**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**
|        | x      | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)**      | ** ** |
|--------|--------|-------------------------------------------------------------|------------|
|   |   | **OF THE SECURITIES EXCHANGE ACT OF 1934**                  | ** ** |
|   |   | **For the fiscal year ended  December 31, 2005**       | ** ** |
|   |   | **or**                                                      | ** ** |
|   | o      | **TRANSITION REPORT PURSUANT TO  SECTION 13 or 15(d)** | ** ** |
|   |   | **OF THE SECURITIES EXCHANGE ACT OF 1934**                  | ** ** |
|   |   | **Commission File Number 0-556**                            | ** ** |

 

| **SUREWEST COMMUNICATIONS**                             |
|---------------------------------------------------------|
| (Exact Name of  Registrant as Specified in Its Charter) |

 

| California                                |   | 68-0365195           |
|-------------------------------------------|--------|----------------------|
| (State or Other  Jurisdiction             |   | (I.R.S. Employer     |
| of Incorporation  or Organization)        |   | Identification  No.) |
| 200  Vernon Street, Roseville, California |   | 95678                |
| (Address of  Principal Executive Offices) |   | (Zip Code)           |

 

Registrant’s telephonenumber, including area code (916) 772-2000

Securities to be registeredpursuant to Section 12(b) of the Act:

None

Securities registeredpursuant to Section 12(g) of the Act:
|        | Common Stock–Without  Par Value |   |
|--------|--------------------------------------|--------|
|   | (Title of class)                     |   |

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.

Yes o   No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. 

Yes o   No x

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

Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

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

Yes x  No o

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

Yes o   No x

On June 30, 2005,which was the last business day of the registrant’s most recently completedsecond fiscal quarter, the registrant had 14,590,005 shares of Common Stockoutstanding and the market value of shares held by non-affiliates wasapproximately $343,724,518 (based on 13,400,566 shares of Common Stock thenheld by non-affiliates and a closing price that day of $25.65 per share ofCommon Stock on the Nasdaq National Market). The market value calculationsexclude shares held on the stated date by registrant’s employee benefit plans,directors and officers on the assumption such shares may be shares owned byaffiliates. (Exclusion from these public market value calculations does notimply affiliate status for any other purpose).

On February 17, 2006,the registrant had 14,630,656 shares of Common Stock outstanding.

**DOCUMENTS INCORPORATED BY REFERENCE**

Incorporatedby reference into Part II, Item 5 and Part III hereof are portions ofthe registrant’s definitive proxy statement to be filed pursuant to Regulation14A within 120 days after the Registrant’s fiscal year-end of December 31,2005.

 

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**TABLE OF CONTENTS**
|                   | ** ** | ** **                                                                                                          | ** ** | **PAGE** |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|----------|
| **PART I**   |       |                                                                                                                |       |     |
| Item 1.           |       | Business                                                                                                            |       |  1  |
| Item 1A.          |       | Risk  Factors                                                                                                       |       | 12       |
| Item 1B.          |       | Unresolved Staff  Comments                                                                                          |       | 14       |
| Item 2.           |       | Properties                                                                                                          |       | 14       |
| Item 3.           |       | Legal  Proceedings                                                                                                  |       | 14       |
| Item 4.           |       | Submission of  Matters to a Vote of Security Holders                                                                |       | 15       |
| **PART II**  |       |                                                                                                                |       |     |
| Item 5.           |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       | 16       |
| Item 6.           |       | Selected Financial  Data                                                                                            |       | 16       |
| Item 7.           |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       | 18       |
| Item 7A.          |       | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       | 45       |
| Item 8.           |       | Financial  Statements and Supplementary Data                                                                        |       | 46       |
| Item 9.           |       | Changes in and Disagreements With Accountants on  Accounting and Financial Disclosure                               |       | 84       |
| Item 9A.          |       | Controls and  Procedures                                                                                            |       | 84       |
| Item 9B.          |       | Other Information                                                                                                   |       | 88       |
| **PART III** |       |                                                                                                                |       |     |
| Item 10.          |       | Directors and  Executive Officers of the Registrant                                                                 |       | 89       |
| Item 11.          |       | Executive  Compensation                                                                                             |       | 89       |
| Item 12.          |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       | 89       |
| Item 13.          |       | Certain  Relationships and Related Transactions                                                                     |       | 90       |
| Item 14.          |       | Principal  Accountant Fees and Services                                                                             |       | 90       |
| **PART IV**  |       |                                                                                                                |       |     |
| Item 15.          |       | Exhibits and  Financial Statement Schedules                                                                         |       | 91       |
| SIGNATURES        |       | 96                                                                                                                  |

 

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**PART I**

**Item 1.****                        Business****.**   (Dollars inthousands, except per share amounts)

**General Development of Business**

SureWest Communications (the “Company” or “we”) is aCalifornia holding company whose operating subsidiaries provide a wide range oftelecommunications, digital video, and other facilities-based communicationservices in Northern California, primarily in the greater Sacramento region. TheCompany was incorporated under the laws of the State of California in 1995, andits predecessor, Roseville Telephone Company, was incorporated in 1914.

As of December 31, 2005, the Company’swholly-owned subsidiaries included SureWest Telephone, SureWest Directories,SureWest Long Distance, SureWest Wireless, SureWest Broadband, SureWestTeleVideo and SureWest TeleVideo of Roseville (collectively, “SureWestBroadband/Residential Services”), SureWest Internet, and SureWest Custom DataServices (formerly Quiknet, Inc.).

The Company’s strategy is to be the first choice as adominant integrated communications provider in the Sacramento region. It seeksto achieve this position by leveraging its existing advanced fiber network toextend its operations throughout Sacramento, Placer and adjacent counties, byproviding superior customer service and by integrating its systems, productsand operating functions.

No customer accounted for more than 10% of the Company’sconsolidated operating revenues during the years ended December 31, 2005,2004 and 2003.

TheCompany currently divides its business into three reportable business segments:Telecommunications (“Telecom”), Broadband and Wireless. The table that followsreflects the percentage of total operating revenues of the Company generated byeach of its three business segments for the last three fiscal years:
| ** **                 | ** ** | **% of Total Operating Revenues** | ** ** |
|----------------------------|------------|-------------------------------------------------------|------------|
| **Reporting Segment** | ** ** | **2005**                                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Telecom                    |       | 61%                                                   |       | 67% |   | 71% |   |
| Broadband                  |       | 23%                                                   |       | 18% |   | 15% |   |
| Wireless                   |       | 16%                                                   |       | 15% |   | 14% |   |
| Total operating revenues   |       | 100%                                                  |       | 100% |   | 100% |   |

 

TheCompany’s products or services that generated 10% or more of its total operatingrevenues in any of the last three years are as follows:
| ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Local service                 |       | $        | 63,522     |     | $          | 69,560   |       | $ | 63,363 |   |
| Network access service        |       | $        | 44,214     |     | $          | 46,161   |       | $ | 51,286 |   |
| Wireless service              |       | $        | 34,205     |     | $          | 31,261   |       | $ | 27,146 |   |
| Residential broadband service |       | $        | 23,991     |     | $          | 17,077   |       | $ | 9,370 |   |

 

A summary of net operating revenues from externalcustomers, net income and assets for each of the business segments is found inNote 13 to the Consolidated Financial Statements, in Item 8, which isincorporated herein by reference. A discussion of factors potentially affectingour operations is set forth in Risk Factors in Item 1A, which is incorporatedherein by reference.

TheCompany currently generates the majority of its revenues from services that aresubject to regulation by either or both of the California Public UtilitiesCommission (“CPUC”) and the Federal Communications Commission (“FCC”). Revenuesfrom services subject to comprehensive regulation include local service andnetwork access service. The Company expects that the proportion of its revenues

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thatcomes from nonregulated or lightly regulated businesses will increase in futureyears because of the successful execution of its business strategy and theimpact of competition on its existing regulated operations. The table thatfollows reflects the percentage of total operating revenues of the Companycontributed by various sources.
| ** **                                                  | ** ** | **Rate Regulated Revenues as a  % of Total  Operating Revenues** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| **Revenues**                                                | ** ** | **     2005     **                                | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** |
| Revenues from services subject to  comprehensive regulation |       |                                                                                                | 49%        |   |   |   | 55% |   |   |   | 59% |   |   |
| Other revenues                                              |       |                                                                                                | 51%        |   |   |   | 45% |   |   |   | 41% |   |   |
| Total operating revenues                                    |       |                                                                                                | 100%       |   |   |   | 100% |   |   |   | 100% |   |   |

 

There continues to be increased competition facingtelecommunications providers. As a result of technology change and industry,legislative and regulatory developments, the Company continues to face newcompetitive challenges. These developments, however, have also provided theCompany with significant growth opportunities. The Company believes that growthfrom its entry into newer businesses in recent years will offset flat orslowing growth in customers in its other businesses, and that the newerbusinesses provide significant revenue opportunities not present before. Competitiveissues facing individual operating units are addressed in connection with theindividual segment discussions below.

As of December 31,2005, the Company had 906 employees, approximately 11% fewer than the number atDecember 31, 2004. In November 2004, the Company announced an earlyretirement offer, which was accepted by 59 employees in December 2004 andan additional 13 employees during the first quarter of 2005. Those employeeswho accepted the offer ultimately retired in February 2005. None of theCompany’s employees are represented by a union. The Company considers itsemployee relations to be positive.

**Telecom**

*General*

The Telecom segment includes SureWest Telephone,SureWest Directories and SureWest Long Distance, which provide landlinetelecommunications services, Digital Subscriber Line (“DSL”) services,directory advertising services, long distance services and certain relatednon-regulated services. The Telecom segment accounted for approximately 61%,67% and 71% of the Company’s operating revenue in the years 2005, 2004 and2003, respectively. Although revenues from this segment have decreased as apercentage of all Company revenues over the past several years, the Companyexpects this segment to continue to provide the largest proportion of itsrevenues and earnings in 2006.

SureWest Telephone operates as an incumbent localexchange carrier (“ILEC”) with a service area of approximately 83 square miles,covering Roseville and Citrus Heights, California, and adjacent areas in Placerand Sacramento Counties. The Company holds a non-exclusive perpetual franchisegranted by Section 7901 of the California Public Utilities Code. The areaserved by SureWest Telephone has been one of the most rapidly growing areas inCalifornia during the past two decades, but the pace of growth has slowed inrecent years as the area has become more developed. The rapid growth alsoattracted new competitors to the area.

SureWest Telephone’s primary services are localtelephone service, network access services, toll services and certain verticaland non-regulated services. Toll services and access to SureWest Telephone’snetwork are provided through connections with other carriers serving adjacentareas, including SBC Communications (“SBC”), and also through serviceagreements with numerous interexchange carriers, including nationalinterexchange carriers.

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SureWest Telephone provides services to residential,business and carrier customers, and continues to be subject to the competitiveand regulatory challenges faced by ILECs both nationally and in California. Asa result of competitive pressures, SureWest Telephone experienced a 2% decreasein total access lines from December 31, 2004 to December 31, 2005. Asof December 31, 2005, SureWest Telephone served 129,291 access lines. TheCompany believes that economic conditions in the area in 2005, expandingcompetition, and service substitution have impacted, and will continue toimpact, the number of access lines provided by SureWest Telephone.

The Telecom segment also includes the operations oftwo other businesses, SureWest Directories and SureWest Long Distance.

SureWest Directories publishes and distributesSureWest Telephone’s directory, including the sale of yellow pages advertising.SureWest Directories is also engaged in the business of producing, publishingand distributing directories in other Northern California communities outsideof SureWest Telephone’s service area. The SureWest Directories’ business facessignificant competition from national print and on-line directory publishersand other local businesses, including SBC. SureWest Directories’ business hasexpanded into electronic and on-line formats in 2005. The directory business isnot regulated by the FCC or CPUC; however, the revenues from publishing rightslicensed by SureWest Telephone under its contractual arrangement with SureWestDirectories are taken into account by the CPUC with respect to SureWestTelephone’s operations.

SureWest Long Distance offers intrastate, interstate,and international long distance services, including calling card and 800services. SureWest Long Distance is a resale business that utilizes othernational and international carriers for wholesale transport, switching andother capabilities. SureWest Long Distance maintains agreements with Sprint andGlobal Crossing to diversify its risks related to its wholesale providers. Therates offered to SureWest Long Distance by these companies are competitive;however, changes in the wholesale marketplace in the recent past have providedrecurring opportunities to long distance resellers to further reduce theircosts. During 2005, SureWest Long Distance renegotiated its agreement withSprint, entering into a long-term agreement securing more favorable rates. SureWestLong Distance maintains a month-to-month agreement with Global Crossing.

As of December 31,2005 and 2004, 40% and 36%, respectively, of the customers of SureWestTelephone chose SureWest Long Distance as their presubscribed long distanceprovider.

*Competition*

In recent years, competition to serve the customers ofSureWest Telephone has increased significantly. Changes in technology have madeit possible for customers to receive services in new ways at competitive rates.To meet the competition, SureWest Telephone has responded in part byintroducing new services and service “bundles,” offering services in convenientgroupings with package discounts and billing advantages, and by investing inits network and business operations. Changing technology requires that theCompany continue to adapt its network and the manner in which it providesservice. Within its telephone service area, services are provided over anintegrated network making extensive use of optical fiber. SureWest Telephonedeploys fiber optic facilities closer to an end user’s premises than itscompetition to broaden the reach and capacity of Company services requiringadditional bandwidth. In some instances, fiber optics is deployed directly to acustomer’s premises. Because bandwidth is limited by distance when utilizingcopper facilities, the Company also is deploying equipment throughout itsservice area to enable the improved provision of services. Certain of theCompany’s facilities take advantage of Internet protocol (“IP”), which allowsfor more efficient use of bandwidth.

See “Item 3–Legal Proceedings” and “Item 7–Management’sDiscussion and Analysis of Financial Condition and Results of Operations” forfurther discussion regarding SureWest Telephone’s revenues that are subject tothe competitive environment in which SureWest Telephone operates.

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The Company anticipatesthat its businesses will continue to experience competition and that the natureand extent of such competition will increase. Competitors to the SureWestTelephone business include competitive local exchange carriers, interexchangecarriers (including interexchange carriers which serve customers directlywithout using facilities of local exchange carriers), wireless serviceproviders (including SureWest Wireless), providers of IP-based callingservices, customers which are telecommunications self-providers, and a range ofother providers that specialize in certain niche areas of telecommunications. Technologychange has accelerated the pressure on established carriers, including SureWestTelephone, by virtue of software-defined businesses, and innovations related topacket switching and use of the Internet and IP capabilities.

*Regulation*

SureWest Telephone’s revenues are influenced greatlyby the actions of the CPUC and the FCC.

All intrastate telecommunications service rates ofSureWest Telephone are subject to comprehensive regulation by the CPUC. Theprovision of access to the networks of interexchange carriers for long distancecalling is governed by access tariffs and by intercarrier agreements, which aresubject to the jurisdiction of the CPUC or FCC, or both, depending upon thenature of the transmissions. SureWest Telephone has a tariff on file with theFCC for all elements of interstate access services except carrier common linecharges, for which SureWest Telephone concurs with the tariff of the NationalExchange Carrier Association (“NECA”).

The FCC monitors SureWest Telephone’s interstateearnings through the use of annual cost separation studies prepared by SureWestTelephone, which utilize estimated cost information and projected demand usage.The FCC establishes rules that carriers must follow in the preparation ofthe annual studies. Additionally, under current FCC rules governing ratemaking, SureWest Telephone is required to establish interstate rates based on projecteddemand usage for its various services and determine the actual earnings fromthese rates once actual volumes and costs are known.

The characterization of traffic as interstate orintrastate, and as a telecommunications or information service has been asignificant source of dispute among carriers and others in recent years, asthose characterizations can impact the regulatory treatment of the traffic andthe payment obligations of the providers which are involved. Thecharacterization of: (i) traffic involved in intercarrier interconnection,(ii) Internet traffic, and (iii) traffic that makes use of IP andother transmission technologies are examples of issues that are currentlysubject to analysis on the state and federal levels, and that are expected tobe subject to regulatory action in the near future. Both the FCC and CPUC haveinitiated proceedings to evaluate the appropriate level of regulation forproviders of telecommunications services and for IP-enabled services. Inaddition, various proceedings at the FCC are pending that could lead tosignificant alteration of the existing compensation arrangements amongproviders of telecommunications services, and that could adversely impact theamount of the payments received by the Company from carriers and others for useof the Company’s network.

In 1996, the CPUC issued a decision that authorizedSureWest Telephone to implement a New Regulatory Framework (“NRF”) for servicesfurnished within SureWest Telephone’s service area in order to accommodate marketand regulatory movement toward competition and greater pricing flexibility.Under the NRF, SureWest Telephone is subject to ongoing monitoring andreporting requirements, and it was initially required to share earnings withcustomers through a reduction of revenues if its earned annual rate-of-returnexceeds that authorized by the CPUC.

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The Company was involved in a proceeding at the CPUCthat considered the continued need for certain sharing requirements in theintrastate jurisdiction and, in connection with that review, also consideredthe issue of whether the Company overearned in the intrastate jurisdiction inrecent monitoring periods and the amount of overearnings that should be sharedwith customers. In July 2004, the Company entered into a settlementagreement (“the settlement agreement”) with the other parties in the proceeding,the Office of Ratepayer Advocates (“ORA”) and The Utility Reform Network(“TURN”), to resolve all issues in the proceeding. In November 2004, theCPUC approved the settlement agreement. The settlement agreement resolvedexisting intrastate sharing obligations and related earnings issues for themonitoring periods 2000 through 2004, put into place a surcredit mechanism forthe amount of the settlement, and suspended the requirement for any intrastatesharing for monitoring periods from January 1, 2005 through at leastDecember 31, 2010. The settlement agreement resulted in SureWest Telephonerecognizing an increase in local revenues of $2,948 due to a change inaccounting estimate in the fourth quarter of 2004. This increase in revenuesresulted in a decrease of the Company’s net loss by $2,046 ($0.14 per share)during 2004.

In accordance with the settlement agreement, SureWestTelephone will return approximately $6,500 plus interest at the 90-daycommercial paper rate for non-financial institutions, which was 4.23% as of December 31,2005, and an imputed rate of 3.15%, to its end users through a consumerdividend over a period of four years, which began January 1, 2005. For theyear ended December 31, 2005, approximately $1,655 was returned to the endusers. In addition, SureWest Telephone will pay a one-time consumer dividend of$2,600, which includes an annual imputed interest rate of 3.15% (no statedcontractual interest rate), over two years, which began January 1, 2005 tosettle the monitoring periods 2000 to 2004. For the year ended December 31,2005, approximately $1,210 was returned to the consumers and was recorded as areduction of the Company’s contractual shareable earnings obligations. At December 31,2005, the aggregate contractual shareable earnings obligation for thesesurcredits was $6,627 (which is net of an unamortized discount pertaining toimputed interest of $274 at that date).

Further, commencing January 1, 2007, SureWestTelephone will implement an annual consumer dividend of $1,300 to end-usersreceiving SureWest Telephone services subject to sharing on or after that date;however, this consumer dividend is subject to reduction based upon the resultsof other pending regulatory proceedings.

During the fourth quarter of 2005, the Company filedan Advice Letter with the CPUC proposing an increase to the consumer dividendsin order to return the amounts entitled under the settlement agreement. Thechange in the consumer dividends resulted from the increase in interest ratesduring 2005. The increase was effective January 1, 2006.

In addition to its regulatory authority with respectto SureWest Telephone’s rates, the CPUC also has the power, among other things,to establish terms and conditions of service, to prescribe uniform systems ofaccounts and to regulate the mortgaging or disposition of public utilityproperties.

Prior to 2000, SBC had been paying SureWest Telephoneapproximately $11,500 per year for extended area service (“EAS”) pursuant to aSettlement Transition Agreement. In November 2000, the CPUC authorized SBCto terminate its approximate annual EAS payments to SureWest Telephoneeffective November 30, 2000. The CPUC authorized replacement funding toSureWest Telephone on an interim basis using funds from the California HighCost Fund (“CHCF”). The CHCF is a program designed by the CPUC to establish afair and equitable local rate structure and to reduce any disparity in therates charged by telephone companies serving high-cost areas. The CHCF isscheduled to expire January 1, 2009. In addition, the CPUC opened an OrderInstituting Investigation (“OII”) for the purpose of determining whether futurerecovery of all, none or a portion of the approximate $11,500 annual paymentspreviously received from SBC and received currently from the CHCF, should comefrom SureWest Telephone’s ratepayers or other regulatory recovery mechanisms.

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In August 2005, the CPUC adopted a decision which(i) authorized SureWest Telephone to continue receiving $11,500 annuallyfrom the CHCF to offset its intrastate regulated operating expenses on aninterim basis, (ii) required SureWest Telephone to prepare and submit acost proxy model (which is used generally as a basis for CHCF-B funding) basedon its current cost data, including analyses of the resulting impacts on rates,on the Universal Lifeline Telephone Service (“ULTS”) fund, and on the CHCFfund, to be filed by SureWest Telephone within 12 months, and (iii) authorizedSureWest Telephone to file an Advice Letter with the Commission’sTelecommunications Division to implement reductions to its business access linerates. The results of this proceeding and the potential effects on SureWestTelephone could impact future funding levels through the CHCF.

These actions of the CPUC and of the FCC, as notedabove, can affect the rates charged for access and interconnection, and, as aresult, the revenues derived by the Company from access and related services.SureWest Telephone’s future operations also may be impacted by otherproceedings at the FCC and CPUC, including proceedings that address interstateaccess and other rates and charges, the nature of interconnection betweenincumbent local exchange carriers and others, the collection and distributionof support payments required to assure universal access to basic telephoneservices, and the charges that can be assessed for new forms of service thatdirectly or indirectly utilize carrier networks.

Substantially all of theinterstate long distance business was detariffed in 2001. The long distancebusiness is recognized as being fully competitive, and there are many providersof long distance services. The emergence from bankruptcy reorganizationproceedings of some larger interexchange and competitive local exchangecarriers has created new competitive pressures in the sector for both wholesaleand retail providers. Because of the level of competition, regulation of thisarea of the telecommunications business is light or has been removed altogether.Where it exists, regulation is focused on specific public policy concerns, suchas customer account slamming, rather than the rates, terms and conditions ofservice.

**Broadband**

*General*

The Broadband segment includes SureWest Broadband,SureWest Internet, SureWest Custom Data Services and SureWestBroadband/Residential Services. The Broadband segment also includes acompetitive local exchange carrier (“CLEC”), which was authorized by the CPUCin 1998 to provide telecommunications services in areas outside the telephoneservice area of SureWest Telephone. As of January 1, 2003, the Companyconsolidated the operations of SureWest Internet and SureWest Custom DataServices into the operations of SureWest Broadband for financial reportingpurposes, though they remain separate legal entities. In addition, as of January 1,2004, the Company consolidated the operations of SureWest Broadband, SureWestTeleVideo and SureWest TeleVideo of Roseville for financial reporting purposes,though they remain separate legal entities.

The Broadband segment provides various services toresidential, business and carrier customers. The services include: high-speedInternet service; digital video; voice, network access and toll telephone; andcustom data solutions, including collocation, fixed and burstable bandwidth,managed services and network monitoring services. Most of these services wereinitially offered in the greater Sacramento area, principally to customersresiding outside of SureWest Telephone’s service area. However, over time, allof SureWest Broadband’s services have been made available to customers withoutregard to service area boundaries and, commencing in December 2003,SureWest Broadband began providing digital video and high-speed Internetservices to customers within SureWest Telephone’s service area.

SureWest Broadband owns two 39 gigahertz LocalMultipoint Distribution System (“LMDS”) licenses, which provide coverage inparts of eleven different counties in the greater Sacramento area. Theselicenses allow SureWest Broadband to expand its network within these areas byusing wireless technology for extra transmission capacity backhaul. During2004, SureWest Broadband also began using these licenses to offer 

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a fixed wireless service to customers outside ofSureWest Telephone’s service area in parts of the cities of Lincoln and Rocklin,California. During 2005, SureWest Broadband further expanded its fixed wirelessservice by offering this service to customers in other areas in Sacramento andPlacer Counties. In addition, SureWest Broadband will continue to use thiswireless technology for backhaul in cost effective areas.

SureWest Broadband/Residential Services possess cabletelevision licenses or franchises in Sacramento and Placer counties, the citiesof Roseville and Lincoln, California and has expanded its services topreviously licensed areas of Elk Grove and Natomas, California as well as otherareas within its service area footprint. The Company is authorized to providevideo programming to substantially all of the residents in the SureWestTelephone service area.

SureWest Broadband/Residential Services procuresdigital transport capability from its affiliate, SureWest Telephone, and hasdeveloped an advanced method of delivering video services to subscribers usingInternet protocol, or IP-video capability.

The Broadband segment utilizes a digital fiber networkand is subject to continual expansion and diversification in response tobusiness growth. The Company expects that each of its segments operating inRoseville and other parts of SureWest Telephone’s service area should benefitfrom the Company’s offerings of telecommunications, cable television andInternet services.

The Broadband segmentaccounted for approximately 23%, 18% and 15% of the Company’s operatingrevenues in the years 2005, 2004 and 2003, respectively. As of December 31,2005, the Broadband segment had 47,110 customers.

*Competition*

The businesses in the Broadband segment are subject toextensive competition. Competition is highly fragmented, and has growndramatically in recent years. Except for the digital video delivery business,which requires significant capital investment to serve designated serviceterritories, the barriers to entry are not high, and technology changes forcerapid competitive adjustments.

SureWest Broadband competes regularly against SBC, whichis the incumbent local exchange carrier in Sacramento and most of itssurrounding areas, and which possesses significantly greater size and scale.The Broadband segment also competes against Frontier Communications in southernSacramento County. Numerous CLECs and others offer telecommunications andrelated services on a flexible and highly specialized basis in the Sacramentoarea. The Company has found that it can be successful by constantly seeking outnew sales opportunities in attractive segments of the market, by maintaining ahighly reliable network that is accessible to new customers, and by focusing onthe provision of excellent service to its customers. To the extent permitted bylaw and regulatory requirements, the Company seeks to operate its businessacross the Broadband segment in an integrated manner, and its network as asingle integrated facility. The operating units in this segment benefit withinthe region from the name recognition and reputation of SureWest, and from theactive participation of Company executives and employees in civic and othergroups. During 2003, the Company was able to obtain approval from theSacramento Metropolitan Cable Television Commission to activate service forcustomers in “green field” areas that were previously outside of the Company’sapproved build-out and activation schedules. It now anticipates that it willachieve a competitive market share in the provision of telephone, digital videoand Internet services in many of these areas around Sacramento. It is importantto the Company that its operations in this segment be able to deliver servicesto customers in developing areas as they grow. The Company is also consideringwhether a modification or expansion of its service territory in SacramentoCounty is appropriate.

The Broadband segment has assumed the responsibilityfor much of the Company’s DSL and high-speed Internet retail customer base. Theemergence of cable modems, wireless Internet access and other avenues 

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to reach the Internet provide significant competition.The presence of other broadband Internet access providers has begun to exertdownward pressure on pricing in the region.

The market faced by theCompany among multichannel video providers is very competitive. The maincompetitors of SureWest Broadband/Residential Services are Comcast and varioussatellite television providers. In the Company’s opinion, the Comcastorganization possesses significant market power in Sacramento County. However,the governing Sacramento County Commission promotes competition in theprovision of cable service, and has a straightforward franchise and licensingordinance that accommodates other new entrants rapidly, and allows themflexibility in defining service territories. SureWest has entered theSacramento, Roseville and Lincoln cable service markets as the second (orsubsequent) franchisee, and while it will, therefore, benefit from the somewhatreduced regulation that such entrants enjoy, it will nevertheless face thechallenge of drawing customers away from the incumbent provider. The provisionof cable television over a closed transmission path has been recognized aspossessing certain monopoly characteristics and, therefore, the ability of asecond or subsequent provider to succeed in the marketplace is not assured.Similarly, the possession of comparative size and scale can give a competitoran advantage in both access to and pricing of the program content needed tooperate a cable television business, and Comcast possesses significantlygreater size and scale in Sacramento than the Company.

*Regulation*

Like SureWest Telephone, SureWest Broadband mustcomply with various rules of the CPUC governing tariffs, access toinformation, consumer protection and similar matters for a telecommunicationservice provider. The FCC has jurisdiction over the SureWest Broadbandinterstate services, such as access service. In 2001, the FCC adoptedrules that have caused CLEC interstate switched access charges to declineover time, and that have also caused a decline in the amount of compensationthat can be derived from Internet Service Provider dial-up traffic. SureWestBroadband is only minimally affected by these actions, and has already modifiedits rates to comply with the FCC requirements.

In late 2001, the FCC began a Triennial Review of itspolicies on unbundled network elements (“UNEs”) and other regulations thataffect the nature of competition between ILECs and CLECs. The FCC concluded itsTriennial Review in early 2003, and its action was appealed by a number ofparties. The appellate court reversed the FCC and vacated significant portionsof the FCC rules in a decision that was released in early March 2004,but stayed its mandate for a short time. Subsequently, the FCC released a newdecision with modified rules. That new decision also has been appealed.SureWest Broadband does not rely to any significant degree on UNEs or otherofferings that would be affected by these appeals, and it does not relygenerally on the availability of discounted incremental cost pricing of serviceelements from the incumbent local exchange carrier to serve retail customers.However, the position of SureWest Broadband in the Sacramento market could beaffected by a change in law or regulation that granted unrestricted pricingflexibility to the incumbent local exchange carrier in Sacramento or thatdenies competitors the ability to assure that pricing concessions given tocustomers are nondiscriminatory and offered on a consistent basis.

The cable televisionbusiness is governed by federal, state and local laws and regulation, but ismost substantially controlled by the mechanisms in Title VI of theCommunications Act of 1934, as amended. While closely regulated in some areas,providers of cable services are generally free from rate regulation, and havewide leeway to select and package the content that they deliver. In exchangefor their use of local streets and rights of way, cable providers are requiredto pay franchise fees, and to deliver public, educational and governmentalchannels for use by the community, among other things.

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**Wireless**

*General*

The Wireless segmentconsists of the Company’s subsidiary SureWest Wireless which was formedfor the purpose of providing wireless personal communications services (“PCS”).PCS is viewed generally as involving the capability to deliver a more advancedset of features and capabilities than the basic form of cellular mobileservice. SureWest Wireless derives its revenue from the provision of wirelessPCS, and the sale of handsets and related communications equipment. Inaddition, SureWest Wireless generates revenue from long distance calls, roamingservice, custom calling and other features.

SureWest Wireless has FCC licenses that allow it tooffer wireless services in four Basic Trading Areas, representing 16 countieslocated in central California. These areas include the cities of Sacramento,Stockton, Modesto and Yuba City. Each license represents 10 megahertz ofspectrum, and accommodates digital wireless technology that is capable ofproviding both voice and data transmission.

SureWest Wireless established its market share in theSacramento market in large part by promoting an unlimited flat rate regionalcalling plan. Wireless customer acquisition has historically been most activeduring the December holiday season, and the Company has always been activein sales and marketing at this time. In recent years, including 2005, SureWestWireless initiated a number of new service options for customers, includingadditional regional plans, an unlimited national plan, a family plan and newvertical services (such as wireless data capabilities), which have attractednew customers. Evolution of the marketplace has prompted SureWest Wireless toopen five retail stores in its service area. SureWest Wireless has been seekingto expand its service penetration among major accounts during 2005, whileseeking to reduce customer turnover (“churn”) and to increase revenues from itscustomer base.

The wireless business requires capital investment tobuild new cell sites and to deploy digital and other advanced servicecapabilities. In 2006, capital investment in SureWest Wireless will emphasizecontinued improvements in service levels rather than network expansion.

As of December 31,2005, SureWest Wireless had 53,858 subscribers. The Wireless segment accountedfor approximately 16%, 15% and 14% of the Company’s operating revenue in theyears 2005, 2004 and 2003, respectively.

*Competition*

The market for wireless services is highlycompetitive. There are numerous facilities-based wireless providers in theSacramento market, including all of the major national providers, andadditional wireless resellers. Most of these competitors have a nationalpresence and, therefore, have the ability to leverage national advertisingbudgets and name recognition. In addition, many of the competitors have accessto additional spectrum in the geographic markets in which SureWest Wirelesscompetes. In order for SureWest Wireless to succeed in this geographic market,it must establish innovative services, such as its unlimited flat rate servicepackage, and continue to leverage the SureWest name and reputation. A trendtoward consolidation in this segment has begun to emerge, with the announcementof merger agreements involving some of the largest wireless providers.Competition in this segment is expected to remain intense.

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

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*Regulation*

Because of their use ofvaluable spectrum resources, wireless services are subject to regulation. Theconstruction, operation, management and transfer of digital wireless systems inthe United States are regulated by the FCC and CPUC. However, regulators do notinterfere with price plans offered to wireless customers.

**Other Significant Events**

*Sale of PayTelephone Assets*

In July 2005, theCompany sold its pay telephone assets for $220 to a nationwide provider ofprivate pay telephone services. During the quarter ended June 30, 2005,the Company incurred a pretax asset impairment charge of $189, which wasrecorded in the Company’s consolidated statements of operations as depreciationand amortization expense. The asset impairment charge reduced the carryingvalue of the pay telephone assets within the Telecom segment to its fair valueof $198, which represented the expected proceeds from the sale of assets.

*WorldCom BankruptcySettlement*

Certain of the Company’s customers filed forbankruptcy protection in 2002, the most notable of which was WorldCom, Inc.(“WorldCom”), which, together with its affiliates (collectively “MCI”), filedfor bankruptcy protection in July 2002. In April 2004, MCI emergedfrom federal bankruptcy protection. In October 2005, the Company resolvedits claim filed in January 2003 related to pre-petition accountsreceivable, and to a conditional payment made by the Company to MCI inconnection with anticipated overearnings during the 1999-2000 monitoringperiod.

In accordance with the MCIPlan of Reorganization, the Company in October 2005 received adistribution of cash and stock, with a combined fair value of approximately$1,400. The distribution was recognized in the Company’s consolidated statementof operations as an increase to network access service revenue and a decreaseto general and administrative expense of $800 and $600, respectively. As of December 31,2005, the Company held 31,292 shares of MCI common stock with an aggregatecarrying value of approximately $617. The Company’s investment in MCI commonstock is classified as an available-for-sale, short-term investment in theconsolidated balance sheet. In October 2005, MCI shareholders approved amerger with Verizon Communications Inc. (“Verizon”). The merger was finalizedin January 2006.

**Executive Officers**

*Kirk C. Doyle; age52; Chairman of the Board of Directors*

Mr. Doyle has served asChairman of the Board of Directors since 2003, and has been a Director since2000. He has been a realtor with and the owner of Kirk Doyle Realty ofRoseville, California since 1982.

*Steven C. Oldham;age 55; President and Chief Executive Officer*

Mr. Oldham has served asPresident and Chief Executive Officer since January 1, 2006, and as amember of the Board of Directors since 2004. He retired from Sierra PacificResources, a Nevada utility holding company in 2002 as Senior Vice President,Energy Supply, after a 26-year career during which he held variouspositions in its accounting, finance and regulatory departments. From 1999 to2001, while at Sierra Pacific Resources, he served as Senior Vice President,Corporate Development and Strategic Planning. After retiring from SierraPacific Resources, Mr. Oldham served as a consultant to The Brattle Group,which provides consulting services and expert testimony on economic, finance,regulatory and strategic issues in various industries.

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*Philip A. Grybas;age 58; Senior Vice President and Chief Financial Officer*

Mr. Grybas has served asSenior Vice President and Chief Financial Officer since he joined the Companyin 2004. Prior to joining the Company, Mr. Grybas served from 2001 to 2004as Vice President, Treasurer, and Chief Financial Officer of Warwick ValleyTelephone Company of Warwick, New York, a local telephone company servingcustomers in New York and New Jersey. Before joining Warwick Telephone in 2001,he consulted with TEG, a performance management analyst firm headquartered inIndianapolis, Indiana.

*Fred A. Arcuri; age53; Senior Vice President and Chief Operating Officer*

Mr. Arcuri has served asSenior Vice President and Chief Operating Officer since January 1, 2006. From2002 to 2005, he served as Senior Vice President and Chief Operating Officer ofSureWest Broadband, after being elected a Vice President in 2000.

*Scott K. Barber; age45; Vice President, Network Operations*

Mr. Barber has served asVice President, Network Operations since 2003. From 2000 to 2003, he served asExecutive Director, Network Services.

*Bill M. DeMuth; age56; Vice President and Chief Technology Officer*

Mr. DeMuth has served asVice President and Chief Technology Officer since 2000.

*Peter C. Drozdoff;age 50; Vice President, Marketing*

Mr. Drozdoff has served asVice President, Marketing since 2002. From 2000 to 2002, he served as ExecutiveDirector, Corporate Marketing.

*Mark W. Triplett;age 44; Vice President, Sales*

Mr. Triplett was electedVice President, Sales in 2005. Prior to his election as Vice President, heserved as Executive Director, Sales from 2004 to 2005. Mr. Triplett joinedthe Company in 2002 as General Manager of SureWest Directories. Prior tojoining the Company, from 2000 to 2002 he was Vice President of the federalgovernment division and Vice President of Business Development of VitriaTechnology, a software and services firm in the telecommunications industry.

*Thomas P. Villa;age 46; Vice President, Customer Operations*

Mr. Villa was elected VicePresident, Corporate Operations in 2005. Prior to his election as VicePresident, he served as General Manager of SureWest Broadband from 2003 to 2005.Prior to joining the Company, from 2001 to 2003 he was Director–West AreaCustomer Service for Verizon Wireless.

*Darla J. Yetter;age 45; Corporate Secretary*

Ms. Yetter was electedCorporate Secretary in 2003. Since 1994, she has served as Assistant to thePresident.

**Available Information**

The Company’s AnnualReport on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and amendments to reports filed pursuantto Sections 13(a) and 15(d) of the Securities Exchange Act of 1934,as amended, are available on our website at ***www.surw.com/ir/***, as soon as reasonably practicable after those reports areelectronically filed with or furnished to the Securities and 

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Exchange Commission.Copies are also available free of charge upon request to SureWestCommunications, P.O. Box 969, Roseville, CA 95678, Attn:  Investor Relations Manager.

**Item 1A.**                RiskFactors.

As a result of the following factors, as well as othervariables affecting our operating results, past financial performance may notbe a reliable indicator of future performance, and historical trends should notnecessarily be used to anticipate results or trends in future periods.

Representative examples of these factors include(without limitation) the following:

*We expect to continue to face significant competitionin all parts of our business and the level of competition is expected tointensify.*   The telecommunications industry is highlycompetitive. We face actual or potential competition from many existing andemerging companies, including other incumbent and competitive local telephonecompanies, long-distance carriers and resellers, wireless telephone companies,Internet service providers, satellite companies and cable television companies.We may not be able to successfully anticipate and respond to variouscompetitive factors affecting the industry, including regulatory changes thatmay affect our competitors and us differently, new technologies and servicesthat may be introduced, changes in consumer preferences, demographic trends anddiscount pricing strategies by competitors. As the incumbent carrier inSacramento, SBC Communications enjoys certain business advantages, includingits size, financial resources, favorable regulatory position, brand recognitionand connection to virtually all of our customers and potential customers there.As the largest cable operator in Sacramento and Placer County, Comcast enjoyscertain business advantages, including its size, financial resources, ownershipor superior access to programming and other content, brand recognition, andfirst-in-the-field advantages with a customer base that generates positive cashflow for its operations. We face intense competition in our markets forlong-distance, Internet access and other ancillary services that are importantto our business and to our growth strategy.

*We must adapt to rapid technological change.*   Technologicaldevelopments could increase our costs and cause a decline in demand for ourservices. In addition, technology changes can reduce the costs of entry forothers and give competitors significant new advantages. If we do not replace orupgrade technology and equipment that becomes obsolete, we will be unable tocompete effectively because we will not be able to meet the needs orexpectations of our customers, and we may be placed at a cost disadvantage inoffering our services. Additionally, replacing or upgrading our infrastructurein the future could result in significant capital expenditures.

*We are subject to a complex and uncertain regulatoryenvironment.**  *Some parts of ourbusiness are extensively regulated, and the nature of regulation continues toundergo fundamental change and reinterpretation. Many businesses that competewith the Company are comparatively less regulated. Many significant regulatorydecisions have had to be accommodated in recent years, and there are pendingdecisions on issues affecting the Company that are of great importance.

*Our operations have undergone material changes, andour actual operating results can be expected to differ from the resultsindicated in our historical financial statements.*   As a resultof our 2002 acquisition of assets, which launched our residential broadbandbusiness, and the subsequent expansion of our cable television business, ourmix of operating assets differs from those operations upon which our historicalfinancial statements are based. Consequently, our historical financialstatements may not be reliable as an indicator of future results.

*Our success depends upon our ability to manage ourgrowth and expansion. If our recent acquisitions and growth initiatives are notsuccessful, we could suffer an adverse effect on our business and results ofoperations.*   Our growth strategy will continue to requireus to invest significant capital in facilities 

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and services that may notachieve the desired returns. Our future success depends, in part, upon ourability to manage our growth, including our ability to build network andrelated facilities to serve new customers, integrate our operations to takeadvantage of new capabilities and systems; attract and retain skilled personnelacross the Company, effectively manage the demands of day to day operations innew areas while attempting to execute our business strategy, and realize theprojected growth and revenue targets developed by Company management.

*We receive support from various funds establishedunder federal and state law and the continued receipt of that support is notassured.*   While we do notreceive any support from the rural or non-rural Federal Universal Service highcost loop fund, we do receive payments from various other federal or stateprograms. These include interstate common line support, California High CostFund–B (“CHCF”) and the Lifeline, Education and Libraries programs. Thesegovernmental programs are reviewed and amended from time to time, and arelikely to change in the near future. As described in the Telecom–Regulation section above, theCompany currently receives funding of $11,500 annually from the CHCF, a programdesigned by the California Public Utilities Commission (“CPUC”) to establish afair and equitable local rate structure and to reduce any disparity in therates charged by certain telephone companies serving high-cost areas. Theamount of this support from the CHCF is the subject of pending regulatoryproceedings, and its continuation is dependent upon many factors. In addition,the state legislative authorization for the CHCF is scheduled to expire January 1,2009. The outcome and impact on the Company’s operations resulting from futurechanges to these governmental programs cannot be determined at this time.

*We could be harmed by the recent developmentsaffecting other communications companies.*   Therehave been numerous bankruptcies and other financial difficulties experienced byother carriers and suppliers in the telecommunications and Internet sectors. Similarsituations with our suppliers, some of whom provide products and services forwhich there are few substitutes, could cause us to experience delays, serviceinterruptions or additional expenses. Situations with carrier and othercustomers could affect our ability to collect services that have been provided.

*We depend on third parties, over whom we have nocontrol, to deliver our services.*   Becauseof the interconnected nature of the telecommunications industry, we dependheavily on other local telephone companies, long-distance carriers, andnumerous other third parties to deliver our services. In addition, we aredependent on easements, franchises and licenses from various private partiessuch as established telephone companies and other utilities, railroads,long-distance companies, and from state highway authorities, local governmentsand transit authorities for access to aerial pole space, underground conduitsand other rights-of-way in order to construct and operate our networks. Thefailure to maintain in effect the necessary third party arrangements onacceptable terms would have an adverse effect on our ability to conduct ourbusiness.

*We are subject to corporate governance and internalcontrol reporting requirements, and our failure to comply with existing andfuture requirements could adversely affect our business.*   Pursuant to Section 404 of the Sarbanes-OxleyAct of 2002 (“Section 404”) and related Securities and Exchange Commissionrules, we have issued a report of management’s assessment of the effectivenessof our internal controls at December 31, 2005. In addition, ourIndependent Registered Public Accounting Firm audited and reported onmanagement’s assessment. Management concluded that the Company’s internalcontrol over financial reporting was effective at December 31, 2005. If weare unable to maintain effective internal controls or if future deficienciesare not adequately addressed, we could experience accounting errors that couldresult in misstatements of our financial position and results of operations,potential restatements of our financial statements or otherwise adverselyaffect our business, reputation and results of operations. Inferior internalcontrols could also cause investors to lose confidence in our reportedfinancial information, which could have a negative effect on the trading priceof our securities.

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**Item 1B.**               UnresolvedStaff Comments.

None.

**Item 2.**                        Properties.

The Company owns andleases office facilities and related equipment for executive headquarters,administrative personnel, central office buildings, and operations inRoseville, Citrus Heights, Granite Bay, and other locations in Sacramento andPlacer Counties. The Company’s executive headquarters, principal business andadministrative office, and operations facility, which are located in Roseville,consist of 261,107 square feet. The Company leases a 213,871 square footfacility in McClellan Park (Sacramento County), which is used by all of itssegments. The Company has appropriate easements, rights of way and otherarrangements for the accommodation of its pole lines, underground conduits,aerial and underground cables and wires, and wireless towers and antennas. SeeNote 9 in the Notes to Consolidated Financial Statements and “Item 7–Management’sDiscussion and Analysis of Financial Condition and Results of Operations” forinformation regarding the Company’s lease obligations.

In addition to land andstructures, the Company’s property consists of equipment necessary for theprovision of communication services. This includes central office equipment,customer premises equipment and connections, radio and wireless antennas,towers, pole lines, video head-end, remote terminals, aerial and undergroundcable and wire facilities, vehicles, furniture and fixtures, computers andother equipment. The Company also owns certain other communications equipmentheld as inventory for sale or lease.

In addition to plant andequipment that it wholly-owns, the Company utilizes poles, towers and cable andconduit systems jointly-owned with other entities, and leases space onfacilities to other entities. These arrangements are in accordance with writtenagreements customary in the industry.

**Item 3.****                        LegalProceedings****.**   (Dollars inthousands)

Except for the proceedingsdescribed below, the Company is not aware of any material pending legalproceedings, other than ordinary routine litigation incidental to its business,to which it is a party or to which any of its property is subject.

Prior to January 1,2002, SureWest Telephone billed SBC Communications (“SBC”) various charges forcertain local service and network access service revenues in accordance withcertain agreements as described below. In 1999, SBC expressed interest inwithdrawing from the designated carrier plan (“DCP”) for SureWest Telephone’stoll traffic. The DCP was a compensation arrangement between SureWest Telephoneand SBC for certain intrastate toll services. SureWest Telephone and SBC agreedto allow the DCP arrangement to expire in December 2001. The terminationof the DCP did not have a material impact on the Company’s consolidatedfinancial position as of December 31, 2002 or results of operations forthe year then ended.

Prior to 2000, SBC hadbeen paying SureWest Telephone approximately $11,500 per year for extended areaservice (“EAS”) pursuant to a Settlement Transition Agreement. In November 2000,the California Public Utilities Commission (“CPUC”) authorized SBC to terminateits annual EAS payments to SureWest Telephone effective November 30, 2000.The CPUC authorized replacement funding to SureWest Telephone on an interimbasis using funds from the California High Cost Fund (“CHCF”). The CHCF is aprogram designed by the CPUC to establish a fair and equitable local ratestructure and to reduce any disparity in the rates charged by telephonecompanies serving high-cost areas. The CHCF is scheduled to expire January 1,2009. In addition, the CPUC opened an Order Instituting Investigation (“OII”)for the purpose of determining whether future recovery of all, none, or aportion of the approximate $11,500 annual payments previously received from SBCshould come from SureWest Telephone’s ratepayers or other regulatory recoverymechanisms.

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In August 2005, theCPUC adopted a decision which (i) authorized SureWest Telephone tocontinue receiving $11,500 annually from the CHCF to offset its intrastateregulated operating expenses on an interim basis, (ii) required SureWestTelephone to prepare and submit a cost proxy model (which is used generally asa basis for CHCF-B funding) based on its current cost data, including analysesof the resulting impacts on rates, on the Universal Lifeline Telephone Service(“ULTS”) fund, and on the CHCF fund, to be filed by SureWest Telephone within12 months, and (iii) authorized SureWest Telephone to file an adviceletter with the Commission’s Telecommunications Division to implementreductions to its business access line rates. The results of this proceedingand the potential effects on SureWest Telephone could impact future fundinglevels through the CHCF.

In 1996, the CPUC issued adecision that authorized SureWest Telephone to implement a New RegulatoryFramework (“NRF”) for services furnished within SureWest Telephone’s servicearea in order to accommodate market and regulatory movement toward competitionand greater pricing flexibility. Under the NRF, SureWest Telephone is subjectto ongoing monitoring and reporting requirements, and it was initially requiredto share earnings with customers through a reduction of revenues if its earnedannual rate-of-return exceeds that authorized by the CPUC.

In accordance with therequirements of its general rate case order, SureWest Telephone filed anapplication for review of its NRF in 1999. In connection with this proceeding,the CPUC’s Office of Ratepayer Advocates (“ORA”) undertook a verification auditof SureWest Telephone’s non-regulated and affiliated transactions pursuant tothe general rate case and other CPUC orders. In June 2001, the CPUCadopted its decision in this matter (the “Decision”). The Decision did notsuspend the sharing mechanism as SureWest Telephone had requested, and furtherprovided that SureWest Telephone must change the method used to allocate costsfor services provided by SureWest Telephone to its affiliates, the treatment ofcertain directory revenues and the treatment of internal-use software costs.Additionally, in accordance with the provisions of the Decision, the Companyrecorded certain liabilities and reductions of revenues relating to estimatedintrastate shareable earnings obligations.

SureWest Telephone’soperations may also be impacted by the Telecommunications Act of 1996 (the “Act”).The Act significantly changed the regulatory environment for telecommunicationscompanies. Beginning in 1996, the Federal Communications Commission (“FCC”)conducted proceedings and adopted orders implementing the Act’s provisions toopen local exchange service markets, such as the market of SureWest Telephone,to competition. These proceedings and orders address the regulation ofcompeting telecommunications companies, interconnection, access charges anduniversal service.

Given the ongoingactivities of the FCC to promulgate rules and regulations on competition,interconnection, access charges, and universal service reform, and the variouson-going legal challenges considering the validity of these FCC orders, it isnot yet possible to determine fully the impact of the Act and related FCCregulations on SureWest Telephone’s operations.

There are a number ofother regulatory proceedings occurring at the federal and state levels that mayhave a material impact on SureWest Telephone. These regulatory proceedingsinclude, but are not limited to, consideration of changes to the jurisdictionalseparations process, the interstate universal service fund, intercarriercompensation access charge reform and the regulation of local exchange carriersand their competitors, including providers of IP-enabled services. The outcomesand impact on SureWest Telephone’s operations of these proceedings and relatedcourt matters cannot be determined at this time.

The regulatory proceedingsoccurring at the state and federal levels described above may also broaden thescope of competition in the provision of regulated services and change therates and rate structure for regulated services furnished by SureWestTelephone, the effects of which on SureWest Telephone cannot yet be determined.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders.

No matters were submittedto a vote of security holders during the fourth quarter of 2005.

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**PART II**

**Item 5.**                        Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities.

TheCompany’s common stock is traded on the Nasdaq National Market (“NASDAQ”) underthe symbol “SURW.” As of February 17, 2006, there were approximately10,477 beneficial owners based on the number of record holders of the Company’scommon stock. The following table indicates the range of stock closing pricesof the Company’s common stock as reported on the NASDAQ, for each of thequarters indicated:
| ** **               | ** ** | **NASDAQ National Market** | ** ** |
|--------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **High**                             | ** ** | **Low** | ** ** |
| March 31,  2004     |       | $                                    | 40.00      |   | $ | 25.65 |   |
| June 30,  2004      |       | $                                    | 32.23      |   | $ | 25.25 |   |
| September 30,  2004 |       | $                                    | 31.28      |   | $ | 25.50 |   |
| December 31,  2004  |       | $                                    | 30.12      |   | $ | 27.30 |   |
| March 31,  2005     |       | $                                    | 28.15      |   | $ | 22.26 |   |
| June 30,  2005      |       | $                                    | 25.95      |   | $ | 19.63 |   |
| September 30,  2005 |       | $                                    | 29.23      |   | $ | 24.01 |   |
| December 31, 2005   |       | $                                    | 29.39      |   | $ | 24.02 |   |

 

The Company paid cash dividends on its common stock of$0.25 per share for each quarter of 2005 and 2004.****See “Part II, Item 7–Management’s Discussion andAnalysis of Financial Condition and Results of Operations–Liquidity and CapitalResources” for a discussion regarding restrictions on the payment of dividends.Additional information concerning dividends may be found in “Selected FinancialData” in Item 6 and in Item 8, which are incorporated herein by reference.

During the year ended December 31,2005, no equity securities of the Company were sold by the Company which werenot registered under the Securities Act of 1933, as amended.

**Item6.**                        SelectedFinancial Data.
| ** **                                       | ** ** | **2005**                                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                       | ** ** | **(Amounts in thousands, except per share amounts)** | ** ** |
| Total operating revenues                         |       | $                                                                                  | 218,588    |     | $          | 211,763  |       | $        | 195,121    |     | $          | 185,849 |   | $ | 163,485 |   |
| Net income (loss)                                |       | $                                                                                  | 6,378      |     | $          | (1,128   | )          | $        | 645        |     | $          | 11,249 |   | $ | 10,317 |   |
| Basic and diluted  earnings (loss) per share (1) |       | $                                                                                  | 0.44       |     | $          | (0.08    | )          | $        | 0.04       |     | $          | 0.76 |   | $ | 0.67 |   |
| Cash dividends per share  (2)                    |       | $                                                                                  | 1.00       |     | $          | 1.00     |       | $        | 1.00       |     | $          | 1.00 |   | $ | 1.00 |   |
| Property, plant and  equipment, at cost          |       | $                                                                                  | 781,579    |     | $          | 715,718  |       | $        | 646,740    |     | $          | 576,579 |   | $ | 524,505 |   |
| Total assets                                     |       | $                                                                                  | 459,029    |     | $448,903   |     | $439,347   |     | $401,390   |     | $420,019   |   |
| Long-term obligations                            |       | $                                                                                  | 89,168     |     | $          | 95,345   |       | $        | 93,135     |     | $          | 52,252 |   | $ | 42,142 |   |
| Shares of common stock  used to calculate:       |       |                                                                               |       |     |       |     |       |     |       |     |       |
| Basic earnings  (loss) per share (1)             |       | 14,552                                                                             |       | 14,531   |       | 14,522   |       | 14,728   |       | 15,326   |       |
| Diluted earnings (loss) per share (1)            |       | 14,631                                                                             |       | 14,531   |       | 14,539   |       | 14,795   |       | 15,387   |       |

 

(1)          Shares used in thecomputation of basic earnings (loss) per share are based on the weightedaverage number of common shares and restricted common stock units (“RSUs”)outstanding, excluding unvested restricted common shares and unvested RSUs.Shares used in the computation of diluted earnings per share are based on theweighted average number of common shares, restricted common shares and RSUsoutstanding, along with other potentially dilutive securities outstanding ineach period. Shares used in the computation of diluted loss per share are basedon the weighted average 

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number of vested commonshares and vested RSUs and exclude potential dilutive common shares, unvestedrestricted common shares and unvested RSUs outstanding, as the effect isantidilutive.

(2)          Cash dividends per shareare based on the actual dividends per share, as declared by the Company’s Boardof Directors. On each date that the Company pays a cash dividend to the holdersof the Company’s common stock, the Company credits to the holders of RSUs anadditional number of RSUs equal to the total number of whole RSUs andadditional RSUs previously credited to the holders multiplied by the dollaramount of the cash dividend per share of common stock. Any fractional RSUsresulting from such calculation will be included in the additional RSUs.

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**Item 7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

*(Amounts inthousands, except selected operating metrics and share and per share amounts)*

Certain information included in this 2005 AnnualReport on Form 10-K of SureWest Communications (the “Company”),including that which relates to the impact on future revenue sources andpotential sharing obligations of pending and future regulatory orders,continued expansion of the telecommunications network and expected changes inthe sources of the Company’s revenue and its cost structure resulting from itsentrance into new communications markets, are forward looking statements andare made pursuant to the safe harbor provisions of the Securities LitigationReform Act of 1995. Such forward looking statements are subject to a number ofrisks, assumptions and uncertainties that could cause the Company’s actualresults to differ from those projected in such forward looking statements.

Important factors thatcould cause actual results to differ from those set forth in the forwardlooking statements include, but are not limited to:  advances in telecommunications technology,changes in the telecommunications regulatory environment, changes in thefinancial stability of other telecommunications providers who are customers ofthe Company, changes in competition in markets in which the Company operates,adverse circumstances affecting the economy in California in general, and inthe Sacramento, California Metropolitan area in particular, the availability offuture financing, changes in the demand for services and products, new productand service development and introductions, pending and future litigation, andunanticipated changes in the growth of the Company’s emerging businesses, includingthe wireless and broadband business segments.

**Corporate Structure**

The Company is a holding company with wholly-ownedsubsidiaries operating in the Telecommunications (“Telecom”), Broadband andWireless segments.

The Telecom segment includes SureWest Telephone,SureWest Directories, and SureWest Long Distance, which provide landlinetelecommunications services, directory advertising, Digital Subscriber Line (“DSL”)service, long distance services and certain non-regulated services. SureWestTelephone, which is the principal operating subsidiary of the Telecom segment,provides local services, toll telephone services, network access services andcertain non-regulated services. SureWest Directories publishes and distributesSureWest Telephone’s directory, including the sale of yellow pages advertising.SureWest Directories is also engaged in the business of producing, publishingand distributing directories in other Northern California communities outsideof SureWest Telephone’s service area. SureWest Long Distance is a reseller oflong distance services.

The Broadband segment includes the Company’ssubsidiaries SureWest Broadband, SureWest TeleVideo and SureWest TeleVideo ofRoseville (collectively referred to as “SureWest Broadband/Residential Services”)and SureWest Broadband Business Services which is comprised, in part, of adivision of SureWest Telephone operating as a Competitive Local ExchangeCarrier (“CLEC”). The Broadband segment provides various services, includinghigh-speed and dial-up Internet, digital video, voice, network access, longdistance and managed services in the greater Sacramento area, principally tocustomers residing outside of SureWest Telephone’s service area. The Companyoffers high-speed Internet, digital video, voice and long distance phoneservice as a bundled package referred to as fiber-to-the-premise (“FTTP”).

The Wireless segment consists of the Company’ssubsidiary SureWest Wireless, which provides wireless services. Wirelessrevenues include wireless voice services, sales of handsets and relatedaccessories, long distance, roaming service and custom calling features.Wireless services are provided on a month-to-month basis and are generallybilled in advance for non-contract subscribers and in arrears for contract subscribers.

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

**Results ofOperations**

**Consolidated Overview**

The tables below reflectcertain financial data (on a consolidated and segment basis) and selectedoperating metrics for each reportable business segment as of and for the yearsended December 31, 2005, 2004 and 2003. Both the financial data and theselected operating metrics demonstrate the continuing increasing contributionsof the Company’s Broadband and Wireless segments.

**FinancialData**
| ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **% Change**       | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2005 vs.  2004** | ** ** | **2004 vs.  2003** | ** ** |
| **Operating revenues**(1)         |       |       |       |       |       |       |       |                    |       |   |   |   |   |   |   |
| Telecom                           |       | $          | 134,468    |       | $          | 141,086    |       | $                       | 138,924    |   |   | (5 | )% |   |   | 2 | % |   |
| Broadband                         |       | 49,915     |       | 39,416     |       | 29,051     |       |                    | 27         |   |   |   | 36 |   |   |
| Wireless                          |       | 34,205     |       | 31,261     |       | 27,146     |       |                    | 9          |   |   |   | 15 |   |   |
| Total operating revenues          |       | 218,588    |       | 211,763    |       | 195,121    |       |                    | 3          |   |   |   | 9 |   |   |
| **Income (loss) from operations** |       |       |       |       |       |       |       |                    |       |   |   |   |   |   |   |
| Telecom                           |       | 53,593     |       | 49,937     |       | 47,598     |       |                    | 7          |   |   |   | 5 |   |   |
| Broadband                         |       | (24,785    | )          | (31,340    | )          | (16,312    | )          |                    | 21         |   |   |   | (92 | ) |   |
| Wireless                          |       | (12,878    | )          | (17,278    | )          | (23,539    | )          |                    | 25         |   |   |   | 27 |   |   |
| Total operating income (loss)     |       | 15,930     |       | 1,319      |       | 7,747      |       |                    | 1,108      |   |   |   | (83 | ) |   |
| **Net income (loss)**             |       |       |       |       |       |       |       |                    |       |   |   |   |   |   |   |
| Telecom                           |       | 30,033     |       | 28,322     |       | 26,565     |       |                    | 6          |   |   |   | 7 |   |   |
| Broadband                         |       | (15,438    | )          | (18,627    | )          | (10,983    | )          |                    | 17         |   |   |   | (70 | ) |   |
| Wireless                          |       | (8,217     | )          | (10,823    | )          | (14,937    | )          |                    | 24         | % |   |   | 28 | % |   |
| Total  net income (loss)          | ** ** | $          | 6,378      |       | $          | (1,128     | )          | $                       | 645        |   |   | NA |   |   |   | NA |   |   |

 

(1)          Externalcustomers only

**Selected OperatingMetrics**
| ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **% Change**       | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2005 vs.  2004** | ** ** | **2004 vs.  2003** | ** ** |
| **Telecom**                                         |       |       |       |       |       |       |       |                    |       |   |   |   |   |   |   |
| Incumbent Local  Exchange Carrier access lines      |       | 129,291    |       | 131,905    |       | 136,365    |       |                    | (2         | )% |   |   | (3 | )% |   |
| Long distance  lines                                |       | 52,288     |       | 47,512     |       | 42,911     |       |                    | 10         |   |   |   | 11 |   |   |
| **Broadband**                                       |       |       |       |       |       |       |       |                    |       |   |   |   |   |   |   |
| Internet  subscribers (1)                           |       | 27,876     |       | 23,811     |       | 19,882     |       |                    | 17         |   |   |   | 20 |   |   |
| Residential  Broadband subscribers (2)              |       | 20,039     |       | 15,689     |       | 11,101     |       |                    | 28         |   |   |   | 41 |   |   |
| Residential Broadband  Revenue-generating units (3) |       | 47,110     |       | 36,319     |       | 25,486     |       |                    | 30         |   |   |   | 43 |   |   |
| **Wireless**                                        |       |       |       |       |       |       |       |                    |       |   |   |   |   |   |   |
| Subscribers                                         |       | 53,858     |       | 52,657     |       | 46,724     |       |                    | 2          | % |   |   | 13 | % |   |

 

(1)          Internetsubscribers are customers who receive data services primarily within SureWestTelephone’s service area.

(2)          ResidentialBroadband subscribers are customers who receive digital video, voice and/ordata services from broadband residential services.

(3)          The Broadband segmentcan deliver multiple services to a customer. Accordingly, the Company maintainsstatistical data regarding Revenue-generating units for digital video, voiceand data, in addition to the number of customers. For example, a singlecustomer who purchases digital video, voice and data services would bereflected as three Revenue-generating units.

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Operating revenues from external customers in theTelecom segment decreased $6,618 in 2005 as compared to 2004. SureWestTelephone continues to experience decreases in local and network accessrevenues as a result of competition from wireless (including SureWest Wireless)and wireline competitors and an approximate 2% decline in access lines. Inaddition, the local and network access revenues were positively impacted in2004 by certain changes in accounting estimates related to SureWest Telephone’sshareable earnings obligations (see *RegulatoryMatters* within the *TelecomSegment Results of Operations* section below). The decrease inTelecom segment revenues was offset in part by revenue growth of $832 inSureWest Long Distance, resulting from an increase in minutes of use and theInfinitAccessä bundle program,which was initiated during the second quarter of 2004. The bundle program isintended to provide customers an incentive to procure multiple services fromthe Company by offering attractive pricing alternatives. In addition, Directoryadvertising revenues increased $1,100 compared to 2004, due primarily toincreases in advertising rates and programs and bundled packages purchased byexisting customers.

While the Telecom segment steadily continues to generatea majority of the Company’s revenues, cash flows and net income, the Companybelieves that the results of the Telecom segment in recent years (reflected indeclining revenues and access lines) support, in part, the Company’s efforts tocontinue to develop its other business segments.

Broadband operating revenues increased $10,499 and$10,365 in 2005 and 2004, respectively, as compared to each prior year period. AtDecember 31, 2005, the Broadband segment experienced a 17% annual increasein Internet subscribers. More significantly, at year-end 2005 the broadbandresidential services business realized 28% and 30% increases in broadbandresidential subscribers and revenue-generating units, respectively. Whilecontinuing to produce significant revenue increases, the expansion of thebroadband residential services has and will continue to require ongoing capitaland expense commitments.

The Wireless segment reported increases in operatingrevenues of $2,944 and $4,115 in 2005 and 2004, respectively, compared to eachprior year period. The number of wireless subscribers increased to 53,858 at December 31,2005, a 2% annual increase. SureWest Wireless established its market share inthe Sacramento market in large part by promoting an unlimited flat rate regionalcalling plan. Wireless customer acquisition has historically been most activeduring the December holiday season, and the Company has always been activein sales and marketing at that time. In recent years, including 2005, SureWestWireless initiated a number of new service options for customers, includingadditional regional plans, an unlimited national plan, a family plan and newroaming packages, which have attracted new customers. Evolution of themarketplace has prompted SureWest Wireless to open five retail stores in itsservice area. SureWest Wireless has been seeking to expand its servicepenetration, while seeking to reduce customer turnover (“churn”) and toincrease revenues from its customer base.

The Company’s consolidated operating expenses, excludingdepreciation and amortization, decreased $12,960 in 2005 as compared to theprior year in large part to labor savings realized through the cost containmentand workforce consolidation plan, as described in more detail below. Generaland administrative expenses decreased 15%, or $6,598 in 2005, due primarily to (i) theincurrence in 2004 of professional and legal fees related to the treasuryinvestigation, as well as Sarbanes-Oxley implementation and compliance costsand (ii) a decrease in information management expense due in large part toa reduction in maintenance and service agreements resulting from theconsolidation of the Company’s billing systems. Customer operations and sellingexpense decreased $2,580, or 7%, in 2005 compared to 2004 due to a consolidatedreduction in labor and a decrease in advertising activity for the Wirelesssegment. Cost of services and products expense (exclusive of depreciation andamortization) decreased $3,782, or 5%, in the current year primarily as aresult of a reduction in network operations and outside plant largely due to areduction in labor as well as the incurrence in 2004 of additional expensesrelated to providing video over the existing in-territory network. Theseexpense reductions were offset in part by an increase in access expense as aresult of the larger number of subscribers and services within the 

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Broadband and Wireless segments. In addition, longdistance access expense increased as a result of the InfinitAccessäbundle program and an increase in the minutes of use.

In December 2004, the Company initiated avoluntary enhanced early retirement program (the “REWARD program”). The REWARDprogram was offered to certain eligible employees across all business units. Inaddition to retirement benefits, program participants receive enhanced medicalbenefits for a specified period of time. As of December 31, 2004, 59employees had accepted the REWARD program and the Company recorded operatingexpenses of $3,768 related to the REWARD program during the fourth quarter of2004. Prior to the completion of the REWARD program in February of 2005,13 additional employees accepted the REWARD program, and the Company recordedan additional $791 in operating expenses during the first quarter of 2005.

During 2005, the Company continued to implement astrategy for driving efficiency and long-term growth through cost reduction andworkforce consolidation. This strategic plan entailed a reduction of operatingexpenses by approximately 6% through a realignment of organizational structurein order to focus on primary customer segments. The ongoing corporaterestructuring has involved a reorganization of stand-alone segment functions inorder to gain operating efficiencies through a consolidated organizationalstructure. In 2005, the Company experienced an approximate 6% year-over-yearsavings in overall labor costs. The Company also expects to continue toidentify and eliminate additional functional redundancies, combine duplicate oroverlapping work areas, and further reduce overall labor costs.

The Company’s consolidated depreciation andamortization expense increased $5,174 in 2005. This increase was primarily dueto continued network build-out within the residential broadband serviceterritories.

In July 2005, theCompany sold its pay telephone assets for $220 to a nationwide provider ofprivate pay telephone services. The Company had experienced a decline in thepay telephone business due to the rapid growth of wireless alternatives andjoined other telephone companies in transitioning the assets to an enterprisespecializing in that business. Divesting these assets represents the Company’scontinued effort to drive efficiency and long-term growth. During the quarterended June 30, 2005, the Company incurred a pretax asset impairment chargeof $189, which was recorded in the Company’s consolidated statements ofoperations as depreciation and amortization expense. The asset impairmentcharge reduced the carrying value of the pay telephone assets within theTelecom segment to its fair value of $198, which represented the expectedproceeds from the sale of assets.

*Reclassification*

Certain amounts in theCompany’s 2004 and 2003 consolidated financial statements have beenreclassified to conform to the presentation of the Company’s 2005 consolidatedfinancial statements.

*Revenue Recognition*

The Company recognizesrevenue when (i) persuasive evidence of an arrangement between the Companyand the customer exists, (ii) delivery of the product to the customer hasoccurred or service has been provided to the customer, (iii) the price tothe customer is fixed or determinable and (iv) collectibility of the salesprice is reasonably assured. Revenues based on a flat fee, derived principallyfrom local telephone, dedicated network access, data communications, Internetaccess service, residential/business broadband service and non-contractwireless services, are billed in advance and recognized in subsequent periodswhen the services are provided. Contract wireless services are billed in arrears.Revenues based on usage, derived primarily from network access, roaming andlong distance services, are recognized monthly as services are provided.Incremental direct costs of telecommunications service activation are chargedto expense in the period in which they are incurred.

Directory advertisingrevenues and costs related to publishing and distributing directories arerecognized using the “circulation period” method, under which revenues andrelated costs are recognized ratably over 

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the expected useful lifeof the directory, generally one year from the date of publication. For allother operations, revenue is recognized when products are delivered or servicesare rendered to customers.

The Company applies theFinancial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force (“EITF”)Issue No. 00-21,*RevenueArrangements with Multiple Deliverables* to all wireless handsetsales below cost, which approximates fair value in the absence of an activation“subsidy,” when receiving an up-front fee of any kind (e.g., a serviceactivation fee). The application of EITF Issue No. 00-21 results inthe immediate recognition of all or a portion of such up-front fees asequipment sales revenue. Additionally, when the Company activates wirelessservice for a customer, but does not concurrently provide the customer with ahandset, any up-front fees received continue to be deferred and amortized overthe expected term of the customer relationship. The Company provides a generalright of return within the first 30 days of service for a 100% refund of thehandset cost. The estimated equipment return allowance associated with thisright of return is estimated based on historical experience.

*NonmonetaryTransactions*

In the normal course ofbusiness, the Company entered into certain nonmonetary transactions that arenot material, either individually or in the aggregate, to the Company’sconsolidated financial statements.

**2005 versus 2004**

**Segment Results of Operations**

**Telecom**
| ** **                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **$Change** | ** ** | **%Change** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|-------------|------------|-------------|------------|
| Local service                                     |       | $        | 63,522     |     | $          | 69,560      |       | $           | (6,038     | ) |   | (9 | )% |   |
| Network access service                            |       | 44,214   |       | 46,161   |       | (1,947      | )          |        | (4         | ) |   |
| Directory advertising                             |       | 17,383   |       | 16,283   |       | 1,100       |       |        | 7          |   |   |
| Long distance service                             |       | 6,016    |       | 5,184    |       | 832         |       |        | 16         |   |   |
| Other                                             |       | 3,333    |       | 3,898    |       | (565        | )          |        | (14        | ) |   |
| Total operating revenues  from external customers |       | 134,468  |       | 141,086  |       | (6,618      | )          |        | (5         | ) |   |
| Intersegment revenues                             |       | 30,056   |       | 25,814   |       | 4,242       |       |        | 16         |   |   |
| Operating expenses*                               |       | 85,503   |       | 91,736   |       | (6,233      | )          |        | (7         | ) |   |
| Depreciation and  amortization                    |       | 25,428   |       | 25,227   |       | 201         |       |        | 1          |   |   |
| Income from operations                            |       | 53,593   |       | 49,937   |       | 3,656       |       |        | 7          |   |   |
| Net income                                        |       | $        | 30,033     |     | $          | 28,322      |       | $           | 1,711      |   |   | 6 | % |   |

*Exclusive of depreciation and amortization

*Operating Revenues*

Operating revenues from external customers in theTelecom segment decreased $6,618 compared to 2004. SureWest Telephone continuesto experience decreases in local and network access revenues as a result ofcompetition from wireless (including SureWest Wireless) and wirelinecompetitors and an approximate 2% decline in access lines.

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The decrease in the local and network access revenueswas offset in part by revenue growth of $832 in SureWest Long Distanceresulting from an increase in minutes of use and the effects of theInfinitAccessä bundle program. Inaddition, Directory advertising revenues increased $1,100 in 2005 compared to2004 primarily due to increases in advertising rates.

Revenues within theTelecom segment are also affected by SureWest Telephone’s shareable earningsobligations. During the years ended December 31, 2005 and 2004, SurewestTelephone changed its estimates for a portion of its interstate shareableearning obligations and certain National Exchange Carrier balances related toprior year monitoring periods resulting in an increase to revenues of $916 and$1,258, respectively, as described in more detail in the *Regulatory Matters* section below.

*Operating Expenses*

Operating expenses for the Telecom segment decreased$6,233 in 2005 compared to 2004. As described in more detail in the *Consolidated Overview* section above, thedecrease in operating expenses was due in large part to labor savings realizedthrough the cost containment and workforce consolidation plan and the REWARDprogram offered to certain eligible employees during the fourth quarter of2004. These savings were partially offset by operating expenses ofapproximately $640 related to certain eligible employee’s who accepted theREWARD program during the quarter ended March 31, 2005, also described inthe *Consolidated Overview* sectionabove.

Cost of services and products (exclusive ofdepreciation and amortization) decreased $1,556 in 2005 compared to 2004. Theyear-over-year decrease is attributable to decreases in outside plant andnetwork operations as a result of reductions in the number of employees as wellas the additional expenses incurred in 2004 as a result of providing video overthe existing in-territory network. The decreases were offset in part byincreases in long distance access expense as a result of the InfinitAccessäbundle program and an increase in minutes of use and directory production anddistribution costs.

Customer operations and selling expense decreased$1,812 in 2005 compared to 2004, due primarily to decreases in labor costs forproduct management and customer and operator services as a result of areduction in the number of employees and internal efficiencies resulting fromintegrated customer support systems and productivity gains. These decreaseswere partially offset by increased billing expenses associated with theincrease in long distance access line usage.

General and administrative expense decreased $2,865 in2005 compared to 2004. The decrease was due primarily to the incurrence in 2004of professional and legal fees related to the treasury investigation andSarbanes-Oxley implementation and compliance costs.

Depreciation and amortization increased $201 in 2005compared to 2004 due primarily to the incurrence of a pretax asset impairmentcharge of $189 associated with the sale of the Company’s pay telephone assets,as described above in the *ConsolidatedOverview* section.

Certain of the Company’s customers filed forbankruptcy protection in 2002, the most notable of which was WorldCom, Inc.(“WorldCom”), which, together with its affiliates (collectively “MCI”), filedfor bankruptcy protection in July 2002. In April 2004, MCI emergedfrom federal bankruptcy protection. In October 2005, the Company resolvedits claim filed in January 2003 related to pre-petition accountsreceivable, and to a conditional payment made by the Company to MCI inconnection with anticipated overearnings during the 1999-2000 monitoringperiod.

In accordance with the MCIPlan of Reorganization, the Company received in October 2005 adistribution of cash and stock, with a combined fair value of approximately$1,400. The distribution was recognized in the Company’s consolidated statementof operations as an increase to network access service revenue and a decreaseto general and administrative expense of $800 and $600, respectively. As of December 31,2005, the Company held 31,292 shares of MCI common stock with an aggregatecarrying value of approximately 

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$617. The Company’sinvestment in MCI common stock is classified as an available-for-sale,short-term investment in the consolidated balance sheet. In October 2005,MCI shareholders approved a merger with Verizon Communications Inc. (“Verizon”).The merger was finalized in January 2006.

*Regulatory Matters*

Revenues fromservices subject to regulation constituted approximately 49% and 55% of theCompany’s total operating revenues in 2005 and 2004, respectively. Thoserevenues, which include local service, network access service and toll service,are derived from various sources, including:

·       business and residentialsubscribers, for basic exchange services;

·       surcharges, mandated by theCalifornia Public Utilities Commission (“CPUC”);

·       long distance carriers, fornetwork access service;

·       competitive accessproviders and subscribers, for network access services:

·       interstate poolsettlements, from the National Exchange Carrier association (“NECA”);

·       support payments fromfederal or state programs, and

·       supportpayments from the California High Cost Fund (“CHCF”), recovering costs ofservices including extended area service (“EAS”).

Revenues from certain telephone services are affectedby rates authorized by various regulatory agencies. Intrastate service ratesare subject to regulation by the CPUC. With respect to toll calls initiated byinterexchange carriers’ customers, the interexchange carriers are assessedaccess charges based on tariffs filed by SureWest Telephone. Interstate accessrates and resultant earnings are subject to regulation by the FederalCommunications Commission (“FCC”). With respect to interstate services,SureWest Telephone has filed its own tariff with the FCC for all elements ofaccess services except carrier common line charges, for which SureWestTelephone concurs with tariffs filed by NECA.

The FCC monitors SureWest Telephone’s interstateearnings through the use of annual cost separation studies prepared by SureWestTelephone, which utilize estimated cost information and projected demand usage.The FCC establishes rules that carriers must follow in the preparation ofthe annual studies. Additionally, under current FCC rules governing ratemaking, SureWest Telephone is required to establish interstate rates based onprojected demand usage for its various services and determine the actualearnings from these rates once actual volumes and costs are known. Based onpreliminary cost studies, the Company recognized liabilities relating toSureWest Telephone’s estimated interstate shareable earnings obligations of$157 and $343 for the years ended December 31, 2005 and 2003,respectively, through reductions of revenues. The Company did not identify anyinterstate shareable earnings obligations at SureWest Telephone during the yearended December 31, 2004.

During September 2005, SureWest Telephone made apayment of $100 to a certain carrier customer in full settlement of aninterstate overearnings dispute for the monitoring period 2001-2002. Thelimitations period applicable to this monitoring period expired. Therefore,SureWest Telephone released all other amounts reserved in connection with thepotential overearnings claims for 2001-2002 monitoring period, whichincreased the Company’s revenues and net income for the year ended December 31,2005 by $125 and $78 ($0.01 per share), respectively.

Prior to 2000, SBC Communications (“SBC”) had beenpaying SureWest Telephone approximately $11,500 per year for EAS pursuant to aSettlement Transition Agreement. In November 2000, the CPUC authorized SBCto terminate its annual EAS payments to SureWest Telephone effective November 30,2000. The CPUC authorized replacement funding to SureWest Telephone on aninterim basis using funds from the CHCF. The CHCF is a program designed by theCPUC to establish a fair and equitable local rate structure and to reduce anydisparity in the rates charged by telephone companies serving high-cost areas.The CHCF is scheduled to expire January 1, 2009. In addition, the CPUCopened an Order Instituting Investigation (“OII”) for the purpose ofdetermining whether future recovery of all, none, or a portion of 

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the approximate $11,500 annual payments previouslyreceived from SBC and currently received from the CHCF, should come fromSureWest Telephone’s ratepayers or other regulatory recovery mechanisms.

In August 2005, the CPUC adopted a decision which(i) authorized SureWest Telephone to continue receiving $11,500 annuallyfrom the CHCF to offset its intrastate regulated operating expenses on aninterim basis, (ii) required SureWest Telephone to prepare and submit acost proxy model (which is used generally as a basis for CHCF-B funding) basedon its current cost data, including analyses of the resulting impacts on rates,on the Universal Lifeline Telephone Service (“ULTS”) fund, and on the CHCFfund, to be filed by SureWest Telephone within 12 months, and (iii) authorizedSureWest Telephone to file an advice letter with the Commission’sTelecommunications Division to implement reductions to its business access linerates. The results of this proceeding and the potential effects on SureWestTelephone could impact future funding levels through the CHCF.

In 1996, the CPUC issued a decision that authorizedSureWest Telephone to implement a New Regulatory Framework (“NRF”) for servicesfurnished within SureWest Telephone’s service area in order to accommodatemarket and regulatory movement toward competition and greater pricing flexibility.Under the NRF, SureWest Telephone is subject to ongoing monitoring andreporting requirements, and it was initially required to share earnings withcustomers through a reduction of revenues if its earned annual rate-of-returnexceeds that authorized by the CPUC.

In accordance with the requirements of its generalrate case order, SureWest Telephone filed an application for review of its NRFin 1999. In connection with this proceeding, the Office of Ratepayer Advocates(“ORA”) undertook a verification audit of SureWest Telephone’s non-regulatedand affiliated transactions pursuant to the general rate case and other CPUCorders. In June 2001, the CPUC adopted its decision in this matter (the “Decision”).The Decision did not suspend the sharing mechanism as SureWest Telephone hadrequested, and the CPUC ruled that SureWest Telephone must change the methodused to allocate costs for services provided by SureWest Telephone to itsaffiliates, the treatment of certain directory revenues and the treatment of internal-usesoftware costs. In accordance with the provisions of the Decision, the Companyrecorded certain liabilities and reductions of revenues of $3,285 relating toits estimated intrastate shareable earnings obligations during the years ended December 31,2003 (none in 2004 or 2005).

The Company was involved in a proceeding at the CPUCthat considered the continued need for certain sharing requirements in theintrastate jurisdiction and, in connection with that review, also consideredthe issue of whether the Company overearned in the intrastate jurisdiction inrecent monitoring periods and the amount of overearnings that should be sharedwith customers. In July 2004, the Company entered into a settlementagreement (“the settlement agreement”) with the other parties in theproceeding, the ORA and The Utility Reform Network (“TURN”), to resolve allissues in the proceeding. In November 2004, the CPUC approved thesettlement agreement. The settlement agreement resolved existing intrastatesharing obligations and related earnings issues for the monitoring periods 2000through 2004, put into place a surcredit mechanism for the amount of thesettlement, and suspended the requirement for any intrastate sharing formonitoring periods from January 1, 2005 through at least December 31,2010. The settlement agreement resulted in SureWest Telephone recognizing anincrease in local revenues of $2,948 due to a change in accounting estimate inthe fourth quarter of 2004. This increase in revenues resulted in a decrease ofthe Company’s net loss by $2,046 ($0.14 per share) during 2004.

In accordance with the settlement agreement, SureWestTelephone will return approximately $6,500, plus interest at the 90-daycommercial paper rate for non-financial institutions, which was 4.23% as of December 31,2005, and an imputed rate of 3.15%, to its end users through a consumerdividend over a period of four years, which began January 1, 2005. For theyear ended December 31, 2005, approximately $1,655 was returned to the endusers. In addition, SureWest Telephone will pay a one-time consumer dividend of$2,600, which includes an annual imputed interest rate of 3.15% (no statedcontractual interest 

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rate), over two years, which began January 1,2005 to settle the monitoring periods 2000 to 2004. For the year ended December 31,2005, approximately $1,210 was returned to the consumers and was recorded as areduction of the Company’s contractual shareable earnings obligations. At December 31,2005, the aggregate contractual shareable earnings obligation for thesesurcredits was $6,627 (which is net of an unamortized discount pertaining toimputed interest of $274 at that date). Future payments for these obligationsare $3,167 in 2006 and $1,867 in 2007 and 2008.

Further, commencing January 1, 2007, SureWestTelephone will implement an annual consumer dividend of $1,300 to end-usersreceiving SureWest Telephone services subject to sharing on or after that date;however, this consumer dividend is subject to reduction based upon the resultsof other pending regulatory proceedings.

During the fourth quarter of 2005, the Company filedan Advice Letter with the CPUC proposing an increase to the consumer dividendsin order to return the amounts entitled per the settlement agreement. Thechange in the consumer dividends resulted from the increase in interest ratesduring 2005. The increase was effective January 1, 2006.

Beginning in November 2003, SureWest Telephonebegan paying a consumer dividend for intrastate overearnings relating to theyear 2002. A portion of the consumer’s intrastate service charges was returnedto the consumers in the form of a surcredit beginning in November 2003 andending in February 2004, totaling $483 (of which $208 was returned during2004) and was recorded as a reduction of the Company’s estimated intrastateshareable earnings obligations.

As a result of periodic cost separation studies,SureWest Telephone changed its estimates for a portion of its interstate andintrastate shareable earnings obligations and certain NECA Carrier Common Line(“CCL”) accounts receivable balances related to prior year monitoring periodsduring the years ended December 31, 2005, 2004 and 2003. For the yearended December 31, 2005, these changes in accounting estimates increasedthe Company’s consolidated revenues and net income by $791 and $482 ($0.03 pershare), respectively. For the year ended December 31, 2004, similarchanges in accounting estimates, including a change in estimate to theCompany’s intrastate shareable earnings obligations, increased the Company’sconsolidated revenues by $1,258 and decreased the net loss by $873 ($.06 pershare). For the year ended December 31, 2003, similar changes inaccounting estimates decreased the Company’s consolidated revenues and netincome by $29 and $11 (no effect on earnings per share), respectively.

As of December 31,2005, the Company’s consolidated balance sheet reflected aggregate liabilitiesof $293 relating to SureWest Telephone’s estimated interstate shareableearnings obligations. The calculations supporting these liabilities are verycomplex and involve a variety of estimates prior to the ultimate settlement ofsuch obligations. In addition, SureWest Telephone’s interstate shareableearnings obligations lapse over time if SureWest Telephone’s interexchangecarrier and other customers do not claim the amounts ascribed to them.Accordingly, it is reasonably possible that management’s estimates of theCompany’s liabilities for interstate shareable earnings obligations couldchange in the near term, and the amounts involved could be material.

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**Broadband**
| ** **                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **$Change** | ** ** | **%Change** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|-------------|------------|-------------|------------|
| Internet service                                  |       | $        | 17,829     |     | $          | 16,679      |       | $           | 1,150      |   |   | 7 | % |   |
| Residential Broadband  service                    |       | 23,991   |       | 17,077   |       | 6,914       |       |        | 40         |   |   |
| Business Broadband  service                       |       | 8,095    |       | 5,660    |       | 2,435       |       |        | 43         |   |   |
| Total operating revenues  from external customers |       | 49,915   |       | 39,416   |       | 10,499      |       |        | 27         |   |   |
| Intersegment revenues                             |       | 1,693    |       | 1,784    |       | (91         | )          |        | (5         | ) |   |
| Operating expenses*                               |       | 59,942   |       | 61,143   |       | (1,201      | )          |        | (2         | ) |   |
| Depreciation and  amortization                    |       | 16,451   |       | 11,397   |       | 5,054       |       |        | 44         |   |   |
| Loss from operations                              |       | (24,785  | )          | (31,340  | )          | 6,555       |       |        | 21         |   |   |
| Net loss                                          |       | $        | (15,438    | )        | $          | (18,627     | )          | $           | 3,189      |   |   | 17 | % |   |

*Exclusive of depreciation and amortization

*Operating Revenues*

Operating revenues fromexternal customers in the Broadband segment increased $10,499 in 2005 comparedto 2004. The increase in Broadband revenues was due to the combined effects of (i) a28% increase in subscribers of broadband residential services, (ii) a 17%increase in the residential and business DSL data subscriber customer base and (iii) thecontinued expansion of the Business Broadband services, resulting in a 17%increase in ending access lines.

*Operating Expenses*

Total operating expenses in the Broadband segmentdecreased $1,201 in 2005 compared to 2004. As described in more detail in the *Consolidated Overview* section above, thisdecrease in operating expenses was due in large part to labor savings realizedthrough the cost containment and workforce consolidation plan and the REWARDprogram offered to certain eligible employees during the fourth quarter of2004. These savings were partially offset by operating expenses ofapproximately $119 related to certain eligible employees who accepted theREWARD program during the quarter ended March 31, 2005, also described inthe *Consolidated Overview* sectionabove.

Cost of services andproducts (exclusive of depreciation and amortization) increased $1,039 during2005 compared to 2004, due primarily to (i) an increase in programming andtransport costs related to the growth in Broadband subscribers and ResidentialBroadband Revenue-generating units, (ii) an increase in network andgeneral support costs corresponding to the increased subscriber count, as wellas the expanded network footprint and (iii) an increase in property taxespredominantly due to the increase in property, plant and equipment as thenetwork is expanded. These increases were offset in part by a decrease inrepair and maintenance costs.

Customer operations expense increased $668 in 2005compared to 2004. The year-over-year increase was attributable to an increasein customer service costs resulting from increased call volume caused by theResidential Broadband subscriber growth.

General and administrative expense decreased $2,908 in2005 compared to 2004 due primarily to (i) the incurrence in 2004 ofprofessional and legal fees related to the treasury investigation andSarbanes-Oxley implementation and compliance costs and (ii) a decrease ininformation management expenses due to a consolidation of billing systems and areduction of maintenance and service agreements.

Depreciation andamortization increased $5,054 in 2005 compared to 2004 primarily due tocontinued network build-out within the residential broadband serviceterritories.

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**Wireless**
| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **$Change** | ** ** | **%Change** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|-------------|------------|-------------|------------|
| Wireless revenues from  external customers | ** ** | $        | 34,205     |     | $          | 31,261      |       |        | $          | 2,944 |   |   |   | 9 | % |   |
| Intersegment revenues                      |       | 2,592    |       | 1,699    |       |        | 893        |        |       |   | 53 |   |   |
| Operating expenses*                        |       | 37,784   |       | 38,266   |       |        | (482       | )           |       |   | (1 | ) |   |
| Depreciation and  amortization             |       | 11,891   |       | 11,972   |       |        | (81        | )           |       |   | (1 | ) |   |
| Loss from operations                       |       | (12,878  | )          | (17,278  | )          |        | 4,400      |        |       |   | 25 |   |   |
| Net loss                                   |       | $        | (8,217     | )        | $          | (10,823     | )          |        | $          | 2,606 |   |   |   | 24 | % |   |

*Exclusive of depreciation and amortization

*Operating Revenues*

Operating revenues fromexternal customers in the Wireless segment increased $2,944 in 2005 compared to2004 due primarily to (i) a 2% increase in Wireless subscriber base, (ii) anincrease in feature revenues, including voicemail and text and picturemessaging, (iii) an increase in equipment revenue due to an increase insubscribers and average handset price and (iv) an increase in local numberportability recovery fees, which were implemented during the second quarter of2004.

*Operating Expenses*

Total operating expenses for the Wireless segmentdecreased $482 in 2005 compared to 2004. The Wireless segment experienced anoverall annual decrease in operating expenses primarily due to the efficienciesgained through the corporate restructuring, as described in the *Consolidated Overview* section above.

Cost of services and products (exclusive ofdepreciation and amortization) increased $1,573 in 2005 compared to 2004primarily due to increases in (i) long distance expense due to an increasein the minutes of use and the introduction of additional unlimited callingplans and (ii) tower rent expense.

Customer operations expense decreased $1,427 in 2005compared to 2004 due primarily to a decrease in (i) sales and advertisingexpense as a result of reduced promotional campaigns and (ii) dealercommissions due to a decline in sales executed through dealer channels.

General and administrativeexpense decreased $628 in 2005 compared to 2004 due primarily to the incurrencein 2004 of professional and legal fees related to the treasury investigationand Sarbanes-Oxley implementation and compliance costs.

**Non-Operating Items**

*Other Income andExpense, Net*

Consolidated investmentincome increased $244, or 121%, compared to 2004. The Company received dividendincome of $175 during 2005 as a result of the receipt of the shares of MCIcommon stock through the MCI Plan of Reorganization, as discussed above in the *Telecom Segment Results of Operations*section.In addition, interest income increased due to higher average interest ratesduring 2005. Consolidated interest expense increased $1,170, or 26%, during2005 as compared to 2004 due to an increase in short-term borrowings and adecrease in capitalized interest. An increase in the turnover rate ofconstruction projects contributed to lower capitalized interest costs.

*Corporate TreasuryLoss Recovery*

In December 2003, theCompany discovered certain irregular bank transactions and deposits in aroutine investigation following the abrupt resignation of the Company’sTreasury Analyst. Immediately following 

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the Company’s initialreview that uncovered these irregularities, the Company broadened its review ofthe investment and cash operations, and a special corporate investigation waslaunched by the Audit Committee and the Board of Directors, which engagedindependent legal counsel and forensic accountants. The investigations revealedconcealed illegal transfers in violation of the Company’s investment and cashmanagement policies. The Company concluded that the irregularities were limitedto the 2003 calendar year. The investigation suggested that as much as $25,000may have been involved in the illegal transfers. Nearly all of the funds hadbeen recovered; however, approximately $1,828 remained outstanding as of December 31,2003 and was reflected as a non-operating loss in the Company’s 2003consolidated financial statements. During 2004, the Company received an insurancerecovery in the amount of $1,803, which was reflected as a non-operating gainin the Company’s 2004 consolidated financial statements.

*Income Taxes*

Income taxes increased $4,406 in 2005 compared to 2004due to a corresponding increase in income subject to tax. The effective federaland state income tax rate were 38.0% and 30.6% for the years ended 2005 and2004, respectively. The change in the effective federal and state income taxrate is primarily due to an increase in income before income taxes for 2005.

As of December 31,2005, the Company had net operating loss carryforwards for federal income taxpurposes of approximately $33,385, which will expire in the years 2018 through2024, if not utilized. As of December 31, 2005, the Company also had netoperating loss carryforwards for state income tax purposes of approximately$355, which will expire in the years 2006 through 2014, if not utilized. TheCompany currently has a net state deferred asset of $2,175 and expects togenerate future state taxable income in excess of the approximately $24,601required to realize the net deferred asset. As of December 31, 2005, theCompany also had research and development tax credit carryforwards ofapproximately $100 for federal income tax purposes. The federal credit willexpire in 2022 if it is not utilized. The Company has an Alternative MinimumTax carryforward of $322 for federal and $343 for state, which do not expire.

***2004versus 2003***

**Segment Results of Operations**

**Telecom**
| ** **                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **$Change** | ** ** | **%Change** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|-------------|------------|-------------|------------|
| Local service                                     |       | $        | 69,560     |     | $          | 63,363      |       | $           | 6,197      |   |   | 10 | % |   |
| Network access service                            |       | 46,161   |       | 51,286   |       | (5,125      | )          |        | (10        | ) |   |
| Directory advertising                             |       | 16,283   |       | 15,087   |       | 1,196       |       |        | 8          |   |   |
| Long distance service                             |       | 5,184    |       | 5,098    |       | 86          |       |        | 2          |   |   |
| Other                                             |       | 3,898    |       | 4,090    |       | (192        | )          |        | (5         | ) |   |
| Total operating revenues  from external customers |       | 141,086  |       | 138,924  |       | 2,162       |       |        | 2          |   |   |
| Intersegment revenues                             |       | 25,814   |       | 23,576   |       | 2,238       |       |        | 9          |   |   |
| Operating expenses*                               |       | 91,736   |       | 83,645   |       | 8,091       |       |        | 10         |   |   |
| Depreciation and  amortization                    |       | 25,227   |       | 31,257   |       | (6,030      | )          |        | (19        | ) |   |
| Income from operations                            |       | 49,937   |       | 47,598   |       | 2,339       |       |        | 5          |   |   |
| Net income                                        |       | $        | 28,322     |     | $          | 26,565      |       | $           | 1,757      |   |   | 7 | % |   |

*Exclusive of depreciation and amortization

*Operating Revenues*

Operating revenues fromexternal customers in the Telecom segment increased $2,162 compared to 2003.Local service revenue increased $6,197 primarily due to changes in accountingestimates related to 

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SureWest Telephone’sshareable earnings obligations, which are discussed in more detail below. Inaddition, directory advertising revenue increased $1,196, resulting primarilyfrom increases in (i) advertising rates and (ii) programs and bundledpackages purchased by existing customers. These increases to operating revenueswere offset, in part, by decreases in local and network access service due tocompetition from wireless and wireline competitors and an approximate 3%decline in access lines.

Revenues within the Telecom segment were also affectedby SureWest Telephone’s shareable earnings obligations. The increase inrevenues in 2004 was attributable, in part, to a settlement agreement approvedby the CPUC in November 2004 that resulted in SureWest Telephone recording$2,948 in local revenues due to a change in accounting estimate (for a moredetailed discussion regarding the settlement agreement see the *Regulatory Matters* section above). Furtheras a result of a decrease in revenues subject to regulation and increasedoperating expenses during 2004, as described below, SureWest Telephone’sprovision related to its estimated interstate and intrastate shareable earningsobligations decreased, which resulted in increased revenue of $3,628 during2004 compared to 2003. In addition, SureWest Telephone had changes in estimatesfor shareable earnings obligations as a result of periodic cost separationstudies. During 2004, changes in estimates pertaining to the Company’sestimated interstate and intrastate shareable earnings obligations and certainNECA CCL accounts receivable balances increased the Telecom segments’ revenuesby $1,430 and decreased net loss by $922. For the year ended December 31,2003, similar changes in accounting estimates decreased Telecom segmentrevenues by $29 and net income by $11 (no effect on earnings per share). Inaddition, SureWest Telephone’s network access revenues decreased during 2004compared to 2003 due partially to an agreement SureWest Telephone entered intoduring 2003, which provided a $1,950 refund from another telecommunicationscompany for a payment made by SureWest Telephone in 2001 related to interstateshareable earnings obligations.

The Company adoptedSecurities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 101,*Revenue Recognition in Financial Statements*,effective January 1, 2000, which requires non-recurring revenuesassociated with service and activation charges to be deferred. The cumulativeeffect of this change in accounting principle on the Company resulted in acharge to income of $3,273, net of tax, ($0.21 per share) in 2000. For theyears ended December 31, 2004 and 2003, the Telecom segment recognized$130 and $413, respectively, of revenues that were in the cumulative effectadjustment as of January 1, 2000. The effect of those revenues was todecrease net loss and increase net income by $90 (net of income taxes of $40)and $160 (net of income taxes of $253) for the years ended December 31,2004 and 2003, respectively.

*Operating Expenses*

Operating expenses for theTelecom segment increased $8,091 compared to 2003 due in part to the REWARDprogram, which was offered to certain eligible employees during the fourthquarter of 2004 and is described in the *ConsolidatedOverview* section above. Cost of services and products (exclusive ofdepreciation and amortization) increased $3,860, or 8%, during 2004 dueprimarily to increases in (i) Federal Universal Service Fund expense, (ii) SureWestDirectories outside sales, as well as a two-month delay in the release of the2003 Sacramento Directory and (iii) network operations as a result ofproviding video over the existing in-territory network.

Customer operations and selling expense increased$724, or 4%, during 2004 due primarily to sales expense due to promotion ofSureWest Telephone’s products. This increase was offset by a decrease inproduct management and operator services headcount.

General and administrativeexpense increased $3,507, or 17%, due primarily to increases in (i) consultingand legal fees due to the treasury investigation, audit services andSarbanes-Oxley implementation and compliance, (ii) an increase instock-based compensation expense, resulting from an increase in the issuance ofrestricted stock awards and restricted stock units and (iii) the size ofthe Company’s workforce, resulting in an increase in salaries and wages,workers’ compensation and medical insurance costs.

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Depreciation andamortization decreased $6,030, or 19%, compared to 2003. This decrease was dueprimarily to a change in accounting estimate during the first quarter of 2004,resulting from the adoption of certain new technologies, which increased theestimated useful lives of Telecom’s switching, circuit and cable equipment byone to three years and decreased the estimated useful lives of certain otherTelecom assets, including certain switching and voicemail equipment. Thischange in accounting estimate decreased depreciation expense by $5,459 for theyear ended December 31, 2004.

**Broadband**
| ** **                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **$Change** | ** ** | **%Change** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|-------------|------------|-------------|------------|
| Internet service                                  |       | $        | 16,679     |     | $          | 15,984      |       | $           | 695        |   |   | 4 | % |   |
| Residential Broadband  service                    |       | 17,077   |       | 9,370    |       | 7,707       |       |        | 82         |   |   |
| Business Broadband service                        |       | 5,660    |       | 3,697    |       | 1,963       |       |        | 53         |   |   |
| Total operating revenues  from external customers |       | 39,416   |       | 29,051   |       | 10,365      |       |        | 36         |   |   |
| Intersegment revenues                             |       | 1,784    |       | 1,683    |       | 101         |       |        | 6          |   |   |
| Operating expenses*                               |       | 61,143   |       | 42,538   |       | 18,605      |       |        | 44         |   |   |
| Depreciation and  amortization                    |       | 11,397   |       | 4,508    |       | 6,889       |       |        | 153        |   |   |
| Loss from operations                              |       | (31,340  | )          | (16,312  | )          | (15,028     | )          |        | (92        | ) |   |
| Net loss                                          |       | $        | (18,627    | )        | $          | (10,983     | )          | $           | (7,644     | ) |   | (70 | )% |   |

*Exclusive of depreciation and amortization

*Operating Revenues*

Operating revenues fromexternal customers in the Broadband segment increased $10,365 compared to 2003.The increase in Broadband revenues was due in a large part to (i) a 41%increase in the number of subscribers of broadband residential services, (ii) a20% increase in the residential and business DSL data subscribers and (iii) thecontinued expansion of the Business Broadband Services, resulting in a 19%increase in ending access lines.

*Operating Expenses*

Total operating expenses for the Broadband segmentincreased $18,605 compared to 2003 due in part to the REWARD program, which wasoffered to certain eligible employees during the fourth quarter of 2004 and isdescribed in the *Consolidated Overview*section. Cost of services and products (exclusive of depreciation andamortization) increased $10,147, or 41%, compared to 2003 due primarily to (i) anincrease in programming and transport costs related to the 41% increase inBroadband Residential subscriber growth of broadband residential services, (ii) anincrease in repairs and maintenance expense resulting from an increase inoutside plant and (iii) an increase in engineering and networkadministration expenses resulting from an increase in subscriber and networkgrowth.

Customer operationsexpense increased $2,908, or 38%, compared to 2003 due primarily to an increasein (i) sales and advertising costs due to the increase in marketable homespassed and the expansion of bundled services into Roseville, Lincoln and ElkGrove, California and (ii) customer service costs resulting from increasedcall volume caused by the Broadband Residential subscriber growth. General andadministrative expense increased $5,550, or 55%, compared to 2003 due primarilyto increases in (i) consulting and legal fees due to the treasuryinvestigation, audit services and Sarbanes-Oxley implementation and compliance,(ii) an increase in stock-based compensation expense, resulting from anincrease in the issuance of restricted stock awards and restricted stock unitsand (iii) the size of the Company’s workforce, resulting in an increase insalaries and wages, workers’ compensation and medical insurance costs. Depreciationand amortization increased $6,889, or 153%, compared to 2003 primarily due tocontinued network build-out within the residential broadband serviceterritories.

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*Nonmonetary Transaction*

During 2003, the Company entered into a 20-yearnonmonetary transaction with a third party involving the exchange of certainfiber optic capacity and collocation rights. This transaction provides theCompany with access and rights to certain collocation facilities and cell sitelocations, which were previously inaccessible due to unreasonably high entrancecosts. The collocation rights provide access to additional network connectionsto the Company while the cell site locations strengthen the Company’s existingcellular network in key areas. Because this nonmonetary transaction did notrepresent the culmination of an earnings process, no revenues or expenses havebeen, or will be, recorded by the Company pursuant to this transaction. Inaddition, there was no indicated loss on this exchange of productive rights.

In the normal course ofbusiness, the Company entered into certain other nonmonetary transactionsduring 2004 that are not material, either individually or in the aggregate, tothe Company’s consolidated financial statements.

**Wireless**
| ** **                                 | ** ** | **2004** | ** ** | **2003** | ** ** | **$Change** | ** ** | **%Change** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|-------------|------------|-------------|------------|
| Wireless revenues from  external customers | ** ** | $        | 31,261     |     | $          | 27,146      |       | $           | 4,115      |   |   | 15 | % |   |
| Intersegment revenues                      |       | 1,699    |       | 744      |       | 955         |       |        | 128        |   |   |
| Operating expenses*                        |       | 38,266   |       | 34,724   |       | 3,542       |       |        | 10         |   |   |
| Depreciation and  amortization             |       | 11,972   |       | 16,705   |       | (4,733      | )          |        | (28        | ) |   |
| Loss from operations                       |       | (17,278  | )          | (23,539  | )          | 6,261       |       |        | 27         |   |   |
| Net loss                                   |       | $        | (10,823    | )        | $          | (14,937     | )          | $           | 4,114      |   |   | 28 | % |   |

*Exclusive of depreciation and amortization

*Operating Revenues*

Operating revenues fromexternal customers in the Wireless segment increased $4,115 compared to 2003due primarily to (i) a 13% increase in Wireless subscriber base, (ii) anincrease in roaming revenues due to an increase in minutes of use, (iii) anincrease in equipment revenue due to increases in subscribers, average handsetprices and the number of handsets sold and (iv) the introduction ofbundled features, including voicemail and text and picture messaging.

*Operating Expenses*

Total operating expenses for the Wireless segmentincreased $3,542 compared to 2003 due in part to the REWARD program, which wasoffered to certain eligible employees during the fourth quarter of 2004 and isdescribed in the *Consolidated Overview*section. Cost of services and products (exclusive of depreciation andamortization) expense increased $2,901, or 15%, compared to 2003 primarily dueto increases in (i) handset costs and interconnection expenses due to anincrease in the subscriber base and the number of handsets sold, (ii) towerrents due to an increase in cell sites and (iii) network operationsexpense due to an increase in labor expense as a result of an increase inheadcount and a decrease in capitalized labor. This increase was offset by adecrease in roaming expenses due to lower roaming rates. General andadministrative expense increased $522, or 14%, compared to 2003 due primarilyto increases in (i) consulting and legal fees due to the treasuryinvestigation, audit services and Sarbanes-Oxley implementation and compliance,(ii) an increase in stock-based compensation expense, resulting from anincrease in the issuance of restricted stock awards and restricted stock unitsand (iii) the size of the Company’s workforce, resulting in an increase insalaries and wages, workers’ compensation and medical insurance costs.

Depreciation andamortization decreased $4,733, or 28%, compared to 2003. This decrease was dueprimarily to a change in accounting estimate during the first quarter of 2004,resulting from the adoption of 

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certain new technologieswhich increased the estimated useful lives of base stations, towers and networksoftware by one to eight years. This change in accounting estimate decreaseddepreciation expense by $5,383 for the year ended December 31, 2004. Theeffects of continuing additions of towers, base station equipment, digitalswitch assets and network software offset this decrease.

**Non-Operating Items**

*Other Interest Income and Expense, Net*

Consolidated interestincome decreased $105, or 34%, compared to 2003 due to lower average investedbalances. Interest expense increased $258, or 6%, compared to 2003, due to adecrease in capitalized interest. A decline in capital expenditures for plantunder construction and an increase in the turnover rate of constructionprojects contributed to lower capitalized interest costs.

*Other Income (Expense), Net*

In December 2003, theCompany discovered certain irregular bank transactions and deposits in aroutine investigation following the abrupt resignation of the Company’sTreasury Analyst. Immediately following the Company’s initial review thatuncovered these irregularities, the Company broadened its review of theinvestment and cash operations, and a special corporate investigation waslaunched by the Audit Committee and the Board of Directors, which engagedindependent legal counsel and forensic accountants. The investigations revealedconcealed illegal transfers in violation of the Company’s investment and cashmanagement policies. The Company concluded that the irregularities were limitedto the 2003 calendar year. The investigation suggested that as much as $25,000may have been involved in the illegal transfers. Nearly all of the funds hadbeen recovered; however, approximately $1,828 remained outstanding as of December 31,2003 and was reflected as a non-operating loss in the Company’s 2003consolidated financial statements. On October 26, 2004, the Companyreceived an insurance recovery in the amount of $1,803, which has beenreflected as a non-operating gain in the Company’s 2004 consolidated financialstatements. In January 2004, the Federal Bureau of Investigation launchedits own probe into the illegal funds transfer, and in February 2004,indictments were returned against three individuals, including the Company’sformer Treasury Analyst, on charges of mail fraud, conspiracy and moneylaundering. The Company has filed a civil lawsuit seeking to recover themisappropriated funds and other costs from five individuals and a privatecompany allegedly associated with the fraudulent scheme to illegally transferthe Company’s funds to outside accounts. The Company will recognize a recoveryof the funds, if any, in future periods to the extent of additional litigationrecoveries.

*Income Taxes*

Income taxes decreased$1,519, or 149%, compared to 2003 due to a corresponding decrease in incomesubject to tax. The effective federal and state income tax rate was 30.6% and61.3% for the years ended 2004 and 2003, respectively. The decrease in theeffective federal and state income tax rate is primarily due to permanentdifferences, including meals and entertainment and certain non-deductiblecontributions, and the impact of the loss before income taxes for 2004.

As of December 31,2004, the Company had net operating loss carryforwards for federal income taxpurposes of approximately $54,120, which will expire in the years 2018 through2024, if not utilized. Deferred tax assets relating to net operating losscarryforwards for federal purposes as of December 31, 2004 includeapproximately $871 associated with stock compensation activity for whichsubsequent realized tax benefits, if any, will reduce income taxes payable inthe future. As of December 31, 2004, the Company also had net operatingloss carryforwards for state income tax purposes of approximately $4,973, whichwill expire in the years 2005 through 2014, if not utilized. The Companycurrently has a net state deferred asset of $2,831 and expects to generatefuture state taxable income in excess of the approximate $32,000 required torealize the net deferred asset over the next ten years. Deferred tax assetsrelating to net 

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operating losscarryforwards for state purposes as of December 31, 2004 includeapproximately $67 associated with stock compensation activity for whichsubsequent realized tax benefits, if any, will reduce income taxes payable inthe future. As of December 31, 2004, the Company also had research anddevelopment tax credit carryforwards of approximately $100 each for federal andstate income tax purposes. The federal credit will expire in 2022 if it is notutilized. The state credits have no expiration date.

**Liquidity and Capital Resources**

As reflected in the Consolidated Statements of CashFlows, net cash provided by operating activities was $57,441, $56,070 and$73,108 in 2005, 2004 and 2003, respectively. Net cash provided by operatingactivities during 2005 was due primarily to (i) net income of $6,378, (ii) non-cashcharges of $53,770 consisting primarily of depreciation and amortization due tocapital investments principally in the Broadband segment, (iii) anincrease in the change of the provision for deferred income taxes ofapproximately $3,417, and (iv) an increase in the Company’s pensionliability resulting from the REWARD program, the return on plan assets and areduction in the discount rate. Cash provided by operating activities wasoffset in part by (i) an approximate $2,718 decrease in the Company’sestimated and contractual shareable earnings obligations due primarily topayments in the form of a surcredit to end users resulting from the November 2004intrastate settlement agreement and (ii) an approximate $3,079 increase inaccounts receivable due primarily to subscriber growth in the Broadbandsegment.

Net cash used in investing activities was $69,344,$68,257 and $78,833 for 2005, 2004 and 2003, respectively. In all three yearsthe primary use of cash was capital expenditures for property, plant andequipment amounting to $69,768, $70,833 and $76,105 for 2005, 2004 and 2003,respectively.

Net cash provided by financing activities was $1,417and $24,348 in 2005 and 2003, respectively. Net cash used in financingactivities was $8,702 in 2004. In 2005 and 2004, short-term borrowingsincreased $20,000 and $10,000, respectively, while 2003 reflected the issuanceof long-term debt of $60,000. For all years, the primary use of cash was forprincipal payments to retire long-term debt and the payment of dividends.

The Company had a working capital deficit of $24,496at December 31, 2005, due primarily to a decrease in cash to fund items asdescribed above and an increase in short-term borrowings and accrued pensionbenefits. The deficit was reduced in part by increases in accounts receivableand prepaid service and maintenance agreements. As discussed below, the Companybelieves that its working capital position, operating cash flows, borrowingcapacity under its unsecured line of credit as described below and otherpotential long-term financing options are sufficient to satisfy its liquidityrequirements during the next twelve months.

The Company’s most significant use of funds in 2006 isexpected to be for (i) budgeted capital expenditures of approximately$60,500, (ii) scheduled payments of long-term debt of $3,636, (iii) supportof the operations of SureWest Broadband/Residential Services up to ananticipated $1,960 and (iv) support of the operations of SureWest Wirelessup to an anticipated $305. In addition, during 2006 the payment of dividends,which is at the discretion of the Company’s Board of Directors, could be asmuch as $14,600 based on the Company’s most recent dividend and payments. Asubstantial portion of the 2006 budgeted capital expenditures is at thediscretion of the Company, and dependent upon the Company’s working capitalposition, operating cash flows and ability to borrow, as described below. TheCompany is required to comply with its cable franchise agreements to continueits build-out in the franchise areas.

The Company currentlyreceives funding of $11,500 annually from the CHCF, a program designed by theCPUC to establish a fair and equitable local rate structure and to reduce anydisparity in the rates charged by certain telephone companies serving high-costareas. The amount of this support from the CHCF is the subject of pendingregulatory proceedings (for a more detailed discussion, see *Regulatory Matters* within the TelecomSegment Results of Operations). In addition, the CHCF is scheduled to expire January 1,2009.

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The Company has a business loan agreement with a bankfor a $50,000 unsecured line of credit, which expires July 1, 2006. As of December 31,2005 and 2004, there was $30,000 and $10,000 outstanding under this creditfacility, respectively, and the weighted average interest rate was 5.75% and3.14%, respectively, which is based on a LIBOR-based pricing formula.

The Company’s Board of Directors has authorized therepurchase of up to 1.5 million shares of the Company’s common stock. Theshares are purchased from time to time in the open market or through privatelynegotiated transactions, subject to overall financial and market conditions.Through December 31, 2005, approximately one million shares of commonstock had been repurchased. The Company has remaining authorization from theBoard of Directors to repurchase an additional 467 outstanding shares. Thepurchase of common shares did not have an effect on the average number ofcommon shares outstanding or the calculation of basic and diluted earnings pershare for the years ended 2005 and 2003 or the calculation of loss per share forthe year ended 2004.

The Company had cash and cash equivalents at December 31,2005, of $7,633. The Company believes that its working capital position,operating cash flows and borrowing capacity are sufficient to satisfy itsliquidity requirements in the next twelve months. The Company’s forecastindicates it is likely that the Company will continue to borrow funds duringthe next twelve months to fund operations and planned capital expenditures,including capital expenditures as required by the Company’s cable franchiseagreements, while maintaining adequate cash and cash equivalents. Suchborrowing might be undertaken under the $50,000 bank credit facility or by theincurrence of additional long-term indebtedness, or a combination of short-andlong-term borrowing. The Company believes, given its financial position anddebt-to-equity position, it has substantial additional short-and long-termborrowing capacity. As indicated above, a substantial portion of the Company’s2006 budgeted capital expenditures and cash dividend payments is at thediscretion of the Company. Such expenditures and payments in 2006 are also atthe discretion of the Company. Accordingly, the Company believes that it canmodify its planned construction and commitments and cash dividend payments ifthe results of operations or available capital so require.

As ofDecember 31, 2005, the Company’s contractual obligations were as follows:
| ** **                                  | ** ** | **2006** | ** ** | **2007-2008** | ** ** | **2009-2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|----------|------------|---------------|------------|---------------|------------|----------------|------------|-----------|------------|
| Long-term debt                              |       | $        | 3,636      |          |       | $             | 7,273      |           |       |      | $          | 31,273 |   |   |   | $ | 46,909 |   |   | $ | 89,091 |   |
| Short-term borrowings                       |       | 30,000   |       |          | –     |          |       |           | –     |      |       |   | – |   |   | 30,000 |   |
| Capital leases                              |       | 33       |       |          | 11         |          |       |           | 7          |      |       |   | – |   |   | 51 |   |
| Contractual shareable  earnings obligations |       | 3,167    |       |          | 3,734      |          |       |           | –     |      |       |   | – |   |   | 6,901 |   |
| Operating leases                            |       | 5,501    |       |          | 11,361     |          |       |           | 11,071     |      |       |   | 20,844 |   |   | 48,777 |   |
| Unconditional purchase obligations          |       | 2,000    |       |          | 75         |          |       |           | –     |      |       |   | – |   |   | 2,075 |   |
|                                             |            |          |            |               |            |               |            |                |            |           |            |  |  |  |  |  |  |  |  |  |  |  |

 

Dividends are declared at the discretion of theCompany’s Board of Directors. However, the Note Purchase Agreement under whichthe Company issued its Series A and Series B Senior Notes, and otherunsecured credit arrangements contain financial and operating covenants thatrestrict, among other things, the payment of cash dividends, the repurchase ofthe Company’s capital stock, the making of certain other restricted paymentsand the incurrence of additional indebtedness. The bank line of creditagreement requires that the Company obtain written consent to exceed $100,000in total debt with maturities greater than five years. The Company does notbelieve this requirement will have a material affect on its ability to obtainadditional debt if it is deemed necessary. In addition, the Company is requiredto maintain certain financial ratios and minimum levels of tangible net worth.At December 31, 2005, retained earnings of approximately $28,266 wereavailable for the payment of cash dividends, the repurchase of the Company’scapital stock or other restricted payments under the terms of the Company’scredit arrangements.

The Company has variouscable television franchise agreements with associated letters of credittotaling $150 in the aggregate as of December 31, 2005.

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**Related Party Transactions**

During the years ended December 31, 2004 and2003, a former officer of the Company was a member of the Board of Directors ofa local banking institution. For the years ended December 31, 2004 and2003, the Company provided $11 and $45, respectively, in telecommunicationsservices to the banking institution.

Beginning January 1,2005, the Company’s employees were covered under an eye care benefit plan froman entity of which one of the Company’s Board Members is a director and also anexecutive officer. Negotiations regarding the benefit plan were completedbefore that entity’s director and executive officer was elected to the Company’sBoard of Directors and without his involvement. The Company’s payments to suchentity approximated $11 in 2005.

**Critical Accounting Policies and Estimates**

Below is a summaryof the Company’s critical accounting policies and estimates, which are morefully described in the referenced Notes to the Company’s Consolidated FinancialStatements. Management has discussed development and selection of criticalaccounting policies and estimates with the Company’s Audit Committee.

·      As discussed more fully inNote 1, in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 142, *Goodwill and Other IntangibleAssets,* goodwill and wireless licenses are reviewed for impairmentannually, or more frequently if an event occurs or circumstances change thatwould reduce the fair value below its carrying value. The impairment test forgoodwill requires the Company to estimate the fair value at the reporting unitlevel. To determine the fair value in 2005, the Company obtained an independentvaluation of the Company’s goodwill using a discounted cash flow model.Assumptions used in this model include the following:

·        cash flow assumptionsregarding investment in network facilities, distribution channels and customerbase (the assumptions underlying these inputs are based upon a combination ofhistorical results and trends, new industry developments and the Company’sbusiness plans);

·        a 14.5% weighted averagecost of capital based on industry weighted averaged cost of capital; and

·        noterminal growth rate.

The carrying value of theCompany’s goodwill was $2,171 as of December 31, 2005. When determiningthe fair value, the use of different estimates or assumptions within thediscounted cash flow model when determining fair value of the Company’sgoodwill could result in a different fair value. For example, the Company useda discount rate of 14.5% and no terminal growth rate in its assessment of fairvalue in 2005. If the discount rate were to increase 2%, the fair value of thegoodwill would decrease by $40, but would not result in an impairment ofgoodwill.

The Company’s wirelesslicenses include Personal Communications Services (“PCS”) and Local MultipointDistribution Service (“LMDS”) licenses. The carrying value at December 31,2005 of the PCS and LMDS licenses was $8,925 and $4,641, respectively. Inassessing the recoverability of the Company’s PCS licenses, the Companyobtained an independent valuation in 2005, which reviewed transactionsinvolving sales of comparable wireless licenses in the aftermarket, usingcharacteristics of the license and the related market, including geographiclocation, market size, megahertz frequency and population density.

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In assessing therecoverability of the Company’s LMDS licenses, the Company obtained anindependent valuation, as comparable license sales data was not available. Theindependent valuation estimates fair value of the Company’s LMDS licenses usinga discounted cash flow model. Assumptions used in this model include thefollowing:

·        cash flow assumptionsregarding investment in network facilities, distribution channels and customerbase (the assumptions underlying these inputs are based upon a combination ofhistorical results and trends, new industry developments and the Company’sbusiness plans);

·        a 20% weighted averagecost of capital based on industry weighted averaged cost of capital adjusted toreflect the inherent risks associated with the introduction of a new serviceoffering; and

·        a4% terminal value growth rate.

The use of different estimates or assumptions withinthe discounted cash flow model when determining fair value of the Company’sLMDS licenses could result in different values for these licenses. For example,the Company used a discount rate of 20% and a terminal growth rate of 4% in itsassessment of fair value in 2005. If the discount rate were to increase 1%, thefair value of the LMDS licenses would decrease by $700, which would result inan impairment charge of approximately $324 based on the carrying value of theLMDS licenses as of December 31, 2005. In addition, the Company’s LMDSlicenses may be impaired in the near future if the estimates and assumptionsused in the 2005 LMDS license discounted cash flow model are not met.

If the estimated fairvalue is less than the carrying value, then the carrying value is written downto the fair value. As a result of the Company’s annual test for 2005, noimpairment of either goodwill or PCS or LMDS licenses was indicated. During2005, the Company was unaware of any events or changes in circumstance thatwould require a test of impairment that may potentially reduce the fair valuebelow the carrying value.

·      Asdiscussed more fully in Note 3, total revenues from telephone services areaffected by rates authorized by various regulatory agencies. The FCC monitorsSureWest Telephone’s interstate earnings through the use of annual costseparation studies prepared by SureWest Telephone. The FCC establishes rules thatcarriers must follow in the preparation of the annual studies. Based on theserules, the Company is required to prospectively set its annual interstate ratesbased on the aforementioned cost separation studies. These cost studies includeestimates and assumptions regarding various financial data including operatingexpenses, taxes and investment in property, plant and equipment. Non-financialdata estimates are also utilized in the preparation of these cost studies,including projected demand usage and detailed network information. The Companymust also make estimates of the jurisdictional separation of this data toassign current financial and operating data to the interstate or intrastate jurisdiction.These estimates are finalized in future periods as actual data becomesavailable to complete the separation studies. The Company also participates inthe NECA pool for certain interstate revenues. In addition to the estimatesnoted above, the Company’s earned rate-of-return from its participation in theNECA pool can also be impacted by the earnings and data of other carriers whoparticipate in the pool.

In accordance with the NRF, SureWest Telephone issubject to ongoing monitoring and reporting requirements by the CPUC, and itwas initially required to share earnings with customers based on its earnedannual rate-of-return. The Company utilizes models, which rely on estimatesregarding the jurisdictional separation of financial data and operational datainto the interstate jurisdictions as discussed previously for the purposes ofcalculating its earned annual rate-of-return. However, as discussed more fullyin Note 3, SureWest Telephone has entered into a settlement agreement, whichwas approved by the CPUC in November 2004, to cease intrastate sharingrequirements beginning 

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January 1, 2005 through at least December 31,2010. The settlement agreement also resolves existing sharing obligations andrelated earnings issues for the monitoring periods 2000-2004.

As a result of these estimates and assumptions, it isreasonably possible that management’s estimates of SureWest Telephone’sshareable earnings obligations could change in the near term, and the amountsinvolved could be material. For example, the CPUC approved a settlementagreement on November 19, 2004 that resolved the Company’s intrastateshareable earnings for the years 2000 through 2004. In accordance with thissettlement agreement, the Company recorded $2,948 in local revenues due to achange in accounting estimate in the fourth quarter of 2004. This increase inrevenue resulted in a decrease of the Company’s net loss by $2,046 ($0.14 pershare). See Note 3 for a more detailed discussion regarding the settlementagreement.

·      Asdiscussed more fully in Note 2, the Company recognizes revenue when (i) persuasiveevidence of an arrangement between the Company and the customer exists, (ii) deliveryof the product to the customer has occurred or service has been provided to thecustomer, (iii) the price to the customer is fixed or determinable and (iv) collectibilityof the sales price is reasonably assured.

·      Asdiscussed more fully in Note 1, the Company maintains allowances for doubtfulaccounts for estimated losses resulting from the potential inability of itscustomers to make required payments. In evaluating the collectibility of itsaccounts receivable, the Company assesses a number of factors including aspecific customer’s or carrier’s ability to meet its financial obligations tothe Company, the length of time the receivable has been past due and historicaland future expectations of conditions that may impact the Company’s ability tocollect its accounts receivable. If circumstances change or economic conditionsworsen such that the Company’s past collection experience is no longerrelevant, the Company’s estimate of the recoverability of its accountsreceivable could be further reduced from the levels reflected in the Company’sconsolidated balance sheet. If uncollectibility of the Company’s billed revenuechanges by 1%, the Company would expect an increase in uncollectible expense ofapproximately $2,200. As of December 31, 2005, the Company had threecustomers that accounted for 5% of consolidated accounts receivable. Althoughmanagement believes that these customers are creditworthy, a severe adverseimpact on their business operations could have a corresponding material effecton their ability to pay timely and, therefore, on the Company’s results ofoperations, cash flows and financial condition. In addition, certain revenuesare subject to refund if the customer terminates services or returns equipmentwithin a stipulated time period, or if certain performance criteria are not met.Accordingly, the Company maintains accounts receivable allowances andrecognizes certain customer refund liabilities, through charges to revenues,based on the Company’s best estimates of the resolution of these contingencies,which are based on historical experience.

·      Asdiscussed more fully in Note 1, the Company states its inventories held forsale at lower of cost or market. In assessing the ultimate recoverability ofinventories, the Company is required to make estimates regarding futurecustomer demand and technological advances of equipment.

·      Asdiscussed more fully in Note 1, property, plant and equipment are recorded atcost. Retirements and other reductions of regulated telephone plant andequipment are charged against accumulated depreciation with no gain or lossrecognized in accordance with the composite group remaining life methodologyutilized for telephone plant assets. When property applicable to non-telephoneoperations is sold or retired, the asset and related accumulated depreciationare removed from the accounts and the associated gain or loss is recognized.Property, plant and equipment is depreciated or amortized using thestraight-line method over their estimated economic lives. The economic livesare estimated at the time the assets are acquired and are based on historicalexperience with similar assets, as well as anticipated technological or otherchanges. If technological changes were to occur more rapidly than anticipatedor differently than anticipated, the economic lives assigned to these assetsmay need to be shortened, resulting in the recognition of increaseddepreciation and amortization expense in future periods. Likewise, if theanticipated technological or other changes 

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occur more slowly than anticipated, the life of theasset group could be extended based on the life assigned to new assets added tothe group. This could result in a reduction of depreciation and amortizationexpense in future periods. The Company reviews the estimated useful lives ofits property, plant and equipment once every three years, or when events or circumstancesindicate that the carrying amount may not be recoverable over the remaininglives of the assets. In assessing the recoverability of the Company’s property,plant and equipment, the Company must make assumptions regarding estimatedfuture cash flows and other factors to determine the fair value of therespective assets.

·      Asdiscussed in Note 1, the Company accounts for asset retirement obligations inaccordance with SFAS No. 143, *Accountingfor Asset Retirement Obligations*and Financial Accounting StandardsBoard Interpretation (“FIN”) No. 47, *Accounting for Conditional RetirementObligations*, which requires the Company to recognize a retirementobligation when a legal obligation exists to remove an asset at some point inthe future or if legislation exists that requires special disposal proceduresof the asset. The Company believes it may have potential retirement obligationsrelating to its wireless cell sites and disposal obligations relating tocertain building materials containing asbestos. Based on terms outlined in itstower leases, the Company is obligated to return the land or facilities totheir original condition at the end of the cell site lease term, should thelease be terminated. Based on the Company’s estimates it believes that the disposalrequirement relating to certain building materials containing asbestos is theexpected retirement date of the underlying assets. The Company has used aprobability-weighted cash flow approach in estimating its potential retirementobligations. The Company calculates the net present value of the retirementobligation assuming an inflation rate of 3%, a discount rate of 7% and a marketrisk premium of 4%. The Company has also assumed the settlement date for itswireless towers to be 25 years from the date the asset is placed into service. TheCompany has estimated that the expected retirement date of its buildings thatcontain asbestos is 2025. The Company has also used a probability-weightedassessment to address the uncertainty regarding the timing of future cash flowsto settle the potential liability. The Company believes that utilizingprobabilities for its wireless towers of less than 100% is appropriate becausethe Company believes the likelihood of incurring material asset retirementexpenditures is remote. The Company used a 100% probability factor of itsbuilding materials containing asbestos. The Company monitors the estimates andassumptions used in determining its potential asset retirement obligations forits cell sites and buildings containing asbestos. However, the Company believesit is remote that any future adjustment to its asset retirement liability forobligations existing as of December 31, 2005 will be material to theCompany’s consolidated financial statements.

·      Asdiscussed more fully in Notes 1 and 7, the Company accounts for income taxesusing the liability method. Under this method, deferred tax assets andliabilities are determined based on differences between the financial reportingand tax bases of assets and liabilities and are measured using the enacted taxrates and laws that are expected to be in effect when the differences areexpected to reverse. The Company does not have a valuation allowance on itsdeferred tax asset as of December 31, 2005 or 2004 because it believes itis more likely than not that such deferred tax asset will be realized. Shouldthe Company determine that it would not be able to realize all or part of itsdeferred tax asset in the future, an adjustment to the deferred tax asset wouldbe charged to income in the period in which the determination was made.

·      As discussed more fully inNote 8, the Company has pension and post-retirement benefit costs andobligations. The Company’s pension and post-retirement benefit obligations areactuarially determined based on estimates of discount rates, long-term rates ofreturn on plan assets and increases in future compensation levels. Changes inthese estimates and other factors could significantly impact the Company’spension and post-retirement benefit costs and obligations. Assumed health carecost trend rates have a significant effect on the amounts reported for thehealth 

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care plans. Aone-percentage-point change in assumed health care cost trend rates would havethe following effects:
| ** **                                                                 | ** ** | **1-Percentage-  Point Increase** | ** ** | **1-Percentage-  Point Decrease** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| Effect on total 2005 post-retirement service and  interest cost            |       |                                   | $          | 109                                    |       |   |   | $ | (92 | ) |   |
| Effect  on post-retirement benefit obligation as of December 31, 2005 |       |                                   | $          | 664                                    |       |   |   | $ | (575 | ) |   |

 

For 2005, the discountrate used for the Company’s pension and post-retirement benefit obligations was5.75% and 5.50%, respectively. The discount rates were determined based oncurrent yields on high quality corporate fixed-income investments withmaturities corresponding to the expected duration of the benefit obligations.The rate used for the post-retirement benefit obligation reflects heavierweighting for retired participants of shorter durations.

The expected return onassets (“EROA”) rate is determined based on the current and projected investmentportfolio mix and estimated long-term investment returns for each asset class.In 2005, the Company used an EROA of 8.5%. The Company evaluated theappropriateness of the EROA rate for 2006 by analyzing the long-term returnsfor domestic and international equities, as well as domestic fixed incomeinstruments. Based on the evaluation the Company decreased the EROA for 2006 to8.0% to better reflect the current economic environment. The 0.5% decrease inthe EROA rate will increase the Company’s 2006 pension expense approximately$550, or 9.0%.

Thefuture compensation levels are based on recent experience as well as futureexpectations. As of December 31, 2005 and during 2006, the Company expectsits future compensation level to remain consistent at 5.0%, which is consistentwith the prior year.

·      As discussed more fully inNotes 3 and 9, the Company is a party to a variety of litigation, regulatoryproceedings and other contingencies that arise in the ordinary course ofbusiness. The Company is required to assess the likelihood of any adversejudgments or outcomes to these matters, as well as potential ranges of probablelosses for certain of these matters. The determination of the liabilitiesrequired, if any, for loss contingencies is made after careful analysis of eachindividual issue. In the opinion of management, the ultimate outcome of thesematters will not materially affect the Company’s consolidated financialposition and results of operations.

·      As discussed more fully inNote 10, the Company currently sponsors two Equity Incentive Plans (the“Plans”) for certain employees, outside directors and consultants of theCompany, which were approved by the Company’s shareholders. The Plans permitissuance by the Company of awards in the form of restricted shares, stockunits, performance shares, stock options and stock appreciation rights.Effective January 1, 2003, the Company adopted the preferable fair valuerecognition provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation.* Under the prospective transitionmethod selected by the Company, as described in SFAS No. 148, *Accounting for Stock-Based Compensation–Transitionand Disclosure*, compensation expense was recognized beginning in2003 for all employee awards granted, modified or settled after January 1,2003. This change in accounting for stock-based compensation resulted inincreased compensation expense of $18 and $47 and decreased net income by $11(no effect on earnings per share) and $18 (no effect on earnings per share) forthe years ended December 31, 2005 and 2003, respectively. For the yearended December 31, 2004, compensation expensed increased $29, whichincreased net loss by $20 (no effect on earnings per share).

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The Company voluntarilymade the choice to change to the preferable method of accounting for employeestock options in accordance with SFAS No. 123. The Company concluded thatstock options are a form of employee compensation expense and, therefore, it isappropriate that these expenses be recorded in the results of operations tomore clearly reflect economic reality.

The Black-Scholes-Merton option-pricing model includesassumptions regarding dividend yields, expected volatility, expected lives andrisk-free interest rates. These assumptions reflect management’s bestestimates, but these items involve inherent uncertainties based on marketconditions generally outside of the control of the Company. As a result, ifother assumptions had been used in the current period, stock-based compensationexpense could have been materially different. If management uses differentassumptions in future periods, stock-based compensation expense could bematerially impacted in future years.

**Recent Accounting Pronouncements**

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections.*TheStatement applies to all voluntary changes in accounting principle, and changesthe requirements for accounting for and reporting of a change in accountingprinciple. SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005. The Company will adopt SFAS No. 154 on January 1, 2006 and doesnot anticipate any material effect on its consolidated financial statements.

In December 2004, the FASB issued SFAS No. 123(revised 2004), *Share-Based Payment*(“SFAS No. 123(R)”), which is a revision of SFAS No. 123, *Accounting for Stock-Based Compensation*. SFASNo. 123(R) supersedes Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,and amends SFAS No. 95, *Statement ofCash Flows*. Generally, the approach in SFAS No. 123(R) issimilar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the statement of operations based on their fairvalues. Pro forma disclosure is no longer an alternative.

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

Effective January 1, 2003, the Company adoptedthe fair value recognition provisions of SFAS No. 123. Under theprospective method of adoption selected by the Company under the provisions ofSFAS No. 148, *Accounting forStock-Based Compensation–Transition and Disclosure*, the fair valuemethod of accounting was applied to all employee awards granted, modified, orsettled after January 1, 2003. SFAS No. 123(R) must be appliednot only to new awards but to previously granted awards that are not fullyvested on the effective date. Compensation cost of previously granted awards thatwere not recognized under SFAS No. 123 will be recognized under SFAS No. 123(R).Had the Company adopted SFAS No. 123(R) in prior periods, the impactwould have approximated the impact of SFAS No. 123 as described in thedisclosure of pro forma net income and earnings per share in Note 1 to theConsolidated Financial Statements.

SFAS No. 123(R) permits public companies toadopt its requirements using either the modified-prospective transition methodor the modified-retrospective transition method. The Company has chosen to usethe modified-prospective method in which compensation cost is recognizedbeginning with the effective date based on the requirements of SFAS No. 123(R) forall share-based payments granted after 

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the effective date, and based on the requirements ofSFAS No. 123 for all awards granted to employees prior to the effectivedate of SFAS No. 123(R) that remain unvested on the effective date.

The Company does not believe the adoption of SFAS No. 123(R) willhave a material effect on its consolidated financial position, results ofoperations or cash flows.

In March 2005, theFASB issued FIN No. 47, *Accounting forConditional Asset Retirement Obligations*. FIN No. 47 clarifiesthat the term “conditional asset retirement obligation” as used in SFAS No. 143,*Accounting for Asset Retirement Obligations*,refers to a legal obligation to perform an asset retirement activity in whichthe timing and/or method of settlement are conditional on a future event thatmay or may not be within the control of the entity. FIN No. 47 requires anentity to recognize a liability for the fair value of a conditional assetretirement obligation if the fair value of the liability can be reasonablyestimated. The Company’s adoption of FIN No. 47 on December 31, 2005did not have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

**Factors That Could Affect Future Results**

As a result of the following factors, as well as othervariables affecting our operating results, past financial performance may notbe a reliable indicator of future performance, and historical trends should notnecessarily be used to anticipate results or trends in future periods.

Representative examples of these factors include(without limitation) the following:

*We expect to continue to face significant competitionin all parts of our business and the level of competition is expected tointensify.*   The telecommunications industry is highlycompetitive. We face actual or potential competition from many existing andemerging companies, including other incumbent and competitive local telephonecompanies, long-distance carriers and resellers, wireless telephone companies,Internet service providers, satellite companies and cable television companies.We may not be able to successfully anticipate and respond to variouscompetitive factors affecting the industry, including regulatory changes thatmay affect our competitors and us differently, new technologies and servicesthat may be introduced, changes in consumer preferences, demographic trends anddiscount pricing strategies by competitors. As the incumbent carrier inSacramento, SBC Communications enjoys certain business advantages, includingits size, financial resources, favorable regulatory position, brand recognitionand connection to virtually all of our customers and potential customers there.As the largest cable operator in Sacramento and Placer County, Comcast enjoyscertain business advantages, including its size, financial resources, ownershipor superior access to programming and other content, brand recognition, andfirst-in-the-field advantages with a customer base that generates positive cashflow for its operations. We face intense competition in our markets forlong-distance, Internet access and other ancillary services that are importantto our business and to our growth strategy.

*We must adapt to rapid technological change.*   Technologicaldevelopments could increase our costs and cause a decline in demand for ourservices. In addition, technology changes can reduce the costs of entry forothers and give competitors significant new advantages. If we do not replace orupgrade technology and equipment that becomes obsolete, we will be unable tocompete effectively because we will not be able to meet the needs orexpectations of our customers, and we may be placed at a cost disadvantage inoffering our services. Additionally, replacing or upgrading our infrastructurein the future could result in significant capital expenditures.

*We are subject to a complex and uncertain regulatoryenvironment.**  *Some parts of ourbusiness are extensively regulated, and the nature of regulation continues toundergo fundamental change and reinterpretation. Many businesses that competewith the Company are comparatively less regulated. 

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Many significant regulatory decisions have had to beaccommodated in recent years, and there are pending decisions on issuesaffecting the Company that are of great importance.

*Our operations have undergone material changes, andour actual operating results can be expected to differ from the resultsindicated in our historical financial statements.*   As a resultof our 2002 acquisition of assets, which launched our residential broadbandbusiness, and the subsequent expansion of our cable television business, ourmix of operating assets differs from those operations upon which our historicalfinancial statements are based. Consequently, our historical financialstatements may not be reliable as an indicator of future results.

*Our success depends upon our ability to manage ourgrowth and expansion. If our recent acquisitions and growth initiatives are notsuccessful, we could suffer an adverse effect on our business and results ofoperations.*   Our growth strategy will continue to requireus to invest significant capital in facilities and services that may notachieve the desired returns. Our future success depends, in part, upon ourability to manage our growth, including our ability to build network andrelated facilities to serve new customers, integrate our operations to takeadvantage of new capabilities and systems; attract and retain skilled personnelacross the Company, effectively manage the demands of day to day operations innew areas while attempting to execute our business strategy, and realize theprojected growth and revenue targets developed by Company management.

*We receive support from various funds establishedunder federal and state law and the continued receipt of that support is notassured.*   While we do notreceive any support from the rural or non-rural Federal Universal Service highcost loop fund, we do receive payments from various other federal or stateprograms. These include interstate common line support, CHCF and the Lifeline,Education and Libraries programs. These governmental programs are reviewed andamended from time to time, and are likely to change in the near future. Asdescribed in the Regulation sectionabove, the Company currently receives funding of $11,500 annually from theCHCF, a program designed by the CPUC to establish a fair and equitable localrate structure and to reduce any disparity in the rates charged by certaintelephone companies serving high-cost areas. The amount of this support fromthe CHCF is the subject of pending regulatory proceedings, and its continuationis dependent upon many factors. In addition, the state legislativeauthorization for the CHCF is scheduled to expire January 1, 2009. Theoutcome and impact on the Company’s operations resulting from future changes tothese governmental programs cannot be determined at this time.

*We could be harmed by the recent developmentsaffecting other communications companies.*   Therehave been numerous bankruptcies and other financial difficulties experienced byother carriers and suppliers in the telecommunications and Internet sectors. Similarsituations with our suppliers, some of whom provide products and services forwhich there are few substitutes, could cause us to experience delays, serviceinterruptions or additional expenses. Situations with carrier and othercustomers could affect our ability to collect services that have been provided.

*We depend on third parties, over whom we have nocontrol, to deliver our services.*   Becauseof the interconnected nature of the telecommunications industry, we dependheavily on other local telephone companies, long-distance carriers, andnumerous other third parties to deliver our services. In addition, we aredependent on easements, franchises and licenses from various private partiessuch as established telephone companies and other utilities, railroads,long-distance companies, and from state highway authorities, local governmentsand transit authorities for access to aerial pole space, underground conduitsand other rights-of-way in order to construct and operate our networks. Thefailure to maintain in effect the necessary third party arrangements onacceptable terms would have an adverse effect on our ability to conduct ourbusiness.

*We are subject tocorporate governance and internal control reporting requirements, and ourfailure to comply with existing and future requirements could adversely affectour business.*   Pursuantto 

43

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Section 404 of theSarbanes-Oxley Act of 2002 (“Section 404”) and related Securities andExchange Commission rules, we have issued a report of management’s assessmentof the effectiveness of our internal controls at December 31, 2005. Inaddition, our Independent Registered Public Accounting Firm audited and reportedon management’s assessment. Management concluded that the Company’s internalcontrol over financial reporting was effective at December 31, 2005. If weare unable to maintain effective internal controls or if future deficienciesare not adequately addressed, we could experience accounting errors that couldresult in misstatements of our financial position and results of operations,potential restatements of our financial statements or otherwise adverselyaffect our business, reputation and results of operations. Inferior internalcontrols could also cause investors to lose confidence in our reportedfinancial information, which could have a negative effect on the trading priceof our securities.

**Regulatory and Legal Matters**

SureWest Telephone is subject to regulation by the FCCand CPUC. In the past, there have been various proceedings before theseagencies to which SureWest Telephone has been a party. In 1996, Congress passedthe Telecommunications Act of 1996 (the “Act”), which significantly changed theregulatory environment for telecommunications companies. Beginning in 1996, theFCC conducted proceedings and adopted orders implementing the Act’s provisionsto open local exchange service markets, such as the market of SureWestTelephone, to competition. These proceedings and orders addressinterconnection, intercarrier compensation, access charges, universal serviceand Internet protocol (“IP”) enabled service. With respect to localcompetition, the FCC rules outline pricing methodologies for the states tofollow when setting rates for incumbent carriers (such as SureWest Telephone)to charge competitors for resale, interconnection and unbundled networkelements.

Due to the ongoing actions taken by the FCC topromulgate rules and regulations on interconnection access charges anduniversal service reform, and the various on-going legal challenges consideringthe validity of these FCC orders, it is not yet possible to determine fully theimpact of the Act and related FCC regulations on SureWest Telephone’soperations.

The Company’sfinancial condition and results of operations have been and will be affected byrecent and future proceedings before the CPUC and FCC. Pending before the FCCand CPUC are proceedings, which are considering:

·       Additionalrules governing the opening of markets to competition and the regulationof the competing telecommunications providers;

·       Thenature and extent of the compensation, if any, to be paid by carriers and otherproviders to one another for network use, and the sums to be recovered throughend users and other sources;

·       Thegoals and definition of universal telephone service in a changing environment,including examination of subsidy support mechanisms for subscribers ofdifferent carriers (including incumbent carriers) and in various geographicareas;

·       Rules thatwill provide non-discriminatory access by competing service providers to thenetwork capabilities of local exchange carriers; and

·       Theregulated rates and earnings of SureWest Telephone.

44

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The Company has been involved in a proceeding at theCPUC that has considered the continued need for certain sharing requirements inthe intrastate jurisdiction, and in connection with that review, has alsoconsidered the issues of whether the Company overearned in the intrastatejurisdiction in recent monitoring periods, and if so, the amount of suchoverearnings that should be shared with customers. In July 2004, theCompany entered into a settlement agreement with the other parties in theproceeding, the ORA and TURN, to resolve all issues in the proceeding. In November 2004,the CPUC approved the settlement agreement. Among other things, the settlementagreement resolves all earnings issues for the monitoring periods 2000-2004,put into place a surcredit mechanism for the amount of the settlement, andsuspends the requirement for any intrastate sharing for later monitoringperiods from January 1, 2005 through at least December 31, 2010.

There are a number of pending and anticipated otherregulatory proceedings occurring at the federal and state levels that may havea material impact on SureWest Telephone. These regulatory proceedings include,but are not limited to, consideration of changes to the interstate universalservice fund, intercarrier compensation, reform and the regulation of localexchange carriers and their competitors, and regulation of IP-enabled services.The outcomes and impact on SureWest Telephone’s operations of these proceedingsand related court matters cannot be determined at this time.

The eventual impact on theCompany of the effect of all the proceedings described above cannot presentlybe determined.

**Item 7A.**                Quantitativeand Qualitative Disclosures About Market Risk.

The Company has limited exposure to the impact ofinterest rate fluctuations. To manage its exposure to interest ratefluctuations, the Company uses a combination of variable short-term and fixedrate long-term financial instruments. In addition, the Company has acontractual obligation related to its intrastate shareable earnings in the formof a surcredit to its customers over a period of four years beginning January 1,2005, which is subject to variable interest rates. The Company does not usederivative financial instruments in its investment portfolio or for any otherpurposes.

The Company primarily enters into debt obligations tofund operations and planned capital expenditures. The Company currently has nocash flow exposure related to its long-term debt obligations as all obligationsare at fixed rates. As of December 31, 2005, the Company had fixed ratedebt obligations of $89.1 million with an average interest rate of 5.3%. Basedon borrowing rates currently available for loans with similar terms andmaturities, the estimated fair value of long-term debt as of December 31,2005 was $89.1 million.

The Company currently has minimal cash flow exposurerelated to its short-term debt obligation as the credit facility can beconverted into a long-term obligation at a fixed rate at anytime. The Companyalso believes there is limited exposure to market risk for change in interestrates related to contractual shareable earnings obligations. The interest rateon the contractual shareable earnings obligations is variable based on a 30-daycommercial paper rate. Assuming a fluctuation of 100 basis points in theinterest rate of the contractual shareable earnings obligations, the fair valuewould increase $87 thousand or decrease $80 thousand. As of December 31,2005, the Company had variable rate debt obligations of $36.6 million with anaverage interest rate of 5.0%.

45

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**Item8.**                        FinancialStatements and Supplementary Data.
|                                                                                                                              | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                                                     |       |     | 47         |   |   |
| Consolidated Statements of Operations for each of  the three years in the period ended December 31, 2005                |       |     | 48         |   |   |
| Consolidated Balance Sheets as of December 31,  2005 and 2004                                                           |       |     | 49         |   |   |
| Consolidated Statements of Shareholders’ Equity for  each of the three years in the period ended December 31, 2005 |       |     | 51         |   |   |
| Consolidated Statements of Cash Flows for each of the  three years in the period ended December 31, 2005                |       |     | 52         |   |   |
| Notes to  Consolidated Financial Statements                                                                                  |       |     | 53         |   |   |

 

46

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**Reportof Independent Registered Public Accounting Firm**

The Board ofDirectors and Shareholders of SureWest Communications

We have audited the accompanying consolidated balancesheets of SureWest Communications as of December 31, 2005 and 2004, andthe related consolidated statements of operations, shareholders’ equity, andcash flows for each of the three years in the period ended December 31,2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of SureWest Communications at December 31, 2005 and 2004, and theconsolidated results of its operations and its cash flows for each of the threeyears in the period ended December 31, 2005, in conformity with U.S.generally accepted accounting principles.

As discussed in Note 1 to the consolidated financialstatements, in 2003 the Company adopted the fair value recognition provisionsof Statement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation*,using the prospective adoption method under the provisions of Statement ofFinancial Accounting Standards No. 148, *Accountingfor Stock-Based Compensation–Transition and Disclosure*. As discussedin Note 1 to the consolidated financial statements, in 2003 the Company changedits method of accounting for revenue recognition upon the prospective adoptionof Emerging Issues Task Force Issue No. 00-21, *Accounting for Revenue Arrangements with MultipleDeliverables*.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of SureWestCommunications’ internal control over financial reporting as of December 31,2005, based on criteria established in Internal Control–Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated February 27, 2006 expressed an unqualified opinionthereon.
|  |   | /s/ Ernst & Young LLP |
|--|--------|--------------------------------|

 

Sacramento,CaliforniaFebruary 27, 2006

47

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**SUREWESTCOMMUNICATIONSCONSOLIDATED STATEMENTS OF OPERATIONS**(amounts in thousands,except per share amounts)
| ** **                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Operating revenues:                                                          |       |                                        |       |   |   |   |   |
| Local service                                                                |       | $                                           | 63,522     |   | $ | 69,560 |   | $ | 63,363 |   |
| Network access  service                                                      |       | 44,214                                      |       | 46,161 |   | 51,286 |   |
| Directory  advertising                                                       |       | 17,383                                      |       | 16,283 |   | 15,087 |   |
| Long distance  service                                                       |       | 6,016                                       |       | 5,184 |   | 5,098 |   |
| Wireless service                                                             |       | 34,205                                      |       | 31,261 |   | 27,146 |   |
| Internet service                                                             |       | 17,829                                      |       | 16,679 |   | 15,984 |   |
| Residential  broadband service                                               |       | 23,991                                      |       | 17,077 |   | 9,370 |   |
| Business  broadband service                                                  |       | 8,095                                       |       | 5,660 |   | 3,697 |   |
| Other                                                                        |       | 3,333                                       |       | 3,898 |   | 4,090 |   |
| Total operating  revenues                                                    |       | 218,588                                     |       | 211,763 |   | 195,121 |   |
| Operating  expenses:                                                         |       |                                        |       |   |   |   |   |
| Cost of services and products (exclusive of  depreciation  and amortization) |       | 77,071                                      |       | 80,853 |   | 66,890 |   |
| Customer  operations and selling                                             |       | 34,595                                      |       | 37,175 |   | 34,094 |   |
| General and  administrative                                                  |       | 37,222                                      |       | 43,820 |   | 33,920 |   |
| Depreciation and  amortization                                               |       | 53,770                                      |       | 48,596 |   | 52,470 |   |
| Total operating  expenses                                                    |       | 202,658                                     |       | 210,444 |   | 187,374 |   |
| Income from  operations                                                      |       | 15,930                                      |       | 1,319 |   | 7,747 |   |
| Other income  (expense):                                                     |       |                                        |       |   |   |   |   |
| Investment income                                                            |       | 445                                         |       | 201 |   | 306 |   |
| Interest expense                                                             |       | (5,675                                      | )          | (4,505 | ) | (4,247 | ) |
| Corporate  treasury loss recovery (loss)                                     |       | –                                      |       | 1,803 |   | (1,828 | ) |
| Other, net                                                                   |       | (414                                        | )          | (443 | ) | (311 | ) |
| Total other  income (expense), net                                           |       | (5,644                                      | )          | (2,944 | ) | (6,080 | ) |
| Income (loss)  before income taxes                                           |       | 10,286                                      |       | (1,625 | ) | 1,667 |   |
| Income tax  expense (benefit)                                                |       | 3,908                                       |       | (497 | ) | 1,022 |   |
| Net income (loss)                                                            |       | $                                           | 6,378      |   | $ | (1,128 | ) | $ | 645 |   |
| Basic and diluted  earnings (loss) per share                                 |       | $                                           | 0.44       |   | $ | (0.08 | ) | $ | 0.04 |   |
| Shares of common  stock used to calculate earnings (loss) per share:         |       |                                        |       |   |   |   |   |
| Basic                                                                        |       | 14,552                                      |       | 14,531 |   | 14,522 |   |
| Diluted                                                                      |       | 14,631                                      |       | 14,531 |   | 14,539 |   |

 

See accompanying notes.

48

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**SUREWESTCOMMUNICATIONSCONSOLIDATED BALANCE SHEETS**(amounts in thousands)
| ** **                                                                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                    | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                    |       |                  |       |   |   |
| Current assets:                                                                                               |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                    |       | $                     | 7,633      |   | $ | 18,119 |   |
| Short-term  investments                                                                                       |       | 617                   |       | – |   |
| Accounts receivable (less allowances of $5,219 and  $3,850 at  December 31, 2005 and 2004, respectively) |       | 23,234                |       | 20,155 |   |
| Inventories                                                                                                   |       | 5,626                 |       | 5,578 |   |
| Deferred  directory costs                                                                                     |       | 5,130                 |       | 5,599 |   |
| Prepaid expenses                                                                                              |       | 3,918                 |       | 2,359 |   |
| Deferred income  taxes                                                                                        |       | 14,502                |       | 13,721 |   |
| Total current assets                                                                                          |       | 60,660                |       | 65,531 |   |
| Property, plant  and equipment, net                                                                           |       | 381,075               |       | 365,613 |   |
| Intangible and  other assets:                                                                                 |       |                  |       |   |   |
| Wireless  licenses, net                                                                                       |       | 13,566                |       | 13,566 |   |
| Goodwill                                                                                                      |       | 2,171                 |       | 2,171 |   |
| Intangible asset  relating to pension plans                                                                   |       | 456                   |       | 802 |   |
| Intangible asset  relating to favorable operating leases, net                                                 |       | 393                   |       | 506 |   |
| Deferred charges  and other assets                                                                            |       | 708                   |       | 714 |   |
|                                                                                                          |       | 17,294                |       | 17,759 |   |
|                                                                                                          |       | $                     | 459,029    |   | $ | 448,903 |   |

 

See accompanying notes.

49

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**SUREWESTCOMMUNICATIONSCONSOLIDATED BALANCE SHEETS (Continued)**(amounts in thousands)
| ** **                                                                                                                                                      | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                                  |       |                  |       |   |   |
| Current liabilities:                                                                                                                                            |       |                  |       |   |   |
| Short-term  borrowings                                                                                                                                          |       | $                     | 30,000     |   | $ | 10,000 |   |
| Current portion  of long-term debt and capital lease obligations                                                                                                |       | 3,669                 |       | 3,991 |   |
| Accounts payable                                                                                                                                                |       | 3,634                 |       | 2,886 |   |
| Other accrued  liabilities                                                                                                                                      |       | 20,496                |       | 22,038 |   |
| Current portion  of contractual shareable earnings obligations                                                                                                  |       | 2,932                 |       | 3,040 |   |
| Estimated  shareable earnings obligations                                                                                                                       |       | 293                   |       | 396 |   |
| Advance billings  and deferred revenues                                                                                                                         |       | 9,730                 |       | 9,883 |   |
| Accrued income taxes                                                                                                                                            |       | 1,015                 |       | 1,549 |   |
| Accrued pension  benefits                                                                                                                                       |       | 7,615                 |       | 3,216 |   |
| Accrued  compensation                                                                                                                                           |       | 5,772                 |       | 5,830 |   |
| Total current  liabilities                                                                                                                                      |       | 85,156                |       | 62,829 |   |
| Long-term debt  and capital lease obligations                                                                                                                   |       | 85,473                |       | 89,143 |   |
| Long-term contractual  shareable earnings obligations                                                                                                           |       | 3,695                 |       | 6,202 |   |
| Deferred income taxes                                                                                                                                           |       | 40,398                |       | 37,855 |   |
| Other liabilities and  deferred revenues                                                                                                                        |       | 12,556                |       | 11,537 |   |
| Commitments and  contingencies                                                                                                                                  |       |                  |       |   |   |
| Shareholders’  equity:                                                                                                                                     |       |                  |       |   |   |
| Common stock, without par value; 100,000 shares  authorized,  14,629 and 14,591 shares issued and outstanding at December 31, 2005  and 2004, respectively |       | 164,598               |       | 161,824 |   |
| Deferred  stock-based compensation                                                                                                                              |       | (2,255                | )          | (949 | ) |
| Accumulated other  comprehensive loss                                                                                                                           |       | (4,909                | )          | (2,126 | ) |
| Retained earnings                                                                                                                                               |       | 74,317                |       | 82,588 |   |
| Total shareholders’  equity                                                                                                                                |       | 231,751               |       | 241,337 |   |
|                                                                                                                                                            |       | $                     | 459,029    |   | $ | 448,903 |   |

 

See accompanying notes.

50

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**SUREWESTCOMMUNICATIONSCONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY**(amounts in thousands)
| ** **                                                                               | ** ** | **Common Stock**  | ** ** | ** ** | ** ** | ** **                              | ** ** | ** **                     | ** ** | ** **             | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------|------------|------------|------------|-----------------------------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                                                                               | ** ** | **Number  of  Shares** | ** ** | **Amount** | ** ** | **Deferred  Stock-Based  Compensation** | ** ** | **Other  Comprehensive  Loss** | ** ** | **Retained  Earnings** | ** ** | **Total** | ** ** |
| Balance  at December 31, 2002                                                       |       |                   | 14,529     |       |       | $                                       | 158,567    |                           |       | $                      | (116       | ) |   |   | $ | (1,637 | ) |   | $ | 112,191 |   | $ | 269,005 |   |
| Issuance  of common stock upon exercise of options                                       |       |                   | 5          |       |       | 164                                     |       |                           | –     |                   |       |   | – |   |   | – |   | 164 |   |
| Recognition  of stock options issued to employees                                        |       |                   | –     |       |       | 47                                      |       |                           | –     |                   |       |   | – |   |   | – |   | 47 |   |
| Issuance  of restricted common stock, net of cancellations                               |       |                   | 44         |       |       | 1,594                                   |       |                           | (1,594     | )                      |       |   | – |   |   | – |   | – |   |
| Amortization  of deferred stock-based compensation                                       |       |                   | –     |       |       | –                                  |       |                           | 291        |                   |       |   | – |   |   | – |   | 291 |   |
| Tax  effect from stock plans                                                             |       |                   | –     |       |       | 539                                     |       |                           | –     |                   |       |   | – |   |   | – |   | 539 |   |
| Minimum  pension and post-retirement benefit obligation adjustment, net of  income taxes |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | 1,376 |   |   | – |   | 1,376 |   |
| Cash  dividends                                                                          |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | – |   |   | (14,539 | ) | (14,539 | ) |
| Net  income                                                                              |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | – |   |   | 645 |   | 645 |   |
| Balance  at December 31, 2003                                                       |       |                   | 14,578     |       |       | 160,911                                 |       |                           | (1,419     | )                      |       |   | (261 | ) |   | 98,297 |   | 257,528 |   |
| Issuance  of common stock upon exercise of options                                       |       |                   | –     |       |       | 10                                      |       |                           | –     |                   |       |   | – |   |   | – |   | 10 |   |
| Recognition  of stock options issued to employees                                        |       |                   | –     |       |       | 29                                      |       |                           | –     |                   |       |   | – |   |   | – |   | 29 |   |
| Issuance  of restricted common stock, net of cancellations and stock repurchases         |       |                   | 13         |       |       | 465                                     |       |                           | (469       | )                      |       |   | – |   |   | – |   | (4 | ) |
| Amortization  of deferred stock-based compensation                                       |       |                   | –     |       |       | –                                  |       |                           | 939        |                   |       |   | – |   |   | – |   | 939 |   |
| Tax  effect from stock plans                                                             |       |                   | –     |       |       | 409                                     |       |                           | –     |                   |       |   | – |   |   | – |   | 409 |   |
| Minimum  pension and post-retirement benefit obligation adjustment, net of  income taxes |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | (1,865 | ) |   | – |   | (1,865 | ) |
| Cash  dividends                                                                          |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | – |   |   | (14,581 | ) | (14,581 | ) |
| Net  loss                                                                                |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | – |   |   | (1,128 | ) | (1,128 | ) |
| Balance  at December 31, 2004                                                       |       |                   | 14,591     |       |       | 161,824                                 |       |                           | (949       | )                      |       |   | (2,126 | ) |   | 82,588 |   | 241,337 |   |
| Recognition  of stock options issued to employees                                        |       |                   | –     |       |       | 18                                      |       |                           | –     |                   |       |   | – |   |   | – |   | 18 |   |
| Issuance  of restricted common stock, net of cancellations and stock repurchases         |       |                   | 38         |       |       | 2,747                                   |       |                           | (2,795     | )                      |       |   | – |   |   | 1 |   | (47 | ) |
| Amortization  of deferred stock-based compensation                                       |       |                   | –     |       |       | –                                  |       |                           | 1,489      |                   |       |   | – |   |   | – |   | 1,489 |   |
| Tax  effect from stock plans                                                             |       |                   | –     |       |       | (50                                     | )          |                           | –     |                   |       |   | – |   |   | – |   | (50 | ) |
| Minimum  pension and post-retirement benefit obligation adjustment, net of  income taxes |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | (2,783 | ) |   | – |   | (2,783 | ) |
| Cash  dividends                                                                          |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | – |   |   | (14,591 | ) | (14,591 | ) |
| Restricted  Stock Unit Dividends                                                         |       |                   | –     |       |       | 59                                      |       |                           | –     |                   |       |   | – |   |   | (59 | ) | – |   |
| Net  income                                                                              |       |                   | –     |       |       | –                                  |       |                           | –     |                   |       |   | – |   |   | 6,378 |   | 6,378 |   |
| Balance at  December 31, 2005                                                       |       |                   | 14,629     |       |       | $                                       | 164,598    |                           |       | $                      | (2,255     | ) |   |   | $ | (4,909 | ) |   | $ | 74,317 |   | $ | 231,751 |   |

 

See accompanying notes.

51

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**SUREWESTCOMMUNICATIONSCONSOLIDATED STATEMENTS OF CASH FLOWS**(amounts in thousands)
| ** **                                                                                | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Cash flows from operating  activities:**                                                |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                           | 6,378      |   | $ | (1,128 | ) | $ | 645 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                                            |       | 53,770                                      |       | 48,596 |   | 52,470 |   |
| Provision for  deferred income taxes                                                      |       | 3,417                                       |       | (372 | ) | (1,309 | ) |
| Provision for  doubtful accounts                                                          |       | 3,892                                       |       | 3,441 |   | 3,381 |   |
| Stock-based compensation                                                                  |       | 1,509                                       |       | 968 |   | 338 |   |
| Non-cash portion  of MCI settlement                                                       |       | (617                                        | )          | – |   | – |   |
| Other, net                                                                                |       | 311                                         |       | – |   | 307 |   |
| Net changes in:                                                                           |       |                                        |       |   |   |   |   |
| Receivables                                                                               |       | (6,971                                      | )          | (4,750 | ) | (2,480 | ) |
| Refundable and  accrued income taxes, net                                                 |       | (534                                        | )          | (359 | ) | 8,852 |   |
| Inventories,  prepaid expenses and other current assets                                   |       | (1,217                                      | )          | (379 | ) | (1,926 | ) |
| Accounts payable                                                                          |       | 748                                         |       | 680 |   | 1,601 |   |
| Accrued  liabilities, other liabilities and deferred credits                              |       | (3,245                                      | )          | 9,373 |   | 11,229 |   |
| Net cash provided by  operating activities                                                |       | 57,441                                      |       | 56,070 |   | 73,108 |   |
| **Cash  flows from investing activities:**                                                |       |                                        |       |   |   |   |   |
| Capital  expenditures for property, plant and equipment                                   |       | (69,768                                     | )          | (70,833 | ) | (76,105 | ) |
| Proceeds from the  sale of pay telephone assets                                           |       | 220                                         |       | – |   | – |   |
| Purchases of  held-to-maturity investments                                                |       | –                                      |       | (4,275 | ) | (25,351 | ) |
| Maturities of  held-to-maturity investments                                               |       | –                                      |       | 6,974 |   | 20,652 |   |
| Sale of  held-to-maturity investment prior to maturity                                    |       | –                                      |       | – |   | 2,000 |   |
| Other, net                                                                                |       | 204                                         |       | (123 | ) | (29 | ) |
| Net cash used in  investing activities                                                    |       | (69,344                                     | )          | (68,257 | ) | (78,833 | ) |
| **Cash  flows from financing activities:**                                                |       |                                        |       |   |   |   |   |
| Increase (decrease) in  short-term borrowings                                             |       | 20,000                                      |       | 10,000 |   | (15,000 | ) |
| Principal payments of  long-term debt and capital lease obligations                       |       | (3,992                                      | )          | (4,127 | ) | (5,921 | ) |
| Proceeds from issuance  of long-term debt                                                 |       | –                                      |       | – |   | 60,000 |   |
| Dividends paid                                                                            |       | (14,591                                     | )          | (14,581 | ) | (14,539 | ) |
| Other, net                                                                                |       | –                                      |       | 6 |   | (192 | ) |
| Net cash provided by  (used in) financing activities                                      |       | 1,417                                       |       | (8,702 | ) | 24,348 |   |
| Increase  (decrease) in cash and cash equivalents                                         |       | (10,486                                     | )          | (20,889 | ) | 18,623 |   |
| Cash and cash equivalents  at beginning of year                                           |       | 18,119                                      |       | 39,008 |   | 20,385 |   |
| Cash and cash equivalents at end of year                                                  |       | $                                           | 7,633      |   | $ | 18,119 |   | $ | 39,008 |   |

 

See accompanying notes.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**(Amounts in thousands, except share and per share amounts)**

**1.   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

**Business and Basis of Accounting**

SureWest Communications (the “Company”) is a holdingcompany with wholly-owned subsidiaries that provide integrated communicationsservices in Northern California. The Company’s principal operating subsidiaryis SureWest Telephone. SureWest Directories, SureWest Long Distance, SureWestWireless, SureWest Broadband, SureWest TeleVideo and SureWest TeleVideo ofRoseville (collectively referred to as “SureWest Broadband/Residential Services”),SureWest Internet and SureWest Custom Data Services are each subsidiaries ofthe Company. The Company expects that the sources of its revenues and its coststructure may be different in future periods, both as a result of its entryinto new communications markets and competitive forces in each of the marketsin which the Company has operations.

Preparation of thefinancial statements in conformity with principles generally accepted in theUnited States and pursuant to the rules and regulations of the Securitiesand Exchange Commission (the “SEC”) requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities at thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results may differ materially fromthose estimates. The Company’s critical accounting estimates include (i) revenuerecognition and the establishment of estimated shareable earnings obligations,accounts receivable allowances and customer refund obligations (Notes 1, 2 and3), (ii) inventory valuation (Note 1), (iii) useful life assignmentsand impairment evaluations associated with property, plant and equipment andintangible assets (Note 1), (iv) asset retirement obligations (Note 1), (v) valuationallowances associated with deferred tax assets (Notes 1 and 7), (vi) pensionand post-retirement benefit costs and obligations (Note 8), (vii) anticipatedoutcomes of litigation, regulatory proceedings and other contingencies (Notes 3and 9) and (viii) employee stock-based compensation (Notes 1 and 10).

**Principles of Consolidation**

The consolidated financialstatements include the accounts of the Company and its wholly-ownedsubsidiaries. All significant intercompany transactions have been eliminated.

**Concentration of Cash**

The Company maintains itscash in bank deposit accounts, which, at times may exceed federally insuredlimits. The Company has not experienced any losses in such accounts.

**CashEquivalents and Short-term Investments**

The Company invests its excess cash in high-qualitydebt instruments and money market mutual funds. The Company considershighly-liquid investments with maturities of three months or less from theacquisition date of the instrument to be cash equivalents. Short-terminvestments at December 31, 2005 consisted of 31,292 shares of MCI commonstock with an aggregate value of approximately $617. The stock was received aspart of the MCI Plan of Reorganization bankruptcy settlement on October 14,2005 (Note 2). There were no short-term investments at December 31,2004. All of the Company’s cash equivalents and short-term investments areconsidered available-for-sale.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The following is a summaryof the Company’s cash equivalents and short-term investments as of December 31,2005 and 2004:
| ** **                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
| Money market  mutual funds  |       | $        | 1          |     |       | $ | 49 |   |   |
| Investment in  common stock |       | 617      |       |     | –     |   |   |
|                        |       | $        | 618        |     |       | $ | 49 |   |   |

 

**Fair Value**

The carrying values of cash equivalents and short-terminvestments at December 31, 2005 and 2004 approximated their fair valuesat such dates. Fair values for cash equivalents and short-term investments weredetermined by quoted market prices.

The aggregate carrying value and fair value of theCompany’s short-term borrowings was approximately $30,000 as of December 31,2005 and $10,000 as of December 31, 2004. The carrying value of theCompany’s long-term debt (including current maturities) was $89,091 and $92,870at December 31, 2005 and 2004, respectively. The aggregate fair value ofthe long-term debt was approximately $89,137 and $93,785 at December 31,2005 and 2004, respectively. The carrying value of the Company’s capital leaseobligations was $51 and $264 as of December 31, 2005 and 2004,respectively. The aggregate fair value of the capital lease obligations was $40and $244 as of December 31, 2005 and 2004, respectively. The aggregatecarrying value and fair value of the Company’s contractual intrastate shareableearnings obligations was $6,901 at December 31, 2005 and $9,242 as of December 31,2004.

The fair values of the Company’s short-termborrowings, long-term debt, capital lease obligations and contractualintrastate shareable earnings obligations were determined through discountedcash flow analyses based on the Company’s current incremental interest ratesfor similar instruments.

Declines in the fair valueof available-for-sale securities below their cost that are deemed to be otherthan temporary are reflected in earnings as realized losses. In estimatingother-than-temporary impairment losses, management considers, among otherthings, (i) the length of time and the extent to which the fair value hasbeen less than cost, (ii) the financial condition and near-term prospectsof the issuer, and (iii) the intent and ability of the Company to retainits investment in the issuer for a period of time sufficient to allow for anyanticipated recovery in fair value.

**Allowancefor Doubtful Accounts**

The Company maintains an allowance for doubtfulaccounts for estimated losses, which result from the inability of customers tomake required payments. Such allowance is based on the likelihood ofrecoverability of accounts receivable based on past experience and management’sbest estimates of current bad debt exposures. The Company performs ongoingcredit evaluations of its customers’ financial condition and managementbelieves that adequate allowances for doubtful accounts have been provided.Accounts are determined to be past due if customer payments have not beenreceived in accordance with the payment terms. Uncollectible accounts arecharged against the allowance for doubtful accounts and removed from the accountsreceivable balances when internal collection efforts have been unsuccessful incollecting the amount due. In addition, certain revenues are subject to refundif the customer terminates 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

services or returnsequipment within a stipulated time period, or if certain performance criteriaare not met. Accordingly, the Company maintains accounts receivable allowancesand recognizes certain customer refund liabilities, through charges torevenues, based on the Company’s best estimates of the resolution of thesecontingencies, which are based on historical experience. For the years ended December 31,2005, 2004 and 2003, the Company wrote-off certain accounts receivable balancesaggregating $3,389, $3,032 and $3,301, respectively. During the years ended December 31,2005, 2004 and 2003, the Company recovered $866, $776 and $755, respectively,of accounts receivable balances previously written-off against such allowance.

**Inventories**

Telephone networkinventories consist of materials and supplies, which are stated at weightedaverage cost. Nonregulated wireline equipment inventory held for sale is statedat the lower of weighted average cost or market value. Wireless handset andaccessory inventories are stated at the lower of average cost or market value.Inventories at SureWest Broadband are comprised of modems, which are held forsale or lease and stated at the lower of weighted average cost or market value,and network materials and supplies, which are stated at weighted average cost.

**Property, Plant and Equipment**

Property, plant and equipment is recorded at cost.Additions and substantial improvements are capitalized. Repairs and maintenancecosts are charged to expense as incurred. Retirements and other reductions ofproperty, plant and equipment were approximately $3,993, $2,861 and $4,079 in2005, 2004 and 2003, respectively. Retirements of regulated telephone plant andequipment are charged against accumulated depreciation with no gain or lossrecognized in accordance with the composite group remaining life methodologyutilized for telephone plant assets. When property applicable to non-telephoneoperations is sold or retired, the asset and related accumulated depreciationare removed from the accounts and the associated gain or loss is recognized.

Property, plant andequipment consisted of the following as of December 31, 2005 and 2004:
| ** **                        | ** ** | **2005** | ** ** | **2004** | ** ** | **Estimated  Useful  Lives** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|------------------------------|------------|
| Land                              |       | $        | 4,198      |     | $          | 4,198                        |       |   |   |
| Buildings                         |       | 82,433   |       | 81,922   |       | 35 years                     |       |
| Central office equipment          |       | 203,125  |       | 181,412  |       | 3-21 years                   |       |
| Outside plant equipment           |       | 362,784  |       | 319,145  |       | 5-40 years                   |       |
| Internal-use software             |       | 55,791   |       | 50,787   |       | 5 years                      |       |
| Other                             |       | 59,993   |       | 63,977   |       | 3-21 years                   |       |
| Total plant in service            |       | 768,324  |       | 701,441  |       |                         |       |
| Less accumulated  depreciation    |       | 400,504  |       | 350,105  |       |                         |       |
| Plant in service, net             |       | 367,820  |       | 351,336  |       |                         |       |
| Plant under construction          |       | 13,255   |       | 14,277   |       |                         |       |
| Property plant and equipment, net |       | $        | 381,075    |     | $          | 365,613                      |       |   |   |

 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Property, plant and equipment is depreciated using thestraight-line method over their estimated economic lives. The useful lives areestimated at the time the assets are acquired and are based on historicalexperience with similar assets, anticipated technological changes and theexpected impact of the Company’s strategic operating plan on its networkinfrastructure. Average annual composite depreciation rates were 7.3%, 7.3% and7.6% in 2005, 2004 and 2003, respectively.

In July 2005, the Company sold its pay telephoneassets for $220 to a nationwide provider of private pay telephone services. Duringthe quarter ended June 30, 2005, the Company incurred a pretax asset impairmentcharge of $189, which was recorded in the Company’s consolidated statements ofoperations as depreciation and amortization expense. The asset impairmentcharge reduced the carrying value of the pay telephone assets within theTelecommunications (“Telecom”) segment to its fair value of $198, whichrepresented the expected proceeds from the sale of assets.

In January 2004, the Company revised itslong-term network operating plan for its Telecom and Wireless segments as aresult of the successful adoption of certain new technologies that enable theCompany to maximize the return on existing network facilities and migrate toother new technologies at the point in time in which the benefit to do soexceeds the cost of conversion. As a result of this change in strategicdirection, which was formally approved by the Company’s Board of Directors in December 2003,the Company has evaluated the appropriateness of its estimated useful lives ofcertain property, plant and equipment at both the Telecom and Wireless segments.Based on this evaluation, the Company increased the estimated useful lives ofTelecom’s digital switching, circuit and cable equipment by one to three yearsand Wireless’ base stations, towers and network software by one to eight years.The Company also decreased the estimated useful lives of certain other Telecomassets, including certain other switching and voicemail equipment. Thesechanges were made effective January 1, 2004. The Company’s revisions havebeen supported by an assessment and report from an independent third party withexpertise in this area that found the revisions to be reasonable in light ofthe Company’s plan and useful life estimates in comparable businesses.

During the year ended December 31,2004, this change in estimate decreased consolidated depreciation expense by$10,842 and decreased consolidated net loss by $7,524 ($0.52 per share). Thischange in accounting estimate decreased Telecom depreciation expense andincreased Telecom income from operations by $5,459 for the year ended December 31,2004. In addition, Wireless depreciation expense and loss from operationsdecreased by approximately $5,383, for the year ended December 31, 2004 asa result of this change in accounting estimate.

**Asset Retirement Obligations**

The Company accounts for its asset retirementobligations in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 143, *Accounting for AssetRetirement Obligations*, and Financial Accounting Standards BoardInterpretation (“FIN”) No. 47, *Accountingfor Conditional Retirement Obligations*. The adoption of FIN No. 47on December 31, 2005 was not material to the Company’s consolidatedbalance sheet or consolidated statement of operations. In accordance with theprovisions of SFAS No. 143 and FIN No. 47, the Company recognizes aretirement obligation pertaining to its long-lived assets, principally wirelesscell sites and disposal obligations relating to certain building materialscontaining asbestos, when a legal obligation exists to remove plant at somepoint in the future or if 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**   SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES (Continued)

legislation exists thatrequires special disposal procedures of the asset. Based on terms outlined inits wireless tower leases, the Company is obligated to return the land orfacilities to their original condition at the end of the cell site lease term,should the lease be terminated. Based on the Company’s estimates, it believesthat the disposal requirement relating to certain building materials containingasbestos is the expected retirement date of the underlying assets. The Companyhas used a probability-weighted cash flow approach in estimating its potentialretirement obligations. As of December 31, 2005 and 2004, the Company’sconsolidated balance sheet includes a liability in the amount of $88 and $60,respectively, pertaining to estimated asset retirement obligations.

**Intangible Assets**

Under the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets,* goodwilland intangible assets that are not subject to amortization are tested forimpairment at least annually or when events or changes in circumstancesindicate that the asset might be impaired.

Goodwill is not amortized but instead evaluatedannually for impairment using a two-step process. In the first step of theimpairment test, the fair value of the reporting unit is compared with thecarrying amount of the reporting unit, including goodwill. The Company hasdetermined that reporting units are equal to its operating segments and itsgoodwill has been allocated to the Telephone operating segment. The estimatedfair value of the reporting unit is determined using a discounted cash flowmodel. The assumptions used in the estimate of fair value are based upon acombination of historical results and trends, new industry developments and theCompany’s current operating plans. Such assumptions are subject to change as aresult of changing economic and competitive conditions. If the carrying valueof the reporting unit exceeds its fair value, the second step of the impairmenttest is performed to measure the amount of impairment loss.

The second step compares the implied fair value of thereporting unit goodwill with the carrying amount of that goodwill. The impliedfair value is determined by allocating the fair value of the reporting unit toall of the assets and liabilities other than goodwill in a manner similar to apurchase price allocation. The excess of the fair value of a reporting unitover the amounts assigned to its assets and liabilities is the implied fairvalue of goodwill. If the carrying amount of goodwill is greater than theimplied fair value of that goodwill, then an impairment charge would berecorded equal to the difference between the implied fair value and thecarrying value.

Indefinite-livedintangible assets consist of the Company’s wireless licenses. Wireless licensesinclude Personal Communications Services (“PCS”) and Local MultipointDistribution Services (“LMDS”), which are stated at cost. The Companydetermined these licenses have indefinite lives as such licenses can be renewedindefinitely for a nominal fee. Accordingly, the Company has applied thenonamortization provisions of SFAS No. 142 to these licenses.

The Company’s wireless licenses are evaluated forimpairment at least annually by comparing the carrying value to the estimatedfair value. The fair value of the Company’s PCS licenses is determined throughreview of transactions involving sales of comparable wireless licenses in theaftermarket. The fair value of the Company’s LMDS licenses is obtained using adiscounted cash flow model. The assumptions used in the estimate of fair valueare based on a combination of historical results and trends, new industrydevelopments and the Company’s current operating plans. Such assumptions aresubject to change as a 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

result of changing economic and competitive conditions.The Company’s LMDS licenses may be impaired in the near future if the estimatesand assumptions used in the 2005 LMDS license discounted cash flow model arenot met. If the carrying value is in excess of the estimated fair value, thenan impairment loss is recognized equal to that excess. Accumulated amortizationrelated to these licenses was $1,195 at December 31, 2005 and 2004.

During 2005 and 2004, theCompany obtained independent valuations, which resulted in no impairmentcharges related to goodwill or wireless licenses as the fair values exceededtheir respective carrying values.

**Nonmonetary Transactions**

During 2003, the Company entered into a 20-yearnonmonetary transaction with a third party involving the exchange of certainfiber optic capacity and collocation rights. This transaction provides theCompany with access and rights to certain collocation facilities and cell sitelocations, which were previously inaccessible due to unreasonably high entrancecosts. The collocation rights provide access to additional network connectionsto the Company while the cell site locations strengthen the Company’s existingcellular network in key areas. Because this nonmonetary transaction did notrepresent the culmination of an earnings process, no revenues or expenses havebeen, or will be, recorded by the Company pursuant to this transaction. Inaddition, there was no indicated loss on this exchange of productive rights.

In the normal course ofbusiness, the Company entered into certain other nonmonetary transactionsduring 2005 and 2004 that are not material, either individually or in theaggregate, to the Company’s consolidated financial statements.

**Stock-based Compensation**

The Company has two stock-based compensation plans,which are described more fully in Note 10. Effective January 1, 2003, theCompany adopted the fair value recognition provisions of SFAS No. 123, *Accounting for Stock-Based Compensation*.Under the prospective method of adoption selected by the Company under theprovisions of SFAS No. 148, *Accountingfor Stock-Based Compensation–Transition and Disclosure*, the fairvalue method of accounting was applied to all employee awards granted,modified, or settled after January 1, 2003. Stock-based compensationassociated with employee stock options is recognized over the vesting periods(which range from 1 to 5 years) using the graded vesting method.

The fair value of the Company’s employee stock optionswas estimated at the date of grant using the Black-Scholes-Mertonoption-pricing model with weighted-average assumptions for 2003 as follows:risk-free interest rate of 1.79%, expected dividend yield of 2.50%, expectedvolatility of 42.48% and an expected life of four years. No options weregranted during 2005 and 2004. During the year ended December 31, 2003, theweighted-average grant date fair value of options granted to employees was$8.75 per share.

The Black-Scholes-Merton option pricing model includesassumptions regarding dividend yields, expected volatility, expected lives andrisk-free interest rates. These assumptions reflect management’s bestestimates, but these items involve inherent uncertainties based on marketconditions generally outside of the control of the Company. As a result, ifother assumptions had been used in the current period, actual and pro formastock-based compensation expense could have been materially different. Ifmanagement 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

uses different assumptions in future periods,stock-based compensation expense could be materially impacted in future years.

Theexpense related to stock-based employee compensation included in the determinationof net income (loss) is less than that which would have been recognized if thefair value method had been applied to all awards granted after the originaleffective date of SFAS No. 123. If the Company had elected to adopt thefair value recognition provisions of SFAS No. 123 as of its originaleffective date, pro forma net income (loss) and earnings (loss) per share wouldbe as follows:
| ** **                                                                                                                            | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                            | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss), as reported                                                                                                        |       | $                                           | 6,378      |   | $ | (1,128 | ) | $ | 645 |   |
| Add: Stock-based  employee compensation expense included in  reported net income (loss), net of related tax effects                   |       | 935                                         |       | 672 |   | 131 |   |
| Deduct:  Stock-based employee compensation expense determined  using the fair value method for all awards, net of related tax effects |       | (967                                        | )          | (912 | ) | (809 | ) |
| Pro forma net income (loss)                                                                                                           |       | $                                           | 6,346      |   | $ | (1,368 | ) | $ | (33 | ) |
| Earnings (loss) per share:                                                                                                            |       |                                        |       |   |   |   |   |
| Basic–as reported                                                                                                                |       | $                                           | 0.44       |   | $ | (0.08 | ) | $ | 0.04 |   |
| Basic–pro forma                                                                                                                  |       | $                                           | 0.44       |   | $ | (0.09 | ) | $ | 0.00 |   |
| Diluted–as reported                                                                                                              |       | $                                           | 0.44       |   | $ | (0.08 | ) | $ | 0.04 |   |
| Diluted–pro  forma                                                                                                               |       | $                                           | 0.43       |   | $ | (0.09 | ) | $ | 0.00 |   |

 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

**Advertising Costs**

The costs of advertising are charged to expense asincurred. Advertising expense was $3,814, $5,143 and $4,339 in 2005, 2004 and2003, respectively.

The Company makes marketdevelopment funds (“MDF”) available to certain retailers that serve as agentsfor SureWest Wireless for the reimbursement of co-branded advertising expenses.To the extent that MDF is used by the Company’s customers for co-brandedadvertising, and (i) the agents provide the Company with third-partyevidence of such co-branded advertising as prescribed by Company policy and (ii) theCompany can reasonably estimate the fair value of its portion of theadvertising, such amounts are charged to advertising expense as incurred. Tothe extent that MDF do not meet the aforementioned criteria, the Companyrecords these expenditures as a reduction of revenue in the period in whichthey are incurred.

**Income Taxes**

The Company accounts forincome taxes using the liability method. Under this method, deferred tax assetsand liabilities are determined based on differences between the financialreporting and tax bases of assets and liabilities and are measured using theenacted tax rates and laws that are expected to be in effect when thedifferences are expected to reverse.

**Per Share Amounts**

Shares used in the computation of basic earnings(loss) per share are based on the weighted average number of common shares andrestricted common stock units (“RSUs”) outstanding, excluding unvestedrestricted common shares and unvested RSUs. Shares used in the computation ofdiluted earnings per share are based on the weighted average number of commonshares, restricted common shares and RSUs outstanding, along with otherpotentially dilutive securities outstanding in each period. Shares used in thecomputation of diluted loss per share are based on the weighted average numberof vested common shares and vested RSUs and exclude potential dilutive commonshares, unvested restricted common shares and unvested RSUs outstanding, as theeffect is antidilutive.

Cash dividends per share are based on the actualdividends per share, as declared by the Company’s Board of Directors. On eachdate that the Company pays a cash dividend to the holders of the Company’scommon stock, the Company credits to the holders of RSUs an additional numberof RSUs equal to the total number of whole RSUs and additional RSUs previouslycredited to the holders multiplied by the dollar amount of the cash dividendper share of common stock. Any fractional RSUs resulting from such calculationare included in the additional RSUs.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)**

The following tablepresents the calculations of weighted average common shares and restrictedcommon stock units used in the computations of basic and diluted per shareamounts presented in the accompanying consolidated statements of operations:
| ** **                                                                                                                                            | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                            | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Basic:**                                                                                                                                            |       |                                        |       |   |   |   |   |
| Weighted average number  of shares of common stock and restricted common stock units outstanding                                                      |       | 14,631                                      |       | 14,571 |   | 14,539 |   |
| Less weighted average  number of unvested shares of restricted common stock and unvested restricted  common stock units outstanding                   |       | 79                                          |       | 40 |   | 17 |   |
| Weighted average number  of common shares and restricted common stock units used in computing basic  per share amounts                                |       | 14,552                                      |       | 14,531 |   | 14,522 |   |
| **Diluted:**                                                                                                                                          |       |                                        |       |   |   |   |   |
| Weighted average number  of shares of common stock and restricted common stock units outstanding                                                      |       | 14,631                                      |       | 14,571 |   | 14,539 |   |
| Less weighted average  number of unvested shares of restricted common stock and unvested restricted  common stock units outstanding, if anti-dilutive |       | –                                      |       | 40 |   | – |   |
| Weighted average number of common shares and restricted  common stock units used in computing diluted per share amounts                               |       | 14,631                                      |       | 14,531 |   | 14,539 |   |

 

**Statementsof Cash Flows Information**

During2005, 2004 and 2003, the Company made payments for interest and income taxes asfollows:
| ** **                                                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest, net of amounts capitalized ($489 in 2005,  $827 in 2004 and $1,095 in 2003) |       | $        | 5,589      |     | $          | 4,453    |       | $ | 3,758 |   |
| Income taxes                                                                          |       | $        | 1,025      |     | $          | 404      |       | $ | – |   |

 

**Other Comprehensive Income (loss)**

Significantcomponents of the Company’s other comprehensive income (loss) are as follows:
| ** **                                                                                                                               | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                               | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                                                                                                                        |       | $                                           | 6,378      |   | $ | (1,128 | ) | $ | 645 |   |
| Minimum pension and  post-retirement benefit liability adjustment, net of income taxes of $1,706,  $822, and $934 in 2005, 2004 and 2003 |       | (2,783                                      | )          | (1,865 | ) | 1,376 |   |
| Other comprehensive  income (loss)                                                                                                       |       | $                                           | 3,595      |   | $ | (2,993 | ) | $ | 2,021 |   |

 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1. SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

As of December 31,2005, 2004 and 2003, the accumulated other comprehensive loss was $4,909,$2,126 and $261, respectively, which consisted of minimum pension andpost-retirement benefit liability adjustments, net of income taxes.

**Recent Accounting Pronouncements**

In May 2005, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 154, *AccountingChanges and Error Corrections.* The Statement applies to allvoluntary changes in accounting principle, and changes the requirementsfor accounting for and reporting of a change in accounting principle. SFAS No. 154is effective for accounting changes and corrections of errors made in fiscalyears beginning after December 15, 2005. The Company will adopt SFAS No. 154on January 1, 2006 and does not anticipate any material effect on itsconsolidated financial statements.

In December 2004, the FASB issued SFAS No. 123(revised 2004), *Share-Based Payment*(“SFAS No. 123(R)”), which is a revision of SFAS No. 123, *Accounting for Stock-Based Compensation*. SFASNo. 123(R) supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and amends SFAS No. 95, *Statementof Cash Flows*. Generally, the approach in SFAS No. 123(R) issimilar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the statement of operations based on their fairvalues. Pro forma disclosure is no longer an alternative.

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

Effective January 1,2003, the Company adopted the fair value recognition provisions of SFAS No. 123.Under the prospective method of adoption selected by the Company under theprovisions of SFAS No. 148, *Accountingfor Stock-Based Compensation–Transition and Disclosure*, the fairvalue method of accounting was applied to all employee awards granted,modified, or settled after January 1, 2003. SFAS No. 123(R) mustbe applied not only to new awards but to previously granted awards that are notfully vested on the effective date. Compensation cost of previously grantedawards that were not recognized under SFAS No. 123 will be recognizedunder SFAS No. 123(R). Had the Company adopted SFAS No. 123(R) inprior periods, the impact would have approximated the impact of SFAS No. 123as described in the disclosure of pro forma net income and earnings per sharein Note 1 to the Consolidated Financial Statements.

SFAS No. 123(R) permits public companies toadopt its requirements using either the modified-prospective transition methodor the modified-retrospective transition method. The Company has chosen to usethe modified-prospective method in which compensation cost is recognizedbeginning with the effective date based on the requirements of SFAS No. 123(R) forall share-based payments granted after the effective date, and based on therequirements of SFAS No. 123 for all awards granted to employees prior tothe effective date of SFAS No. 123(R) that remain unvested on theeffective date.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1. SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

The Company does not believe the adoption of SFASNo. 123(R) will have a material effect on its consolidated financialposition, results of operations or cash flows.

In March 2005, the FASB issued FIN No. 47, *Accounting for Conditional Asset RetirementObligations*. FIN No. 47 clarifies that the term “conditionalasset retirement obligation”, as used in SFAS No. 143, *Accounting for Asset Retirement Obligations*,refers to a legal obligation to perform an asset retirement activity in whichthe timing and/or method of settlement are conditional on a future event thatmay or may not be within the control of the entity. FIN No. 47 requires anentity to recognize a liability for the fair value of a conditional assetretirement obligation if the fair value of the liability can be reasonablyestimated. The Company’s adoption of FIN No. 47 on December 31, 2005did not have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

**Adjustments and Reclassifications**

During the Company’s financial statement closingprocess for the year ended December 31, 2003, certain matters wereidentified related to prior financial reporting periods that necessitated therecording of adjustments to the Company’s consolidated financial statements.Such adjustments pertained principally to property, plant and equipment, andmanagement believes that weaknesses in the Company’s internal controls causedthe errors that resulted in these adjustments. The Company does not believe anyof the aforementioned amounts are material, individually or in the aggregate,to the respective prior annual periods based on both quantitative andqualitative factors, including the trend of operating results, nor does itbelieve the prospective correction of such amounts during the quarter ended December 31,2003 is material to the Company’s 2003 consolidated results of operations basedon both quantitative and qualitative factors, including the trend of operatingresults. The prospective correction of the aforementioned amounts relating toprior periods reduced the Company’s 2003 consolidated net income by $1,603, or$0.11 per basic and diluted share. The internal control weaknesses noted abovehave been remediated subsequently and management has concluded that itsinternal controls are effective as of December 31, 2005.

Certain amounts in the Company’s 2004 and 2003consolidated financial statements have been reclassified to conform to thepresentation of the Company’s 2005 consolidated financial statements.

**2. REVENUE RECOGNITION**

The Company recognizes revenue when(i) persuasive evidence of an arrangement between the Company and thecustomer exists, (ii) delivery of the product to the customer has occurredor service has been provided to the customer, (iii) the price to thecustomer is fixed or determinable and (iv) collectibility of the salesprice is reasonably assured. Revenues based on a flat fee, derived principallyfrom local telephone, dedicated network access, data communications, Internetaccess service, residential/business broadband service and non-contractwireless services, are billed in advance and recognized in subsequent periodswhen the services are provided. Contract wireless services are billed inarrears. Revenues based on usage, derived primarily from network access andlong distance services, are recognized monthly as services are provided.Incremental direct costs of telecommunications service activation are chargedto expense in the period in which they are incurred. Directory advertisingrevenues and costs related to publishing and distributing directories arerecognized using the “circulation period” method, under which revenues andrelated costs are recognized ratably over the expected useful life of thedirectory, generally one year from the date of publication. For all other operations,revenue is recognized when products are delivered or services are rendered tocustomers.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**2. REVENUE RECOGNITION(Continued)**

The Company applies Emerging Issues Task Force (“EITF”)Issue No. 00-21, *RevenueArrangements with Multiple Deliverables* to all wireless handsetsales below cost, which approximates fair value in the absence of an activation“subsidy,” when it receives an up-front fee of any kind (e.g., a serviceactivation fee). The application of EITF Issue No. 00-21 results inthe immediate recognition of all or a portion of such up-front fees asequipment sales revenue. Additionally, when the Company activates wirelessservice for a customer, but does not concurrently provide the customer with ahandset, any up-front fees received continue to be deferred and amortized overthe expected term of the customer relationship. The Company provides a generalright of return within the first 30 days of service for a 100% refund of thehandset cost. The estimated equipment return liability associated with thisright of return is estimated based on historical experience.

Certain of the Company’s customers filed forbankruptcy protection in 2002, the most notable of which was WorldCom, Inc.(“WorldCom”), which, together with its affiliates (collectively “MCI”), filedfor bankruptcy protection in July 2002. In April 2004, MCI emergedfrom federal bankruptcy protection. In October 2005, the Company resolvedits claim filed in January 2003 related to pre-petition accountsreceivable, and to a conditional payment made by the Company to MCI inconnection with anticipated overearnings during the 1999-2000 monitoringperiod.

In accordance with the MCI Plan of Reorganization, theCompany in October 2005 received a distribution of cash and stock, with acombined fair value of approximately $1,400. The distribution was recognized inthe Company’s consolidated statement of operations as an increase to networkaccess service revenue and a decrease to general and administrative expense of$800 and $600, respectively. As of December 31, 2005, the Company held31,292 shares of MCI common stock with an aggregate carrying value ofapproximately $617. The Company’s investment in MCI common stock is classifiedas an available-for-sale, short-term investment in the consolidated balancesheet. In October 2005, MCI shareholders approved a merger with VerizonCommunications Inc. (“Verizon”). The merger was finalized in January 2006.

During the fourth quarterof 2000, the Company changed its method of accounting, retroactive to January 1,2000, for up-front fees associated with telecommunications service activationin accordance with the guidance contained in the SEC Staff Accounting Bulletin(“SAB”) No. 101, *Revenue Recognition inFinancial Statements*. Previously, the Company had recognized suchup-front fees as revenues upon activation of service. Under the new accountingmethod, the Company now recognizes up-front fees associated with serviceactivation over the expected duration of the customer relationships, whichpresently ranges from one to five years, using the straight-line method. Thecumulative effect of the change on prior years resulted in a charge to incomeof $3,273 (net of income taxes of $2,250), which was included in net income forthe year ended December 31, 2000. For the years ended December 31,2004 and 2003, the Company recognized $130 and $413, respectively, of revenuesthat were in the cumulative effect adjustment as of January 1, 2000. Duringthe year ended December 31, 2005, no additional revenues were recognizedas the revenues that were in the cumulative effect adjustment as of January 1,2000 were completely recognized in the prior years. The effect of thoserevenues was to decrease net loss by $90 (net of income taxes of $40) for theyear ended December 31, 2004, and increase net income by $160 (net ofincome taxes of $253) for the year ended December 31, 2003.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**3. ESTIMATED SHAREABLE EARNINGS OBLIGATIONS**

Certain of the Company’s rates are subject toregulation by the Federal Communications Commission (“FCC”) and the CaliforniaPublic Utilities Commission (“CPUC”). Pending and future regulatory actions mayhave a material impact on the Company’s consolidated financial position andresults of operations.

Revenues from certain telephone services are affectedby rates authorized by various regulatory agencies. Intrastate service ratesare subject to regulation by the CPUC. With respect to toll calls initiated byinterexchange carriers’ customers, the interexchange carriers are assessedaccess charges based on tariffs filed by SureWest Telephone. Interstate accessrates and resultant earnings are subject to regulation by the FCC. With respectto interstate services, SureWest Telephone has filed its own tariff with theFCC for all elements of access services except carrier common line charges, forwhich SureWest Telephone concurs with tariffs filed by the National ExchangeCarrier Association (“NECA”).

The FCC monitors SureWest Telephone’s interstateearnings through the use of annual cost separation studies prepared by SureWestTelephone, which utilize estimated cost information and projected demand usage.The FCC establishes rules that carriers must follow in the preparation ofthe annual studies. Additionally, under current FCC rules governing ratemaking, SureWest Telephone is required to establish interstate rates based onprojected demand usage for its various services and determine the actualearnings from these rates once actual volumes and costs are known. Based onpreliminary cost studies, the Company recognized liabilities relating toSureWest Telephone’s estimated interstate shareable earnings obligations of$157 and $343 for the years ended December 31, 2005 and 2003,respectively, through reductions of revenues. The Company did not identify anyinterstate shareable earnings obligations at SureWest Telephone during the yearended December 31, 2004.

During September 2005, SureWest Telephone made apayment of $100 to a certain carrier customer in full settlement of aninterstate overearnings dispute for the monitoring period 2001-2002. Thelimitations period applicable to this monitoring period expired. Therefore,SureWest Telephone released all other amounts reserved in connection with thepotential overearnings claims for 2001-2002 monitoring period, whichincreased the Company’s revenues and net income for the year ended December 31,2005 by $125 and $78 ($0.01 per share), respectively.

Prior to 2000, SBC Communications (“SBC”) had beenpaying SureWest Telephone approximately $11,500 per year for extended areaservice (“EAS”) pursuant to a Settlement Transition Agreement. In November 2000,the CPUC authorized SBC to terminate its annual EAS payments to SureWestTelephone effective November 30, 2000. The CPUC authorized replacementfunding to SureWest Telephone on an interim basis using funds from theCalifornia High Cost Fund (“CHCF”). The CHCF is a program designed by the CPUCto establish a fair and equitable local rate structure and to reduce anydisparity in the rates charged by telephone companies serving high-cost areas.The CHCF is scheduled to expire January 1, 2009. In addition, the CPUCopened an Order Instituting Investigation (“OII”) for the purpose ofdetermining whether future recovery of all, none, or a portion of theapproximate $11,500 annual payments previously received from SBC and currentlyreceived from the CHCF, should come from SureWest Telephone’s ratepayers orother regulatory recovery mechanisms.

In August 2005, the CPUC adopted a decision which(i) authorized SureWest Telephone to continue receiving $11,500 annuallyfrom the CHCF to offset its intrastate regulated operating expenses on aninterim basis, (ii) required SureWest Telephone to prepare and submit acost proxy model (which is used generally as a basis for CHCF-B funding) basedon its current cost data, including analyses of the resulting 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**3. ESTIMATEDSHAREABLE EARNINGS OBLIGATIONS (Continued)**

impacts on rates, on the Universal Lifeline TelephoneService (“ULTS”) fund, and on the CHCF fund, to be filed by SureWest Telephonewithin 12 months, and (iii) authorized SureWest Telephone to file anadvice letter with the Commission’s Telecommunications Division to implementreductions to its business access line rates. The results of this proceedingand the potential effects on SureWest Telephone could impact future fundinglevels through the CHCF.

In 1996, the CPUC issued a decision that authorizedSureWest Telephone to implement a New Regulatory Framework (“NRF”) for servicesfurnished within SureWest Telephone’s service area in order to accommodatemarket and regulatory movement toward competition and greater pricingflexibility. Under the NRF, SureWest Telephone is subject to ongoing monitoringand reporting requirements, and it was initially required to share earningswith customers through a reduction of revenues if its earned annual rate-of-returnexceeds that authorized by the CPUC.

In accordance with the requirements of its generalrate case order, SureWest Telephone filed an application for review of its NRFin 1999. In connection with this proceeding, the Office of Ratepayer Advocates(“ORA”) undertook a verification audit of SureWest Telephone’s non-regulatedand affiliated transactions pursuant to the general rate case and other CPUCorders. In June 2001, the CPUC adopted its decision in this matter (the “Decision”).The Decision did not suspend the sharing mechanism as SureWest Telephone hadrequested, and the CPUC ruled that SureWest Telephone must change the methodused to allocate costs for services provided by SureWest Telephone to itsaffiliates, the treatment of certain directory revenues and the treatment ofinternal-use software costs. In accordance with the provisions of the Decision,the Company recorded certain liabilities and reductions of revenues of $3,285relating to its estimated intrastate shareable earnings obligations during theyears ended December 31, 2003 (none in 2004 or 2005).

The Company was involved in a proceeding at the CPUCthat considered the continued need for certain sharing requirements in theintrastate jurisdiction and, in connection with that review, also consideredthe issue of whether the Company overearned in the intrastate jurisdiction inrecent monitoring periods and the amount of overearnings that should be sharedwith customers. In July 2004, the Company entered into a settlementagreement (“the settlement agreement”) with the other parties in theproceeding, the ORA and The Utility Reform Network (“TURN”), to resolve allissues in the proceeding. In November 2004, the CPUC approved thesettlement agreement. The settlement agreement resolved existing intrastatesharing obligations and related earnings issues for the monitoring periods 2000through 2004, put into place a surcredit mechanism for the amount of thesettlement, and suspended the requirement for any intrastate sharing formonitoring periods from January 1, 2005 through at least December 31,2010. The settlement agreement resulted in SureWest Telephone recognizing anincrease in local revenues of $2,948 due to a change in accounting estimate inthe fourth quarter of 2004. This increase in revenues resulted in a decrease ofthe Company’s net loss by $2,046 ($0.14 per share) during 2004.

In accordance with the settlement agreement, SureWestTelephone will return approximately $6,500, plus interest at the 90-daycommercial paper rate for non-financial institutions, which was 4.23% as of December 31,2005, and an imputed rate of 3.15%, to its end users through a consumerdividend over a period of four years, which began January 1, 2005. For theyear ended December 31, 2005, approximately $1,655 was returned to the endusers. In addition, SureWest Telephone will pay a one-time consumer dividend of$2,600, which includes an annual imputed interest rate of 3.15% (no statedcontractual interest rate), over two years, which began January 1, 2005 tosettle the monitoring periods 2000 to 2004. For the 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**3. ESTIMATEDSHAREABLE EARNINGS OBLIGATIONS (Continued)**

year ended December 31, 2005, approximately$1,210 was returned to the consumers and was recorded as a reduction of theCompany’s contractual shareable earnings obligations. At December 31,2005, the aggregate contractual shareable earnings obligation for thesesurcredits was $6,627 (which is net of an unamortized discount pertaining toimputed interest of $274 at that date). Future payments for these obligationsare $3,167 in 2006 and $1,867 in 2007 and 2008.

Further, commencing January 1, 2007, SureWestTelephone will implement an annual consumer dividend of $1,300 to end-usersreceiving SureWest Telephone services subject to sharing on or after that date;however, this consumer dividend is subject to reduction based upon the resultsof other pending regulatory proceedings.

During the fourth quarter of 2005, the Company filedan Advice Letter with the CPUC proposing an increase to the consumer dividendsin order to return the amounts entitled per the settlement agreement. Thechange in the consumer dividends resulted from the increase in interest ratesduring 2005. The increase was effective January 1, 2006.

Beginning in November 2003, SureWest Telephonebegan paying a customer dividend for intrastate overearnings relating to theyear 2002. A portion of the consumer’s intrastate service charges was returnedto the consumers in the form of a surcredit beginning in November 2003 andending in February 2004, totaling $483 (of which $208 was returned during2004) and was recorded as a reduction of the Company’s estimated intrastateshareable earnings obligations.

As a result of periodiccost separation studies, SureWest Telephone changed its estimates for a portionof its interstate and intrastate shareable earnings obligations and certainNECA Carrier Common Line (“CCL”) accounts receivable balances related to prioryear monitoring periods during the years ended December 31, 2005, 2004 and2003. For the year ended December 31, 2005, these changes in accountingestimates increased the Company’s consolidated revenues and net income by $791and $482 ($0.03 per share), respectively. For the year ended December 31,2004, similar changes in accounting estimates, including a change in estimateto the Company’s intrastate shareable earnings obligations, increased theCompany’s consolidated revenues by $1,258 and decreased the net loss by $873($.06 per share). For the year ended December 31, 2003, similar changes inaccounting estimates decreased the Company’s consolidated revenues and netincome by $29 and $11 (no effect on earnings per share), respectively.

**As of December 31,2005, the Company’s consolidated balance sheet reflected aggregate liabilitiesof $293 relating to SureWest Telephone’s estimated interstate shareableearnings obligations. The calculations supporting these liabilities are verycomplex and involve a variety of estimates prior to the ultimate settlement ofsuch obligations. In addition, SureWest Telephone’s interstate shareableearnings obligations lapse over time if SureWest Telephone’s interexchangecarrier and other customers do not claim the amounts ascribed to them. Accordingly,it is reasonably possible that management’s estimates of the Company’sliabilities for interstate shareable earnings obligations could change in thenear term, and the amounts involved could be material.**

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**4. CORPORATE TREASURY INVESTIGATION**

In December 2003, theCompany discovered certain irregular bank transactions and deposits in aroutine investigation following the abrupt resignation of the Company’sTreasury Analyst. Immediately following the Company’s initial review thatuncovered these irregularities, the Company broadened its review of theinvestment and cash operations, and a special corporate investigation waslaunched by the Audit Committee and the Board of Directors, which engagedindependent legal counsel and forensic accountants. The investigations revealedconcealed illegal transfers in violation of the Company’s investment and cashmanagement policies. The Company concluded that the irregularities were limitedto the 2003 calendar year. The investigation suggested that as much as $25,000may have been involved in the illegal transfers. Nearly all of the funds hadbeen recovered; however, approximately $1,828 remained outstanding as ofDecember 31, 2003 and was reflected as a non-operating loss in theCompany’s 2003 consolidated financial statements. During 2004, the Companyreceived an insurance recovery in the amount of $1,803, which was reflected asa non-operating gain in the Company’s 2004 consolidated financial statements.

**5. ASSET PURCHASE**

**On July 12, 2002, the Companypurchased substantially all of the assets of Western Integrated Networks, LLCand certain affiliates (collectively, “WIN”) in a transaction supervised by theUnited States Bankruptcy Court for the District of Colorado (the “BankruptcyCourt”). The purchase price for the assets of WIN consisted of (i) $12,000in cash, (ii) direct acquisition costs of $622 and (iii) theassumption of certain current liabilities aggregating $4,717 relatingprincipally to executory contracts and capital lease obligations. Since July 12,2002, the Company has been utilizing the assets acquired from WIN to offerbundled high-speed Internet, digital video and telephone services under theSureWest Broadband name in the Sacramento metropolitan area.**

The Company recognized an intangible asset of $893related to favorable operating leases assumed from WIN. This intangible assetis being amortized to rent expense over the remaining lease terms, which rangefrom two to ten years. As of December 31, 2005, 2004 and 2003, accumulatedamortization associated with this intangible asset was $500, $387 and $244,respectively.

Under the terms of theasset purchase agreement, $1,200 of the aggregate purchase price was held in anescrow account to protect the Company in the event of any claims available tothe Company. In January 2003, $150 was released to the Company. During March 2004,the Company resolved the remaining issues related to the escrow, and asettlement agreement was executed that gave the Company undisputed rights tocertain deposits held by a third party in connection with WIN’s networkconstruction. As a result, in April 2004, the Bankruptcy Court signed anorder that allowed the remainder of the funds in escrow to be released to theWIN estate. In November 2004, the third party refunded $695 to the Companyto cover all unused deposits through April 1, 2004, which was recorded asa reduction of property, plant and equipment.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**6. CREDIT ARRANGEMENTS**

Long-termdebt outstanding as of December 31, 2005 and 2004 consisted of thefollowing:
| ** **                                                                                                                                                                                                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Unsecured  Series A Senior Notes, with interest payable semiannually at a fixed  rate of 6.30%; principal payments are due in equal annual installments of  approximately $3,636, through December 2013                     |       | $        | 29,091     |     | $          | 32,727 |   |
| Unsecured  Series B Senior Notes, with interest payable semiannually at a fixed  rate of 4.74%; principal payments are due in equal annual installments of  $12,000, commencing in March 2009 and ending in March 2013 |       | 60,000   |       | 60,000   |       |
| Note payable, with  interest payable quarterly at a fixed rate of 8.00%; principal payments are  due in equal quarterly installments of approximately $36, through  November 2005                                                |       | –   |       | 143      |       |
| Total long-term  debt                                                                                                                                                                                                                 |       | 89,091   |       | 92,870   |       |
| Less current  portion                                                                                                                                                                                                                 |       | 3,636    |       | 3,779    |       |
| Total long-term debt,  net of current portion                                                                                                                                                                                         |       | $        | 85,455     |     | $          | 89,091 |   |

 

At December 31, 2005, the aggregate maturities oflong-term debt were (i) $3,636 annually through 2008 and (ii) $15,636annually from 2009 through 2013 for a total of $89,091.

The Company has a business loan agreement with a bankfor a $50,000 line of credit, which expiries July 1, 2006. As of December 31,2005, and 2004, there was $30,000 and $10,000 outstanding, respectively, underthis credit facility and the weighted average interest rate was 5.75% and3.14%, respectively, which is based on a LIBOR-based pricing formula.

Certain of the credit arrangements described abovecontain financial and operating covenants that restrict, among other things,the payment of cash dividends, repurchase of the Company’s capital stock, themaking of certain other restricted payments and the incurrence of additionalindebtedness. The bank line of credit agreement requires that the Companyobtain written consent to exceed $100,000 in total debt with maturities greaterthan five years. The covenants also require the Company to maintain certainfinancial ratios and minimum levels of tangible net worth. At December 31,2005 and 2004, retained earnings of approximately $28,266, and $37,347,respectively, were available for the payment of cash dividends or otherrestricted payments under the terms of the Company’s credit arrangements.

The Company has enteredinto various cable television franchise agreements with associated letters ofcredit totaling $150 in the aggregate as of December 31, 2005.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**7. INCOME TAXES**

Incometax expense (benefit) consists of the following components:
| ** **                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current expense  (benefit):         |       |     |       |     |       |     |       |
| Federal                             |       | $        | 523        |     | $          | (71      | )          | $ | 782 |   |
| State                               |       | (33      | )          | (54      | )          | 1,549    |       |
| Total current  expense (benefit)    |       | 490      |       | (125     | )          | 2,331    |       |
| Deferred expense (benefit):         |       |     |       |     |       |     |       |
| Federal                             |       | 2,581    |       | (299     | )          | 75       |       |
| State                               |       | 837      |       | (73      | )          | (1,384   | )          |
| Total deferred  expense (benefit)   |       | 3,418    |       | (372     | )          | (1,309   | )          |
| Total income tax  expense (benefit) |       | $        | 3,908      |     | $          | (497     | )          | $ | 1,022 |   |

 

Income tax expense (benefit)differs from the amounts computed by using the statutory federal tax rate (35%in all years presented) due to the following:
| ** **                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed at statutory  rates         |       | $        | 3,600      |     | $          | (569     | )          | $ | 583 |   |
| Increase  (decrease):                |       |     |       |     |       |     |       |
| State taxes, net  of federal benefit |       | 523      |       | (82      | )          | 108      |       |
| Other, net                           |       | (215     | )          | 154      |       | 331      |       |
| Income tax  expense (benefit)        |       | $        | 3,908      |     | $          | (497     | )          | $ | 1,022 |   |
| Effective federal and state tax rate |       | 38.0     | %          | 30.6     | %          | 61.3     | %          |

 

Thesignificant components of the Company’s deferred income tax assets andliabilities were as follows at December 31, 2005 and 2004:
| ** **                                                                                    | ** ** | **Deferred Income Taxes** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                    | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                                    | ** ** | **Assets**                          | ** ** | **Liabilities** | ** ** | **Assets** | ** ** | **Liabilities** | ** ** |
| Property, plant and  equipment-primarily due to timing of recognition of depreciation expense |       | $                                   | –     |   |   | $ | 52,900 |   |   | $ | – |   |   | $ | 57,004 |   |   |
| Differences in the  timing of recognition of revenues                                         |       | 7,685                               |       |   | – |   |   | 8,468 |   |   | – |   |   |
| Net operating losses                                                                          |       | 11,705                              |       |   | – |   |   | 19,221 |   |   | – |   |   |
| Post-retirement and  post-employment benefits                                                 |       | 6,709                               |       |   | – |   |   | 4,812 |   |   | – |   |   |
| Other, net                                                                                    |       | 2,084                               |       |   | 1,179 |   |   | 1,911 |   |   | 1,542 |   |   |
| Total deferred income  taxes                                                                  |       | $                                   | 28,183     |   |   | $ | 54,079 |   |   | $ | 34,412 |   |   | $ | 58,546 |   |   |
| Net deferred income tax liability                                                             |       |                                |       |   | $ | 25,896 |   |   |   |   |   | $ | 24,134 |   |   |

 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**7. INCOME TAXES(Continued)**

As of December 31, 2005, the Company had netoperating loss carryforwards for federal income tax purposes of approximately$33,385, which will expire in the years 2018 through 2024, if not utilized. Asof December 31, 2005, the Company also had net operating losscarryforwards for state income tax purposes of approximately $355, which willexpire in the years 2006 through 2014, if not utilized. As of December 31,2005, the Company also had research and development tax credit carryforwards ofapproximately $100 for federal income tax purposes. The federal credit willexpire in 2022 if it is not utilized. The Company has an Alternative MinimumTax carryforward of $322 for federal and $343 for state, which do not expire.

The Company believes it ismore likely than not that the benefit associated with the deferred tax assetsresulting from net operating loss carryforwards will be ultimately realizedbased on its assessment of future taxable income during the periods in whichthe net operating losses remain available. The Company considers the scheduledreversal of its deferred tax liabilities, primarily depreciationexpense-related, and projected future taxable income in making this assessment.As a result of this assessment, the Company has not recognized a valuationallowance associated with its deferred tax assets as of December 31, 2005and 2004.

**8. PENSION AND OTHERPOST-RETIREMENT BENEFITS**

The Company sponsors anoncontributory defined benefit pension plan (the “Pension Plan”) coveringsubstantially all of its employees. In December 2003, the Company approvedan amendment to the Pension Plan that essentially provided for the adoption ofthe Pension Plan by all subsidiaries, thereby extending the pension benefit toall employees of the Company, effective January 1, 2004. Benefits arebased on years of service and the employee’s average compensation during thefive highest consecutive years of the last ten years of credited service. TheCompany’s funding policy is to contribute annually an actuarially determinedamount consistent with applicable federal income tax regulations. Contributionsare intended to provide for benefits attributed to service to date. PensionPlan assets are primarily invested in domestic equity securities, United Statesgovernment and agency securities and international equity securities.

TheCompany also has an unfunded Supplemental Executive Retirement Plan (“SERP”),which provides supplemental retirement benefits to certain executives of theCompany. The SERP provides for incremental pension payments to partially offsetthe reduction in amounts that would have been payable under the Pension Plan ifit was not for limitations imposed by federal income tax regulations.

In addition, the Companyprovides certain post-retirement benefits other than pensions (“Other Benefits”)to substantially all employees, including life insurance benefits and a statedreimbursement for Medicare supplemental insurance.

In December 2004, theCompany initiated a voluntary enhanced early retirement program (the “REWARDprogram”). The REWARD program was offered to certain eligible employees acrossall business units. In addition to retirement benefits, eligible employees willreceive enhanced medical benefits for a specified period of time. As of December 31,2004, 59 employees had accepted the REWARD program. Accordingly, the Companyrecorded $3,768 in operating expenses related to the REWARD program during thefourth quarter of 2004. Prior to the completion of the REWARD program in February of2005, 13 additional employees accepted the REWARD program, and the Companyrecorded an additional $791 in operating expenses during the first quarter of2005.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**8. PENSIONAND OTHER POST-RETIREMENT BENEFITS (Continued)**

The Company uses ameasurement date of December 31 for the majority of its pension and otherpost-retirement benefit plans.

The following table sets forth the change in benefitobligation, change in plan assets and funded status of the Pension Plan (whichencompasses the REWARD program), SERP and Other Benefits (which encompasses theREWARD program) as of December 31, 2005 and 2004:
| ** **                              | ** ** | **Pension Plan & SERP** | ** ** | **Other Benefits** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **2005**                                   | ** ** | **2004**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Change in benefit obligation:**       |       |                                       |       |                    |       |   |   |   |   |
| Benefit obligation at beginning of year |       | $                                          | 126,862    |                    | $          | 110,353 |   | $ | 9,547 |   | $ | 5,036 |   |
| Service cost                            |       | 5,629                                      |       | 5,360                   |       | 645 |   | 469 |   |
| Interest cost                           |       | 7,464                                      |       | 7,095                   |       | 692 |   | 351 |   |
| Plan participants’  contributions  |       | –                                     |       | –                  |       | 381 |   | 240 |   |
| Actuarial losses                        |       | 6,870                                      |       | 8,022                   |       | 1,710 |   | 659 |   |
| Special termination  benefits           |       | 51                                         |       | 632                     |       | 740 |   | 3,136 |   |
| Benefits paid                           |       | (8,467                                     | )          | (4,600                  | )          | (474 | ) | (344 | ) |
| Benefit  obligation at end of year      |       | $                                          | 138,409    |                    | $          | 126,862 |   | $ | 13,241 |   | $ | 9,547 |   |

 
| ** **                                     | ** ** | **Pension Plan & SERP** | ** ** | **Other Benefits** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|
| ** **                                     | ** ** | **2005**                                   | ** ** | **2004**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Change in plan assets:**                     |       |                                       |       |                    |       |   |   |   |   |
| Fair value of plan assets at beginning of year |       | $                                          | 105,338    |                    | $          | 93,949 |   | $ | 2,102 |   | $ | 1,890 |   |
| Actual return on plan assets                   |       | 7,405                                      |       | 10,859                  |       | 154 |   | 217 |   |
| Company contribution                           |       | 5,140                                      |       | 5,130                   |       | 1,852 |   | 76 |   |
| Participants’ contributions               |       | –                                     |       | –                  |       | 381 |   | 240 |   |
| Benefits paid                                  |       | (8,467                                     | )          | (4,600                  | )          | (474 | ) | (321 | ) |
| Fair value of  plan assets at end of year      |       | $                                          | 109,416    |                    | $          | 105,338 |   | $ | 4,015 |   | $ | 2,102 |   |

 
| ** **                             | ** ** | **Pension Plan & SERP** | ** ** | **Other Benefits** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|
| **Funded status:**                | ** ** | **2005**                                   | ** ** | **2004**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Unfunded status of plan at end of year |       | $                                          | (28,994    | )                       | $          | (21,524 | ) | $ | (9,226 | ) | $ | (7,445 | ) |
| Unrecognized actuarial loss            |       | 28,997                                     |       | 21,501                  |       | 1,980 |   | 386 |   |
| Unrecognized prior service cost        |       | 418                                        |       | 497                     |       | 366 |   | 408 |   |
| Unrecognized net transition obligation |       | 38                                         |       | 305                     |       | – |   | – |   |
| Prepaid (accrued)  benefits            |       | $                                          | 459        |                    | $          | 779 |   | $ | (6,880 | ) | $ | (6,651 | ) |

 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**8. PENSION AND OTHER POST-RETIREMENT BENEFITS(Continued)**

Amounts recognized in theconsolidated balance sheets at December 31, 2005 and 2004 consist of:
| ** **                           | ** ** | **Pension Plan & SERP** | ** ** | **Other Benefits** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **2005**                                   | ** ** | **2004**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Prepaid benefit cost                 |       | $                                          | 2,220      |                    | $          | 2,447 |   | $ | – |   | $ | – |   |
| Accrued benefit cost                 |       | (1,761                                     | )          | (1,668                  | )          | (6,880 | ) | (6,651 | ) |
| Additional minimum liability         |       | (8,074                                     | )          | (3,931                  | )          | – |   | – |   |
| Intangible assets                    |       | 456                                        |       | 802                     |       | – |   | – |   |
| Accumulated other comprehensive loss |       | 7,618                                      |       | 3,129                   |       | – |   | – |   |
| Prepaid (accrued)  benefits          |       | $                                          | 459        |                    | $          | 779 |   | $ | (6,880 | ) | $ | (6,651 | ) |

 

Informationfor the Pension Plan and SERP, which have accumulated benefit obligations inexcess of plan assets as of December 31, 2005 and 2004 is as follows:
| ** **                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Projected benefit obligation   |       | $        | 138,409    |     | $          | 126,862 |   |
| Accumulated benefit obligation |       | $        | 117,031    |     | $          | 108,490 |   |
| Fair value of  plan assets     |       | $        | 109,416    |     | $          | 105,338 |   |

 

Netperiodic pension cost recognized in the consolidated statements of operationsfor the years ended December 31, 2005, 2004 and 2003 under the PensionPlan, SERP and Other Benefits plan included the following components:
| ** **                                      | ** ** | **Pension Plan & SERP** | ** ** | **Other Benefits** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **2005**                                   | ** ** | **2004**                | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Service cost-benefits  earned during the period |       | $                                          | 5,629      |                    | $          | 5,360 |   | $ | 4,557 |   | $ | 645 |   | $ | 469 |   | $ | 353 |   |
| Interest cost on projected benefit obligation   |       | 7,464                                      |       | 7,095                   |       | 6,841 |   | 692 |   | 351 |   | 326 |   |
| Expected return on plan assets                  |       | (8,733                                     | )          | (8,033                  | )          | (6,305 | ) | (135 | ) | (151 | ) | (108 | ) |
| Amortization of prior service cost              |       | 78                                         |       | 78                      |       | 92 |   | 43 |   | 43 |   | 26 |   |
| Recognized net actuarial loss                   |       | 704                                        |       | 480                     |       | 798 |   | 97 |   | – |   | – |   |
| Amortization of transition obligation           |       | 267                                        |       | 267                     |       | 267 |   | – |   | – |   | – |   |
| Effect of special termination benefits          |       | 51                                         |       | 632                     |       | – |   | 740 |   | 3,136 |   | – |   |
| Net pension cost                                |       | $                                          | 5,460      |                    | $          | 5,879 |   | $ | 6,250 |   | $ | 2,082 |   | $ | 3,848 |   | $ | 597 |   |

 

The weighted-average assumptions used to determineprojected benefit obligations as of December 31, 2005 and 2004 were asfollows:
| ** **                     | ** ** | **Pension Plan & SERP**   | ** ** | **Other Benefits**                      | ** ** |
|--------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                     | ** ** | **   2005   ** | ** ** | **   2004   ** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Discount rate                  |       |                                         | 5.75%      |                                         |       |   | 5.75% |   |   | 5.50% |   | 5.75% |   |
| Rate of  compensation increase |       |                                         | 5.00%      |                                         |       |   | 5.00% |   |   | 5.00% |   | 5.00% |   |

** **

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**8. PENSIONAND OTHER POST-RETIREMENT BENEFITS (Continued)**

The weighted-average assumptions used to determine netperiodic benefit cost for the years ended December 31, 2005, 2004 and 2003were as follows:
| ** **                               | ** ** | **Pension Plan & SERP** | ** ** | **Other Benefits** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **2005**                                   | ** ** | **2004**                | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Discount rate                            |       | 5.75                                       | %          | 6.25                    | %          | 6.75 | % | 5.75 | % | 6.25 | % | 6.75 | % |
| Expected long-term return on plan assets |       | 8.50                                       | %          | 8.50                    | %          | 8.50 | % | 8.50 | % | 8.50 | % | 8.50 | % |
| Rate of  compensation increase           |       | 5.00                                       | %          | 5.00                    | %          | 5.00 | % | 5.00 | % | 5.00 | % | 5.00 | % |

 

The expected rate ofreturn on plan assets is the weighted average of expected long-term assetreturn assumptions.

Assumed health care costtrend rates at December 31, 2005 and 2004 were as follows:
| ** **                                                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Health care cost trend assumed for the next year                              |       | 10.00    | %          | 9.00     | %          |
| Rate to which the cost trend is assumed to decline  (the ultimate trend rate) |       | 5.00     | %          | 6.00     | %          |
| Year that the  rate reaches the ultimate trend rate                           |       | 2010     |       | 2007     |       |

 

Assumed health care costtrend rates have a significant effect on the amounts reported for the OtherBenefits plan. A one-percentage-point change in assumed health care cost trendrates would have the following effects:
| ** **                                                             | ** ** | **1-Percentage-  Point Increase** | ** ** | **1-Percentage-  Point Decrease** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| Effect on total  2005 service and interest costs                       |       | $                                      | 109        |                                   | $          | (92) |   |
| Effect on Other Benefits  plan obligation as of December 31, 2005 |       | $                                      | 664        |                                   | $          | (575) |   |

 

The assets of the Pension Plan and Other Benefits planare combined in a single trust and invested in the aggregate. The SERP benefitobligation is funded by the Company’s assets. The allocation for the PensionPlan and Other Benefits plan assets at the end of 2005 and 2004, and the targetallocation for 2006, by asset category is as follows:
| ** **                                      | ** ** | **Target Allocation** | ** ** | **Percentage of   Plan Assets at  December 31,** | ** ** |
|-------------------------------------------------|------------|----------------------------|------------|----------------------------------------------------------------------|------------|
| **Asset Category**                         | ** ** | **2006**                   | ** ** | **2005**                                                             | ** ** | **2004** | ** ** |
| Domestic equity  securities                     |       |                       | 39%        |                                                                 |       | 39% |   | 40% |   |
| United States  government and agency securities |       |                       | 40%        |                                                                 |       | 38% |   | 39% |   |
| International  equity securities                |       |                       | 20%        |                                                                 |       | 21% |   | 20% |   |
| Cash equivalents                                |       |                       | 1%         |                                                                 |       | 2% |   | 1% |   |
| Total                                           |       |                       | 100%       |                                                                 |       | 100% |   | 100% |   |

 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**8. PENSIONAND OTHER POST-RETIREMENT BENEFITS (Continued)**

The fair value of planassets for these plans is $113,431 and $107,440 at December 31, 2005 and2004, respectively. The expected long-term rate of return on these plans assetsfor 2005 and 2004 was 8.5%.

TheCompany’s investment strategy is designed to provide a stable environment tosecure participant retirement benefits and minimize the reliance oncontributions as a source of benefit security. As such, plan assets areinvested to maximize the plan’s funded ratios over the long-term while managingthe downside risk that funded ratios fall below some specified threshold level.The asset return objective is to achieve, as a minimum over time, the passivelymanaged return earned by managed index funds, weighted in the proportions outlinedby the asset class exposures identified in the plan’s strategic allocation.

The Company expects to contribute $3,000 and $1,300 tothe Pension Plan and Other Benefits plan, respectively, in 2006.

*EstimatedFuture Benefit Payments*

The following table reflectsthe total benefits expected to be paid from the Pension Plan, SERP and OtherBenefits  plans or from the Company’sassets, including both the Company’s share of the benefit cost and theparticipants’ share of the cost, which is funded by participant contributionsto the plans. Expected contributions reflect amounts expected to be contributedto funded plans.
| ** **                  | ** ** | **Pension Plan & SERP** | ** ** | **Other Benefits** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|-------------------------|------------|
| Expected benefit  payments: |       |                                       |       |                    |       |   |   |   |   |
| 2006                        |       |                                       | $          | 6,464                   |       |   |   | $ | 1,170 |   |   |
| 2007                        |       |                                       | 6,641      |                    |       |   | 952 |   |   |
| 2008                        |       |                                       | 6,838      |                    |       |   | 1,024 |   |   |
| 2009                        |       |                                       | 7,058      |                    |       |   | 1,093 |   |   |
| 2010                        |       |                                       | 7,327      |                    |       |   | 1,154 |   |   |
| 2011-2015                   |       |                                       | 42,507     |                    |       |   | 6,550 |   |   |
|                             |            |                                            |            |                         |            |  |  |  |  |  |  |

 

The Company maintains adefined contribution retirement plan, the SureWest KSOP (the “KSOP”). TheCompany has retained an investment management company to be the record keeperand fund manager of the KSOP. The KSOP allows its participants an opportunityto diversify their retirement holdings. Employees may choose from eleveninvestment options, including the Company’s common stock. The KSOP has both aretirement and savings feature. The retirement feature allows for qualified taxdeferred contributions by employees under Section 401(k) of theInternal Revenue Code. The Company matches an employee’s contributionsdollar-for-dollar up to six percent of an employee’s salary. The KSOP providesfor voting rights as to the participant’s share of the Company’s common stockheld by the KSOP and for certain diversification rights of the participant’saccount balances. Aggregate matching contributions made by the Company and chargedto expense under the KSOP were $2,308, $2,466 and $2,204 in 2005, 2004 and2003, respectively. At December 31, 2005, 2004 and 2003 the KSOP heldapproximately 880,000, 1,085,000, and 1,211,000 shares, respectively, of theCompany’s common stock. During the years ended December 31, 2005, 2004 and2003, the KSOP received dividends from the Company of approximately $957,$1,166 and $1,275, respectively. The Company’s earnings (loss) per sharecalculations include the issued and outstanding shares held by the KSOP.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**9. COMMITMENTS ANDCONTINGENCIES**

**Capital and Operating Leases**

TheCompany holds capital leases for certain vehicles. These leases bear interestat imputed rates of 6.3% to 16.2% per annum and expire throughDecember 2010. The capitalized costs related to assets under capital leasewere $1,064 as of December 31, 2005 and 2004. The amortization of assetsunder capital leases is included in depreciation and amortization expense inthe accompanying consolidated financial statements. As of December 31,2005 and 2004, the accumulated amortization for these assets was $734 and $524,respectively.

TheCompany leases certain facilities and equipment used in its operations underarrangements accounted for as operating leases. The facility leases generallyrequire the Company to pay operating costs, including property taxes, insuranceand maintenance, and certain of them contain scheduled rent increases andrenewal options. Leasehold improvements are amortized over their estimateduseful lives or lease period, whichever is shorter. The Company recognizes rentexpense on a straight-line basis over the term of each lease. Total rentexpense for all operating leases was $6,246, $5,567 and $5,032 in 2005, 2004and 2003, respectively.

As of December 31,2005, the Company had various non-cancelable operating and capital leases withterms greater than one year. Future minimum lease payments for allnon-cancelable operating and capital leases at December 31, 2005 were asfollows:
| ** **                                   | ** ** | **Operating** | ** ** | **Capital** | ** ** |
|----------------------------------------------|------------|---------------|------------|-------------|------------|
| ** **                                   | ** ** | **Leases**    | ** ** | **Leases**  | ** ** |
| 2006                                         |       |          | $          | 5,501       |       |   |   | $ | 36 |   |   |
| 2007                                         |       |          | 5,638      |        |       |   | 7 |   |   |
| 2008                                         |       |          | 5,723      |        |       |   | 7 |   |   |
| 2009                                         |       |          | 5,602      |        |       |   | 7 |   |   |
| 2010                                         |       |          | 5,469      |        |       |   | – |   |   |
| Thereafter                                   |       |          | 20,844     |        |       |   | – |   |   |
|                                         |       |          | $          | 48,777      |       |   |   | 57 |   |   |
| Less: amount  representing interest          |       |          |       |        |       |   | 6 |   |   |
| Present value of net  minimum lease payments |       |          |       |        |       |   | 51 |   |   |
| Less: current portion                        |       |          |       |        |       |   | 33 |   |   |
|                                         |       |          |       |        |       |   | $ | 18 |   |   |

 

**Other Commitments**

As of December 31, 2005, binding commitments forfuture capital expenditures were approximately $1,550 in the aggregate.

SureWest Long Distance provides long distance servicesunder resale arrangements with two interexchange carriers, Global Crossing Ltd.(“Global Crossing”) and Sprint Communications Company L.P. (“Sprint”). Theagreement with Global Crossing expired in July 2004. SureWest LongDistance now maintains a month-to-month agreement with Global Crossing. During2005, the Company renegotiated its agreement with Sprint through March 2007.The Company’s minimum usage requirement for Sprint for 

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**9. COMMITMENTSAND CONTINGENCIES (Continued)**

2006 and 2007 is $300 and$75, respectively. For the years ended December 31, 2005, 2004 and 2003,the Company paid $2,088, $1,435 and $1,183, respectively, under these longdistance resale arrangements.

SureWest Broadbandprovides Internet access services and has procured dedicated access andtransport agreements with various communication providers. The Company’sminimum usage requirement related to these agreements for 2006 is $143. For theyear ended December 31, 2005, the Company paid $419 (none in 2004 or2003).

**Litigation,Regulatory Proceedings and Other Contingencies**

The Company is subject tocertain legal and regulatory proceedings, Internal Revenue Service examinationsand other income tax exposures, and other claims arising in the ordinary courseof its business. In the opinion of management, the ultimate outcome of thesematters will not materially affect the consolidated financial position, resultsof operations or cash flows of the Company.

**10. EQUITY INCENTIVE PLANS**

The Company has two EquityIncentive Plans (the “Plans”) for certain employees, outside directors andconsultants of the Company, which were approved by shareholders. The Companyauthorized for future issuance under the Plans approximately 1.6 million shares(subject to upward adjustment based upon the Company’s issued and outstandingshares) of authorized, but unissued, common stock. As of December 31,2005, 733,769 shares were available for grant. The Plans permit issuance by theCompany of awards in the form of restricted common shares, RSUs, performanceshares, stock options and stock appreciation rights. The exercise price pershare of the Company’s common stock purchasable under any stock option shallnot be less than 100% of the fair market value of a share of the Company’s commonstock on the date of the grant, and the exercise price under a non-qualifiedstock option shall not be less than 85% of the fair market value of the Company’scommon stock at the date of the grant. The term of any stock option shall notexceed 10 years.

The following tablesummarizes stock option activity for the years ended December 31, 2005,2004 and 2003, along with options exercisable at the end of each year:
| ** **                         | ** ** | **2005**    | ** ** | **2004**                     | ** ** | **2003**    | ** ** |
|------------------------------------|------------|-------------|------------|------------------------------|------------|-------------|------------|
| ** **                         | ** ** | **Options** | ** ** | **Weighted  Average  Price** | ** ** | **Options** | ** ** | **Weighted  Average**

**Price** | ** ** | **Options** | ** ** | **Weighted  Average**

**Price** | ** ** |
| Outstanding–January 1,   |       | 707,725     |       |                         | $          | 40.71       |       |   | 824,474 |   |   | $ | 40.72 |   |   | 865,122 |   |   | $ | 40.87 |   |   |
| Granted                            |       | –      |       |                         | –     |        |       | – |   |   | – |   |   | 12,750 |   |   | 30.26 |   |   |
| Exercised                          |       | –      |       |                         | –     |        |       | (334 | ) |   | 30.07 |   |   | (5,344 | ) |   | 30.77 |   |   |
| Cancelled                          |       | (85,412     | )          |                         | 41.11      |        |       | (116,415 | ) |   | 40.81 |   |   | (48,054 | ) |   | 41.74 |   |   |
| Outstanding–December 31, |       | 622,313     |       |                         | $          | 40.65       |       |   | 707,725 |   |   | $ | 40.71 |   |   | 824,474 |   |   | $ | 40.72 |   |   |
| Exercisable at end of year         |       | 616,302     |       |                         |       |        |       | 641,444 |   |   |   |   |   | 448,471 |   |   |   |   |   |

 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**10. EQUITYINCENTIVE PLANS (Continued)**

The following is a summaryof the status of the stock options outstanding at December 31, 2005:
| ** **                         | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | ** **                   | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Remaining**

**Contractual**

**Life** | ** ** | **Weighted**

**Average  Exercise**

**Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $26.51-$39.00                      |       |                         | 142,213    |                         |       |   | 6.26 |   |   |   | $ | 36.56 |   |   |   | 139,952 |   |   |   | $ | 36.67 |   |   |
| $39.25-$39.25                      |       |                         | 234,500    |                         |       |   | 4.53 |   |   |   | $ | 39.25 |   |   |   | 233,250 |   |   |   | $ | 39.25 |   |   |
| $39.50-$45.50                      |       |                         | 156,100    |                         |       |   | 5.22 |   |   |   | $ | 40.77 |   |   |   | 153,600 |   |   |   | $ | 40.77 |   |   |
| $49.25-$55.74                      |       |                         | 89,500     |                         |       |   | 5.96 |   |   |   | $ | 50.62 |   |   |   | 89,500 |   |   |   | $ | 50.62 |   |   |
|                               |       |                         | 622,313    |                         |       |   | 5.31 |   |   |   | $ | 40.65 |   |   |   | 616,302 |   |   |   | $ | 40.69 |   |   |
|                                    |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the year ended December 31,2005, the Company issued 40,414 shares of the Company’s restricted commonstock, which had a fair market value ranging from $27.65 to $29.05 per share atthe dates of grant, to certain employees and members of management. Deferredstock-based compensation of $1,171 was recorded as a result of the issuance ofthese shares of restricted common stock. During the year ended December 31,2004, the Company recorded deferred stock-based compensation of $552 as aresult of issuing 18,875 shares of the Company’s restricted common stock, whichhad a fair market value ranging from $26.57 to $32.01 per share at the date ofgrant, to certain employees and members of management. During the year ended December 31,2003, the Company recorded deferred stock-based compensation of $1,594 as aresult of issuing 43,491 shares of the Company’s restricted common stock, whichhad a fair market value ranging from $26.40 to $39.00 per share as of the dateof grant, to members of the Company’s Board of Directors and certain members ofmanagement and outside counsel. These amounts were determined based on the fairmarket value of such common shares at the date of grant and are being amortizedto operations over the vesting periods (which range from one to five years)using the graded vesting method. Stock-based compensation expense related tothese restricted common stock issuances was $568, $845 and $291 for the yearsended December 31, 2005, 2004 and 2003, respectively.

During the year ended December 31,2005, the Company issued 66,749 RSUs which had a fair market value ranging from$22.43 to $29.05 per unit at the dates of grant, to certain employees, membersof management, and members of the Company’s Board of Directors. Deferredstock-based compensation of $1,789 was recorded as a result of the issuance ofthese RSUs. During the year ended December 31, 2004, the Company issued5,200 RSUs, which had a fair market value of $28.75 per unit at the date ofgrant, to certain members of the Company’s Board of Directors. Deferredstock-based compensation of $150 was recorded as a result of the issuance ofthese RSUs, which was determined based on the fair market value of such commonunits at the date of grant and is being amortized over the vesting periods(which range from immediate vesting to four years) using the graded vestingmethod. Stock-based compensation expense related to these restricted stock unitissuances was $921 and $94 for the years ended December 31, 2005 and 2004,respectively, (none in 2003).

On each date that the Company pays a cash dividend tothe holders of the Company’s common stock, the Company credits to the holdersof RSUs an additional number of RSUs equal to the total number of whole RSUsand additional RSUs previously credited to the holders multiplied by the dollaramount of the cash dividend per share of common stock. Any fractional RSUsresulting from such calculation will be 

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**10. EQUITYINCENTIVE PLANS (Continued)**

included in the additionalRSUs. Additional RSUs are subject to the same terms and conditions of the RSUsto which they relate. The Company recorded the additional RSUs of $59 for theyear ended December 31, 2005 (none for 2004 or 2003).

**11. STOCKREPURCHASE**

The Company’s Board ofDirectors has authorized the repurchase of up to 1.5 million shares of theCompany’s common stock. The shares are purchased from time to time in the openmarket, or through privately negotiated transactions, subject to overallfinancial and market conditions. Through December 31, 2005, approximatelyone million shares of common stock have been repurchased. The Company hasremaining authorization from the Board of Directors to repurchase an additional467 thousand outstanding shares as of December 31, 2005.

**12. SHAREHOLDER RIGHTS PLAN AND CHANGE IN CONTROLAGREEMENT**

The Company has a Shareholder Rights Plan whereinshareholders of the Company receive rights to purchase the Company’s commonstock, or an acquirer’s common stock, at a discount in certain events involvingan acquisition of 20% or more of the Company’s common stock by any person orgroup in a transaction not approved by the Company’s Board of Directors. Therights expire in March 2008.

The Company has change incontrol agreements with approximately 27 employees, which provide upon(i) a change in control of the Company and (ii) a constructivetermination of employment, the payment of a severance benefit approximatelyequal to twice the employee’s annual compensation.

**13. BUSINESS SEGMENTS**

The Company has three reportable business segments:Telecom, Broadband and Wireless. The Telecom segment includes SureWestTelephone, SureWest Directories and SureWest Long Distance, which providelandline telecommunications services, directory advertising, Digital SubscriberLine (“DSL”) service, long distance services and certain non-regulatedservices. SureWest Telephone, which is the principal operating subsidiary ofthe Telecom segment, provides local services, toll telephone services, networkaccess services and certain non-regulated services. SureWest Directoriespublishes and distributes SureWest Telephone’s directory, including the sale ofyellow pages advertising. SureWest Directories is also engaged in thebusiness of producing, publishing and distributing directories in otherNorthern California communities outside of SureWest Telephone’s service area.SureWest Long Distance provides long distance services.

The Broadband segment provides various services,including: high-speed and dial-up Internet; digital video; voice, networkaccess and toll telephone; and managed services in the greater Sacramento area,principally to customers residing outside of SureWest Telephone’s service area.The Company offers high-speed Internet, digital video, voice and long distancephone service as a bundled package referred to as fiber-to-the-premise(“FTTP”). The Broadband segment includes the Company’s subsidiary SureWestBroadband and SureWest Broadband Business services, which is comprised, inpart, of a division of SureWest Telephone operating as a Competitive LocalExchange Carrier.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**13. BUSINESS SEGMENTS(Continued)**

The Wireless segment consists of the Company’ssubsidiary SureWest Wireless, which provides wireless services. Wirelessrevenues include wireless voice services, sales of handsets and relatedaccessories, long distance, roaming service and custom calling features.Wireless services are provided on a month-to-month basis and are generallybilled in advance for non-contract subscribers and in arrears for contractsubscribers.

In accordance with the provisions of SFAS No. 131,*Disclosure About Segments of an Enterpriseand Related Information*, the Company has aggregated certain of itsoperating segments within the Telecom and Broadband segments because itbelieves that such operating segments share similar economic characteristics.

Corporate Operations are allocated to the appropriatesegment, except for cash; investments, certain property, plant, and equipment;and miscellaneous other assets, which are not allocated to the segments.However, the investment income associated with cash and investments held byCorporate Operations is included in the results of the operations of theCompany’s segments. The Company evaluates the performance of its segments basedon income (loss) from operations.

These segments are strategic business units that offerdifferent products and services. The accounting policies of these segments arethe same as those described in Notes 1 and 2. The Company accounts forintersegment revenues and expenses at prevailing market rates. The Company’sbusiness segment information is as follows:
| **2005**                                       | ** ** | **Telecom** | ** ** | **Broadband** | ** ** | **Wireless** | ** ** | **Corporate  Operations** | ** ** | **Intercompany**

**Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|---------------------------|------------|------------------------------------|------------|------------------|------------|
| Operating  revenues from external customers    |       | $           | 134,468    |          |       | $            | 49,915     |                      |       | $                                  | 34,205     |             |       | $ | – |   |   |   | $ | – |   |   |   | $ | 218,588 |   |   |
| Intersegment revenues                          |       | 30,056      |       |          | 1,693      |         |       | 2,592                     |       |                               | –     |             |       |   | (34,341 | ) |   |   | – |   |   |
| Operating  expenses*                           |       | 85,503      |       |          | 59,942     |         |       | 37,784                    |       |                               | –     |             |       |   | (34,341 | ) |   |   | 148,888 |   |   |
| Depreciation and  amortization                 |       | 25,428      |       |          | 16,451     |         |       | 11,891                    |       |                               | –     |             |       |   | – |   |   |   | 53,770 |   |   |
| Income (loss)  from operations                 |       | 53,593      |       |          | (24,785    | )            |       | (12,878                   | )          |                               | –     |             |       |   | – |   |   |   | 15,930 |   |   |
| Interest income                                |       | 437         |       |          | 7          |         |       | 1                         |       |                               | –     |             |       |   | – |   |   |   | 445 |   |   |
| Interest expense,  net of capitalized interest |       | (841        | )          |          | (3,171     | )            |       | (1,663                    | )          |                               | –     |             |       |   | – |   |   |   | (5,675 | ) |   |
| Income tax  expense (benefit)                  |       | 22,951      |       |          | (12,579    | )            |       | (6,464                    | )          |                               | –     |             |       |   | – |   |   |   | 3,908 |   |   |
| Net income (loss)                              |       | $           | 30,033     |          |       | $            | (15,438    | )                         |       | $                                  | (8,217     | )                |       | $ | – |   |   |   | $ | – |   |   |   | $ | 6,378 |   |   |
| Total assets                                   |       | $           | 674,894    |          |       | $292,903     |       |                      | $147,955   |                               |       | $                | 318,056    |   |   |   | $ | (974,779 | ) |   |   | $459,029 |   |   |
| Capital expenditures                           |       | $           | 10,205     |          |       | $            | 54,677     |                      |       | $                                  | 3,061      |             |       | $ | 1,825 |   |   |   | $ | – |   |   |   | $ | 69,768 |   |   |

** **

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**13. BUSINESSSEGMENTS (Continued)**
| **2004**                                       | ** ** | **Telecom** | ** ** | **Broadband** | ** ** | **Wireless** | ** ** | **Corporate  Operations** | ** ** | **Intercompany  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|---------------------------|------------|--------------------------------|------------|------------------|------------|
| Operating  revenues from external customers    |       | $           | 141,086    |          |       | $            | 39,416     |                      |       | $                              | 31,261     |             |       | $ | – |   |   |   | $ | – |   |   |   | $ | 211,763 |   |   |
| Intersegment  revenues                         |       | 25,814      |       |          | 1,784      |         |       | 1,699                     |       |                           | –     |             |       |   | (29,297 | ) |   |   | – |   |   |
| Operating  expenses*                           |       | 91,736      |       |          | 61,143     |         |       | 38,266                    |       |                           | –     |             |       |   | (29,297 | ) |   |   | 161,848 |   |   |
| Depreciation and  amortization                 |       | 25,227      |       |          | 11,397     |         |       | 11,972                    |       |                           | –     |             |       |   | – |   |   |   | 48,596 |   |   |
| Income (loss)  from operations                 |       | 49,937      |       |          | (31,340    | )            |       | (17,278                   | )          |                           | –     |             |       |   | – |   |   |   | 1,319 |   |   |
| Interest income                                |       | 193         |       |          | 8          |         |       | –                    |       |                           | –     |             |       |   | – |   |   |   | 201 |   |   |
| Interest expense,  net of capitalized interest |       | (488        | )          |          | (2,247     | )            |       | (1,770                    | )          |                           | –     |             |       |   | – |   |   |   | (4,505 | ) |   |
| Corporate  treasury loss recovery              |       | 1,246       |       |          | 342        |         |       | 215                       |       |                           | –     |             |       |   | – |   |   |   | 1,803 |   |   |
| Income tax  expense (benefit)                  |       | 22,347      |       |          | (14,558    | )            |       | (8,286                    | )          |                           | –     |             |       |   | – |   |   |   | (497 | ) |   |
| Net income (loss)                              |       | $           | 28,322     |          |       | $            | (18,627    | )                         |       | $                              | (10,823    | )                |       | $ | – |   |   |   | $ | – |   |   |   | $ | (1,128 | ) |   |
| Total assets                                   |       | $622,668    |       |          | $          | 202,335      |       |                      | $          | 139,830                        |       |             | $          | 178,904 |   |   |   | $ | (694,834 | ) |   |   | $ | 448,903 |   |   |
| Capital expenditures                           |       | $           | 9,678      |          |       | $            | 50,330     |                      |       | $                              | 5,605      |             |       | $ | 5,220 |   |   |   | $ | – |   |   |   | $ | 70,833 |   |   |

 
| **2003**                                       | ** ** | **Telecom** | ** ** | **Broadband** | ** ** | **Wireless** | ** ** | **Corporate  Operations** | ** ** | **Intercompany  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|---------------------------|------------|--------------------------------|------------|------------------|------------|
| Operating  revenues from external customers    |       | $           | 138,924    |          |       | $            | 29,051     |                      |       | $                              | 27,146     |             |       | $ | – |   |   |   | $ | – |   |   |   | $ | 195,121 |   |   |
| Intersegment  revenues                         |       | 23,576      |       |          | 1,683      |         |       | 744                       |       |                           | –     |             |       |   | (26,003 | ) |   |   | – |   |   |
| Operating  expenses*                           |       | 83,645      |       |          | 42,538     |         |       | 34,724                    |       |                           | –     |             |       |   | (26,003 | ) |   |   | 134,904 |   |   |
| Depreciation and  amortization                 |       | 31,257      |       |          | 4,508      |         |       | 16,705                    |       |                           | –     |             |       |   | – |   |   |   | 52,470 |   |   |
| Income (loss)  from operations                 |       | 47,598      |       |          | (16,312    | )            |       | (23,539                   | )          |                           | –     |             |       |   | – |   |   |   | 7,747 |   |   |
| Interest income                                |       | 322         |       |          | 2          |         |       | (18                       | )          |                           | –     |             |       |   | – |   |   |   | 306 |   |   |
| Interest expense,  net of capitalized interest |       | (452        | )          |          | (1,890     | )            |       | (1,905                    | )          |                           | –     |             |       |   | – |   |   |   | (4,247 | ) |   |
| Corporate  treasury loss                       |       | (1,263      | )          |          | (347       | )            |       | (218                      | )          |                           | –     |             |       |   | – |   |   |   | (1,828 | ) |   |
| Income tax  expense (benefit)                  |       | 19,327      |       |          | (7,551     | )            |       | (10,754                   | )          |                           | –     |             |       |   | – |   |   |   | 1,022 |   |   |
| Net income (loss)                              |       | $           | 26,565     |          |       | $            | (10,983    | )                         |       | $                              | (14,937    | )                |       | $ | – |   |   |   | $ | – |   |   |   | $ | 645 |   |   |
| Total assets                                   |       | $           | 572,983    |          |       | $            | 104,545    |                      |       | $                              | 80,923     |             |       | $ | 53,025 |   |   |   | $ | (372,129 | ) |   |   | $ | 439,347 |   |   |
| Capital expenditures                           |       | $           | 15,675     |          |       | $            | 47,626     |                      |       | $                              | 5,224      |             |       | $ | 7,580 |   |   |   | $ | – |   |   |   | $ | 76,105 |   |   |

*Exclusive of depreciation and amortization

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**14.RELATED PARTY TRANSACTIONS**

During the years ended December 31,2004 and 2003, a former officer of the Company was a member of the Board ofDirectors of a local banking institution. For the years ended December 31,2004 and 2003, the Company provided $11 and $45, respectively, intelecommunications services to the banking institution.

Beginning January 1,2005, the Company’s employees were covered under an eye care benefit plan froman entity of which one of the Company’s Board Members is a director and also anexecutive officer. Negotiations regarding the benefit plan were completedbefore that entity’s director and executive officer was elected to the Company’sBoard of Directors and without his involvement. The Company’s payments to suchentity approximated $11 in 2005.

**15.QUARTERLY FINANCIAL INFORMATION (UNAUDITED)**
| **2005**                   | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|----------------------------|------------|-------------------|------------|------------------|------------|-----------------------|------------|----------------------|------------|
| Operating revenues         |       |              | $          | 53,456           |       |                  | $          | 55,087               |       |   | $ | 56,096 |   |   |   | $ | 53,949 |   |   |
| Income from operations     |       |              | $          | 2,569            |       |                  | $          | 4,897                |       |   | $ | 4,797 |   |   |   | $ | 3,667 |   |   |
| Net income                 |       |              | $          | 843              |       |                  | $          | 2,147                |       |   | $ | 1,960 |   |   |   | $ | 1,428 |   |   |
| Basic earnings per share   |       |              | $          | 0.06             |       |                  | $          | 0.15                 |       |   | $ | 0.13 |   |   |   | $ | 0.10 |   |   |
| Diluted earnings per share |       |              | $          | 0.06             |       |                  | $          | 0.15                 |       |   | $ | 0.13 |   |   |   | $ | 0.10 |   |   |

 
| **2004**                          | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|-----------------------------------|------------|-------------------|------------|------------------|------------|-----------------------|------------|----------------------|------------|
| Operating revenues                |       |              | $          | 51,588           |       |                  | $          | 52,115               |       |   | $ | 53,239 |   |   |   | $ | 54,821 |   |   |
| Income (loss) from  operations    |       |              | $          | 1,758            |       |                  | $          | 3,771                |       |   | $ | (1,517 | ) |   |   | $ | (2,693 | ) |   |
| Net income (loss)                 |       |              | $          | 381              |       |                  | $          | 1,561                |       |   | $ | (1,602 | ) |   |   | $ | (1,468 | ) |   |
| Basic earnings (loss)  per share  |       |              | $          | 0.03             |       |                  | $          | 0.11                 |       |   | $ | (0.11 | ) |   |   | $ | (0.11 | ) |   |
| Diluted earnings (loss) per share |       |              | $          | 0.03             |       |                  | $          | 0.11                 |       |   | $ | (0.11 | ) |   |   | $ | (0.11 | ) |   |

 

The CPUC approved asettlement agreement in November 2004 that resolved the Company’sintrastate shareable earnings for the years 2000 through 2004. In accordancewith this settlement agreement, the Company recorded $2,948 in local revenuesdue to a change in accounting estimate in the fourth quarter of 2004 (for amore detailed discussion regarding the settlement agreement, see Note 3). Thisincrease in revenue resulted in a decrease of the Company’s net loss by $2,046($0.14 per share) in 2004.

In December 2004, theCompany initiated the REWARD program. The REWARD program was offered to certaineligible employees across all business units. In addition to retirementbenefits, eligible employees will receive enhanced medical benefits for aspecified period of time. As of December 31, 2004, 59 employees hadaccepted the REWARD program. Accordingly, the Company recorded $3,768 inoperating expenses related to the REWARD program during the fourth quarter of2004. Prior to the completion of the REWARD program in February 2005, 13additional employees accepted the REWARD program. As a result, the Companyrecorded $791 in operating expenses during the first quarter of 2005.

In October 2005, theCompany resolved its claim filed in January 2003 related to pre-petitionaccounts receivable, and to a conditional payment made by SureWest to MCI inconnection with anticipated overearnings during the 1999-2000 monitoringperiod. In accordance with the MCI Plan of Reorganization, the Company receiveda distribution of cash and stock, with a combined fair value of approximately$1,400. The distribution was recognized in the Company’s consolidated statementof operations as an increase to network access service revenue and a decreaseto general and administrative expense of $800 and $600, respectively.

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**SUREWEST COMMUNICATIONS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**15. QUARTERLYFINANCIAL INFORMATION (UNAUDITED) (Continued)**

In July 2005, theCompany sold its pay telephone assets for $220 to a nationwide provider ofprivate pay telephone services. During the quarter ended June 30, 2005,the Company incurred a pretax asset impairment charge of $189, which wasrecorded in the Company’s consolidated statements of operations as depreciationand amortization expense. The asset impairment charge reduced the carryingvalue of the pay telephone assets within the Telecom segment to its fair valueof $198, which represented the expected proceeds from the sale of assets.

As a result of periodiccost separation studies, SureWest Telephone changed its estimates for a portionof its interstate and intrastate shareable earnings obligations and certainNECA CCL accounts receivable balances related to current and prior yearmonitoring periods during the years ended December 31, 2005, 2004 and 2003.These changes in accounting estimates increased the Company’s consolidatedrevenues and net income by $57 and $35 (no effect on earnings per share), $757and $462 (no effect on earnings per share), $175 and $107 (no effect onearnings per share) and $47 and $29 (no effect on earnings per share) duringthe first, second, third and fourth quarters of 2005, respectively. During thefirst and third quarters of 2004, similar changes in accounting estimates,including a change in estimate to the Company’s intrastate shareable earningsobligations, increased the Company’s consolidated revenues by $539 and $891 anddecreased the net loss by $310 ($0.02 per share) and $533 ($0.04 per share),respectively.

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**Item9.**                        Changes inand Disagreements With Accountants on Accounting and Financial Disclosure.

Not Applicable.

**Item 9A.**                Controlsand Procedures.

**Controls and Procedures**

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934). Based on this evaluation, the Chief Executive Officerand Chief Financial Officer have concluded that, as of December 31, 2005,the Company’s disclosure controls and procedures were effective to ensure thatinformation required to be disclosed by the Company in reports that it files orsubmits under the Securities Exchange Act is authorized, recorded, processed,summarized and reported within the time periods specified in SEC rules andforms.

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** **

**Management’sReport on Internal Control over Financial Reporting**

The management of the Company is responsible forestablishing and maintaining adequate internal control over financialreporting. The Company’s internal control system was designed to providereasonable assurance to the Company’s management, Board of Directors and AuditCommittee regarding the reliability of financial reporting and the preparationof published financial statements in accordance with generally acceptedaccounting principles in the United States of America. Under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer, we conducted an evaluation of theeffectiveness of our internal control over financial reporting as of December 31,2005 based on the framework in Internal Control-Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Basedon this assessment, the Company’s management concluded that, as of December 31,2005, the Company’s internal control over financial reporting was effective.

All internal control systems, no matter how welldesigned, have inherent limitations. Therefore, even those systems determinedto be effective can provide only reasonable assurance with respect to financialstatement preparation and presentation.

Management’s assessment ofthe effectiveness of our internal control over financial reporting as of December 31,2005 has been audited by Ernst & Young LLP, an independent registeredpublic accounting firm, as stated in its report, which is included elsewhereherein.

**Resolutionof Prior Year Material Weakness**

As more fully described in our 2004 Annual Report on Form 10-Kand our 2005 Quarterly Reports on Form 10-Q, our Report on Internal Control over FinancialReporting as of December 31, 2004 identified a material weakness inthe Company’s internal control over financial reporting relating to theaccounting for property, plant and equipment which resulted from controlweaknesses that caused certain conditions described therein. A materialweakness is a significant deficiency, or combination of significantdeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected. A significant deficiency is a control deficiency, orcombination of control deficiencies, that adversely affects the Company’sability to initiate, authorize, record, process, or report external financialdata reliably in accordance with generally accepted accounting principles inthe United States of America such that there is more than a remote likelihoodthat a misstatement of the Company’s annual or interim financial statementsthat is more than inconsequential will not be prevented or detected.

The Companyimplemented the following relating to the remediation and resolution of thematerial weakness discussed above:

·       Variousenhancements to the Company’s enterprise resource planning and accountingsoftware were completed during 2005. These enhancements enabled the Company toidentify reconciling items between the project and plant subsidiary ledgers andthe corresponding general ledger accounts. The depreciation and capitalizedinterest routines were also modified to enable consistency in system calculatedresults. The systematic routines were enhanced to enable more timelyidentification of errors in the transfer of data to and from the projectsubsidiary ledger. Modifications to the retirement routines were also made toproperly adjust plant records when retirements occur.

·       Detailedmonthly reviews of all open construction projects by the appropriate projectmanager have been and continue to be performed to validate the resultsgenerated by the Company’s systems, and to improve controls over projectcharging and placing projects in service in a timely manner.  These additional reviews were implemented in2004 and continued through 2005.

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·       During 2005, we implementeda review of the systematic routines which generate and transfer data betweenthe property, plant and equipment modules within the enterprise resourceplanning system to determine if the routines are generating accurate reports. Thisreview process has been improved by the development of system enhancements whichprovide additional up-front edits and improved reporting tools.

**Changein Internal Control over Financial Reporting**

During the fourth quarterof 2005, the Company implemented various improvements to internal controls,which included: (i) the design of additional up-front edits in the Company’senterprise resource planning system over time charging and (ii) thecontinued implementation of various process improvements to InformationTechnology general and application controls. Except for the items discussedabove, there has been no change in the Company’s internal control overfinancial reporting during the fourth quarter of 2005 that has materiallyaffected, or is reasonably likely to materially affect, the Company’s controlover financial reporting.

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** **

**Reportof Independent Registered Public Accounting Firm**

**TheBoard of Directors and Shareholders of**SureWest Communications

We have audited management’sassessment, included in the accompanying “Management’s Report on InternalControl Over Financial Reporting,” that SureWest Communications maintainedeffective internal control over financial reporting as of December 31,2005, based on criteria established inInternal Control–Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). SureWestCommunication’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of thecompany’s internal control over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that SureWest Communications maintained effective internal controlover financial reporting as of December 31, 2005, is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, SureWestCommunications maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2005, based on****theCOSO criteria**.**

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of SureWest Communications asof December 31, 2005 and 2004, and the related consolidated statements ofoperations, shareholders’ equity, and cash flows for each of the three years inthe period ended December 31, 2005 of SureWest Communications and ourreport dated February 27, 2006 expressed an unqualified opinion thereon.

/s/ Ernst & YoungLLP

Sacramento, California

February 27, 2006

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**Item 9B.**               OtherInformation.

Not applicable.

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**PART III**

**Item 10.**                 Directorsand Executive Officers of the Registrant.

For information regardingthe executive officers of the Company, see “Executive Officers” in Part I,Item 1 of this report. Other information required by this item is incorporatedherein by reference from the proxy statement for the annual meeting of theCompany’s shareholders to be filed pursuant to Regulation 14A within 120 daysafter the Company’s fiscal year-end of December 31, 2005.

**Item 11.**                 ExecutiveCompensation.

Incorporated herein byreference from the proxy statement for the annual meeting of the Company’sshareholders to be filed pursuant to Regulation 14A within 120 days after theCompany’s fiscal year-end of December 31, 2005.

**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters.

**EquityCompensation Plan Information**

The Company maintains the 1999 Restricted Stock BonusPlan (the “1999 Plan”) and the 2000 Equity Incentive Plan (the “2000 Plan”),pursuant to which it may grant equity awards to eligible persons. The 1999 Planand the 2000 Plan were approved by the Company’s shareholders.

Thefollowing table provides information about equity awards under the 1999 Planand the 2000 Plan.
| **Plan category**                                      | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options  warrants and rights** | ** ** | **Number of securities  remaining available  for future issuance  under equity  compensation plans  (excluding securities  reflected in column (a)** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                                                                          | ** ** | **(b)**                                                                                                    | ** ** | **(c)**                                                                                                                                                                                                     | ** ** |
| Equity compensation  plans approved by security holders     |       |                                                                                                                                             | 622,313    |                                                                                                       |       |                                                                                                                                                                                                        | $          | 40.65 |   |   |   | 733,769 |   |   |
| Equity compensation  plans not approved by security holders |       |                                                                                                                                             | –     |                                                                                                       |       |                                                                                                                                                                                                        | –     |   |   |   | – |   |   |
| Total                                                       |       |                                                                                                                                             | 622,313    |                                                                                                       |       |                                                                                                                                                                                                        | $          | 40.65 |   |   |   | 733,769 |   |   |

 

(1)          The 1999 Plan permitsonly the issuance of Restricted Shares. As of December 31, 2005, theCompany had made Restricted Share grants of 34,268 shares of the Company’scommon stock, and 166,107 shares of the Company’s common stock remain availableunder the 1999 Plan.

(2)          The 2000 Plan, asoriginally approved by the Company’s shareholders, contemplated the issuance ofup to 800,000 shares of the Company’s common stock. Thereafter, the Company’sshareholders approved an increase to 950,000 shares and the incorporation of anevergreen provision pursuant to which the number of shares of the Company stockwhich shall be made available under the 2000 Plan shall be 950,000 shares plusan annual increase to be added on the first business day of each calendar yearand thereafter beginning with January 2, 2003 equal to one percent of theoutstanding shares as of December 31 of the immediately preceding calendaryear.

Additional informationrequired by Item 12 is incorporated herein by reference from the proxystatement for the annual meeting of the Company’s shareholders to be filedpursuant to Regulation 14A within 120 days after the Company’s fiscal year-endof December 31, 2005.

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**Item 13.**                 CertainRelationships and Related Transactions.

Incorporated herein byreference from the proxy statement for the annual meeting of the Company’sshareholders to be filed pursuant to Regulation 14A within 120 days after theCompany’s fiscal year-end of December 31, 2005.

**Item 14.**                 PrincipalAccountant Fees and Services.

Incorporated herein byreference from the proxy statement for the annual meeting of the Company’sshareholders to be filed pursuant to Regulation 14A within 120 days after theCompany’s fiscal year-end of December 31, 2005.

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**PART IV**

**Item 15.**                 Exhibitsand Financial Statement Schedules.

(a)            1.    All Financial Statements

The following financial statements are filed as partof this report under Item 8–“Financial Statements and Supplementary Data”:

Report of Independent Registered Public AccountingFirm

Consolidated Statements of Operations for each of thethree years in the period ended December 31, 2005

Consolidated Balance Sheets as of December 31,2005 and 2004

Consolidated Statements of Shareholders’ Equity foreach of the three years in the period ended December 31, 2005

Consolidated Statements of Cash Flows for each of thethree years in the period ended December 31, 2005

Notes to Consolidated Financial Statements (including:Quarterly Financial Information (Unaudited))

Management’s Report on Internal Control over FinancialReporting is contained as part of this report under Item 9A–“Controls andProcedures.”

2.                 FinancialStatement Schedules

Financial statement schedules have been omittedbecause they are not required, not applicable or the information is otherwiseincluded in the notes to the consolidated financial statements.

3.                 Exhibits

The exhibits listed on the accompanying Index toExhibits are filed or furnished as part of this report.

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**SUREWESTCOMMUNICATIONSINDEX TO EXHIBITS(Item 15 (a) 3)**
| Exhibit   No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **Method   of Filing**      |
|---------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|
| 3.1           |       | Articles of Incorporation of Registrant, together  with Certificate of Amendment of Articles of Incorporation dated January 25,  1996 and Certificate of Amendment of Articles of Incorporation dated  June 21, 1996 (Filed as Exhibit 3(a) to Form 10-Q  Quarterly Report for the quarter ended September 30, 1996)                                                                                                                                                                                                                                                                 |       | Incorporated by  reference  |
| 3.2           |       | Certificate of Amendment  of Articles of Incorporation dated May 18, 2001 (Filed as  Exhibit 3(b) to Form 10-Q Quarterly Report for the  quarter ended June 30, 2001)                                                                                                                                                                                                                                                                                                                                                                                                                     |       | Incorporated  by  reference |
| 3.3           |       | Bylaws of Registrant  (Filed as Exhibit 3(b) to Form 10-K Annual Report of the  Registrant for the year ended December 31, 2000)                                                                                                                                                                                                                                                                                                                                                                                                                                                               |       | Incorporated  by  reference |
| 4.1           |       | Shareholder Rights Plan  (Filed as Exhibit 2.1 to Form 8-A Registration Statement  under the Securities Act of 1934)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       | Incorporated  by  reference |
| 10.1          |       | Note Purchase Agreement  for Series A Senior Notes in the aggregate amount of $40,000,000 dated  December 9, 1998 (Filed as Exhibit 10(b) to Form 10-K  Annual Report of Registrant for the year ended December 31, 1998)                                                                                                                                                                                                                                                                                                                                                            |       | Incorporated  by  reference |
| 10.2          |       | Supplement to Note  Purchase Agreement for Series B Senior Notes in the aggregate amount of  $60,000,000 dated March 13, 2003 (Filed as Exhibit 99.1 to the  Form 8-K filed March 13, 2003)                                                                                                                                                                                                                                                                                                                                                                                               |       | Incorporated  by  reference |
| 10.3          |       | Business Loan Agreement  of Registrant with Bank of America, dated March 15, 2000, as amended by  Amendment No. 1 dated as of April 10, 2000 (Filed as  Exhibit 10(f) to Form 10-Q Quarterly Report of  Registrant for the quarter ended March 31, 2000), as amended by  Amendment No. 2 dated as of September 15, 2000, Amendment  No. 3 dated as of July 17, 2001, and Amendment No. 4 dated as  of June 26, 2000 (Filed as Exhibit 10(l) to Form 10-Q  Quarterly Report of Registrant for the Quarter ended June 30, 2002) |       | Incorporated  by  reference |
| 10.4          |       | Amendment No. 5 to  Business Loan Agreement dated February 26, 2003 (Filed as  Exhibit 10(e) to Form 10-K Annual Report of Registrant  for the year ended December 31, 2002)                                                                                                                                                                                                                                                                                                                                                                                                         |       | Incorporated  by  reference |
| 10.5          |       | Amendment No. 6 to  Business Loan Agreement dated as of January 13, 2004 (Filed as  Exhibit 10.6 to Form 10-K/A Annual Report of Registrant for  the year ended December 31, 2003)                                                                                                                                                                                                                                                                                                                                                                                                        |       | Incorporated  by  reference |
| 10.6          |       | Amendment No. 7 to  Business Loan Agreement dated as of March 25, 2004 (Filed as  Exhibit 10.7 to Form 10-K/A Annual Report of Registrant for  the year ended December 31, 2003)                                                                                                                                                                                                                                                                                                                                                                                                          |       | Incorporated  by  reference |

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| 10.7  |   | Amendment No. 8 to  Business Loan Agreement dated as of December 31, 2004                                                                                                                                                                                |   | Incorporated  by  reference |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|
| 10.8  |   | 1999 Restricted Stock  Bonus Plan (Filed as Exhibit 10(d) to Form 10-K Annual  Report of Registrant for the year ended December 31, 1998)                                                                                                      |   | Incorporated  by  reference |
| 10.9  |   | 2000 Equity Incentive  Plan, as amended (Filed as Exhibit 10.9 to Form 10-Q  Quarterly Report for the quarter ended June 30, 2005)                                                                                                                  |   | Incorporated  by  reference |
| 10.10 |   | SureWest KSOP (Filed as  Exhibit 4.1 to Registration Statement on Form S-8  [No. 333-87222])                                                                                                                                                        |   | Incorporated  by  reference |
| 10.11 |   | Letter agreement dated  January 16, 2001 between Registrant and Brian H. Strom (Filed as  Exhibit 10 (g) to Form 10-K Annual Report of Registrant  for the year ended December 31, 2000)                                                  |   | Incorporated  by  reference |
| 10.12 |   | Letter agreement dated  January 16, 2001 between Registrant and Jay B. Kinder (Filed as  Exhibit 10 (i) to Form 10-K Annual Report of Registrant  for the year ended December 31, 2000)                                                   |   | Incorporated  by  reference |
| 10.13 |   | Letter agreement dated  January 16, 2001 between Registrant and Bill M. DeMuth (Filed as  Exhibit 10.14 to Form 10-K/A Annual Report of Registrant for  the year ended December 31, 2003)                                                      |   | Incorporated  by  reference |
| 10.14 |   | Letter agreement dated  January 16, 2001 between Registrant and Fred A. Arcuri (Filed as  Exhibit 10.15 to Form 10-K/A Annual Report of Registrant for  the year ended December 31, 2003)                                                      |   | Incorporated  by  reference |
| 10.15 |   | Separation Agreement  dated October 6, 2005 between Registrant and Robert M. Burger (Filed as  Exhibit 99.1 to Form 8-K filed October 7, 2005)                                                                                                 |   | Incorporated  by  reference |
| 10.16 |   | Appointment of Robert D.  Kittredge to the Registrant’s Board of Directors dated November 29, 2005  (Filed as Exhibit 99.1 to Form 8-K filed November 29,  2005)                                                                          |   | Incorporated  by  reference |
| 10.17 |   | Restricted Stock Unit  Award, dated December 8, 2005, between Registrant and Robert D.  Kittredge and summary of Registrants executive and Board of Directors’  compensation (Filed as Item 1.01 to Form 8-K filed on  December 13, 2005) |   | Incorporated  by  reference |
| 10.18 |   | Steven C. Oldham  Employment Agreement dated December 15, 2005 (Filed as Exhibit 99.1  to Form 8-K filed December 16, 2005)                                                                                                                    |   | Incorporated  by  reference |
| 10.19 |   | Letter agreement dated  December 15, 2005 between Registrant and Steven C. Oldham (Filed as  Exhibit 99.5 to Form 8-K filed December 16, 2005)                                                                                                 |   | Incorporated  by  reference |
|       |        |                                                                                                                                                                                                                                                                    |        |                             |  |

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| 10.20 |   | Letter agreement dated  December 15, 2005 between Registrant and Brian H. Strom (Filed as  Exhibit 99.2 to Form 8-K filed December 16, 2005)                                                                                                                                           |   | Incorporated  by  reference |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|
| 10.21 |   | Letter agreement dated  December 15, 2005 between Registrant and Jay B. Kinder (Filed as  Exhibit 99.3 to Form 8-K filed December 16, 2005)                                                                                                                                            |   | Incorporated  by  reference |
| 10.22 |   | Release agreement dated  December 15, 2005 between Registrant and Fred A. Arcuri (Filed as  Exhibit 99.1 to Form 8-K filed December 21, 2005)                                                                                                                                          |   | Incorporated  by  reference |
| 10.23 |   | Letter agreement dated  October 4, 2004 between Registrant and Philip A. Grybas                                                                                                                                                                                                                       |   | Filed  herewith             |
| 10.24 |   | Summary of Board of  Directors’ Compensation (Filed as Exhibit 99.1 to Form 8-K  filed January 26, 2006)                                                                                                                                                                               |   | Incorporated  by  reference |
| 10.25 |   | Restricted Stock Unit  Award, dated December 21, 2004, between Registrant and Roger J. Valine  (Filed as Exhibit 10.15 to Form 10-K Annual Report of  Registrant for the year ended December 31, 2004)                                                                                 |   | Incorporated  by  reference |
| 10.26 |   | Form of Restricted  Stock Unit Award, dated December 21, 2004, between Registrant and each  of Guy R. Gibson, Steven C. Oldham, John R. Roberts III and Timothy D. Taron  (Filed as Exhibit 10.16 to Form 10-K Annual Report of  Registrant for the year ended December 31, 2004) |   | Incorporated  by  reference |
| 10.27 |   | Form of Restricted  Stock Unit Award, dated February 23, 2005, between Registrant and Brian  H. Strom (Filed as Exhibit 10.17 to Form 10-K Annual Report  of Registrant for the year ended December 31, 2004)                                                                     |   | Incorporated  by  reference |
| 10.28 |   | Form of Restricted  Stock Unit Award, dated January 26, 2005, between Registrant and Timothy  D. Taron and Roger J. Valine (Filed as Item 1.01 to Form 8-K filed  January 27, 2006)                                                                                                    |   | Incorporated  by  reference |
| 10.29 |   | Form of Restricted  Stock Unit Award, dated February 23, 2005, between Registrant and each  of Fred A. Arcuri, Bill M. DeMuth and Jay B. Kinder (Filed as  Exhibit 10.18 to Form 10-K Annual Report of Registrant for  the year ended December 31, 2004)                          |   | Incorporated  by  reference |
| 10.30 |   | Form of Restricted  Stock Unit Award for Registrant’s 2000 Equity Incentive Plan (Filed as  Exhibit 10.19 to Form 10-K Annual Report of Registrant for  the year ended December 31, 2004)                                                                                         |   | Incorporated  by  reference |
| 10.31 |   | Form of Stock  Option Agreement for Registrant’s 2000 Equity Incentive Plan (Filed as  Exhibit 10.20 to Form 10-K Annual Report of Registrant for  the year ended December 31, 2004)                                                                                              |   | Incorporated  by  reference |

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| 10.32 |   | Form of Restricted  Stock Agreement for Registrant’s 2000 Equity Incentive Plan (Filed as  Exhibit 10.21 to Form 10-K Annual Report of Registrant for  the year ended December 31, 2004) |   | Incorporated  by  reference |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|
| 21.1  |   | List of Subsidiaries                                                                                                                                                                                              |   | Filed  herewith             |
| 23.1  |   | Consent of Independent  Registered Public Accounting Firm                                                                                                                                                         |   | 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 Philip  A. Grybas, Senior Vice President and Chief Financial Officer, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                 |   | Filed  herewith             |
| 32.1  |   | Certification of 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 Philip  A. Grybas, Senior Vice President and Chief Financial Officer, pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002       |   | Filed  herewith             |

 

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto 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 |
| Date:   February 21, 2006    |   |   |

 
|                                | By:    | /s/ PHILIP A. GRYBAS                                                  |
|-------------------------------------|--------|-----------------------------------------------------------------------|
|                                |   | Philip A. Grybas,  Senior Vice President  and Chief Financial Officer |
| Date:   February 21, 2006 |   |                                                                  |

 

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.
|                                | /s/ KIRK C. DOYLE                                                     |
|-------------------------------------|-----------------------------------------------------------------------|
|                                | Kirk C. Doyle,  Chairman of the Board                                 |
|                                | /s/ STEVEN C. OLDHAM                                                  |
|                                | Steven C. Oldham,  President and Chief Executive  Officer, Director   |
|                                | /s/ PHILIP A. GRYBAS                                                  |
|                                | Philip A. Grybas,  Senior Vice President  and Chief Financial Officer |
|                                | /s/ GUY R. GIBSON                                                     |
|                                | Guy R. Gibson,  Director                                              |
|                                | /s/ ROBERT D. KITTREDGE                                               |
|                                | Robert D. Kittredge,  Director                                        |
|                                | /s/ JOHN R. ROBERTS III                                               |
|                                | John R. Roberts  III,  Director                                       |
|                                | /s/ TIMOTHY D. TARON                                                  |
|                                | Timothy D. Taron,  Director                                           |
|                                | /s/ ROGER J. VALINE                                                   |
|                                | Roger J. Valine,  Director                                            |
| Date:   February 21, 2006 |                                                                  |

 

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