenues
|
|
$ |
211,763 |
|
|
$ |
195,121 |
|
|
$ |
185,849 |
|
|
$ |
163,485 |
|
|
$ |
143,194 |
|
|
Gain on sale of investment in cellular partnership (1)
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
201,294 |
|
|
Net income (loss)
|
|
$ |
(1,128 |
) |
|
$ |
645 |
|
|
$ |
11,249 |
|
|
$ |
10,317 |
|
|
$ |
125,793 |
|
|
Basic earnings (loss) per share (2)
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
|
$ |
0.67 |
|
|
$ |
8.06 |
|
|
Diluted earnings (loss) per share (2)
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
|
$ |
0.67 |
|
|
$ |
8.05 |
|
|
Extraordinary loss, net of tax (3)
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
(10,932 |
) |
|
Cumulative effect of change in accounting principle, net of
tax (4)
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
(3,273 |
) |
|
Extraordinary loss, net of tax, per share (basic and diluted)
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
(0.70 |
) |
|
Cumulative effect of change in accounting principle, net of tax,
per share, (basic and diluted)
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
(0.21 |
) |
|
Pro forma amounts assuming the accounting change is applied
retroactively:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income (loss) before extraordinary loss and cumulative effect of
change in accounting principle
|
|
$ |
(1,128 |
) |
|
$ |
645 |
|
|
$ |
11,249 |
|
|
$ |
10,317 |
|
|
$ |
139,998 |
|
| |
Net income (loss)
|
|
$ |
(1,128 |
) |
|
$ |
645 |
|
|
$ |
11,249 |
|
|
$ |
10,317 |
|
|
$ |
129,066 |
|
| |
Basic per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income (loss) before extraordinary loss and cumulative effect of
change in accounting principle
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
|
$ |
0.67 |
|
|
$ |
8.97 |
|
| |
Net income (loss)
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
|
$ |
0.67 |
|
|
$ |
8.27 |
|
| |
Diluted per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income (loss) before extraordinary loss and cumulative effect of
change in accounting principle
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
|
$ |
0.67 |
|
|
$ |
8.96 |
|
| |
Net income (loss)
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
|
$ |
0.67 |
|
|
$ |
8.26 |
|
|
Cash dividends per share (5)
|
|
$ |
1.00 |
|
|
$ |
1.00 |
|
|
$ |
1.00 |
|
|
$ |
1.00 |
|
|
$ |
1.00 |
|
|
Property, plant and equipment, at cost
|
|
$ |
715,718 |
|
|
$ |
646,740 |
|
|
$ |
576,579 |
|
|
$ |
524,505 |
|
|
$ |
469,389 |
|
|
Total assets
|
|
$ |
435,182 |
|
|
$ |
435,209 |
|
|
$ |
396,516 |
|
|
$ |
412,343 |
|
|
$ |
528,942 |
|
|
Long-term obligations
|
|
$ |
95,345 |
|
|
$ |
93,135 |
|
|
$ |
52,252 |
|
|
$ |
42,142 |
|
|
$ |
44,285 |
|
|
Shares of common stock used to calculate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Basic earnings (loss) per share (2)
|
|
|
14,531 |
|
|
|
14,522 |
|
|
|
14,728 |
|
|
|
15,326 |
|
|
|
15,610 |
|
| |
|
Diluted earnings per (loss) share (2)
|
|
|
14,531 |
|
|
|
14,539 |
|
|
|
14,795 |
|
|
|
15,387 |
|
|
|
15,630 |
|
|
|
| (1) |
On November 3, 2000, two of the Company’s subsidiaries
sold their collective 24% cellular partnership interest in
Sacramento – Valley Limited Partnership to Verizon
Wireless for approximately $236,150, resulting in a pre-tax gain
of $201,294. |
| |
| (2) |
Shares used in the computation of basic earnings per share are
based on the weighted average number of common shares and
restricted common stock units (“RSUs”) outstanding,
excluding unvested restricted common shares and unvested RSUs.
Shares and RSUs used in the computation of diluted earnings per |
21
|
|
|
share are based on the weighted average number of common shares
and RSUs outstanding, along with other potentially dilutive
securities outstanding in each period. Shares used in the
computation of diluted loss per share are based on the weighted
average number of common shares and RSUs outstanding and exclude
potential dilutive common shares, as their effect is
antidulitive. |
| |
| (3) |
In December 2000, the Company recognized an extraordinary loss
due to the discontinuation of accounting under
SFAS No. 71, “Accounting for the Effects of
Certain Types of Regulation.” Consequently, the Company
recorded an extraordinary non-cash charge of $10,932, which is
net of related tax benefits of $7,631, in 2000. |
| |
| (4) |
The Company changed its method of accounting, retroactive to
January 1, 2000, for up-front fees associated with
telecommunications service activation in accordance with Staff
Accounting Bulletin No. 101. The cumulative effect of
the change in prior years resulted in a charge to 2000 net
income of $3,273 (net of income taxes of $2,250). |
| |
| (5) |
Cash dividends per share are based on the actual dividends per
share, as declared by the Company’s Board of Directors. On
each date that the Company pays a cash dividend to the holders
of the Company’s common stock, the Company shall credit to
the holders of RSUs an additional number of RSUs equal to the
total number of whole RSUs and additional RSUs previously
credited to the holders multiplied by the dollar amount of the
cash dividend per share of common stock. Any fractional RSUs
resulting from such calculation shall be included in the
additional RSUs. |
22
|
|
| Item 7. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS. |
(Amounts in thousands, except selected operating metrics and
per share amounts)
Certain information included in the Company’s 2004 Annual
Report on Form 10-K, including that which relates to the
impact on future revenue sources and potential sharing
obligations of pending and future regulatory orders, continued
expansion of the telecommunications network and expected changes
in the sources of the Company’s revenue and its cost
structure resulting from its entrance into new communications
markets, are forward looking statements and are made pursuant to
the safe harbor provisions of the Securities Litigation Reform
Act of 1995. Such forward looking statements are subject to a
number of risks, assumptions and uncertainties that could cause
the Company’s actual results to differ from those projected
in such forward looking statements.
Important factors that could cause actual results to differ from
those set forth in the forward looking statements include, but
are not limited to: advances in telecommunications technology,
changes in the telecommunications regulatory environment,
changes in the financial stability of other telecommunications
providers who are customers of the Company, changes in
competition in markets in which the Company operates, adverse
circumstances affecting the economy in California in general,
and in the Sacramento, California Metropolitan area in
particular, the availability of future financing, changes in the
demand for services and products, new product and service
development and introductions, pending and future litigation,
internal control weaknesses and unanticipated changes in the
growth of the Company’s emerging businesses, including the
wireless, Internet, digital video and Competitive Local Exchange
Carrier operating entities.
Corporate Structure
SureWest Communications (the “Company”) is a holding
company with wholly-owned subsidiaries operating in the
Telecommunications (“Telecom”), Broadband and Wireless
segments. Prior to 2003, the Company reported its operating
results in two segments – Telecom and Wireless.
Beginning in 2003, the Company began reporting its operations in
segments as previously defined.
The 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 subsidiary,
SureWest Broadband, and SureWest Broadband Business Services,
which is comprised 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, long distance
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 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 service, 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.
23
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 the law firm of
Reed Smith LLP as independent legal counsel to conduct the
investigation with the assistance of forensic accountants (the
firm of Deloitte & Touche LLP was retained by Reed
Smith LLP). The investigation resulted from a preliminary
investigation by Company management, (commenced approximately
December 15, 2003 and concluded December 26, 2003)
triggered by the abrupt resignation of an employee in the
Company’s Corporate Finance Department, 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 $1,828
of Company funds were outstanding without proper documentation.
On October 26, 2004, the Company executed a release and
partial assignment of claims with the insurance company and
received an insurance recovery in the amount of $1,803, which
has been reflected as a non-operating gain in the Company’s
2004 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 was advised by
independent legal counsel that:
|
|
|
| |
• |
All of the unauthorized transactions occurred in 2003 and
remained undetected until December 2003, consisting of thirteen
distinct principal transfers to and from the Company beginning
on January 10, 2003, with additional transfers occurring in
the months of March, April, July, August and December 2003; |
| |
| |
• |
The unauthorized transactions were actively concealed by the
Company’s former employee in the Company’s books and
records; and |
| |
| |
• |
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
registered public accounting firm, advised the Audit Committee
on March 12, 2004, and delivered a formal letter to the
Audit Committee on March 26, 2004, 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. Other than the material weaknesses
described in their letter, Ernst & Young LLP did not
advise the Company of any other reportable conditions. The
Company performed substantial additional procedures designed to
ensure that the internal control deficiencies did not lead to
material misstatements in its 2003 consolidated financial
statements, notwithstanding the presence of the noted internal
control weaknesses.
24
During 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 cash
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 in the
second quarter of 2004, and contemplated additional actions
thereafter. Such initiatives related to:
|
|
|
| |
• |
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. During the second
quarter, the Company’s Board of Directors approved the
addition of six personnel in the Corporate Finance Department.
The Company has hired three of the six additional personnel and
has subsequently filled two of the three remaining positions.
Further evaluation will be conducted by the Chief Financial
Officer and, if deemed appropriate, with the assistance of a
third party, in continuing consultation with the Board. The
evaluation was completed in February 2005. See
Item 9A – “Controls and Procedures” for
further discussion; |
| |
| |
• |
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 (implemented in
part by the Company’s hiring of a Senior Internal Auditor
in July 2004); |
| |
| |
• |
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 retention in May 2004 of third-parties 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 |
| |
| |
• |
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
accounting policies and procedures manual was completed in draft
in October 2004, and completed in final form in February 2005. |
The Company has previously taken actions that it believes have
improved internal controls, including:
|
|
|
| |
• |
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 (“SEC”); |
| |
| |
• |
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
beginning in 2004 for all Company employees to review the Code
of Ethics and Business Conduct); and |
| |
| |
• |
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
improved modules in its new software and undertook in October
2004 revised physical verification and other procedures to
improve its accounting for property, plant and equipment).
However, as of December 31, 2004, Management concluded that
the material weakness relating to property, plant and equipment
had not been remediated. See Item 9A –
“Controls and Procedures” for further discussion. |
On April 15, 2004, Michael D. Campbell, the Company’s
Executive Vice President and Chief Financial Officer retired
from the Company. Brian H. Strom, President and Chief Executive
Officer of the Company, served as
25
interim Chief Financial Officer while the Company undertook the
search for a new Chief Financial Officer. Effective
October 4, 2004, Philip A. Grybas joined the Company as
Senior Vice President and Chief Financial Officer.
Mr. Grybas has more than 20 years of finance and
accounting experience in the telecommunications industry.
The Company filed an insurance claim to recover the missing
funds, for which payment was received in the amount of $1,803 in
October 2004, and has filed a civil lawsuit seeking to recover
its losses and other costs from five individuals and a private
company allegedly associated with the fraudulent scheme to
illegally transfer the Company’s funds to outside accounts.
The Company will recognize a recovery of funds, if any, in
future periods to the extent of additional litigation recoveries.
The Company, in early 2004, engaged in informal discussions with
the SEC, which has been in possession of certain background
information, regarding the facts and circumstances of the
unauthorized funds transfers. The Company 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 will
provide additional information if so requested.
In the third quarter of 2004, the Company identified certain
deficiencies related to its Information Technology general and
application controls in its enterprise planning and accounting
software. In response to these deficiencies, during the third
quarter of 2004 the Company engaged an outside consulting firm
to design and implement changes to the controls in an effort to
remediate the identified deficiencies. Although the Company has
made progress in its remediation effort in 2004, efforts are
continuing in 2005 to remediate the deficiencies. See
Item 9A – “Controls and Procedures for
further discussion regarding Information Technology general and
application controls.
The Company performed a number of procedures to compensate for
the identified material weaknesses in internal controls to
permit its certifying officers to state that the Company’s
financial statements fairly presented in all material respects
the Company’s financial condition, results of operation,
and cash flows in 2003. Specifically, with respect to the
control of cash and investments, the Company performed a
comprehensive reconciliation of all cash and investment accounts
for each month during 2003 and 2004 (in addition to procedures
performed in connection with prior years in connection with the
Audit Committee’s special investigation).
26
Results of Operations
Consolidated Overview
The tables below reflect certain financial data (on a
consolidated and segment basis) and selected operating metrics
for each reportable segment as of and for the years ended
December 31, 2004, 2003 and 2002. Both the financial data
and the selected operating metrics demonstrate the increasing
importance of the Company’s Broadband and Wireless segments.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Financial Data | |
| |
|
|
|
% Change | |
| |
|
|
|
| |
| |
|
|
|
2004 vs. | |
|
2003 vs. | |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Operating revenues (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Telecom
|
|
$ |
141,086 |
|
|
$ |
138,924 |
|
|
$ |
149,679 |
|
|
|
2 |
% |
|
|
(7 |
)% |
| |
Broadband
|
|
|
39,416 |
|
|
|
29,051 |
|
|
|
12,945 |
|
|
|
36 |
|
|
|
124 |
|
| |
Wireless
|
|
|
31,261 |
|
|
|
27,146 |
|
|
|
23,225 |
|
|
|
15 |
|
|
|
17 |
|
| |
Total operating revenues
|
|
|
211,763 |
|
|
|
195,121 |
|
|
|
185,849 |
|
|
|
9 |
|
|
|
5 |
|
|
Operating income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Telecom
|
|
|
49,937 |
|
|
|
47,598 |
|
|
|
51,839 |
|
|
|
5 |
|
|
|
(8 |
) |
| |
Broadband
|
|
|
(31,340 |
) |
|
|
(16,312 |
) |
|
|
(11,180 |
) |
|
|
92 |
|
|
|
46 |
|
| |
Wireless
|
|
|
(17,278 |
) |
|
|
(23,539 |
) |
|
|
(24,969 |
) |
|
|
(27 |
) |
|
|
(6 |
) |
| |
Total operating income (loss)
|
|
|
1,319 |
|
|
|
7,747 |
|
|
|
15,690 |
|
|
|
(83 |
) |
|
|
(51 |
) |
|
Net income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Telecom
|
|
|
28,322 |
|
|
|
26,565 |
|
|
|
33,634 |
|
|
|
7 |
|
|
|
(21 |
) |
| |
Broadband
|
|
|
(18,627 |
) |
|
|
(10,983 |
) |
|
|
(6,715 |
) |
|
|
70 |
|
|
|
64 |
|
| |
Wireless
|
|
|
(10,823 |
) |
|
|
(14,937 |
) |
|
|
(15,670 |
) |
|
|
(28 |
) |
|
|
(5 |
) |
| |
Total net income (loss)
|
|
|
(1,128 |
) |
|
|
645 |
|
|
|
11,249 |
|
|
|
(275 |
)% |
|
|
(94 |
)% |
|
|
| (1) |
External customers only |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Selected Operating Metrics | |
| |
|
|
|
% Change | |
| |
|
|
|
| |
| |
|
|
|
2004 vs. | |
|
2003 vs. | |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Telecom
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
ILEC access lines
|
|
|
131,905 |
|
|
|
136,365 |
|
|
|
137,240 |
|
|
|
(3 |
)% |
|
|
(1 |
)% |
| |
Long distance lines
|
|
|
47,512 |
|
|
|
42,911 |
|
|
|
39,654 |
|
|
|
11 |
|
|
|
8 |
|
|
Broadband
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
DSL subscribers (1)
|
|
|
22,442 |
|
|
|
19,882 |
|
|
|
15,648 |
|
|
|
13 |
|
|
|
27 |
|
| |
FTTP subscribers (2)
|
|
|
15,689 |
|
|
|
11,101 |
|
|
|
5,646 |
|
|
|
41 |
|
|
|
97 |
|
| |
Revenue-generating units (3)
|
|
|
36,336 |
|
|
|
25,486 |
|
|
|
13,271 |
|
|
|
43 |
|
|
|
92 |
|
|
Wireless
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Subscribers
|
|
|
52,657 |
|
|
|
46,724 |
|
|
|
40,454 |
|
|
|
13 |
% |
|
|
15 |
% |
|
|
| (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 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. |
27
Operating revenues from external customers in the Telecom
segment increased $2,162 compared to 2003. Local service revenue
increased $6,197 primarily due to changes in accounting
estimates related to SureWest Telephone’s shareable
earnings obligations (for a more detailed discussion see
Regulatory Matters within the Telecom Segment Results
of Operations section below). In addition, Directory
advertising revenue increased $1,196, resulting primarily from
increases in (i) advertising rates and (ii) programs
and bundled packages purchased by existing customers. These
increases to operating revenues were offset, in part, by
decreases in local and network access service due to competition
from wireless and wireline competitors and an approximate 3%
decline in access lines.
While the Telecom segment continues to generate a majority of
the Company’s revenues and yield significant cash flows and
net income, the Company believes that the results of the Telecom
segment in recent years support, in part, the Company’s
decision to develop its other business segments.
Broadband operating revenues increased $10,365 and $16,106 in
2004 and 2003, respectively, as compared to each prior year
period. During 2004, the Broadband segment experienced a 13%
increase in the number of DSL subscribers compared to 2003. More
significantly, this segment had 15,689 FTTP subscribers and
36,336 Revenue-generating units at December 31, 2004 within
the broadband residential services business. While continuing to
produce significant revenue increases, the expansion of the
broadband residential services has and will continue to require
significant capital and expense commitments. Accordingly, the
Broadband segment incurred larger year-over-year operating and
net losses in the years 2004 and 2003.
The Wireless segment reported increases in operating revenues of
$4,115 and $3,921 in 2004 and 2003, respectively, compared to
each prior year period. The number of wireless subscribers
increased to 52,657 at December 31, 2004, representing a
13% increase for the year 2004. SureWest Wireless established
its market share in the Sacramento market in large part by
promoting an unlimited flat rate regional calling plan. Wireless
customer acquisition has historically been most active during
the December holiday season, and the Company has always been
active in sales and marketing at that time. Throughout 2003 and
2004, SureWest Wireless initiated a number of new service
options for customers, including additional regional plans, an
unlimited national plan, a family plan and new vertical services
(such as wireless data capabilities), which have attracted new
customers. Evolution of the marketplace has prompted SureWest
Wireless to open five retail stores in its service area with
plans to open a sixth store in late 2005. SureWest Wireless is
also seeking to expand its service penetration among major
accounts in 2005, while seeking to reduce customer turnover
(“churn”) and to increase revenues from its customer
base.
The Company’s consolidated operating expenses increased
$26,944 in 2004 compared to the prior year. This increase was
due in part to an increase in cost of services and products
expense (exclusive of depreciation and amortization) associated
with a larger number of subscribers and services within the
Broadband and Wireless segments. General and administrative
expenses increased as a result of (i) consulting and legal
fees due to the treasury investigation, audit services and
Sarbanes-Oxley implementation and compliance and (ii) an
increase in stock-based compensation. The Company experienced an
approximate 2% increase in full-time equivalent employees,
resulting in increases to salaries and wages, worker’s
compensation and medical insurance costs.
Further, on December 6, 2004, the Company initiated a
voluntary enhanced early retirement program (the “REWARD
program”). The REWARD program was offered to certain
eligible employees across all business units. In addition to
retirement benefits, eligible employees will receive enhanced
medical benefits for a specified period of time. As of
December 31, 2004, 59 employees had accepted the
REWARD program. Accordingly, the Company recorded $3,768 in
operating expenses related to the REWARD program during the
fourth quarter of 2004. Additionally, subsequent to
December 31, 2004, 13 additional employees accepted the
REWARD program. As a result, the Company will record
approximately $830 in additional operating expense during the
first quarter of 2005.
28
The Company’s consolidated depreciation and amortization
expense decreased $3,874 in 2004. This decrease was primarily
due to a change in accounting estimate, predominately increasing
the estimated useful lives of certain assets. The asset life
extension resulted from the adoption of new technologies that
enable the Company to maximize the use of 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 evaluated the
appropriateness of its estimated useful lives of certain
property, plant and equipment in both the Telecom and Wireless
segments. Based on this evaluation, 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. The changes were made
effective January 1, 2004. The Company’s revisions
have been supported by an assessment and report from an
independent third party with expertise in this area that found
the revisions to be reasonable in light of the Company’s
plans and useful life estimates in comparable businesses.
During 2004, this change in estimate decreased consolidated
depreciation expense by $10,842 and consolidated net loss by
$7,524 ($0.52 per share). This change in accounting
estimate decreased Telecom depreciation expense and increased
Telecom income from operations by $5,459 in 2004. In addition,
Wireless depreciation expense and loss from operations decreased
by approximately $5,383 in 2004 as a result of this change in
accounting estimate. This decrease was offset by the effects of
additions to property, plant and equipment, primarily within the
Broadband segment.
During 2005, the Company plans to implement a strategy for
driving efficiency and long-term growth through cost reduction
and workforce consolidation. This strategic plan entails a
reduction of operating expenses by approximately 6 percent
through a realignment of its organizational structure in order
to focus on its primary customer segments. The Company also
expects to eliminate functional redundancies, combine duplicate
or overlapping work areas, consolidate separate billing and
other systems and reduce overall labor costs.
|
|
|
Adjustments and Reclassification |
During the Company’s financial statement closing process
for the year ended December 31, 2003, certain matters were
identified related to prior financial reporting periods that
necessitated the recording of adjustments to the Company’s
consolidated financial statements. Such adjustments pertained
principally to property, plant and equipment, and management
believes that weaknesses in the Company’s internal controls
caused the errors that resulted in these adjustments. The
Company does not believe any of the aforementioned amounts are
material, individually or in the aggregate, to the respective
prior annual periods based on both quantitative factors,
including the trend of operating results, nor does it believe
the prospective correction of such amounts during the quarter
ended December 31, 2003 is material to the Company’s
2003 consolidated results of operations based on both
quantitative and qualitative factors, including the trend of
operating results. The prospective correction of the
aforementioned amounts relating to prior periods reduced the
Company’s 2003 consolidated net income by $1,603, or
$0.11 per basic and diluted share, and would have reduced
the Company’s 2002 and 2001 consolidated net income by
$796, or $0.05 per basic and diluted share, and $217, or
$0.01 per basic and diluted share, respectively, had such
errors been corrected in the periods in which they originated.
Certain amounts in the Company’s 2003 and 2002 consolidated
financial statements have been reclassified to conform to the
presentation of the Company’s 2004 consolidated financial
statements.
The Company recognizes revenue when (i) persuasive evidence
of an arrangement between the Company and the customer exists,
(ii) delivery of the product to the customer has occurred
or service has been provided to the customer, (iii) the
price to the customer is fixed or determinable and
(iv) collectibility of the sales price is reasonably
assured. Revenues based on a flat fee, derived principally from
local telephone, dedicated network access, data communications,
Internet access service, residential/business broadband service
and non-contract wireless services, are billed in advance and
recognized in subsequent periods when the services are provided.
29
Contract wireless services are billed in arrears. Revenues based
on usage, derived primarily from network access, roaming and
long distance services, are recognized monthly as services are
provided. Incremental direct costs of telecommunications service
activation are charged to expense in the period in which they
are incurred.
Directory advertising revenues and costs related to publishing
and distributing directories are recognized using the
“circulation period” method, under which revenues and
related costs are recognized ratably over the expected useful
life of the directory, generally one year from the date of
publication. For all other operations, revenue is recognized
when products are delivered or services are rendered to
customers.
Effective July 1, 2003, the Company began applying the
Financial Accounting Standards Board’s (“FASB”)
Emerging Issues Task Force (“EITF”) Issue
No. 00-21 to all wireless handset sales below cost, which
approximates fair value in the absence of an activation
“subsidy,” when it receives an up-front fee of any
kind (e.g., a service activation fee). The application of EITF
Issue No. 00-21 resulted in the immediate recognition of
all or a portion of such up-front fees as equipment sales
revenue. Additionally, when the Company activates wireless
service for a customer, but does not concurrently provide the
customer with a handset, any up-front fees received continue to
be deferred and amortized over the expected term of the customer
relationship. The Company provides a general right of return
within the first 30 days of service for a 100% refund of
the handset cost. The estimated equipment return allowance
associated with this right of return is estimated based on
historical experience.
2004 versus 2003
Segment Results of Operations
Telecom
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
$Change | |
|
%Change | |
| |
|
| |
|
| |
|
| |
|
| |
|
Local service
|
|
$ |
69,560 |
|
|
$ |
63,363 |
|
|
$ |
6,197 |
|
|
|
10 |
% |
|
Network access service
|
|
|
46,161 |
|
|
|
51,286 |
|
|
|
(5,125 |
) |
|
|
(10 |
) |
|
Directory advertising
|
|
|
16,283 |
|
|
|
15,087 |
|
|
|
1,196 |
|
|
|
8 |
|
|
Long distance service
|
|
|
5,184 |
|
|
|
5,098 |
|
|
|
86 |
|
|
|
2 |
|
|
Other
|
|
|
3,898 |
|
|
|
4,090 |
|
|
|
(192 |
) |
|
|
(5 |
) |
|
Total operating revenues from external customers
|
|
|
141,086 |
|
|
|
138,924 |
|
|
|
2,162 |
|
|
|
2 |
|
|
Intersegment revenues
|
|
|
25,814 |
|
|
|
23,576 |
|
|
|
2,238 |
|
|
|
9 |
|
|
Operating expenses *
|
|
|
91,736 |
|
|
|
83,645 |
|
|
|
8,091 |
|
|
|
10 |
|
|
Depreciation and amortization
|
|
|
25,227 |
|
|
|
31,257 |
|
|
|
(6,030 |
) |
|
|
(19 |
) |
|
Operating income
|
|
|
49,937 |
|
|
|
47,598 |
|
|
|
2,339 |
|
|
|
5 |
|
|
Net income
|
|
$ |
28,322 |
|
|
$ |
26,565 |
|
|
$ |
1,757 |
|
|
|
7 |
% |
|
|
| * |
Exclusive of depreciation and amortization |
Operating revenues from external customers in the Telecom
segment increased $2,162 compared to 2003. Local service revenue
increased $6,197 primarily due to changes in accounting
estimates related to SureWest Telephone’s shareable
earnings obligations, which are discussed in more detail below.
In addition, Directory advertising revenue increased $1,196,
resulting primarily from increases in (i) advertising rates
and (ii) programs and bundled packages purchased by
existing customers. These increases to operating revenues were
offset, in part, by decreases in local and network access
service due to competition from wireless and wireline
competitors and an approximate 3% decline in access lines.
Revenues within the Telecom segment are also affected by
SureWest Telephone’s shareable earnings obligations. The
increase in revenues in 2004 is attributable, in part, to a
settlement agreement approved by the CPUC in November 2004 that
resulted in SureWest Telephone recording $2,948 in local
revenues due to a change in accounting estimate (for a more
detailed discussion regarding the settlement agreement see the
Regulatory Matters section below). Further as a result of
a decrease in revenues subject to regulation and increased
operating
30
expenses during 2004, as described below, SureWest
Telephone’s provision related to its estimated interstate
and intrastate shareable earnings obligations decreased, which
resulted in increased revenue of $3,628 during 2004 compared to
2003. In addition, SureWest Telephone had changes in estimates
for shareable earnings obligations as a result of periodic cost
separation studies. During 2004, 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 increased the
Telecom segments’ revenues by $1,430 and decreased net loss
by $922. For the year ended December 31, 2003, similar
changes in accounting estimates decreased Telecom segment
revenues by $29 and net income by $11 (no effect on earnings per
share). In addition, SureWest Telephone’s network access
revenues decreased during 2004 compared to 2003 due partially to
an agreement SureWest Telephone entered into during 2003, which
provided a $1,950 refund from another telecommunications company
for a payment made by SureWest Telephone in 2001 related to
interstate shareable earnings obligations. For a more detailed
discussion about this agreement, see the Regulatory Matters
section below.
The Company adopted SEC Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial
Statements, effective January 1, 2000, which requires
non-recurring revenues associated with service and activation
charges to be deferred. The cumulative effect of this change in
accounting principle on the Company resulted in a charge to
income of $3,273, net of tax, ($0.21 per share) in 2000.
For the years ended December 31, 2004 and 2003, the Telecom
segment recognized $130 and $413, respectively, of revenues that
were in the cumulative effect adjustment as of January 1,
2000. The effect of those revenues was to decrease net loss and
increase net income by $90 (net of income taxes of $40) and $160
(net of income taxes of $253) for the years ended
December 31, 2004 and 2003, respectively.
Operating expenses for the Telecom segment increased $8,091
compared to 2003 due in part to the REWARD program, which was
offered to certain eligible employees during the fourth quarter
of 2004 and is described in the Consolidated Overview
section above. Cost of services and products (exclusive of
depreciation and amortization) increased $3,860, or 8%, during
2004 due primarily to increases in (i) Federal Universal
Service Fund expense, (ii) SureWest Directories outside
sales, as well as a two-month delay in the release of the 2003
Sacramento Directory and (iii) network operations as a
result of providing video over the existing in-territory network.
Customer operations and selling expense increased $724, or 4%,
during 2004 due primarily to sales expense due to promotion of
SureWest Telephone’s products. This increase was offset by
a decrease in product management and operator services headcount.
General and administrative expense increased $3,507, or 17%, due
primarily to increases in (i) consulting and legal fees due
to the treasury investigation, audit services and Sarbanes-Oxley
implementation and compliance, (ii) an increase in
stock-based compensation expense, resulting from an increase in
the issuance of restricted stock awards and restricted stock
units and (iii) the size of the Company’s workforce,
resulting in an increase in salaries and wages, worker’s
compensation and medical insurance costs.
Depreciation and amortization decreased $6,030, or 19%, compared
to 2003. This decrease was due primarily to a change in
accounting estimate during the first quarter of 2004, resulting
from the adoption of certain new technologies, 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 decreased depreciation expense by $5,459
for the year ended December 31, 2004.
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 in July 2002. In April 2004,
WorldCom emerged from federal bankruptcy protection. Settlement
of the Company’s pending pre-bankruptcy claims against
WorldCom remain subject to the distribution terms, applicable to
creditors, contained in WorldCom’s plan of reorganization.
As of December 31, 2004, the amount of any settled pre-
31
bankruptcy claims could not be determined. Through
December 31, 2004, obligations owed by WorldCom to the
Company for post-petition services have been paid on a timely
basis.
Revenues from services subject to comprehensive regulation
constituted approximately 55% of the Company’s total
operating revenues in 2004. Such revenues, which include local
and network access services, are derived from various sources,
including:
|
|
|
| |
• |
business and residential subscribers, for basic exchange
services; |
| |
• |
surcharges, mandated by the California Public Utilities
Commission (“CPUC”); |
| |
• |
long distance carriers, for network access service; |
| |
• |
competitive access providers and subscribers, for network access
services: |
| |
• |
interstate pool settlements, from the National Exchange Carrier
Association (“NECA”); |
| |
• |
support payments from the Universal Service Fund; and |
| |
• |
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 $343 and $650 for the years
ended December 31, 2003 and 2002, respectively, through
reductions of revenues. The Company did not identify any
interstate shareable earnings obligations at SureWest Telephone
during the year ended December 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 years ended December 31,
2004, 2003 or 2002. During 2003, the Company entered into an
agreement to recover the amount paid to a telecommunications
company in 2001. Therefore, the Company recognized an increase
in network access service revenues of $1,950 during 2003. The
Company is currently seeking a similar refund from another
telecommunications company, which later filed for bankruptcy
protection under Chapter 11 of the Bankruptcy Code. 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.
In May 2002, the D.C. Circuit Court of Appeals (the
“Court”) issued a decision in a case involving ACS of
Anchorage. The Court determined that a tariff filed properly
under Section 204 “streamlined” procedures and
allowed to go into effect without suspension is deemed lawful,
and the carrier is not subsequently obligated to pay
32
refunds for earnings higher than the permitted rate of return as
prescribed by the FCC for that monitoring period. Subsequent to
the Court’s decision, certain telecommunication companies
filed a petition for rehearing. In August 2002, the petitions
for rehearing were denied by the Court, and later that month the
Court’s order became effective. For the monitoring periods
1999 through 2001, SureWest Telephone filed tariffs pursuant to
the streamlined procedures and such tariffs were not suspended
or investigated. Consequently, during 2002, SureWest Telephone
changed its estimate for a portion of its interstate shareable
earnings obligations related to those monitoring periods. For
the year ended December 31, 2002, this change in accounting
estimate increased the Company’s revenues by $5,092 and net
income by $3,065 ($0.21 per share).
In 1999, SBC 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. The CHCF is a program designed by the
CPUC to establish a fair and equitable local rate structure and
to reduce any disparity in the rates charged by telephone
companies serving high-cost areas. The CHCF was due to expire on
January 1, 2005. However, on September 28, 2004, the
Governor of California signed SB1276 into law, which amended the
existing legislation and extended the expiration date to
January 1, 2009. 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
CPUC’s 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 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, and it was
initially 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 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 $3,285 and $1,750 relating to estimated
intrastate shareable earnings obligations during the years ended
December 31, 2003 and 2002, respectively (none in 2004).
The Company has been involved in a proceeding at the CPUC that
has considered the continued need for certain sharing
requirements in the intrastate jurisdiction and, in connection
with that review, has also considered the issue of whether the
Company overearned in the intrastate jurisdiction in recent
monitoring periods and, if so, the amount of such overearnings
that should be shared with customers. On July 27, 2004, the
Company entered into a settlement agreement with the other
parties in the proceeding, the ORA and The Utility Reform
Network (“TURN”), to resolve all issues in the
proceeding. In November 2004 the CPUC approved the settlement
agreement. The settlement agreement resolves existing sharing
obligations and related earnings issues for the monitoring
periods 2000 through 2004, puts into place a surcredit mechanism
for the amount of the settlement, and suspends the requirement
for any intrastate sharing for monitoring periods from
January 1, 2005 through at least December 31, 2010.
The settlement agreement resulted in SureWest Telephone
recognizing an increase in
33
local revenues of $2,948 due to a change in accounting estimate.
This increase in revenue resulted in a decrease of the
Company’s net loss by $2,046 ($0.14 per share) during
2004.
In accordance with the November 2004 settlement agreement,
SureWest Telephone will return approximately $6,500, plus
interest at an annual contractual rate of 2.34% and imputed rate
of 3.15%, to its customers in the form of a surcredit over a
period of four years beginning January 1, 2005 and will pay
a one-time customer refund of $2,600, which includes an annual
imputed interest rate of 3.15% (no stated contractual interest
rate), in the form of a surcredit over two years beginning
January 1, 2005 to settle the monitoring periods 2000 to
2004. At December 31, 2004, the aggregate contractual
shareable earnings obligation for these surcredits was $9,242
(which is net of an unamortized discount pertaining to imputed
interest of $524 at such date). Future payments for these
obligations are $3,092 in 2005 and 2006 and $1,791 in 2007 and
2008. Further, commencing January 1, 2007, SureWest
Telephone shall implement a permanent annual consumer dividend
of $1,300 to end-users receiving SureWest Telephone services
subject to sharing on or after that date; however, this consumer
dividend is subject to reduction based upon the results of other
pending regulatory proceedings.
Beginning in January 2002, SureWest Telephone began paying a
customer refund for intrastate shareable earnings obligations
relating to the years 1998 and 1999. A portion of the
customers’ intrastate service charges was returned in the
form of a surcredit beginning in January 2002 and ending in
January 2003, totaling approximately $4,605 (of which $294 was
returned during 2003). Such refunds were recorded as a reduction
of the Company’s estimated intrastate shareable earnings
obligations.
Beginning in November 2003, SureWest Telephone began paying a
customer 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 2004). Such refunds were
recorded as a reduction of the Company’s estimated
intrastate shareable earnings obligations.
As a result of periodic cost separation studies, SureWest
Telephone changed its estimates for a portion of its interstate
and intrastate shareable earnings obligations and certain NECA
CCL accounts receivable balances during the years ended
December 31, 2004, 2003 and 2002. For the year ended
December 31, 2004, these changes in accounting estimates
decreased the Company’s revenues by $1,430 and increased
net loss by $992 ($0.07 per share). For the year ended
December 31, 2003, similar changes in accounting estimates
decreased the Company’s revenues by $29 and net income by
$11 (no effect on earnings per share). For the year ended
December 31, 2002, similar changes in accounting estimates
decreased the Company’s revenues by $1,115 and net income
by $671 ($0.05 per share).
As of December 31, 2004, the Company’s consolidated
balance sheet reflected aggregate liabilities of $396 relating
to SureWest Telephone’s estimated interstate 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 shareable earnings
obligations could change in the near term, and the amounts
involved could be material.
34
Broadband
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
$Change | |
|
%Change | |
| |
|
| |
|
| |
|
| |
|
| |
|
Internet service
|
|
$ |
16,679 |
|
|
$ |
15,984 |
|
|
$ |
695 |
|
|
|
4 |
% |
|
Residential Broadband service
|
|
|
17,077 |
|
|
|
9,370 |
|
|
|
7,707 |
|
|
|
82 |
|
|
Business Broadband service
|
|
|
5,660 |
|
|
|
3,697 |
|
|
|
1,963 |
|
|
|
53 |
|
|
Total operating revenues from external customers
|
|
|
39,416 |
|
|
|
29,051 |
|
|
|
10,365 |
|
|
|
36 |
|
|
Intersegment revenues
|
|
|
1,784 |
|
|
|
1,683 |
|
|
|
101 |
|
|
|
6 |
|
|
Operating expenses *
|
|
|
61,143 |
|
|
|
42,538 |
|
|
|
18,605 |
|
|
|
44 |
|
|
Depreciation and amortization
|
|
|
11,397 |
|
|
|
4,508 |
|
|
|
6,889 |
|
|
|
153 |
|
|
Operating loss
|
|
|
(31,340 |
) |
|
|
(16,312 |
) |
|
|
15,028 |
|
|
|
92 |
|
|
Net loss
|
|
$ |
(18,627 |
) |
|
$ |
(10,983 |
) |
|
$ |
7,644 |
|
|
|
70 |
% |
|
|
| * |
Exclusive of depreciation and amortization |
Operating revenues from external customers in the Broadband
segment increased $10,365 compared to 2003. The increase in
Broadband revenues is due in a large part to (i) a 41%
increase in the number of FTTP subscribers for broadband
residential services, (ii) a 13% increase in the
residential and business DSL subscriber count base and
(iii) the continued expansion of the Business Broadband
Services, resulting in a 19% increase in ending access lines.
Total operating expenses for the Broadband segment increased
$18,605 compared to 2003 due in part to the REWARD program,
which was offered to certain eligible employees during the
fourth quarter of 2004 and is described in the Consolidated
Overview section. Cost of services and products (exclusive
of depreciation and amortization) increased $10,147, or 41%,
compared to 2003 due primarily to (i) an increase in
programming and transport costs related to the 41% increase in
FTTP subscriber growth of broadband residential services,
(ii) an increase in repairs and maintenance expense
resulting from an increase in outside plant and (iii) an
increase in engineering and network administration expenses
resulting from an increase in subscriber and network growth.
Customer operations expense increased $2,908, or 38%, compared
to 2003 due primarily to an increase in (i) sales and
advertising costs due to the increase in marketable homes passed
and the expansion of bundled services into Roseville, Lincoln
and Elk Grove, California and (ii) customer service costs
resulting from increased call volume caused by the FTTP
subscriber growth. General and administrative expense increased
$5,550, or 55%, compared to 2003 due primarily to increases in
(i) consulting and legal fees due to the treasury
investigation, audit services and Sarbanes-Oxley implementation
and compliance, (ii) an increase in stock-based
compensation expense, resulting from an increase in the issuance
of restricted stock awards and restricted stock units and
(iii) the size of the Company’s workforce, resulting
in an increase in salaries and wages, worker’s compensation
and medical insurance costs. Depreciation and amortization
increased $6,889, or 153%, compared to 2003 primarily due to
continued network build-out within the residential broadband
service territories.
During 2003, the Company entered into a 20-year nonmonetary
transaction with a third party involving the exchange of certain
fiber optic capacity and collocation rights. This transaction
provides the Company with access and rights to certain
collocation facilities and cell site locations, which were
previously inaccessible due to unreasonably high entrance costs.
The collocation rights provide access to additional network
connections to the Company while the cell site locations
strengthen the Company’s existing cellular network in key
areas. Because this nonmonetary transaction did not represent
the culmination of an earnings process, no revenues or expenses
have been, or will be, recorded by the Company pursuant to this
transaction. In addition, there was no indicated loss on this
exchange of productive rights.
35
In the normal course of business, the Company entered into
certain other nonmonetary transactions during 2004 that are not
material, either individually or in the aggregate, to the
Company’s consolidated financial statements.
Wireless
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
$Change | |
|
%Change | |
| |
|
| |
|
| |
|
| |
|
| |
|
Wireless revenues from external customers
|
|
$ |
31,261 |
|
|
$ |
27,146 |
|
|
$ |
4,115 |
|
|
|
15 |
% |
|
Intersegment revenues
|
|
|
1,699 |
|
|
|
744 |
|
|
|
955 |
|
|
|
128 |
|
|
Operating expenses *
|
|
|
38,266 |
|
|
|
34,724 |
|
|
|
3,542 |
|
|
|
10 |
|
|
Depreciation and amortization
|
|
|
11,972 |
|
|
|
16,705 |
|
|
|
(4,733 |
) |
|
|
(28 |
) |
|
Operating loss
|
|
|
(17,278 |
) |
|
|
(23,539 |
) |
|
|
(6,261 |
) |
|
|
(27 |
) |
|
Net loss
|
|
$ |
(10,823 |
) |
|
$ |
(14,937 |
) |
|
$ |
(4,114 |
) |
|
|
(28 |
)% |
|
|
| * |
Exclusive of depreciation and amortization |
Operating revenues from external customers in the Wireless
segment increased $4,115 compared to 2003 due primarily to
(i) a 13% increase in Wireless subscriber base,
(ii) an increase in roaming revenues due to an increase in
minutes of use, (iii) an increase in equipment revenue due
to increases in subscribers, average handset prices and the
number of handsets sold and (iv) the introduction of
bundled features, including voicemail and text and picture
messaging.
Total operating expenses for the Wireless segment increased
$3,542 compared to 2003 due in part to the REWARD program, which
was offered to certain eligible employees during the fourth
quarter of 2004 and is described in the Consolidated Overview
section. Cost of services and products (exclusive of
depreciation and amortization) expense increased $2,901, or 15%,
compared to 2003 primarily due to increases in (i) handset
costs and interconnection expenses due to an increase in the
subscriber base and the number of handsets sold, (ii) tower
rents due to an increase in cell sites and (iii) network
operations expense due to an increase in labor expense as a
result of an increase in headcount and a decrease in capitalized
labor. This increase was offset by a decrease in roaming
expenses due to lower roaming rates. General and administrative
expense increased $522, or 14%, compared to 2003 due primarily
to increases in (i) consulting and legal fees due to the
treasury investigation, audit services and Sarbanes-Oxley
implementation and compliance, (ii) an increase in
stock-based compensation expense, resulting from an increase in
the issuance of restricted stock awards and restricted stock
units and (iii) the size of the Company’s workforce,
resulting in an increase in salaries and wages, worker’s
compensation and medical insurance costs.
Depreciation and amortization decreased $4,733, or 28%, compared
to 2003. This decrease was due primarily to a change in
accounting estimate during the first quarter of 2004, resulting
from the adoption of certain new technologies which increased
the estimated useful lives of base stations, towers and network
software by one to eight years. This change in accounting
estimate decreased depreciation expense by $5,383 for the year
ended December 31, 2004. This decrease was offset by the
effects of continuing additions of towers, base station
equipment, digital switch assets and network software.
Effective November 24, 2003, the FCC mandated that wireless
carriers provide for local number portability (“LNP”).
LNP allows subscribers to keep their wireless phone numbers
while switching to a different service provider. Although the
Company has experienced favorable porting activity, the
implementation of LNP has not had a material effect on the
Company’s consolidated financial position or results of
operations.
36
Non-Operating Items
|
|
|
Interest Income and Expense, Net |
Consolidated interest income decreased $105, or 34%, compared to
2003 due to lower average invested balances. Interest expense
increased $258, or 6%, compared to 2003, due to a decrease in
capitalized interest. A decline in capital expenditures for
plant under construction and an increase in the turnover rate of
construction projects contributed to lower capitalized interest
costs.
|
|
|
Other Income (Expense), Net |
In December 2003, the Company discovered certain irregular bank
transactions and deposits in a routine investigation following
the abrupt resignation of the Company’s Treasury Analyst.
Immediately following the Company’s initial review that
uncovered these irregularities, the Company broadened its review
of the investment and cash operations, and a special corporate
investigation was launched by the Audit Committee and the Board
of Directors, which engaged independent legal counsel and
forensic accountants. The investigations revealed concealed
illegal transfers in violation of the Company’s investment
and cash management policies. The Company has concluded that the
irregularities were limited to the 2003 calendar year. The
investigation suggests that as much as $25,000 may have been
involved in the scheme. Nearly all of the funds have been
recovered; however, approximately $1,828 remained outstanding as
of December 31, 2003 and was reflected as a non-operating
loss in the Company’s 2003 consolidated financial
statements. On October 26, 2004, the Company received an
insurance recovery in the amount of $1,803, which has been
reflected as a non-operating gain in the Company’s 2004
consolidated financial statements. In January 2004, the Federal
Bureau of Investigation (“FBI”) launched its own probe
into the illegal funds transfer, and in February 2004,
indictments were returned against three individuals, including
the Company’s former Treasury Analyst, on charges of mail
fraud, conspiracy and money laundering. The Company has filed a
civil lawsuit seeking to recover the misappropriated funds and
other costs from five individuals and a private company
allegedly associated with the fraudulent scheme to illegally
transfer the Company’s funds to outside accounts. The
Company will recognize a recovery of the funds, if any, in
future periods to the extent of additional litigation recoveries.
Income taxes decreased $1,519, or 149%, compared to 2003 due to
a corresponding decrease in income subject to tax. The effective
federal and state income tax rate was 30.6% and 61.3% for the
years ended 2004 and 2003, respectively. The decrease in the
effective federal and state income tax rate is primarily due to
permanent differences, including meals and entertainment and
certain non-deductible contributions, and the impact of the loss
before income taxes for 2004.
As of December 31, 2004, the Company had net operating loss
carryforwards for federal income tax purposes of approximately
$54,120, which will expire in the years 2018 through 2024, if
not utilized. Deferred tax assets relating to net operating loss
carryforwards for federal purposes as of December 31, 2004
include approximately $871 associated with stock compensation
activity for which subsequent realized tax benefits, if any,
will reduce income taxes payable in the future. As of
December 31, 2004, the Company also had net operating loss
carryforwards for state income tax purposes of approximately
$4,973, which will expire in the years 2005 through 2014, if not
utilized. The Company currently has a net state deferred asset
of $2,831 and expects to generate future state taxable income in
excess of the approximate $32,000 required to realize the net
deferred asset over the next ten years. Deferred tax assets
relating to net operating loss carryforwards for state purposes
as of December 31, 2004 include approximately $67
associated with stock compensation activity for which subsequent
realized tax benefits, if any, will reduce income taxes payable
in the future. As of December 31, 2004, the Company also
had research and development tax credit carryforwards of
approximately $100 each for federal and state income tax
purposes. The federal credit will expire in 2022 if it is not
utilized. The state credits have no expiration date.
37
2003 versus 2002
Segment Results of Operations
Telecom
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2003 | |
|
2002 | |
|
$Change | |
|
%Change | |
| |
|
| |
|
| |
|
| |
|
| |
|
Local service
|
|
$ |
63,363 |
|
|
$ |
66,283 |
|
|
$ |
(2,920 |
) |
|
|
(4 |
)% |
|
Network access service
|
|
|
51,286 |
|
|
|
58,426 |
|
|
|
(7,140 |
) |
|
|
(12 |
) |
|
Directory advertising
|
|
|
15,087 |
|
|
|
14,824 |
|
|
|
263 |
|
|
|
2 |
|
|
Long distance service
|
|
|
5,098 |
|
|
|
5,368 |
|
|
|
(270 |
) |
|
|
(5 |
) |
|
Other
|
|
|
4,090 |
|
|
|
4,778 |
|
|
|
(688 |
) |
|
|
(14 |
) |
|
Total operating revenues from external customers
|
|
|
138,924 |
|
|
|
149,679 |
|
|
|
(10,755 |
) |
|
|
(7 |
) |
|
Intersegment revenues
|
|
|
23,576 |
|
|
|
16,826 |
|
|
|
6,750 |
|
|
|
40 |
|
|
Operating expenses *
|
|
|
83,645 |
|
|
|
86,417 |
|
|
|
(2,772 |
) |
|
|
(3 |
) |
|
Depreciation and amortization
|
|
|
31,257 |
|
|
|
28,249 |
|
|
|
3,008 |
|
|
|
11 |
|
|
Operating income
|
|
|
47,598 |
|
|
|
51,839 |
|
|
|
(4,241 |
) |
|
|
(8 |
) |
|
Net income
|
|
$ |
26,565 |
|
|
$ |
33,634 |
|
|
$ |
(7,069 |
) |
|
|
(21 |
)% |
|
|
| * |
Exclusive of depreciation and amortization |
Operating revenues from external customers in the Telecom
segment decreased $10,755 compared to 2002. Revenues from
services subject to regulation, which include local and network
access services, decreased $10,060 compared to 2002. The
decrease in operating revenues was primarily due to the combined
effects of (i) decreased zone and toll calls resulting from
increased competition from wireless service, (ii) a $1,535
increase in SureWest Telephone’s provision for its
estimated intrastate shareable earnings obligations compared to
the same period in 2002 and (iii) a change in accounting
estimate during 2002 for a portion of SureWest Telephone’s
interstate and intrastate shareable earnings obligations related
to the 1999 through 2001 monitoring periods, resulting in an
increase to the Telecom segment’s revenues of $6,207 and
net income of $3,724, respectively (for a more detailed
discussion refer to the Regulatory Matters section).
These decreases to operating revenues during 2003 were partially
offset by continued growth and demand for dedicated access, the
introduction of Ethernet Service in mid-2002 and an increase in
SureWest Telephone’s billing surcharge. The decrease in
operating revenues in the Telecom segment was also offset, in
part, by a Final Settlement Agreement (the “Settlement
Agreement”) SureWest Telephone entered into during 2003. As
discussed in greater detail in the Regulatory Matters section,
the Settlement Agreement provided for a $1,950 refund from
another telecommunications company for a payment made by the
SureWest Telephone in 2001 related to interstate shareable
earnings obligations.
SureWest Telephone’s operating revenues were also affected
by the commencement of a wholesaling arrangement in the fourth
quarter of 2002 for its DSL service. This wholesaling
arrangement resulted in a decrease to network access revenues of
$5,142 for the year ended December 31, 2003 compared to
2002.
The Company adopted SEC Staff Accounting
Bulletin No. 101, “Revenue Recognition in
Financial Statements,” effective January 1, 2000,
which requires non-recurring revenues associated with service
and activation charges to be deferred. The cumulative effect of
this change in accounting principle on the Company resulted in a
charge to income of $3,273, net of tax, ($0.21 per share)
in 2000. For the years ended December 31, 2003 and 2002,
the Telecom segment recognized $413 and $926, respectively, of
revenues that were in the cumulative effect adjustment as of
January 1, 2000. The effect of those revenues was to
increase income by $160 (net of income taxes of $253) and $557
(net of income taxes of $369) for the years ended
December 31, 2003 and 2002, respectively.
38
Operating expenses for the Telecom segment decreased $2,772
compared to 2002. Cost of services and products (exclusive of
depreciation and amortization) decreased $1,170, or 2%, during
2003 due primarily to an increase in allocation of resources
provided to other affiliates.
Customer operations and selling expense decreased $1,925, or
10%, during 2003 due primarily to (i) internal efficiencies
resulting from integrated customer support systems and
productivity gains and (ii) a decrease in brand advertising
expenses.
General and administrative expense increased $323, or 2%, due
primarily to (i) a $375 one-time settlement reached in
connection with the litigation arising from the agreement for
the sale of alarm monitoring assets during 2002, (ii) an
increase in medical and liability insurance costs and
(iii) an increase in costs related to compliance with the
requirements imposed by the Sarbanes-Oxley Act and related
regulations. This increase was offset in part by bad debt
expense recognized during 2002 associated with access charge
billings to an interexchange carrier that filed for bankruptcy
protection as described in more detail below.
Depreciation and amortization expenses increased $3,008 during
2003 due primarily to additions to central office assets, cable
and wire facilities and internal-use software.
Certain of the Company’s customers filed for bankruptcy
protection in 2002, the most notable of which was WorldCom,
which, together with its affiliates, filed for bankruptcy
protection in July 2002. In April 2004, WorldCom emerged from
federal bankruptcy protection. Settlement of the Company’s
pending pre-bankruptcy claims against WorldCom will remain
subject to the distribution terms, applicable to creditors,
contained in WorldCom’s plan of reorganization. As of
December 31, 2003 the amount of any settled pre-bankruptcy
claims could not be determined. Through December 31, 2003,
obligations owed by WorldCom to the Company for post-petition
services have been paid on a timely basis.
|
|
|
Significant Business Event |
In January 2002, the Company sold substantially all of the
assets of its alarm monitoring division, which was a component
of the Telecom segment, for approximately $5,150. This sale
resulted in a pre-tax gain of $4,435 during 2002. Through
December 31, 2003, the Company had received cash proceeds
of $4,995, of which $4,495 and $500 were received during 2002
and the fourth quarter of 2001, respectively, related to the
sale of the alarm monitoring division assets. The alarm
monitoring assets consisted primarily of customer contracts and
equipment, which had a net book value of approximately $355 as
of the date of the sale. The purchaser of the assets commenced
litigation against the Company relating to claims under the
asset purchase agreement, generally in connection with certain
contracts assigned to the purchaser. In July 2003, the Company
and the purchaser settled the litigation and the parties
released all claims in exchange for payment by the Company to
the purchaser of $375, which was paid during 2003. Total
operating revenues attributable to the Company’s alarm
monitoring division during 2002 was $279 (none in 2003).
Broadband
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2003 | |
|
2002 | |
|
$Change | |
|
%Change | |
| |
|
| |
|
| |
|
| |
|
| |
|
Internet service
|
|
$ |
15,984 |
|
|
$ |
7,578 |
|
|
$ |
8,406 |
|
|
|
111 |
% |
|
Residential Broadband service
|
|
|
9,370 |
|
|
|
2,946 |
|
|
|
6,424 |
|
|
|
218 |
|
|
Business Broadband service
|
|
|
3,697 |
|
|
|
2,421 |
|
|
|
1,276 |
|
|
|
53 |
|
|
Total operating revenues from external customers
|
|
|
29,051 |
|
|
|
12,945 |
|
|
|
16,106 |
|
|
|
124 |
|
|
Intersegment revenues
|
|
|
1,683 |
|
|
|
1,189 |
|
|
|
494 |
|
|
|
42 |
|
|
Operating expenses *
|
|
|
42,538 |
|
|
|
23,342 |
|
|
|
19,196 |
|
|
|
82 |
|
|
Depreciation and amortization
|
|
|
4,508 |
|
|
|
1,972 |
|
|
|
2,536 |
|
|
|
129 |
|
|
Operating loss
|
|
|
(16,312 |
) |
|
|
(11,180 |
) |
|
|
5,132 |
|
|
|
46 |
|
|
Net loss
|
|
$ |
(10,983 |
) |
|
$ |
(6,715 |
) |
|
$ |
4,268 |
|
|
|
64 |
% |
|
|
| * |
Exclusive of depreciation and amortization |
39
Operating revenues from external customers in the Broadband
segment increased $16,106 compared to 2002. The increase in
Broadband revenues is due in a large part to (i) a 27%
increase in residential and business DSL subscriber customer
base, (ii) an increase in operating revenues resulting from
the commencement of a wholesale DSL service arrangement with
SureWest Telephone in the fourth quarter of 2002, (iii) a
97% increase in the number of SureWest Broadband/ Residential
Services subscribers and (iv) the continued expansion of
the Business Broadband Services, resulting in a 73% increase in
ending access lines.
Total operating expenses for the Broadband segment increased
$19,196 compared to 2002. Cost of services and products
(exclusive of depreciation and amortization) increased $14,293,
or 136%, compared to 2002 due primarily to (i) an increase
in network administration due to a 27% increase in DSL
subscriber base (ii) an increase in expenses, including
programming and transport costs, from the expanded operations of
SureWest Broadband/ Residential Services, (iii) the
commencement of a wholesale DSL service arrangement with
SureWest Telephone in the fourth quarter of 2002 and
(iv) increased transport costs related to business
Broadband services. These increases were partially offset by a
decrease in the number of DSL modems expensed in the 2003
periods due to a leasing program implemented in the current year
and a 65% decrease in the cost of the DSL modems as compared to
the same period in the prior year. Customer operations expense,
general and administrative expense and depreciation and
amortization expense increased $2,478, $2,425 and $2,536,
respectively, for the year ended December 31, 2003 compared
to the same period in 2002. The increases are primarily due to
the expanded operations of SureWest Broadband/ Residential
Services in 2003, the related significant increase in the size
of the Company’s workforce, increased medical and liability
insurance costs and an increase in depreciation expense
resulting from property, plant and equipment additions at
SureWest Broadband, including DSL modems leased to customers.
During 2003, the Company entered into a 20-year nonmonetary
transaction with a third party involving the exchange of certain
fiber optic capacity and collocation rights. This transaction
provides the Company with access and rights to certain
collocation facilities and cell site locations, which were
previously inaccessible due to unreasonably high entrance costs.
The collocation rights provide access to additional network
connections to the Company while the cell site locations
strengthen the Company’s existing cellular network in key
areas. Because this nonmonetary transaction did not represent
the culmination of an earnings process, no revenues or expenses
have been, or will be, recorded by the Company pursuant to this
transaction. In addition, there was no indicated loss on this
exchange of productive rights.
On July 12, 2002, the Company purchased substantially all
of the assets of Western Integrated Networks, LLC and certain
affiliates (collectively, “WIN”) in a transaction
supervised by the United States Bankruptcy Court for the
District of Colorado. The purchase price for the assets of WIN
consisted of (i) $12,000 in cash, (ii) direct
acquisition costs of $622 and (iii) the assumption of
certain current liabilities aggregating $4,717 relating
principally to executory contracts and capital lease obligations.
40
Prior to July 12, 2003, the Company obtained additional
information regarding the fair values of certain assets acquired
and liabilities assumed from WIN. Accordingly, the Company
prospectively adjusted the preliminary purchase price allocation
in connection with the preparation of its 2003 consolidated
financial statements. The following table summarizes the
estimated fair values of the assets acquired and liabilities
assumed at the date of acquisition, July 12, 2002,
based on the Company’s final allocation of the
aforementioned purchase price:
| |
|
|
|
|
|
|
Accounts receivable, net
|
|
$ |
615 |
|
|
Equipment held for sale
|
|
|
2,573 |
|
|
Other current assets
|
|
|
931 |
|
|
Property, plant and equipment
|
|
|
12,327 |
|
|
Intangible asset relating to favorable operating leases
|
|
|
893 |
|
| |
|
|
|
| |
Total assets acquired
|
|
|
17,339 |
|
|
Current liabilities assumed under executory contracts
|
|
|
3,483 |
|
|
Liabilities assumed under capital lease obligations
|
|
|
1,064 |
|
|
Other liabilities
|
|
|
170 |
|
| |
|
|
|
| |
Total liabilities assumed
|
|
|
4,717 |
|
| |
|
|
|
| |
Net assets acquired
|
|
$ |
12,622 |
|
| |
|
|
|
The equipment purchased from WIN that was held for sale
consisted primarily of network assets located in Dallas, Texas.
The Company completed the sale of such equipment during the
first quarter of 2003. The Company did not recognize a gain or
loss on the sale of these assets.
Wireless
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2003 | |
|
2002 | |
|
$Change | |
|
%Change | |
| |
|
| |
|
| |
|
| |
|
| |
|
Wireless revenues from external customers
|
|
$ |
27,146 |
|
|
$ |
23,225 |
|
|
$ |
3,921 |
|
|
|
17 |
% |
|
Intersegment revenues
|
|
|
744 |
|
|
|
507 |
|
|
|
237 |
|
|
|
47 |
|
|
Operating expenses *
|
|
|
34,724 |
|
|
|
33,796 |
|
|
|
928 |
|
|
|
3 |
|
|
Depreciation and amortization
|
|
|
16,705 |
|
|
|
14,905 |
|
|
|
1,800 |
|
|
|
12 |
|
|
Operating loss
|
|
|
(23,539 |
) |
|
|
(24,969 |
) |
|
|
(1,430 |
) |
|
|
(6 |
) |
|
Net loss
|
|
$ |
(14,937 |
) |
|
$ |
(15,670 |
) |
|
$ |
(733 |
) |
|
|
(5 |
)% |
* Exclusive of depreciation and amortization
Operating revenues from external customers in the Wireless
segment increased $3,921 due primarily to (i) continued
additions to the customer base, with a 15% overall increase in
wireless subscribers based on subscriber counts at
December 31, 2003 compared to December 31, 2002,
(ii) an increase in roaming revenues, (iii) the
introduction of new features and (iv) a decrease in
uncollectible revenues.
Total operating expenses for the Wireless segment increased $928
compared to 2002. Cost of services and products (exclusive of
depreciation and amortization) expense increased $882, or 5%,
compared to 2002 primarily due to increased interconnect usage
associated with the increase in subscriber base and increased
property taxes due to the addition of cell sites. This increase
was partially offset by (i) a reduction in roaming expenses
due to a lower roaming rate and (ii) decreased handset
insurance costs due to fewer claims submitted, outsourcing of
the insurance function to a third party and fewer customers
selecting this feature. Customer operations and selling expense
decreased $311, or 3%, compared to 2002 due primarily to
decreased sales expense resulting from fewer dealer sales. This
decrease was offset in part by an increase in subscriber billing
costs associated with the higher average customer base. General
and administrative expense increased $357, or 10%, compared to
2002 due primarily to an increase in medical and liability
insurance costs.
41
Effective November 24, 2003, the FCC mandated that wireless
carriers provide for local number portability (“LNP”).
LNP allows subscribers to keep their wireless phone numbers
while switching to a different service provider. Although the
Company has experienced favorable porting activity, the
implementation of LNP has not had a material effect on the
Company’s consolidated financial position or results of
operations.
Non-Operating Items
|
|
|
Interest Income and Expense, Net |
Interest expense increased $2,371, or 126%, compared to 2002 due
to the Company’s issuance in March 2003 of $60,000 of
unsecured Series B Senior Notes, $15,000 of the proceeds of
which was used to retire certain short-term borrowings.
|
|
|
Other Income (Expense), Net |
In December 2003, the Company discovered certain irregular bank
transactions and deposits in a routine investigation following
the abrupt resignation of the Company’s Treasury Analyst.
Immediately following the Company’s initial review that
uncovered these irregularities, the Company broadened its review
of the investment and cash operations, and a special corporate
investigation was launched by the Audit Committee and the Board
of Directors, which engaged independent legal counsel and
forensic accountants. The investigations revealed concealed
illegal transfers in violation of the Company’s investment
and cash management policies. The Company has concluded that the
irregularities were limited to the 2003 calendar year. The
investigation suggests that as much as $25,000 may have been
involved in the scheme. Nearly all of the funds have been
recovered; however, as of December 31, 2003, approximately
$1,828 was outstanding and was reflected as a non-operating loss
in the Company’s 2003 consolidated financial statements.
(On October 26, 2004, the Company received an insurance
recovery in the amount of $1,803, which has been reflected as a
non-operating gain in the Company’s 2004 consolidated
financial statements.) In January 2004, the Federal Bureau of
Investigation (“FBI”) launched its own probe into the
illegal funds transfer, and in February 2004, indictments were
returned against three individuals, including the Company’s
former Treasury Analyst, on charges of mail fraud, conspiracy
and money laundering. The Company has filed a civil lawsuit
seeking to recover the misappropriated funds and other costs
from five individuals and a private company allegedly associated
with the fraudulent scheme to illegally transfer the
Company’s funds to outside accounts. The Company will
recognize a recovery of the funds, if any, in future periods to
the extent of its additional litigation recoveries.
Income taxes decreased $6,404, or 86%, compared to 2002 due to a
corresponding decrease in income subject to tax. The effective
federal and state income tax rate was 61.3% and 39.8% for the
years ended 2003 and 2002, respectively. The increase in the
effective federal and state income tax rate is primarily due to
an increase in state income tax expense and an increase in
permanent differences.
As of December 31, 2003, the Company had net operating loss
carryforwards for federal income tax purposes of approximately
$19,434, which will expire in the years 2018 through 2023, if
not utilized. Deferred tax assets relating to net operating loss
carryforwards for federal purposes as of December 31, 2003
include approximately $463 associated with stock compensation
activity for which subsequent realized tax benefits, if any,
will reduce income taxes payable in the future. The Company also
had net operating loss carryforwards for state income tax
purposes of approximately $218, which will expire in the years
2004 through 2011, if not utilized. The Company also had
research and development tax credit carryforwards of
approximately $100 each for federal and state income tax
purposes. The federal credit will expire in 2022 if it is not
utilized. The state credits have no expiration date.
42
Liquidity and Capital Resources
As reflected in the Consolidated Statements of Cash Flows, net
cash provided by operating activities was $56,070, $73,108 and
$46,802 in 2004, 2003 and 2002, respectively. The decrease in
cash provided by operating activities for 2004 compared to 2003
was due primarily to (i) an approximate $7,790 decrease in
the change of liabilities related to the Company’s
estimated shareable earnings obligations primarily due to the
November 19, 2004 intrastate settlement agreement and the
Company’s periodic preparation of its cost studies, which
resulted in changes in estimates to prior year monitoring
periods and a decrease in the amount provided for shareable
earnings obligations, (ii) a decrease in the change of
refundable and accrued incomes taxes of approximately $9,211,
(iii) a decrease in the change of the provision for
deferred income taxes of approximately $936 due primarily to
accelerated depreciation, (iv) an approximate $2,270
decrease in the change of accounts receivable primarily due to
an increase in the subscriber base within the Wireless and
Broadband segments and (v) an approximate $4,628 decrease
in the change in accrued liabilities primarily due to 2003
capital expenditures associated with the network buildout offset
by an increase in 2004 accrued liabilities associated with
consulting and legal fees due to the treasury investigation,
audit services and Sarbanes-Oxley implementation and compliance.
These decreases were offset by increases in (i) accrued
compensation due to the timing of executive bonuses and payroll
disbursements and an increase in compensated absences and
(ii) the Company’s pension liability resulting from
the REWARD program, the return on plan assets and a change in
the discount rate. Operating cash flows in the next few years
will be negatively impacted by higher federal income tax
payments as the timing of accelerated tax depreciation in 2004,
2003 and 2002 begins to reverse.
Net cash provided by operating activities during 2004 was
greater than net loss of $1,128 due primarily to
(i) non-cash charges of approximately $48,596 consisting of
depreciation and amortization due to increased capital
investments in the Broadband and Wireless Segments,
(ii) the Company’s pension liability of approximately
$7,249 resulting from the REWARD program, the return on plan
assets and a change in the discount rate and (iii) an
increase in accrued liabilities of $4,019 primarily due to
consulting and legal resulting from the treasury investigation,
audit services and Sarbanes-Oxley implementation and compliance.
These amounts are offset by a decrease in liabilities related to
the Company’s estimated shareable earnings obligations of
approximately $3,751 due to the intrastate settlement agreement,
changes in estimates related to prior year monitoring periods
and a decrease in the amount required to be provided for
estimated shareable earnings obligations. During 2004, the
Company used cash flows from operations, borrowings from its
line of credit and existing cash, cash equivalents and
short-term investments to fund (i) capital expenditures of
$70,833 pertaining to ongoing plant construction projects,
(ii) dividends of $14,581 and (iii) principal payments
of $4,127 to retire long-term debt.
The Company had a working capital deficit of $11,019 at
December 31, 2004. This working capital deficit is due
primarily to a decrease in cash and short-term investments to
fund items as described above and an increase in short-term
borrowings, accrued liabilities and accrued pension benefits,
and was partially offset by a decrease in the shareable earnings
obligations. As discussed below, the Company believes that its
working capital position, operating cash flows and borrowing
capacity are sufficient to satisfy its liquidity requirements in
2005.
The Company’s most significant use of funds in 2005 is
expected to be for (i) budgeted capital expenditures of
approximately $79,000, (ii) scheduled payments of long-term
debt of $3,779, (iii) support of the operations of SureWest
Broadband/ Residential Services up to an anticipated $8,846 and
(iv) support of the operations of SureWest Wireless up to
an anticipated $2,106. In addition, during 2005 the payment of
dividends, which is at the discretion of the Company’s
Board of Directors, could be as much as $14,600 based on the
Company’s most recent dividend and payments. A substantial
portion of the 2005 budgeted capital expenditures are at the
discretion of the Company, and are dependent upon the
Company’s working capital position, operating cash flows
and ability to borrow, as described below. The Company is
required to comply with its cable franchise agreements to
continue its build-out in the franchise areas.
The Company currently receives funding of $11,500 annually from
the CHCF, a program designed by the CPUC to establish a fair and
equitable local rate structure and to reduce any disparity in
the rates charged by certain telephone companies serving
high-cost areas. The CHCF was due to expire on January 1,
2005. However, on
43
September 28, 2004, the Governor of California signed
SB1276 into law, which amended the existing legislation and
extended the expiration date to January 1, 2009.
In March 2003, the Company completed a note purchase agreement
for the issuance of its unsecured 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.
The Company has a business loan agreement with a bank for a
$50,000 line of credit. As of December 31, 2004, there was
$10,000 outstanding under this credit facility and the interest
rate was 3.14%, which is based on a LIBOR-based pricing formula.
There were no amounts outstanding as of December 31, 2003.
In December 2004, the bank amended the credit facility,
extending the expiration date until July 1, 2006 and
revising certain covenants.
In April 2003, the Company sold a short-term investment prior to
its maturity date. The investment was sold without the consent
of the Company’s management and was a part of the irregular
transactions discovered in connection with the Corporate
Treasury Investigation described in “2003 versus
2002 – Non-Operating Items,” above. The Company
incurred a nominal penalty for the premature redemption of this
investment. The redemption did not have a material effect on the
Company’s 2003 consolidated financial statements.
In February 2000, the Board of Directors authorized the
repurchase of up to one million shares of the Company’s
common stock. In June 2002, the Board of Directors approved the
repurchase of an additional 500 thousand shares. The shares are
purchased from time to time in the open market or through
privately negotiated transactions, subject to overall financial
and market conditions. Through December 31, 2004,
approximately one million shares of common stock had been
repurchased through the programs. The Company has remaining
authorization from the Board of Directors to repurchase an
additional 469 thousand outstanding shares. The purchase of
common shares resulted in a decrease in the average number of
common shares outstanding used in calculating both basic and
diluted earnings per share by 3% for 2002 (none in 2004 and
2003). The effects on the average number of common shares
outstanding resulting from the repurchase of stock resulted in
an increase in basic earnings per share of $0.02 for the year
ended 2002 (no effect in 2004 or 2003). The effects on the
average number of common shares outstanding resulting from the
repurchase of stock resulted in an increase in diluted earnings
per share of $0.02 for 2002 (no effect in 2004 and 2003).
The Company had cash and cash equivalents at December 31,
2004, of $18,119. The Company believes that its working capital
position, operating cash flows and borrowing capacity are
sufficient to satisfy its liquidity requirements in 2005. The
Company’s forecast indicates it is likely that the Company
will continue to borrow funds during 2005 to fund operations and
planned capital expenditures, while maintaining adequate cash
and cash equivalents. Such borrowing might be undertaken under
the newly extended bank 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 2005 budgeted
capital expenditures and cash dividend payments are at the
discretion of the Company. Accordingly, the Company believes
that it can modify its planned construction and commitments and
cash dividend payments if the results of operations or available
capital so require.
44
As of December 31, 2004, the Company’s contractual
obligations were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2005 | |
|
2006-2007 | |
|
2008-2009 | |
|
Thereafter | |
|
Total | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Long-term debt
|
|
$ |
3,779 |
|
|
$ |
7,273 |
|
|
$ |
19,273 |
|
|
$ |
62,545 |
|
|
$ |
92,870 |
|
|
Short-term borrowings
|
|
|
10,000 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
10,000 |
|
|
Capital leases
|
|
|
212 |
|
|
|
39 |
|
|
|
13 |
|
|
|
– |
|
|
|
264 |
|
|
Contractual shareable earnings obligations
|
|
|
3,092 |
|
|
|
4,883 |
|
|
|
1,791 |
|
|
|
– |
|
|
|
9,766 |
|
|
Operating leases
|
|
|
4,957 |
|
|
|
9,130 |
|
|
|
8,769 |
|
|
|
17,736 |
|
|
|
40,592 |
|
|
Unconditional purchase obligations
|
|
|
1,700 |
|
|
|
275 |
|
|
|
– |
|
|
|
– |
|
|
|
1,975 |
|
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 financial and operating covenants that
restrict, among other things, the payment of cash dividends,
repurchase of the Company’s capital stock, the making of
certain other restricted payments and the incurrence of
additional indebtedness. Under the Line of Credit covenants, the
Company must obtain written consent to exceed $100,000 in total
debt with maturities greater than five years. The Company does
not believe this requirement will have a material affect on its
ability to obtain additional debt if it is deemed necessary. In
addition, the covenants require the Company to maintain certain
financial ratios and minimum levels of tangible net worth. At
December 31, 2004, retained earnings of approximately
$37,347 were available for the payment of cash dividends, the
repurchase of the Company’s capital stock or other
restricted payments under the terms of the Company’s credit
arrangements.
Related Party Transactions
A former officer of the Company is a member of the Board of
Directors of a local banking institution. During the years ended
December 31, 2004, 2003 and 2002, the Company provided $11,
$45 and $17, respectively, in telecommunications services to the
banking institution.
During 2002, the Company repurchased 300 thousand shares of its
common stock from one of its employee benefit plans. The Company
utilized two separate independent third party entities for the
purpose of providing fairness opinions in connection with the
transaction. The shares were repurchased at a price of
$50 per share and were retired upon repurchase.
Beginning January 1, 2005, the Company’s employees are
covered under an eye care benefit plan from an entity, of which
one of the Company’s Board Members is a director and also
an executive officer. Negotiations regarding the benefit plan
were completed before that entity’s director and executive
officer was elected to the Company’s Board of Directors and
without his involvement or knowledge. The Company anticipates
that its payment to such entity will approximate $10 in 2005.
Critical Accounting Policies and Estimates
Below is a summary of the Company’s critical accounting
policies and estimates, which are more fully described in the
referenced Notes to the Company’s Consolidated Financial
Statements. Management has discussed development and selection
of critical accounting policies and estimates with the
Company’s Audit Committee.
|
|
| • |
As discussed more fully in Note 1, in accordance with
SFAS No. 142, Goodwill and Other Intangible Assets,
goodwill and wireless spectrum licenses are reviewed for
impairment annually, or more frequently if an event occurs or
circumstances change that would reduce the fair value below its
carrying value. The impairment test for goodwill requires the
Company to estimate the fair value at the reporting unit level.
To determine |
45
|
|
| |
the fair value in 2004, the Company obtained an independent
valuation of the Company’s goodwill using a discounted cash
flow model. Assumptions used in this model include the following: |
|
|
|
| |
• |
cash flow assumptions regarding investment in network
facilities, distribution channels and customer base (the
assumptions underlying these inputs are based upon a combination
of historical results and trends, new industry developments and
the Company’s business plans); |
| |
• |
an 11% weighted average cost of capital based on industry
weighted averaged cost of capital; and |
| |
• |
no terminal growth rate. |
|
|
| |
The use of different estimates or assumptions within the
discounted cash flow model when determining fair value of the
Company’s goodwill could result in a different fair value.
For example, the Company used a discount rate of 11% and no
terminal growth rate in its assessment of fair value in 2004. If
the discount rate were to increase two percent, the fair value
of the goodwill would decrease by $49,400, but would not result
in an impairment of goodwill. |
| |
| |
The Company’s wireless spectrum licenses include Personal
Communications Services (“PCS”) and Local Multipoint
Distribution Service (“LMDS”) licenses. In assessing
the recoverability of the Company’s PCS licenses, the
Company obtained an independent valuation in 2004, which
reviewed transactions involving sales of comparable wireless
spectrum licenses in the aftermarket, using characteristics of
the license and the related market, including geographic
location, market size, megahertz frequency and population
density. |
| |
| |
In assessing the recoverability of the Company’s LMDS
licenses, the Company obtained an independent valuation, as
comparable license sales data was not available. The independent
valuation estimates fair value of the Company’s LMDS
licenses using a discounted cash flow model. Assumptions used in
this model include the following: |
|
|
|
| |
• |
cash flow assumptions regarding investment in network
facilities, distribution channels and customer base (the
assumptions underlying these inputs are based upon a combination
of historical results and trends, new industry developments and
the Company’s business plans); |
| |
• |
a 20% weighted average cost of capital based on industry
weighted averaged cost of capital adjusted to reflect the
inherent risks associated with the introduction of a new service
offering; and |
| |
• |
a 3% terminal value growth rate. |
|
|
| |
The use of different estimates or assumptions within the
discounted cash flow model when determining fair value of the
Company’s LMDS licenses could result in different values
for these licenses. For example, the Company used a discount
rate of 20% and a terminal growth rate of 3% in its assessment
of fair value in 2004. If the discount rate were to increase one
percent, the fair value of the LMDS licenses would decrease by
$600, which would result in an impairment charge of
approximately $140 based on the carrying value of the LMDS
licenses as of December 31, 2004. In addition, the
Company’s LMDS licenses may be impaired in the near future
if the estimates and assumptions used in the 2004 LMDS license
discounted cash flow model are not met. |
| |
| |
If the estimated fair value is less than the carrying value,
then the carrying value is written down to the fair value. As a
result of the Company’s annual test for the current year,
no impairment of either goodwill or PCS or LMDS licenses was
indicated. |
|
|
|
| |
• |
As discussed more fully in Note 1, total revenues from
telephone services are affected by rates authorized by various
regulatory agencies. The FCC monitors SureWest Telephone’s
interstate earnings through the use of annual cost separation
studies prepared by SureWest Telephone. The FCC establishes
rules that carriers must follow in the preparation of the annual
studies. Based on these rules, the Company is required to
prospectively set its annual interstate rates based on the
aforementioned cost separation studies. These cost studies
include estimates and assumptions regarding various financial
data including operating expenses, taxes and investment in
property, plant and equipment. Non-financial data estimates are
also utilized in the preparation of these cost studies,
including projected demand usage and detailed network
information. The Company must also make estimates of the
jurisdictional separation of this data to assign current
financial |
46
|
|
|
and operating data to the interstate or intrastate jurisdiction.
These estimates are finalized in future periods as actual data
becomes available to complete the separation studies.
Additionally, certain FCC rules regarding interstate shareable
earnings obligations have not yet been clarified as to whether
the Company’s rate filings are deemed lawful and,
therefore, protected from over-earnings liability. Further, the
Company’s separation studies include estimates and
assumptions regarding issues before the FCC involving
intercarrier interconnection, Internet traffic, and traffic
utilizing Internet Protocol. The Company also participates in
the NECA pool for certain interstate revenues. In addition to
the estimates noted above, the Company’s earned
rate-of-return from its participation in the NECA pool can also
be impacted by the earnings and data of other carriers who
participate in the pool. |
|
|
| |
In accordance with the NRF, SureWest Telephone is subject to
ongoing monitoring and reporting requirements by the CPUC, and
it was initially required to share earnings with customers based
on its earned annual rate-of-return. The Company utilizes
models, which rely on estimates regarding the jurisdictional
separation of financial data and operational data into the
intrastate and interstate jurisdictions as discussed previously
for the purposes of calculating its earned annual
rate-of-return. However, as discussed more fully in Note 1,
SureWest Telephone has entered into a settlement agreement,
which was approved by the CPUC in November 2004, to cease
intrastate sharing requirements beginning January 1, 2005
through at least December 31, 2010. The settlement
agreement also resolves existing sharing obligations and related
earnings issues for the monitoring periods 2000-2004. |
| |
| |
In addition, the Company must make estimates and assumptions
regarding various issues before the FCC and CPUC involving
intercarrier interconnection, Internet traffic, traffic
utilizing Internet Protocol, methods used to allocate costs for
services provided by SureWest Communications and SureWest
Telephone to its affiliates and the treatment of certain plant
and tax costs, including internal-use software costs. |
| |
| |
As a result of these estimates and assumptions, it is reasonably
possible that management’s estimates of SureWest
Telephone’s interstate shareable earnings obligations could
change in the near term, and the amounts involved could be
material. For example, the CPUC approved a settlement agreement
on November 19, 2004 that resolved the Company’s
intrastate shareable earnings for the years 2000 through 2004.
In accordance with this settlement agreement, the Company
recorded $2,948 in local revenues due to a change in accounting
estimate in the fourth quarter of 2004 (for a more detailed
discussion regarding the settlement agreement, see Regulation
and Contractual and Estimated Shareable Earnings Obligations
within Note 1 to the Company’s consolidated
financial statements). This increase in revenue resulted in a
decrease of the Company’s net loss by $2,046
($0.14 per share). In addition, in 2002 the Company made
changes in its estimates for interstate shareable earnings
obligations for approximately $5,800, principally due to the
D.C. Circuit Court of Appeals decision issued in May 2002, which
determined that a tariff filed properly under Section 204
“streamlined” procedures and allowed to go into effect
without suspension is deemed lawful. Therefore, the carrier is
not subsequently obligated to pay refunds for earnings higher
than the permitted rate of return as prescribed by the FCC for
that monitoring period. |
|
|
|
| |
• |
As discussed more fully in Note 2, the Company recognizes
revenue when (i) persuasive evidence of an arrangement
between the Company and the customer exists, (ii) delivery
of the product to the customer has occurred or service has been
provided to the customer, (iii) the price to the customer
is fixed or determinable and (iv) collectibility of the
sales price is reasonably assured. |
| |
| |
• |
As discussed more fully in Note 1, the Company maintains
allowances for doubtful accounts for estimated losses resulting
from the potential inability of its customers to make required
payments. In evaluating the collectibility of its accounts
receivable, the Company assesses a number of factors including a
specific customer’s or carrier’s ability to meet its
financial obligations to the Company, the length of time the
receivable has been past due and historical and future
expectations of conditions that may impact the Company’s
ability to collect its accounts receivable. If circumstances
change or economic conditions worsen such that the
Company’s past collection experience is no longer relevant,
the Company’s estimate of the recoverability of its
accounts receivable could be further reduced from the levels
reflected in the Company’s consolidated balance sheet. If
uncollectibility of the Company’s billed revenue changes by
1%, the Company would expect an increase in uncollectible
expense of approximately $2,200. As of December 31, 2004,
the |
47
|
|
|
Company had three customers that accounted for 4% of
consolidated accounts receivable in the aggregate. Although
management believes that these customers are creditworthy, a
severe adverse impact on their business operations could have a
corresponding material effect on their ability to pay timely
and, therefore, on the Company’s results of operations,
cash flows and financial condition. In addition, certain
revenues are subject to refund if the customer terminates
services or returns equipment within a stipulated time period,
or if certain performance criteria are not met. Accordingly, the
Company maintains accounts receivable allowances and recognizes
certain customer refund liabilities, through charges to
revenues, based on the Company’s best estimates of the
resolution of these contingencies, which are based on historical
experience. |
| |
| • |
As discussed more fully in Note 1, the Company states its
inventories held for sale at lower of cost or market. In
assessing the ultimate recoverability of inventories, the
Company is required to make estimates regarding future customer
demand and technological advances of equipment. |
| |
| • |
As discussed more fully in Note 1, property, plant and
equipment 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 the estimated
useful lives of its property, plant and equipment once every
three years, 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, the Company must
make assumptions regarding estimated future cash flows and other
factors to determine the fair value of the respective assets. |
| |
| • |
As discussed in Note 1, the Company accounts for asset
retirement obligations in accordance with
SFAS No. 143, Accounting for Asset Retirement
Obligations, which requires the Company to recognize a
retirement obligation (future cost of removal) when a legal
obligation exists to remove plant at some point in the future.
The Company believes it may have potential retirement
obligations relating to its wireless cell sites. Based on terms
outlined in its tower leases, the Company is obligated to return
the land or facilities to their original condition at the end of
the cell site lease term, should the lease be terminated. The
Company has used a probability-weighted cash flow approach in
estimating its potential retirement obligation. The Company
calculates the net present value of the retirement obligation
assuming an inflation rate of 3%, a discount rate of 7% and a
market risk premium of 4%. The Company has also assumed the
settlement date is 25 years from the date the asset is
placed into service. The Company has also used a
probability-weighted assessment to address the uncertainty
regarding the timing of future cash flows to settle the
potential liability. The Company believes that utilizing
probabilities less than 100% is appropriate because the Company
believes the likelihood of incurring material asset retirement
expenditures is remote. The Company monitors the estimates and
assumptions used in determining its potential asset retirement
obligations for its cell sites. However, the Company believes it
is remote that any future adjustment to its asset retirement
liability for obligations existing as of December 31, 2004
will be material to the Company’s consolidated financial
statements. |
| |
| • |
As discussed more fully in Notes 1 and 7, the Company
accounts for income taxes using the liability method. Under this
method, deferred tax assets and liabilities are determined based
on differences between the financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax
rates and laws that are expected to be in effect when the
differences are expected to reverse. The Company does not have a
valuation allowance on its deferred tax asset as of
December 31, 2004 or 2003 because it believes |
48
|
|
| |
it is more likely than not that such deferred tax asset will be
realized. Should the Company determine that it would not be able
to realize all or part of its deferred tax asset in the future,
an adjustment to the deferred tax asset would be charged to
income in the period in which the determination was made.
However, the Company believes it will generate sufficient
taxable income from future operations and reversal of deferred
tax liabilities to realize the deferred tax asset of $34,412 as
of December 31, 2004. |
|
|
| • |
As discussed more fully in Note 8, the Company has pension
and post-retirement benefit costs and obligations. The
Company’s pension and post-retirement benefit obligations
are actuarially determined based on estimates of discount rates,
long-term rates of return on plan assets and increases in future
compensation levels. Changes in these estimates and other
factors could significantly impact the Company’s pension
and post-retirement benefit costs and obligations. Assumed
health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A
one-percentage-point change in assumed health care cost trend
rates would have the following effects: |
| |
|
|
|
|
|
|
|
|
| |
|
1-Percentage- | |
|
1-Percentage- | |
| |
|
Point Increase | |
|
Point Decrease | |
| |
|
| |
|
| |
|
Effect on total 2004 service and interest cost
|
|
$ |
72 |
|
|
$ |
(61 |
) |
| |
|
Effect on post-retirement benefit obligation as of
December 31, 2004
|
|
$ |
526 |
|
|
$ |
(499 |
) |
|
|
| |
The discount rate is determined based on the current yields on
high quality corporate fixed-income investments with maturities
corresponding to the expected duration of the benefit
obligations. As of December 31, 2004, the Company used a
discount rate of 5.75%, which represents a reduction of
50 basis points from the discount rate of 6.25% as of
December 31, 2003. This change in the discount rate did not
have a material impact on the Company’s 2004 and 2003
consolidated results of operations. |
| |
| |
In 2004, the Company used an expected long-term rate of return
of 8.50%. For 2005, the Company does not believe the expected
long-term rate will change significantly. The expected long-term
rate of return on plan assets is determined based on the current
and projected investment portfolio mix and estimated long-term
investment returns for each asset class. The projected portfolio
mix of the plan assets is developed in consideration of the
expected duration of related plan obligations and private equity
positions. The expected return on plan assets is determined by
applying the expected long-term rate of return to the
market-value of plan assets. |
| |
| |
The future compensation levels are based on recent experience as
well as future expectations. As of December 31, 2003, the
Company reduced the future compensation level by 100 basis
points to 5.00% and it remains at that level for 2004. This
change in the future compensation level did not have a material
impact on the Company’s 2004 and 2003 consolidated results
of operations. |
|
|
| • |
As discussed more fully in Notes 1 and 9, 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. |
| |
| • |
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 year ended December 31, 2002, as all
stock |
49
|
|
|
options granted under those plans had an exercise price equal to
the fair value of the underlying common stock on the date of
grant. Effective January 1, 2003, the Company adopted the
preferable fair value recognition provisions of Statement of
Financial Accounting Standards (“SFAS”) No. 123,
Accounting for Stock-Based Compensation Transition and
Disclosure. Under the prospective transition method selected
by the Company, as described in SFAS No. 148,
Accounting for Stock-Based Compensation-Transition and
Disclosure, compensation expense was recognized in 2003 for
all employee awards granted, modified or settled after
January 1, 2003. This change in accounting for stock-based
compensation resulted in increased compensation expense of $29
and $47, which increased net loss and decreased net income by
$20 (no effect on loss per share) and $18 (no effect on earnings
per share) for the years ended December 31, 2004 and 2003,
respectively. |
|
|
| |
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-Merton option pricing model includes
assumptions regarding dividend yields, expected volatility,
expected lives and risk-free interest rates. These assumptions
reflect management’s best estimates, but these items
involve inherent uncertainties based on market conditions
generally outside of the control of the Company. As a result, if
other assumptions had been used in the current period,
stock-based compensation expense could have been materially
different. If management uses different assumptions in future
periods, stock-based compensation expense could be materially
impacted in future years. |
Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards
Board (“FASB”) issued Statement of Financial
Accounting Standards (“SFAS”) No. 123 (revised
2004), Share-Based Payment
(“SFAS No. 123(R)”), which is a revision
of SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 123(R) supersedes
Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and amends
SFAS No. 95, Statement of Cash Flows.
Generally, the approach in SFAS No. 123(R) is similar
to the approach described in SFAS No. 123. However,
SFAS No. 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be
recognized in the statement of operations based on their fair
values. Pro forma disclosure is no longer an alternative.
SFAS No. 123(R) must be adopted no later than
July 1, 2005. Early adoption will be permitted in periods
in which financial statements have not yet been issued. The
Company expects to adopt SFAS No. 123(R) on
July 1, 2005.
SFAS No. 123(R) permits public companies to adopt its
requirements using one of two methods:
|
|
|
| |
1. |
A “modified prospective” method in which compensation
cost is recognized beginning with the effective date
(a) based on the requirements of SFAS No. 123(R)
for all share-based payments granted after the effective date
and (b) based on the requirements of SFAS No. 123
for all awards granted to employees prior to the effective date
of SFAS No. 123(R) that remain unvested on the
effective date. |
| |
| |
2. |
A “modified retrospective” method, which includes the
requirements of the modified prospective method described above,
but also permits entities to restate their financial statements
based on the amounts previously recognized under
SFAS No. 123 for purposes of pro forma disclosures
either for (a) all prior periods presented or
(b) prior interim periods of the year of adoption. |
The Company is in the process of evaluating which method of
adoption it will use to adopt SFAS No. 123(R). The
Company does not believe the adoption of this new guidance will
have a material effect on its consolidated financial position,
results of operations and cash flows.
50
On May 15, 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity.
SFAS No. 150 establishes standards for classifying and
measuring as liabilities certain financial instruments that
embody obligations of the issuer and have characteristics of
both liabilities and equity, such as mandatorily redeemable
equity instruments. The adoption of SFAS No. 150 in
2003 had no effect on the Company’s 2003 consolidated
financial statements.
In January 2003, the FASB issued Interpretation
(“FIN”) No. 46, Consolidation of Variable
Interest Entities, an interpretation of Accounting Research
Bulletin (“ARB”) No. 51, Consolidated
Financial Statements. FIN No. 46 applies to any
business enterprise that has a controlling interest, contractual
relationship or other business relationship with a variable
interest entity (“VIE”) and establishes guidance for
the consolidation of VIEs that function to support the
activities of the primary beneficiary. The Company believes it
has no investments in, or contractual or other business
relationships with, VIEs. The adoption of FIN No. 46
had no effect on the Company’s 2003 consolidated financial
statements.
In July 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with an Exit or Disposal
Activity. SFAS No. 146 revises the accounting for
exit and disposal activities EITF Issue No. 94-3,
Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (Including Certain
Costs Incurred in a Restructuring), by extending the period
in which expenses related to restructuring activities are
reported. A commitment to a plan to exit an activity or dispose
of long-lived assets is no longer sufficient to record a
one-time charge for most restructuring activities. Instead,
companies will record exit or disposal costs when they are
“incurred” and can be measured at fair value. In
addition, the resultant liabilities must be subsequently
adjusted for changes in estimated cash flows. The Company
adopted SFAS No. 146 on January 1, 2003, and the
adoption of this new standard did not have a material effect on
the Company’s 2003 consolidated financial statements.
On December 31, 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based
Compensation – Transition and Disclosure.
SFAS No. 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation to provide
alternative methods of transition for an entity that voluntarily
changes to the fair value method of accounting for stock-based
employee compensation. In addition, it also amends the
disclosure provisions of SFAS No. 123 to require
prominent disclosure about the effects on reported net income,
including per share amounts, of an entity’s accounting
policy decisions with respect to stock-based employee
compensation in annual and interim financial statements.
SFAS No. 148 does not amend SFAS No. 123 to
require companies to account for their stock-based employee
compensation using the fair value method. The disclosure
provisions of SFAS No. 123 were effective immediately
in 2002. The Company changed its method of accounting on a
prospective basis for stock-based employee compensation to the
fair value method during the fourth quarter of 2003. The
adoption of this new standard did not have a material effect on
the Company’s 2003 consolidated financial statements.
In August 2001, the FASB issued SFAS No. 143,
Accounting for Asset Retirement
Obligations. SFAS No. 143 requires that the
fair value of a liability for an asset retirement obligation be
recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The associated asset
retirement costs are capitalized as part of the carrying amount
of the long-lived asset. The Company adopted
SFAS No. 143 on January 1, 2003. The adoption of
this new standard did not have a material effect on the
Company’s 2003 consolidated financial statements.
In October 2002, the FASB’s EITF reached a consensus on
EITF Issue No. 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. Under EITF
Issue No. 00-21, revenue arrangements with multiple
deliverables are required to be divided into separate units of
accounting under certain circumstances. The Company adopted EITF
Issue No. 00-21 on a prospective basis for arrangements
entered into after June 30, 2003. The Company has
determined that the sale of its wireless handsets and the
associated phone service provided by the Wireless segment should
be considered separate units of accounting under EITF Issue
No. 00-21. Accordingly, beginning on July 1, 2003, the
Company began applying EITF Issue No. 00-21 to all wireless
handset sales below cost, which approximates fair value in the
absence of an activation “subsidy,” when it receives
an up-front fee of any kind (e.g., a service activation fee).
The application of EITF Issue No. 00-21 resulted in the
immediate recognition of all or a portion of such up-front fees
as equipment sales revenue.
51
Additionally, when the Company activates wireless service for a
customer, but does not concurrently provide the customer with a
handset, any up-front fees received continue to be deferred and
amortized over the expected term of the customer relationship.
The Company provides a general right of return within the first
30 days of service for a 100% refund of the handset cost.
The estimated equipment return liability associated with this
right of return is estimated based on historical experience. The
adoption of EITF Issue No. 00-21 did not have a material
effect on the Company’s 2003 consolidated financial
statements.
In November 2002, the FASB issued FIN No. 45,
Guarantor’s Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN No. 45 requires certain
guarantees to be recorded at fair value, which is different from
previous practice, which was generally to record a liability
only when a loss is probable and reasonably estimable.
FIN No. 45 also requires a guarantor to make
significant new disclosures, even when the likelihood of making
any payments under the guarantee is remote. The disclosure
provisions of FIN No. 45 were effective immediately in
2002. The Company adopted the recognition and measurement
provisions of FIN No. 45 on a prospective basis with
respect to guarantees issued or modified after December 31,
2002. The adoption of the recognition and measurement provisions
of FIN No. 45 did not have a material effect on the
Company’s 2003 consolidated financial statements.
Factors That Could Affect Future Results
As a result of the following factors, as well as other variables
affecting our operating results, past financial performance may
not be a reliable indicator of future performance, and
historical trends should not necessarily be used to anticipate
results or trends in future periods.
Representative examples of these factors include (without
limitation) the following:
|
|
| |
We expect to continue to face significant competition in all
parts of our business and the level of competition is expected
to intensify. The telecommunications industry is highly
competitive. We face actual or potential competition from many
existing and emerging companies, including other incumbent and
competitive local telephone companies, long-distance carriers
and resellers, wireless telephone companies, Internet service
providers, satellite companies and cable television companies.
We may not be able to successfully anticipate and respond to
various competitive factors affecting the industry, including
regulatory changes that may affect our competitors and us
differently, new technologies and services that may be
introduced, changes in consumer preferences, demographic trends
and discount pricing strategies by competitors. As the incumbent
carrier in Sacramento, SBC Communications enjoys certain
business advantages, including its size, financial resources,
favorable regulatory position, brand recognition and connection
to virtually all of our customers and potential customers there.
As the largest cable operator in Sacramento and Placer County,
Comcast enjoys certain business advantages, including its size,
financial resources, ownership or superior access to programming
and other content, brand recognition, and first-in-the-field
advantages with a customer base that generates positive cash
flow for its operations. We face intense competition in our
markets for long-distance, Internet access and other ancillary
services that are important to our business and to our growth
strategy. |
| |
| |
We must adapt to rapid technological change.
Technological developments could increase our costs and cause a
decline in demand for our services. In addition, technology
changes can reduce the costs of entry for others and 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, and we may be
placed at a cost disadvantage in offering our services.
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. Many businesses that
compete with the Company are comparatively less regulated. Many
significant regulatory decisions have had to be accommodated in
recent years, and there are pending decisions on issues
affecting the Company that are of great importance. |
52
|
|
| |
Our operations have undergone material changes, and our
actual operating results can be expected to differ from the
results indicated in our historical financial statements. As
a result of our acquisition of assets from WIN in 2002, and the
subsequent expansion of our cable television business, 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 continue
to require us to invest significant capital in facilities and
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: interstate common line 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. As
described in the Regulation section above, the Company
currently receives funding of $11,500 annually from the CHCF, a
program designed by the CPUC to establish a fair and equitable
local rate structure and to reduce any disparity in the rates
charged by certain telephone companies serving high-cost areas.
The CHCF was due to expire on January 1, 2005. On
September 28, 2004, the Governor of California signed
SB1276 into law, which amended the existing legislation and
extended the expiration date to January 1, 2009. 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. Situations
with carrier and other customers could affect our ability to
collect services that have been provided. |
| |
| |
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, and from
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. |
| |
| |
We are subject to new corporate governance and internal
control reporting requirements, and our failure to comply with
existing and future requirements could adversely affect our
business. Pursuant to Section 404 of the Sarbanes-Oxley
Act of 2002 (“Section 404”) and related
Securities and Exchange Commission rules, we have furnished a
report of management’s assessment of the effectiveness of
our internal controls at December 31, 2004. In addition,
our Independent Registered Public Accounting Firm audited and
reported on, management’s assessment. Management concluded
that the Company’s internal control over financial
reporting was not effective at December 31, 2004. If our
deficiencies are not adequately addressed, we could experience
accounting errors that could result in misstatements of our
financial position and results of operations, potential
restatements of our financial statements or otherwise adversely
affect our business, reputation and results of operations.
Inferior internal controls could also cause investors to lose
confidence in our reported financial information, which could
have a negative effect on the trading price of our securities. |
53
|
|
| |
If we are unable to effectively and efficiently implement the
necessary initiatives to eliminate the material weakness
identified in our internal controls and procedures, there could
be an adverse affect on our operations or financial results.
In connection with the Management’s Report on Internal
Control over Financial Reporting, management identified a
material weakness in the Company’s internal control over
financial reporting relating to the accounting for property,
plant and equipment, which resulted from a control weakness that
caused the following conditions: The Company was unable to
completely reconcile its plant in service and plant under
construction subsidiary ledgers to the corresponding general
ledger balances for periods throughout 2004 and as of
December 31, 2004. Management believes these unreconciled
differences are attributable principally to deficiencies in the
reliability of the Company’s information system interfaces
between the general ledger and the property, plant and equipment
subsidiary ledgers. In addition, during 2004, several errors
occurred in the Company’s periodic depreciation and
capitalized interest calculations that were more than
inconsequential. Additionally, as of December 31, 2004, the
Company did not have effective procedures with which to
determine the cost bases of property, plant and equipment that
had been retired. Moreover, certain manual internal controls
pertaining to property, plant and equipment implemented by the
Company during the third quarter of 2004 were not operating
effectively as of December 31, 2004. These matters required
the Company to record adjustments to both its annual and interim
2004 consolidated financial statements. The significant accounts
affected by this material weakness are property, plant and
equipment and related accumulated depreciation included in the
Company’s consolidated balance sheets, and depreciation
expense and interest expense included in the Company’s
consolidated statements of operations. Due to this material
weakness, management believes that as of December 31, 2004,
the Company’s internal control over financial reporting was
not effective based on the Committee of Sponsoring Organizations
of the Treadway Commission criteria. |
| |
| |
During the year ended December 31, 2004, we implemented
various initiatives, and will be implementing additional
initiatives in 2005 to improve our internal controls, and
address the matters discussed in Management’s Report on
Internal Control over Financial Reporting. 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 the identified material weakness is eliminated, there is a
risk of an adverse affect on our operations or financial results. |
54
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, intercarrier compensation, access charges,
universal service and IP-enabled 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.
Due to 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:
|
|
|
| |
• |
Additional rules governing the opening of markets to competition; |
| |
| |
• |
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; |
| |
| |
• |
Rules that will provide non-discriminatory access by competing
service providers to the network capabilities of local exchange
carriers; and |
| |
| |
• |
The regulated rates and earnings of SureWest Telephone. |
The Company has been involved in a proceeding at the CPUC that
has considered the continued need for certain sharing
requirements in the intrastate jurisdiction, and in connection
with that review, has also considered the issues of whether the
Company overearned in the intrastate jurisdiction in recent
monitoring periods, and if so, the amount of such overearnings
that should be shared with customers. On July 27, 2004, the
Company entered into a settlement agreement with the other
parties in the proceeding, the ORA and The Utility Reform
Network (“TURN”), to resolve all issues in the
proceeding. In 2004, the CPUC approved the settlement agreement.
Among other things, the settlement agreement resolves all
earnings issues for the monitoring periods 2000-2004, put into
place a surcredit mechanism for the amount of the settlement,
and suspends the requirement for any intrastate sharing for
later monitoring periods from January 1, 2005 through at
least December 31, 2010.
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, 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.
55
|
|
| Item 7A. |
Quantitative and Qualitative Disclosures About Market
Risk. |
The Company has limited exposure to the impact of interest rate
fluctuations. To manage its exposure to interest rate
fluctuations, the Company uses a combination of variable
short-term and fixed rate long-term financial instruments. In
addition, the Company has a contractual obligation related to
its intrastate shareable earnings in the form of a surcredit to
its customers over a period of four years beginning
January 1, 2005, which is subject to variable interest
rates. The Company does not use derivative financial instruments
in its investment portfolio or for any other purposes.
The Company primarily enters into debt obligations to fund
operations and planned capital expenditures. The Company
currently has no cash flow exposure related to its long-term
debt obligations as all obligations are at fixed rates. As of
December 31, 2004, the Company had fixed rate debt
obligations of $92.9 million with an average interest rate
of 5.3%. Based on borrowing rates currently available for loans
with similar terms and maturities, the estimated fair value of
long-term debt as of December 31, 2004 was
$93.8 million.
The Company currently has minimal cash flow exposure related to
its short-term debt obligation as the credit facility can be
converted into a long-term obligation at a fixed rate at
anytime. The Company also believes there is limited exposure to
market risk for change in interest rates related to contractual
shareable earnings obligations. The interest rate on the
contractual shareable earnings obligations is variable based on
a 30-day commercial paper rate. Assuming a fluctuation of
100 basis points in the interest rate of the contractual
shareable earnings obligations, the fair value would increase
$148 or decrease $140. As of December 31, 2004, the Company
had variable rate debt obligations of $19.2 million with an
average interest rate of 2.5%.
56
|
|
| Item 8. |
Financial Statements and Supplementary Data. |
| |
|
|
|
|
| |
|
Page | |
|
Report of Ernst and Young LLP, Independent Registered Public
Accounting Firm
|
|
|
58 |
|
| |
|
Consolidated Balance Sheets as of December 31, 2004 and 2003
|
|
|
59 |
|
| |
|
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2004
|
|
|
61 |
|
| |
|
Consolidated Statements of Shareholders’ Equity for each of
the three years in the period ended December 31, 2004
|
|
|
62 |
|
| |
|
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2004
|
|
|
63 |
|
| |
|
Notes to Consolidated Financial Statements
|
|
|
65 |
|
57
Report of Ernst & Young LLP, Independent Registered
Public Accounting Firm
The Board of Directors and Shareholders
SureWest Communications
We have audited the accompanying consolidated balance sheets of
SureWest Communications as of December 31, 2004 and 2003,
and the related consolidated statements of operations,
shareholders’ equity, and cash flows for each of the three
years in the period ended December 31, 2004. These
financial statements are the responsibility of the
Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of SureWest Communications at
December 31, 2004 and 2003, and the consolidated results of
its operations and its cash flows for each of the three years in
the period ended December 31, 2004, in conformity with
U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial
statements, in 2003 the Company adopted the fair value
recognition provisions of Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based
Compensation, using the prospective adoption method under
the provisions of Statement of Financial Accounting Standards
No. 148, Accounting for Stock-Based
Compensation – Transition and Disclosure. As
discussed in Note 1 to the consolidated financial
statements, in 2003 the Company changed its method of accounting
for revenue recognition upon the prospective adoption of
Emerging Issues Task Force Issue No. 00-21, Accounting
for Revenue Arrangements with Multiple Deliverables.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of SureWest Communications’ internal control
over financial reporting as of December 31, 2004, based on
criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission and our report dated March 11, 2005
expressed an unqualified opinion on management’s assessment
of the effectiveness of internal control over financial
reporting and an adverse opinion on the effectiveness of
internal control over financial reporting.
Sacramento, California
March 11, 2005
58
SUREWEST COMMUNICATIONS
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
2004 | |
|
2003 | |
| ASSETS |
|
| |
|
| |
|
Current assets:
|
|
|
|
|
|
|
|
|
| |
Cash and cash equivalents
|
|
$ |
18,119 |
|
|
$ |
39,008 |
|
| |
Short-term investments
|
|
|
– |
|
|
|
2,699 |
|
| |
Accounts receivable (less allowances of $3,850 and $2,665 at
December 31, 2004 and 2003, respectively)
|
|
|
20,155 |
|
|
|
18,846 |
|
| |
Deferred income tax asset
|
|
|
– |
|
|
|
209 |
|
| |
Inventories
|
|
|
5,578 |
|
|
|
5,537 |
|
| |
Deferred directory costs
|
|
|
5,599 |
|
|
|
5,320 |
|
| |
Prepaid expenses
|
|
|
2,359 |
|
|
|
2,544 |
|
| |
Prepaid pension benefits
|
|
|
– |
|
|
|
896 |
|
| |
|
|
|
|
|
|
|
Total current assets
|
|
|
51,810 |
|
|
|
75,059 |
|
|
Property, plant and equipment, net
|
|
|
365,613 |
|
|
|
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
|
|
|
802 |
|
|
|
125 |
|
| |
Intangible asset relating to favorable operating leases, net
|
|
|
506 |
|
|
|
649 |
|
| |
Deferred charges and other assets
|
|
|
714 |
|
|
|
672 |
|
| |
|
|
|
|
|
|
| |
|
|
17,759 |
|
|
|
17,183 |
|
| |
|
|
|
|
|
|
| |
|
$ |
435,182 |
|
|
$ |
435,209 |
|
| |
|
|
|
|
|
|
See accompanying notes.
59
SUREWEST COMMUNICATIONS
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(amounts in thousands)
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
2004 | |
|
2003 | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY |
|
| |
|
| |
|
Current liabilities:
|
|
|
|
|
|
|
|
|
| |
Short-term borrowings
|
|
$ |
10,000 |
|
|
$ |
– |
|
| |
Current portion of long-term debt
|
|
|
3,779 |
|
|
|
3,779 |
|
| |
Current portion of capital lease obligations
|
|
|
212 |
|
|
|
347 |
|
| |
Accounts payable
|
|
|
2,886 |
|
|
|
2,206 |
|
| |
Current portion of contractual shareable earnings obligations
(less unamortized discount of $52 as of December 31, 2004)
|
|
|
3,040 |
|
|
|
– |
|
| |
Estimated shareable earnings obligations
|
|
|
396 |
|
|
|
13,389 |
|
| |
Advance billings and deferred revenues
|
|
|
9,883 |
|
|
|
9,882 |
|
| |
Accrued income taxes
|
|
|
1,549 |
|
|
|
1,908 |
|
| |
Accrued pension benefits
|
|
|
3,216 |
|
|
|
– |
|
| |
Accrued compensation
|
|
|
5,830 |
|
|
|
4,860 |
|
| |
Other accrued liabilities
|
|
|
22,038 |
|
|
|
14,727 |
|
| |
|
|
|
|
|
|
|
Total current liabilities
|
|
|
62,829 |
|
|
|
51,098 |
|
|
Long-term debt
|
|
|
89,091 |
|
|
|
92,870 |
|
|
Long-term capital lease obligations
|
|
|
52 |
|
|
|
265 |
|
|
Long-term contractual shareable earnings obligations (less
unamortized discount of $472 as of December 31, 2004)
|
|
|
6,202 |
|
|
|
– |
|
|
Deferred income taxes
|
|
|
24,134 |
|
|
|
25,946 |
|
|
Other liabilities and deferred revenues
|
|
|
11,537 |
|
|
|
7,502 |
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
Shareholders’ equity:
|
|
|
|
|
|
|
|
|
| |
Common stock, without par value; 100,000 shares authorized,
14,591 and 14,578 shares issued and outstanding at
December 31, 2004 and 2003, respectively
|
|
|
161,824 |
|
|
|
160,911 |
|
| |
Deferred stock-based compensation
|
|
|
(949 |
) |
|
|
(1,419 |
) |
| |
Accumulated other comprehensive loss
|
|
|
(2,126 |
) |
|
|
(261 |
) |
| |
Retained earnings
|
|
|
82,588 |
|
|
|
98,297 |
|
| |
|
|
|
|
|
|
|
Total shareholders’ equity
|
|
|
241,337 |
|
|
|
257,528 |
|
| |
|
|
|
|
|
|
| |
|
$ |
435,182 |
|
|
$ |
435,209 |
|
| |
|
|
|
|
|
|
See accompanying notes.
60
SUREWEST COMMUNICATIONS
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share amounts)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Operating revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Local service
|
|
$ |
69,560 |
|
|
$ |
63,363 |
|
|
$ |
66,283 |
|
| |
Network access service
|
|
|
46,161 |
|
|
|
51,286 |
|
|
|
58,426 |
|
| |
Directory advertising
|
|
|
16,283 |
|
|
|
15,087 |
|
|
|
14,824 |
|
| |
Long distance service
|
|
|
5,184 |
|
|
|
5,098 |
|
|
|
5,368 |
|
| |
Wireless service
|
|
|
31,261 |
|
|
|
27,146 |
|
|
|
23,225 |
|
| |
Internet service
|
|
|
16,679 |
|
|
|
15,984 |
|
|
|
7,578 |
|
| |
Residential broadband service
|
|
|
17,077 |
|
|
|
9,370 |
|
|
|
2,946 |
|
| |
Business broadband service
|
|
|
5,660 |
|
|
|
3,697 |
|
|
|
2,421 |
|
| |
Other
|
|
|
3,898 |
|
|
|
4,090 |
|
|
|
4,778 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Total operating revenues
|
|
|
211,763 |
|
|
|
195,121 |
|
|
|
185,849 |
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Cost of services and products (exclusive of depreciation and
amortization)
|
|
|
80,853 |
|
|
|
66,890 |
|
|
|
61,220 |
|
| |
Customer operations and selling
|
|
|
37,175 |
|
|
|
34,094 |
|
|
|
34,165 |
|
| |
General and administrative
|
|
|
43,820 |
|
|
|
33,920 |
|
|
|
29,648 |
|
| |
Depreciation and amortization
|
|
|
48,596 |
|
|
|
52,470 |
|
|
|
45,126 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Total operating expenses
|
|
|
210,444 |
|
|
|
187,374 |
|
|
|
170,159 |
|
|
Income from operations
|
|
|
1,319 |
|
|
|
7,747 |
|
|
|
15,690 |
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Interest income
|
|
|
201 |
|
|
|
306 |
|
|
|
739 |
|
| |
Interest expense
|
|
|
(4,505 |
) |
|
|
(4,247 |
) |
|
|
(1,876 |
) |
| |
Gain on sale of alarm monitoring assets
|
|
|
– |
|
|
|
– |
|
|
|
4,435 |
|
| |
Corporate treasury loss recovery (loss)
|
|
|
1,803 |
|
|
|
(1,828 |
) |
|
|
– |
|
| |
Other, net
|
|
|
(443 |
) |
|
|
(311 |
) |
|
|
(313 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Total other income (expense), net
|
|
|
(2,944 |
) |
|
|
(6,080 |
) |
|
|
2,985 |
|
| |
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
(1,625 |
) |
|
|
1,667 |
|
|
|
18,675 |
|
|
Income taxes
|
|
|
(497 |
) |
|
|
1,022 |
|
|
|
7,426 |
|
| |
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$ |
(1,128 |
) |
|
$ |
645 |
|
|
$ |
11,249 |
|
| |
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings (loss) per share
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
| |
|
|
|
|
|
|
|
|
|
|
Dividends per share
|
|
$ |
1.00 |
|
|
$ |
1.00 |
|
|
$ |
1.00 |
|
| |
|
|
|
|
|
|
|
|
|
|
Shares of common stock used to calculate
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Basic
|
|
|
14,531 |
|
|
|
14,522 |
|
|
|
14,728 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Diluted
|
|
|
14,531 |
|
|
|
14,539 |
|
|
|
14,795 |
|
| |
|
|
|
|
|
|
|
|
|
See accompanying notes.
61
SUREWEST COMMUNICATIONS
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(amounts in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Common Stock | |
|
|
|
|
|
|
|
|
| |
|
| |
|
Deferred | |
|
Other | |
|
|
|
|
| |
|
Number | |
|
|
|
Stock-Based | |
|
Comprehensive | |
|
Retained | |
|
|
| |
|
of Shares | |
|
Amount | |
|
Compensation | |
|
Loss | |
|
Earnings | |
|
Total | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Balance at December 31, 2001
|
|
|
15,110 |
|
|
$ |
172,083 |
|
|
$ |
(303 |
) |
|
$ |
– |
|
|
$ |
130,013 |
|
|
$ |
301,793 |
|
| |
Issuance of common stock upon exercise of options
|
|
|
23 |
|
|
|
896 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
896 |
|
| |
Issuance of restricted common stock
|
|
|
2 |
|
|
|
46 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
46 |
|
| |
Repurchase of common stock
|
|
|
(606 |
) |
|
|
(15,149 |
) |
|
|
– |
|
|
|
– |
|
|
|
(14,318 |
) |
|
|
(29,467 |
) |
| |
Amortization of deferred stock-based compensation
|
|
|
– |
|
|
|
– |
|
|
|
187 |
|
|
|
– |
|
|
|
– |
|
|
|
187 |
|
| |
Tax benefits from stock plans
|
|
|
– |
|
|
|
691 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
691 |
|
| |
Minimum pension and post-retirement benefit obligation
adjustment, net of income taxes
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
(1,637 |
) |
|
|
– |
|
|
|
(1,637 |
) |
| |
Cash dividends
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
(14,753 |
) |
|
|
(14,753 |
) |
| |
Net income
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
11,249 |
|
|
|
11,249 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2002
|
|
|
14,529 |
|
|
|
158,567 |
|
|
|
(116 |
) |
|
|
(1,637 |
) |
|
|
112,191 |
|
|
|
269,005 |
|
| |
Issuance of common stock upon exercise of options
|
|
|
5 |
|
|
|
164 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
164 |
|
| |
Issuance of stock options to employees
|
|
|
– |
|
|
|
47 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
47 |
|
| |
Issuance of restricted common stock
|
|
|
44 |
|
|
|
1,594 |
|
|
|
(1,594 |
) |
|
|
– |
|
|
|
– |
|
|
|
– |
|
| |
Amortization of deferred stock-based compensation
|
|
|
– |
|
|
|
– |
|
|
|
291 |
|
|
|
– |
|
|
|
– |
|
|
|
291 |
|
| |
Tax benefits from stock plans
|
|
|
– |
|
|
|
539 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
539 |
|
| |
Minimum pension and post-retirement benefit obligation
adjustment, net of income taxes
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
1,376 |
|
|
|
– |
|
|
|
1,376 |
|
| |
Cash dividends
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
(14,539 |
) |
|
|
(14,539 |
) |
| |
Net income
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
645 |
|
|
|
645 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2003
|
|
|
14,578 |
|
|
|
160,911 |
|
|
|
(1,419 |
) |
|
|
(261 |
) |
|
|
98,297 |
|
|
|
257,528 |
|
| |
Issuance of common stock upon exercise of options
|
|
|
– |
|
|
|
10 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
10 |
|
| |
Recognition of stock options issued to employees
|
|
|
– |
|
|
|
29 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
29 |
|
| |
Issuance of restricted common stock, net of cancellations
|
|
|
13 |
|
|
|
315 |
|
|
|
(319 |
) |
|
|
– |
|
|
|
– |
|
|
|
(4 |
) |
| |
Issuance of restricted common stock units
|
|
|
– |
|
|
|
150 |
|
|
|
(150 |
) |
|
|
– |
|
|
|
– |
|
|
|
– |
|
| |
Amortization of deferred stock-based compensation
|
|
|
– |
|
|
|
– |
|
|
|
939 |
|
|
|
– |
|
|
|
– |
|
|
|
939 |
|
| |
Tax benefits from stock plans
|
|
|
– |
|
|
|
409 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
409 |
|
| |
Minimum pension and post-retirement benefit obligation
adjustment, net of income taxes
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
(1,865 |
) |
|
|
– |
|
|
|
(1,865 |
) |
| |
Cash dividends
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
(14,581 |
) |
|
|
(14,581 |
) |
| |
Net loss
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
(1,128 |
) |
|
|
(1,128 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
14,591 |
|
|
$ |
161,824 |
|
|
$ |
(949 |
) |
|
$ |
(2,126 |
) |
|
$ |
82,588 |
|
|
$ |
241,337 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
62
SUREWEST COMMUNICATIONS
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(amounts in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net income (loss)
|
|
$ |
(1,128 |
) |
|
$ |
645 |
|
|
$ |
11,249 |
|
| |
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Depreciation and amortization
|
|
|
48,596 |
|
|
|
52,470 |
|
|
|
45,126 |
|
| |
|
Provision for deferred income taxes
|
|
|
(372 |
) |
|
|
(1,309 |
) |
|
|
17,128 |
|
| |
|
Gain on sale of alarm monitoring assets
|
|
|
– |
|
|
|
– |
|
|
|
(4,435 |
) |
| |
|
Provision for doubtful accounts
|
|
|
3,441 |
|
|
|
3,381 |
|
|
|
3,811 |
|
| |
|
Stock-based compensation
|
|
|
968 |
|
|
|
338 |
|
|
|
202 |
|
| |
|
Other, net
|
|
|
– |
|
|
|
307 |
|
|
|
(4 |
) |
| |
|
Net changes in:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
Receivables
|
|
|
(4,750 |
) |
|
|
(2,480 |
) |
|
|
(3,624 |
) |
| |
|
|
Refundable and accrued income taxes, net
|
|
|
(359 |
) |
|
|
8,852 |
|
|
|
(3,558 |
) |
| |
|
|
Inventories, prepaid expenses and other current assets
|
|
|
(379 |
) |
|
|
(1,926 |
) |
|
|
(155 |
) |
| |
|
|
Accounts payable
|
|
|
680 |
|
|
|
1,601 |
|
|
|
(2,777 |
) |
| |
|
|
Accrued liabilities, other liabilities and deferred credits
|
|
|
9,373 |
|
|
|
11,229 |
|
|
|
(16,161 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
56,070 |
|
|
|
73,108 |
|
|
|
46,802 |
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Purchase of substantially all of the assets from Western
Integrated Networks, LLC
|
|
|
– |
|
|
|
(62 |
) |
|
|
(12,529 |
) |
| |
Proceeds from the sale of alarm monitoring assets
|
|
|
– |
|
|
|
– |
|
|
|
4,495 |
|
| |
Capital expenditures for property, plant and equipment
|
|
|
(70,833 |
) |
|
|
(76,105 |
) |
|
|
(44,352 |
) |
| |
Purchases of held-to-maturity investments
|
|
|
(4,275 |
) |
|
|
(25,351 |
) |
|
|
– |
|
| |
Maturities of held-to-maturity investments
|
|
|
6,974 |
|
|
|
20,652 |
|
|
|
1,723 |
|
| |
Sale of held-to-maturity investment prior to maturity
|
|
|
– |
|
|
|
2,000 |
|
|
|
– |
|
| |
Other, net
|
|
|
(123 |
) |
|
|
33 |
|
|
|
192 |
|
| |
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(68,257 |
) |
|
|
(78,833 |
) |
|
|
(50,471 |
) |
See accompanying notes.
63
SUREWEST COMMUNICATIONS
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Increase (Decrease) in Cash and Cash Equivalents
(amounts in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Increase (decrease) in short-term borrowings
|
|
$ |
10,000 |
|
|
$ |
(15,000 |
) |
|
$ |
15,000 |
|
| |
Principal payments of long-term debt and capital lease
obligations
|
|
|
(4,127 |
) |
|
|
(5,921 |
) |
|
|
(2,142 |
) |
| |
Proceeds from issuance of long-term debt
|
|
|
– |
|
|
|
60,000 |
|
|
|
– |
|
| |
Payment of debt issuance costs
|
|
|
– |
|
|
|
(356 |
) |
|
|
– |
|
| |
Dividends paid
|
|
|
(14,581 |
) |
|
|
(14,539 |
) |
|
|
(14,753 |
) |
| |
Proceeds from exercise of stock options
|
|
|
10 |
|
|
|
164 |
|
|
|
896 |
|
| |
Repurchase of common stock
|
|
|
– |
|
|
|
– |
|
|
|
(29,467 |
) |
| |
Other, net
|
|
|
(4 |
) |
|
|
– |
|
|
|
– |
|
| |
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
(8,702 |
) |
|
|
24,348 |
|
|
|
(30,466 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents
|
|
|
(20,889 |
) |
|
|
18,623 |
|
|
|
(34,135 |
) |
|
Cash and cash equivalents at beginning of year
|
|
|
39,008 |
|
|
|
20,385 |
|
|
|
54,520 |
|
| |
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year
|
|
$ |
18,119 |
|
|
$ |
39,008 |
|
|
$ |
20,385 |
|
| |
|
|
|
|
|
|
|
|
|
See accompanying notes.
64
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Amounts in thousands, except share and per share amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business, Basis of Accounting and Liquidity
SureWest Communications (the “Company”) is a holding
company with wholly-owned subsidiaries that provide integrated
communications services in Northern California. The
Company’s principal operating subsidiary is SureWest
Telephone. SureWest Directories, SureWest Long Distance,
SureWest Wireless, SureWest Broadband, SureWest TeleVideo and
SureWest TeleVideo of Roseville (“SureWest
Broadband/Residential Services”), SureWest Internet and
SureWest Custom Data Services (formerly Quiknet, Inc.) are each
subsidiaries of the Company. The Company expects that the
sources of its revenues and its cost structure may be different
in future periods, both as a result of its entry into new
communications markets and competitive forces in each of the
markets in which the Company has operations.
The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results may differ
materially from those estimates. The Company’s critical
accounting estimates include (i) revenue recognition and
the establishment of estimated shareable earnings obligations,
accounts receivable allowances and customer refund obligations
(Notes 1 and 2), (ii) inventory valuation
(Note 1), (iii) useful life assignments and impairment
evaluations associated with property, plant and equipment and
intangible assets (Note 1), (iv) asset retirement
obligations (Note 1), (v) valuation allowances
associated with deferred tax assets (Notes 1 and 7),
(vi) pension and post-retirement benefit costs and
obligations (Note 8), (vii) anticipated outcomes of
litigation, regulatory proceedings and other contingencies
(Notes 1 and 9) and (viii) employee stock-based
compensation (Notes 1 and 10).
The Company had a working capital deficit of $11,019 at
December 31, 2004. Management believes the Company’s
cash flows from operating activities and borrowing capacity
under its bank line of credit arrangement (Note 6) are
sufficient to satisfy its liquidity requirements in 2005.
Principles of Consolidation
The consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant
intercompany transactions have been eliminated.
Adjustments and Reclassifications
During the Company’s financial statement closing process
for the year ended December 31, 2003, certain matters were
identified related to prior financial reporting periods that
necessitated the recording of adjustments to the Company’s
consolidated financial statements. Such adjustments pertained
principally to property, plant and equipment, and management
believes that weaknesses in the Company’s internal controls
caused the errors that resulted in these adjustments. The
Company does not believe any of the aforementioned amounts are
material, individually or in the aggregate, to the respective
prior annual periods based on both quantitative and qualitative
factors, including the trend of operating results, nor does it
believe the prospective correction of such amounts during the
quarter ended December 31, 2003 is material to the
Company’s 2003 consolidated results of operations based on
both quantitative and qualitative factors, including the trend
of operating results. (The prospective correction of the
aforementioned amounts relating to prior periods reduced the
Company’s 2003 consolidated net income by $1,603, or
$0.11 per basic and diluted share, and would have reduced
the Company’s 2002 and 2001 consolidated net income by
$796, or $0.05 per basic and diluted share and $217, or
$0.01 per basic and diluted share, respectively, had such
errors been corrected in the periods in which they originated.)
65
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
Certain amounts in the Company’s 2003 and 2002 consolidated
financial statements have been reclassified to conform to the
presentation of the Company’s 2004 consolidated financial
statements.
Regulation and Contractual and Estimated Shareable Earnings
Obligations
Certain of the Company’s rates are subject to regulation by
the Federal Communications Commission (“FCC”) and the
California Public Utilities Commission (“CPUC”).
Pending and future regulatory actions may have a material impact
on the Company’s consolidated financial position and
results of operations.
Revenues from certain telephone services are affected by rates
authorized by various regulatory agencies. Intrastate service
rates are subject to regulation by the CPUC. With respect to
toll calls initiated by interexchange carriers’ customers,
the interexchange carriers are assessed access charges based on
tariffs filed by SureWest Telephone. Interstate access rates and
resultant earnings are subject to regulation by the FCC. With
respect to interstate services, SureWest Telephone has filed its
own tariff with the FCC for all elements of access services
except carrier common line charges, for which SureWest Telephone
concurs with tariffs filed by the National Exchange Carrier
Association (“NECA”).
The FCC monitors SureWest Telephone’s interstate earnings
through the use of annual cost separation studies prepared by
SureWest Telephone, which utilize estimated cost information and
projected demand usage. The FCC establishes rules that carriers
must follow in the preparation of the annual studies.
Additionally, under current FCC rules governing rate making,
SureWest Telephone is required to establish interstate rates
based on projected demand usage for its various services and
determine the actual earnings from these rates once actual
volumes and costs are known.
In January 2001, the FCC issued a Memorandum Opinion and Order
to another telephone company in which it clarified how Internet
traffic, which the FCC had prior to that date characterized as
largely interstate in nature, should be treated. During 2000 and
2001, Internet traffic and digital subscriber line
(“DSL”) service grew substantially, far exceeding
SureWest Telephone’s estimates, which resulted in actual
earnings exceeding the levels allowed by the FCC. Based on
preliminary cost studies, the Company recognized liabilities
relating to SureWest Telephone’s estimated interstate
shareable earnings obligations of $343 and $650 for the years
ended December 31, 2003 and 2002, respectively, through
reductions of revenues. The Company did not identify any
interstate shareable earnings obligations at SureWest Telephone
during the year ended December 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 years ended December 31,
2004, 2003 or 2002. During 2003, the Company entered into an
agreement to recover the amount paid to a telecommunications
company in 2001. Therefore, the Company recognized an increase
in network access service revenues of $1,950 during 2003. The
Company is currently seeking a similar refund from another
telecommunications company, which later filed for bankruptcy
protection under Chapter 11 of the Bankruptcy Code. 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.
In May 2002, the D.C. Circuit Court of Appeals (the
“Court”) issued a decision in a case involving ACS of
Anchorage. The Court determined that a tariff filed properly
under Section 204 “streamlined” procedures and
allowed to go into effect without suspension is deemed lawful,
and the carrier is not subsequently obligated to pay refunds for
earnings higher than the permitted rate of return as prescribed
by the FCC for that monitoring period. Subsequent to the
Court’s decision, certain telecommunication companies filed
a petition for rehearing. In August 2002, the petitions for
rehearing were denied by the Court, and later that month the
Court’s order
66
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
became effective. For the monitoring periods 1999 through 2001,
SureWest Telephone filed tariffs pursuant to the streamlined
procedures and such tariffs were not suspended or investigated.
Consequently, during 2002, SureWest Telephone changed its
estimate for a portion of its interstate shareable earnings
obligations related to those monitoring periods. For the year
ended December 31, 2002, this change in accounting estimate
increased the Company’s revenues by $5,092 and net income
by $3,065 ($0.21 per share).
In 1999, SBC Communications (“SBC”) expressed interest
in entering into a new, permanent compensation arrangement for
extended area service (“EAS”). At that time, SBC was
paying SureWest Telephone approximately $11,500 per year
for EAS pursuant to a Settlement Transition Agreement. In
November 2000, the CPUC authorized SBC to terminate its annual
EAS payments to SureWest Telephone effective November 30,
2000. The CPUC authorized replacement funding to SureWest
Telephone on an interim basis using funds from the California
High Cost Fund (“CHCF”). The CHCF is a program
designed by the CPUC to establish a fair and equitable local
rate structure and to reduce any disparity in the rates charged
by telephone companies serving high-cost areas. The CHCF was due
to expire on January 1, 2005. However, on
September 28, 2004, the Governor of California signed
SB1276 into law, which amended the existing legislation and
extended the expiration date to January 1, 2009. 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 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, and it was
initially 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 ORA
undertook a verification audit of SureWest Telephone’s
non-regulated and affiliated transactions pursuant to the
general rate case and other CPUC orders. In June 2001, the CPUC
adopted its decision in this matter (the “Decision”).
The Decision did not suspend the sharing mechanism as SureWest
Telephone had requested, and the CPUC ruled that SureWest
Telephone must change the method used to allocate costs for
services provided by SureWest Telephone to its affiliates, the
treatment of certain directory revenues and the treatment of
internal-use software costs. In accordance with the provisions
of the Decision, the Company recorded certain liabilities and
reductions of revenues of $3,285 and $1,750 relating to its
estimated intrastate shareable earnings obligations during the
years ended December 31, 2003 and 2002, respectively (none
in 2004).
The Company has been involved in a proceeding at the CPUC that
has considered the continued need for certain sharing
requirements in the intrastate jurisdiction and, in connection
with that review, has also considered the issue of whether the
Company overearned in the intrastate jurisdiction in recent
monitoring periods and, if so, the amount of such overearnings
that should be shared with customers. On July 27, 2004, the
Company entered into a settlement agreement with the other
parties in the proceeding, the ORA and The Utility Reform
Network (“TURN”), to resolve all issues in the
proceeding. In November 2004 the CPUC approved the settlement
67
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
agreement. The settlement agreement resolves existing sharing
obligations and related earnings issues for the monitoring
periods 2000 through 2004, puts into place a surcredit mechanism
for the amount of the settlement, and suspends the requirement
for any intrastate sharing for monitoring periods from
January 1, 2005 through at least December 31, 2010.
The settlement agreement resulted in SureWest Telephone
recognizing an increase in local revenues of $2,948 in 2004 due
to a change in accounting estimate. This increase in revenues
resulted in a decrease of the Company’s net loss by $2,046
($0.14 per share) during 2004.
In accordance with the November 2004 settlement agreement,
SureWest Telephone will return approximately $6,500, plus
interest at an annual contractual rate of 2.34% and imputed rate
of 3.15%, to its customers in the form of a surcredit over a
period of four years beginning January 1, 2005 and will pay
a one-time customer refund of $2,600, which includes an annual
imputed interest rate of 3.15% (no stated contractual interest
rate), in the form of a surcredit over two years beginning
January 1, 2005 to settle the monitoring periods 2000 to
2004. At December 31, 2004, the aggregate contractual
shareable earnings obligation for these surcredits was $9,242
(which is net of an unamortized discount pertaining to imputed
interest of $524 at such date). Future payments for these
obligations are $3,092 in 2005 and 2006 and $1,791 in 2007 and
2008.
Further, commencing January 1, 2007, SureWest Telephone
shall implement a permanent annual consumer dividend of $1,300
to end-users receiving SureWest Telephone services subject to
sharing on or after that date; however, this consumer dividend
is subject to reduction based upon the results of other pending
regulatory proceedings.
Beginning in January 2002, SureWest Telephone began paying a
customer refund for intrastate shareable earnings obligations
relating to the years 1998 and 1999. A portion of the
customers’ intrastate service charges was returned in the
form of a surcredit beginning in January 2002 and ending in
January 2003, totaling approximately $4,605 (of which $294 was
returned during 2003). Such refunds were recorded as a reduction
of the Company’s estimated intrastate shareable earnings
obligations.
Beginning in November 2003, SureWest Telephone began paying a
customer 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 2004). Such refunds were
recorded as a reduction of the Company’s estimated
intrastate shareable earnings obligations.
As a result of periodic cost separation studies, SureWest
Telephone changed its estimates for a portion of its interstate
and intrastate shareable earnings obligations and certain NECA
CCL accounts receivable balances during the years ended
December 31, 2004, 2003 and 2002. For the year ended
December 31, 2004, these changes in accounting estimates
increased the Company’s revenues by $1,430 and decreased
net loss by $992 ($0.07 per share). For the year ended
December 31, 2003, similar changes in accounting estimates
decreased the Company’s revenues by $29 and net income by
$11 (no effect on earnings per share). For the year ended
December 31, 2002, similar changes in accounting estimates
decreased the Company’s revenues by $1,115 and net income
by $671 ($0.05 per share).
As of December 31, 2004, the Company’s consolidated
balance sheet reflected aggregate liabilities of $396 relating
to SureWest Telephone’s estimated interstate 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 shareable earnings
obligations could change in the near term, and the amounts
involved could be material.
68
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
Cash Equivalents and Short-term Investments
The Company invests its excess cash in high-quality debt
instruments and money market mutual funds. The Company considers
highly liquid investments with maturities of three months or
less from the acquisition date of the instrument to be cash
equivalents. There were no short-term investments at
December 31, 2004. Short-term investments at
December 31, 2003 had maturities ranging from greater than
90 days to less than one year. Management determines the
appropriate classification of securities at the time of purchase
and re-evaluates such designation as of each balance sheet date.
At December 31, 2003, all securities were designated as
held-to-maturity because management had the positive intent and
ability to hold the securities until maturity. Held-to-maturity
securities are stated at cost, adjusted for amortization of
premiums and accretion of discounts to maturity. Such
amortization and accretion, as well as any interest on the
securities, is included in interest income.
In April 2003, the Company sold a short-term investment prior to
its maturity date. The investment was sold without the consent
of the Company’s management and was a part of the irregular
transactions discovered in connection with the Company’s
treasury investigation (refer to Note 3 for a more detailed
discussion about the Company’s treasury investigation). The
Company incurred a nominal penalty for the premature redemption
of this investment. The redemption did not have a material
effect on the Company’s 2003 consolidated financial
statements.
The following is a summary of the Company’s cash
equivalents and short-term investments as of December 31,
2004 and 2003 at amortized cost, which approximates fair market
value:
| |
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Money market mutual funds
|
|
$ |
49 |
|
|
$ |
15,726 |
|
|
United States government agency securities
|
|
|
– |
|
|
|
999 |
|
|
Auction rate securities
|
|
|
– |
|
|
|
1,700 |
|
| |
|
|
|
|
|
|
| |
|
$ |
49 |
|
|
$ |
18,425 |
|
| |
|
|
|
|
|
|
Fair Values of Financial Instruments
As of December 31, 2004 and 2003, the Company’s
financial instruments consisted of cash, cash equivalents,
short-term investments, short-term borrowings, long-term debt,
capital lease obligations and contractual intrastate shareable
earnings obligations.
Management believes the carrying values of cash equivalents and
short-term investments at December 31, 2004 and 2003, which
are at amortized cost, approximated their fair values at such
dates. Fair values for cash equivalents and short-term
investments were determined by quoted market prices.
The aggregate carrying value and fair value of the
Company’s short-term borrowings was approximately $10,000
as of December 31, 2004 (no short-term borrowings were
outstanding as of December 31, 2003). The carrying value of
the Company’s long-term debt (including current maturities)
was $92,870 and $96,649 at December 31, 2004 and 2003,
respectively. The aggregate fair value of the long-term debt was
approximately $93,785 and $101,288 at December 31, 2004 and
2003, respectively. The carrying value of the Company’s
capital lease obligations was $264 and $612 as of
December 31, 2004 and 2003, respectively. The aggregate
fair value of the capital lease obligations was $244 and $581 as
of December 31, 2004 and 2003, respectively. The aggregate
carrying value and fair value of the Company’s contractual
intrastate shareable earnings obligations was $9,242 as of
December 31, 2004 (no similar obligation existed as of
December 31, 2003).
69
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
The fair values of the Company’s short-term borrowings,
long-term debt, capital lease obligations and contractual
intrastate shareable earnings obligations were determined
through discounted cash flow analyses based on the
Company’s current incremental interest rates for similar
instruments.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for
estimated losses, which result from the inability of customers
to make required payments. Such allowance is based on the
likelihood of recoverability of accounts receivable based on
past experience and management’s best estimates of current
bad debt exposures. The Company performs ongoing credit
evaluations of its customers’ financial condition and
management believes that adequate allowances for doubtful
accounts have been provided. Accounts are determined to be past
due if customer payments have not been received in accordance
with the payment terms. Uncollectible accounts are charged
against the allowance for doubtful accounts and removed from the
accounts receivable balances when internal collection efforts
have been unsuccessful in collecting the amount due. In
addition, certain revenues are subject to refund if the customer
terminates services or returns equipment within a stipulated
time period, or if certain performance criteria are not met.
Accordingly, the Company maintains accounts receivable
allowances and recognizes certain customer refund liabilities,
through charges to revenues, based on the Company’s best
estimates of the resolution of these contingencies, which are
based on historical experience. For the years ended
December 31, 2004, 2003 and 2002, the Company wrote-off
certain accounts receivable balances aggregating $3,032, $3,301
and $3,480, respectively. During the years ended
December 31, 2004, 2003 and 2002, the Company recovered
$776, $755 and $367, respectively, of accounts receivable
balances previously written-off against such allowance.
Inventories
Telephone network inventories consist of materials and supplies,
which are stated at weighted average cost. Nonregulated wireline
equipment inventory held for sale is stated at the lower of
weighted average cost or market value. Wireless handset and
accessory inventories are stated at the lower of average cost or
market value. Inventories at SureWest Broadband are comprised of
modems, which are held for sale or lease and stated at the lower
of weighted average cost or market value, and network materials
and supplies, which are stated at weighted average cost.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Additions and
substantial improvements are capitalized. Repairs and
maintenance costs are charged to expense as incurred.
Retirements and other reductions of regulated telephone plant
and equipment with a cost of approximately $2,861, $4,079 and
$6,470 in 2004, 2003 and 2002, respectively, were charged
against accumulated depreciation with no gain or loss recognized
in accordance with the composite group remaining life
methodology utilized for telephone plant assets. When property
applicable to non-telephone operations is sold or retired, the
asset and related accumulated depreciation are removed from the
accounts and the associated gain or loss is recognized.
70
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
Property, plant and equipment consisted of the following as of
December 31, 2004 and 2003:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Estimated | |
| |
|
2004 | |
|
2003 | |
|
Useful Lives | |
| |
|
| |
|
| |
|
| |
|
Land
|
|
$ |
4,198 |
|
|
$ |
4,198 |
|
|
|
|
|
|
Buildings
|
|
|
81,922 |
|
|
|
79,286 |
|
|
|
35 years |
|
|
Central office equipment
|
|
|
181,412 |
|
|
|
156,374 |
|
|
|
3 - 21 years |
|
|
Outside plant equipment
|
|
|
319,145 |
|
|
|
281,903 |
|
|
|
5 - 40 years |
|
|
Internal-use software
|
|
|
50,787 |
|
|
|
46,137 |
|
|
|
5 years |
|
|
Other
|
|
|
63,977 |
|
|
|
63,735 |
|
|
|
3 - 21 years |
|
| |
|
|
|
|
|
|
|
|
|
|
Total plant in service
|
|
|
701,441 |
|
|
|
631,633 |
|
|
|
|
|
|
Less accumulated depreciation
|
|
|
350,105 |
|
|
|
303,773 |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
Plant in service, net
|
|
|
351,336 |
|
|
|
327,860 |
|
|
|
|
|
|
Plant under construction
|
|
|
14,277 |
|
|
|
15,107 |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
Property plant and equipment, net
|
|
$ |
365,613 |
|
|
$ |
342,967 |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Property, plant and equipment is depreciated using the
straight-line method over their estimated economic lives. The
useful lives of property, plant and equipment are estimated in
order to determine the amount of depreciation expense to be
recorded. The useful lives are estimated at the time the assets
are acquired and are based on historical experience with similar
assets, as well as taking into account anticipated technological
or other changes. Average annual composite depreciation rates
were 7.3%, 7.6% and 7.1% in 2004, 2003 and 2002, respectively.
In January 2004, the Company 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 evaluated the appropriateness of its estimated useful lives
of certain property, plant and equipment at both the Telecom and
Wireless segments. Based on this evaluation, 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. These changes were made
effective January 1, 2004. The Company’s revisions
have been supported by an assessment and report from an
independent third party with expertise in this area that found
the revisions to be reasonable in light of the Company’s
plan and useful life estimates in comparable businesses.
During the year ended December 31, 2004, this change in
estimate decreased consolidated depreciation expense by $10,842
and decreased consolidated net loss by $7,524 ($0.52 per
share). This change in accounting estimate decreased Telecom
depreciation expense and increased Telecom income from
operations by $5,459 for the year ended December 31, 2004.
In addition, Wireless depreciation expense and loss from
operations decreased by approximately $5,383, for the year ended
December 31, 2004 as a result of this change in accounting
estimate.
Effective November 1, 2002, the Company increased the
estimated useful lives primarily related to its Wireless segment
switching and voice mail equipment from five to ten years. This
change in accounting estimate decreased the Company’s 2004,
2003 and 2002 depreciation expense by $789, $930 and $206,
respectively, decreased the Company’s 2004 net loss by
$548 ($0.04 per basic and diluted share) and increased 2003
and 2002 consolidated net income by $360 and $124, respectively
($0.02 and $0.01 per basic and diluted share, respectively).
71
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
Asset Retirement Obligations
The Company adopted Statement of Financial Accounting Standards
(“SFAS”) No. 143, Accounting for Asset
Retirement Obligations, on January 1, 2003. In
accordance with the provisions of SFAS No. 143, the
Company recognizes a retirement obligation (future cost of
removal) pertaining to its long-lived assets, principally
wireless cell sites, when a legal obligation exists to remove
plant at some point in the future. Based on terms outlined in
its wireless tower leases, the Company is obligated to return
the land or facilities to their original condition at the end of
the cell site lease term, should the lease be terminated. The
Company has used a probability-weighted cash flow approach in
estimating its potential retirement obligation. As of
December 31, 2004, the Company’s consolidated balance
sheet includes a liability in the amount of $60 pertaining to
estimated asset retirement obligations.
Intangible Assets
The Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets, on January 1, 2002. Under the
provisions of SFAS No. 142, goodwill is not amortized
but instead evaluated at least annually for impairment in a
two-step process. Accordingly, the goodwill recognized by the
Company in connection with the acquisition of SureWest Custom
Data Services in July 2001 is not being amortized based on the
provisions of SFAS No. 142. In the first step of the
annual impairment test, the fair value of each reporting unit is
compared with the carrying amount of the reporting unit,
including goodwill. The Company has determined that the
reporting units are equal to its operating segments. Goodwill
was allocated to the telephone operating segment. The estimated
fair value of the reporting unit is generally determined on the
basis of discounted future cash flows. The assumptions used in
the estimate of fair value are generally consistent with the
past performance of each reporting unit and are also consistent
with the forecast and assumptions that are used in current
operating plans. Such assumptions are subject to change as a
result of changing economic and competitive conditions. If the
estimated fair value of the reporting unit is less than the
carrying amount of the reporting unit, then a second step must
be completed in order to determine the amount of the goodwill
impairment that should be recorded. In the second step, the
implied fair value of the reporting unit’s goodwill is
determined by allocating the reporting unit’s fair value to
all of its assets and liabilities other than goodwill in a
manner similar to a purchase price allocation. The resulting
implied fair value of the goodwill that results from the
application of this second step is then compared to the carrying
amount of the goodwill and an impairment charge is recorded for
the difference if the fair value is less than the carrying value.
Wireless spectrum licenses, which include Personal
Communications Services (“PCS”) and Local Multipoint
Distribution Services (“LMDS”), are stated at cost.
Accumulated amortization related to these licenses was $1,195 at
December 31, 2004 and 2003. The Company believes these
licenses have indefinite lives because such licenses can be
renewed indefinitely at little cost. Accordingly, the Company
has applied the nonamortization provisions of
SFAS No. 142 to the Company’s wireless spectrum
licenses effective January 1, 2002. The Company’s
wireless spectrum licenses are evaluated for impairment at least
annually by comparing the carrying value to the estimated fair
value. If the estimated fair value is less than the carrying
value, then the carrying value is written down to the fair value.
The fair value of the Company’s PCS licenses is determined
through review of transactions involving sales of comparable
wireless spectrum licenses in the aftermarket. The fair value of
the Company’s LMDS licenses is obtained using a discounted
cash flow model. The assumptions used in the estimate of fair
value are based on a combination of historical results and
trends, new industry developments and the Company’s
business plans. Such
72
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
assumptions are subject to change as a result of changing
economic and competitive conditions. The Company’s LMDS
licenses may be impaired in the near future if the estimates and
assumptions used in the 2004 LMDS license discounted cash flow
model are not met.
Goodwill and wireless spectrum licenses are tested for
impairment annually during the fourth quarter. During 2004, the
Company obtained independent valuations for its annual
impairment tests. During 2003, the Company performed an annual
impairment test for goodwill and PCS licenses and obtained an
independent valuation for its annual impairment test of LMDS
licenses. The annual impairment tests for both 2003 and 2004
resulted in no impairment charges related to goodwill or
wireless spectrum licenses as the fair values exceeded the
carrying values.
Nonmonetary Transactions
During 2003, the Company entered into a 20-year nonmonetary
transaction with a third party involving the exchange of certain
fiber optic capacity and collocation rights. This transaction
provides the Company with access and rights to certain
collocation facilities and cell site locations, which were
previously inaccessible due to unreasonably high entrance costs.
The collocation rights provide access to additional network
connections to the Company while the cell site locations
strengthen the Company’s existing cellular network in key
areas. Because this nonmonetary transaction did not represent
the culmination of an earnings process, no revenues or expenses
have been, or will be, recorded by the Company pursuant to this
transaction. In addition, there was no indicated loss on this
exchange of productive rights.
In the normal course of business, the Company entered into
certain other nonmonetary transactions during 2004 that are not
material, either individually or in the aggregate, to the
Company’s consolidated financial statements.
Stock-based Compensation
The Company has two stock-based compensation plans, which are
described more fully in Note 10. Prior to 2003, the Company
accounted for employee stock options issued under these plans
using the intrinsic value method pursuant to Accounting
Principles Board Opinion (“APB”) No. 25,
Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation expense
pertaining to employee stock options was recognized in the
Company’s 2002 consolidated financial statements because
all such options had an exercise price equal to the market value
of the underlying common stock on the date of grant. Effective
January 1, 2003, the Company adopted the fair value
recognition provisions of SFAS No. No. 123,
Accounting for Stock-Based Compensation. Under the
prospective method of adoption selected by the Company under the
provisions of SFAS No. 148, Accounting for
Stock-Based Compensation – Transition and
Disclosure, the fair value method of accounting was applied
to all employee awards granted, modified, or settled after
January 1, 2003. Stock-based compensation associated with
employee stock options is recognized over the vesting periods
(which range from 1 to 5 years) using the graded vesting
method.
73
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
The fair value of the Company’s employee stock options were
estimated at the date of grant using the Black-Scholes-Merton
option-pricing model with the following weighted-average
assumptions for 2003 and 2002 (no options were granted during
2004):
| |
|
|
|
|
|
|
|
|
| |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
Risk-free Interest Rate
|
|
|
1.79% |
|
|
|
2.54% |
|
|
Expected Dividend Yield
|
|
|
2.50% |
|
|
|
2.13% |
|
|
Expected Volatility
|
|
|
42.48% |
|
|
|
39.95% |
|
|
Expected Lives
|
|
|
4 years |
|
|
|
4 years |
|
The Black-Scholes-Merton option pricing model includes
assumptions regarding dividend yields, expected volatility,
expected lives and risk-free interest rates. These assumptions
reflect management’s best estimates, but these items
involve inherent uncertainties based on market conditions
generally outside of the control of the Company. As a result, if
other assumptions had been used in the current period, actual
and pro forma stock-based compensation expense could have been
materially different. If management uses different assumptions
in future periods, stock-based compensation expense could be
materially impacted in future years.
The expense related to stock-based employee compensation
included in the determination of net income (loss) is less than
that which would have been recognized if the fair value method
had been applied to all awards granted after the original
effective date of SFAS No. 123. If the Company had
elected to adopt the fair value recognition provisions of
SFAS No. 123 as of its original effective date, pro
forma net income (loss) and earnings (loss) per share would be
as follows (the pro forma amounts for the years ended
December 31, 2003 and 2002 have been revised in a manner
consistent with the 2004 presentation):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Net income (loss), as reported
|
|
$ |
(1,128 |
) |
|
$ |
645 |
|
|
$ |
11,249 |
|
|
Add: Stock-based employee compensation expense included in
reported net income (loss), net of related tax effects
|
|
|
672 |
|
|
|
131 |
|
|
|
122 |
|
|
Deduct: Stock-based employee compensation expense determined
using the fair value method for all awards, net of related tax
effects
|
|
|
(912 |
) |
|
|
(809 |
) |
|
|
(1,677 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Pro forma net income (loss)
|
|
$ |
(1,368 |
) |
|
$ |
(33 |
) |
|
$ |
9,694 |
|
| |
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic — as reported
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
| |
Basic — pro forma
|
|
$ |
(0.09 |
) |
|
$ |
0.00 |
|
|
$ |
0.66 |
|
| |
| |
Diluted — as reported
|
|
$ |
(0.08 |
) |
|
$ |
0.04 |
|
|
$ |
0.76 |
|
| |
Diluted — pro forma
|
|
$ |
(0.09 |
) |
|
$ |
0.00 |
|
|
$ |
0.66 |
|
During the years ended December 31, 2003 and 2002, the
weighted-average grant date fair value of options granted to
employees was $8.75 and $11.42 per share, respectively.
There were no options granted to employees during the year ended
December 31, 2004.
74
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
Advertising Costs
The costs of advertising are charged to expense as incurred.
Advertising expense was $5,143, $4,339 and $3,659 in 2004, 2003
and 2002, respectively.
The Company makes market development funds (“MDF”)
available to certain retailers that serve as agents for SureWest
Wireless for the reimbursement of co-branded advertising
expenses. To the extent that MDF is used by the Company’s
customers for co-branded advertising, and (i) the agents
provide the Company with third-party evidence of such co-branded
advertising as prescribed by Company policy and (ii) the
Company can reasonably estimate the fair value of its portion of
the advertising, such amounts are charged to advertising expense
as incurred. To the extent that MDF do not meet the
aforementioned criteria, the Company records these expenditures
as a reduction of revenue in the period in which they are
incurred.
Income Taxes
The Company accounts for income taxes using the liability
method. Under this method, deferred tax assets and liabilities
are determined based on differences between the financial
reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that are expected
to be in effect when the differences are expected to reverse.
Per Share Amounts
Basic per share amounts are computed using the weighted average
number of shares of common stock and restricted common stock
units outstanding, less the weighted average number of unvested
restricted common shares and unvested restricted common stock
units outstanding during the period.
Diluted earnings per share amounts are determined in the same
manner as basic earnings per share amounts, except the number of
weighted average common shares and restricted common stock units
used in the computations (i) includes unvested restricted
common shares and unvested restricted common stock units
outstanding and (ii) is increased assuming the exercise of
dilutive stock options using the treasury stock method. Diluted
loss per share amounts are determined in the same manner as
basic loss per share amounts and exclude potential dilutive
common shares from stock options, as their effect is
antidilutive.
75
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
The following table presents the calculations of weighted
average common shares and restricted common stock units used in
the computations of basic and diluted per share amounts
presented in the accompanying consolidated statements of
operations:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Weighted average number of shares of common stock and restricted
common stock units outstanding
|
|
|
14,571 |
|
|
|
14,539 |
|
|
|
14,737 |
|
| |
Less weighted average number of unvested shares of restricted
common stock and unvested restricted common stock units
outstanding
|
|
|
40 |
|
|
|
17 |
|
|
|
9 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Weighted average number of common shares and restricted common
stock units used in computing basic per share amounts
|
|
|
14,531 |
|
|
|
14,522 |
|
|
|
14,728 |
|
| |
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Weighted average number of shares of common stock and restricted
common stock units outstanding
|
|
|
14,571 |
|
|
|
14,539 |
|
|
|
14,737 |
|
| |
Less weighted average number of unvested shares of restricted
common stock and unvested restricted common stock units
outstanding, if anti-dulitive
|
|
|
40 |
|
|
|
– |
|
|
|
– |
|
| |
Plus weighted average number of shares of common stock from the
assumed exercise of dilutive stock options
|
|
|
– |
|
|
|
– |
|
|
|
58 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Weighted average number of common shares and restricted common
stock units used in computing diluted per share amounts
|
|
|
14,531 |
|
|
|
14,539 |
|
|
|
14,795 |
|
| |
|
|
|
|
|
|
|
|
|
Statements of Cash Flows Information
During 2004, 2003 and 2002, the Company made payments for
interest and income taxes as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Interest, net of amounts capitalized ($827 in 2004, $1,095 in
2003 and $1,074 in 2002)
|
|
$ |
4,453 |
|
|
$ |
3,758 |
|
|
$ |
2,485 |
|
|
Income taxes
|
|
$ |
404 |
|
|
$ |
– |
|
|
$ |
2,812 |
|
76
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
Other Comprehensive Income (loss)
Significant components of the Company’s other comprehensive
income (loss) are as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Net income (loss)
|
|
$ |
(1,128 |
) |
|
$ |
645 |
|
|
$ |
11,249 |
|
|
Minimum pension and post-retirement benefit liability
adjustment, net of income taxes of $822, $934 and $1,138 in
2004, 2003 and 2002
|
|
|
(1,865 |
) |
|
|
1,376 |
|
|
|
(1,637 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss)
|
|
$ |
(2,993 |
) |
|
$ |
2,021 |
|
|
$ |
9,612 |
|
| |
|
|
|
|
|
|
|
|
|
As of December 31, 2004, 2003 and 2002, the accumulated
other comprehensive loss was $2,126, $261 and $1,637,
respectively, which consisted of minimum pension and
post-retirement benefit liability adjustments, net of income
taxes.
Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards
Board (“FASB”) issued SFAS No. 123 (revised
2004), Share-Based Payment
(“SFAS No. 123(R)”), which is a revision
of SFAS No. 123. SFAS No. 123(R) supersedes
APB No. 25 and amends SFAS No. 95, Statement
of Cash Flows. Generally, the approach in
SFAS No. 123(R) is similar to the approach described
in SFAS No. 123. However, SFAS No. 123(R)
requires all share-based payments to employees, including grants
of employee stock options, to be recognized in the statement of
operations based on their fair values. Pro forma disclosure is
no longer an alternative.
SFAS No. 123(R) must be adopted no later than
July 1, 2005. Early adoption will be permitted in periods
in which financial statements have not yet been issued. The
Company expects to adopt SFAS No. 123(R) on
July 1, 2005.
SFAS No. 123(R) permits public companies to adopt its
requirements using one of two methods:
|
|
|
| |
1. |
A “modified prospective” method in which compensation
cost is recognized beginning with the effective date
(a) based on the requirements of SFAS No. 123(R)
for all share-based payments granted after the effective date
and (b) based on the requirements of SFAS No. 123
for all awards granted to employees prior to the effective date
of SFAS No. 123(R) that remain unvested on the
effective date. |
| |
| |
2. |
A “modified retrospective” method, which includes the
requirements of the modified prospective method, described
above, but also permits entities to restate their financial
statements based on the amounts previously recognized under
SFAS No. 123 for purposes of pro forma disclosures
either for (a) all prior periods presented or
(b) prior interim periods of the year of adoption. |
The Company is in the process of evaluating which method of
adoption it will use to adopt SFAS No. 123(R). The
Company does not believe the adoption of this new guidance will
have a material effect on its consolidated financial position,
results of operations and cash flows.
77
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
On May 15, 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity.
SFAS No. 150 establishes standards for classifying and
measuring as liabilities certain financial instruments that
embody obligations of the issuer and have characteristics of
both liabilities and equity, such as mandatorily redeemable
equity instruments. The adoption of SFAS No. 150 in
2003 had no effect on the Company’s 2003 consolidated
financial statements.
In January 2003, the FASB issued Interpretation
(“FIN”) No. 46, Consolidation of Variable
Interest Entities an interpretation of Accounting Research
Bulletin (“ARB”) No. 51, Consolidated
Financial Statements. FIN No. 46 applies to any
business enterprise that has a controlling interest, contractual
relationship or other business relationship with a variable
interest entity (“VIE”) and establishes guidance for
the consolidation of VIEs that function to support the
activities of the primary beneficiary. The Company believes it
has no investments in, or contractual or other business
relationships with, VIEs. The adoption of FIN No. 46
had no effect on the Company’s 2003 consolidated financial
statements.
In July 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with an Exit or Disposal
Activity. SFAS No. 146 revises the accounting for
exit and disposal activities under Emerging Issues Task Force
(“EITF”) Issue No. 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (Including Certain Costs Incurred in a
Restructuring), by extending the period in which expenses
related to restructuring activities are reported. A commitment
to a plan to exit an activity or dispose of long-lived assets is
no longer sufficient to record a one-time charge for most
restructuring activities. Instead, companies will record exit or
disposal costs when they are “incurred” and can be
measured at fair value. In addition, the resultant liabilities
must be subsequently adjusted for changes in estimated cash
flows. The Company adopted SFAS No. 146 on
January 1, 2003, and the adoption of this new standard did
not have a material effect on the Company’s 2003
consolidated financial statements.
On December 31, 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based
Compensation – Transition and Disclosure.
SFAS No. 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide
alternative methods of transition for an entity that voluntarily
changes to the fair value method of accounting for stock-based
employee compensation. In addition, it also amends the
disclosure provisions of SFAS No. 123 to require
prominent disclosure about the effects on reported net income,
including per share amounts, of an entity’s accounting
policy decisions with respect to stock-based employee
compensation in annual and interim financial statements.
SFAS No. 148 does not amend SFAS No. 123 to
require companies to account for their stock-based employee
compensation using the fair value method. The disclosure
provisions of SFAS No. 123 were effective immediately
in 2002. The Company changed its method of accounting on a
prospective basis for stock-based employee compensation to the
fair value method during 2003. The adoption of this new standard
did not have a material effect on the Company’s 2003
consolidated financial statements.
In August 2001, the FASB issued SFAS No. 143,
Accounting for Asset Retirement Obligations.
SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in
the period in which it is incurred if a reasonable estimate of
fair value can be made. The associated asset retirement costs
are capitalized as part of the carrying amount of the long-lived
asset. The Company adopted SFAS No. 143 on
January 1, 2003. The adoption of this new standard did not
have a material effect on the Company’s 2003 consolidated
financial statements.
In October 2002, the FASB’s EITF reached a consensus on
EITF Issue No. 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. Under EITF Issue
No. 00-21, revenue arrangements with multiple deliverables
are required to be divided into separate units of accounting
under certain circumstances. The Company adopted EITF Issue
No. 00-21 on a prospective basis for arrangements entered
into after June 30, 2003. The Company has determined that
the sale of its wireless handsets and the associated phone
service
78
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 1. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) |
provided by the Wireless segment should be considered separate
units of accounting under EITF Issue No. 00-21. The
adoption of EITF Issue No. 00-21 did not have a material
effect on the Company’s 2003 consolidated financial
statements. See Note 2 below for further discussion of the
Company’s application of EITF Issue No. 00-21.
In November 2002, the FASB issued FIN No. 45,
Guarantor’s Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN No. 45 requires certain guarantees to
be recorded at fair value, which is different from previous
practice, which was generally to record a liability only when a
loss is probable and reasonably estimable. FIN No. 45
also requires a guarantor to make significant new disclosures,
even when the likelihood of making any payments under the
guarantee is remote. The disclosure provisions of
FIN No. 45 were effective immediately in 2002. The
Company adopted the recognition and measurement provisions of
FIN No. 45 on a prospective basis with respect to
guarantees issued or modified after December 31, 2002. The
adoption of the recognition and measurement provisions of
FIN No. 45 did not have a material effect on the
Company’s 2003 consolidated financial statements.
The Company recognizes revenue when (i) persuasive evidence
of an arrangement between the Company and the customer exists,
(ii) delivery of the product to the customer has occurred
or service has been provided to the customer, (iii) the
price to the customer is fixed or determinable and
(iv) collectibility of the sales price is reasonably
assured. Revenues based on a flat fee, derived principally from
local telephone, dedicated network access, data communications,
Internet access service, residential/business broadband service
and non-contract wireless services, are billed in advance and
recognized in subsequent periods when the services are provided.
Contract wireless services are billed in arrears. Revenues based
on usage, derived primarily from network access and long
distance services, are recognized monthly as services are
provided. Incremental direct costs of telecommunications service
activation are charged to expense in the period in which they
are incurred. Directory advertising revenues and costs related
to publishing and distributing directories are recognized using
the “circulation period” method, under which revenues
and related costs are recognized ratably over the expected
useful life of the directory, generally one year from the date
of publication. For all other operations, revenue is recognized
when products are delivered or services are rendered to
customers.
Effective July 1, 2003, the Company began applying EITF
Issue No. 00-21 to all wireless handset sales below cost,
which approximates fair value in the absence of an activation
“subsidy,” when it receives an up-front fee of any
kind (e.g., a service activation fee). The application of EITF
Issue No. 00-21 resulted in the immediate recognition of
all or a portion of such up-front fees as equipment sales
revenue. Additionally, when the Company activates wireless
service for a customer, but does not concurrently provide the
customer with a handset, any up-front fees received continue to
be deferred and amortized over the expected term of the customer
relationship. The Company provides a general right of return
within the first 30 days of service for a 100% refund of
the handset cost. The estimated equipment return liability
associated with this right of return is estimated based on
historical experience.
Certain of the Company’s customers have filed for
bankruptcy protection, the most notable of which was WorldCom,
Inc. (“WorldCom”), which, together with its
affiliates, filed for bankruptcy protection in July 2002. In
April 2004, WorldCom emerged from federal bankruptcy protection.
Settlement of the Company’s pending pre-bankruptcy claims
against WorldCom will remain subject to the distribution terms,
applicable to creditors, contained in WorldCom’s plan of
reorganization. As of December 31, 2004, the amount of any
settled pre-bankruptcy claims could not be determined. Through
December 31, 2004, obligations owed by WorldCom to the
Company for post-petition services have been paid on a timely
basis.
79
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 2. |
REVENUE RECOGNITION (CONTINUED) |
During the fourth quarter of 2000, the Company changed its
method of accounting, retroactive to January 1, 2000, for
up-front fees associated with telecommunications service
activation in accordance with the guidance contained in the
Securities and Exchange Commission (“SEC”) Staff
Accounting Bulletin (“SAB”) No. 101, Revenue
Recognition in Financial Statements. Previously, the Company
had recognized such up-front fees as revenues upon activation of
service. Under the new accounting method, the Company now
recognizes up-front fees associated with service activation over
the expected duration of the customer relationships, which
presently ranges from one to five years, using the straight-line
method. The cumulative effect of the change on prior years
resulted in a charge to income of $3,273 (net of income taxes of
$2,250), which was included in net income for the year ended
December 31, 2000. For the years ended December 31,
2004, 2003 and 2002, the Company recognized $130, $413 and $926,
respectively, of revenues that were in the cumulative effect
adjustment as of January 1, 2000. The effect of those
revenues was to decrease net loss by $90 (net of income taxes of
$40) for the year ended December 31, 2004 and increase net
income by $160 (net of income taxes of $253) and $557 (net of
income taxes of $369) for the years ended December 31, 2003
and 2002, respectively.
|
|
| 3. |
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 the suspect transfers, the Company broadened its
review of the investment and cash operations, and a special
corporate investigation was launched by the Audit Committee,
which engaged outside counsel and forensic auditors. The
investigations revealed concealed illegal transfers in violation
of the Company’s investment and cash management policies.
The Company believes that the irregularities were limited to the
2003 calendar year. The investigation suggests that as much as
$25,000 may have been involved in the scheme. Nearly all of the
funds have been recovered; however, approximately $1,828
remained outstanding as of December 31, 2003 and was
reflected as a non-operating loss in the Company’s 2003
consolidated financial statements. On October 26, 2004, the
Company received an insurance recovery in the amount of $1,803,
which has been reflected as a non-operating gain in the
Company’s 2004 consolidated financial statements. 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. The Company will recognize additional recoveries of
funds, if any, in future periods to the extent of its litigation
recoveries.
On July 12, 2002, the Company purchased substantially all
of the assets of Western Integrated Networks, LLC and certain
affiliates (collectively, “WIN”) in a transaction
supervised by the United States Bankruptcy Court for the
District of Colorado (the “Bankruptcy Court”). The
purchase price for the assets of WIN consisted of
(i) $12,000 in cash, (ii) direct acquisition costs of
$622 and (iii) the assumption of certain current
liabilities aggregating $4,717 relating principally to executory
contracts and capital lease obligations.
The Company does not believe the assets acquired from WIN
constitute a self-sustaining, integrated set of activities and
assets that would constitute a business, principally due to the
absence of an established customer base at WIN or significant
revenue generating activities as of July 12, 2002. Since
July 12, 2002, the Company has been utilizing the assets
acquired from WIN to offer bundled high-speed Internet, digital
cable and telephone services under the SureWest Broadband/
Residential Services name in the Sacramento metropolitan area.
80
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 4. |
ASSET PURCHASE (CONTINUED) |
Prior to July 12, 2003, the Company obtained additional
information regarding the fair values of certain assets acquired
and liabilities assumed from WIN. Accordingly, the Company
prospectively adjusted the preliminary purchase price allocation
in connection with the preparation of its 2003 consolidated
financial statements. The following table summarizes the
estimated fair values of the assets acquired and liabilities
assumed at the date of acquisition, July 12, 2002,
based on the Company’s final allocation of the
aforementioned purchase price:
| |
|
|
|
|
|
|
Accounts receivable, net
|
|
$ |
615 |
|
|
Equipment held for sale
|
|
|
2,573 |
|
|
Other current assets
|
|
|
931 |
|
|
Property, plant and equipment
|
|
|
12,327 |
|
|
Intangible asset relating to favorable operating leases
|
|
|
893 |
|
| |
|
|
|
| |
Total assets acquired
|
|
|
17,339 |
|
|
Current liabilities assumed under executory contracts
|
|
|
3,483 |
|
|
Liabilities assumed under capital lease obligations
|
|
|
1,064 |
|
|
Other liabilities
|
|
|
170 |
|
| |
|
|
|
| |
Total liabilities assumed
|
|
|
4,717 |
|
| |
|
|
|
| |
Net assets acquired
|
|
$ |
12,622 |
|
| |
|
|
|
The equipment purchased from WIN that was held for sale
consisted primarily of network assets located in Dallas, Texas.
The Company completed the sale of such equipment during the
first quarter of 2003. The Company did not recognize a gain or
loss on the sale of these assets.
The property, plant and equipment acquired from WIN consisted
principally of a primary processing center, video head end
equipment, a fiber-coaxial cable network located in the
Sacramento metropolitan area, software licenses and office
furniture and equipment. The Company is depreciating these
assets on a straight-line basis over estimated useful lives
ranging from three to fifteen years.
In addition, the Company recognized an intangible asset related
to favorable operating leases assumed from WIN. This intangible
asset is being amortized to rent expense over the remaining
lease terms, which range from two to ten years. As of
December 31, 2004 and 2003, accumulated amortization
associated with this intangible asset was $854 and $711,
respectively.
Under the terms of the asset purchase agreement, $1,200 of the
aggregate purchase price was held in an escrow account to
protect the Company in the event of any claims available to the
Company. In January 2003, $150 was released to the Company.
During March 2004, the Company resolved the remaining issues
related to the escrow, and a settlement agreement was executed
that gave the Company undisputed rights to certain deposits held
by a third party in connection with WIN’s network
construction. As a result, in April 2004, the Bankruptcy Court
signed an order that allowed the remainder of the funds in
escrow to be released to the WIN estate. In November 2004, the
third party refunded $695 to the Company to cover all unused
deposits through April 1, 2004, which was recorded as a
reduction of property, plant and equipment.
|
|
| 5. |
SALE OF ALARM MONITORING DIVISION |
On January 25, 2002, the Company sold substantially all of
the assets of its alarm monitoring division, which was a
component of the Telecom segment, for approximately $5,150. This
sale resulted in a pre-tax gain of $4,435 during 2002. Through
December 31, 2003, the Company had received cash proceeds
of $4,995, of which $4,495
81
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 5. |
SALE OF ALARM MONITORING DIVISION (CONTINUED) |
and $500 were received during 2002 and the fourth quarter of
2001, respectively, related to the sale of the alarm monitoring
division assets. The alarm monitoring assets consisted primarily
of customer contracts and equipment, which had a net book value
of approximately $355 as of the date of the sale. The purchaser
of the assets commenced litigation against the Company relating
to claims under the asset purchase agreement, generally in
connection with certain contracts assigned to the purchaser. In
July 2003, the Company and the purchaser settled the litigation
and the parties released all claims in exchange for payment by
the Company to the purchaser of $375, which was paid during
2003. Total operating revenues attributable to the
Company’s alarm monitoring division during 2002 were $279
(none in 2004 or 2003).
Long-term debt outstanding as of December 31, 2004 and 2003
consisted of the following:
| |
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Unsecured Series A Senior Notes, with interest payable
semiannually at a fixed rate of 6.3%; principal payments are due
in equal annual installments of approximately $3,636, commencing
in December 2003 and ending in December 2013
|
|
$ |
32,727 |
|
|
$ |
36,363 |
|
|
Unsecured Series B Senior Notes, with interest payable
semiannually at a fixed rate of 4.74%; principal payments are
due in equal annual installments of approximately $12,000,
commencing in March 2009 and ending in March 2013
|
|
|
60,000 |
|
|
|
60,000 |
|
|
Note payable, with interest payable quarterly at a fixed rate of
8.00%; principal payments are due in equal quarterly
installments of approximately $36, through November 2005
|
|
|
143 |
|
|
|
286 |
|
| |
|
|
|
|
|
|
|
Total long-term debt
|
|
|
92,870 |
|
|
|
96,649 |
|
|
Less current portion
|
|
|
3,779 |
|
|
|
3,779 |
|
| |
|
|
|
|
|
|
|
Total long-term debt, net of current portion
|
|
$ |
89,091 |
|
|
$ |
92,870 |
|
| |
|
|
|
|
|
|
At December 31, 2004, the aggregate maturities of long-term
debt were (i) $3,636 annually through 2008,
(ii) $15,636 annually from 2009 through 2013 and
(iii) $143 in 2005 for a total of $92,870.
The Company has a business loan agreement with a bank for a
$50,000 line of credit. As of December 31, 2004, there was
$10,000 outstanding under this credit facility and the interest
rate was 3.14%, which is based on a LIBOR-based pricing formula.
There were no amounts outstanding as of December 31, 2003.
In December 2004, the bank amended the credit facility,
extending the expiration date until July 1, 2006 and
revising certain covenants.
Certain of the aforementioned credit arrangements contain
financial and operating covenants that restrict, among other
things, the payment of cash dividends, repurchase of the
Company’s capital stock, the making of certain other
restricted payments and the incurrence of additional
indebtedness. The covenants also require the Company to maintain
certain financial ratios and minimum levels of tangible net
worth. At December 31, 2004 and 2003, retained earnings of
approximately $37,347 and $28,986, respectively, were available
for the payment of cash dividends or other restricted payments
under the terms of the Company’s credit arrangements.
82
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Income tax expense (benefit) consists of the following
components:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Current expense (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Federal
|
|
$ |
(71 |
) |
|
$ |
782 |
|
|
$ |
(9,095 |
) |
| |
State
|
|
|
(54 |
) |
|
|
1,549 |
|
|
|
(607 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Total current expense (benefit)
|
|
|
(125 |
) |
|
|
2,331 |
|
|
|
(9,702 |
) |
| |
|
Deferred expense (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Federal
|
|
|
(299 |
) |
|
|
75 |
|
|
|
15,010 |
|
| |
State
|
|
|
(73 |
) |
|
|
(1,384 |
) |
|
|
2,118 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total deferred expense (benefit)
|
|
|
(372 |
) |
|
|
(1,309 |
) |
|
|
17,128 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total income tax expense (benefit)
|
|
$ |
(497 |
) |
|
$ |
1,022 |
|
|
$ |
7,426 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
| |
Income tax expense (benefit) differs from the amounts computed
by using the statutory federal tax rate (35% in all years
presented) due to the following: |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Computed at statutory rates
|
|
$ |
(569 |
) |
|
$ |
583 |
|
|
$ |
6,536 |
|
|
Increase (decrease):
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
State taxes, net of federal benefit
|
|
|
(82 |
) |
|
|
108 |
|
|
|
982 |
|
| |
Other, net
|
|
|
154 |
|
|
|
331 |
|
|
|
(92 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Income tax expense (benefit)
|
|
$ |
(497 |
) |
|
$ |
1,022 |
|
|
$ |
7,426 |
|
| |
|
|
|
|
|
|
|
|
|
|
Effective federal and state tax rate
|
|
|
30.6 |
% |
|
|
61.3 |
% |
|
|
39.8 |
% |
| |
|
|
|
|
|
|
|
|
|
83
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 7. |
INCOME TAXES (CONTINUED) |
The significant components of the Company’s deferred income
tax assets and liabilities were as follows at December 31,
2004 and 2003:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Deferred Income Taxes | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
Assets | |
|
Liabilities | |
|
Assets | |
|
Liabilities | |
| |
|
| |
|
| |
|
| |
|
| |
|
Property, plant and equipment-primarily due to timing of
recognition of depreciation expense
|
|
$ |
– |
|
|
$ |
57,004 |
|
|
$ |
– |
|
|
$ |
44,751 |
|
| |
|
Differences in the timing of recognition of revenues
|
|
|
8,468 |
|
|
|
– |
|
|
|
9,838 |
|
|
|
– |
|
| |
|
State franchise taxes
|
|
|
3 |
|
|
|
– |
|
|
|
209 |
|
|
|
– |
|
| |
|
Net operating losses
|
|
|
19,221 |
|
|
|
– |
|
|
|
6,814 |
|
|
|
– |
|
| |
|
Other, net
|
|
|
6,720 |
|
|
|
1,542 |
|
|
|
3,712 |
|
|
|
1,559 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Total
|
|
|
34,412 |
|
|
|
58,546 |
|
|
|
20,573 |
|
|
|
46,310 |
|
| |
|
Less current portion
|
|
|
– |
|
|
|
– |
|
|
|
209 |
|
|
|
– |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Total deferred income taxes
|
|
$ |
34,412 |
|
|
$ |
58,546 |
|
|
$ |
20,364 |
|
|
$ |
46,310 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Net long-term deferred income tax liability
|
|
|
|
|
|
$ |
24,134 |
|
|
|
|
|
|
$ |
25,946 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2004, the Company had net operating loss
carryforwards for federal income tax purposes of approximately
$54,120, which will expire in the years 2018 through 2024, if
not utilized. Deferred tax assets relating to net operating loss
carryforwards for federal purposes as of December 31, 2004
include approximately $871 associated with stock compensation
activity for which subsequent realized tax benefits, if any,
will reduce income taxes payable in the future. As of
December 31, 2004, the Company also had net operating loss
carryforwards for state income tax purposes of approximately
$4,973, which will expire in the years 2005 through 2014, if not
utilized. The deferred tax assets relating to net operating loss
carryforwards for state purposes as of December 31, 2004
include approximately $67 associated with stock compensation
activity for which subsequent realized tax benefits, if any,
will reduce income taxes payable in the future. As of
December 31, 2004, the Company also had research and
development tax credit carryforwards of approximately $100 both
for federal and state income tax purposes. The federal credit
will expire in 2022 if it is not utilized. The state credits
have no expiration date.
The Company believes it is more likely than not that the benefit
associated with the deferred tax assets resulting from net
operating loss carryforwards will be ultimately realized based
on its assessment of future taxable income during the periods in
which the net operating losses remain available. The Company
considers the scheduled reversal of its deferred tax
liabilities, primarily depreciation expense-related, and
projected future taxable income in making this assessment. As a
result of this assessment, the Company has not recognized a
valuation allowance associated with its deferred tax assets as
of December 31, 2004 and 2003.
84
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 8. |
PENSION AND OTHER POST-RETIREMENT BENEFITS |
The Company sponsors a noncontributory defined benefit pension
plan (the “Pension Plan”) covering substantially all
of its employees. In December 2003, the Company approved an
amendment to the Pension Plan that essentially provided for the
adoption of the Pension Plan by all subsidiaries, thereby
extending the pension benefit to all employees of the Company,
effective January 1, 2004. Benefits are based on years of
service and the employee’s average compensation during the
five highest consecutive years of the last ten years of credited
service. The Company’s funding policy is to contribute
annually an actuarially determined amount consistent with
applicable federal income tax regulations. Contributions are
intended to provide for benefits attributed to service to date.
Pension Plan assets are primarily invested in domestic equity
securities, United States government and agency securities and
international equity securities.
The Company also has an unfunded Supplemental Executive
Retirement Plan (“SERP”), which provides supplemental
retirement benefits to certain executives of the Company. The
SERP provides for incremental pension payments partially to
offset the reduction in amounts that would have been payable
under the Pension Plan if it was not for limitations imposed by
federal income tax regulations.
In addition, the Company provides certain post-retirement
benefits other than pensions (“Other Benefits”) to
substantially all employees, including life insurance benefits
and a stated reimbursement for Medicare supplemental insurance.
On December 6, 2004, the Company initiated a voluntary
enhanced early retirement program (the “REWARD
program.”) The REWARD program was offered to certain
eligible employees across all business units. In addition to
retirement benefits, eligible employees will receive enhanced
medical benefits for a specified period of time. As of
December 31, 2004, 59 employees had accepted the REWARD
program. Accordingly, the Company recorded $3,768 in operating
expenses related to the REWARD program during 2004.
The Company uses a measurement date of December 31 for the
majority of its pension and other post-retirement benefit plans.
The following table sets forth the change in benefit obligation,
change in plan assets and funded status of the Pension Plan
(which encompasses the REWARD program), SERP and Other Benefits
(which encompasses the REWARD program) as of December 31,
2004 and 2003:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Pension Plan & SERP | |
|
Other Benefits | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Change in benefit obligation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefit obligation at beginning of year
|
|
$ |
110,353 |
|
|
$ |
98,853 |
|
|
$ |
5,036 |
|
|
$ |
4,554 |
|
| |
Service cost
|
|
|
5,360 |
|
|
|
4,557 |
|
|
|
469 |
|
|
|
353 |
|
| |
Interest cost
|
|
|
7,095 |
|
|
|
6,841 |
|
|
|
351 |
|
|
|
326 |
|
| |
Plan participants’ contributions
|
|
|
– |
|
|
|
– |
|
|
|
240 |
|
|
|
228 |
|
| |
Plan amendments
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
175 |
|
| |
Actuarial losses (gain)
|
|
|
8,022 |
|
|
|
4,521 |
|
|
|
659 |
|
|
|
(180 |
) |
| |
Special termination benefits
|
|
|
632 |
|
|
|
– |
|
|
|
3,136 |
|
|
|
– |
|
| |
Benefits paid
|
|
|
(4,600 |
) |
|
|
(4,419 |
) |
|
|
(344 |
) |
|
|
(420 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefit obligation at end of year
|
|
$ |
126,862 |
|
|
$ |
110,353 |
|
|
$ |
9,547 |
|
|
$ |
5,036 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
85
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
8. PENSION AND OTHER POST-RETIREMENT BENEFITS (CONTINUED)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Pension Plan & SERP | |
|
Other Benefits | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Change in plan assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of plan assets at beginning of year
|
|
$ |
93,949 |
|
|
$ |
73,806 |
|
|
$ |
1,890 |
|
|
$ |
1,347 |
|
|
Actual return on plan assets
|
|
|
10,859 |
|
|
|
15,453 |
|
|
|
217 |
|
|
|
289 |
|
|
Company contribution
|
|
|
5,130 |
|
|
|
9,109 |
|
|
|
76 |
|
|
|
446 |
|
|
Participants’ contributions
|
|
|
– |
|
|
|
– |
|
|
|
240 |
|
|
|
228 |
|
|
Benefits paid
|
|
|
(4,600 |
) |
|
|
(4,419 |
) |
|
|
(321 |
) |
|
|
(420 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of plan assets at end of year
|
|
$ |
105,338 |
|
|
$ |
93,949 |
|
|
$ |
2,102 |
|
|
$ |
1,890 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Pension Plan & SERP | |
|
Other Benefits | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Funded status:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unfunded status of plan at end of year
|
|
$ |
(21,524 |
) |
|
$ |
(16,404 |
) |
|
$ |
(7,445 |
) |
|
$ |
(3,146 |
) |
|
Unrecognized actuarial loss (gain)
|
|
|
21,501 |
|
|
|
16,784 |
|
|
|
386 |
|
|
|
(142 |
) |
|
Unrecognized prior service cost
|
|
|
497 |
|
|
|
575 |
|
|
|
408 |
|
|
|
408 |
|
|
Unrecognized net transition obligation
|
|
|
305 |
|
|
|
573 |
|
|
|
– |
|
|
|
– |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid (accrued) benefits
|
|
$ |
779 |
|
|
$ |
1,528 |
|
|
$ |
(6,651 |
) |
|
$ |
(2,880 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
Amounts recognized in the consolidated balance sheets at
December 31, 2004 and 2003 consist of:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Pension Plan & SERP | |
|
Other Benefits | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Prepaid benefit cost
|
|
$ |
2,447 |
|
|
$ |
3,009 |
|
|
$ |
– |
|
|
$ |
– |
|
|
Accrued benefit cost
|
|
|
(1,668 |
) |
|
|
(1,481 |
) |
|
|
(6,651 |
) |
|
|
(2,880 |
) |
|
Additional minimum liability
|
|
|
(3,931 |
) |
|
|
(568 |
) |
|
|
– |
|
|
|
– |
|
|
Intangible assets
|
|
|
802 |
|
|
|
126 |
|
|
|
– |
|
|
|
– |
|
|
Accumulated other comprehensive loss
|
|
|
3,129 |
|
|
|
442 |
|
|
|
– |
|
|
|
– |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid (accrued) benefits
|
|
$ |
779 |
|
|
$ |
1,528 |
|
|
$ |
(6,651 |
) |
|
$ |
(2,880 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
Information for the Pension Plan and SERP, which have
accumulated benefit obligations in excess of plan assets as of
December 31, 2004 is as follows:
| |
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Projected benefit obligation
|
|
$ |
126,862 |
|
|
$ |
110,353 |
|
|
Accumulated benefit obligation
|
|
$ |
108,490 |
|
|
$ |
91,375 |
|
|
Fair value of plan assets
|
|
$ |
105,338 |
|
|
$ |
93,949 |
|
86
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
8. PENSION AND OTHER POST-RETIREMENT BENEFITS (CONTINUED)
Net periodic pension cost recognized in the consolidated
statements of operations for the years ended December 31,
2004, 2003 and 2002 under the Pension Plan, SERP and Other
Benefits plan included the following components:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Pension Plan & SERP | |
|
Other Benefits | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Service cost-benefits earned during the period
|
|
$ |
5,360 |
|
|
$ |
4,557 |
|
|
$ |
4,552 |
|
|
$ |
469 |
|
|
$ |
353 |
|
|
$ |
320 |
|
|
Interest cost on projected benefit obligation
|
|
|
7,095 |
|
|
|
6,841 |
|
|
|
6,866 |
|
|
|
351 |
|
|
|
326 |
|
|
|
297 |
|
|
Expected return on plan assets
|
|
|
(8,033 |
) |
|
|
(6,305 |
) |
|
|
(6,368 |
) |
|
|
(151 |
) |
|
|
(108 |
) |
|
|
(117 |
) |
|
Amortization of prior service cost
|
|
|
78 |
|
|
|
92 |
|
|
|
92 |
|
|
|
43 |
|
|
|
26 |
|
|
|
26 |
|
|
Recognized net actuarial loss
|
|
|
480 |
|
|
|
798 |
|
|
|
151 |
|
|
|
– |
|
|
|
– |
|
|
|
(6 |
) |
|
Amortization of transition obligation
|
|
|
267 |
|
|
|
267 |
|
|
|
267 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
Effect of special termination benefits
|
|
|
632 |
|
|
|
– |
|
|
|
– |
|
|
|
3,136 |
|
|
|
– |
|
|
|
– |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net pension cost
|
|
$ |
5,879 |
|
|
$ |
6,250 |
|
|
$ |
5,560 |
|
|
$ |
3,848 |
|
|
$ |
597 |
|
|
$ |
520 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted-average assumptions used to determine projected
benefit obligations as of December 31, 2004 and 2003 were
as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Pension Plan & SERP | |
|
Other Benefits | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Discount rate
|
|
|
5.75% |
|
|
|
6.25% |
|
|
|
5.75% |
|
|
|
6.25% |
|
|
Rate of compensation increase
|
|
|
5.00% |
|
|
|
5.00% |
|
|
|
5.00% |
|
|
|
5.00% |
|
The weighted-average assumptions used to determine net periodic
benefit cost for the years ended December 31, 2004, 2003
and 2002 were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Pension Plan & SERP | |
|
Other Benefits | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Discount rate
|
|
|
6.25% |
|
|
|
6.75% |
|
|
|
7.00% |
|
|
|
6.25% |
|
|
|
6.75% |
|
|
|
7.00% |
|
|
Expected long-term return on plan assets
|
|
|
8.50% |
|
|
|
8.50% |
|
|
|
8.50% |
|
|
|
8.50% |
|
|
|
8.50% |
|
|
|
8.50% |
|
|
Rate of compensation increase
|
|
|
5.00% |
|
|
|
5.00% |
|
|
|
6.00% |
|
|
|
5.00% |
|
|
|
5.00% |
|
|
|
6.00% |
|
The expected rate of return on plan assets is the weighted
average of expected long-term asset return assumptions.
Assumed health care cost trend rates at December 31, 2004
and 2003 were as follows:
| |
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Health care cost trend assumed for the next year
|
|
|
9.00% |
|
|
|
9.00% |
|
|
Rate to which the cost trend is assumed to decline (the ultimate
trend rate)
|
|
|
6.00% |
|
|
|
6.00% |
|
|
Year that the rate reaches the ultimate trend rate
|
|
|
2007 |
|
|
|
2007 |
|
87
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
8. PENSION AND OTHER POST-RETIREMENT BENEFITS (CONTINUED)
Assumed health care cost trend rates have a significant effect
on the amounts reported for the Other Benefits plan. A
one-percentage-point change in assumed health care cost trend
rates would have the following effects:
| |
|
|
|
|
|
|
|
|
| |
|
1-Percentage- | |
|
1-Percentage- | |
| |
|
Point Increase | |
|
Point Decrease | |
| |
|
| |
|
| |
|
Effect on total 2004 service and interest costs
|
|
$ |
72 |
|
|
$ |
(61) |
|
|
Effect on Other Benefits plan obligation as of December 31,
2004
|
|
$ |
526 |
|
|
$ |
(499) |
|
The assets of the Pension Plan and Other Benefits plan are
combined in a single trust and invested in the aggregate. The
SERP benefit obligation is funded by the Company’s assets.
The allocation for the Pension Plan and Other Benefits plan
assets at the end of 2004 and 2003, and the target allocation
for 2005, by asset category is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Target | |
|
Percentage of Plan | |
| |
|
Allocation | |
|
Assets at December 31, | |
| |
|
| |
|
| |
| Asset Category |
|
2005 | |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
| |
|
Domestic equity securities
|
|
|
39.0% |
|
|
|
39.7% |
|
|
|
39.6% |
|
|
United States government and agency securities
|
|
|
40.0% |
|
|
|
38.9% |
|
|
|
38.6% |
|
|
International equity securities
|
|
|
20.0% |
|
|
|
20.2% |
|
|
|
20.9% |
|
|
Cash equivalents
|
|
|
1.0% |
|
|
|
1.2% |
|
|
|
0.9% |
|
| |
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100% |
|
|
|
100% |
|
|
|
100% |
|
| |
|
|
|
|
|
|
|
|
|
The fair value of plan assets for these plans is $107,440 and
$95,839 at December 31, 2004 and 2003, respectively. The
expected long-term rate of return on these plan assets for 2004
and 2003 was 8.5%.
Revised in mid-2003, the Company’s investment strategy is
designed to provide a stable environment to secure participant
retirement benefits and minimize the reliance on contributions
as a source of benefit security. As such, plan assets are
invested to maximize the plan’s funded ratios over the
long-term while managing the downside risk that funded ratios
fall below some specified threshold level. The asset return
objective is to achieve, as a minimum over time, the passively
managed return earned by managed index funds, weighted in the
proportions outlined by the asset class exposures identified in
the plan’s strategic allocation.
The Company expects to contribute $5,000 and $517 to the Pension
Plan and Other Benefits plan, respectively, in 2005.
88
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
8. PENSION AND OTHER POST-RETIREMENT BENEFITS (CONTINUED)
|
|
|
Estimated Future Benefit Payments |
Information about the expected cash flows for the Pension Plan,
SERP and Other Benefits plan is as follows:
| |
|
|
|
|
|
|
|
|
|
| |
|
Pension Plan & | |
|
|
| |
|
SERP | |
|
Other Benefits | |
| |
|
| |
|
| |
|
Expected benefit payments:
|
|
|
|
|
|
|
|
|
| |
2005
|
|
$ |
5,437 |
|
|
$ |
201 |
|
| |
2006
|
|
|
6,254 |
|
|
|
239 |
|
| |
2007
|
|
|
6,434 |
|
|
|
278 |
|
| |
2008
|
|
|
6,643 |
|
|
|
318 |
|
| |
2009
|
|
|
6,875 |
|
|
|
358 |
|
| |
2010 - 2014
|
|
|
39,372 |
|
|
|
2,514 |
|
The above table reflects the total benefits expected to be paid
from the plans or from the Company’s assets, including both
the Company’s share of the benefit cost and the
participants’ share of the cost, which is funded by
participant contributions to the plans. Expected contributions
reflect amounts expected to be contributed to funded plans.
Prior to December 31, 2001, the Company maintained two
defined contribution retirement plans, the Employee Stock
Ownership Plan (“ESOP”) and the Retirement Supplement
Plan (“RSP”), which together provided retirement and
savings features for substantially all employees. As of
January 1, 2002, the Company approved an amendment to merge
the RSP into the ESOP and to change the structure of the
Company’s provision to match employee contributions to the
ESOP from one-half of an employee’s contributions to a
dollar-for-dollar match up to six percent of an employee’s
salary.
In addition, effective June 1, 2002, the Company approved
an amendment to establish the SureWest KSOP (the
“KSOP”), replacing the ESOP, in order to allow its
participants an opportunity to diversify their retirement
holdings. All of the assets held in the ESOP were transferred to
the KSOP. The Company has retained an investment management
company to be the record keeper and fund manager of the KSOP.
Employees may choose from eleven investment options, including
the Company’s Stock Fund. The KSOP will continue to have
both a retirement and savings feature. The retirement feature
allows for qualified tax deferred contributions by employees
under Section 401(k) of the Internal Revenue Code. The KSOP
provides for voting rights as to the participant’s share of
the Company’s common stock held by the KSOP and for certain
diversification rights of the participant’s account
balances. Aggregate matching contributions made by the Company
and charged to expense under the KSOP, RSP and ESOP were $844,
$2,204 and $1,962 in 2004, 2003 and 2002, respectively. The KSOP
held 1,085,000, 1,211,000, and 1,263,000 shares of the
Company’s common stock and received dividends of $1,166,
$1,275 and $1,410, respectively, during the years ended
December 31, 2004, 2003 and 2002, respectively. The
Company’s earnings (loss) per share calculations includes
the issued and outstanding shares held by the KSOP.
9. COMMITMENTS AND CONTINGENCIES
Capital and Operating Leases
As a result of the acquisition by SureWest TeleVideo of certain
WIN assets in July 2002 (Note 4) the Company assumed
capital leases for certain vehicles. These leases bear interest
at imputed rates of 6.3% to 16.2% per annum and expire
through December 2010. The capitalized costs related to assets
under capital leases were
89
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
$1,064 as of December 31, 2004 and 2003. The amortization
of assets under capital leases is included in depreciation and
amortization expense in the accompanying consolidated financial
statements. As of December 31, 2004 and 2003, the
accumulated amortization for these assets was $524 and $315,
respectively.
The Company leases certain facilities and equipment used in its
operations under arrangements accounted for as operating leases.
The facility leases generally require the Company to pay
operating costs, including property taxes, insurance and
maintenance, and certain of them contain scheduled rent
increases and renewal options. The Company recognizes rent
expense on a straight-line basis over the term of each lease.
Total rent expense for all operating leases was $5,567, $5,032
and $4,238 in 2004, 2003 and 2002, respectively.
As of December 31, 2004, the Company had various
non-cancelable operating and capital leases with terms greater
than one year. Future minimum lease payments for all
non-cancelable operating and capital leases at December 31,
2004 were as follows:
| |
|
|
|
|
|
|
|
|
| |
|
Operating | |
|
Capital | |
| |
|
Leases | |
|
Leases | |
| |
|
| |
|
| |
|
2005
|
|
$ |
4,957 |
|
|
$ |
230 |
|
|
2006
|
|
|
4,592 |
|
|
|
36 |
|
|
2007
|
|
|
4,538 |
|
|
|
7 |
|
|
2008
|
|
|
4,520 |
|
|
|
7 |
|
|
2009
|
|
|
4,249 |
|
|
|
7 |
|
|
Thereafter
|
|
|
17,736 |
|
|
|
– |
|
| |
|
|
|
|
|
|
| |
|
$ |
40,592 |
|
|
|
287 |
|
| |
|
|
|
|
|
|
|
Less: amount representing interest
|
|
|
|
|
|
|
23 |
|
| |
|
|
|
|
|
|
|
Present value of net minimum lease payments
|
|
|
|
|
|
|
264 |
|
|
Less: current portion
|
|
|
|
|
|
|
212 |
|
| |
|
|
|
|
|
|
| |
|
|
|
|
|
$ |
52 |
|
| |
|
|
|
|
|
|
Other Commitments
As of December 31, 2004, binding commitments for future
capital expenditures were approximately $1,400 in the aggregate.
SureWest Long Distance provides long distance services under
resale arrangements with two interexchange carriers, Global
Crossing Ltd. (“Global Crossing”) and Sprint
Communications Company L.P. (“Sprint”). The agreement
with Global Crossing expired in July 2004. SureWest Long
Distance now maintains a month-to-month agreement with Global
Crossing. The Company’s 2-year non-exclusive agreement with
Sprint was due to expire in December 2004; however, the contract
was amended with an extension through November 2006 at an
approximate 20% cost savings. The Company’s minimum usage
requirement for Sprint for 2005 and 2006 is $300 and $275,
respectively. For the years ended December 31, 2004, 2003
and 2002, the Company paid $1,435, $1,183 and $1,343,
respectively, under long distance resale arrangements.
90
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company executed a surety and indemnification agreement in
the amount of $500 related to a Facility License Agreement
entered into during 2003. In addition, the Company has certain
other guarantees surrounding its cable franchise licenses.
Litigation, Regulatory Proceedings and Other Contingencies
The Company is subject to certain legal and regulatory
proceedings, Internal Revenue Service examinations and other
income tax exposures, and other claims arising in the ordinary
course of its business. In the opinion of management, the
ultimate outcome of these matters will not materially affect the
consolidated financial position, results of operations or cash
flows of the Company.
|
|
| 10. |
EQUITY INCENTIVE PLANS |
The Company has two Equity Incentive Plans (the
“Plans”) for certain employees, outside directors and
consultants of the Company, which were approved by shareholders.
The Company authorized for future issuance under the Plans one
million shares (subject to upward adjustment based upon the
Company’s issued and outstanding shares) of authorized, but
unissued, common stock. As of December 31, 2004,
604,365 shares were available for grant. The Plans permit
issuance by the Company of awards in the form of restricted
shares, stock units, performance shares, stock options and stock
appreciation rights. The exercise price per share of the
Company’s common stock purchasable under any stock option
shall not be less than 100% of the fair market value of a share
of the Company’s common stock on the date of the grant, and
the exercise price under a non-qualified stock option shall not
be less than 85% of the fair market value of the Company’s
common stock at the date of the grant.
The following table summarizes stock option activity for the
years ended December 31, 2004, 2003 and 2002, along with
options exercisable at the end of each year:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
|
|
Weighted | |
|
|
|
Weighted | |
|
|
|
Weighted | |
| |
|
|
|
Average | |
|
|
|
Average | |
|
|
|
Average | |
| |
|
Options | |
|
Price | |
|
Options | |
|
Price | |
|
Options | |
|
Price | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Outstanding-January 1,
|
|
|
824,474 |
|
|
$ |
40.72 |
|
|
|
865,122 |
|
|
$ |
40.87 |
|
|
|
739,887 |
|
|
$ |
41.28 |
|
|
Granted
|
|
|
– |
|
|
|
– |
|
|
|
12,750 |
|
|
|
30.26 |
|
|
|
180,250 |
|
|
|
38.83 |
|
|
Exercised
|
|
|
(334 |
) |
|
|
30.07 |
|
|
|
(5,344 |
) |
|
|
30.77 |
|
|
|
(22,805 |
) |
|
|
39.28 |
|
|
Cancelled
|
|
|
(116,415 |
) |
|
|
40.81 |
|
|
|
(48,054 |
) |
|
|
41.74 |
|
|
|
(32,210 |
) |
|
|
39.91 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding-December 31,
|
|
|
707,725 |
|
|
$ |
40.71 |
|
|
|
824,474 |
|
|
$ |
40.72 |
|
|
|
865,122 |
|
|
$ |
40.87 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of year
|
|
|
641,444 |
|
|
|
|
|
|
|
448,471 |
|
|
|
|
|
|
|
262,091 |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
91
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 10. |
EQUITY INCENTIVE PLANS (CONTINUED) |
The following is a summary of the status of the stock options
outstanding at December 31, 2004:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Options Outstanding | |
|
Options Exercisable | |
| |
|
| |
|
| |
| |
|
|
|
Weighted | |
|
|
|
|
| |
|
|
|
Average | |
|
Weighted | |
|
|
|
Weighted | |
| |
|
|
|
Remaining | |
|
Average | |
|
|
|
Average | |
| |
|
Number of | |
|
Contractual | |
|
Exercise | |
|
Number of | |
|
Exercise | |
| Range of Exercise Prices |
|
Shares | |
|
Life | |
|
Price | |
|
Shares | |
|
Price | |
| | |
|
$26.51 - $39.00
|
|
|
171,179 |
|
|
|
7.21 |
|
|
$ |
36.68 |
|
|
|
131,844 |
|
|
$ |
37.14 |
|
|
$39.25 - $39.25
|
|
|
265,096 |
|
|
|
5.53 |
|
|
$ |
39.25 |
|
|
|
258,699 |
|
|
$ |
39.25 |
|
|
$39.50 - $50.50
|
|
|
262,950 |
|
|
|
6.49 |
|
|
$ |
44.32 |
|
|
|
244,901 |
|
|
$ |
44.48 |
|
|
$53.37 - $55.74
|
|
|
8,500 |
|
|
|
7.31 |
|
|
$ |
55.46 |
|
|
|
6,000 |
|
|
$ |
55.35 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
707,725 |
|
|
|
6.31 |
|
|
$ |
40.71 |
|
|
|
641,444 |
|
|
$ |
40.96 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the year ended December 31, 2004, the Company issued
18,875 shares of the Company’s restricted common
stock, which had a fair market value ranging from $26.57 to
$32.01 per share at the dates of grant, to certain
employees and members of management. Deferred stock-based
compensation of $552 was recorded as a result of the issuance of
these shares of restricted common stock. For the year ended
December 31, 2003, the Company recorded deferred
stock-based compensation of $1,594 as a result of issuing
43,491 shares of the Company’s restricted common
stock, which had a fair market value ranging from $26.40 to
$39.00 per share at the date of grant, to certain members
of management and outside counsel. For the year ended
December 31, 2002, the Company recorded deferred
stock-based compensation of $46 as a result of issuing
1,500 shares of the Company’s restricted common stock,
which had a fair market value of $46.00 as of the date of grant,
to members of the Company’s Board of Directors and certain
members of management. These amounts were determined based on
the fair market value of such common shares at the date of grant
and are being amortized to operations over the vesting periods
(which range from 1 – 5 years) using the graded
vesting method. Stock-based compensation expense related to
these restricted stock issuances was $845, $291 and $202 for the
years ended December 31, 2004, 2003 and 2002, respectively.
During the year ended December 31, 2004, the Company issued
5,200 restricted common stock units (“RSUs”), which
had a fair market value of $28.75 per unit at the date of
grant, to certain members of the Company’s Board of
Directors. Deferred stock-based compensation of $150 was
recorded as a result of the issuance of these RSUs, which was
determined based on the fair market value of such common units
at the date of grant and is being amortized over the vesting
periods (which range from immediate vesting to 4 years)
using the graded vesting method. Stock-based compensation
expense related to these restricted stock unit issuances was $94
for the year ended December 31, 2004. During the years
ended December 31, 2003 and 2002, there were no RSUs issued
by the Company. On each date that the Company pays a cash
dividend to the holders of the Company’s common stock, the
Company shall credit to the holders of RSUs an additional number
of RSUs equal to the total number of whole RSUs and additional
RSUs previously credited to the holders multiplied by the dollar
amount of the cash dividend per share of common stock. Any
fractional RSUs resulting from such calculation shall be
included in the additional RSUs.
92
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
In February 2000, the Board of Directors authorized the
repurchase of up to one million shares of the Company’s
common stock. In June 2002, the Board of Directors approved the
repurchase of an additional 500 thousand shares. The shares are
purchased from time to time in the open market, or through
privately negotiated transactions, subject to overall financial
and market conditions. Additionally, the Company implemented an
odd-lot repurchase program during 2001. Through
December 31, 2004, approximately one million shares of
common stock have been repurchased through the programs. The
Company has remaining authorization from the Board of Directors
to repurchase an additional 469 thousand outstanding shares as
of December 31, 2004.
|
|
| 12. |
SHAREHOLDER RIGHTS PLAN AND CHANGE IN CONTROL AGREEMENT |
The Company has a Shareholder Rights Plan wherein shareholders
of the Company receive rights to purchase the Company’s
common stock, or an acquirer’s common stock, at a discount
in certain events involving an acquisition of 20% or more of the
Company’s common stock by any person or group in a
transaction not approved by the Company’s Board of
Directors. The rights expire in March 2008.
The Company has change in control agreements with approximately
20 employees, which provide upon (i) a change in control of
the Company and (ii) a constructive termination of
employment, the payment of a severance benefit approximately
equal to twice the employee’s annual compensation.
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, 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 provides long distance services.
The Broadband segment provides various services, including
high-speed and dial-up Internet, digital video, local, network
access and toll telephone and managed services in the greater
Sacramento area, principally to customers residing outside of
SureWest Telephone’s service area. The Company offers
high-speed Internet, digital video and local and long distance
phone service as a bundled package referred to as Triple Play.
The Broadband segment includes the Company’s subsidiary,
SureWest Broadband, and SureWest Broadband Business services,
which is comprised, in part, of a division of SureWest Telephone
operating as a Competitive Local Exchange Carrier.
The Wireless segment consists of the Company’s subsidiary
SureWest Wireless, which provides wireless services. SureWest
Wireless derives its revenue from the provision of wireless
services and the sale of handsets and related communications
equipment. Revenues include wireless voice services, sales of
handsets and related accessories, long distance, roaming service
and custom calling features. Non-contract wireless services are
billed in advance and recognized in subsequent periods when the
services are provided. Contract wireless services are billed in
arrears.
93
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 13. |
BUSINESS SEGMENTS (CONTINUED) |
In accordance with the provisions of SFAS No 131,
Disclosure About Segments of an Enterprise and Related
Information, the Company has aggregated certain of its
operating segments within the Telecom and Broadband segments
because it believes that such operating segments share similar
economic characteristics.
Corporate Operations are allocated to the appropriate segment,
except for: cash; investments; certain property, plant, and
equipment; and miscellaneous other assets, which are not
allocated to the segments. However, the investment income
associated with cash and investments held by Corporate
Operations is included in the results of the operations of the
Company’s segments. The Company evaluates the performance
of its segments based on income (loss) from operations.
These segments are strategic business units that offer different
products and services. The accounting policies of these segments
are the same as those described in Notes 1 and 2. The
Company accounts for intersegment revenues and expenses at
prevailing market rates.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
Corporate | |
|
Intercompany | |
|
|
| 2004 |
|
Telecom | |
|
Broadband | |
|
Wireless | |
|
Operations | |
|
Eliminations | |
|
Consolidated | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Operating revenues from external customers
|
|
$ |
141,086 |
|
|
$ |
39,416 |
|
|
$ |
31,261 |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
211,763 |
|
|
Intersegment revenues
|
|
|
25,814 |
|
|
|
1,784 |
|
|
|
1,699 |
|
|
|
– |
|
|
|
(29,297 |
) |
|
|
– |
|
|
Operating expenses *
|
|
|
91,736 |
|
|
|
61,143 |
|
|
|
38,266 |
|
|
|
– |
|
|
|
(29,297 |
) |
|
|
161,848 |
|
|
Depreciation and amortization
|
|
|
25,227 |
|
|
|
11,397 |
|
|
|
11,972 |
|
|
|
– |
|
|
|
– |
|
|
|
48,596 |
|
|
Income (loss) from operations
|
|
|
49,937 |
|
|
|
(31,340 |
) |
|
|
(17,278 |
) |
|
|
– |
|
|
|
– |
|
|
|
1,319 |
|
|
Interest income
|
|
|
193 |
|
|
|
8 |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
201 |
|
|
Interest expense, net of capitalized interest
|
|
|
(488 |
) |
|
|
(2,247 |
) |
|
|
(1,770 |
) |
|
|
– |
|
|
|
– |
|
|
|
(4,505 |
) |
|
Corporate treasury loss recovery
|
|
|
1,246 |
|
|
|
342 |
|
|
|
215 |
|
|
|
– |
|
|
|
– |
|
|
|
1,803 |
|
|
Income tax expense (benefit)
|
|
|
22,347 |
|
|
|
(14,558 |
) |
|
|
(8,286 |
) |
|
|
– |
|
|
|
– |
|
|
|
(497 |
) |
|
Net income (loss)
|
|
$ |
28,322 |
|
|
$ |
(18,627 |
) |
|
$ |
(10,823 |
) |
|
$ |
– |
|
|
$ |
– |
|
|
$ |
(1,128 |
) |
|
Total assets
|
|
$ |
617,205 |
|
|
$ |
199,174 |
|
|
$ |
134,733 |
|
|
$ |
178,904 |
|
|
$ |
(694,834 |
) |
|
$ |
435,182 |
|
|
Capital expenditures
|
|
$ |
9,678 |
|
|
$ |
50,330 |
|
|
$ |
5,605 |
|
|
$ |
5,220 |
|
|
$ |
– |
|
|
$ |
70,833 |
|
94
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 13. |
BUSINESS SEGMENTS (CONTINUED) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
Corporate | |
|
Intercompany | |
|
|
| 2003 |
|
Telecom | |
|
Broadband | |
|
Wireless | |
|
Operations | |
|
Eliminations | |
|
Consolidated | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Operating revenues from external customers
|
|
$ |
138,924 |
|
|
$ |
29,051 |
|
|
$ |
27,146 |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
195,121 |
|
|
Intersegment revenues
|
|
|
23,576 |
|
|
|
1,683 |
|
|
|
744 |
|
|
|
– |
|
|
|
(26,003 |
) |
|
|
– |
|
|
Operating expenses *
|
|
|
83,645 |
|
|
|
42,538 |
|
|
|
34,724 |
|
|
|
– |
|
|
|
(26,003 |
) |
|
|
134,904 |
|
|
Depreciation and amortization
|
|
|
31,257 |
|
|
|
4,508 |
|
|
|
16,705 |
|
|
|
– |
|
|
|
– |
|
|
|
52,470 |
|
|
Income (loss) from operations
|
|
|
47,598 |
|
|
|
(16,312 |
) |
|
|
(23,539 |
) |
|
|
– |
|
|
|
– |
|
|
|
7,747 |
|
|
Interest income
|
|
|
322 |
|
|
|
2 |
|
|
|
(18 |
) |
|
|
– |
|
|
|
– |
|
|
|
306 |
|
|
Interest expense, net of capitalized interest
|
|
|
(452 |
) |
|
|
(1,890 |
) |
|
|
(1,905 |
) |
|
|
– |
|
|
|
– |
|
|
|
(4,247 |
) |
|
Corporate treasury loss
|
|
|
(1,263 |
) |
|
|
(347 |
) |
|
|
(218 |
) |
|
|
– |
|
|
|
– |
|
|
|
(1,828 |
) |
|
Income tax expense (benefit)
|
|
|
19,327 |
|
|
|
(7,551 |
) |
|
|
(10,754 |
) |
|
|
– |
|
|
|
– |
|
|
|
1,022 |
|
|
Net income (loss)
|
|
$ |
26,565 |
|
|
$ |
(10,983 |
) |
|
$ |
(14,937 |
) |
|
$ |
– |
|
|
$ |
– |
|
|
$ |
645 |
|
|
Total assets
|
|
$ |
569,574 |
|
|
$ |
104,522 |
|
|
$ |
80,217 |
|
|
$ |
53,025 |
|
|
$ |
(372,129 |
) |
|
$ |
435,209 |
|
|
Capital expenditures
|
|
$ |
15,675 |
|
|
$ |
47,626 |
|
|
$ |
5,224 |
|
|
$ |
7,580 |
|
|
$ |
– |
|
|
$ |
76,105 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
Corporate | |
|
Intercompany | |
|
|
| 2002 |
|
Telecom | |
|
Broadband | |
|
Wireless | |
|
Operations | |
|
Eliminations | |
|
Consolidated | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Operating revenues from external customers
|
|
$ |
149,679 |
|
|
$ |
12,945 |
|
|
$ |
23,225 |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
185,849 |
|
|
Intersegment revenues
|
|
|
16,826 |
|
|
|
1,189 |
|
|
|
507 |
|
|
|
– |
|
|
|
(18,522 |
) |
|
|
– |
|
|
Operating expenses*
|
|
|
86,417 |
|
|
|
23,342 |
|
|
|
33,796 |
|
|
|
– |
|
|
|
(18,522 |
) |
|
|
125,033 |
|
|
Depreciation and amortization
|
|
|
28,249 |
|
|
|
1,972 |
|
|
|
14,905 |
|
|
|
– |
|
|
|
– |
|
|
|
45,126 |
|
|
Income (loss) from operations
|
|
|
51,839 |
|
|
|
(11,180 |
) |
|
|
(24,969 |
) |
|
|
– |
|
|
|
– |
|
|
|
15,690 |
|
|
Interest income
|
|
|
738 |
|
|
|
– |
|
|
|
1 |
|
|
|
– |
|
|
|
– |
|
|
|
739 |
|
|
Interest expense, net of capitalized interest
|
|
|
(366 |
) |
|
|
(85 |
) |
|
|
(1,425 |
) |
|
|
– |
|
|
|
– |
|
|
|
(1,876 |
) |
|
Income tax expense (benefit)
|
|
|
22,762 |
|
|
|
(4,585 |
) |
|
|
(10,751 |
) |
|
|
– |
|
|
|
– |
|
|
|
7,426 |
|
|
Net income (loss)
|
|
$ |
33,634 |
|
|
$ |
(6,715 |
) |
|
$ |
(15,670 |
) |
|
|
– |
|
|
$ |
– |
|
|
$ |
11,249 |
|
|
Total assets
|
|
$ |
524,913 |
|
|
$ |
64,654 |
|
|
$ |
132,483 |
|
|
$ |
15,085 |
|
|
$ |
(340,619 |
) |
|
$ |
396,516 |
|
|
Capital expenditures
|
|
$ |
16,460 |
|
|
$ |
10,125 |
|
|
$ |
10,650 |
|
|
$ |
7,117 |
|
|
$ |
– |
|
|
$ |
44,352 |
|
|
|
| * |
Exclusive of depreciation and amortization |
|
|
| 14. |
RELATED PARTY TRANSACTIONS |
A former officer of the Company is a member of the Board of
Directors of a local banking institution. During the years ended
December 31, 2004, 2003 and 2002, the Company provided $11,
$45 and $17, respectively, in telecommunications services to
this banking institution.
During 2002, the Company repurchased 300 thousand shares of its
common stock from one of its employee benefit plans. The Company
utilized two separate independent third party entities for the
purpose of providing fairness opinions in connection with the
transaction. The shares were repurchased at a price of
$50 per share and were retired upon purchase.
95
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 14. |
RELATED PARTY TRANSACTIONS (CONTINUED) |
Beginning January 1, 2005, the Company’s employees are
covered under an eye care benefit plan from an entity, of which
one of the Company’s Board Members is a director and also
an executive officer. Negotiations regarding the benefit plan
were completed before that entity’s director and executive
officer was elected to the Company’s Board of Directors and
without his involvement or knowledge. The Company anticipates
that its payment to such entity will approximate $10 in 2005.
|
|
| 15. |
QUARTERLY FINANCIAL INFORMATION (UNAUDITED) |
During the Company’s financial statement closing process
for the quarter ended December 31, 2003, certain matters
were identified related to prior interim financial reporting
periods that necessitated the recording of adjustments to the
Company’s condensed consolidated financial statements. Such
adjustments pertained principally to (i) property, plant
and equipment and (ii) cash, and management believes that
weaknesses in the Company’s internal controls caused the
errors that resulted in these adjustments. The Company does not
believe any of the aforementioned amounts are material,
individually or in the aggregate, to the respective prior
interim periods based on both quantitative and qualitative
factors, including the trend of operating results, nor does it
believe the prospective correction of such amounts during the
quarter ended December 31, 2003 is material to the
Company’s fourth quarter 2003 condensed consolidated
results of operations based on both quantitative and qualitative
factors, including the trend of operating results. The
prospective correction of the aforementioned amounts relating to
prior periods increased the Company’s fourth quarter 2003
condensed consolidated net loss by $3,157, or $0.22 per
basic and diluted share, and would have reduced the
Company’s (i) first, second and third quarter 2003
condensed consolidated net income by $223, or $0.02 per
basic and diluted share, $119, or $0.01 per basic and
diluted share, and $1,250, or $0.09 per basic and diluted
share and (ii) first, second, third and fourth quarter 2002
condensed consolidated net income by $54, or $0.00 per
basic and diluted share, $61, or $0.00 per basic and
diluted share, $86, or $0.01 per basic and diluted share,
and $595, or $0.04 per basic and diluted share,
respectively, had such errors been corrected in the periods in
which they originated.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 2004 |
|
March 31 | |
|
June 30 | |
|
September 30 | |
|
December 31 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Operating revenues
|
|
$ |
51,588 |
|
|
$ |
52,115 |
|
|
$ |
53,239 |
|
|
$ |
54,821 |
|
|
Income (loss) from operations
|
|
|
1,758 |
|
|
|
3,771 |
|
|
|
(1,517 |
) |
|
|
(2,693 |
) |
|
Net income (loss)
|
|
$ |
381 |
|
|
$ |
1,561 |
|
|
$ |
(1,602 |
) |
|
$ |
(1,468 |
) |
|
Basic earnings (loss) per share
|
|
$ |
0.03 |
|
|
$ |
0.11 |
|
|
$ |
(0.11 |
) |
|
$ |
(0.11 |
) |
|
Diluted earnings (loss) per share
|
|
$ |
0.03 |
|
|
$ |
0.11 |
|
|
$ |
(0.11 |
) |
|
$ |
(0.11 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 2003 |
|
March 31 | |
|
June 30 | |
|
September 30 | |
|
December 31 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Operating revenues
|
|
$ |
47,375 |
|
|
$ |
50,252 |
|
|
$ |
48,855 |
|
|
$ |
48,639 |
|
|
Income (loss) from operations
|
|
|
1,905 |
|
|
|
5,567 |
|
|
|
3,677 |
|
|
|
(3,402 |
) |
|
Net income (loss)
|
|
$ |
675 |
|
|
$ |
2,713 |
|
|
$ |
1,502 |
|
|
$ |
(4,245 |
) |
|
Basic earnings (loss) per share
|
|
$ |
0.05 |
|
|
$ |
0.19 |
|
|
$ |
0.10 |
|
|
$ |
(0.30 |
) |
|
Diluted earnings (loss) per share
|
|
$ |
0.05 |
|
|
$ |
0.19 |
|
|
$ |
0.10 |
|
|
$ |
(0.30 |
) |
The CPUC approved a settlement agreement on November 19,
2004 that resolved the Company’s intrastate shareable
earnings for the years 2000 through 2004. In accordance with
this settlement agreement, the Company recorded $2,948 in local
revenues due to a change in accounting estimate in the fourth
quarter of 2004 (for a more detailed discussion regarding the
settlement agreement, see Regulation and Contractual and
Estimated
96
SUREWEST COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
|
|
| 15. |
QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (CONTINUED) |
Shareable Earnings Obligations within Note 1 to the
consolidated financial statements). This increase in revenue
resulted in a decrease of the Company’s net loss by $2,046
($0.14 per share).
On December 6, 2004, the Company initiated the REWARD
program. The REWARD program was offered to certain eligible
employees across all business units. In addition to retirement
benefits, eligible employees will receive enhanced medical
benefits for a specified period of time. As of December 31,
2004, 59 employees had accepted the REWARD program.
Accordingly, the Company recorded $3,768 in operating expenses
related to the REWARD program during the fourth quarter of 2004.
The Company adopted SAB No. 101 effective
January 1, 2000, which requires non-recurring revenues
associated with service and activation charges to be deferred.
The cumulative effect of this change in accounting principle on
the Company resulted in a charge to income of $3,273, net of
tax, ($0.21 per share) in 2000.
For the three-month periods ended March 31, June 30,
September 30 and December 31, 2004 and 2003, the
Company recognized the following revenues that were included in
the cumulative effect adjustment as of January 1, 2000:
| |
|
|
|
|
|
|
Three months ended:
|
|
|
|
|
| |
March 31, 2004
|
|
$ |
56 |
|
| |
June 30, 2004
|
|
$ |
40 |
|
| |
September 30, 2004
|
|
$ |
26 |
|
| |
December 31, 2004
|
|
$ |
8 |
|
| |
March 31, 2003
|
|
$ |
128 |
|
| |
June 30, 2003
|
|
$ |
114 |
|
| |
September 30, 2003
|
|
$ |
96 |
|
| |
December 31, 2003
|
|
$ |
75 |
|
The net effect of these revenues in 2004 was to increase net
income in the three-month periods ended March 31 and
June 30, 2004 by $32 (no effect on earnings per share) and
$23 (no effect on earnings per share), respectively, and
decrease net loss for the three-month periods ended
September 30 and December 31, 2004 by $16 (no effect
on loss per share) and $5 (no effect on loss per share),
respectively.
The net effect of these revenues in 2003 was to increase net
income in the three-month periods ended March 31,
June 30 and September 30, 2003 by $75 ($0.01 per
share), $68 (no effect on earnings per share) and $57 (no effect
on earnings per share), respectively, and decrease net loss for
the three-month period ended December 31, 2003 by $44 (no
effect on earnings per share).
97
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.
Not Applicable.
Item 9A. Controls and Procedures.
Controls and Procedures
As of the end of the period covered by this report, we carried
out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934). Based on this evaluation, and
due to the material weakness in the Company’s internal
control over accounting for property, plant and equipment (as
described below in Management’s Report on Internal Control
over Financial Reporting), the Chief Executive Officer and Chief
Financial Officer have concluded that, as of December 31,
2004, the Company’s disclosure controls and procedures were
not effective to ensure that information required to be
disclosed by the Company in reports that it files or submits
under the Securities Exchange Act is authorized, recorded,
processed, summarized and reported within the time periods
specified in SEC rules and forms.
Management’s Report on Internal Control over Financial
Reporting
The management of the Company is responsible for establishing
and maintaining adequate internal control over financial
reporting. The Company’s internal control system was
designed to provide reasonable assurance to the Company’s
management, Board of Directors and Audit Committee regarding the
reliability of financial reporting and the preparation of
published financial statements in accordance with generally
accepted accounting principles.
All internal control systems, no matter how well designed, have
inherent limitations. Therefore, even those systems determined
to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation.
A material weakness is a significant deficiency, or combination
of significant deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. A
significant deficiency is a control deficiency, or combination
of control deficiencies, that adversely affects the
company’s ability to initiate, authorize, record, process,
or report external financial data reliably in accordance with
generally accepted accounting principles such that there is more
than a remote likelihood that a misstatement of the
company’s annual or interim financial statements that is
more than inconsequential will not be prevented or detected.
Under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief
Financial Officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting
as of December 31, 2004 based on the framework in Internal
Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Our
evaluation identified a material weakness in the Company’s
internal control over financial reporting relating to the
accounting for property, plant and equipment, which resulted
from control weaknesses that caused the following conditions:
The Company was unable to completely reconcile its plant in
service and plant under construction subsidiary ledgers to the
corresponding general ledger balances for periods throughout
2004 and as of December 31, 2004. Management believes these
unreconciled differences are attributable principally to
deficiencies in the reliability of the Company’s
information system interfaces between the general ledger and the
property, plant and equipment subsidiary ledgers. In addition,
during 2004, several errors occurred in the Company’s
periodic depreciation and capitalized interest calculations that
were more than inconsequential. Additionally, as of
December 31, 2004, the Company did not have effective
procedures with which to determine the cost bases of property,
plant and equipment that had been retired. Moreover, certain
manual internal controls pertaining to property, plant and
equipment implemented by the Company during the third quarter of
2004 were not operating effectively as of December 31,
2004. These matters required the Company to record adjustments
to both its
98
annual and interim 2004 consolidated financial statements. The
significant accounts affected by this material weakness are
property, plant and equipment and related accumulated
depreciation included in the Company’s consolidated balance
sheets, and depreciation expense and interest expense included
in the Company’s consolidated statements of operations. Due
to this material weakness, management believes that as of
December 31, 2004, the Company’s internal control over
financial reporting was not effective based on the COSO criteria.
Management’s assessment of the effectiveness of our
internal control over financial reporting as of
December 31, 2004 has been audited by Ernst &
Young LLP, an independent registered public accounting firm, as
stated in its report, which is included elsewhere herein.
Remediation Steps Related to Material Weakness
As noted above in Management’s Report on Internal Control
over Financial Reporting, the material weakness relating to the
accounting for property, plant and equipment resulted from
control weaknesses that caused the following conditions:
|
|
|
| |
• |
The Company was unable to completely reconcile its plant in
service and plant under construction subsidiary ledgers to the
corresponding general ledger balances for periods throughout
2004 and as of December 31, 2004. At December 31,
2004, the unreconciled difference was less than 1% of the
Company’s consolidated net property, plant and equipment
balance. Management believes these unreconciled differences are
attributable principally to deficiencies in the reliability of
the Company’s information system interfaces between the
general ledger and the property, plant and equipment subsidiary
ledgers. Manual controls, put in place in the third quarter of
2004 as noted in the Company’s Form 10-Q for the
quarter ended September 30, 2004, were not adequate to
resolve to a reasonable level the various data errors. |
| |
| |
• |
Depreciation and capitalized interest calculations by the
Company’s enterprise resource planning system have been
inconsistent and have required various manual adjustments to
properly record depreciation expense and related interest costs
in the proper period. |
| |
| |
• |
Monthly reviews of plant under construction balances for
propriety and correct classification, a manual control
implemented in the third quarter of 2004, were not performed at
the appropriate level or at the appropriate time to provide
reasonable assurance that costs are properly reflected in the
property, plant and equipment sub-modules. |
| |
| |
• |
As of December 31, 2004, the Company did not have effective
procedures with which to determine the cost bases of property,
plant and equipment that had been retired. |
The Company has or will implement the following remediation
steps to address the material weakness discussed above:
|
|
|
| |
• |
Enhancements to the Company’s enterprise resource planning
and accounting software, for which implementation commenced in
the second quarter of 2004, is ongoing. |
| |
| |
• |
The performance of additional detailed reviews, on a monthly
basis, of all open construction projects by the appropriate
project manager to validate the results generated by the
Company’s systems. |
| |
| |
• |
The review of systematic routines, which generate and transfer
data between modules within the enterprise resource planning
system, as necessary to determine if the routines are generating
accurate reports. |
| |
| |
• |
Timely detailed reviews by management will occur to provide
reasonable assurance that manual controls are operating
effectively. |
99
The Company believes that it is reasonably likely the material
weakness related to property, plant and equipment will be
remediated and tested in 2005.
Other Internal Control Matters
Management of the Company, during its assessment of the
effectiveness of the Company’s internal control over
financial reporting as of December 31, 2004, identified the
following other internal control deficiencies:
|
|
|
| |
• |
The Company has identified certain deficiencies related to its
Information Technology general and application controls. In
response to these deficiencies, during the third quarter of
2004, the Company engaged an outside consulting firm to design
and implement changes to the controls in an effort to remediate
the identified deficiencies. Although the Company has made
progress in its remediation efforts, these efforts were not
completed by December 31, 2004. The Company believes that
it is reasonably likely that this control deficiency will be
remediated and tested in 2005. |
|
|
|
Accounting Personnel, Policies and Procedures |
|
|
|
| |
• |
In the third quarter of 2004, the Company expected that the
assessment of the Corporate Finance Department by management,
including the new Senior Vice President and Chief Financial
Officer who joined the Company on October 4, 2004, and the
implementation of a training program and the hiring of new
personnel as necessary, to assure the proper mix of technical
skills and the relevant personnel, would be completed by
December 31, 2004. This review and the Chief Financial
Officer’s report to the Audit Committee were completed in
February 2005. |
| |
| |
• |
On September 30, 2004, the Company issued in draft its
Accounting Policies and Procedure Manual. The manual and certain
additional sections were completed subsequent to
December 31, 2004. |
| |
| |
• |
During management’s assessment of internal controls, it was
noted that the quality of evidence was not consistent across the
Company’s controls. Management put into place various
remediation steps during the third and fourth quarters of 2004,
which it believed would improve the overall quality of the
control documentation. During management’s testing of
internal controls in 2005, we will determine if such remediation
was effective in improving the Company’s overall quality of
control documentation. |
Change in Internal Control over Financial Reporting
During the fourth quarter of 2004, the Company implemented
various improvements to internal controls, which included:
(i) a formal reconciliation process to better manage its
monthly close process, (ii) a continuation of the effort to
review and validate the integrity of the data contained in the
Company’s property, plant and equipment sub-modules and
(iii) the commencement of service of the new Chief
Financial Officer effective October 4, 2004. Except for the
items discussed above, there has been no change in the
Company’s internal control over financial reporting during
the fourth quarter of 2004 that has materially affected, or is
reasonably likely to materially affect, the Company’s
control over financial reporting.
100
Report of Ernst & Young LLP, Independent Registered
Public Accounting Firm, on Internal Control over Financial
Reporting
The Board of Directors and Shareholders
SureWest Communications
We have audited management’s assessment, included in the
accompanying report entitled “Management’s Report on
Internal Control over Financial Reporting,” that SureWest
Communications did not maintain effective internal control over
financial reporting as of December 31, 2004, because of the
effect of a material weakness relating to the accounting for
property, plant and equipment, based on criteria established in
Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). SureWest Communication’s management is
responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an
opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of
control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. The
following material weakness has been identified and included in
management’s assessment. In its assessment as of
December 31, 2004, management identified a material
weakness in the Company’s internal control over financial
reporting relating to the accounting for property, plant and
equipment, which resulted from control weaknesses that caused
the following conditions: The Company was unable to completely
reconcile its plant in service and plant under construction
subsidiary ledgers to the corresponding general ledger balances
for periods throughout 2004 and as of December 31, 2004.
Management believes these unreconciled differences are
attributable principally to deficiencies in the reliability of
the Company’s information system interfaces between the
general ledger and the property, plant and equipment subsidiary
ledgers. In addition, during 2004, several errors occurred in
the Company’s periodic depreciation and capitalized
interest calculations that were more than inconsequential.
Additionally, as of December 31, 2004, the Company did not
have effective procedures with which to determine the cost bases
of property, plant and equipment that had been retired.
Moreover, certain manual internal controls pertaining to
property, plant and equipment implemented by the Company during
the third quarter of 2004 were not operating effectively as of
December 31, 2004. These matters required the
101
Company to record adjustments to both its annual and interim
2004 consolidated financial statements. The significant accounts
affected by this material weakness are property, plant and
equipment and related accumulated depreciation included in the
Company’s consolidated balance sheets, and depreciation
expense and interest expense included in the Company’s
consolidated statements of operations. This material weakness
was considered in determining the nature, timing, and extent of
audit tests applied in our audit of the 2004 consolidated
financial statements, and this report does not affect our report
dated March 11, 2005 on those financial statements.
In our opinion, management’s assessment that SureWest
Communications did not maintain effective internal control over
financial reporting as of December 31, 2004 is fairly
stated, in all material respects, based on the COSO control
criteria. Also, in our opinion, because of the effect of the
material weakness described above on the achievement of the
objectives of the control criteria, SureWest Communications has
not maintained effective internal control over financial
reporting as of December 31, 2004, based on the COSO
control criteria.
Sacramento, California
March 11, 2005
Item 9B. Other Information
Not applicable.
102
PART III
|
|
| Item 10. |
Directors and Executive Officers of the Registrant. |
For information regarding the executive officers of the Company,
see “Executive Officers of the Registrant” at the end
of Part I of this report. Other information required by
this item is incorporated herein by reference from the proxy
statement for the annual meeting of the Company’s
shareholders to be filed pursuant to Regulation 14A within
120 days after the Company’s fiscal year-end of
December 31, 2004.
Code of Ethics
The Company has adopted a Code of Ethics and Business Conduct
applicable to all employees and members of the Board of
Directors. The Code of Ethics and Business Conduct is available
on the Company’s website at
http://www.surw.com/ir/corpgov/Code of Ethics Business Conduct.php.
Shareholders may request a free copy of the Code of Ethics and
Business Conduct from:
|
|
| |
SureWest Communications |
| |
P.O. Box 969 |
| |
Roseville, California 95678 |
| |
Attention: Investor Relations |
|
|
| Item 11. |
Executive Compensation. |
Incorporated herein by reference from the proxy statement for
the annual meeting of the Company’s shareholders to be
filed pursuant to Regulation 14A within 120 days after
the Company’s fiscal year-end of December 31, 2004.
Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters.
Equity Compensation Plan Information
The Company maintains the 1999 Restricted Stock Bonus Plan (the
“1999 Plan”) and the 2000 Equity Incentive Plan (the
“2000 Plan”), pursuant to which it may grant equity
awards to eligible persons. The 1999 Plan and the 2000 Plan were
approved by the Company’s shareholders.
103
The following table provides information about equity awards
under the 1999 Plan and the 2000 Plan.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Number of securities | |
| |
|
|
|
|
|
remaining available for | |
| |
|
Number of securities | |
|
|
|
future issuance under | |
| |
|
to be issued upon | |
|
Weighted-average | |
|
equity compensation | |
| |
|
exercise of | |
|
exercise price of | |
|
plans (excluding | |
| |
|
outstanding options, | |
|
outstanding options | |
|
securities reflected in | |
| Plan category |
|
warrants and rights | |
|
warrants and rights | |
|
column (a) | |
| |
|
| |
|
| |
|
| |
| |
|
(a) | |
|
(b) | |
|
(c) | |
|
Equity compensation plans approved by security holders
|
|
|
707,725 |
|
|
$ |
40.71 |
|
|
|
604,365 |
|
|
Equity compensation plans not approved by security holders
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
| |
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
707,725 |
|
|
$ |
40.71 |
|
|
|
604,365 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
| (1) |
The 1999 Plan permits only the issuance of Restricted Shares. As
of December 31, 2004, the Company had made Restricted Share
grants in respect of 34,268 shares of the Company’s
common stock, and 166,107 shares of the Company’s
common stock remain available under the 1999 Plan. |
| |
| (2) |
The 2000 Plan, as originally approved by the Company’s
shareholders, contemplated the issuance of up to
800,000 shares of the Company’s common stock.
Thereafter, the Company’s shareholders approved an increase
to 950,000 shares and the incorporation of an evergreen
provision pursuant to which the number of shares of the Company
stock which shall be made available under the 2000 Plan shall be
950,000 shares plus an annual increase to be added on the
first business day of each calendar year and thereafter
beginning with January 2, 2003 equal to one percent of the
outstanding shares as of December 31 of the immediately
preceding calendar year. |
Additional information required by Item 12 is incorporated
herein by reference from the proxy statement for the annual
meeting of the Company’s shareholders to be filed pursuant
to Regulation 14A within 120 days after the
Company’s fiscal year-end of December 31, 2004.
|
|
| Item 13. |
Certain Relationships and Related Transactions. |
Incorporated herein by reference from the proxy statement for
the annual meeting of the Company’s shareholders to filed
pursuant to Regulation 14A within 120 days after the
Company’s fiscal year-end of December 31, 2004.
|
|
| Item 14. |
Principal Accountant Fees and Services |
Incorporated herein by reference from the proxy statement for
the annual meeting of the Company’s shareholders to be
filed pursuant to Regulation 14A within 120 days after
the Company’s fiscal year-end of December 31, 2004.
104
PART IV
|
|
| Item 15. |
Exhibits and Financial Statement Schedules. |
|
|
| (a) 1 and 2. |
Financial Statement Schedules |
Financial statement schedules have been omitted because they are
not required, not applicable or the information is otherwise
included in the notes to the consolidated financial statements.
The exhibits listed on the accompanying Index to Exhibits are
filed as part of this annual report.
105
SUREWEST COMMUNICATIONS
INDEX TO EXHIBITS
(Item 15 (A) 3)
| |
|
|
|
|
|
|
| Exhibit | |
|
|
|
Method |
| No. | |
|
Description |
|
of Filing |
| | |
|
|
|
|
| |
3 |
.1 |
|
Articles of Incorporation of Registrant, together with
Certificate of Amendment of Articles of Incorporation dated
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) |
|
Incorporated by reference |
| |
| |
3 |
.2 |
|
Certificate of Amendment of Articles of Incorporation dated
May 18, 2001 (Filed as Exhibit 3(b) to Form 10-Q
Quarterly Report for the quarter ended June 30, 2001) |
|
Incorporated by reference |
| |
| |
3 |
.3 |
|
Bylaws of Registrant (Filed as Exhibit 3(b) to
Form 10-K Annual Report of the Registrant for the year
ended December 31, 2000) |
|
Incorporated by reference |
| |
| |
4 |
.1 |
|
Shareholder Rights Plan (Filed as Exhibit 2.1 to
Form 8-A Registration Statement under the Securities Act of
1934) |
|
Incorporated by reference |
| |
| |
10 |
.1 |
|
Note Purchase Agreement for Series A Senior Notes in
the aggregate amount of $40,000,000 dated December 9, 1998
(Filed as Exhibit 10(b) to Form 10-K Annual Report of
Registrant for the year ended December 31, 1998) |
|
Incorporated by reference |
| |
| |
10 |
.2 |
|
Supplement to Note Purchase Agreement for Series B
Senior Notes in the aggregate amount of $60,000,000 dated
March 13, 2003 (Filed as Exhibit 99.1 to the
Form 8-K filed March 13, 2003) |
|
Incorporated by reference |
| |
| |
10 |
.3 |
|
Business Loan Agreement of Registrant with Bank of America,
dated March 15, 2000, as amended by Amendment No. 1
dated as of April 10, 2000 (Filed as Exhibit 10(f) to
Form 10-Q Quarterly Report of Registrant for the quarter
ended March 31, 2000), as amended by Amendment No. 2
dated as of September 15, 2000, Amendment No. 3 dated
as of July 17, 2001, and Amendment No. 4 dated as of
June 26, 2000 (Filed as Exhibit 10(l) to
Form 10-Q Quarterly Report of Registrant for the Quarter
ended June 30, 2002) |
|
Incorporated by reference |
| |
| |
10 |
.4 |
|
Amendment No. 5 to Business Loan Agreement dated
February 26, 2003 (Filed as Exhibit 10(e) to
Form 10-K Annual Report of Registrant for the year ended
December 31, 2002) |
|
Incorporated by reference |
| |
| |
10 |
.5 |
|
Amendment No. 6 to Business Loan Agreement dated as of
January 13, 2004 (Filed as exhibit 10.6 to Form 10-K/A
Annual Report of Registrant for the year ended December 31,
2003) |
|
Incorporated by reference |
| |
| |
10 |
.6 |
|
Amendment No. 7 to Business Loan Agreement dated as of
March 25, 2004 (Filed as Exhibit 10.7 to
Form 10-K/A Annual Report of Registrant for the year ended
December 31, 2003) |
|
Incorporated by reference |
| |
| |
10 |
.7 |
|
Amendment No. 8 to Business Loan Agreement dated as of
December 31, 2004 |
|
Filed herewith |
106
| |
|
|
|
|
|
|
| Exhibit | |
|
|
|
Method |
| No. | |
|
Description |
|
of Filing |
| | |
|
|
|
|
| |
| |
10 |
.8 |
|
1999 Restricted Stock Bonus Plan (Filed as Exhibit 10(d) to
Form 10-K Annual Report of Registrant for the year ended
December 31, 1998) |
|
Incorporated by reference |
| |
| |
10 |
.9 |
|
2000 Equity Incentive Plan, as amended (filed as
Exhibit 10.9 to Form 10-K/A Annual Report of
Registrant for year ended December 31, 2003) |
|
Incorporated by reference |
| |
| |
10 |
.10 |
|
SureWest KSOP (filed as Exhibit 4.1 to Registration
Statement on Form S-8 [No. 333-87222]) |
|
Incorporated by reference |
| |
| |
10 |
.11 |
|
Letter agreement dated January 16, 2001 between Registrant
and Brian H. Strom (Filed as Exhibit 10(g) to
Form 10-K Annual Report of Registrant for the year ended
December 31, 2000) |
|
Incorporated by reference |
| |
| |
10 |
.12 |
|
Letter agreement dated January 16, 2001 between Registrant
and Jay B. Kinder (Filed as Exhibit 10(i) to
Form 10-K Annual Report of Registrant for the year ended
December 31, 2000) |
|
Incorporated by reference |
| |
| |
10 |
.13 |
|
Letter agreement dated January 16, 2001 between Registrant
and Bill M. DeMuth (Filed as Exhibit 10.14 to
Form 10-K/A Annual Report of Registrant for the year ended
December 31, 2003) |
|
Incorporated by reference |
| |
| |
10 |
.14 |
|
Letter agreement dated January 16, 2001 between Registrant
and Fred A. Arcuri (Filed as Exhibit 10.15 to
Form 10-K/A Annual Report of Registrant for the year ended
December 31, 2003) |
|
Incorporated by reference |
| |
| |
10 |
.15 |
|
Restricted Stock Unit Award, dated December 21, 2004,
between Registrant and Roger J. Valine |
|
Filed herewith |
| |
| |
10 |
.16 |
|
Form of Restricted Stock Unit Award, dated December 21,
2004, between Registrant and each of Guy R. Gibson, Steven C.
Oldham, John R. Roberts III and Timothy D. Taron |
|
Filed herewith |
| |
| |
10 |
.17 |
|
Form of Restricted Stock Unit Award, dated February 23,
2005, between Registrant and Brian H. Strom |
|
Filed herewith |
| |
| |
10 |
.18 |
|
Form of Restricted Stock Unit Award, dated February 23,
2005, between Registrant and each of Fred A. Arcuri, Bill M.
DeMuth and Jay B. Kinder |
|
Filed herewith |
| |
| |
10 |
.19 |
|
Form of Restricted Stock Unit Award for Registrant’s 2000
Equity Incentive Plan |
|
Filed herewith |
| |
| |
10 |
.20 |
|
Form of Stock Option Agreement for Registrant’s 2000 Equity
Incentive Plan |
|
Filed herewith |
| |
| |
10 |
.21 |
|
Form of Restricted Stock Agreement for Registrant’s 2000
Equity Incentive Plan |
|
Filed herewith |
| |
| |
21 |
.1 |
|
List of Subsidiaries |
|
Filed herewith |
107
| |
|
|
|
|
|
|
| Exhibit | |
|
|
|
Method |
| No. | |
|
Description |
|
of Filing |
| |
|
|
|
|
| |
23 |
.1 |
|
Consent of Ernst & Young LLP, Independent Registered
Public Accounting Firm |
|
Filed herewith |
| |
| |
31 |
.1 |
|
Certification of Brian H. Strom, President and Chief Executive
Officer, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
|
Filed herewith |
| |
| |
31 |
.2 |
|
Certification of Philip A. Grybas, Senior Vice President and
Chief Financial Officer, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 |
|
Filed herewith |
| |
| |
32 |
.1 |
|
Certification of Brian H. Strom, President and Chief Executive
Officer, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 |
|
Filed herewith |
| |
| |
32 |
.2 |
|
Certification of Philip A. Grybas, Senior Vice President and
Chief Financial Officer, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 |
|
Filed herewith |
108
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
SUREWEST COMMUNICATIONS
(Registrant)
| |
|
|
|
|
|
Date: March 10, 2005
|
|
By: |
|
/s/ Brian H. Strom
Brian H. Strom,
President and Chief
Executive Officer |
| |
|
Date: March 10, 2005
|
|
By: |
|
/s/ Philip A. Grybas
Philip
A. Grybas,
Senior Vice President
and Chief Financial Officer |
109
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.
|
|
| |
/s/ Kirk C. Doyle |
| |
|
| |
Kirk C. Doyle, |
| |
Chairman of the Board |
| |
| |
/s/ Brian H. Strom |
| |
|
| |
Brian H. Strom, |
| |
President and Chief |
| |
Executive Officer; Director |
| |
| |
/s/ Philip A. Grybas |
| |
|
| |
Philip A. Grybas, |
| |
Senior Vice President |
| |
and Chief Financial Officer |
| |
| |
/s/ Guy R. Gibson |
| |
|
| |
Guy R. Gibson, |
| |
Director |
| |
| |
/s/ Steven C. Oldham |
| |
|
| |
Steven C. Oldham, |
| |
Director |
| |
| |
/s/ John R. Roberts III |
| |
|
| |
John R. Roberts III, |
| |
Director |
| |
| |
/s/ Timothy D. Taron |
| |
|
| |
Timothy D. Taron, |
| |
Director |
| |
| |
/s/ Roger J. Valine |
| |
|
| |
Roger J. Valine, |
| |
Director |
Date: March 10, 2005
110