UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[ X ]        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

    OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

or

[     ]        TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)

    OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 000-29660

(Exact name of registrant as specified in its charter)

               (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 ____

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    X             No ____

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 ____                                               Accelerated filer   X  

Non-accelerated filer___ (Do not check if a smaller reporting company)                         Smaller reporting company ____

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes                  No   X

On April 17, 2012, the registrant had 14,330,035 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)

See accompanying notes.

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SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited; Amounts in thousands)

See accompanying notes.

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SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; Amounts in thousands)

See accompanying notes.

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SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; Amounts in thousands)

See accompanying notes.

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SUREWEST COMMUNICATIONS

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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 (“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.

On February 5, 2012, we entered into an Agreement and Plan of Merger (“the Merger Agreement”) by and among SureWest, Consolidated Communications Holdings, Inc., a Delaware corporation, (“Consolidated”), WH Acquisition Corp., a California corporation and wholly owned subsidiary of Consolidated (“Merger Sub I”) and WH Acquisition II Corp., a California corporation and wholly owned subsidiary of Consolidated (“Merger Sub II”), pursuant to which Merger Sub I will merge with and into SureWest, (the “First Merger”) and following consummation of the First Merger, SureWest will merge with and into Merger Sub II, and Merger Sub II shall be the surviving corporation.  See Note 10 for further details regarding this pending merger.

In the opinion of management, the accompanying condensed consolidated balance sheets and related interim statements of operations, comprehensive loss 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 the accompanying notes to the financial statements (“Notes”) thereto included in our 2011 Annual Report on Form 10-K filed with the SEC.

Recent Developments

Assets Held For Sale

Assets held for sale consist of certain real estate assets that are currently marketed for sale.  These regulated assets, which are included in the Telecommunications (“Telecom”) segment, include 21 acres of undeveloped land and an office building.

The following is the carrying value of the assets held for sale as of March 31, 2012 and December 31, 2011:

We continue to actively market the undeveloped land and expect it to sell in the range of $2,000 to $5,000.  We evaluated the fair value of the land at March 31, 2012 and determined that the estimated fair value less estimated selling costs exceeds its carrying value; therefore, no impairment charge was recorded during the quarter ended March 31, 2012.

In August 2011, we entered into an agreement to sell an office building included in assets held for sale for a purchase price of $3,500. The sale was expected to close by the end of the second quarter of 2012; however, during the quarter ended March 31, 2012, the sales agreement was terminated.  We continue to actively market the office building for sale.  There was no change to the estimated fair value of the assets held for sale as of March 31, 2012; therefore, no additional impairment charge was recorded during the quarter ended March 31, 2012.

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Statements of Cash Flow Information

Noncash Financing Activities

In March 2011, our Board of Directors approved a cash dividend of $0.08 per share.  The dividend was paid on June 15, 2011 to shareholders of record at the close of business on May 16, 2011.  In connection with the approval of the cash dividend, we recorded a current liability of approximately $1,141, which was included in other accrued liabilities on our condensed consolidated balance sheet as of March 31, 2011.  The accrued liability for the cash dividend represents a noncash financing activity during the quarter ended March 31, 2011.  We did not have any noncash financing activities during the quarter ended March 31, 2012.

Recently Issued Accounting Pronouncements

There was no newly issued accounting guidance during the quarter ended March 31, 2012.

Recently Adopted Accounting Pronouncements

On January 1, 2012 we adopted the Accounting Standards Update (“ASU”) on fair value measurements and disclosures.  The updated guidance (i) clarifies the application of existing fair value measurement and disclosure requirements and (ii) changes a particular principle or requirement for measuring fair value or disclosing information about fair value measurements.  Our adoption of this guidance did not impact our consolidated financial position or results of operations.

On January 1, 2012, we adopted an ASU that amended the presentation of comprehensive income to (i) eliminate the option to present the components of other comprehensive income (“OCI”) in the statement of changes in stockholder’s equity, (ii) require presentation of net income and OCI and their respective components either in a single continuous statement or in two separate but consecutive statements and (iii) require presentation of reclassification adjustments on the face of the statement. The amendments in this ASU do not change (i) the items that must be reported in OCI or when an item of OCI must be reclassified to net income or (ii) the option for an entity to present components of OCI either net of related tax effects or before related tax effects. In December 2011, the Financial Accounting Standards Board issued an ASU to indefinitely defer the effective date of the provision pertaining only to the presentation of reclassification adjustments out of accumulated other OCI and reinstated the previous requirements to present reclassification adjustments either on the face of the statement in which OCI is reported or to disclose them in a note to the financial statements. Our adoption of this guidance did not impact our consolidated financial position or results of operations.

Earnings and Dividends Per Share

Basic earnings (loss) per share is computed by dividing the net income (loss) applicable to common stockholders by the weighted average number of common shares outstanding during the period.

Diluted earnings (loss) per share (“diluted EPS”) is computed based on the weighted average number of common shares plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method.  Dilutive potential common shares include time and performance based stock awards and stock units.  Diluted EPS excludes the impact of potential common shares related to our stock options in periods where the option exercise price is greater than the average market price of our common stock.

Diluted EPS for the three months ended March 31, 2012 and 2011 exclude potential common shares of 618 and 548, respectively, because their inclusion would have had an anti-dilutive effect.

Cash dividends per share are based on the actual dividends per share, as declared by the Company’s Board of Directors. On each date that the Company pays a cash dividend to the holders of the Company’s common stock, the Company credits to the holders of restricted stock units and performance share units (collectively “stock units”) an additional number of stock units equal to the total number of whole stock units and additional stock units previously credited to the holders, multiplied by the dollar amount of the cash dividend per share of common stock and divided by the closing share price. Any fractional stock units resulting from such calculation are included in the additional stock units.

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2. FAIR VALUE MEASUREMENTS & FINANCIAL INSTRUMENTS

Cost Method Investments

Cost method investments are originally recorded at cost, and we record dividend income or patronage income when they are declared. Cost method investments are reported as other long-term assets in our condensed consolidated balance sheets. Dividend income is reported in other income (expense), interest income in our condensed consolidated statements of income and patronage income is reported against other income (expense), interest expense in our condensed consolidated statements of income.  We held $1,482 and $1,430 in cost method investments which were included in other long-term assets in the condensed consolidated balance sheets as of March 31, 2012 and December 31, 2011, respectively. Our cost method investments primarily consist of our investment in CoBank, ACB (“CoBank”) and are related to patronage distributions of restricted equity.  Our investment in CoBank is required in accordance with the provisions of our Credit Agreement (see Note 3) held by CoBank.  We review all of our cost method investments quarterly to determine if impairment indicators are present; however, we are not required to determine the fair value of these investments unless impairment indicators exist. We estimate that the fair value of our cost method investments approximates their carrying values as of March 31, 2012 and December 31, 2011.

Fair Value of Financial Instruments

We account for certain assets and liabilities at fair value.  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 a three-tiered value hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The hierarchy 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 and liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011:

Fair values for interest rate caps and interest rate swaps are valued using models based on readily observable market parameters for all substantial terms and are classified within Level 2. See Note 4 for further discussion regarding our interest rate caps and interest rate swap.

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Fair Value of Debt

We had no short-term borrowings as of March 31, 2012 and December 31, 2011. 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. The fair value of the long-term debt, using Level 2 inputs of similarly traded liabilities as of March 31, 2012 and December 31, 2011 was $205,780 and $202,793, respectively.

3. CREDIT ARRANGEMENTS

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

In March 2011, we entered into a $264,000 five-year senior secured Credit Agreement (“Credit Agreement”) to replace our unsecured Third Amended and Restated Credit Agreement (“Previous Agreement”) from September 2008.  The proceeds from the Credit Agreement were used to repay the Previous Agreement in its entirety and to repay the unsecured Series A and Series B Senior Notes issued in December 1998 and March 2003, respectively.

The Credit Agreement includes (i) a $34,000 Revolving Loan Facility, which includes a $6,000 swingline loan commitment and a $5,000 commitment for the issuances of letters of credit, each as a subfacility to the Revolving Loan Facility, (ii) a fully drawn $40,000 Term A Loan Facility and (iii) a $190,000 Term Loan B Commitment. On May 31, 2011, the Term Loan A Facility matured and converted to a Term Loan B borrowing thus increasing the Term Loan B Commitment by $40,000 to $230,000.  All amounts outstanding on the Revolving Loan Facility and the Term Loan B Facility will be due on March 2, 2016.  As of March 31, 2012, $5,000 was outstanding under the Revolving Loan Facility.

The Term Loan B Commitment included a delayed draw amount which allowed for one or more additional advances not to exceed $20,000. The delayed draw was to be used solely for capital expenditures.  During the quarter ended March 31, 2012, we determined that we would not utilize our $20,000 delayed draw prior to the end of the Term Loan B Availability Period of September 1, 2012. Accordingly, we cancelled our delayed draw effective March 5, 2012.

In connection with entering into the Credit Agreement, we incurred $3,565 in debt issuance costs of which $301 were recognized during the quarter ended March 31, 2011. The remaining deferred debt issuance costs are being amortized over the term of the Credit Agreement.  In addition, we incurred early termination fees of $2,346 related to the repayment of our Series A and Series B Senior Notes during the quarter ended March 31, 2011.  The early termination fees and the debt issuance costs expensed were recognized in other income (expense), interest expense in the condensed consolidated statements of operations during the quarter ended March 31, 2011.

Commencing on September 30, 2011, and on the last day of each quarter thereafter, principal payments for the Term Loan B Facility are due in equal quarterly amounts of $3,750. In addition, we must make mandatory repayments under certain circumstances upon receipt of proceeds from insurance, asset dispositions, debt issuances and equity issuances.

Borrowings under the Credit Agreement (other than the swingline loan) bear interest based, at our election, on the London Interbank Offered Rate (“LIBOR”) or the bank’s base rate in either case, plus an applicable margin based on our leverage ratio.  The swingline loan will accrue interest at the base rate, plus an applicable margin.

In November 2011, we entered into a Second Amendment to Credit Agreement (“Amendment”) to amend certain terms of the Credit Agreement.  The Amendment reduced the quarterly principal payments from $3,750 to $1,875, commencing on December 31, 2011 and on the last day of each quarter thereafter, provided that our Leverage Ratio is less than 2.60:1.0 for the preceding two consecutive fiscal quarters.  The Amendment also reduced the applicable LIBOR margin and the bank’s base rate margin by 50 basis points per annum commencing in November 2011.

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At March 31, 2012, the aggregate maturities of long-term debt are expected to be (i) $5,625 in the remainder of 2012, (ii) $7,500 annually in 2013 through 2015 and (ii) $179,375 in 2016 for a total of $207,500.

Our obligations under the Credit Agreement are secured by a first priority security interest in essentially all our currently existing and future assets.  Security includes the capital stock we own or should acquire in all of our subsidiaries.

The Credit Agreement includes financial and operating covenants that may limit the incurrence of additional indebtedness, investments, the payment of dividends, the making of certain other restricted payments, transactions with affiliates, liens, mergers, asset sales and material changes in our business.  The Credit Agreement also requires us to maintain certain financial ratios and minimum levels of tangible net worth.

Our financial covenants as defined in the Credit Agreement, measured quarterly, are as follows:

4. DERIVATIVES

We use derivative instruments to manage our interest rate exposure associated with our variable-rate debt and to achieve a desired proportion of fixed and variable-rate debt. At the inception of a hedge transaction, we formally document the relationship between the hedging instruments including our objective and strategy for establishing the hedge.  In addition, the effectiveness of the derivative instrument is assessed at inception and on an ongoing basis, at least quarterly. Counterparties to derivative instruments expose us to credit related losses in the event of nonperformance. We execute agreements only with financial institutions we believe to be creditworthy and regularly assess the creditworthiness of each of the counterparties.  We do not use derivative instruments for trading or speculative purposes.

All derivative instruments are recorded at fair value in the condensed consolidated balance sheet.  For derivatives designated as a cash flow hedge, the effective portion of the change in the fair value is recognized as a component of accumulated other comprehensive loss.  The change in fair value related to the ineffective portion of the hedge is immediately recognized as interest expense in the condensed consolidated statements of operations. Amounts in accumulated other comprehensive loss will be reclassified to earnings when the related hedged items impact earnings.  Cash flows from derivative instruments are classified in operating activities in the condensed consolidated statement of cash flows, which is consistent with the items being hedged.

In June 2011, we entered into an interest rate swap agreement and two interest rate cap agreements. These agreements have been designated as cash flow hedges. The swap agreement is on a notional amount of $75,000 with a fixed rate of 1.85% and is benchmarked based on the three month LIBOR. The objective is to effectively fix the total interest expense on $75,000 of our outstanding long-term debt at 4.60% over the term of the swap, which includes the fixed rate of 185 basis points plus our current applicable interest margin of 275 basis points at March 31, 2012. During the life of the swap, we are still exposed to variability in interest expense to the extent our applicable interest margin changes.  The interest rate swap agreement was effective June 30, 2011 and ends March 2, 2016, but includes a cancellation provision which provides us the right to cancel the agreement on June 30, 2014. The interest rate swap agreement contains standard credit-risk-related contingent features which could result in the counterparty requesting termination and immediate settlement of the contract in the event of default.

The interest rate cap agreements each have a notional amount of $25,000 with a 2.00% strike price and are effective through June 30, 2014 and March 2, 2014, respectively.  In June 2011, we paid premiums of $333 to enter into the interest rate cap agreements.  The premiums are being amortized to interest expense over the term of the agreements.

During the quarter ended December 31, 2011, our prospective assessment of hedge effectiveness indicated the interest rate swap agreement was ineffective in offsetting the future changes in expected cash flows over the remaining term of the agreement. Therefore, changes in the fair value of the interest rate swap agreement are being recognized in interest expense in the condensed consolidated statement of operations. Prior to becoming ineffective, the effective portion of the changes in fair value of the interest rate swap agreement were recognized in accumulated other

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comprehensive loss.  The balance of the unrealized loss included in accumulated other comprehensive loss related to the ineffective swap agreement is being amortized to interest expense over the remaining term of the agreement. If it becomes probable that we will not have variable-rate debt through the term of the agreement, the remaining unrealized loss in accumulated other comprehensive loss will be immediately recognized as interest expense in the condensed consolidated statement of operations.

The fair values of derivative instruments included in the condensed consolidated balance sheets at March 31, 2012 and December 31, 2011 consisted of:

The effect of derivative instruments on the condensed consolidated statements of operations, before tax effects, for the three months ended March 31, 2012 consisted of:

We did not have any derivative instruments during the three months ended March 31, 2011. We expect to reclassify $182 of the net loss included in accumulated other comprehensive loss into earnings during the next 12 months.

5. EQUITY

Share-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 employees, outside directors and consultants.  The Stock Plan permits issuance of awards in the form of restricted shares, stock units, performance shares, options or stock appreciation rights.  Under the Stock Plan, approximately 2.4 million shares of our common stock are authorized for issuance, including those outstanding as of March 31, 2012.

Time Based Stock Awards and Units

We measure the fair value of time-based restricted stock awards (“RSAs”) and restricted stock units (“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 four-year vesting period using the straight-line method.  We have estimated expected forfeitures based on historical experience and are recognizing compensation only for those RSAs and RSUs expected to vest.

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The following table summarizes the grants of time-based RSAs and RSUs that occurred under the Stock Plan during the quarters ended March 31, 2012 and 2011:

The following summarizes the time-based RSA and RSU stock activity during the quarter ended March 31, 2012:

The total fair value of the RSAs and RSUs that vested during the quarters ended March 31, 2012 and 2011 was $360 and $216, respectively.

Performance Share Awards and Units

We derive the fair value of performance share awards (“PSAs”) and performance share units (“PSUs”) (collectively “the awards”) using the Monte Carlo Simulation (“MCS”) valuation method.  The MCS utilizes multiple input variables to determine the probability of the Company achieving the market condition and the derived fair value of the awards. PSAs and PSUs are generally granted in six vesting tranches over a vesting period ranging from thirty to thirty-five months.  The awards vest based on the achievement of stock price appreciation and continuous employee service over the life of the award.  As of each vesting date, each tranche vests if the average closing stock price of the SureWest common stock for an eleven trading day period is equal to or exceeds the respective target stock price.  If the tranche does not meet the target stock price condition on its corresponding target date, then it may vest at a subsequent target date if the stock price condition is met.  However, the tranche may not vest earlier than its corresponding target date. The fair values of the awards are amortized over the derived service period of each vesting tranche. We have estimated expected forfeitures based on historical experience and are recognizing compensation only for those PSAs and PSUs expected to vest.

The following table summarizes the grants of PSAs and PSUs that occurred under the Stock Plan during the quarters ended March 31, 2012 and 2011.

The following table summarizes the PSA and PSU activity during the quarter ended March 31, 2012:

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The total fair value of the PSAs and PSUs that vested during the quarter ended March 31, 2012 was $634.

Share Based Compensation Expense

The following table summarizes total compensation costs recognized for share-based payments during the quarters ended March 31, 2012 and 2011:

(1) Pursuant to a severance agreement entered into on March 31, 2011 between the Company and a retiring officer, share-based compensation expense recognized during the quarter ended March 31, 2011 included approximately $647 related to the acceleration of unvested, time-based RSAs.

As of March 31, 2012, total unrecognized compensation costs related to nonvested RSAs, RSUs, PSAs, and PSUs was $7,127 and will be recognized over a weighted-average period of approximately 2.66 years.

6. PENSION PLAN AND OTHER POST-RETIREMENT BENEFITS

We maintain a frozen 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.

Effective April 1, 2007, we amended our Pension Plan, SERP and Other Benefits Plan (collectively the “Plans”) such that the Plans were frozen 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.

Components of Net Periodic Pension Cost

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

Net periodic benefit costs related to the Other Benefits Plan were not significant to our condensed consolidated financial statements for the quarters ended March 31, 2012 and 2011.

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Cash Flows

Contributions

We expect to contribute $8,462 to our Pension Plan in 2012.  As of March 31, 2012, we have contributed $578 of the annual contribution to the Pension Plan.

7. INCOME TAXES

Our effective federal income tax rates were 13.7% and 25.5% for the three-month periods ended March 31, 2012 and 2011, respectively. For the three-month period ended March 31, 2012, our actual tax expense differed from the federal statutory rate primarily due to permanent differences related to the transaction costs, as well as the reversal of unrecognized tax benefits and a change to state deferred tax expense attributable to apportionment changes.

As of March 31, 2012, we did not have a material liability for uncertain tax positions.  During the three months ended March 31, 2012, we recorded a decrease of $97 to our unrecognized tax benefits, which increased our tax benefit by a corresponding amount, due to the expirations of a statute of limitations.  We do not expect any material changes in our uncertain tax positions for the remainder of 2012.

8. 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; certain property, plant, and equipment; and miscellaneous other assets, which are not allocated to the segments.  However, the interest income associated with cash held by Corporate Operations is included in the results of the operations of our segments.

Our business segment information is as follows:

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9. 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 service guides in California.  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 requires SureWest Telephone to prepare and submit periodic cost separation studies related to certain NECA CL accounts receivable balances.  As a result of the cost separation filings, SureWest Telephone may change its estimates for certain NECA CL accounts receivable balances related to the prior year monitoring period.  During the quarter ended March 31, 2012, this change in estimate decreased our consolidated revenues and increased our loss from operations by $348 and increased our net loss by $213 ($0.02 per share), respectively.  We did not record any significant changes in estimates related to prior year monitoring periods during the quarter ended March 31, 2011.

California Public Utility Commission (“CPUC”) Matters

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, (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.  On December 31, 2010, the CPUC issued a ruling to initiate a new proceeding to assess whether, or to what extent, the level of competition in the telecommunications industry is sufficient to control prices for the four largest Incumbent Local Exchange Carriers in the state, including SureWest Telephone.  Subsequently, the CPUC issued a ruling temporarily deferring the proceeding.  The status on when the CPUC may open this proceeding is unclear and on hold at this time. The CPUC’s actions in this and future proceedings could lead to new rules and an increase in government regulation. The Company will continue to monitor this matter.

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In September 2007, the CPUC issued Decision 07-09-002 which provided for SureWest Telephone to phase-down its $11,500 interim annual California High Cost Fund draw (“interim draw”) by $2,040 over a five-year period, from 2007 to 2011.  As a result of the completion of the phase-down, we did not receive an interim draw during the quarter ended March 31, 2012 which resulted in a decrease to access revenues of $510 during the quarter ended March 31, 2012 compared to the same period in 2011.

10. PENDING MERGER

On February 5, 2012, we entered into an Agreement and Plan of Merger (“the Merger Agreement”) by and among SureWest, Consolidated Communications Holdings, Inc., a Delaware corporation, (“Consolidated”), WH Acquisition Corp., a California corporation and wholly owned subsidiary of Consolidated (“Merger Sub I”) and WH Acquisition II Corp., a California corporation and wholly owned subsidiary of Consolidated (“Merger Sub II”), pursuant to which Merger Sub I will merge with and into SureWest, (the “First Merger”) and following consummation of the First Merger, SureWest will merge with and into Merger Sub II, and Merger Sub II shall be the surviving corporation.

Pursuant to the terms of the Merger Agreement our shareholders may elect to exchange each share of SureWest Common Stock for either $23.00 in cash (without interest) or shares of Consolidated Common Stock having an equivalent value based on average trading prices for the 20-day period ending two days before the closing of the acquisition, subject to a collar so that there will be a maximum exchange ratio of 1.40565 shares of Consolidated Common Stock for each share of SureWest Common Stock and a minimum of 1.03896 shares of Consolidated Common Stock for each share of SureWest Common Stock.  Overall elections are subject to proration so that 50% of the SureWest shares will be exchanged for cash and 50% for stock.  The results of applying the collar and proration provisions are subject to adjustment to ensure the transaction will be treated as a tax-free reorganization for federal income tax purposes. Shares of SureWest with respect to which no election is timely made will be converted into the right to receive the cash consideration or the Consolidated Common Stock, as determined in accordance with the proration described in the Merger Agreement.

The completion of this transaction is subject to customary closing conditions, including the receipt of certain regulatory approvals and approval by our shareholders and the stockholders of Consolidated.  The Merger Agreement contains certain termination rights for SureWest and Consolidated.  The Merger Agreement stipulates that in the event of a termination of the Merger Agreement under specified circumstances, we would be required to pay Consolidated a fee of $14,675.

In connection with entering into the Merger Agreement with Consolidated, we incurred transaction fees of $3,292 during the quarter ended March 31, 2012.

11. COMMITMENTS AND CONTINGENCIES

The Company, our Board of Directors and Consolidated are named as defendants in six putative shareholder class action lawsuits challenging the proposed Merger. Five shareholder actions were filed in the Superior Court of California, Placer County, and one shareholder action was filed in the United States District Court for the Eastern District of California. The actions are called Needles v. SureWest Communications, et al., filed February 17, 2012, Case No. SCV0030665, Errecart v. Oldham, et al., filed February 24, 2012, Case No. SCV0030703, Springer v. SureWest Communications, et al., filed March 9, 2012, Case No. SCV0030669, Aievoli v. Oldham, et al., filed March 15, 2012, Case No. SCV0030671 and Waterbury v. SureWest Communications, et al., filed March 26, 2012, Case No. SCV0030854, and the federal action is called Broering v. Oldham, et al., filed April 18, 2012, Case No. 212-CV-01025-JAM-EFB. The actions generally allege, among other things, that each member of our Board of Directors breached fiduciary duties to the Company and its shareholders by authorizing the sale of the Company to Consolidated for consideration that is unfair to the our shareholders and agreeing to terms that unduly restrict other bidders from making a competing offer. The complaints also allege that Consolidated and the Company aided and abetted the breaches of fiduciary duties allegedly committed by the members of our Board of Directors. The Broering complaint also alleges, among other things, that the joint proxy statement/prospectus filed with the SEC on March 28, 2012 does not make sufficient disclosures regarding the Merger, that our Board of Directors should have appointed an independent committee to negotiate the transaction and that we should have gone back to another bidder to create a competitive bid process. The lawsuits seek equitable relief, including an order to prevent the defendants from consummating the Merger on the agreed-upon terms and/or an award of unspecified money damages. We believe that these claims are without merit. On March 14, 2012, the Placer County Superior Court entered an order consolidating the Needles, Errecart and Springer actions into a single action under the caption In re SureWest Communications Shareholder Litigation, Case No. SCV-0030655. Under the terms of this order, all cases subsequently filed in the Superior Court for the State of California, County of Placer, that relate to the same subject matter and involve similar questions of law or fact are to be consolidated with these cases as well. Any party objecting to such consolidation must file its objection within ten days of receiving a copy of the order. Attorneys for the plaintiffs in Aievoli and Waterbury received copies of the order on or before March 29, 2012 and have not filed any objection. On April 10, 2012, the plaintiff in Waterbury filed a request for voluntary dismissal of her complaint without prejudice.

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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 and continued expansion of the telecommunications network, 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 2011 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 (“MD&A”) 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 three months ended March 31, 2012 included in Item 1 of this Quarterly Report on Form 10-Q.

Throughout MD&A, we refer to measures that are not a measure of financial performance in accordance with United States generally accepted accounting principles (“US GAAP” or “GAAP”).  We believe the use of these non-GAAP measures on a consolidated and segment basis provides the reader with additional information that is useful in understanding our operating results and trends. These measures should be viewed in addition to, rather than as a substitute for, those measures prepared in accordance with GAAP. See the Non-GAAP Measures section below for a more detailed discussion on the use and calculation of these measures.

Significant Recent Development

On February 5, 2012, SureWest Communications entered into an Agreement and Plan of Merger (“the Merger Agreement”) by and among SureWest, Consolidated Communications Holdings, Inc., a Delaware corporation, (“Consolidated”), WH Acquisition Corp., a California corporation and wholly owned subsidiary of Consolidated (“Merger Sub I”) and WH Acquisition II Corp., a California corporation and wholly owned subsidiary of Consolidated (“Merger Sub II”), pursuant to which Merger Sub I will merge with and into SureWest, (the “First Merger”) and following consummation of the First Merger, SureWest will merge with and into Merger Sub II, and Merger Sub II shall be the surviving corporation (the “Second Merger” and, together with the First Merger, the “Mergers”).

Overview

We are one of the leading providers of integrated communications services and are the bandwidth leader in the markets we serve.  We provide data, video and voice services to residential and business customers in the greater Sacramento, California (“Sacramento region”) 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 Sacramento region.  We classify our operations in two reportable segments: Broadband and Telecommunications (“Telecom”).

Broadband Segment

Our Broadband segment generated approximately 80% of our consolidated operating revenues, primarily from subscriptions to our data, video and voice services (“broadband services”) and business services during the quarter ended March 31, 2012.  We market our broadband services to residential and business customers, either individually or as part of a bundled package. As of March 31, 2012, our broadband services served approximately 106,800 residential subscribers, of which 84% subscribed to two or more of our broadband services, including 45% that subscribed to all three of our broadband services (“triple play”).  As of March 31, 2012, we had approximately 8,400

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business customers. Products and features including Advanced Digital TV (“ADTV”), faster data speeds, increased high definition (“HD”) channels, home networking and Internet security software create enhanced subscriber value for our broadband services. We continue to successfully offset industry-wide declines of operating revenues in the Telecom segment with our long-term strategy to grow our Broadband operations.

Our data service can provide high-speed Internet access at symmetrical speeds of up to 50 megabits per second (“Mbps”), depending on the nature of the network facilities that are available, the level of service selected and the geographic market availability.  Our advanced telecommunications networks gives us the ability to offer our customers in many locations both faster and symmetrical data speeds, meaning Internet speeds downstream are the same as those upstream, than those of our competitors.  Customers can use the faster speeds for such things as enhanced online gaming and faster uploading and downloading of multimedia content such as music, photos and video.  As of March 31, 2012, approximately 65% and 32% of our data customers subscribed to speeds of 5 Mbps and 15 Mbps or greater, respectively.  In the Sacramento region, approximately 41% of our data customers subscribe to plans with speeds at or higher than 15 Mbps.  As of March 31, 2012, approximately 31% of the homes in the areas we serve subscribed to one of our high-speed Internet services.

Our video services range from a limited basic service to ADTV, powered by Microsoft® Mediaroom™.  Depending on the service selected and subject to geographic market availability, our digital video service subscribers have access to over 345 channels, including premium and pay-per-view channels (which include concerts, 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, 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, the VOD library and recorded programs).  Digital video subscribers may also subscribe to our advanced services, which consist of high-definition television (“HDTV”), digital video recorders (“DVR”) and/or a Whole Home DVR.  As a result of the launch of a Whole Home DVR in the Kansas City area on March 29, 2012, our digital video subscribers in both regions have 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.  As of March 31, 2012, approximately 22% of the homes in the areas we serve subscribed to one of our video services.

Our Voice over Internet Protocol (“VoIP”) digital phone product (“VoIP phone service”) is available in the Sacramento market, including those customers residing in the Telecom segment service territory.  Customers 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.  As of March 31, 2012, approximately 19% of the homes in our Sacramento market have subscribed to our VoIP phone service. We also offer traditional circuit-switched voice services in the areas we serve.  Our Broadband segment’s total voice penetration in the markets we serve was approximately 23% as of March 31, 2012.

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. Utilizing our existing fiber-optic network, we have successfully secured contracts to serve approximately 398 wireless backhaul access points, primarily in the Sacramento region. We anticipate backhaul revenue will continue to grow as wireless carriers, faced with escalating consumer and business demand for mobile broadband connectivity, are forced to expand and improve their networks, and to replace existing backhaul facilities with new facilities capable of handling more traffic at faster speeds.

Telecom Segment

Our Telecom segment, which operates only in the Sacramento region, 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. Most long distance services are offered by our subsidiary SureWest Long Distance, which is a reseller of long distance services.

The Telecom segment provides 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 customized data and Ethernet transport services, traditional landline and scalable IP communication systems.  We are experiencing strong competitive pressure for small business customers; however the market for medium and large business customers remains stable.  Business service revenues now represent 62% of the Telecom segment total operating revenues.

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The Telecom segment also provides wholesale access and other services to the Broadband segment, which enables the Broadband segment to offer high-speed Internet, VoIP, video and wireless backhaul services to some customers within SureWest Telephone’s service area. We anticipate the wholesale access services revenue stream will continue to increase as customers within the Telecom segment service territory continue to demand more broadband services.

Telecom segment revenues continue to decrease as a percentage of our consolidated operating revenues.  During the quarter ended March 31, 2012, the Telecom segment generated 20% of our consolidated revenues, a decrease from 25% compared to the same period in 2011.  The decline in revenues was primarily the result of an industry wide trend of declining circuit-switched voice Revenue-generating units (“RGUs”) and a corresponding reduction in the use of related services. Many customers are choosing to subscribe to our Broadband Digital Phone product instead of the traditional circuit-switched phone service offered by SureWest Telephone.  In addition, the Telecom segment revenues were impacted by scheduled reductions for certain regulatory support subsidies.  The scheduled declines of regulatory support subsidies began in 2006 and are now fully phased out.  We anticipate the recent declines in Telecom revenues to flatten as the scheduled phase out of certain Telecom support mechanisms have been completed and access line losses ease. The Telecom segment continues to generate the majority of our net income and adjusted free cash flow and remains an important part of our long-term growth strategy to fund the expansion of our Broadband segment.

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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 ended March 31, 2012 and 2011.

Financial Data