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EX-32.2 - EX-32.2 - SUREWEST COMMUNICATIONSa10-12764_1ex32d2.htm
EX-10.1 - EX-10.1 - SUREWEST COMMUNICATIONSa10-12764_1ex10d1.htm
EX-32.1 - EX-32.1 - SUREWEST COMMUNICATIONSa10-12764_1ex32d1.htm
EX-31.2 - EX-31.2 - SUREWEST COMMUNICATIONSa10-12764_1ex31d2.htm
EX-31.1 - EX-31.1 - SUREWEST COMMUNICATIONSa10-12764_1ex31d1.htm

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2010

 

or

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 000-29660

 

SureWest Communications

(Exact name of registrant as specified in its charter)

 

California

 

68-0365195

(State or other jurisdiction

 

(IRS Employer

of incorporation or organization)

 

Identification No.)

 

 

 

8150 Industrial Avenue, Building A, Roseville, California

 

95678

(Address of principal executive offices)

 

(Zip Code)

 

(916) 786-6141

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x

 

On July 19, 2010, the registrant had 13,970,465 shares of Common Stock outstanding.

 

 

 




Table of Contents

 

PART 1 — FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS.

 

SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited; Amounts in thousands, except per share amounts)

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Operating revenues:

 

 

 

 

 

 

 

 

 

Broadband

 

$

43,076

 

$

40,259

 

$

85,653

 

$

79,481

 

Telecom

 

17,472

 

20,671

 

35,083

 

42,391

 

Total operating revenues

 

60,548

 

60,930

 

120,736

 

121,872

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of services and products (exclusive of depreciation and amortization)

 

26,261

 

25,118

 

51,179

 

50,132

 

Customer operations and selling

 

8,225

 

8,345

 

16,434

 

16,580

 

General and administrative

 

8,763

 

8,624

 

17,576

 

18,187

 

Depreciation and amortization

 

15,262

 

14,228

 

30,368

 

29,038

 

Total operating expenses

 

58,511

 

56,315

 

115,557

 

113,937

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

2,037

 

4,615

 

5,179

 

7,935

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

28

 

34

 

46

 

71

 

Interest expense

 

(2,235

)

(3,046

)

(3,878

)

(5,356

)

Other, net

 

(167

)

(88

)

(333

)

(172

)

Total other income (expense), net

 

(2,374

)

(3,100

)

(4,165

)

(5,457

)

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

(337

)

1,515

 

1,014

 

2,478

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

190

 

616

 

1,014

 

1,500

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

(527

)

899

 

 

978

 

 

 

 

 

 

 

 

 

 

 

Discontinued operations, net of tax:

 

 

 

 

 

 

 

 

 

Loss from discontinued operations

 

 

 

 

(69

)

Gain on sale of discontinued operations

 

 

60

 

 

2,568

 

Total discontinued operations

 

 

60

 

 

2,499

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(527

)

$

959

 

$

 

$

3,477

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

(0.04

)

$

0.06

 

$

 

$

0.07

 

Discontinued operations, net of tax

 

 

0.01

 

 

0.18

 

Net income (loss) per basic and diluted common share

 

$

(0.04

)

$

0.07

 

$

 

$

0.25

 

 

 

 

 

 

 

 

 

 

 

Shares of common stock used to calculate basic and diluted earnings per share

 

13,913

 

14,020

 

13,958

 

13,992

 

 

See accompanying notes.

 

1



Table of Contents

 

SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; Amounts in thousands)

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

6,154

 

$

7,489

 

Short-term investments

 

551

 

4,306

 

Accounts receivable, net

 

19,074

 

19,734

 

Income tax receivable

 

2,156

 

2,221

 

Prepaid expenses

 

3,938

 

3,704

 

Deferred income taxes

 

9,030

 

3,373

 

Other current assets

 

 

1,760

 

Assets held for sale

 

6,009

 

6,009

 

Total current assets

 

46,912

 

48,596

 

 

 

 

 

 

 

Property, plant and equipment, net

 

519,137

 

522,493

 

 

 

 

 

 

 

Intangible and other assets:

 

 

 

 

 

Customer relationships, net

 

3,240

 

3,847

 

Goodwill

 

45,814

 

45,814

 

Deferred charges and other assets

 

2,674

 

2,113

 

 

 

 51,728

 

51,774

 

 

 

$

617,777

 

$

622,863

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt

 

$

15,636

 

$

15,636

 

Accounts payable

 

1,785

 

2,547

 

Other accrued liabilities

 

15,084

 

18,315

 

Advance billings and deferred revenues

 

8,056

 

8,580

 

Accrued compensation

 

6,062

 

9,172

 

Total current liabilities

 

46,623

 

54,250

 

 

 

 

 

 

 

Long-term debt

 

203,409

 

207,409

 

Deferred income taxes

 

61,532

 

54,856

 

Accrued pension and other post-retirement benefits

 

33,284

 

32,451

 

Other liabilities and deferred revenues

 

4,668

 

4,714

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, without par value; 100,000 shares authorized, 13,970 and 14,148 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively

 

144,427

 

146,844

 

Accumulated other comprehensive loss

 

(15,338

)

(15,280

)

Retained earnings

 

139,172

 

137,619

 

Total shareholders’ equity

 

268,261

 

269,183

 

 

 

$

617,777

 

$

622,863

 

 

See accompanying notes.

 

2



Table of Contents

 

SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; Amounts in thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Net cash provided by continuing operations

 

$

26,427

 

$

32,291

 

Net cash used in discontinued operations

 

 

(507

)

Net cash provided by operating activities

 

26,427

 

31,784

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from sale of discontinued operations

 

1,725

 

10,947

 

Capital expenditures for property, plant and equipment

 

(26,414

)

(29,522

)

Proceeds from sale of available-for-sale securities

 

3,700

 

 

Purchases of available-for-sale securities

 

(18

)

(16

)

Net cash used in investing activities

 

(21,007

)

(18,591

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

8,069

 

10,500

 

Principal payments on long-term debt

 

(12,069

)

(15,503

)

Repurchases and surrenders of common stock

 

(2,755

)

(1,151

)

Net cash used in financing activities

 

(6,755

)

(6,154

)

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

(1,335

)

7,039

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

7,489

 

2,840

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

6,154

 

$

9,879

 

 

See accompanying notes.

 

3



Table of Contents

 

SUREWEST COMMUNICATIONS

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited; Amounts in thousands, except share and per share amounts)

 

1.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Business and Basis of Accounting

 

SureWest Communications (the “Company”, “we” or “our”) is a holding company with operating subsidiaries that provide communications services in Northern California, primarily the greater Sacramento region, and the greater Kansas City, Kansas and Missouri areas (“Kansas City area”). Our operating subsidiaries are SureWest Broadband, SureWest TeleVideo, SureWest Kansas, Inc. (“SureWest Kansas” or the “Kansas City operations”), SureWest Telephone and SureWest Long Distance.

 

As discussed in Note 3, we sold the operating assets of our Wireless business, SureWest Wireless in May 2008 and we sold our communication tower assets in February 2009. Accordingly, the financial results of SureWest Wireless and our communication tower assets have been reported as discontinued operations for all periods presented in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 360, Property, Plant and Equipment (formerly Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets). The notes to condensed consolidated financial statements (“Notes”) reflect historical amounts exclusive of discontinued operations, unless otherwise noted.

 

We expect that the sources of our revenues and our cost structure may be different in future periods, both as a result of our entry into new communications markets and competitive forces in each of the markets in which we have operations.

 

In the opinion of management, the accompanying condensed consolidated balance sheets and related interim statements of operations and cash flows include all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States (“U.S. GAAP” or “GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such SEC rules and regulations and accounting principles applicable for interim periods. Events subsequent to the balance sheet date have been evaluated for inclusion in the accompanying condensed consolidated financial statements through the date of issuance.  Management believes that the disclosures made are adequate to make the information presented not misleading. Interim results are not necessarily indicative of results for a full year.  The information presented in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included in our 2009 Annual Report on Form 10-K filed with the SEC.

 

Reclassifications

 

Certain amounts in our 2009 condensed consolidated financial statements have been reclassified to conform to the presentation of our 2010 condensed consolidated financial statements.  The reclassification consists of the effects on the condensed consolidated balance sheets of the reclassification of inventories from current assets to property, plant and equipment.  Inventories consist primarily of network construction materials and supplies that when issued are capitalized as part of new customer installations and the construction of the network. The proportion of the items included in inventories that are capitalized to property, plant and equipment has increased as a result of the growth in the Broadband business.

 

4



Table of Contents

 

Property, Plant and Equipment

 

Property, plant and equipment consisted of the following:

 

 

 

June 30,
2010

 

December 31,
2009

 

Estimated
Useful Lives

 

Land

 

$

2,824

 

$

2,824

 

 

 

Buildings

 

76,482

 

76,363

 

35 years

 

Central office equipment

 

323,570

 

312,338

 

3-12 years

 

Outside plant equipment

 

487,291

 

481,099

 

5-40 years

 

Internal-use software

 

59,369

 

58,714

 

5-7 years

 

Other

 

57,183

 

56,974

 

3-25 years

 

Total plant in service

 

1,006,719

 

988,312

 

 

 

Less accumulated depreciation and amortization

 

500,836

 

481,639

 

 

 

Plant in service

 

505,883

 

506,673

 

 

 

Plant under construction

 

8,005

 

10,557

 

 

 

Construction inventory

 

5,249

 

5,263

 

 

 

Property, plant and equipment, net

 

$

519,137

 

$

522,493

 

 

 

 

Construction inventory, which is stated at weighted average cost, consists primarily of network construction materials and supplies that when issued are predominately capitalized as part of new customer installations and the construction of the network.

 

During the first quarter of 2010, we completed our triennial review that evaluated the appropriateness of the estimated useful lives of our property, plant and equipment for all segments.  The evaluation considered our investment and business strategy, reliability and historical performance data of certain assets, as well as the impacts of competition and anticipated technological change. As a result of this evaluation, effective January 1, 2010, we increased the estimated useful lives of general purpose software, general purpose hardware and certain central office equipment. We decreased the lives of certain of our customer premise equipment and outside plant categories. During the quarter and six-month period ended June 30, 2010, this change in estimate did not have a material effect to consolidated depreciation expense or net income and is not expected to have a material impact for the year ended December 31, 2010.

 

Intangible Assets

 

Goodwill and intangible assets that are not subject to amortization are tested for impairment at least annually or when events or changes in circumstances indicate that the asset might be impaired in accordance with FASB ASC Topic 350, Intangibles-Goodwill and Other (“ASC Topic 350”) (formerly SFAS No. 142, Goodwill and other Intangible Assets). Normally, we perform the annual impairment test as of November 30.  However, as a result of recent declines in the market price of the Company’s common stock at June 30, 2010, we concluded that this was an indicator of potential impairment of goodwill and therefore, we performed an interim goodwill impairment test.

 

We completed the first step of the interim impairment test, which indicated that the estimated fair value of the reporting units was greater than the net carrying value of the reporting units.  As such, we concluded that goodwill was not impaired as of June 30, 2010 and we were not required to perform the second step of the evaluation.

 

Stock-based Compensation

 

Stock Plan

 

Our Board of Directors may grant share-based awards from our shareholder approved Equity Incentive Plan; the 2000 Equity Incentive Plan (the “Stock Plan”) to certain of our employees, outside directors and consultants. The Stock Plan permits issuance of awards in the form of restricted common stock (“RSAs”), restricted common stock units (“RSUs”), performance shares, stock options and stock appreciation rights. Under the Stock Plan, approximately 2.1 million shares of our common stock were authorized for issuance, including those outstanding as of June 30, 2010.

 

Restricted Common Stock Awards and Units

 

We measure the fair value of the RSAs and RSUs based upon the market price of the underlying common stock as of the date of the grant.  RSAs and RSUs are amortized over their respective vesting periods, generally from immediate vest to a five-year vesting period using the straight-line method.  We have estimated expected forfeitures based on historical experience and are recognizing compensation expense only for those RSAs and RSUs expected to vest.

 

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Table of Contents

 

The following table summarizes the grants that occurred under the Stock Plan during the quarters and six-month periods ended June 30, 2010 and 2009:

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

2010

 

Fair Value

 

2009

 

Fair Value

 

2010

 

Fair Value

 

2009

 

Fair Value

 

RSAs Granted

 

 

$

 

 

$

 

217,575

 

$

9.95

 

166,506

 

$

11.56

 

RSUs Granted

 

 

$

 

 

$

 

92,709

 

$

9.95

 

72,443

 

$

11.56

 

RSU Dividends

 

 

$

 

933

 

$

8.29

 

 

$

 

7,970

 

$

9.66

 

Total

 

 

 

 

933

 

 

 

310,284

 

 

 

246,919

 

 

 

 

RSU Dividends consist of dividends that were previously granted to the holders of RSUs, which have fully vested and were released during the quarter and six-month period ended June 30, 2009 (none in the quarter or six-month period ended June 30, 2010) in accordance with the underlying award agreement.  Stock-based compensation expense for both RSAs and RSUs of $1,144 and $1,944 was recorded during the quarter and six-month period ended June 30, 2010, respectively.  During the same prior year periods, we recorded stock-based compensation expense of $464 and $1,072, respectively.

 

The following table summarizes the RSA and RSU activity during the six-month period ended June 30, 2010:

 

 

 

 

 

Weighted Average

 

 

 

Shares

 

Grant Date Fair Value

 

 

 

 

 

 

 

Nonvested-January 1, 2010

 

349,916

 

$

12.90

 

Granted

 

310,284

 

$

9.95

 

Vested

 

(147,354

)

$

11.39

 

Nonvested-June 30, 2010

 

512,846

 

$

11.55

 

 

As of June 30, 2010, total unrecognized compensation costs related to nonvested restricted stock was $5,549 and will be recognized over a weighted-average period of approximately 2.75 years. The total fair value of RSAs and RSUs vested during the six-month period ended June 30, 2010 was $1,678.

 

Stock Options

 

In 2003, we ceased granting stock options and have since granted RSAs and RSUs as part of our equity compensation plan. We issue new shares of common stock upon exercise of stock options. The exercise price per share of the Company’s common stock to be purchased under any incentive stock option shall not be less than 100% of the fair market value of a share of the Company’s common stock on the date of the grant, and the exercise price under a non-qualified stock option shall not be less than 85% of the fair market value of the Company’s common stock at the date of the grant. The term of any stock option shall not exceed ten years.

 

During the six-month periods ended June 30, 2010 and 2009, no stock options were granted or exercised.  During the same periods 110,475 and 11,650 unexercised options expired, respectively.  As of June 30, 2010, 207,914 outstanding options were vested and exercisable at a weighted average exercise price of $41.08 with a weighted average remaining contractual life of one year. The aggregate intrinsic value is calculated as the difference between the exercise price of the stock options and the quoted price of our common stock.  There were no options that were in-the-money as of June 30, 2010 and 2009.

 

Earnings Per Share

 

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

 

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Table of Contents

 

Other Comprehensive Income

 

Significant components of our other comprehensive income are as follows:

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income (loss)

 

$

 (527

)

$

959

 

$

  —

 

$

 3,477

 

Unrealized gain (loss) on available-for-sale investments, net of tax

 

            (35

)

               1

 

            (58

)

            (34

)

Reclassification adjustment for losses included in net income, net of tax

 

 —

 

             16

 

 —

 

             16

 

Comprehensive income (loss)

 

$

          (562

)

$

 976

 

$

  (58

)

$

3,459

 

 

Accumulated other comprehensive loss consists of adjustments, net of tax, related to unrealized losses on available-for-sale securities and minimum pension and post-retirement benefits.

 

Severance and Termination Costs

 

In an effort to improve operating efficiencies and align operating costs, during the quarter ended June 30, 2010 we implemented a workforce reduction initiative in which approximately 60 positions were eliminated.  Affected employees were provided a range of benefits and resources, including severance payments (collectively “severance costs”).  As a result, estimated severance costs of $1,640 were recorded to the statements of operations during the quarter ended June 30, 2010, primarily to general and administrative expense.  Estimated severance costs of approximately $720 and $920 were recorded to the Broadband and Telecom segments, respectively. As of June 30, 2010, we had an accrued liability of $365 relating to the severance costs. We anticipate most of the remaining severance costs will be paid during the third quarter of 2010 and will be finalized prior to December 31, 2010.

 

2.   FAIR VALUE MEASUREMENTS & FINANCIAL INSTRUMENTS

 

Investments

 

The following is a summary of our short-term available-for-sale investments:

 

 

 

As of June 30, 2010

 

As of December 31, 2009

 

 

 

Adjusted
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair
Market
Value

 

Adjusted
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair
Market
Value

 

Equity securities

 

$

672

 

$

 

$

       (121

)

$

551

 

$

654

 

$

 

$

 (23

)

$

631

 

 

As of June 30, 2010 and December 31, 2009, the decline in the fair value of our short-term available-for-sale investments had been in a continuous loss position for more than twelve months.  We concluded that the gross unrealized losses of our equity securities were temporary, as the extent of the decline, both in dollars and percentages of cost were not considered significant and we have the ability and intent to hold the investments until at least substantially all of the costs of the investment are recovered.  The unrealized losses, net of tax, on our short-term available-for-sale investments were recorded as a component of other comprehensive income. We determined the fair value of our short-term equity security investments by quoted market prices.

 

Cost Method Investments

 

We held $1,115 and $772 in cost method investments which were included in other long-term assets in the condensed consolidated balance sheets as of June 30, 2010 and December 31, 2009, respectively. The cost method investments primarily represent our investment in CoBank, ACB (“CoBank”) and are related to patronage distributions of restricted equity.  This is a required investment in accordance with our Credit Agreement (see Note 8) held by CoBank.  We periodically monitor our investments for impairment and will record reductions in carrying values if and when necessary.  We did not estimate the fair value of the cost method investments as no events or changes in circumstances that may have a significant adverse effect on the fair value of the investment were identified during the quarter or six-month periods ended June 30, 2010. We determined, in accordance with ASC Topic 825, Financial Instruments (formerly SFAS No. 107, Fair Value Disclosures About Financial Instruments), that it was not practicable to estimate the fair value of the investments.

 

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Fair Value of Financial Instruments

 

In accordance with ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”) (formerly SFAS No. 157, Fair Value Measurements), we measure our cash equivalents (money market funds) and short-term investments (equity securities, auction rate security (“ARS”) and put option) at fair value.  ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. As a basis for considering such assumptions, ASC 820 establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

 

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2 — Inputs that reflect quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets and inputs other than quoted prices that are directly or indirectly observable in the marketplace.

 

Level 3 — Unobservable inputs which are supported by little or no market activity.

 

The following tables summarize our financial assets (cash equivalents and short-term investments) measured at fair value on a recurring basis:

 

 

 

As of June 30, 2010

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Money market funds

 

$

392

 

$

392

 

$

 

$

 

Equity securities

 

551

 

551

 

 

 

 

 

$

943

 

$

943

 

$

 

$

 

 

 

 

As of December 31, 2009

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Money market funds

 

$

5,346

 

$

5,346

 

$

 

$

 

Equity securities

 

631

 

631

 

 

 

Auction rate securities

 

3,054

 

 

 

3,054

 

Put option (Right)

 

621

 

 

 

621

 

 

 

$

9,652

 

$

5,977

 

$

 

$

3,675

 

 

Fair values for cash equivalents and equity securities in short-term investments were determined by quoted market prices. Fair value of the ARS and put option were determined based on discounted cash flow models.  See discussion below regarding the ARS and put option.

 

The following table provides a reconciliation of the beginning and ending balances for the assets measured at fair value using significant unobservable inputs (Level 3):

 

 

 

2010

 

2009

 

 

 

Put Option

 

Auction Rate
Securities

 

Put Option

 

Auction Rate
Securities

 

Beginning balance at January 1st

 

$

 

621

 

$

 

3,054

 

$

 

1,383

 

$

 

2,125

 

Sale of auction rate security

 

 

(3,700

)

 

 

Gains (losses) included in earnings

 

(621

)

646

 

(745

)

745

 

Balance at March 31st

 

$

 

 

$

 

 

$

 

638

 

$

 

2,870

 

Gains (losses) included in earnings

 

 

 

(41

)

162

 

Balance at June 30th

 

$

 

 

$

 

 

$

 

597

 

$

 

3,032

 

 

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As of December 31, 2009, we held one $3,700 par value ARS purchased from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”) with an estimated fair value of $3,054, which was measured using Level 3 inputs. This ARS was collateralized by student loans that are guaranteed primarily by a monoline insurance company and partially by the Federal Family Education Loan Program (“FFELP”). As of December 31, 2009, we also held an offer (“Right” or “put option”) entitling us to sell at par our ARS anytime during a two-year period from June 30, 2010 through July 2, 2012.

 

As of December 31, 2009, the ARS and Right were classified as current assets in short-term investments on our consolidated balance sheet, as a result of our put option period under the Right. We continued to earn and receive interest on our ARS, as specified in the terms of the prospectus, during 2009.

 

On January 6, 2010, UBS exercised their rights under the Right to purchase our ARS at par of $3,700 and we recorded a gain of $646 on the ARS to other income (expense), other, net in the condensed consolidated statements of income during the quarter ended March 31, 2010.  The gain was largely offset by a loss of $621 recorded on the Right resulting from the cancellation of our put option under the Right.

 

Fair Value of Debt

 

We had no short-term borrowings as of June 30, 2010 and December 31, 2009. The fair value of our long-term debt was estimated using discounted cash flow analyses based on incremental borrowing rates for similar types of borrowing arrangements.

 

 

 

As of June 30, 2010

 

As of December 31, 2009

 

 

 

Carrying Value

 

Fair Value

 

Carrying Value

 

Fair Value

 

Long-term debt (including current maturities)

 

$

219,045

 

$

216,961

 

$

223,045

 

$

221,323

 

 

3.   DIVESTITURES

 

SureWest Wireless

 

In May 2008, we completed the sale of the operating assets of our Wireless business, SureWest Wireless, to Verizon Wireless (“Verizon”) for an aggregate cash purchase price of $69,746, resulting in a gain of $18,864, net of tax.  A portion of the purchase price equal to $3,450 was placed in escrow, half of which was received during the quarter ended June 30, 2009 and the balance of which was received during the quarter ended June 30, 2010.  During the quarter ended March 31, 2009, the gain on sale was increased by $43, net of tax, as a result of changes in estimated transaction costs. As part of the sale, Verizon acquired the spectrum licenses and operating assets of SureWest Wireless, excluding our owned communication towers.  See the Communication Tower Assets section below for further discussion regarding our owned communication towers.  SureWest Wireless was previously reported as a separate reportable segment.

 

Communication Tower Assets

 

In February 2009, we sold fifty-two wireless communications towers (“Tower Assets”) owned by our subsidiary West Coast PCS, LLC (“West Coast PCS”) to Global Tower Partners. West Coast PCS was a component of our Broadband segment. The sale was completed for an aggregate cash purchase price of $9,222, resulting in a gain of $2,525, net of tax.

 

The results of the Tower Assets have been reported as a discontinued operation in our condensed consolidated financial statements for all periods presented.

 

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The following table summarizes the financial information for the operations of the Tower Assets:

 

 

 

Quarter Ended
June 30, 2009

 

Six Months Ended
June 30, 2009

 

Operating revenues

 

$

 

$

249

 

Operating expenses including depreciation and amortization

 

 

365

 

Loss from operations

 

 

(116

)

Income tax benefit

 

 

(47

)

Loss from discontinued operations

 

$

 

$

(69

)

 

 

 

 

 

 

Gain on sale of discontinued operations, net of tax

 

$

60

 

$

2,525

 

 

Assets Held For Sale

 

In connection with our efforts to evaluate and potentially monetize excess assets, during 2009 we identified and began to actively market for sale certain of our real estate assets.  These regulated assets, which are included in the Telecommunications (“Telecom”) Segment, include 21 acres of undeveloped land and an office building.  During the quarter ended December 31, 2009, we completed our plan to sell these assets and as a result they were classified as assets held for sale.  The following is the carrying value of the assets held for sale as of June 30, 2010 and December 31, 2009:

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

Undeveloped land

 

$

1,556

 

$

1,556

 

Office building

 

4,453

 

4,453

 

 

 

$

6,009

 

$

6,009

 

 

We expect that the land will sell in the range of $3,000 to $5,000. In connection with the classification to assets held for sale, the carrying value of the office building was reduced to its estimated fair value, less selling costs, based on the current market conditions and listed selling price. As a result, an impairment charge of $1,199 was recorded against accumulated depreciation during the quarter ended December 31, 2009, in accordance with regulated telephone plant and equipment composite group remaining life methodology.  We evaluated the estimated fair value of the assets held for sale as of June 30, 2010 and determined there was not a significant change.  Therefore, no additional impairment charge was recorded during the quarter ended June 30, 2010.

 

4.   BUSINESS SEGMENTS

 

We have two reportable business segments: Broadband and Telecom. We have aggregated certain of our operating segments within the Broadband and Telecom segments because we believe that such operating segments share similar economic characteristics.  We measure and evaluate the performance of our segments based on income (loss) from operations. 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 interest income associated with cash and investments held by Corporate Operations is included in the results of the operations of our segments.

 

The Broadband segment increasingly expands its use of optical fiber.  As a result, we have expanded our use of fiber-to-the-premise and fiber-to-the-node networks to offer many of our bundled residential and commercial services that include Internet Protocol-based digital and high-definition television, high-speed internet, Voice over Internet Protocol and local and long distance telephone in the greater Sacramento region and Kansas City area.

 

The Telecom segment, which operates only in the Sacramento area, offers a broad selection of telecommunications services including traditional circuit-switched voice services, long distance services and a number of lightly-regulated or non-regulated services. Customers in the Telecom segment can select individual services or bundled packages that may include unlimited local calling or unlimited local and domestic long distance calling plans.  Our voice products also include value-added services such as voicemail, call waiting, caller identification and many other calling feature options.  Most long distance services are offered by our subsidiary SureWest Long Distance, which is a reseller of long distance services.

 

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These segments are strategic business units that offer different products and services. The accounting policies of these segments are the same as those described in Note 1 (refer to notes to the consolidated financial statements included in our 2009 Annual Report on Form 10-K filed with the SEC for a more detailed discussion of our accounting policies). We account for intersegment revenues and expenses at prevailing market rates.  Our business segment information is as follows:

 

 

 

 

 

 

 

Intercompany

 

 

 

 

 

Broadband

 

Telecom

 

Eliminations

 

Consolidated

 

For the three months ended June 30, 2010:

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

43,076

 

$

17,472

 

$

 

$

60,548

 

Intersegment revenues

 

145

 

5,091

 

(5,236

)

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

25,145

 

5,656

 

(4,540

)

26,261

 

Customer operations and selling

 

6,106

 

2,678

 

(559

)

8,225

 

General and administrative

 

4,752

 

4,148

 

(137

)

8,763

 

Depreciation and amortization

 

12,140

 

3,122

 

 

15,262

 

Income (loss) from operations

 

(4,922

)

6,959

 

 

2,037

 

Income (loss) from continuing operations

 

$

(4,269

)

$

3,742

 

$

 

$

(527

)

 


*Exclusive of depreciation and amortization

 

 

 

 

 

 

 

Intercompany

 

 

 

 

 

Broadband

 

Telecom

 

Eliminations

 

Consolidated

 

For the three months ended June 30, 2009:

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

40,259

 

$

20,671

 

$

 

$

60,930

 

Intersegment revenues

 

94

 

4,981

 

(5,075

)

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

22,823

 

6,566

 

(4,271

)

25,118

 

Customer operations and selling

 

6,468

 

2,535

 

(658

)

8,345

 

General and administrative

 

5,003

 

3,767

 

(146

)

8,624

 

Depreciation and amortization

 

11,283

 

2,945

 

 

14,228

 

Income (loss) from operations

 

(5,224

)

9,839

 

 

4,615

 

Income (loss) from continuing operations

 

$

(4,884

)

$

5,783

 

$

 

$

899

 

 


*Exclusive of depreciation and amortization

 

 

 

 

 

 

 

Intercompany

 

 

 

 

 

Broadband

 

Telecom

 

Eliminations

 

Consolidated

 

For the six months ended June 30, 2010:

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

85,653

 

$

35,083

 

$

 

$

120,736

 

Intersegment revenues

 

313

 

10,010

 

(10,323

)

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

48,738

 

11,361

 

(8,920

)

51,179

 

Customer operations and selling

 

12,497

 

5,068

 

(1,131

)

16,434

 

General and administrative

 

9,905

 

7,943

 

(272

)

17,576

 

Depreciation and amortization

 

24,320

 

6,048

 

 

30,368

 

Income (loss) from operations

 

(9,494

)

14,673

 

 

5,179

 

Income (loss) from continuing operations

 

$

(7,989

)

$

7,989

 

$

 

$

 

 


*Exclusive of depreciation and amortization

 

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Intercompany

 

 

 

 

 

Broadband

 

Telecom

 

Eliminations

 

Consolidated

 

For the six months ended June 30, 2009:

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

79,481

 

$

42,391

 

$

 

$

121,872

 

Intersegment revenues

 

185

 

9,855

 

(10,040

)

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

45,723

 

12,834

 

(8,425

)

50,132

 

Customer operations and selling

 

12,728

 

5,176

 

(1,324

)

16,580

 

General and administrative

 

10,538

 

7,940

 

(291

)

18,187

 

Depreciation and amortization

 

22,903

 

6,135

 

 

29,038

 

Income (loss) from operations

 

(12,226

)

20,161

 

 

7,935

 

Income (loss) from continuing operations

 

$

(10,282

)

$

11,260

 

$

 

$

978

 

 


*Exclusive of depreciation and amortization

 

5.   REGULATORY MATTERS

 

Certain of our interstate telecommunications service rates are subject to regulation by the Federal Communications Commission (“FCC”). Interstate switched and special access rates are established through a SureWest Telephone tariff filed with the FCC.  For interstate common line (“CL”) charges, SureWest Telephone concurs with tariffs filed by the National Exchange Carrier Association (“NECA”).  Intrastate service rates are subject to regulation by state commissions.  Prices for intrastate telecommunications services are established through tariffs or through other regulatory mechanisms, including, in California, service guides.  Pending and future regulatory actions may have a material impact on our consolidated financial position and results of operations.

 

FCC Matters

 

Under current FCC rules governing rate making, SureWest Telephone is required to establish rates for its interstate telecommunications services based on projected demand usage for the various services.   SureWest Telephone projects its earnings through the use of annual cost separation studies, which utilize estimated total cost information and projected demand usage. Carriers are required to follow FCC rules in the preparation of these annual studies.  SureWest Telephone determines actual earnings from its interstate rates as actual volumes and costs become known.  The FCC monitors SureWest Telephone’s interstate earnings.

 

California Public Utility Commission (“CPUC”) Matters

 

In 2004, we entered into a settlement agreement (the “Settlement Agreement”), which was ultimately approved by the CPUC, to resolve an ongoing regulatory proceeding with various parties.  The Settlement Agreement resolved past sharing liabilities and suspended future sharing requirements in the intrastate jurisdiction.  In accordance with the Settlement Agreement, SureWest Telephone returned approximately $6,500, plus interest, to its end-users through a consumer dividend.  The surcredit was recorded as a reduction of our contractual shareable earnings obligations over a period of approximately four years, which began January 1, 2005.  During the first quarter of 2009 and prior to the cessation of the surcredit on February 9, 2009, we returned approximately $165.

 

As part of the Settlement Agreement, SureWest Telephone was required to implement an additional annual consumer dividend of $1,300 on January 1, 2007 to end-users receiving SureWest Telephone services subject to sharing on or after that date.  In December 2006, the CPUC authorized us to offset our annual $11,500 interim draw from the California High Cost Fund (“CHCF”) with the aforementioned $1,300 consumer dividend Settlement Agreement.  The CHCF was previously authorized by the CPUC on an interim basis to offset certain of SureWest Telephone’s intrastate regulated operating expenses that previously had been recovered through direct carrier payments.  In September 2007, the CPUC issued Decision 07-09-002 which provides for SureWest Telephone to phase-down its annual CHCF interim draw over a five-year period, to end on January 1, 2012.  In 2009, our interim CHCF draw was $6,120 and is being incrementally reduced by $2,040 annually.

 

In an ongoing proceeding relating to the New Regulatory Framework (under which SureWest Telephone has been regulated since 1996), the CPUC adopted Decision 06-08-030 in 2006, which grants carriers broader pricing freedom in the provision of telecommunications services, bundling of services, promotions and customer contracts.  This decision adopted a new regulatory framework, the Uniform Regulatory Framework (“URF”), which among other

 

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things (i) eliminates price regulation and allows full pricing flexibility for all new and retail services except basic residential services, which limits increases to $3.25 per year during 2009 and 2010, (ii) allows new forms of bundles and promotional packages of telecommunication services, (iii) allocates all gains and losses from the sale of assets to shareholders and (iv) eliminates almost all elements of rate of return regulation, including the calculation of shareable earnings.  Beginning January 1, 2011, the URF Incumbent Local Exchange Carriers will be allowed full pricing flexibility for the basic residential rate.

 

6.   INCOME TAXES

 

Our effective federal income tax rates for continuing operations were 100.0% and 60.5% for the six-month periods ended June 30, 2010 and 2009, respectively. For the six-month period ended June 30, 2010, our actual tax expense differed from the federal statutory rate primarily due to state taxes, permanent differences resulting from the decrease between the grant and vesting prices of RSAs and RSUs that vested during the period and a change to state deferred tax expense attributable to apportionment changes.

 

Our policy is to recognize interest and penalties related to uncertain tax positions as additional income tax expense.  We did not accrue significant amounts of interest and penalties related to unrecognized tax benefits during the six-month periods ended June 30, 2010 and 2009.  As of June 30, 2010, we had approximately $114 of accrued interest and approximately $28 of penalties in the amount disclosed below for unrecognized tax benefits.

 

We had a liability for unrecognized tax benefits of approximately $241 and $203 at June 30, 2010 and December 31, 2009, respectively.  The following table provides a reconciliation of the beginning and ending amount of unrecognized tax benefits during the six-month period ended June 30, 2010:

 

Balance at December 31, 2009

 

$

203

 

Additions based on prior year tax positions

 

38

 

Balance at June 30, 2010

 

$

241

 

 

The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate were $168 and $129 at June 30, 2010 and December 31, 2009, respectively.

 

As of June 30, 2010, the following tax years and related taxing jurisdictions were open:

 

Tax Year

 

Taxing Jurisdiction

 

2002 - 2009

 

Federal

 

2004 - 2009

 

California

 

2006 - 2009

 

Kansas and Missouri

 

 

7.   PENSION PLAN AND OTHER POST-RETIREMENT BENEFITS

 

We maintain a noncontributory defined benefit pension plan (the “Pension Plan”) which covers certain eligible employees. Benefits are based on years of service and the employee’s average compensation during the five highest consecutive years of the last ten years of credited service. Our funding policy is to contribute annually an actuarially determined amount consistent with applicable federal income tax regulations. Contributions are intended to provide for benefits attributed to service to date. Pension Plan assets are primarily invested in domestic equity securities, fixed income and international equity securities.

 

We also maintain an unfunded Supplemental Executive Retirement Plan (“SERP”), which provides supplemental retirement benefits to certain of our retired executives. The SERP provides for incremental pension payments to partially offset the reduction in amounts that would have been payable under the Pension Plan if it were not for limitations imposed by federal income tax regulations.

 

In addition, we provide certain post-retirement benefits other than pensions (“Other Benefits Plan”) to certain eligible employees of our California location, including life insurance benefits and a stated reimbursement for Medicare supplemental insurance.

 

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We amended our Pension Plan, SERP and Other Benefits Plan (collectively the “Plans”), effective April 1, 2007, which froze the Plans so that no person is eligible to become a new participant on or following that date and all future benefit accruals for existing participants under the Plans cease.

 

We account for our Pension Plan in accordance with ASC Topic 715, Compensation — Retirement Benefits (“ASC 715”) (formerly SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Post-retirement Plans, an Amendment of FASB Statements No. 87, 88, 106 and 132(R)).  ASC 715 requires an employer to recognize the overfunded or underfunded status of a defined benefit post-retirement plan as an asset or liability in its statement of financial position, to recognize changes in that funded status in the year in which the changes occur through comprehensive income and to measure the funded status of a plan as of the date of its year-end statement of financial position.

 

Components of Net Periodic Pension Cost

 

The following table summarizes the benefit costs related to our Pension and SERP Plans:

 

Quarter ended June 30,

 

2010

 

2009

 

Interest cost on projected benefit obligation

 

$

1,778

 

$

1,809

 

Expected return on plan assets

 

(1,815

)

(1,667

)

Amortization of:

 

 

 

 

 

Net actuarial loss

 

530

 

566

 

Net periodic pension expense

 

$

493

 

$

708

 

 

Six months ended June 30,

 

2010

 

2009

 

Interest cost on projected benefit obligation

 

$

3,584

 

$

3,617

 

Expected return on plan assets

 

(3,640

)

(3,342

)

Amortization of:

 

 

 

 

 

Prior service cost

 

1

 

1

 

Net actuarial loss

 

1,087

 

1,296

 

Net periodic pension expense

 

$

1,032

 

$

1,572

 

 

Net periodic benefit costs related to the Other Benefits Plan were not significant to our condensed consolidated financial statements for the quarters or six-month periods ended June 30, 2010 and 2009.

 

8.   CREDIT ARRANGEMENTS

 

A summary of our long-term debt is as follows:

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

Series A Senior Notes

 

$

14,545

 

$

14,545

 

Series B Senior Notes

 

36,000

 

48,000

 

Term Loan A credit facility

 

120,000

 

120,000

 

Term Loan B credit facility

 

30,000

 

30,000

 

Revolving Loan credit facility

 

18,500

 

10,500

 

Total long-term debt

 

219,045

 

223,045

 

Less current portion

 

15,636

 

15,636

 

Total long-term debt, net of current

 

$

203,409

 

$

207,409

 

 

Our long-term debt consists of unsecured Senior Notes and an unsecured Third Amended and Restated Credit Agreement (“Credit Agreement”) with CoBank. The Credit Agreement includes term and revolving loan facilities.

 

In September 2008, we entered into the Credit Agreement to restate and replace a February 2008 credit agreement. The Credit Agreement terms, among other things (i) reflected the repayment of $30,000 of the Term Loan B facility under the February 2008 credit agreement to reduce the principal balance from $60,000 to $30,000, (ii) modified interest margins, (iii) extended the maturity date of the Term Loan B facility to May 1, 2012, (iv) separated the total revolving commitments of $60,000 into a Revolving Loan facility of $57,500 and a Swingline Loan facility of $2,500 and (v) required permanent reductions of the Revolving Loan facility of $7,500 at December 31, 2009 and 2010.

 

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On January 29, 2010, we entered into a letter agreement with CoBank amending certain terms of the Credit Agreement, including (i) an increase in the total Revolving Loan facility of $7,500, (ii) CoBank’s share of the Revolving Loan facility will be permanently reduced by $5,000 (rather than $7,500) on December 31, 2010 and (iii) the total Revolving Loan facility will be $57,500.  As a result of this letter agreement, our combined revolving commitment balance on our Revolving Loan and Swingline Loan facilities is $60,000 and our available balance as of June 30, 2010, which was less our outstanding balance of $18,500, was approximately $41,500.

 

Our Series A and Series B Senior Notes and the Credit Agreement contain financial and operating covenants that may restrict, among other things, the repurchase of the Company’s common stock, the payment of dividends, the making of certain other restricted payments and the incurrence of additional indebtedness. The covenants also require us to maintain certain financial ratios and minimum levels of tangible net worth. If we fail to comply with the covenants and other restrictions, such as making timely interest or principal payments, it could lead to an event of default and the acceleration of our obligations under those agreements. As of June 30, 2010, we were in compliance with all of our debt covenants.

 

Our financial covenants as defined in the Series A and Series B Senior Notes and the Credit Agreement, measured quarterly, are as follows:

 

Financial Covenant

 

Required Ratio Level

 

Actual Performance
at June 30, 2010

 

Leverage ratio

 

Not more than 3.75

 

2.92

 

Interest coverage ratio

 

Not less than 3.00

 

7.62

 

Consolidated net worth

 

Not less than $160,000

 

$268,261

 

Debt to capitalization

 

Not more than 0.55

 

0.45

 

 

At June 30, 2010 and December 31, 2009, retained earnings of $108,261 and $109,183, respectively, were available for the payments described above.

 

9.   COMMITMENTS AND CONTINGENCIES

 

Litigation, Regulatory Proceedings and Other Contingencies

 

We are subject to certain legal proceedings, Internal Revenue Service examinations and other income tax exposures and other claims arising in the ordinary course of our business. In the opinion of management, the ultimate outcome of these matters will not materially affect our consolidated financial position, results of operations or cash flows.

 

We are also subject to a number of regulatory proceedings occurring at the federal and state levels that may have a material impact on our operations. The FCC and state commissions have authority to issue rules and regulations related to our business.  A number of proceedings are pending or anticipated that are related to such telecommunications issues as competition, interconnection, access charges, intercarrier compensation, broadband deployment, consumer protection and universal service reform.  Some proceedings may authorize new services to compete with our existing services.  Proceedings that relate to our cable television operations include rulemakings on set top boxes, carriage of programming, industry consolidation and ways to promote additional competition.  There are various on-going legal challenges to the scope or validity of FCC orders that have been issued.  As a result, it is not yet possible to determine fully the impact of the related FCC rules and regulations on our operations.

 

10.  RECENT ACCOUNTING PRONOUNCEMENTS

 

Recently Issued Accounting Pronouncements

 

In October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”).  ASU 2009-13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit and modifies the manner in which the transaction consideration is allocated across the separately identified deliverables.  ASU 2009-13 significantly expands the disclosure requirements for multiple-deliverable revenue arrangements.  ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, and may be applied retrospectively for all periods presented or prospectively to arrangements entered into or materially modified after the adoption date.  Early adoption is permitted, provided that the guidance is retroactively applied to the beginning of the year of adoption. We are currently evaluating the impact this update will have on our condensed consolidated financial statements.

 

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Recently Adopted Accounting Pronouncements

 

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855) — Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”). ASU 2010-09 amends ASC Topic 855 to remove the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated both in issued and revised financial statements.  ASU 2010-09 was effective immediately.  Our adoption of this guidance had no impact on our condensed consolidated financial position and results of operations.

 

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements (“ASU 2010-06”).  ASU 2010-06 amends ASC 820 to require additional disclosures regarding fair value measurements. Specifically, ASU 2010-06 requires entities to disclose additional information regarding (i) the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis, (ii) the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers and (iii) the reasons for any transfers in or out of Level 3. In addition to these new disclosure requirements, ASU 2010-06 also amends ASC 820 to further clarify existing guidance pertaining to the level of disaggregation at which fair value disclosures should be made and the requirements to disclose information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. Our adoption of the requirements of this guidance on January 1, 2010, except for the requirement to separately disclose information about purchases, sales, issuances, and settlements in the reconciliation of recurring Level 3 measurements on a gross basis which becomes effective for fiscal years (and interim periods within those fiscal years) beginning after December 15, 2010, did not have a material impact on our condensed consolidated financial position or results of operations.

 

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

 

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

 

Certain statements included in this report, 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 our revenue and cost structure resulting from our 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. These forward looking statements generally are identified by the words “believe”, “expect”, “anticipate”, “estimate”, “intend”, “should”, “may”, “will”, “would”, “will be”, “will continue” or similar expressions. Such forward looking statements involve known and unknown risks, the impact of current economic conditions, uncertainties and other factors that may cause actual results, performance or achievements of SureWest Communications (the “Company”, “we” or “our”) to be different from those expressed or implied in the forward-looking statements. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward—looking statements is included in our 2009 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”). We disclaim any intention or obligation to update or revise publicly any forward-looking statements. Management’s Discussion and Analysis should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes to the financial statements (“Notes”) as of and for the six months ended June 30, 2010 included in Item 1 of this Quarterly Report on Form 10-Q.

 

Overview

 

We are one of the leading integrated communications providers and are the bandwidth leader in the markets we serve.  We provide voice, video and data services, either individually or as a part of bundled services to residential and business customers in the greater Sacramento, California and greater Kansas City, Kansas and Missouri areas (“Kansas City area”). We continue to expand the use of optical fiber in our networks.  We increasingly deploy our services by combining fiber-to-the-home (“FTTH”) and fiber-to-the-node (“FTTN”) facilities with the use of Internet Protocol (“IP”) based communications protocol.  Our advanced telecommunications networks give us a competitive edge that enables us to provide our customers with higher data speeds for Internet service and deploy multiple services at superior quality through our high bandwidth capacity.  Our IP based communication protocol enables us to provide dedicated bandwidth at symmetrical data speeds to each of our customers in the greater Sacramento, California area. We classify our operations in two reportable segments: Broadband and Telecommunications (“Telecom”).

 

Our Broadband segment earns revenues primarily through subscriptions to our video, high-speed Internet and phone services.  Our video services range from a limited basic service to our newest product offering Advanced Digital TV (“ADTV”), powered by Microsoft® Mediaroom.  Many of our services are delivered utilizing FTTH and FTTN networks, which allow us to offer a high quality experience with our digital TV Packages. ADTV was launched in the Sacramento region in January 2010 and enhancements were completed on existing copper network marketable homes to provide this new video service, resulting in an increase of 24,000 video marketable homes as of June 30, 2010.  This enhanced video product includes a Whole Home digital video recorder (“DVR”) (which allows subscribers to watch and record up to four programs at the same time and pause, replay and rewind “live” television), instant channel changes and an intuitive, user-friendly guide. Our ADTV product provides access to over 335 channels in our California market.  Our full digital cable service in the Kansas City area provides access to over 300 channels and additional digital cable services, including a DVR.  Our video product offerings include access to high-definition (“HD”) television (“HDTV”), which provides multiple channels in high definition, premium and pay-per-view channels (which include concerts, wrestling, boxing, sporting events and movies); video on demand (“VOD”) service (which allows access to a library of movies and the ability to start a selection at any time and to pause, rewind and fast-forward and replay); premium VOD channels, music channels and an interactive, on-screen program guide (which allows the subscriber to navigate the channel lineup and the VOD library).  As of June 30, 2010, approximately 23% of the homes in the areas we serve subscribed to one of our video services.

 

Our high-speed Internet service can provide Internet access at symmetrical speeds of up to 50 Mbps, depending on the nature of the network facilities that are available, the level of service selected and the location.  As of June 30, 2010, approximately 32% of the homes in the areas we serve subscribed to one of our high-speed Internet services.  Our Voice over Internet Protocol (“VoIP”) digital phone product is available in the Sacramento market in packages ranging from basic service to unlimited local and domestic long distance calling plans.  Nearly all of our VoIP phone

 

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service plans include an extensive array of calling features including caller identification and call waiting, Find Me/Follow Me, sequential ringing and selective call acceptance and rejection.  As of June 30, 2010, approximately 16% of the homes in our Sacramento market have subscribed to our VoIP phone service. We also offer traditional circuit-switched voice services in some of the areas we serve.  The total voice penetration in the markets we serve was approximately 24% as of June 30, 2010.

 

Our Telecom segment, which operates only in the Sacramento area, offers a broad selection of telecommunications services including traditional circuit-switched voice services, long distance services and a number of lightly-regulated or non-regulated services. Customers in the Telecom segment can select individual services or bundled packages that may include unlimited local calling or unlimited local and domestic long distance calling plans.  Our voice products also include value-added services such as voicemail, call waiting, caller identification and many other calling feature options.  Most long distance services are offered by our subsidiary SureWest Long Distance, which is a reseller of long distance services.

 

Current Business Developments

 

In connection with our efforts to evaluate and potentially monetize excess assets, during 2009 we identified and began to actively market for sale certain of our real estate assets.  These regulated assets, which are included in the Telecom Segment, include 21 acres of undeveloped land and an office building.  During the quarter ended December 31, 2009, we completed our plan to sell these assets and as a result they were classified as assets held for sale.  We expect the land will sell in the range of $3,000 to $5,000. In connection with the classification to assets held for sale, the carrying value of the office building was reduced to its estimated fair value, less selling costs, based on the current market conditions and listed selling price. As a result, an impairment charge of $1,199 was recorded against accumulated depreciation during the quarter ended December 31, 2009, in accordance with regulated telephone plant and equipment composite group remaining life methodology.  We evaluated the estimated fair value of the assets held for sale as of June 30, 2010 and determined there was not a significant change.  Therefore, no additional impairment charge was recorded during the quarter or six-month period ended June 30, 2010.

 

In February 2009, we sold fifty-two wireless communications towers (“Tower Assets”) owned by our subsidiary West Coast PCS, LLC (“West Coast PCS”) to Global Tower Partners. West Coast PCS was a component of our Broadband segment. The sale was completed for an aggregate cash purchase price of $9,222, resulting in a gain of $2,525, net of tax. Proceeds from the sale of the Tower Assets were used to repay a portion of outstanding long-term debt.

 

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Results of Operations

 

The tables below reflect certain financial data (on a consolidated and segment basis) and select operating metrics for each of our reportable segments as of and for the quarters and six months ended June 30, 2010 and 2009.

 

Financial Data

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

$

 

%

 

 

 

2010

 

2009

 

Change

 

Change

 

2010

 

2009

 

Change

 

Change

 

Operating revenues (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

$

43,076

 

$

40,259

 

$

2,817

 

7

%

$

85,653

 

$

79,481

 

$

6,172

 

8

%

Telecom

 

17,472

 

20,671

 

(3,199

)

(15

)

35,083

 

42,391

 

(7,308

)

(17

)

Operating revenues

 

60,548

 

60,930

 

(382

)

(1

)

120,736

 

121,872

 

(1,136

)

(1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

(4,922

)

(5,224

)

302

 

6

 

(9,494

)

(12,226

)

2,732

 

22

 

Telecom

 

6,959

 

9,839

 

(2,880

)

(29

)

14,673

 

20,161

 

(5,488

)

(27

)

Income from operations

 

2,037

 

4,615

 

(2,578

)

(56

)

5,179

 

7,935

 

(2,756

)

(35

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

(4,269

)

(4,884

)

615

 

13

 

(7,989

)

(10,282

)

2,293

 

22

 

Telecom

 

3,742

 

5,783

 

(2,041

)

(35

)

7,989

 

11,260

 

(3,271

)

(29

)

Income (loss) from continuing operations

 

(527

)

899

 

(1,426

)

(159

)

 

978

 

(978

)

(100

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

8,409

 

6,346

 

2,063

 

33

 

16,608

 

11,595

 

5,013

 

43

 

Telecom

 

11,519

 

13,513

 

(1,994

)

(15

)

22,788

 

27,757

 

(4,969

)

(18

)

Adjusted EBITDA

 

19,928

 

19,859

 

69

 

0

 

39,396

 

39,352

 

44

 

0

 

 


(1)    External customers only.

(2)             Adjusted EBITDA represents net income (loss) from continuing operations excluding amounts for income taxes; depreciation and amortization; non-cash pension and certain post-retirement benefits; non-cash stock compensation; severance and other related termination costs; and all other non-operating income and expenses.  Adjusted EBITDA is a common measure of operating performance in the telecommunications industry. Adjusted EBITDA helps us evaluate our performance by removing from our operating results items which do not relate to our core operating performance.  The presentation of Adjusted EBITDA is not a measure of financial performance under United States generally accepted accounting principles (“U.S. GAAP” or “GAAP”) and should not be considered in isolation or as a substitute for consolidated net income (loss) as a measure of performance and may not be comparable to similarly titled measures used by other companies.  The following tables are a reconciliation of our income (loss) from continuing operations to Adjusted EBITDA on a consolidated and segment basis for the quarters and six-month periods ended June 30, 2010 and 2009:

 

 

 

Quarter Ended June 30, 2010

 

 

 

Broadband

 

Telecom

 

Consolidated

 

Income (loss) from continuing operations

 

$

(4,269

)

$

3,742

 

$

(527

)

Add (subtract):

 

 

 

 

 

 

 

Income tax expense (benefit)

 

(2,867

)

3,057

 

190

 

Other (income) expense

 

2,214

 

160

 

2,374

 

Depreciation and amortization

 

12,140

 

3,122

 

15,262

 

Non-cash pension and post-retirement expense

 

162

 

179

 

341

 

Non-cash stock compensation expense

 

560

 

584

 

1,144

 

Severance and other related termination costs (a)

 

469

 

675

 

1,144

 

Adjusted EBITDA

 

$

8,409

 

$

11,519

 

$

19,928

 

 

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Six Months Ended June 30, 2010

 

 

 

Broadband

 

Telecom

 

Consolidated

 

Income (loss) from continuing operations

 

$

(7,989

)

$

7,989

 

$

 

Add (subtract):

 

 

 

 

 

 

 

Income tax expense (benefit)

 

(5,371

)

6,385

 

1,014

 

Other (income) expense

 

3,866

 

299

 

4,165

 

Depreciation and amortization

 

24,320

 

6,048

 

30,368

 

Non-cash pension and post-retirement expense

 

367

 

394

 

761

 

Non-cash stock compensation expense

 

946

 

998

 

1,944

 

Severance and other related termination costs (a)

 

469

 

675

 

1,144

 

Adjusted EBITDA

 

$

16,608

 

$

22,788

 

$

39,396

 

 


(a)              As discussed in the Consolidated Overview section below, severance and other related termination costs were incurred as a result of the workforce reduction initiative implemented during the quarter ended June 30, 2010 in which approximately 60 positions were eliminated. Amounts exclude the termination costs related to stock compensation expense, which are included in non-cash stock compensation expense of the Adjusted EBITDA reconciliation.

 

 

 

Quarter Ended June 30, 2009

 

 

 

Broadband

 

Telecom

 

Consolidated

 

Income (loss) from continuing operations

 

$

(4,884

)

$

5,783

 

$

899

 

Add (subtract):

 

 

 

 

 

 

 

Income tax expense (benefit)

 

(3,312

)

3,928

 

616

 

Other (income) expense

 

2,972

 

128

 

3,100

 

Depreciation and amortization

 

11,283

 

2,945

 

14,228

 

Non-cash pension and post-retirement expense

 

56

 

496

 

552

 

Non-cash stock compensation expense

 

231

 

233

 

464

 

Adjusted EBITDA

 

$

6,346

 

$

13,513

 

$

19,859

 

 

 

 

Six Months Ended June 30, 2009

 

 

 

Broadband

 

Telecom

 

Consolidated

 

Income (loss) from continuing operations

 

$

(10,282

)

$

11,260

 

$

978

 

Add (subtract):

 

 

 

 

 

 

 

Income tax expense (benefit)

 

(6,968

)

8,468

 

1,500

 

Other (income) expense

 

5,024

 

433

 

5,457

 

Depreciation and amortization

 

22,903

 

6,135

 

29,038

 

Non-cash pension and post-retirement expense

 

383

 

924

 

1,307

 

Non-cash stock compensation expense

 

535

 

537

 

1,072

 

Adjusted EBITDA

 

$

11,595

 

$

27,757

 

$

39,352

 

 

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Select Operating Metrics

 

 

 

As of June 30,

 

 

 

2010

 

2009

 

Change

 

% Change

 

Broadband

 

 

 

 

 

 

 

 

 

Total residential subscribers (1)

 

103,100

 

101,800

 

1,300

 

1

%

Broadband residential revenue-generating units (2)

 

233,700

 

224,800

 

8,900

 

4

 

Data

 

99,200

 

97,700

 

1,500

 

2

 

Video

 

60,300

 

59,100

 

1,200

 

2

 

Voice

 

74,200

 

68,000

 

6,200

 

9

 

Total business customers (3)

 

7,300

 

6,800

 

500

 

7

 

 

 

 

 

 

 

 

 

 

 

Telecom

 

 

 

 

 

 

 

 

 

Voice revenue-generating units (4)

 

32,800

 

45,100

 

(12,300

)

(27

)

Total business customers (3)

 

8,200

 

8,900

 

(700

)

(8

)

 


(1)             Total residential subscribers are customers who receive one or more residential data, video or voice services from one of our subsidiaries in the Broadband segment.

(2)             We can deliver multiple services to a customer. Accordingly, we maintain statistical data regarding Revenue-generating units (“RGUs”) for video, voice and data, in addition to the number of subscribers. For example, a single customer who purchases video, voice and data services would be reflected as three RGUs.

(3)             Total business customers are customers who receive business data, voice or video services and represent a distinct customer account.

(4)             Voice RGUs are residential customers who subscribe to one or more voice access lines.

 

Consolidated Overview

 

Operating Revenues

 

Operating revenues in the Broadband segment increased $2,817 and $6,172 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009. Broadband residential revenues increased $1,138 and $3,261 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 due in part to a 4% growth in RGUs. Broadband residential revenues also increased as a result of higher pricing for video and data services in 2010, which were effective in November 2009.

 

We offer a broadband VoIP digital phone service (“VoIP phone service”) in the Sacramento market, including in the Telecom segment service territory.  The VoIP phone service provides us with a competitive triple-play offering and has mitigated past declines in consolidated operating revenue and voice RGUs by allowing us to migrate those customers to voice RGUs in the Broadband segment rather than losing those customers to competitors.  Broadband voice RGUs in the Sacramento market increased 21% as of June 30, 2010 compared to the same prior year period.

 

Broadband business revenues increased $1,638 and $2,623 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009. Business customers increased 7% as of June 30, 2010 compared to the same period in 2009 as a result of growth primarily in the Kansas City market.  The variety of our product offerings and our ability to offer customized service packages to businesses of all sizes as well as superior business customer satisfaction levels contributed to the current year growth in business revenue and will continue to provide us with new opportunities in the commercial market.

 

We will continue to invest in new opportunities as they emerge in order to develop and enhance the broadband infrastructure and the services we offer, such as wireless carrier backhaul and data center services, while focusing on the generation of new customers and increasing residential penetration on existing marketable homes.

 

Operating revenues in the Telecom segment decreased $3,199 and $7,308 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009. Residential services decreased $1,928 and $3,922 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 and were largely impacted by our customer’s migration toward alternative communication services, including those offered by our Broadband segment, as discussed above, which contributed to a 27% decline in the Telecom segment voice RGUs as of June 30, 2010 compared to 2009.  Business revenues decreased $689 and $1,319 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 as a result

 

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of an 8% decline in business customers due to the economic impact on small and medium sized businesses in the California market. The decrease in operating revenues was also impacted by the scheduled reduction in support received from the California High Cost Fund (“CHCF”) of $510 and $1,020 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  See the Regulatory Matters section below for a further discussion regarding the regulatory subsidies we receive.

 

The Telecom segment provides wholesale access and Digital Subscriber Line (“DSL”) services through the use of its network to the Broadband segment, which enables the Broadband segment to offer high-speed Internet, VoIP, video and wireless backhaul services to those customers within SureWest Telephone’s service area. These wholesale services are included as intersegment revenues and expenses in each of the respective segments and eliminated in the consolidated statements of income.

 

Operating Expenses

 

Consolidated operating expenses, excluding depreciation and amortization, increased $1,162 and $290 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009. During the quarter ended June 30, 2010, we implemented a workforce reduction initiative in which approximately 60 positions were eliminated as we continue to improve operating efficiencies and align operating costs with the decline in Telecom revenues, while enhancing our focus on the growth of our broadband services.  Affected employees were provided a range of benefits and resources, including severance. As a result, estimated severance and other related termination costs of approximately $1,640 were incurred during the quarter ended June 30, 2010.  The change in consolidated operating expenses was also impacted by a decrease in costs associated with our defined benefit pension plan (the “Pension Plan”) of $133 and $409 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.

 

Cost of services and products expense increased $1,143 and $1,047 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The increase in expenses in the current year periods was largely due to increases in programming and network costs related to providing video and data services.  These costs result from an increase in programming fees per subscriber and the growth in business services.

 

Customer operations and selling expense decreased $120 and $146 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The decrease in expenses in the current year periods was largely due to a reduction in labor and customer support costs; however was offset in part by an increase in selling costs related to the launch and promotion of our new ADTV product during the current year periods.

 

General and administrative expenses increased $139 and decreased $611 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 primarily as a result of employee severance costs of approximately $1,146 incurred during the quarter ended June 30, 2010 related to the workforce reduction initiative.  These costs were mitigated by a reduction in professional fees as a result of lower annual rates and a decrease in labor costs due to a decline in pension expense and information technology project support costs in the current year.

 

Our consolidated depreciation and amortization expense increased $1,034 and $1,330 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The increase in depreciation and amortization expense was primarily due to the continued expansion of the network and success-based capital projects undertaken within the residential and business broadband service territories.

 

Reclassifications

 

Certain amounts in our 2009 condensed consolidated financial statements have been reclassified to conform to the presentation of our 2010 condensed consolidated financial statements.

 

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Segment Results of Operations

 

Broadband

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

$

 

%

 

 

 

2010

 

2009

 

Change

 

Change

 

2010

 

2009

 

Change

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Data

 

$

12,145

 

$

11,184

 

$

961

 

9

%

$

24,393

 

$

21,947

 

$

2,446

 

11

%

Video

 

12,166

 

11,995

 

171

 

1

 

24,385

 

23,684

 

701

 

3

 

Voice

 

6,600

 

6,594

 

6

 

0

 

13,107

 

12,993

 

114

 

1

 

Total residential revenues

 

30,911

 

29,773

 

1,138

 

4

 

61,885

 

58,624

 

3,261

 

6

 

Business

 

11,253

 

9,615

 

1,638

 

17

 

21,823

 

19,200

 

2,623

 

14

 

Access

 

541

 

398

 

143

 

36

 

1,268

 

782

 

486

 

62

 

Other

 

371

 

473

 

(102

)

(22

)

677

 

875

 

(198

)

(23

)

Total operating revenues from external customers

 

43,076

 

40,259

 

2,817

 

7

 

85,653

 

79,481

 

6,172

 

8

 

Intersegment revenues

 

145

 

94

 

51

 

54

 

313

 

185

 

128

 

69

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

25,145

 

22,823

 

2,322

 

10

 

48,738

 

45,723

 

3,015

 

7

 

Customer operations and selling

 

6,106

 

6,468

 

(362

)

(6

)

12,497

 

12,728

 

(231

)

(2

)

General and administrative

 

4,752

 

5,003

 

(251

)

(5

)

9,905

 

10,538

 

(633

)

(6

)

Depreciation and amortization

 

12,140

 

11,283

 

857

 

8

 

24,320

 

22,903

 

1,417

 

6

 

Loss from operations

 

(4,922

)

(5,224

)

302

 

6

 

(9,494

)

(12,226

)

2,732

 

22

 

Loss from continuing operations

 

(4,269

)

(4,884

)

615

 

13

 

(7,989

)

(10,282

)

2,293

 

22

 

 


*Exclusive of depreciation and amortization

 

Broadband Segment Operating Revenues

 

Operating revenues from external customers in the Broadband segment increased $2,817 and $6,172 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The increase in operating revenues was due in part to the growth in residential RGUs and business customers.

 

Residential Revenues

 

Broadband residential revenues increased $1,138 and $3,261 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  Broadband residential RGUs increased 4% as of June 30, 2010 compared to the same period in 2009 due to a 9% growth in voice RGUs, as discussed below.  We anticipate continued growth in residential broadband RGUs and average revenue per user resulting from our HD DVR, VoIP phone service and the launch in January 2010 of our ADTV product powered by Microsoft® Mediaroom.  ADTV is currently deployed through our copper and fiber networks in the greater Sacramento area.  The integration of the new Mediaroom platform includes a Whole Home DVR, which allows customers the ability to watch recorded shows on any television in the house, record multiple shows at one time and utilize an intuitive on-screen guide and user interface.

 

Data

 

We offer high speed Internet access at symmetrical speeds of up to 50 Mbps, depending on the nature of the network facilities that are available, the level of service selected and the location.  The reliability and high speeds of the data service in both the Sacramento and Kansas City markets enhance other services such as VoIP and Digital Phone, where customers manage phone services through the online SureWest portal.  Through the SureWest portal, customers can manage their VoIP or Digital Phone service and access a variety of value added features and enhancements that are designed to take advantage of the speed of the Internet service we provide.

 

Our residential data revenues increased $961 and $2,446 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 as a result of higher price points on our data services, which were effective November 2009.

 

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Table of Contents

 

Video

 

Our video services range from limited basic cable service to our newest product offering ADTV.  Our services increasingly are delivered utilizing FTTH and FTTN networks, which allow us to offer a high quality experience with digital TV Packages.  Our full digital cable service provides access to over 335 and 300 channels in our California and Kansas City markets, respectively, including premium and pay-per-view channels, VOD service, premium VOD channels, music channels and an interactive, on-screen program guide. Digital cable subscribers can also subscribe to additional digital cable services, including a DVR and HDTV.

 

Residential video revenues increased $171 and $701 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  Revenues increased as a result of both higher pricing on many of our video service offerings, which were effective November 2009, and new demand for enhanced video offerings such as VOD, DVR and HDTV.

 

Voice

 

We offer phone services that provide local and long-distance calling and include features such as caller ID and call waiting. As of June 30, 2010, approximately 24% of the homes in the areas we serve subscribed to one of our phone services.

 

Our VoIP phone service is offered in the Sacramento market and is available in packages ranging from basic telephone service to unlimited local and domestic long distance calling plans.  Nearly all of our VoIP phone service plans include enhanced calling features such as Find Me/Follow Me, sequential ringing and selective call acceptance and rejection.  Voice RGUs in the Sacramento market increased 21% as of June 30, 2010 compared to the same period in 2009.  As of June 30, 2010, approximately 16% of the homes in our Sacramento market have subscribed to our VoIP phone service.  Our VoIP phone service in the Sacramento market offers our customers, including those in the Telecom service territory, an alternative to traditional circuit switched land line service and presents our customers with a more competitive triple-play offering with increased options and multiple packages.

 

Residential voice revenues increased $6 and $114 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 primarily as a result of growth in voice RGUs of 9% in that same time period.  Average revenue per voice user declined to approximately $30.01 as of June 30, 2010 from approximately $32.69 compared to the same period in 2009, due to customers receiving service as a part of a promotional offer or in a bundled service offering.

 

Business Revenues

 

We provide a variety of business communications services to small, medium and large business customers.  The services we offer to our business customers include: fiber-optics-based high-speed Internet, customized data and Ethernet transport services, data center and disaster recovery solutions, traditional landline and VoIP phone services, wireless backhaul and digital TV.

 

Business revenues increased $1,638 and $2,623 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  This increase was due primarily to a 7% increase in business customers as of June 30, 2010 compared to the same period in 2009.  Our Kansas City operations contributed a significant portion of the business revenue growth.

 

Wireless backhaul revenue contributed slightly to the growth in the business revenue during the quarter and six-month period ended June 30, 2010.  We anticipate backhaul revenue will grow during the remainder of 2010 as wireless carriers, faced with escalating consumer and business demand for mobile broadband traffic, are forced to increase backhaul capacity.

 

Access Revenues

 

Access revenues increased $143 and $486 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The increase was mostly attributable to cash settlements received during the quarter ended March 31, 2010 from certain telecommunications carriers relating to disputed carrier access charges which were fully reserved in prior year periods.

 

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Broadband Segment Operating Expenses

 

Total operating expenses in the Broadband segment increased $1,709 and $2,151 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.

 

Cost of services and products (exclusive of depreciation and amortization) increased $2,322 and $3,015 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The increase in costs in the current year periods was largely due to direct costs incurred to provide our voice, video and data services.

 

Video programming fees are paid to programming networks to license the programming we distribute to our video customers.  Video programming costs have been increasing over the last several years primarily due to the expansion of channels and an increase in costs on a per subscriber basis and per program channel, particularly for local television broadcast stations, sports and HD channels.

 

We incur network access and transport costs to provide data and voice services to our customers.  Due to the increasing demand for our VoIP product in the Sacramento market and the additional capacity required to handle the increasing volume of data usage, costs have increased in the current year periods.  Network access costs include costs paid to external vendors as well as our Telecom segment, in accordance with the provisions of a wholesale access agreement. The wholesale access agreement enables the Broadband segment to offer high-speed Internet, VoIP, video and wireless backhaul services to its customers within the Telecom segment territory.

 

Customer operations expense decreased $362 and $231 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The decrease in the current year period was mostly attributable to a decrease in labor for customer support services as a result of reduction in headcount.  The decrease was offset in part by an increase in selling expenses, primarily salaries and wages, commissions and customer events to promote the launch of our new ADTV product in the current year periods.

 

General and administrative expense decreased $251 and $633 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The decrease in costs were primarily due to (i) a decline in labor costs resulting from improved operating efficiencies in the current year period, (ii) a decrease in professional fees and (iii) the incurrence in the prior year period of information technology costs related to system maintenance and development and increased production support projects.  The decrease in costs was offset in part by severance costs of approximately $558 incurred during the quarter ended June 30, 2010 related to the workforce reduction initiative, as discussed in the consolidated overview section above.

 

Depreciation and amortization increased $857 and $1,417 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 due primarily to the continued expansion of the broadband network and success-based capital projects.

 

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Table of Contents

 

Telecom

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

$

 

%

 

 

 

2010

 

2009

 

Change

 

Change

 

2010

 

2009

 

Change

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

$

4,479

 

$

6,407

 

$

(1,928

)

(30

)%

$

9,347

 

$

13,269

 

$

(3,922

)

(30

)%

Business

 

8,400

 

9,089

 

(689

)

(8

)

16,818

 

18,137

 

(1,319

)

(7

)

Access

 

4,408

 

4,953

 

(545

)

(11

)

8,568

 

10,600

 

(2,032

)

(19

)

Other

 

185

 

222

 

(37

)

(17

)

350

 

385

 

(35

)

(9

)

Total operating revenues from external customers

 

17,472

 

20,671

 

(3,199

)

(15

)

35,083

 

42,391

 

(7,308

)

(17

)

Intersegment revenues

 

5,091

 

4,981

 

110

 

2

 

10,010

 

9,855

 

155

 

2

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

5,656

 

6,566

 

(910

)

(14

)

11,361

 

12,834

 

(1,473

)

(11

)

Customer operations and selling

 

2,678

 

2,535

 

143

 

6

 

5,068

 

5,176

 

(108

)

(2

)

General and administrative

 

4,148

 

3,767

 

381

 

10

 

7,943

 

7,940

 

3

 

0

 

Depreciation and amortization

 

3,122

 

2,945

 

177

 

6

 

6,048

 

6,135

 

(87

)

(1

)

Income from operations

 

6,959

 

9,839

 

(2,880

)

(29

)

14,673

 

20,161

 

(5,488

)

(27

)

Income from continuing operations

 

3,742

 

5,783

 

(2,041

)

(35

)

7,989

 

11,260

 

(3,271

)

(29

)

 


*Exclusive of depreciation and amortization

 

Telecom Segment Operating Revenues

 

Operating revenues from external customers in the Telecom segment decreased $3,199 and $7,308 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009. The decrease in operating revenues was due in part to the decline in voice RGUs, business customers and regulatory subsidies.

 

Residential Revenues

 

SureWest Telephone offers several different phone service options, from basic local service packages to unlimited California and nationwide flat-rate plans.  All of the plans include options for voicemail and other calling features such as caller ID and call forwarding.  SureWest Telephone residential revenues decreased $1,928 and $3,922 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 as we continue to experience decreases in revenue due to competition from wireless, wireline, and digital phone competitors (including SureWest Broadband).  Residential subscribers and voice RGUs declined approximately 27% as of June 30, 2010 compared to the same period in 2009.  We continue to mitigate additional voice access line and operating revenue losses through our VoIP phone service now offered to customers within the Telecom service area through our Broadband segment.  As a result, we expect a portion of the Telecom segment’s voice revenue will continue to shift to the VoIP service being offered by our Broadband segment.  As reflected in the Select Operating Metrics section above, as of June 30, 2010, nearly half of the decline in Telecom voice RGUs is due to customers who have transferred to SureWest Broadband’s VoIP phone service rather than being lost to competitors.  See the Broadband segment residential revenue section above for a more detailed discussion regarding VoIP and other services offered by SureWest Broadband.

 

Business Revenues

 

We provide a variety of business service offerings to small, medium and large business customers, including many services over our advanced fiber network.  The services we offer to our business customers include, but are not limited to fiber-optics-based high-speed Internet, customized data and Ethernet transport services, data center and disaster recovery solutions, traditional landline and scalable IP communication systems.

 

SureWest Telephone business revenues decreased $689 and $1,319 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009 largely due to the current economic impact on small to medium sized businesses and continued strong competitive pressures, as discussed above. While our Telecom segment business customer base declined 8% as of June 30, 2010 compared to the same period in 2009, average monthly revenue per user (“ARPU”) remained relatively flat.

 

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Access Revenues

 

Access revenues, which include interstate and intrastate switched and special access revenue, interstate common line (“CL”) revenue and declining support payments from the CHCF, decreased $545 and $2,032 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009. As anticipated, CHCF support received during the quarter and six-month period ended June 30, 2010 decreased $510 and $1,020, respectively, compared to the same periods in 2009. Interstate CL settlements received from the National Exchange Carrier Association (“NECA”) decreased $35 and $364 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009. Revenue recovery from the NECA pool declined as a result of the reduced customer base and a lower rate base due to cost reductions in the Telecom segment.  See the Regulatory Matters section below for a more detailed discussion regarding SureWest Telephone’s regulated revenues.

 

Intersegment Revenues

 

Intersegment revenues consist predominately of revenues earned through a wholesale access agreement between the Telecom and Broadband segments.  The Telecom segment supplies wholesale access and DSL services through its network to the Broadband segment, which enables the Broadband segment to offer high-speed internet, VoIP, video and wireless backhaul services to customers residing within the Telecom service territory.  Wholesale access and DSL intersegment revenue increased in the current year periods compared to the same periods in 2009 and is anticipated to continue to increase with heightened demand for the Broadband segment’s VoIP and ADTV products offered in the Telecom segment service territory.  See the Broadband operating revenue section above for more detailed discussion of the Broadband revenues and product offerings.

 

Telecom Segment Operating Expenses

 

Total operating expenses for the Telecom segment decreased $386 and $1,578 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  As discussed in the Residential Revenue section above, during 2010 we experienced a decline in voice RGUs due in part to subscribers opting to initiate VoIP phone service offered by our Broadband segment.  As a result, certain of the operating costs associated with these subscribers are now included in the Broadband segment.  In addition, costs related to our Pension Plan decreased approximately $278 and $457 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.

 

Cost of services and products (exclusive of depreciation and amortization) decreased $910 and $1,473 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  As of June 30, 2010 compared to the same period in 2009 and as discussed above, local and long distance expenses declined as a result of decreases in residential voice RGUs and business customers.  Additionally, in the current year periods, rent and utility costs have declined due to a consolidation of office space.  The decrease in costs was offset in part by severance costs of approximately $299 incurred during the quarter ended June 30, 2010 related to the workforce reduction initiative, as discussed in the consolidated overview section above.

 

Customer operations expense increased $143 and decreased $108 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The decrease in expenses during the six months ended June 30, 2010 was largely due to the decline in voice RGUs and business customer base, as discussed above, and a reduction in labor costs.  The decrease in costs was offset in part by an increase in advertising and promotion costs to support product offerings in the Telecom segment service territory.

 

General and administrative expense increased $381 during the quarter ended June 30, 2010 compared to the same period in 2009.  The increase in costs was the result of severance costs of approximately $588 incurred during the quarter ended June 30, 2010 related to the workforce reduction initiative, as discussed in the consolidated overview section above.  The increase in costs was offset in part by a reduction in professional fees.

 

Depreciation and amortization increased $177 and decreased $87 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The increase in costs during the quarter ended June 30, 2010 was due to i) plant additions for customers with digital VoIP service and ii) enhancements to the existing copper network marketable homes to support the ADTV product offered by the Broadband segment.  The decrease during the six months ended June 30, 2010 was due predominately to a portion of aerial and underground cable becoming fully depreciated during 2009.

 

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Table of Contents

 

Regulatory Matters

 

Revenues subject to regulation, which include such telecommunications services as local telephone service, network access service and toll service, are derived from various sources, including:

 

·                  business and residential subscribers of basic exchange services;

·                  surcharges mandated by state commissions;

·                  long distance carriers, for network access service;

·                  competitive access providers and commercial enterprises for network access service;

·                  interstate pool settlements from NECA;

·                  support payments from federal or state programs; and

·                  support payments from the CHCF, recovering costs of services including extended area service.

 

Certain of our interstate telecommunications service rates are subject to regulation by the Federal Communications Commission (“FCC”). Interstate switched and special access rates are established through a SureWest Telephone tariff filed with the FCC.  For interstate CL charges, SureWest Telephone concurs with tariffs filed by NECA.  Intrastate service rates are subject to regulation by state commissions.  Prices for intrastate telecommunications services are established through tariffs or through other regulatory mechanisms, including, in California, service guides.  Pending and future regulatory actions may have a material impact on our consolidated financial position and results of operations.

 

FCC Matters

 

Under current FCC rules governing rate making, SureWest Telephone is required to establish rates for its interstate telecommunications services based on projected demand usage for the various services.  SureWest Telephone projects its earnings through the use of annual cost separation studies, which utilize estimated total cost information and projected demand usage. Carriers are required to follow FCC rules in the preparation of these annual studies.  SureWest Telephone determines actual earnings from its interstate rates as actual volumes and costs become known.  The FCC monitors SureWest Telephone’s interstate earnings.

 

The FCC was directed by Congress to develop a National Broadband Plan (“NBP”) as part of the American Recovery and Reinvestment Act of 2009.  In March 2010, after taking extensive public comment, the FCC released the full text of its NBP, which contains policy recommendations on a variety of issues that the FCC has linked to expanded broadband deployment.  The policy recommendations include guiding principles to foster competition in broadband, telephone, wireless and cable services over the next decade, including recommendations related to universal service fund (“USF”) reform, intercarrier compensation, cable set-top boxes and spectrum reallocation, among others.  The NBP recommendations most relevant to the Company include shifting the current USF mechanisms that support universal voice telephone services to support of universal broadband deployment and the phased reduction of intercarrier access compensation levels to local reciprocal compensation levels, with a potential phase-out of all such compensation within ten years.  Some of these recommendations only restate pre-existing FCC proposals in current rulemakings while others raise new issues.  The FCC did not actually take action on any issue in the NBP itself. Approximately half of these issues will require separate FCC rulemaking action and the remainder consists of policy recommendations for action by Congress or other governmental entities.  The FCC is already beginning some separate proceedings.  Most recently, in response to a recent Federal Appeals Court decision which found that the FCC lacked authority over certain Internet-related practices of Comcast, the FCC opened proceedings to reassess the nature of Internet-related activities of Internet providers and to consider rules related to such activities.  Among other things, the FCC indicated it will consider possible redefinition of some forms of Internet “connectivity” which could make these activities subject to new regulation under Title II of the Act.  The FCC’s actions in these proceedings could lead to new rules and a significant increase in government regulation.  These proceedings are also creating significant new regulatory uncertainties for participants across the Internet sector. Action to deal with this and other issues addressed by the NBP may have a material impact on us.  We will continue to monitor these matters and their potential impact on our consolidated financial position and results of operations.

 

California Public Utility Commission (“CPUC”) Matters

 

In 2004, we entered into a settlement agreement (the “Settlement Agreement”), which was ultimately approved by the CPUC, to resolve an ongoing regulatory proceeding with various parties.  The Settlement Agreement resolved past sharing liabilities and suspended future sharing requirements in the intrastate jurisdiction.  In accordance with the Settlement Agreement, SureWest Telephone returned approximately $6,500, plus interest, to its end-users through a consumer dividend.  The surcredit was recorded as a reduction of our contractual shareable earnings obligations over a period of approximately four years, which began January 1, 2005.  During the first quarter of 2009 and prior to the cessation of the surcredit on February 9, 2009, we returned approximately $165.

 

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Table of Contents

 

As part of the Settlement Agreement, SureWest Telephone was required to implement an additional annual consumer dividend of $1,300 on January 1, 2007 to end-users receiving SureWest Telephone services subject to sharing on or after that date.  In December 2006, the CPUC authorized us to offset our annual $11,500 interim draw from the CHCF with the aforementioned $1,300 consumer dividend Settlement Agreement.  The CHCF was previously authorized by the CPUC on an interim basis to offset certain of SureWest Telephone’s intrastate regulated operating expenses that previously had been recovered through direct carrier payments. In September 2007, the CPUC issued Decision 07-09-002 which provides for SureWest Telephone to phase-down its annual CHCF interim draw over a five-year period, to end on January 1, 2012.  In 2009, our interim CHCF draw was $6,120 and is being incrementally reduced by $2,040 annually.  We anticipate our 2010 interim CHCF draw will be $4,080, of which through June 30 we have received $2,040.

 

In an ongoing proceeding relating to the New Regulatory Framework (under which SureWest Telephone has been regulated since 1996), the CPUC adopted Decision 06-08-030 in 2006, which grants carriers broader pricing freedom in the provision of telecommunications services, bundling of services, promotions and customer contracts.  This decision adopted a new regulatory framework, the Uniform Regulatory Framework (“URF”), which among other things (i) eliminates price regulation and allows full pricing flexibility for all new and retail services except basic residential services, which limits increases to $3.25 per year during 2009 and 2010, (ii) allows new forms of bundles and promotional packages of telecommunication services, (iii) allocates all gains and losses from the sale of assets to shareholders and (iv) eliminates almost all elements of rate of return regulation, including the calculation of shareable earnings.  Beginning January 1, 2011, the URF Incumbent Local Exchange Carriers will be allowed full pricing flexibility for the basic residential rate.

 

Other Regulatory Matters

 

We are also subject to a number of regulatory proceedings occurring at the federal and state levels that may have a material impact on our operations. The FCC and state commissions have authority to issue rules and regulations related to our business.  A number of proceedings are pending or anticipated that are related to such telecommunications issues as competition, interconnection, access charges, intercarrier compensation, broadband deployment, consumer protection and universal service reform.  Some proceedings may authorize new services to compete with our existing services.  Proceedings that relate to our cable television operations include rulemakings on set top boxes, carriage of programming, industry consolidation and ways to promote additional competition.  There are various on-going legal challenges to the scope or validity of FCC orders that have been issued.  As a result, it is not yet possible to determine fully the impact of the related FCC rules and regulations on our operations.

 

Non-Operating Items

 

Other Income and Expense, Net

 

Consolidated interest expense decreased $811 and $1,478 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009, primarily due to a decrease in long-term debt.  A decline in interest rates on our outstanding debt subject to London Interbank Offered Rates also contributed to the reduction in interest expense.

 

We received a patronage dividend of $979 and $963 during the quarters ended March 31, 2010 and 2009, respectively. We earn patronage dividends from CoBank, ACB (“CoBank”) based on our share of the net income earned by CoBank.  We record the receipt of the patronage dividends against interest expense.

 

Income Taxes

 

Income taxes decreased $426 and $486 during the quarter and six-month period ended June 30, 2010, respectively, compared to the same periods in 2009.  The decrease in income taxes in the current year periods was due primarily to a reduction in income before income taxes.  The effective federal income tax rates for continuing operations were 100.0% and 60.5% for the six-month periods ended June 30, 2010 and 2009, respectively.  The increase in the effective tax rate in the current year compared to the same period in 2009 was due primarily to deferred state income tax related to apportionment changes and permanent differences resulting from the decrease between the grant and vesting prices of restricted common stock and restricted common stock units that vested during the six-month period ended June 30, 2010.  Changes in state apportionment factors, based on operational results, may affect our future effective tax rates.

 

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Table of Contents

 

Liquidity and Capital Resources

 

Overview

 

We generate significant cash flows from operating activities.  We believe that we will be able to meet our current and long-term liquidity and capital requirements through our cash flow from operating activities, existing cash, cash equivalents and investments; through available borrowings under our existing credit facilities; and through our ability to obtain future external financing.  Our primary use of cash in 2010 has been for capital expenditures and scheduled payments of long-term debt (including interest). We anticipate continuing to use a substantial portion of our cash flow to fund our capital expenditures, invest in new business opportunities, fund network expansion, meet scheduled payments of long-term debt and may fund the share repurchase plan.

 

The following table summarizes our cash flows:

 

 

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

$ Change

 

Cash Flows Provided By (Used In)

 

 

 

 

 

 

 

Operating Activities:

 

 

 

 

 

 

 

Continuing operations

 

$

26,427

 

$

32,291

 

$

(5,864

)

Discontinued operations

 

 

(507

)

507

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

 

Continuing operations

 

(21,007

)

(18,591

)

(2,416

)

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

 

Continuing operations

 

(6,755

)

(6,154

)

(601

)

Increase (Decrease) in Cash and Cash Equivalents

 

$

(1,335

)

$

7,039

 

$

(8,374

)

 

Cash Flows Provided By Operating Activities

 

Net cash provided by continuing operating activities was $26,427 during the six-month period ended June 30, 2010.  Significant adjustments to net income to arrive at cash provided by operating activities primarily include non-cash charges of $32,312 consisting primarily of (a) depreciation and amortization of $30,368 due to capital investments principally in the Broadband segment and (b) stock compensation expense of $1,944. Cash provided by operating activities was offset in part by a decrease in (i) accrued compensation of $3,110 related in part to the payment in the current year of 2009 incentive compensation and (ii) accrued liabilities of $3,330 related to the timing of various expenditures in the current year.

 

Cash Flows Used In Investing Activities

 

Net cash used in continuing investing activities was $21,007 during the six-month period ended June 30, 2010 and was primarily related to capital expenditures that were partially offset by proceeds from the sale of our auction rate security (“ARS”).

 

Capital Expenditures

 

Capital expenditures continue to be our primary recurring investing activity and were $26,414 in the six-month period ended June 30, 2010. We invest a significant portion of our capital spending in our Broadband segment as a result of business growth, the introduction of new products and services and the expansion of the network.

 

Proceeds from Sale of Discontinued Operations

 

In May 2008, we sold the operating assets of our Wireless business, SureWest Wireless, to Verizon for an aggregate cash purchase price of $69,746. A portion of the purchase price equal to $3,450 was placed in escrow, half of which was received during the quarter ended June 30, 2009 and the balance of which was received during the quarter ended June 30, 2010.

 

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Table of Contents

 

Auction Rate Security

 

As of December 31, 2009, we held one $3,700 par value ARS purchased from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”) with an estimated fair value of $3,054, which was measured using Level 3 inputs. This ARS was collateralized by student loans that are guaranteed primarily by a monoline insurance company and partially by the Federal Family Education Loan Program (“FFELP”). As of December 31, 2009, we also held an offer (“Right” or “put option”) entitling us to sell at par our ARS anytime during a two-year period from June 30, 2010 through July 2, 2012.

 

As of December 31, 2009, the ARS and Right were classified as current assets in short-term investments on our consolidated balance sheet, as a result of our put option period under the Right. We continued to earn and receive interest on our ARS, as specified in the terms of the prospectus, during 2009.

 

On January 6, 2010, UBS exercised their rights under the Right to purchase our ARS at par of $3,700 and we recorded a gain of $646 on the ARS in the condensed consolidated statements of income during the quarter ended March 31, 2010.  The gain was largely offset by a loss of $621 recorded on the Right resulting from the cancellation of our put option under the Right.

 

Cash Flows Provided By Financing Activities

 

Net cash used in financing activities consists primarily of our proceeds and principal payments on long-term borrowings and planned repurchases of our common stock.

 

Long-term Debt

 

In September 2008, we entered into a Third Amended and Restated Credit Agreement (“Credit Agreement”) with CoBank to restate and replace a February 2008 Agreement. The Credit Agreement terms, among other things (i) reflected the repayment of $30,000 of the Term Loan B facility under the February 2008 Agreement to reduce the principal balance from $60,000 to $30,000, (ii) modified interest margins, (iii) extended the maturity date of the Term Loan B facility to May 1, 2012, (iv) separated the total revolving commitments of $60,000 into a Revolving Loan facility of $57,500 and a Swingline Loan facility of $2,500 and (v) required permanent reductions of the Revolving Loan facility of $7,500 at December 31, 2009 and 2010.

 

On January 29, 2010, we entered into a letter agreement with CoBank amending certain terms of the Credit Agreement, including (i) an increase in the total Revolving Loan facility of $7,500, (ii) CoBank’s share of the Revolving Loan facility will be permanently reduced by $5,000 (rather than $7,500) on December 31, 2010 and (iii) the total Revolving Loan facility will be $57,500.  As a result of this letter agreement, our combined revolving commitment balance on our Revolving Loan and Swingline Loan facilities was $60,000 and our available balance as of June 30, 2010, which is less our outstanding balance of $18,500, was approximately $41,500.

 

As of June 30, 2010, $14,545 and $36,000 were outstanding on the Series A and Series B Senior Notes, respectively. As of June 30, 2010, $120,000, $30,000, $18,500 and zero were outstanding on the CoBank Term Loan A, Term Loan B, Revolving Loan and Swingline Loan facilities, respectively. We had no short-term borrowings as of June 30, 2010.

 

Debt Covenants

 

Our Series A and Series B Senior Notes and the Credit Agreement contain financial and operating covenants that may restrict, among other things, the repurchase of the Company’s common stock, the payment of dividends, the making of certain other restricted payments and the incurrence of additional indebtedness. The covenants also require us to maintain certain financial ratios and minimum levels of tangible net worth. If we fail to comply with the covenants and other restrictions, such as making timely interest or principal payments, it could lead to an event of default and the acceleration of our obligations under those agreements. As of June 30, 2010, we were in compliance with all of our debt covenants.

 

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Our financial covenants as defined in the Series A and Series B Senior Notes and the Credit Agreement, measured quarterly, are as follows:

 

Financial Covenant

 

Required Ratio Level

 

Actual Performance
at June 30, 2010

 

Leverage ratio

 

Not more than 3.75

 

2.92

 

Interest coverage ratio

 

Not less than 3.00

 

7.62

 

Consolidated net worth

 

Not less than $160,000

 

$268,261

 

Debt to capitalization

 

Not more than 0.55

 

0.45

 

 

At June 30, 2010 and December 31, 2009, retained earnings of $108,261 and $109,183, respectively, were available for the payments described above.

 

Share Repurchase Program

 

Our Board of Directors has authorized the repurchase of up to 2.5 million shares of our common stock. Shares are purchased from time to time in the open market or through privately negotiated transactions, subject to overall financial and market conditions. Starting in the first quarter of 2000 through June 30, 2010, approximately 2.2 million shares of common stock had been repurchased. As of June 30, 2010, we had remaining authorization from the Board of Directors to repurchase approximately 253 thousand additional outstanding shares. We repurchased approximately 358 thousand shares during the quarter ended June 30, 2010 (none during the quarter ended March 31, 2010).  We did not repurchase any shares during the quarter or six-month period ended 2009. The purchase of common shares did not have a substantive effect on the average number of common shares outstanding or the calculation of basic and diluted earnings per share for the quarters or six-month period ended June 30, 2010.

 

Sufficiency of Cash Resources

 

We had cash, cash equivalents and short-term investments at June 30, 2010 of $6,705.  As discussed in the Long-term debt section above, we have additional long-term borrowing capacity of approximately $60,000 available to us through our Revolving Loan facility; of which, $18,500 was outstanding as of June 30, 2010.  We believe our operating cash flows and our borrowing capacity are sufficient to satisfy our liquidity requirements for the next twelve months, while maintaining adequate cash and cash equivalents.

 

Our most significant use of funds in the remainder of 2010 is expected to be for (i) budgeted capital expenditures of up to approximately $29,000, (ii) scheduled payments of long-term debt of $3,636 and (iii) anticipated interest payments of $4,500. As discussed above, throughout the year we may repurchase shares of the Company’s common stock in the open market at the prevailing market price up to an amount authorized by the Board of Directors.

 

A portion of the 2010 budgeted capital expenditures is at our discretion and dependent upon our working capital position, operating cash flows and ability to borrow. We can modify our planned construction and commitments if the results of operations or available capital so require. A significant portion of our 2010 budgeted capital expenditures are success based and is partially dependent on our ability to manage our growth and expansion. We are required to comply with our cable franchise agreements to continue our build-out in the franchise areas.

 

Defined Benefit Pension Plan

 

As required, we contribute to the Pension Plan, Supplemental Executive Retirement Plan and certain post-retirement benefits other than pensions (“Other Benefits Plan”) (collectively the “Plans”), which provide retirement benefits to certain eligible employees. Contributions are intended to provide for benefits attributed to service to date. Our funding policy is to contribute annually an actuarially determined amount consistent with applicable federal income tax regulations. We stopped accruing benefits for active participants effective April 1, 2007 and we anticipate that future funding requirements will decrease significantly as a result of the freeze of the Plans.  However, the significant decline in the equity markets precipitated by the recent credit crisis and financial system instability has negatively affected the value of our Pension Plan assets.  Our minimum funding requirement for 2010 related to the Pension Plan is $2,620; however, due to a carryover credit balance of $4,461, no cash contribution will be required.  We will continue to evaluate the future funding requirements of the Plans and fund them as necessary. See Note 7 for a more detailed discussion regarding our Pension Plan and Other Benefits Plan.

 

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Income Taxes

 

The timing of cash payments for income taxes, which is governed by the Internal Revenue Service and other taxing jurisdictions, will differ from the timing of recording tax expense and deferred income taxes, which are reported in accordance with GAAP. For example, tax laws in effect for 2009 regarding accelerated or “bonus” depreciation for tax reporting resulted in less cash payments than the GAAP tax expense on continuing and discontinued operations. Acceleration of tax deductions could eventually result in situations where cash payments will exceed GAAP tax expense. Changes in tax laws create uncertainty as to when or if this situation will occur within the next three years.

 

Our deferred tax assets are expected to be realized through the reversal of deferred tax liabilities and through the generation of future taxable income from ordinary and recurring operations. Deferred tax assets that are dependent on specific business segments generating future taxable income were determined to be more likely than not to be realized since those segments have at least 10 years in which to generate the estimated required taxable income. Approximately $1,500 of future taxable income is estimated to be required to realize these deferred tax assets.

 

Historically, pre-tax earnings for financial reporting purposes have exceeded the amount of taxable income reported for income tax purposes. This has primarily occurred due to the acceleration of depreciation deductions for income tax reporting purposes.

 

Regulatory Matters

 

As discussed more fully in the Regulatory Matters section above, the CPUC issued a final decision which will phase down our annual CHCF interim draw by approximately $2,040 annually, over a 5-year period ending on January 1, 2012.  In addition, SureWest Telephone’s intrastate access element, the transport interconnection charge (“TIC”), will be eliminated effective January 1, 2011 in accordance with previous CPUC final decisions.  We anticipate a reduction in our 2011 intrastate access revenues of up to approximately $2,150 when the TIC is eliminated. SureWest Telephone will have an opportunity to recover all or part of the lost TIC revenue elsewhere, including residential rate adjustments.

 

Critical Accounting Estimates

 

Our condensed consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Our judgments are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making estimates about the carrying values of assets and liabilities that are not readily apparent from other sources. For a full discussion of our accounting estimates and assumptions that we have identified as critical in the preparation of our condensed consolidated financial statements, refer to our 2009 Annual Report on Form 10-K.

 

As discussed more fully in Note 1 of the condensed consolidated financial statements, in accordance with FASB Accounting Standards Codification (“ASC”) Topic 350, Intangibles-Goodwill and Other (“ASC Topic 350”) (formerly SFAS No. 142, Goodwill and other Intangible Assets), goodwill is reviewed for impairment annually or more frequently if an event occurs or circumstances change that would reduce the fair value below its carrying value. As a result of recent declines in the market price of the Company’s common stock, at June 30, 2010 we concluded that this was an indicator of potential impairment of goodwill and performed an interim goodwill impairment test.

 

The impairment test for goodwill requires us to estimate the fair value at the reporting unit level. Our goodwill is allocated goodwill to the Telephone reporting unit and the Kansas City operations reporting unit. The Telecom segment includes the Telephone reporting unit.  The Broadband segment includes the Kansas City operations reporting unit. At June 30, 2010 the goodwill allocated to the Telephone reporting unit and the Kansas City operations reporting unit was $2,171 and $43,643, respectively. The June 30, 2010 interim goodwill impairment test was only performed on the goodwill recorded at the Kansas City operations reporting unit. At November 30, 2009 the Telephone reporting unit’s fair value was $102,000 and the associated carrying value was $(39,065).

 

For the Kansas City operations reporting unit, the estimated fair value of the reporting unit is determined using a combination of a discounted cash flow (“DCF”) model and a market based approach. The assumptions used in the estimate of fair value are based upon a combination of historical results and trends, new industry developments, future cash flow projections, as well as relevant comparable company earnings multiples for the market based approach. Such assumptions are subject to change as a result of changing economic and competitive conditions.  We use a

 

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weighted average of the various models to estimate the fair value of the Kansas City operating reporting unit.  At June 30, 2010, we performed a valuation to determine the fair value of our goodwill using a DCF 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 14% weighted average cost of capital based on industry weighted averaged cost of capital; and

·      a 4% terminal growth rate.

 

The carrying value of the goodwill allocated to the Kansas City operations reporting unit was $43,643 as of June 30, 2010.  When determining the fair value, the use of different estimates or assumptions within the DCF model or other market based approaches could result in a different fair value. For example, in our DCF model we used a discount rate of 14% and a terminal growth rate of 4% in our assessment of fair value in 2010.  At June 30, 2010 the fair value of the Kansas City operating unit was $225,000 and the associated carrying value was $200,000. If the discount rate in our DCF model were to increase 2%, the fair value of $225,000 would decrease by approximately $19,000, which would not result in an impairment of goodwill recorded at the Kansas City operations reporting unit, assuming there are no changes to the market-based approaches used in the valuation. Assuming the discount rate in our DCF model was to increase 2% and the market-based valuation approaches decreased by 5%, the fair value of $225,000 would decrease by approximately $25,000, and would equal the June 30, 2010 carrying value. As discussed above, the other market-based approaches are subject to change as a result of changing economic and competitive conditions. Negative changes relating to the Kansas City operations could result in a potential impairment of goodwill recorded at the Kansas City operations reporting unit.

 

Recent Accounting Pronouncements

 

Recently Issued Accounting Pronouncements

 

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”).  ASU 2009-13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit and modifies the manner in which the transaction consideration is allocated across the separately identified deliverables.  ASU 2009-13 significantly expands the disclosure requirements for multiple-deliverable revenue arrangements.  ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, and may be applied retrospectively for all periods presented or prospectively to arrangements entered into or materially modified after the adoption date.  Early adoption is permitted, provided that the guidance is retroactively applied to the beginning of the year of adoption. We are currently evaluating the impact this update will have on our condensed consolidated financial statements.

 

Recently Adopted Accounting Pronouncements

 

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855) — Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”). ASU 2010-09 amends ASC Topic 855 to remove the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated both in issued and revised financial statements.  ASU 2010-09 was effective immediately.  Our adoption of this guidance had no impact on our condensed consolidated financial position and results of operations.

 

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements (“ASU 2010-06”).  ASU 2010-06 amends ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”) to require additional disclosures regarding fair value measurements. Specifically, ASU 2010-06 requires entities to disclose additional information regarding (i) the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis, (ii) the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers and (iii) the reasons for any transfers in or out of Level 3. In addition to these new disclosure requirements, ASU 2010-06 also amends ASC 820 to further clarify existing guidance pertaining to the level of disaggregation at which fair value disclosures should be made and the requirements to disclose information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. Our adoption of the

 

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requirements of this guidance on January 1, 2010, except for the requirement to separately disclose information about purchases, sales, issuances, and settlements in the reconciliation of recurring Level 3 measurements on a gross basis which becomes effective for fiscal years (and interim periods within those fiscal years) beginning after December 15, 2010, did not have a material impact on our condensed consolidated financial position or results of operations.

 

Regulatory and Legal Matters

 

Significant portions of our telecommunication rates and charges are subject to regulation by the FCC and state commissions.  Many of these rates and charges are based on various tariffs or service guides filed by SureWest and others, including those filed by the NECA for CL charges.  Pending and future regulatory actions, with respect to these and other matters and the filing of new or amended tariffs, may have a material impact on our consolidated financial position and results of operations.  In addition, the emergence of a range of products and services that operate partially or entirely outside traditional regulatory frameworks but that compete with regulated service offerings has created new challenges for both us and the regulators.

 

Our consolidated financial condition and results of operations have been and will be affected by recent and future proceedings before the state commissions and FCC. Pending before the FCC and state commissions are proceedings that, among other things, are considering:

 

·                              additional rules governing the opening of markets to competition and the regulation of the competing telecommunications providers;

·                              the nature and extent of the compensation, if any, to be paid by carriers and other providers to one another for network use, and the sums to be recovered through end users and other sources;

·                              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.

 

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 and also on subsidiaries in the Broadband segment. These regulatory proceedings also include newer issues, such as consideration of broadband deployment and regulation of IP-enabled services. The outcomes and impact of these proceedings and related court matters on the Telecom segment, the Broadband segment and the Company as a whole cannot be determined at this time.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Our 2009 Annual Report on Form 10-K contains certain disclosures about our limited exposure to market risk for changes in interest rates.  There have been no material changes to the information provided which would require additional disclosures as of the date of this filing.

 

ITEM 4.  CONTROLS AND PROCEDURES.

 

Evaluation of disclosure controls and procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated 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) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon, and as of the date of this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective, at the reasonable assurance level, to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act is authorized, recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

 

On May 25, 2010, we announced a plan to reduce our workforce by approximately 60 positions, which included seven open and unfilled positions. The affected positions were comprised of a range of levels across the Company, including management.  The responsibilities of the affected employees were assumed by remaining employees and management, as deemed necessary.  In addition, on May 28, 2010, we announced that Bill M. DeMuth, Senior Vice President and Chief Technology Officer would be leaving the Company on June 30, 2010 pursuant to a Severance Agreement.  Based on our interim control testing and management’s continual assessment of our internal control environment to date, it appears that the changes to our employee base and management team have not adversely impacted our internal controls or control environment, however we will continue to monitor our internal controls for any adverse impacts.

 

There has been no change in our internal control over financial reporting during the quarter and six-month period ended June 30, 2010 that has materially affected, or is reasonably likely to materially affect, our control over financial reporting.  However, beginning in the second quarter of 2010, we commenced certain strategic projects to move our cash management services from our existing financial institutions to two new financial institutions. The movement of these services will likely be completed in the third quarter of 2010.  As part of these projects, management will be evaluating our internal controls over financial reporting after the completion of all of the cash management changes.

 

Limitations on the effectiveness of controls

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to our 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.

 

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PART II —OTHER INFORMATION

 

ITEM 1LEGAL PROCEEDINGS.

 

Refer to Notes 5 and 9 to our condensed consolidated financial statements of the Quarterly Report on Form 10-Q for a discussion of recent developments related to our regulatory and legal proceedings.

 

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

 

Period

 

(a) Total Number
of Shares
Purchased

 

(b) Average
Price Paid
per Share

 

(c) Total Number of

Shares Purchased as
Part of Publicly
Announced Plan

 

(d) Shares
Available for
Repurchase under
the Plan

 

April 1, 2010 - April 30, 2010

 

 

$

 

1,888,767

 

611,233

 

May 1, 2010 - May 31, 2010

 

149,474

 

$

7.65

 

2,038,241

 

461,759

 

June 1, 2010 - June 30, 2010

 

208,622

 

$

6.59

 

2,246,863

 

253,137

 

 

ITEM 6.  EXHIBITS.

 

(a)          Index to Exhibits.

 

Exhibit
No.

 

Description

 

Method
of Filing

10.1

 

Severance Agreement dated June 22, 2010 between SureWest Communications and Bill DeMuth

 

Filed herewith

 

 

 

 

 

31.1

 

Certification of Steven C. Oldham, President and Chief Executive Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

Filed herewith

 

 

 

 

 

31.2

 

Certification of Dan T. Bessey, Vice President and Chief Financial Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

Filed herewith

 

 

 

 

 

32.1

 

Certification of Steven C. Oldham, President and Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Filed herewith

 

 

 

 

 

32.2

 

Certification of Dan T. Bessey, Vice President and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Filed herewith

 

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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.

 

 

SUREWEST COMMUNICATIONS

 

(Registrant)

 

 

 

 

 

By:

/s/ STEVEN C. OLDHAM

 

 

Steven C. Oldham,

 

 

President and Chief

 

 

Executive Officer

 

 

 

 

 

 

 

By:

/s/ DAN T. BESSEY

 

 

Dan T. Bessey,

 

 

Vice President and

 

 

Chief Financial Officer

 

 

 

 

 

 

Date: July 30, 2010

 

 

 

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