UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended March 31, 2005

or

Commission File Number 0-556

SUREWEST COMMUNICATIONS

Registrant’s telephone number, including area code (916) 786-6141

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of April 29, 2005, 14,590,051 shares of the registrant’s Common Stock were outstanding.

TABLE OF CONTENTS

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SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited; Amounts in thousands, except per share amounts)

See accompanying notes.

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SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)

See accompanying notes.

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SUREWEST COMMUNICATIONS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
DECREASE IN CASH AND CASH EQUIVALENTS
(Unaudited; Amounts in thousands)

See accompanying notes.

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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except share and per share amounts)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The condensed consolidated financial statements of SureWest Communications (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the results for the interim periods shown have been included. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules and regulations and accounting principles applicable for interim periods. Management believes that the disclosures made are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2004 Annual Report on Form 10-K filed with the SEC.

The Company is a holding company with wholly-owned subsidiaries that provide integrated communications services in Northern California. The Company’s principal operating subsidiary is SureWest Telephone. 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 are each subsidiaries of the Company. The Company expects that the sources of its revenues and its cost structure may be different in future periods, both as a result of its entry into new communications markets and competitive forces in each of the markets in which the Company has operations.

Stock-based Compensation

The Company has two stock-based compensation plans. Effective January 1, 2003, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation. Under the prospective method of adoption selected by the Company under the provisions of SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, the fair value method of accounting was applied to all employee awards granted, modified, or settled after January 1, 2003. Stock-based compensation associated with employee stock options is recognized over the vesting periods (which range from 1 to 5 years) using the graded vesting method.

The fair value of the Company’s employee stock options was estimated at the date of grant using the Black-Scholes-Merton option-pricing model. The Company did not issue any stock options during the quarters ended March 31, 2005 or 2004.

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 periods.

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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The expense related to stock-based employee compensation included in the determination of net income is less than that which would have been recognized if the fair value method had been applied to all awards granted after the original effective date of SFAS No. 123. If the Company had elected to adopt the fair value recognition provisions of SFAS No. 123 as of its original effective date, pro forma net income and earnings per share would be as follows:

During the quarter ended March 31, 2005, the Company issued 45,024 restricted common stock units (“RSUs”), which had a fair market value ranging from $22.43 to $28.35 per unit at the dates of grant, to certain eligible participants. Deferred stock-based compensation of $1,015 was recorded as a result of the issuance of these RSUs, which was determined based on the fair value of such common units at the date of grant and is being amortized over a four-year vesting period. During the quarter ended March 31, 2004, no RSUs were issued by the Company.

During the quarter ended March 31, 2004, the Company issued 3,050 shares of the Company’s restricted common stock, which had a fair market value of $32.01 per share at the date of grant, to certain employees. Deferred stock-based compensation of $98 was recorded as a result of the issuance of these shares of restricted common stock, which was determined based on the fair value of such common shares at the date of grant and is being amortized over a four-year vesting period. During the quarter ended March 31, 2005, no shares of restricted common stock were issued by the Company.

Per Share Amounts

Shares used in the computation of basic earnings per share are based on the weighted average number of common shares and RSUs outstanding, excluding unvested restricted common shares and unvested RSUs. Shares and RSUs used in the computation of diluted earnings per share are based on the weighted average number of common shares and RSUs outstanding, along with other potentially dilutive securities outstanding in each period.

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 credits 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 are included in the additional RSUs.

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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Other Comprehensive Income (Loss)

The Company’s consolidated net income equaled its consolidated comprehensive income for the quarters ended March 31, 2005 and 2004.

As of March 31, 2005 and 2004, the accumulated other comprehensive loss was $2,126 and $261, respectively, which consisted of minimum pension and post-retirement benefit liability adjustments, net of income taxes.

Adjustments and Reclassifications

During the Company’s financial statement closing process for the quarter ended September 30, 2004, certain matters were identified related to prior financial reporting periods that necessitated the recording of adjustments to the Company’s condensed consolidated financial statements. Such adjustments increased depreciation expense by $822 and decreased cost of sales by $39 in the quarter ended September 30, 2004. Management believes that weaknesses in the Company’s internal controls caused the errors that resulted in these adjustments. The Company does not believe the aforementioned amounts are material, individually or in the aggregate, to the respective prior quarterly 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 September 30, 2004 was material to the Company’s 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 consolidated net loss by $468, or $0.03 per basic and diluted share, for the quarter ended September 30, 2004. Such amounts would have reduced the Company’s quarterly consolidated net income by $239, or $0.02 per basic and diluted share, and $272, or $0.02 per basic and diluted share, for the quarters ended March 31, 2004 and June 30, 2004, respectively, had such errors been corrected in the periods in which they originated.

Certain amounts in the Company’s 2004 condensed consolidated financial statements have been reclassified to conform to the presentation of the Company’s 2005 condensed consolidated financial statements.

2. BUSINESS SEGMENTS

The Company has three reportable business segments: Telecommunications (“Telecom”), Broadband and Wireless. The Telecom segment includes SureWest Telephone, SureWest Directories and SureWest Long Distance, which provide landline telecommunications services, directory advertising, 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 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 fiber-to-the-premise (“FTTP”) (previously 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. 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.

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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

2. 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 Company accounts for intersegment revenues and expenses at prevailing market rates. The Company’s business segment information is as follows:

3. 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”).

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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

3. ESTIMATED SHAREABLE EARNINGS OBLIGATIONS (CONTINUED)

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. Based on preliminary cost studies, the Company recognized liabilities relating to SureWest Telephone’s estimated interstate shareable earnings obligations of $80 (no effect on earnings per share) for the quarter ended March 31, 2005, through reductions of revenues. The Company did not identify any interstate shareable earnings obligations at SureWest Telephone during the quarter ended March 31, 2004.

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 is scheduled to expire 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 and received currently from the CHCF, 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 provisions of the NRF, the Company recorded certain liabilities and reductions of revenues of $70 (no effect on earnings per share) relating to its estimated intrastate shareable earnings obligations during the quarter ended March 31, 2004 (none for the quarter ended March 31, 2005).

The Company was involved in a proceeding at the CPUC that considered the continued need for certain sharing requirements in the intrastate jurisdiction and, in connection with that review, also considered the issue of whether the Company overearned in the intrastate jurisdiction in recent monitoring periods and the amount of such overearnings that should be shared with customers. In July 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 resolved existing sharing obligations and related earnings issues for the monitoring periods 2000 through 2004, put into place a surcredit mechanism for the amount of the settlement, and suspended the requirement for any intrastate sharing for monitoring periods from January 1, 2005 through at least December 31, 2010.

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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

3. ESTIMATED SHAREABLE EARNINGS OBLIGATIONS (CONTINUED)

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 end users through a consumer dividend over a period of four years beginning January 1, 2005. For the quarter ended March 31, 2005, approximately $395 was returned to the end users. In addition, SureWest Telephone will pay a one-time consumer dividend of $2,600, which includes an annual imputed interest rate of 3.15% (no stated contractual interest rate), over two years beginning January 1, 2005 to settle the monitoring periods 2000 to 2004. For the quarter ended March 31, 2005, approximately $289 was returned to the consumers and was recorded as a reduction of the Company’s contractual shareable earnings obligations. At March 31, 2005, the aggregate contractual shareable earnings obligation for these surcredits was $8,557 (which is net of an unamortized discount pertaining to imputed interest of $520 at such date).

Further, commencing January 1, 2007, SureWest Telephone will 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 November 2003, SureWest Telephone began paying a consumer dividend for intrastate overearnings relating to the year 2002. A portion of the consumer’s intrastate service charges was returned to the consumers in the form of a surcredit beginning in November 2003 and ending in February 2004, totaling $483 (of which $208 was returned during the first quarter of 2004) and was recorded as a reduction of the Company’s estimated 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 during the quarters ended March 31, 2005 and 2004. For the quarter ended March 31, 2005, these changes in estimates increased the Company’s consolidated revenues by $57 and net income by $35 (no effect on earnings per share). For the quarter ended March 31, 2004, similar changes in estimates increased the Company’s consolidated revenues by $539 and net income by $310 ($0.02 per share).

As of March 31, 2005, the Company’s condensed consolidated balance sheet reflected aggregate liabilities of $418 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.

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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

4. PENSION AND OTHER POST-RETIREMENT BENEFITS

Components of Net Periodic Benefit Cost

Net periodic pension costs recognized in the condensed consolidated statements of income for the three month periods ended March 31, 2005 and 2004 under the defined benefit pension plan (“Pension Plan”), Supplemental Executive Retirement Plan (“SERP”) and post-retirement benefits other than pension (“Other Benefits”) plan included the following components:

In December 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 and the Company recorded operating expenses of $3,768 related to the REWARD program during the fourth quarter of 2004. During the first quarter of 2005, 13 additional employees accepted the REWARD program. As a result, the Company recorded $791 in operating expenses during the first quarter of 2005.

Employer Contributions

The Company expects to contribute $5,000 and $517 to the Pension Plan and Other Benefits plan, respectively, in 2005. As of March 31, 2005, the Company has contributed $447 to the Other Benefits plan (no contributions have been made to the Pension Plan).

5. RECENT ACCOUNTING PRONOUNCEMENTS

In December 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 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) as originally issued was to be effective for public companies for interim or annual periods beginning after June 15, 2005. However, in April 2005, the SEC announced that companies may implement SFAS No. 123(R) at the beginning of their next fiscal year (instead of their next reporting period) beginning after June 15, 2005. The effective date of the new standard for the Company’s consolidated financial statements is January 1, 2006 (beginning with the reporting period ending March 31, 2006). 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 January 1, 2006.

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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

5. RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)

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 or cash flows.

In March 2005, the FASB issued Interpretation (“FIN”) No. 47, Accounting for Conditional Asset Retirement Obligations. FIN No. 47 clarifies that the term “conditional asset retirement obligation” as used in SFAS No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN No. 47 requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. The Company is currently evaluating the effect FIN No. 47 will have on its consolidated financial position, results of operations or cash flows.

6. COMMITMENTS AND CONTINGENCIES

The Company has entered into various cable television franchise agreements with associated letters of credit totaling $150 in the aggregate as of March 31, 2005.

The Company is subject to certain legal and regulatory proceedings and examinations, Internal Revenue Service examinations and other tax exposures, and other claims arising in the ordinary course of its business. In the opinion of management, the ultimate outcome of these matters will not materially affect the consolidated financial position or results of operations of the Company.

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PART I

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

(Amounts in thousands, except selected operating metrics and per share amounts)

Certain information included in the Company’s quarterly report on Form 10-Q, including that which relates to the impact on future revenue sources and potential sharing obligations of pending and future regulatory orders, continued expansion of the telecommunications network and expected changes in the sources of the Company’s revenue and its cost structure resulting from its entrance into new communications markets, are forward looking statements and are made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. Such forward looking statements are subject to a number of risks, assumptions and uncertainties that could cause the Company’s actual results to differ from those projected in such forward looking statements.

Important factors that could cause actual results to differ from those set forth in the forward looking statements include, but are not limited to: advances in telecommunications technology, changes in the telecommunications regulatory environment, changes in the financial stability of other telecommunications providers who are customers of the Company, changes in competition in markets in which the Company operates, adverse circumstances affecting the economy in California in general, and in the Sacramento, California Metropolitan area in particular, the availability of future financing, changes in the demand for services and products, new product and service development and introductions, pending and future litigation, internal control weaknesses and unanticipated changes in the growth of the Company’s emerging businesses, including the wireless, Internet, digital video and Competitive Local Exchange Carrier operating entities.

Corporate Structure

SureWest Communications (the “Company”) is a holding company with wholly-owned subsidiaries operating in the Telecommunications (“Telecom”), Broadband and Wireless segments.

The Telecom segment includes SureWest Telephone, SureWest Directories and SureWest Long Distance, which provide landline telecommunications services, directory advertising, Digital Subscriber Line (“DSL”) service, long distance services and certain non-regulated services. SureWest Telephone, which is the principal operating subsidiary of the Telecom segment, provides local and toll telephone services, network access services and certain non-regulated services. SureWest Directories publishes and distributes SureWest Telephone’s directory, including the sale of yellow pages advertising. SureWest Directories is also engaged in the business of producing, publishing and distributing directories in other Northern California communities outside of SureWest Telephone’s service area. SureWest Long Distance is a reseller of 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 fiber-to-the-premise (“FTTP”) (previously 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. Wireless services are provided on a month-to-month basis and are generally billed in advance for non-contract subscribers and in arrears for contract subscribers.

The Company expects that the sources of its revenues and its cost structure may be different in future periods, both as a result of its entry into new communications markets and competitive forces in each of the markets in which the Company has operations.

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Results of Operations

Consolidated Overview

The tables below reflect certain financial data (on a consolidated and segment basis) and selected operating metrics for each reportable segment as of and for the quarters ended March 31, 2005 and 2004. Both the financial data and the selected operating metrics demonstrate the increasing importance of the Company’s Broadband and Wireless segments.

Financial Data

(1)	External customers only

Selected Operating Metrics

(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.

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Operating revenues from external customers in the Telecom segment decreased $1,722 for the first quarter of 2005 compared to the same period in 2004. SureWest Telephone continues to experience decreases in local and network access as a result of competition from wireless (including SureWest Wireless) and wireline competitors and an approximate 3% decline in access lines. The decrease in revenues in the Telecom segment was offset in part by revenue growth of $280 in SureWest Long Distance, resulting from an increase in minutes of use and the Infinite Access bundle program, which was initiated during the second quarter of 2004. In addition, Directory advertising revenue increased $194 for the quarter ended March 31, 2005, compared to the same period in 2004, due primarily to increases in advertising rates and programs and bundled packages purchased by existing customers.

While the Telecom segment continues to generate a majority of the Company’s revenues and yields significant cash flows and net income, the Company believes that the results of the Telecom segment in recent years support (reflected in declining revenues, net income and access lines), in part, the Company’s decision to develop its other business segments.

Broadband operating revenues increased $2,622 during the first quarter of 2005 compared to the same period in 2004. The Broadband segment experienced a 14% increase in the number of DSL data subscribers compared to 2004. More significantly, this segment had 16,623 FTTP subscribers and 38,818 FTTP Revenue-generating units at March 31, 2005 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, operating and net losses for the Broadband segment remained relatively consistent with the prior-year period.

The Wireless segment reported increases in operating revenues of $968 during the first quarter of 2005 as compared to the same period in 2004. The number of wireless subscribers increased to 52,887 at March 31, 2005, representing a 12% increase from March 31, 2004. SureWest Wireless established its market share in the Sacramento market in large part by promoting an unlimited flat rate regional calling plan. Throughout 2004 and the first quarter of 2005, 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, excluding depreciation and amortization, decreased $362 in 2005 compared to the prior year. General and administrative expense decreased due primarily to the incurrence of consulting and legal fees related to the treasury investigation and audit fees during the quarter ended March 31, 2004, offset in part by an increase in Sarbanes-Oxley compliance costs during the current year. This decrease was further offset by 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. In addition, long distance access expense increased as a result of the Infinite Access bundle program, which was initiated during the second quarter of 2004, and an increase in the minutes of use.

In December 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 and the Company recorded operating expenses of $3,768 related to the REWARD program during the fourth quarter of 2004. During the first quarter of 2005, 13 additional employees accepted the REWARD program. As a result, the Company recorded $791 in operating expenses during the first quarter of 2005. Through March 31, 2005, the Company experienced an approximate savings in labor costs of $585.

The Company’s consolidated depreciation and amortization expense increased $1,419 during the first quarter in 2005 compared to the same period in 2004. This increase was primarily due to continued network build-out within the residential broadband service territories.

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During the first quarter of 2005, the Company continued to implement a strategy for driving efficiency and long-term growth through cost reduction and workforce consolidation. This strategic plan entailed 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. Throughout the remainder of 2005, 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 quarter ended September 30, 2004, certain matters were identified related to prior financial reporting periods that necessitated the recording of adjustments to the Company’s condensed consolidated financial statements. Such adjustments increased depreciation expense by $822 and decreased cost of sales by $39 in the quarter ended September 30, 2004. Management believes that weaknesses in the Company’s internal controls caused the errors that resulted in these adjustments. The Company does not believe the aforementioned amounts are material, individually or in the aggregate, to the respective prior quarterly 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 September 30, 2004 was material to the Company’s 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 consolidated net loss by $468, or $0.03 per basic and diluted share, for the quarter ended September 30, 2004. Such amounts would have reduced the Company’s quarterly consolidated net income by $239, or $0.02 per basic and diluted share, and $272, or $0.02 per basic and diluted share, for the quarters ended March 31, 2004 and June 30, 2004, respectively, had such errors been corrected in the periods in which they originated.

Segment Results of Operations

Telecom

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               Operating Revenues

Operating revenues from external customers in the Telecom segment decreased $1,722 for the quarter ended March 31, 2005 compared to the same period in 2004. SureWest Telephone continues to experience decreases in local and network access as a result of competition from wireless (including SureWest Wireless) and wireline competitors and an approximate 3% decline in access lines. In addition, revenues within the Telecom segment were also affected by changes in estimates to the Company’s intrastate and interstate shareable earnings obligations, which are discussed in more detail below.

The decrease in the Telecom segment revenues was offset in part by revenue growth of $280 in SureWest Long Distance resulting from an increase in minutes of use and the Infinite Access bundle program, which was initiated during the second quarter of 2004. In addition, Directory advertising revenue increased $194 for the quarter ended March 31, 2005, compared to the same period in 2004, due primarily to increases in advertising rates and programs and bundled packages purchased by existing customers.

               Operating Expenses

Operating expenses for the Telecom segment decreased $548 for the quarter ended March 31, 2005, compared to the same period in 2004. This decrease was offset in part by approximately $640 in operating expenses incurred during the quarter ended March 31, 2005 related 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 $1,118, or 10%, for the quarter ended March 31, 2005, compared to the same period in 2004 due primarily to increases in (i) long distance access expense as a result of the Infinite Access bundle program and an increase in minutes of use and (ii) network operations expense due to an increase in expensed-versus-capitalized labor.

Customer operations and selling expense decreased $427, or 10%, for the quarter ended March 31, 2005, compared to the same period in 2004 due primarily to decreases in (i) sales and advertising expense due to decreased advertising campaigns and sales force and (ii) product management and operator services headcount.

General and administrative expense decreased $1,239, or 18%, for the quarter ended March 31, 2005 compared to the same period in 2004 due primarily to the incurrence of consulting and legal fees related to the treasury investigation and audit fees during the quarter ended March 31, 2004. These decreases were offset in part by an increase in Sarbanes-Oxley compliance costs.

Depreciation and amortization decreased $184, or 3%, for the quarter ended March 31, 2005, compared to the same period in 2004, due primarily to the retirement of assets subsequent to March 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 March 31, 2005, the amount of any settled pre-bankruptcy claims could not be determined. Through March 31, 2005, obligations owed by WorldCom to the Company for post-petition services have been paid on a timely basis.

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               Regulatory Matters

Revenues from services subject to comprehensive regulation constituted approximately 50% and 56% of the Company’s total operating revenues for the quarters ended March 31, 2005 and 2004, respectively. 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. Based on preliminary cost studies, the Company recognized liabilities relating to SureWest Telephone’s estimated interstate shareable earnings obligations of $80 (no effect on earnings per share) for the quarter ended March 31, 2005, through reductions of revenues. The Company did not identify any interstate shareable earnings obligations at SureWest Telephone during the quarter ended March 31, 2004.

In 1999, SBC Communications (“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 is scheduled to expire 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 and received currently from the CHCF, 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

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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 provisions of the NRF, the Company recorded liabilities and reductions of revenues of $70 (no effect on earnings per share) relating to estimated intrastate shareable earnings obligation during the quarter ended March 31, 2004 (none for the quarter ended March 31, 2005).

The Company was involved in a proceeding at the CPUC that considered the continued need for certain sharing requirements in the intrastate jurisdiction and, in connection with that review, also considered the issue of whether the Company overearned in the intrastate jurisdiction in recent monitoring periods and the amount of such overearnings that should be shared with customers. In July 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 resolved existing sharing obligations and related earnings issues for the monitoring periods 2000 through 2004, put into place a surcredit mechanism for the amount of the settlement, and suspended the requirement for any intrastate sharing for monitoring periods from January 1, 2005 through at least December 31, 2010.

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 end users through a consumer dividend over a period of four years beginning January 1, 2005. For the quarter ended March 31, 2005, approximately $395 has been returned to the end users. In addition, SureWest Telephone will pay a one-time consumer dividend of $2,600, which includes an annual imputed interest rate of 3.15% (no stated contractual interest rate), over two years beginning January 1, 2005 to settle the monitoring periods 2000 to 2004. For the quarter ended March 31, 2005, approximately $289 has been returned to the end users and was recorded as a reduction of the Company’s contractual shareable earnings obligations. At March 31, 2005, the aggregate contractual shareable earnings obligation for these surcredits was $8,557 (which is net of an unamortized discount pertaining to imputed interest of $520 at such date).

Further, commencing January 1, 2007, SureWest Telephone will 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 November 2003, SureWest Telephone began paying a consumer dividend for intrastate overearnings relating to the year 2002. A portion of the consumer’s intrastate service charges was returned to the consumers in the form of a surcredit beginning in November 2003 and ending in February 2004, totaling $483 (of which $208 was returned during 2004) and was 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 during the quarters ended March 31, 2005 and 2004. For the quarter ended March 31, 2005, these changes in estimates increased the Company’s consolidated revenues by $57 and net income by $35 (no effect on earnings per share). For the quarter ended March 31, 2004, similar changes in estimates increased the Company’s consolidated revenues by $539 and net income by $310 ($0.02 per share).

As of March 31, 2005, the Company’s condensed consolidated balance sheet reflected aggregate liabilities of $418 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.

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Broadband

               Operating Revenues

Operating revenues from external customers in the Broadband segment increased $2,622 for the quarter ended March 31, 2005, compared to the same period in 2004. The increase in Broadband revenues was due to the combined effects of (i) a 39% increase in the number of FTTP subscribers of broadband residential services, (ii) a 14% increase in the residential and business DSL data subscriber customer base and (iii) the continued expansion of the Business Broadband Services, resulting in a 29% increase in ending access lines.

               Operating Expenses

Total operating expenses in the Broadband segment increased $798 for the quarter ended March 31, 2005, compared to the same period in 2004. This increase was due in part to the incurrence of approximately $120 in operating expenses during the quarter ended March 31, 2005 related to the REWARD program, which was offered to certain eligible employees during 2004 and is described in the Consolidated Overview section above. Cost of services and products (exclusive of depreciation and amortization) increased $634, or 8%, during the quarter ended March 31, 2005, compared to the same period in 2004, due primarily to (i) an increase in programming and transport costs related to the 39% increase in FTTP subscriber growth of broadband residential services and (ii) an increase in engineering and network administration expenses resulting from an increase in subscriber and network growth. These increases were offset in part by a decrease in repairs and maintenance costs.

Customer operations expense increased $631, or 31%, during the quarter ended March 31, 2005, compared to the same period in 2004 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 the cities of 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 decreased $467, or 13%, during the quarter ended March 31, 2005, compared to the same period in 2004 due primarily to (i) the incurrence in the prior year period of professional and legal expense related to the treasury investigation and audit fees and (ii) a decrease in information management expenses due to a decrease in maintenance and service agreements and an increase in capitalized labor costs. These decreases were offset in part by an increase in Sarbanes-Oxley compliance costs.

Depreciation and amortization increased $1,616, or 80%, during the quarter ended March 31, 2005, compared to the same period in 2004 primarily due to continued network build-out within the residential broadband service territories.

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Wireless

               Operating Revenues

Operating revenues from external customers in the Wireless segment increased $968 for the quarter ended March 31, 2005, compared to the same period in 2004 due primarily to (i) a 12% increase in Wireless subscriber base, (ii) an increase in feature revenues, including voicemail and text and picture messaging and (iii) an increase in local number portability recovery fees, which were implemented during the second quarter of 2004.

               Operating Expenses

Total operating expenses for the Wireless segment increased $326 for the quarter ended March 31, 2005, compared to the same period in 2004. Cost of services and products (exclusive of depreciation and amortization) increased $411, or 8%, for the quarter ended March 31, 2005, compared to the same period in 2004 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 and (ii) long distance expense due to an increase in the minutes of use and the introduction of additional unlimited calling plans. Customer operations expense decreased $101, or 4%, for the quarter ended March 31, 2005, compared to the same period in 2004 due primarily to decreases in (i) sales and advertising expense due to the timing of promotional campaigns and (ii) dealer commissions, resulting from a shift in the percentage of sales from dealer channels to the Company’s retail stores.

               Local Number Portability

Effective November 24, 2003, the FCC mandated that wireless carriers provide for local number portability (“LNP”). LNP allows subscribers to keep their wireless phone numbers while switching to a different service provider. Although the Company has experienced favorable porting activity, the implementation of LNP has not had a material effect on the Company’s consolidated financial position or results of operations.

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Non-operating Items

               Other Income and Expense, Net

Interest expense increased $118 during the quarter ended March 31, 2005, compared to the same period in 2004 due primarily 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.

               Income Taxes

Income taxes for the quarter ended March 31, 2005, increased $258, compared to the same period in 2004, due primarily to corresponding increases in income subject to tax. The effective federal and state income tax rates were approximately 39.0% and 42.4% for the quarters ended March 31, 2005 and 2004, respectively. The decrease in the effective tax rate is primarily due to a decrease in permanent differences.

Liquidity and Capital Resources

As reflected in the Condensed Consolidated Statements of Cash Flow, net cash provided by the Company’s operating activities was $14,243 for the quarter ended March 31, 2005 primarily due to (i) net income of $843, (ii) non-cash charges of $12,713 consisting of depreciation and amortization due to increased capital investments principally in the Broadband segment, (iii) an increase in accounts payable and accrued liabilities of approximately $2,432 primarily due to an increase in outstanding capital obligations related to the broadband residential services network build-out and (iv) an increase in income taxes payable of $538 due to the timing of the first quarter estimated income taxes payment. These amounts were offset by an increase in accounts receivable of $2,496 due primarily to subscriber growth in the Broadband segment and the timing of the receipt of a payment from the CHCF.

Net cash used in the Company’s investing activities for the quarter ended March 31, 2005 was $19,090 due to capital expenditures pertaining to ongoing plant construction projects.

Net cash used in the Company’s financing activities was $3,783 for the quarter ended March 31, 2005 due primarily to (i) dividend payments of $3,648 and (ii) payments related to capital lease obligations.

The Company had a working capital deficit of $20,385 at March 31, 2005, 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 income taxes, accrued pension benefits and other accrued liabilities. The deficit was reduced in part by a decrease in estimated and contractual 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 for the remainder of 2005 is expected to be for (i) budgeted capital expenditures of approximately $60,000, (ii) scheduled payments of long-term debt of $3,743, (iii) support of the operations of SureWest Broadband/Residential Services up to an anticipated $6,241 and (iv) support of the operations of SureWest Wireless up to an anticipated $1,546. In addition, during the remainder of 2005 the payment of dividends, which is at the discretion of the Company’s Board of Directors, could be as much as $11,000 based on the Company’s most recent dividend and payments. A substantial portion of the 2005 budgeted capital expenditures is at the discretion of the Company and 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 is due to expire January 1, 2009.

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The Company has a business loan agreement with a bank for a $50,000 line of credit. As of March 31, 2005 and December 31, 2004, there was $10,000 outstanding under this credit facility and the interest rate was 3.65% and 3.14%, respectively, which is based on a LIBOR-based pricing formula. In December 2004, the bank amended the credit facility, extending the expiration date until July 1, 2006 and revising certain covenants.

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 March 31, 2005, 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 Company had cash and cash equivalents at March 31, 2005, of $9,489. 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 the remainder of 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 is 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.

Dividends are declared at the discretion of the Company’s Board of Directors. However, the Note Purchase Agreement under which the Company issued its Series A and Series B Senior Notes, and other unsecured credit arrangements contain financial and operating covenants that restrict, among other things, the payment of cash dividends, the repurchase of the Company’s capital stock, the making of certain other restricted payments and the incurrence of additional indebtedness. The bank line of credit agreement requires that the Company 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 Company is required to maintain certain financial ratios and minimum levels of tangible net worth. At March 31, 2005, retained earnings of approximately $34,885 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.

Critical Accounting Policies and Estimates

Below is a summary of the Company’s critical accounting policies and estimates. Management has discussed development and selection of critical accounting policies and estimates with the Company’s Audit Committee.

•

In accordance with Statement of Financial Accounting Standards (“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 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.

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	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, in 2004 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 in 2004, no impairment of either goodwill or PCS or LMDS licenses was indicated. Further, during the quarter ended March 31, 2005, the Company was unaware of any events or changes in circumstance that would require a test of impairment that may potentially reduce the fair value below the carrying value.
•	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 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

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	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 interstate jurisdictions as discussed previously for the purposes of calculating its earned annual rate-of-return. However, as discussed more fully in Note 3, 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 3 to the Company’s condensed 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.
•	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.
•	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 condensed 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 March 31, 2005, the Company had three customers that accounted for 3% 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

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	charges to revenues, based on the Company’s best estimates of the resolution of these contingencies, which are based on historical experience.
•	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.
•	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.
•	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 March 31, 2005 will be material to the Company’s condensed consolidated financial statements.
•	The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The Company does not have a valuation allowance on its deferred tax asset as of March 31, 2005 or 2004 because it believes it is more likely than not that such deferred tax asset will be realized. Should the Company determine that it would not be able to realize all or part of its deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period in which the determination was made.
•	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

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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:

	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. During 2005, the Company expects the discount rate to remain at 5.75%, which is consistent with the prior year.
	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. During 2005 the Company expects its future compensation level to remain consistent at 5%, which is consistent with the prior year.
•	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. Effective January 1, 2003, the Company adopted the preferable fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation. 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 beginning 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 $5 and $9, which decreased net income by $3 (no effect on earnings per share) and $5 (no effect on earnings per share) for the quarters ended March 31, 2005 and 2004, 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,

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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

In December 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 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) as originally issued was to be effective for public companies for interim or annual periods beginning after June 15, 2005. However, in April 2005 the Securities and Exchange Commission (the “SEC”) announced that companies may implement SFAS No. 123(R) at the beginning of their next fiscal year (instead of their next reporting period) beginning after June 15, 2005. The effective date of the new standard for the Company’s consolidated financial statements is January 1, 2006 (beginning with the reporting period ending March 31, 2006). 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 January 1, 2006.

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 condensed consolidated financial position, results of operations or cash flows.

In March 2005, the FASB issued Interpretation (“FIN”) No. 47, Accounting for Conditional Asset Retirement Obligations. FIN No. 47 clarifies that the term “conditional asset retirement obligation” as used in SFAS No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN No. 47 requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. The Company is currently evaluating the effect FIN No. 47 will have on its consolidated financial position, results of operations or cash flows.

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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.
	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 2002 acquisition of assets, which launched our residential broadband business, 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

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	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 is scheduled to expire 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 previously issued 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 as a result of a material weakness identified at December 31, 2004, for which remediation efforts are ongoing. 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.
	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 at 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 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 were 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

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	interest expense included in the Company’s consolidated statements of operations. Due to this material weakness, management believes that as of March 31, 2005, the Company’s disclosure controls and procedures were not effective.
	During the year ended December 31, 2004 and during the first quarter of 2005, we implemented various initiatives, and will be implementing additional initiatives during the remainder of 2005, which are intended 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.

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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. In July 2004, the Company entered into a settlement agreement with the other parties in the proceeding, the ORA and TURN, to resolve all issues in the proceeding. In November 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.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company’s 2004 Annual Report on Form 10-K contains certain disclosures about the Company’s limited exposure to market risk for changes in interest rates. There have been no material changes to the information provided which would require additional disclosures as of the date of this filing.

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ITEM 4. 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 Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended). Based upon, and as of the date of this evaluation, and due to the material weakness in the Company’s internal control over accounting for property, plant and equipment (as described below), the Chief Executive Officer and Chief Financial Officer have concluded that, the Company’s disclosure controls and procedures were not effective, at the reasonable assurance level, 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 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.

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.

The Company has 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.

Remediation Steps Related to Material Weakness

The Company has or intends to 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, and which 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.

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	•	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.

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:

     Information Technology

•

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. The Company has commenced its remediation testing relating to specific Information Technology controls discussed above, and based on the preliminary results, it appears that the remediation efforts are improving the overall controls over the Information Technology area. However, the Company is not able to make conclusions relative to the overall effectiveness of the improvements.

     Accounting Personnel, Policies and Procedures

•

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. In April 2005, the Company commenced its 2005 testing of selected internal controls for the quarter ended March 31, 2005, and anticipates completing its testing for the selected controls during the second quarter of 2005. The Company will test the balance of its internal controls during the remainder of 2005 and ending in the first quarter of 2006 with respect to the necessary testing of year-end controls.

	Change in Internal Control over Financial Reporting
	During the quarter ended March 31, 2005, the Company implemented various improvements to internal controls, which included: (i) 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 (ii) the creation of a formal committee comprised of employees from the Company’s Corporate Finance, Information Technology and Human Resources departments to assess the timing of the Company’s monthly financial statement close process.
	In February 2005, the Company completed its REWARD program, which resulted in the early retirement of approximately 7% of the workforce. In addition, during the quarter ended March 31, 2005 and effective April 1, 2005, the Company completed a reorganization to better align its business into functional support groups.
	In February 2005, the Company announced that it had begun a search for a President and CEO/Elect as a result of the indication by Brian H. Strom of his desire to ultimately retire from those positions. The Company intends to conduct and complete the search for a successor that will allow the President and CEO/Elect to serve with Mr. Strom prior to his formal retirement to assure an effective and smooth transition.

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	The effects on internal controls of the REWARD program, the reorganization and the officer transition have not yet been fully assessed by the Company.
	Except for the items discussed above, there has been no change in the Company’s internal control over financial reporting during the quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s control over financial reporting.

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PART II

ITEM 1. 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.

In 1996, the California Public Utilities Commission (“CPUC”) issued a decision in connection with SureWest Telephone’s general rate proceeding, which authorized SureWest Telephone to implement a New Regulatory Framework (“NRF”) for services furnished within SureWest Telephone’s service area in order to accommodate market and regulatory movement toward competition and greater pricing flexibility. Under the NRF, SureWest Telephone is subject to ongoing monitoring and reporting requirements, 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. In July 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 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 Communications (“SBC”) various charges for certain local service and network access service revenues in accordance with certain agreements as described below. In 1999, SBC expressed interest in withdrawing from the designated carrier plan (“DCP”) for SureWest Telephone’s toll traffic. The DCP was a compensation arrangement between SureWest Telephone and SBC for certain intrastate toll services. SureWest Telephone and SBC agreed to allow the DCP arrangement to expire in December 2001. The termination of the DCP did not have a material impact on the Company’s consolidated financial position as of 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

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is scheduled to expire 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 Federal Communications Commission (“FCC”) conducted proceedings and adopted orders implementing the Act’s provisions to open local exchange service markets, such as the market of SureWest Telephone, to competition. These proceedings and orders address interconnection, access charges and universal service.

Given the ongoing activities of the FCC to promulgate rules and regulations on interconnection, access charges, and universal service reform, and the various on-going legal challenges considering the validity of these FCC orders, it is not yet possible to determine fully the impact of the Act and related FCC regulations on SureWest Telephone’s operations.

There are a number of other regulatory proceedings occurring at the federal and state levels that may have a material impact on SureWest Telephone. These regulatory proceedings include, but are not limited to, consideration of changes to the jurisdictional separations process, the interstate universal service fund, 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.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS

(a) Index to Exhibits.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: May 4, 2005

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