##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2005oro
    
    TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
  SUREWEST COMMUNICATIONS
  California
    
    68-0365195(State or Other Jurisdiction
of Incorporation or Organization)
    
    (IRS Employer
Identification No.)200 Vernon Street, Roseville, California
    
    95678(Address of Principal Executive Offices)
    
    (Zip Code)
 (916) 786-6141
  x o
  x o




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TABLE OF CONTENTS  SUREWEST COMMUNICATIONS NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)EXHIBIT 10.9EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2    Table of Contents  TABLE OF CONTENTS
 PagePART I  FINANCIAL INFORMATIONItem 1. Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    37Item 4. Controls And Procedures
    
    
    38PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    41Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    42Item 3. Defaults Upon Senior Securities
    
    
    42Item 4. Submission of Matters to a Vote of Security Holders
    
    
    43Item 5. Other Information
    
    
    43Item 6. Exhibits
    
    
    44SIGNATURES
    
    
    47
 2




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##### Table of Contents



Quarter Ended June 30,
    
    
    Six Months Ended June 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Operating revenues:Local service
    
    $
    15,924
    
    
    $
    16,699
    
    
    $
    31,961
    
    
    $
    33,833Network access service
    
    
    11,801
    
    
    
    11,760
    
    
    
    22,434
    
    
    
    23,370Directory advertising
    
    
    4,341
    
    
    
    3,939
    
    
    
    8,636
    
    
    
    8,041Long distance service
    
    
    1,399
    
    
    
    1,336
    
    
    
    2,896
    
    
    
    2,553Wireless service
    
    
    8,543
    
    
    
    7,629
    
    
    
    16,932
    
    
    
    15,049Internet service
    
    
    4,381
    
    
    
    4,268
    
    
    
    8,693
    
    
    
    8,419Residential broadband service
    
    
    5,937
    
    
    
    4,084
    
    
    
    11,534
    
    
    
    7,637Business broadband service
    
    
    1,787
    
    
    
    1,362
    
    
    
    3,474
    
    
    
    2,632Other
    
    
    974
    
    
    
    1,038
    
    
    
    1,983
    
    
    
    2,169Total operating revenues
    
    
    55,087
    
    
    
    52,115
    
    
    
    108,543
    
    
    
    103,703Operating expenses:Cost of services and products
(exclusive of depreciation and
amortization)
    
    
    18,958
    
    
    
    18,027
    
    
    
    38,890
    
    
    
    36,638Customer operations and selling
    
    
    8,771
    
    
    
    8,470
    
    
    
    17,447
    
    
    
    17,108General and administrative
    
    
    9,075
    
    
    
    10,272
    
    
    
    18,641
    
    
    
    21,559Depreciation and amortization
    
    
    13,386
    
    
    
    11,575
    
    
    
    26,099
    
    
    
    22,869Total operating expenses
    
    
    50,190
    
    
    
    48,344
    
    
    
    101,077
    
    
    
    98,174Income from operations
    
    
    4,897
    
    
    
    3,771
    
    
    
    7,466
    
    
    
    5,529Other income (expense):Interest income
    
    
    92
    
    
    
    44
    
    
    
    139
    
    
    
    103Interest expense
    
    
    (1,422
    )
    
    
    (1,073
    )
    
    
    (2,624
    )
    
    
    (2,158
    )Other, net
    
    
    (47
    )
    
    
    (87
    )
    
    
    (79
    )
    
    
    (158
    )Total other expense, net
    
    
    (1,377
    )
    
    
    (1,116
    )
    
    
    (2,564
    )
    
    
    (2,213
    )Income before income taxes
    
    
    3,520
    
    
    
    2,655
    
    
    
    4,902
    
    
    
    3,316Income taxes
    
    
    1,373
    
    
    
    1,094
    
    
    
    1,912
    
    
    
    1,374Net income
    
    $
    2,147
    
    
    $
    1,561
    
    
    $
    2,990
    
    
    $
    1,942Earnings per share:Basic
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.21
    
    
    $
    0.13Diluted
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.20
    
    
    $
    0.13Cash dividends per share
    
    $
    0.25
    
    
    $
    0.25
    
    
    $
    0.50
    
    
    $
    0.50Shares of common stock used to
calculate earnings per share:Basic
    
    
    14,543
    
    
    
    14,530
    
    
    
    14,543
    
    
    
    14,530Diluted
    
    
    14,643
    
    
    
    14,576
    
    
    
    14,611
    
    
    
    14,573
  3




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June 30,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    7,795
    
    
    $
    18,119Accounts receivable, net
    
    
    21,837
    
    
    
    20,155Inventories
    
    
    5,990
    
    
    
    5,578Deferred directory costs
    
    
    4,500
    
    
    
    5,599Prepaid expenses
    
    
    4,983
    
    
    
    2,359Total current assets
    
    
    45,105
    
    
    
    51,810Property, plant and equipment, net
    
    
    376,065
    
    
    
    365,613Intangible and other assets:Wireless spectrum licenses, net
    
    
    13,566
    
    
    
    13,566Goodwill
    
    
    2,171
    
    
    
    2,171Intangible asset relating to pension plans
    
    
    802
    
    
    
    802Intangible asset relating to favorable operating leases, net
    
    
    436
    
    
    
    506Deferred charges and other assets
    
    
    718
    
    
    
    71417,693
    
    
    
    17,759$
    438,863
    
    
    $
    435,182LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Short-term borrowings
    
    $
    20,000
    
    
    $
    10,000Current portion of long-term debt
    
    
    3,707
    
    
    
    3,779Current portion of capital lease obligations
    
    
    74
    
    
    
    212Accounts payable
    
    
    3,545
    
    
    
    2,886Other accrued liabilities
    
    
    15,565
    
    
    
    22,038Current portion of contractual shareable earnings obligations
    
    
    2,886
    
    
    
    3,040Estimated shareable earnings obligations
    
    
    418
    
    
    
    396Advance billings and deferred revenues
    
    
    10,229
    
    
    
    9,883Accrued income taxes
    
    
    1,971
    
    
    
    1,549Accrued pension benefits
    
    
    4,402
    
    
    
    3,216Accrued compensation
    
    
    6,308
    
    
    
    5,830Total current liabilities
    
    
    69,105
    
    
    
    62,829Long-term debt
    
    
    89,091
    
    
    
    89,091Long-term capital lease obligations
    
    
    28
    
    
    
    52Long-term contractual shareable earnings obligations
    
    
    5,074
    
    
    
    6,202Deferred income taxes
    
    
    25,439
    
    
    
    24,134Other liabilities and deferred revenues
    
    
    12,377
    
    
    
    11,537Commitments and contingenciesShareholders equity:Common stock, without par value; 100,000 shares authorized,
14,590 and 14,591 shares issued and outstanding at
June 30, 2005 and December 31, 2004, respectively
    
    
    163,223
    
    
    
    161,824Deferred stock-based compensation
    
    
    (1,632
    )
    
    
    (949
    )Accumulated other comprehensive loss
    
    
    (2,126
    )
    
    
    (2,126
    )Retained earnings
    
    
    78,284
    
    
    
    82,588Total shareholders equity
    
    
    237,749
    
    
    
    241,337$
    438,863
    
    
    $
    435,182
  4




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Six Months EndedJune 30,2005
    
    
    2004Net cash provided by operating activities
    
    $
    24,082
    
    
    $
    21,442Cash flows from investing activities:Capital expenditures for property, plant and
equipment, including network parts inventory
    
    
    (36,874
    )
    
    
    (33,968
    )Changes in deferred charges and other assets
    
    
    
    
    
    
    (11
    )Purchase of held-to-maturity investments
    
    
    
    
    
    
    (4,276
    )Net cash used in investing activities
    
    
    (36,874
    )
    
    
    (38,255
    )Cash flows from financing activities:Increase in short-term borrowings
    
    
    10,000
    
    
    
    Principal payments of long-term debt and
capital lease obligations
    
    
    (237
    )
    
    
    (242
    )Dividends paid
    
    
    (7,295
    )
    
    
    (7,288
    )Other
    
    
    
    
    
    
    10Net cash provided by (used in) financing activities
    
    
    2,468
    
    
    
    (7,520
    )Net decrease in cash and cash equivalents
    
    
    (10,324
    )
    
    
    (24,333
    )Cash and cash equivalents at beginning of period
    
    
    18,119
    
    
    
    39,008Cash and cash equivalents at end of period
    
    $
    7,795
    
    
    $
    14,675
  5




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except share and per share amounts)
 1.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
   Stock-based Compensation
 Accounting for Stock-Based Compensation Accounting for Stock-Based Compensation -
Transition and Disclosure
    6




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 1.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 Quarter Ended June 30,
    
    
    Six Months Ended June 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income, as reported
    
    $
    2,147
    
    
    $
    1,561
    
    
    $
    2,990
    
    
    $
    1,942Add: Stock-based
employee compensation
expense included in
reported net income,
net of related tax
effects
    
    
    261
    
    
    
    112
    
    
    
    440
    
    
    
    275Deduct: Total
stock-based employee
compensation expense
determined using the
fair value method for
all awards, net of
related tax effects
    
    
    (270
    )
    
    
    (119
    )
    
    
    (470
    )
    
    
    (393
    )Pro forma net income
    
    $
    2,138
    
    
    $
    1,554
    
    
    $
    2,960
    
    
    $
    1,824Earnings per share:Basicas reported
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.21
    
    
    $
    0.13Basicpro forma
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.20
    
    
    $
    0.13Dilutedas reported
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.20
    
    
    $
    0.13Dilutedpro forma
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.20
    
    
    $
    0.13
   Per Share Amounts
   7




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 1.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 Other Comprehensive Income (Loss)
   Impairment of Long-Lived Assets
  Adjustments and Reclassifications
   2.      BUSINESS SEGMENTS
  8




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 2.      BUSINESS SEGMENTS (CONTINUED)
   Disclosure About Segments of an Enterprise and
Related Information
   Corporate
    
    
    IntercompanyTelecom
    
    
    Broadband
    
    
    Wireless
    
    
    Operations
    
    
    Eliminations
    
    
    ConsolidatedFor the three months
ended June 30, 2005:Operating revenues
from external
customers
    
    $
    34,439
    
    
    $
    12,105
    
    
    $
    8,543
    
    
    $
    
    
    
    $
    
    
    
    $
    55,087Intersegment revenues
    
    
    7,108
    
    
    
    399
    
    
    
    643
    
    
    
    
    
    
    
    (8,150
    )
    
    
    Operating expenses*
    
    
    20,955
    
    
    
    14,420
    
    
    
    9,579
    
    
    
    
    
    
    
    (8,150
    )
    
    
    36,804Depreciation and
amortization
    
    
    6,363
    
    
    
    3,997
    
    
    
    3,026
    
    
    
    
    
    
    
    
    
    
    
    13,386Income (loss) from
operations
    
    
    14,229
    
    
    
    (5,913
    )
    
    
    (3,419
    )
    
    
    
    
    
    
    
    
    
    
    4,897Net income (loss)
    
    $
    8,306
    
    
    $
    (3,882
    )
    
    $
    (2,277
    )
    
    $
    
    
    
    $
    
    
    
    $
    2,147For the three months
ended June 30, 2004:Operating revenues
from external
customers
    
    $
    34,772
    
    
    $
    9,714
    
    
    $
    7,629
    
    
    $
    
    
    
    $
    
    
    
    $
    52,115Intersegment revenues
    
    
    6,489
    
    
    
    435
    
    
    
    378
    
    
    
    
    
    
    
    (7,302
    )
    
    
    Operating expenses*
    
    
    20,320
    
    
    
    14,594
    
    
    
    9,157
    
    
    
    
    
    
    
    (7,302
    )
    
    
    36,769Depreciation and
amortization
    
    
    6,348
    
    
    
    2,271
    
    
    
    2,956
    
    
    
    
    
    
    
    
    
    
    
    11,575Income (loss) from
operations
    
    
    14,593
    
    
    
    (6,716
    )
    
    
    (4,106
    )
    
    
    
    
    
    
    
    
    
    
    3,771Net Income (loss)
    
    $
    8,567
    
    
    $
    (4,318
    )
    
    $
    (2,688
    )
    
    $
    
    
    
    $
    
    
    
    $
    1,561
 9




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 2.      BUSINESS SEGMENTS (CONTINUED)
 Corporate
    
    
    IntercompanyTelecom
    
    
    Broadband
    
    
    Wireless
    
    
    Operations
    
    
    Eliminations
    
    
    ConsolidatedAs of and for the
six months ended
June 30, 2005:Operating revenues
from external
customers
    
    $
    67,910
    
    
    $
    23,701
    
    
    $
    16,932
    
    
    $
    
    
    
    

$          
    
    
    
    $108,543Intersegment revenues
    
    
    13,984
    
    
    
    841
    
    
    
    1,241
    
    
    
    
    
    
    
    (16,066
    )
    
    
    Operating expenses*
    
    
    43,225
    
    
    
    29,150
    
    
    
    18,669
    
    
    
    
    
    
    
    (16,066
    )
    
    
    74,978Depreciation and
amortization
    
    
    12,358
    
    
    
    7,631
    
    
    
    6,110
    
    
    
    
    
    
    
    
    
    
    
    26,099Income (loss) from
operations
    
    
    26,311
    
    
    
    (12,239
    )
    
    
    (6,606
    )
    
    
    
    
    
    
    
    
    
    
    7,466Net Income (loss)
    
    
    15,379
    
    
    
    (7,983
    )
    
    
    (4,406
    )
    
    
    
    
    
    
    
    
    
    
    2,990Total assets
    
    $
    641,707
    
    
    $
    237,443
    
    
    $
    136,959
    
    
    $
    242,951
    
    
    
    $(820,197
    )
    
    
    $438,863As of and for the
six months ended
June 30, 2004:Operating revenues
from external
customers
    
    $
    69,966
    
    
    $
    18,688
    
    
    $
    15,049
    
    
    $
    
    
    
    
    $          
    
    
    
    $103,703Intersegment revenues
    
    
    12,704
    
    
    
    888
    
    
    
    689
    
    
    
    
    
    
    
    (14,281
    )
    
    
    Operating expenses*
    
    
    43,137
    
    
    
    28,528
    
    
    
    17,921
    
    
    
    
    
    
    
    (14,281
    )
    
    
    75,305Depreciation and
amortization
    
    
    12,527
    
    
    
    4,289
    
    
    
    6,053
    
    
    
    
    
    
    
    
    
    
    
    22,869Income (loss) from
operations
    
    
    27,006
    
    
    
    (13,241
    )
    
    
    (8,236
    )
    
    
    
    
    
    
    
    
    
    
    5,529Net income (loss)
    
    
    15,838
    
    
    
    (8,509
    )
    
    
    (5,387
    )
    
    
    
    
    
    
    
    
    
    
    1,942Total assets
    
    $
    590,743
    
    
    $
    168,810
    
    
    $
    135,240
    
    
    $
    139,485
    
    
    
    $(605,301
    )
    
    
    $428,977
 * Exclusive of depreciation and amortization 3.      ESTIMATED SHAREABLE EARNINGS OBLIGATIONS
    10




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 3.      ESTIMATED SHAREABLE EARNINGS OBLIGATIONS (CONTINUED)
     11




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 3.      ESTIMATED SHAREABLE EARNINGS OBLIGATIONS (CONTINUED)
      12




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 4.      PENSION AND OTHER POST-RETIREMENT BENEFITS
 Components of Net Periodic Benefit Cost
  Pension Plan and SERP
    
    
    Other Benefits2005
    
    
    2004
    
    
    2005
    
    
    2004Quarter
ended June 30,Service cost-benefits earned
during the period
    
    $
    1,407
    
    
    $
    1,340
    
    
    $
    118
    
    
    $
    95Interest cost on projected
benefit obligation
    
    
    1,866
    
    
    
    1,773
    
    
    
    88
    
    
    
    71Expected return on plan assets
    
    
    (2,183
    )
    
    
    (2,009
    )
    
    
    (38
    )
    
    
    (31
    )Amortization of prior service cost
    
    
    86
    
    
    
    87
    
    
    
    10
    
    
    
    9Recognized net actuarial loss
    
    
    176
    
    
    
    120
    
    
    
    
    
    
    
    Expected disbursement for life
insurance premiums
    
    
    
    
    
    
    
    
    
    
    (19
    )
    
    
    (15
    )Net pension cost
    
    $
    1,352
    
    
    $
    1,311
    
    
    $
    159
    
    
    $
    129Six
months ended June 30,Service cost-benefits earned
during the period
    
    $
    2,814
    
    
    $
    2,680
    
    
    $
    235
    
    
    $
    190Interest cost on projected
benefit obligation
    
    
    3,732
    
    
    
    3,547
    
    
    
    176
    
    
    
    142Expected return on plan assets
    
    
    (4,366
    )
    
    
    (4,017
    )
    
    
    (76
    )
    
    
    (62
    )Amortization of prior service cost
    
    
    172
    
    
    
    173
    
    
    
    21
    
    
    
    18Recognized net actuarial loss
    
    
    352
    
    
    
    240
    
    
    
    
    
    
    
    Expected disbursement for life
insurance premiums
    
    
    
    
    
    
    
    
    
    
    (38
    )
    
    
    (30
    )Special termination benefits
    
    
    51
    
    
    
    
    
    
    
    740
    
    
    
    Net pension cost
    
    $
    2,755
    
    
    $
    2,623
    
    
    $
    1,058
    
    
    $
    258
  Employer Contributions
  13




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 5.      RECENT ACCOUNTING PRONOUNCEMENTS
 Accounting
Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3.
 Share-Based Payment . Accounting for Stock Issued to Employees, Statement
of Cash Flows.
   1.
    
    A modified prospective method in which compensation cost is recognized beginning with
the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based
payments granted after the effective date and (b) based on the requirements of SFAS No. 123
for all awards granted to employees prior to the effective date of SFAS No. 123(R) that
remain unvested on the effective date.2.
    
    A modified retrospective method, which includes the requirements of the modified
prospective method described above, but also permits entities to restate their financial
statements based on the amounts previously recognized under SFAS No. 123 for purposes of
pro forma disclosures either for (a) all prior periods presented or (b) prior interim
periods of the year of adoption.
  Accounting for Conditional Asset
Retirement Obligations Accounting for Asset Retirement Obligations
 14




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SUREWEST COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)
 6.      COMMITMENTS AND CONTINGENCIES
    15




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##### Table of Contents



PART I
 
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 (Amounts in thousands, except selected operating metrics and per share amounts)
   Corporate Structure
      16




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##### Table of Contents



Results of Operations
 Consolidated Overview
  Financial Data
 Quarter Ended June 30,
    
    
    Six Months Ended June 30,$
    
    
    %
    
    
    
    
    
    
    
    
    
    
    $
    
    
    %2005
    
    
    2004
    
    
    Change
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    ChangeOperating revenues(1)Telecom
    
    $
    34,439
    
    
    $
    34,772
    
    
    $
    (333
    )
    
    
    (1
    )%
    
    $
    67,910
    
    
    $
    69,966
    
    
    $
    (2,056
    )
    
    
    (3
    )%Broadband
    
    
    12,105
    
    
    
    9,714
    
    
    
    2,391
    
    
    
    25
    
    
    
    23,701
    
    
    
    18,688
    
    
    
    5,013
    
    
    
    27Wireless
    
    
    8,543
    
    
    
    7,629
    
    
    
    914
    
    
    
    12
    
    
    
    16,932
    
    
    
    15,049
    
    
    
    1,883
    
    
    
    13Total operating revenues
    
    
    55,087
    
    
    
    52,115
    
    
    
    2,972
    
    
    
    6
    
    
    
    108,543
    
    
    
    103,703
    
    
    
    4,840
    
    
    
    5Operating income (loss)Telecom
    
    
    14,229
    
    
    
    14,593
    
    
    
    (364
    )
    
    
    (2
    )
    
    
    26,311
    
    
    
    27,006
    
    
    
    (695
    )
    
    
    (3
    )Broadband
    
    
    (5,913
    )
    
    
    (6,716
    )
    
    
    803
    
    
    
    12
    
    
    
    (12,239
    )
    
    
    (13,241
    )
    
    
    1,002
    
    
    
    8Wireless
    
    
    (3,419
    )
    
    
    (4,106
    )
    
    
    687
    
    
    
    17
    
    
    
    (6,606
    )
    
    
    (8,236
    )
    
    
    1,630
    
    
    
    20Total operating income
    
    
    4,897
    
    
    
    3,771
    
    
    
    1,126
    
    
    
    30
    
    
    
    7,466
    
    
    
    5,529
    
    
    
    1,937
    
    
    
    35Net income (loss)Telecom
    
    
    8,306
    
    
    
    8,567
    
    
    
    (261
    )
    
    
    (3
    )
    
    
    15,379
    
    
    
    15,838
    
    
    
    (459
    )
    
    
    (3
    )Broadband
    
    
    (3,882
    )
    
    
    (4,318
    )
    
    
    436
    
    
    
    10
    
    
    
    (7,983
    )
    
    
    (8,509
    )
    
    
    526
    
    
    
    6Wireless
    
    
    (2,277
    )
    
    
    (2,688
    )
    
    
    411
    
    
    
    15
    
    
    
    (4,406
    )
    
    
    (5,387
    )
    
    
    981
    
    
    
    18Total net income
    
    $
    2,147
    
    
    $
    1,561
    
    
    $
    586
    
    
    
    38
    %
    
    $
    2,990
    
    
    $
    1,942
    
    
    $
    1,048
    
    
    
    54
    %
 (1)
    
    External customers only
 Selected Operating Metrics
 As of June 30,2005
    
    
    2004
    
    
    Change
    
    
    % ChangeTelecomILEC access lines
    
    
    130,202
    
    
    
    134,274
    
    
    
    (4,072
    )
    
    
    (3
    )%Long distance lines
    
    
    50,094
    
    
    
    44,682
    
    
    
    5,412
    
    
    
    12BroadbandDSL subscribers (1)
    
    
    23,861
    
    
    
    20,885
    
    
    
    2,976
    
    
    
    14FTTP subscribers (2)
    
    
    18,057
    
    
    
    13,714
    
    
    
    4,343
    
    
    
    32FTTP
Revenue-generating
units (3)
    
    
    42,255
    
    
    
    32,101
    
    
    
    10,154
    
    
    
    32WirelessSubscribers
    
    
    53,361
    
    
    
    48,531
    
    
    
    4,830
    
    
    
    10
    %
 (1)
    
    DSL subscribers are customers who receive data services within SureWest Telephones
service area.
 (2)
    
    FTTP subscribers are customers who receive digital video, voice and/or data services
from broadband residential services.
 (3)
    
    The Broadband segment can deliver multiple services to a customer. Accordingly, the
Company maintains statistical data regarding Revenue-generating units for digital video,
voice and data, in addition to the number of customers. For example, a single customer who
purchases digital video, voice and data services would be reflected as three
Revenue-generating units.
 17




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ä
    ä
  18




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Adjustments and Reclassification
  Segment Results of Operations
 Telecom
 Quarter Ended June 30,
    
    
    Six Months Ended June 30,$
    
    
    %
    
    
    
    
    
    
    
    
    
    
    $
    
    
    %2005
    
    
    2004
    
    
    Change
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    ChangeLocal service
    
    $
    15,924
    
    
    $
    16,699
    
    
    $
    (775
    )
    
    
    (5
    )%
    
    $
    31,961
    
    
    $
    33,833
    
    
    $
    (1,872
    )
    
    
    (6
    )%Network access service
    
    
    11,801
    
    
    
    11,760
    
    
    
    41
    
    
    
    
    
    
    
    22,434
    
    
    
    23,370
    
    
    
    (936
    )
    
    
    (4
    )Directory advertising
    
    
    4,341
    
    
    
    3,939
    
    
    
    402
    
    
    
    10
    
    
    
    8,636
    
    
    
    8,041
    
    
    
    595
    
    
    
    7Long distance service
    
    
    1,399
    
    
    
    1,336
    
    
    
    63
    
    
    
    5
    
    
    
    2,896
    
    
    
    2,553
    
    
    
    343
    
    
    
    13Other
    
    
    974
    
    
    
    1,038
    
    
    
    (64
    )
    
    
    (6
    )
    
    
    1,983
    
    
    
    2,169
    
    
    
    (186
    )
    
    
    (9
    )Total operating
revenues from
external customers
    
    
    34,439
    
    
    
    34,772
    
    
    
    (333
    )
    
    
    (1
    )
    
    
    67,910
    
    
    
    69,966
    
    
    
    (2,056
    )
    
    
    (3
    )Intersegment revenues
    
    
    7,108
    
    
    
    6,489
    
    
    
    619
    
    
    
    10
    
    
    
    13,984
    
    
    
    12,704
    
    
    
    1,280
    
    
    
    10Operating expenses*
    
    
    20,955
    
    
    
    20,320
    
    
    
    635
    
    
    
    3
    
    
    
    43,225
    
    
    
    43,137
    
    
    
    88
    
    
    
    Depreciation and
amortization
    
    
    6,363
    
    
    
    6,348
    
    
    
    15
    
    
    
    
    
    
    
    12,358
    
    
    
    12,527
    
    
    
    (169
    )
    
    
    (1
    )Operating income
    
    
    14,229
    
    
    
    14,593
    
    
    
    (364
    )
    
    
    (2
    )
    
    
    26,311
    
    
    
    27,006
    
    
    
    (695
    )
    
    
    (3
    )Net income
    
    $
    8,306
    
    
    $
    8,567
    
    
    $
    (261
    )
    
    
    (3
    )%
    
    $
    15,379
    
    
    $

    15,838
    
    
    $
    (459
    )
    
    
    (3
    )%
 *
    
    Exclusive of depreciation and amortization
 19




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Operating Revenues
  Regulatory Matters
 ä
 Operating Expenses
 Consolidated Overview ä
   the Consolidated Overview
  20




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Regulatory Matters
  
    
    business and residential subscribers, for basic exchange services;
    
    surcharges, mandated by the California Public Utilities Commission (CPUC);
    
    long distance carriers, for network access service;
    
    competitive access providers and subscribers, for network access services;
    
    interstate pool settlements, from the National Exchange Carrier Association (NECA);
    
    support payments from the Universal Service Fund; and
    
    support payments from the California High Cost Fund (CHCF),
recovering costs of services including extended area service.
    21




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22




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Broadband
 Quarter Ended June 30,
    
    
    Six Months Ended June 30,$
    
    
    %
    
    
    
    
    
    
    
    
    
    
    $
    
    
    %2005
    
    
    2004
    
    
    Change
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    ChangeInternet service
    
    $
    4,381
    
    
    $
    4,268
    
    
    $
    113
    
    
    
    3
    %
    
    $
    8,693
    
    
    $
    8,419
    
    
    $
    274
    
    
    
    3
    %Residential Broadband
service
    
    
    5,937
    
    
    
    4,084
    
    
    
    1,853
    
    
    
    45
    
    
    
    11,534
    
    
    
    7,637
    
    
    
    3,897
    
    
    
    51Business Broadband service
    
    
    1,787
    
    
    
    1,362
    
    
    
    425
    
    
    
    31
    
    
    
    3,474
    
    
    
    2,632
    
    
    
    842
    
    
    
    32Total operating revenues
from external customers
    
    
    12,105
    
    
    
    9,714
    
    
    
    2,391
    
    
    
    25
    
    
    
    23,701
    
    
    
    18,688
    
    
    
    5,013
    
    
    
    27Intersegment revenues
    
    
    399
    
    
    
    435
    
    
    
    (36
    )
    
    
    (8
    )
    
    
    841
    
    
    
    888
    
    
    
    (47
    )
    
    
    (5
    )Operating expenses*
    
    
    14,420
    
    
    
    14,594
    
    
    
    (174
    )
    
    
    (1
    )
    
    
    29,150
    
    
    
    28,528
    
    
    
    622
    
    
    
    2Depreciation and
amortization
    
    
    3,997
    
    
    
    2,271
    
    
    
    1,726
    
    
    
    76
    
    
    
    7,631
    
    
    
    4,289
    
    
    
    3,342
    
    
    
    78Operating loss
    
    
    (5,913
    )
    
    
    (6,716
    )
    
    
    803
    
    
    
    12
    
    
    
    (12,239
    )
    
    
    (13,241
    )
    
    
    1,002
    
    
    
    8Net loss
    
    $
    (3,882
    )
    
    $
    (4,318
    )
    
    $
    436
    
    
    
    10
    %
    
    $
    (7,983
    )
    
    $
    (8,509
    )
    
    $
    526
    
    
    
    6
 *
    
    Exclusive of depreciation and amortization
 Operating Revenues
  Operating Expenses
 Consolidated Overview
 23




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##### Table of Contents



Wireless
 Quarter Ended June 30,
    
    
    Six Months Ended June 30,$
    
    
    %
    
    
    
    
    
    
    
    
    
    
    $
    
    
    %2005
    
    
    2004
    
    
    Change
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    ChangeWireless revenues from
external customers
    
    $
    8,543
    
    
    $
    7,629
    
    
    $
    914
    
    
    
    12
    %
    
    $
    16,932
    
    
    $
    15,049
    
    
    $
    1,883
    
    
    
    13
    %Intersegment revenues
    
    
    643
    
    
    
    378
    
    
    
    265
    
    
    
    70
    
    
    
    1,241
    
    
    
    689
    
    
    
    552
    
    
    
    80Operating expenses*
    
    
    9,579
    
    
    
    9,157
    
    
    
    422
    
    
    
    5
    
    
    
    18,669
    
    
    
    17,921
    
    
    
    748
    
    
    
    4Depreciation and amortization
    
    
    3,026
    
    
    
    2,956
    
    
    
    70
    
    
    
    2
    
    
    
    6,110
    
    
    
    6,053
    
    
    
    57
    
    
    
    1Operating loss
    
    
    (3,419
    )
    
    
    (4,106
    )
    
    
    687
    
    
    
    17
    
    
    
    (6,606
    )
    
    
    (8,236
    )
    
    
    1,630
    
    
    
    20Net loss
    
    $
    (2,277
    )
    
    $
    (2,688
    )
    
    $
    411
    
    
    
    15
    %
    
    $
    (4,406
    )
    
    $
    (5,387
    )
    
    $
    981
    
    
    
    18
    %
 *
    
    Exclusive of depreciation and amortization
 Operating Revenues
  Operating Expenses
  24




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##### Table of Contents



Non-operating Items
 Other Income and Expense, Net
  Income Taxes
  Liquidity and Capital Resources
       25




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Regulatory Matters
     Critical Accounting Policies and Estimates
  
    
    In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill
and Other Intangible Assets,goodwill and wireless spectrum licenses are reviewed for
impairment annually, or more frequently if an event occurs or circumstances change that would
reduce the fair value below its carrying value. The impairment test for goodwill requires the
Company to estimate the fair value at the reporting unit level. To determine the fair value in
2004, the Company obtained an independent valuation of the Companys goodwill using a
discounted cash flow model. Assumptions used in this model include the following:
 
    
    cash flow assumptions regarding investment in network facilities, distribution channels
and customer base (the assumptions underlying these inputs are based upon a combination of
historical results and trends, new industry developments and the Companys business plans);
 26




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
    
    an 11% weighted average cost of capital based on industry weighted averaged cost of capital; and
    
    no terminal growth rate.The use of different estimates or assumptions within the discounted cash flow model when
determining fair value of the Companys goodwill could result in a different fair value. For
example, the Company used a discount rate of 11% and no terminal growth rate in its assessment
of fair value in 2004. If the discount rate were to increase two percent, the fair value of the
goodwill would decrease by $49,400, but would not result in an
impairment of goodwill.The Companys wireless spectrum licenses include Personal Communications Services (PCS) and
Local Multipoint Distribution Service (LMDS) licenses. In assessing the recoverability of the
Companys PCS licenses, the Company obtained an independent valuation in 2004, which reviewed
transactions involving sales of comparable wireless spectrum licenses in the aftermarket, using
characteristics of the license and the related market, including geographic location, market
size, megahertz frequency and population density.In assessing the recoverability of the Companys LMDS licenses, in 2004 the Company obtained an
independent valuation, as comparable license sales data was not available. The independent
valuation estimates fair value of the Companys LMDS licenses using a discounted cash flow
model. Assumptions used in this model include the following:
    
    cash flow assumptions regarding investment in network facilities, distribution channels
and customer base (the assumptions underlying these inputs are based upon a combination of
historical results and trends, new industry developments and the Companys business plans);
    
    a 20% weighted average cost of capital based on industry weighted averaged cost of
capital adjusted to reflect the inherent risks associated with the introduction of a new
service offering; and
    
    a 3% terminal value growth rate.The use of different estimates or assumptions within the discounted cash flow model when
determining fair value of the Companys LMDS licenses could result in different values for these
licenses. For example, the Company used a discount rate of 20% and a terminal growth rate of 3%
in its assessment of fair value in 2004. If the discount rate were to increase 1%, the fair
value of the LMDS licenses would decrease by $600, which would result in an impairment charge of
approximately $140 based on the carrying value of the LMDS licenses as of December 31, 2004. In
addition, the Companys LMDS licenses may be impaired in the near future if the estimates and
assumptions used in the 2004 LMDS license discounted cash flow model are not met.If the estimated fair value is less than the carrying value, then the carrying value is written
down to the fair value. As a result of the Companys annual test in 2004, no impairment of
either goodwill or PCS or LMDS licenses was indicated. Further, during the quarter ended June
30, 2005, the Company was unaware of any events or changes in circumstance that would require a
test of impairment that may potentially reduce the fair value below the carrying value.
    
    Total revenues from telephone services are affected by rates authorized by
various regulatory agencies. The FCC monitors SureWest Telephones interstate earnings through
the use of annual cost separation studies prepared by SureWest Telephone. The FCC establishes
rules that carriers must follow in the preparation of the annual studies. Based on these
rules, the Company is required to prospectively set its annual interstate rates based on the
aforementioned cost separation studies. These cost studies include estimates and assumptions
regarding various financial data including operating expenses, taxes and investment in
property, plant and equipment. Non-financial data estimates are also utilized in the
preparation of these cost studies, including projected demand usage and detailed network
information. The Company must also make estimates of the jurisdictional separation of this
data to assign current financial and operating data to the interstate or intrastate
jurisdiction. These estimates are finalized in future periods as actual data becomes available
to complete the separation studies. Additionally, certain FCC rules regarding interstate
shareable earnings obligations have not yet been clarified as to whether the Companys rate
filings are deemed lawful and, therefore, protected from over-earnings liability. Further, the
Companys separation studies include estimates and assumptions regarding
 27




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issues before the FCC involving intercarrier interconnection, Internet traffic, and traffic
utilizing Internet Protocol. The Company also participates in the NECA pool for certain
interstate revenues. In addition to the estimates noted above, the Companys earned
rate-of-return from its participation in the NECA pool can also be impacted by the earnings and
data of other carriers who participate in the pool.In accordance with the NRF, SureWest Telephone is subject to ongoing monitoring and reporting
requirements by the CPUC, and it was initially required to share earnings with customers based
on its earned annual rate-of-return. The Company utilizes models, which rely on estimates
regarding the jurisdictional separation of financial data and operational data into the
interstate jurisdictions as discussed previously for the purposes of calculating its earned
annual rate-of-return. However, SureWest Telephone has entered into a settlement agreement,
which was approved by the CPUC in November 2004, to cease intrastate sharing requirements
beginning January 1, 2005 through at least December 31, 2010. The settlement agreement also
resolves existing intrastate sharing obligations and related earnings issues for the monitoring
periods 2000-2004.In addition, the Company must make estimates and assumptions regarding various issues before the
FCC and CPUC involving intercarrier interconnection, Internet traffic, traffic utilizing
Internet Protocol, methods used to allocate costs for services provided by SureWest
Communications and SureWest Telephone to its affiliates and the treatment of certain plant and
tax costs, including internal-use software costs.As a result of these estimates and assumptions, it is reasonably possible that managements
estimates of SureWest Telephones interstate shareable earnings obligations could change in the
near term, and the amounts involved could be material. For example, the CPUC approved a
settlement agreement on November 19, 2004 that resolved the Companys intrastate shareable
earnings for the years 2000 through 2004. In accordance with this settlement agreement, the
Company recorded $2,948 in local revenues due to a change in accounting estimate in the fourth
quarter of 2004 (for a more detailed discussion regarding the settlement agreement, see
Regulation and Contractual and Estimated Shareable Earnings Obligationswithin Note 3 to the
Companys condensed consolidated financial statements). This increase in revenue resulted in a
decrease of the Companys net loss by $2,046 ($0.14 per share). In addition, in 2002 the Company
made changes in its estimates for interstate shareable earnings obligations for approximately
$5,800, principally due to the D.C. Circuit Court of Appeals decision issued in May 2002, which
determined that a tariff filed properly under Section 204 streamlined procedures and allowed
to go into effect without suspension is deemed lawful. Therefore, the carrier is not
subsequently obligated to pay refunds for earnings higher than the permitted rate of return as
prescribed by the FCC for that monitoring period.
    
    The Company recognizes revenue when (i) persuasive
evidence of an arrangement between the Company and
the customer exists, (ii) delivery of the product to
the customer has occurred or service has been
provided to the customer, (iii) the price to the
customer is fixed or determinable and (iv)
collectibility of the sales price is reasonably
assured.
    
    The Company maintains allowances for doubtful
accounts for estimated losses resulting from the
potential inability of its customers to make required
payments. In evaluating the collectibility of its
accounts receivable, the Company assesses a number of
factors including a specific customers or carriers
ability to meet its financial obligations to the
Company, the length of time the receivable has been
past due and historical and future expectations of
conditions that may impact the Companys ability to
collect its accounts receivable. If circumstances
change or economic conditions worsen such that the
Companys past collection experience is no longer
relevant, the Companys estimate of the
recoverability of its accounts receivable could be
further reduced from the levels reflected in the
Companys condensed consolidated balance sheet. If
uncollectibility of the Companys billed revenue
changes by 1%, the Company would expect an increase
in uncollectible expense of approximately $2,200. As
of June 30, 2005, the Company had three customers
that in the aggregate accounted for 3% of
consolidated accounts receivable. Although
management believes that these customers are
creditworthy, a severe adverse impact on their
business operations could have a corresponding
material effect on their ability to pay timely and,
therefore, on the Companys results of operations,
cash flows and financial condition. In addition,
certain revenues are subject to refund if the
customer terminates services or returns equipment
within a stipulated time period, or if certain
performance criteria are not met. Accordingly, the
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Company maintains accounts receivable allowances and recognizes certain
customer refund liabilities, through charges to revenues, based on the
Companys best estimates of the resolution of these contingencies, which are
based on historical experience.
    
    The Company states its inventories held for sale at
lower of cost or market. In assessing the ultimate
recoverability of inventories, the Company is
required to make estimates regarding future customer
demand and technological advances of equipment.
    
    Property, plant and equipment are recorded at cost.
Retirements and other reductions of regulated
telephone plant and equipment are charged against
accumulated depreciation with no gain or loss
recognized in accordance with the composite group
remaining life methodology utilized for telephone
plant assets. When property applicable to
non-telephone operations is sold or retired, the
asset and related accumulated depreciation are
removed from the accounts and the associated gain or
loss is recognized. Property, plant and equipment is
depreciated or amortized using the straight-line
method over their estimated economic lives. The
economic lives are estimated at the time the assets
are acquired and are based on historical experience
with similar assets, as well as anticipated
technological or other changes. If technological
changes were to occur more rapidly than anticipated
or differently than anticipated, the economic lives
assigned to these assets may need to be shortened,
resulting in the recognition of increased
depreciation and amortization expense in future
periods. Likewise, if the anticipated technological
or other changes occur more slowly than anticipated,
the life of the asset group could be extended based
on the life assigned to new assets added to the
group. This could result in a reduction of
depreciation and amortization expense in future
periods. The Company reviews the estimated useful
lives of its property, plant and equipment once every
three years, or when events or circumstances indicate
that the carrying amount may not be recoverable over
the remaining lives of the assets. In assessing the
recoverability of the Companys property, plant and
equipment, the Company must make assumptions
regarding estimated future cash flows and other
factors to determine the fair value of the respective
assets.
    
    The Company accounts for asset retirement obligations
in accordance with SFAS No. 143, Accounting for Asset
Retirement Obligations, which requires the Company to
recognize a retirement obligation (future cost of
removal) when a legal obligation exists to remove
plant at some point in the future. The Company
believes it may have potential retirement obligations
relating to its wireless cell sites. Based on terms
outlined in its tower leases, the Company is
obligated to return the land or facilities to their
original condition at the end of the cell site lease
term, should the lease be terminated. The Company has
used a probability-weighted cash flow approach in
estimating its potential retirement obligation. The
Company calculates the net present value of the
retirement obligation assuming an inflation rate of
3%, a discount rate of 7% and a market risk premium
of 4%. The Company has also assumed the settlement
date is 25 years from the date the asset is placed
into service. The Company has also used a
probability-weighted assessment to address the
uncertainty regarding the timing of future cash flows
to settle the potential liability. The Company
believes that utilizing probabilities less than 100%
is appropriate because the Company believes the
likelihood of incurring material asset retirement
expenditures is remote. The Company monitors the
estimates and assumptions used in determining its
potential asset retirement obligations for its cell
sites. However, the Company believes it is remote
that any future adjustment to its asset retirement
liability for obligations existing as of June 30,
2005 will be material to the Companys condensed
consolidated financial statements.
    
    The Company accounts for income taxes using the liability method. Under this method,
deferred tax assets and liabilities are determined based on differences between the financial
reporting and tax bases of assets and liabilities and are measured using the enacted tax rates
and laws that are expected to be in effect when the differences are expected to reverse. The
Company does not have a valuation allowance on its deferred tax asset as of June 30, 2005 or
2004 because it believes it is more likely than not that such deferred tax asset will be
realized. Should the Company determine that it would not be able to realize all or part of its
deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to
income in the period in which the determination was made.
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
    
    The Company has pension and post-retirement benefit costs and obligations. The Companys
pension and post-retirement benefit obligations are actuarially determined based on estimates
of discount rates, long-term rates of return on plan assets and increases in future
compensation levels. Changes in these estimates and other factors could significantly impact
the Companys pension and post-retirement benefit costs and obligations. Assumed health care
cost trend rates have a significant effect on the amounts reported for the health care plans.
A one-percentage-point change in assumed health care cost trend rates would have the following
effects:
 1-Percentage-Point
    
    
    1-Percentage-PointIncrease
    
    
    DecreaseEffect on total 2004 service and interest cost
    
    $
    72
    
    
    $
    (61
    )Effect on post-retirement benefit obligation
as of December 31, 2004
    
    $
    526
    
    
    $
    (499
    )
 The discount rate is determined based on the current yields on high quality corporate
fixed-income investments with maturities corresponding to the expected duration of the benefit
obligations. During 2005, the Company expects the discount rate to remain at 5.75%, which is
consistent with the prior year.In 2004, the Company used an expected long-term rate of return of 8.50%. For 2005, the Company
does not believe the expected long-term rate will change significantly. The expected long-term
rate of return on plan assets is determined based on the current and projected investment
portfolio mix and estimated long-term investment returns for each asset class. The projected
portfolio mix of the plan assets is developed in consideration of the expected duration of
related plan obligations and private equity positions. The expected return on plan assets is
determined by applying the expected long-term rate of return to the market-value of plan assets.The future compensation levels are based on recent experience as well as future expectations.
During 2005 the Company expects its future compensation level to remain consistent at 5%, which
is consistent with the prior year.
    
    The Company is a party to a variety of litigation, regulatory proceedings and other
contingencies that arise in the ordinary course of business. The Company is required to assess
the likelihood of any adverse judgments or outcomes to these matters, as well as potential
ranges of probable losses for certain of these matters. The determination of the liabilities
required, if any, for loss contingencies is made after careful analysis of each individual
issue. In the opinion of management, the ultimate outcome of these matters will not materially
affect the Companys consolidated financial position and results of operations.
    
    The Company currently sponsors two Equity Incentive Plans (the Plans) for certain
employees, outside directors and consultants of the Company, which were approved by the
Companys shareholders. The Plans permit issuance by the Company of awards in the form of
restricted shares, stock units, performance shares, stock options and stock appreciation
rights. Effective January 1, 2003, the Company adopted the preferable fair value recognition
provisions of SFAS No. 123, Accounting for Stock-Based Compensation.Under the prospective
transition method selected by the Company, as described in SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure, compensation expense was recognized
beginning in 2003 for all employee awards granted, modified or settled after January 1, 2003.
This change in accounting for stock-based compensation resulted in increased compensation
expense of $5 and $9, which decreased net income by $3 (no effect on earnings per share) and
$6 (no effect on earnings per share) for the quarter and six-month period ended June 30, 2005,
respectively. For the same prior year periods, this change in accounting for stock based
compensation resulted in increased compensation expense of $11 and $19, respectively, which
decreased net income by $6 (no effect on earnings per share) and $11 (no effect on earnings
per share), respectively.The Company voluntarily made the choice to change to the preferable method of accounting for
employee stock options in accordance with SFAS No. 123. The Company concluded that stock
options are a form of employee
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compensation expense and, therefore, it is appropriate that these expenses be recorded in the
results of operations to more clearly reflect economic reality.The Black-Scholes-Merton option pricing model includes assumptions regarding dividend yields,
expected volatility, expected lives and risk-free interest rates. These assumptions reflect
managements best estimates, but these items involve inherent uncertainties based on market
conditions generally outside of the control of the Company. As a result, if other assumptions
had been used in the current period, stock-based compensation expense could have been materially
different. If management uses different assumptions in future periods, stock-based compensation
expense could be materially impacted in future years.
 Recent Accounting Pronouncements
 Accounting
Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3.
 Share-Based Payment . Accounting for Stock Issued to Employees, Statement
of Cash Flows.
   1.
    
    A modified prospective method in which compensation cost is recognized
beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for
all share-based payments granted after the effective date and (b) based on the
requirements of SFAS No. 123 for all awards granted to employees prior to the effective
date of SFAS No. 123(R) that remain unvested on the effective date.2.
    
    A modified retrospective method, which includes the requirements of the
modified prospective method described above, but also permits entities to restate their
financial statements based on the amounts previously recognized under SFAS No. 123 for
purposes of pro forma disclosures either for (a) all prior periods presented or (b)
prior interim periods of the year of adoption.
  Accounting for Conditional Asset
Retirement Obligations Accounting for Asset Retirement Obligations
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Factors That Could Affect Future Results
   We expect to continue to face significant competition in all parts of our business and the
level of competition is expected to intensify.
 We must adapt to rapid technological change
 We are subject to a complex and uncertain regulatory environment.
 Our operations have undergone material changes, and our actual operating results can be
expected to differ from the results indicated in our historical financial statements
 Our success depends upon our ability to manage our growth and expansion. If our acquisitions
and growth initiatives are not successful, we could suffer an adverse effect on our business
and results of operations
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We are reliant on support funds provided under federal and state laws Regulation
 We could be harmed by the recent adverse developments affecting other communications companies
 We depend on third parties, over whom we have no control, to deliver our services
 We are subject to new corporate governance and internal control reporting requirements, and our
failure to comply with existing and future requirements could adversely affect our business.
 If we are unable to effectively and efficiently implement the necessary initiatives to
eliminate the material weakness identified in our internal controls and procedures, there could
be an adverse affect on our operations or financial results.
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Regulatory and Legal Matters
    
    
    Additional rules governing the opening of markets to competition and the
regulation of the competing telecommunications providers;
    
    The nature and extent of the compensation, if any, to be paid by carriers
and other providers to one another for network use, and the sums to be
recovered through end users and other sources;
    
    The goals and definition of universal telephone service in a changing
environment, including examination of subsidy support mechanisms for subscribers
of different carriers (including incumbent carriers) and in various geographic
areas;
    
    Rules that will provide non-discriminatory access by competing service
providers to the network capabilities of local exchange carriers; and
    
    The regulated rates and earnings of SureWest Telephone.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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ITEM 4. CONTROLS AND PROCEDURES
     Remediation Steps Related to Material Weakness
  
    
    Enhancements to the Companys enterprise resource planning and accounting
software, for which implementation commenced in the second quarter of 2004, and which is
ongoing.
    
    The performance of additional detailed reviews, on a monthly basis, of
construction projects by the appropriate project manager to validate the results generated
by the Companys systems.
    
    The review of systematic routines, which generate and transfer data between
modules within the enterprise resource planning system, as necessary to determine if the
routines are generating accurate reports.
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
    
    Timely detailed reviews by management will occur to provide reasonable
assurance that manual controls are operating effectively.
  Other Internal Control Matters
  Information Technology
 
    
    The Company has identified certain deficiencies related to its Information
Technology general and application controls. In response to these deficiencies, during the
third quarter of 2004, the Company engaged an outside consulting firm to design and
implement changes to the controls in an effort to remediate the identified deficiencies.
Although the Company has made progress in its remediation efforts, these efforts were not
completed by December 31, 2004. The Company believes that it is reasonably likely that
this control deficiency will be remediated and the related controls will be
tested in 2005. The Company has commenced its remediation and interim testing
relating to specific Information Technology controls discussed above, and based on the
preliminary results, it appears that the remediation efforts are improving the overall
controls over the Information Technology area. However, the Company is not able to make
conclusions relative to the overall effectiveness of the improvements.
 Accounting Personnel, Policies and Procedure
 
    
    During managements assessment of internal controls, it was noted that the
quality of evidence was not consistent across the Companys controls. Management put into
place various remediation steps during the third and fourth quarters of 2004 which it
believed would improve the overall quality of the control documentation. During
managements testing of internal controls in 2005, the Company will determine if such
remediation was effective in improving the Companys overall quality of control
documentation. In April 2005, the Company commenced its 2005 testing plan of the Companys
key controls over financial reporting processes. In June 2005, the Company implemented
its internal control tracking software which requires control and process owners to update
key controls for changes on a quarterly basis. Based on the results of the Companys
interim testing results and updating of control documentation, it appears the quality of
evidence and ownership of controls has improved. The Company will test the balance of
its internal controls during the remainder of 2005 and ending in the first quarter of 2006
with respect to the necessary testing of year-end controls.
 Change in Internal Control over Financial Reporting
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PART II
 
 ITEM 1. LEGAL PROCEEDINGS
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 (a)
    
    On May 17, 2005, the Company held its Annual Meeting of Shareholders, at which the
shareholders elected a Board of seven (7) Directors.(b)
    
    The seven nominees to serve as directors, which constituted the entire Board of Directors
as of the meeting date, were all reelected to serve as directors by the following votes (out
of 14,570,117).
 BrokerNon-VotesDirector
    
    Votes For
    
    
    Votes Withheld
    
    
    and AbstentionsKirk C. Doyle
    
    
    11,508,226
    
    
    
    296,826
    
    
    
    16,618Brian H. Strom
    
    
    11,314,152
    
    
    
    490,900
    
    
    
    16,618John R. Roberts III
    
    
    11,437,201
    
    
    
    367,851
    
    
    
    16,618Timothy D. Taron
    
    
    11,423,748
    
    
    
    381,304
    
    
    
    16,618Guy R. Gibson
    
    
    11,449,533
    
    
    
    355,519
    
    
    
    16,618Steven C. Oldham
    
    
    11,380,780
    
    
    
    424,272
    
    
    
    16,618Roger J. Valine
    
    
    11,304,274
    
    
    
    500,778
    
    
    
    16,618
 
 ITEM 5. OTHER INFORMATION
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ITEM 6. EXHIBITS
  MethodExhibit No.
    
    Description
    
    of Filing3.1
    
    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 reference3.2
    
    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 reference3.3
    
    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 reference4.1
    
    Shareholder Rights Plan
(Filed as Exhibit 2.1 to
Form 8-A Registration
Statement under the
Securities Act of 1934)
    
    Incorporated by reference10.1
    
    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 reference10.2
    
    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 reference10.3
    
    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 reference10.4
    
    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
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10.5
    
    Amendment No. 6 to Business Incorporated by reference
Loan Agreement dated as of
January 13, 2004 (Filed as
Exhibit 10.7 to Form 10-K/A
Annual Report of Registrant for
the year ended December 31,
2003)
    
    Incorporated byreference10.6
    
    Amendment No. 7 to Business Loan Incorporated by
Agreement dated as of March 25, 2004 reference
(Filed as Exhibit 10.7 to Form 10-K/A
Annual Report of Registrant for the year
ended December 31, 2003)
    
    Incorporated byreference10.7
    
    Amendment No. 8 to Business Loan Incorporated by
Agreement dated as of December 31, 2004 reference
    
    Incorporated byreference10.8
    
    1999 Restricted Stock Bonus Plan (Filed Incorporated by
as Exhibit 10(d) to Form 10-K Annual reference
Report of Registrant for the year ended
December 31, 1998)
    
    Incorporated byreference10.9
    
    2000 Equity Incentive Plan, as amended Filed herewith
    
    Filed herewith10.10
    
    SureWest KSOP (filed as Exhibit 4.1 to Incorporated by
Registration Statement on Form S-8 [No. reference
333-87222])
    
    Incorporated byreference10.11
    
    Letter agreement dated January 16, 2001 Incorporated by
between Registrant and Brian H. Strom reference
(Filed as Exhibit 10 (g) to Form 10-K
Annual Report of Registrant for the year
ended December 31, 2000)
    
    Incorporated byreference10.12
    
    Letter agreement dated January 16, 2001 Incorporated by
between Registrant and Jay B. Kinder reference
(Filed as Exhibit 10 (i) to Form 10-K
Annual Report of Registrant for the year
ended December 31, 2000)
    
    Incorporated byreference10.13
    
    Letter agreement dated January 16, 2001 Incorporated by
between Registrant and Bill M. DeMuth reference
(Filed as Exhibit 10.14 to Form 10-K/A
Annual Report of Registrant for the year
ended December 31, 2003)
    
    Incorporated byreference10.14
    
    Letter agreement dated January 16, 2001 Incorporated by
between Registrant and Fred A. Arcuri reference
(Filed as Exhibit 10.15 to Form 10-K/A
Annual Report of Registrant for the year
ended December 31, 2003)
    
    Incorporated byreference10.15
    
    Letter agreement dated January Incorporated by reference
16, 2001 between Registrant
and Robert M. Burger (Filed as
Exhibit 10(k) to Form 10-K
Annual Report of Registrant
for the year ended December
31, 2000)
    
    Incorporated byreference10.16
    
    Restricted Stock Unit Award, Incorporated by reference
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 byreference
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10.17
    
    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 reference10.18
    
    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 reference10.19
    
    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 reference10.20
    
    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 reference10.21
    
    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 reference10.22
    
    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 reference31.1
    
    Certification of Brian H.
Strom, President and Chief
Executive Officer, as adopted
pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
    
    Filed herewith31.2
    
    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 herewith32.1
    
    Certification of Brian H.
Strom, President and Chief
Executive Officer, pursuant to
18 U.S.C. Section 1350, as
adopted pursuant to Section
906 of the Sarbanes-Oxley Act
of 2002
    
    Filed herewith32.2
    
    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
  SUREWEST COMMUNICATIONS
(Registrant)By:
    /s/ BRIAN H. STROMBrian H. Strom,President and Chief
Executive Officer By:
    /s/ PHILIP A. GRYBASPhilip A. Grybas,Senior Vice President and
Chief Financial Officer Date:  August 2, 2005 47