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** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

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

 

**For thequarterly period ended March 31, 2010**

 

**or**

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

 

**CommissionFile Number 000-29660**

 

**SureWestCommunications**

(Exact name ofregistrant as specified in its charter)

 

| **California**                     | ** ** | **68-0365195**       |
|------------------------------------|------------|----------------------|
| (State or other  jurisdiction      |       | (IRS Employer        |
| of incorporation  or organization) |       | Identification  No.) |

 

| **8150  Industrial Avenue, Building A, Roseville, California** | ** ** | **95678**  |
|----------------------------------------------------------------|------------|------------|
| (Address of  principal executive offices)                      |       | (Zip Code) |

 

**(916)786-6141**

(Registrant’stelephone number, including area code)

 

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

 

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

 

| Large  accelerated filer o                |   | Accelerated  filer x         |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer o                  |   | Smaller  reporting company o |
| (Do not check  if a smaller reporting company) |   |                              |

 

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

 

On April 20, 2010, the registrant had 14,365,832shares of Common Stock outstanding.

 

 

 

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**TABLE OF CONTENTS**

 
| ** **                              | ** **                                                                                  | **Page** |
|-----------------------------------------|---------------------------------------------------------------------------------------------|----------|
|                                    |                                                                                        |     |
| **PART I - FINANCIAL INFORMATION** |                                                                                        |
| Item 1.                                 | Financial Statements                                                                        | 1        |
| Item 2.                                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 16       |
| Item 3.                                 | Quantitative  and Qualitative Disclosures About Market Risk                                 | 32       |
| Item 4.                                 | Controls and  Procedures                                                                    | 32       |
|                                    |                                                                                        |     |
| **PART II  - OTHER INFORMATION**   |                                                                                        |
| Item 1.                                 | Legal Proceedings                                                                           | 33       |
| Item 6.                                 | Exhibits                                                                                    | 33       |
| SIGNATURES                              | 34                                                                                          |

 

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**PART 1 — FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS.**

 

**SUREWEST COMMUNICATIONS**

**CONDENSED CONSOLIDATED STATEMENTS OFINCOME**

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

* *
| ** **                                                                         | ** ** | **Quarter Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                                                                               |       |                             |       |   |   |
| **Operating revenues:**                                                            |       |                             |       |   |   |
| Broadband                                                                          |       | $                                | 42,577     |   | $ | 39,222 |   |
| Telecom                                                                            |       | 17,611                           |       | 21,720 |   |
| Total  operating revenues                                                          |       | 60,188                           |       | 60,942 |   |
|                                                                               |       |                             |       |   |   |
| **Operating expenses:**                                                            |       |                             |       |   |   |
| Cost  of services and products (exclusive of depreciation and amortization)        |       | 24,918                           |       | 25,014 |   |
| Customer  operations and selling                                                   |       | 8,209                            |       | 8,235 |   |
| General  and administrative                                                        |       | 8,813                            |       | 9,563 |   |
| Depreciation  and amortization                                                     |       | 15,106                           |       | 14,810 |   |
| Total  operating expenses                                                          |       | 57,046                           |       | 57,622 |   |
|                                                                               |       |                             |       |   |   |
| **Income from operations**                                                         |       | 3,142                            |       | 3,320 |   |
|                                                                               |       |                             |       |   |   |
| Other  income (expense):                                                           |       |                             |       |   |   |
| Interest  income                                                                   |       | 18                               |       | 37 |   |
| Interest  expense                                                                  |       | (1,643                           | )          | (2,310 | ) |
| Other,  net                                                                        |       | (166                             | )          | (84 | ) |
| Total  other income (expense), net                                                 |       | (1,791                           | )          | (2,357 | ) |
|                                                                               |       |                             |       |   |   |
| Income  from continuing operations before income taxes                             |       | 1,351                            |       | 963 |   |
|                                                                               |       |                             |       |   |   |
| Income  tax expense                                                                |       | 824                              |       | 884 |   |
|                                                                               |       |                             |       |   |   |
| **Income from continuing operations**                                              |       | 527                              |       | 79 |   |
|                                                                               |       |                             |       |   |   |
| Discontinued  operations, net of tax:                                              |       |                             |       |   |   |
| Loss  from discontinued operations                                                 |       | —                           |       | (69 | ) |
| Gain  on sale of discontinued operations                                           |       | —                           |       | 2,508 |   |
| Total  discontinued operations                                                     |       | —                           |       | 2,439 |   |
|                                                                               |       |                             |       |   |   |
| **Net income**                                                                     |       | $                                | 527        |   | $ | 2,518 |   |
|                                                                               |       |                             |       |   |   |
| **Basic and diluted earnings per common share:**                                   |       |                             |       |   |   |
| Income  from continuing operations                                                 |       | $                                | 0.04       |   | $ | 0.01 |   |
| Discontinued  operations, net of tax                                               |       | —                           |       | 0.17 |   |
| Net  income per basic and diluted common share                                     |       | $                                | 0.04       |   | $ | 0.18 |   |
|                                                                               |       |                             |       |   |   |
| **Shares of common stock used to calculate basic and diluted  earnings per share** |       | 14,002                           |       | 14,008 |   |

 

See accompanyingnotes.

 

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**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

*(Unaudited;Amounts in thousands)*

* *
| ** **                                                                                                                                                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| **ASSETS**                                                                                                                                                                     |       |               |       |                  |       |
| Current  assets:                                                                                                                                                               |       |               |       |                  |       |
| Cash  and cash equivalents                                                                                                                                                     |       | $                  | 6,982      |                  | $          | 7,489 |   |
| Short-term  investments                                                                                                                                                        |       | 601                |       | 4,306                 |       |
| Accounts  receivable, net                                                                                                                                                      |       | 18,116             |       | 19,734                |       |
| Income  tax receivable                                                                                                                                                         |       | 2,056              |       | 2,221                 |       |
| Prepaid  expenses                                                                                                                                                              |       | 2,978              |       | 3,704                 |       |
| Deferred  income taxes                                                                                                                                                         |       | 3,561              |       | 3,373                 |       |
| Other  current assets                                                                                                                                                          |       | 1,760              |       | 1,760                 |       |
| Assets  held for sale                                                                                                                                                          |       | 6,009              |       | 6,009                 |       |
| Total  current assets                                                                                                                                                          |       | 42,063             |       | 48,596                |       |
|                                                                                                                                                                           |       |               |       |                  |       |
| Property,  plant and equipment, net                                                                                                                                            |       | 520,243            |       | 522,493               |       |
|                                                                                                                                                                           |       |               |       |                  |       |
| Intangible  and other assets:                                                                                                                                                  |       |               |       |                  |       |
| Customer  relationships, net                                                                                                                                                   |       | 3,543              |       | 3,847                 |       |
| Goodwill                                                                                                                                                                       |       | 45,814             |       | 45,814                |       |
| Deferred  charges and other assets                                                                                                                                             |       | 2,515              |       | 2,113                 |       |
|                                                                                                                                                                           |       | 51,872             |       | 51,774                |       |
|                                                                                                                                                                           |       | $                  | 614,178    |                  | $          | 622,863 |   |
|                                                                                                                                                                           |       |               |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                  |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                          |       |               |       |                  |       |
| Current  portion of long-term debt                                                                                                                                             |       | $                  | 15,636     |                  | $          | 15,636 |   |
| Accounts  payable                                                                                                                                                              |       | 3,161              |       | 2,547                 |       |
| Other  accrued liabilities                                                                                                                                                     |       | 16,994             |       | 18,315                |       |
| Advance  billings and deferred revenues                                                                                                                                        |       | 8,487              |       | 8,580                 |       |
| Accrued  compensation                                                                                                                                                          |       | 6,766              |       | 9,172                 |       |
| Total  current liabilities                                                                                                                                                     |       | 51,044             |       | 54,250                |       |
|                                                                                                                                                                           |       |               |       |                  |       |
| Long-term  debt                                                                                                                                                                |       | 199,409            |       | 207,409               |       |
| Deferred  income taxes                                                                                                                                                         |       | 55,668             |       | 54,856                |       |
| Accrued  pension and other post-retirement benefits                                                                                                                            |       | 32,917             |       | 32,451                |       |
| Other  liabilities and deferred revenues                                                                                                                                       |       | 4,656              |       | 4,714                 |       |
|                                                                                                                                                                           |       |               |       |                  |       |
| Commitments  and contingencies                                                                                                                                                 |       |               |       |                  |       |
|                                                                                                                                                                           |       |               |       |                  |       |
| Shareholders’  equity:                                                                                                                                                    |       |               |       |                  |       |
| Common  stock, without par value; 100,000 shares authorized, 14,366 and 14,148 shares  issued and outstanding at March 31, 2010 and December 31, 2009,  respectively |       | 147,641            |       | 146,844               |       |
| Accumulated  other comprehensive loss                                                                                                                                          |       | (15,303            | )          | (15,280               | )          |
| Retained  earnings                                                                                                                                                             |       | 138,146            |       | 137,619               |       |
| Total  shareholders’ equity                                                                                                                                               |       | 270,484            |       | 269,183               |       |
|                                                                                                                                                                           |       | $                  | 614,178    |                  | $          | 622,863 |   |

 

See accompanyingnotes.

 

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**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

*(Unaudited;Amounts in thousands)*

 
| ** **                                              | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                              | ** ** | **2010**                              | ** ** | **2009** | ** ** |
|                                                    |       |                                  |       |   |   |
| Net  cash provided by continuing operations             |       | $                                     | 16,341     |   | $ | 9,983 |   |
| Net  cash used in discontinued operations               |       | —                                |       | (439 | ) |
| Net  cash provided by operating activities              |       | 16,341                                |       | 9,544 |   |
|                                                    |       |                                  |       |   |   |
| Cash  flows from investing activities:                  |       |                                  |       |   |   |
| Proceeds  from sale of discontinued operations          |       | —                                |       | 9,222 |   |
| Capital  expenditures for property, plant and equipment |       | (12,536                               | )          | (18,352 | ) |
| Proceeds  from sale of available-for-sale securities    |       | 3,700                                 |       | — |   |
| Purchases  of available-for-sale securities             |       | (9                                    | )          | — |   |
| Net  cash used in investing activities                  |       | (8,845                                | )          | (9,130 | ) |
|                                                    |       |                                  |       |   |   |
| Cash  flows from financing activities:                  |       |                                  |       |   |   |
| Proceeds  from issuance of long-term debt               |       | 4,000                                 |       | 10,500 |   |
| Principal  payments on long-term debt                   |       | (12,000                               | )          | (12,001 | ) |
| Repurchases  and surrenders of common stock             |       | (3                                    | )          | (75 | ) |
| Net  cash used in financing activities                  |       | (8,003                                | )          | (1,576 | ) |
|                                                    |       |                                  |       |   |   |
| Decrease  in cash and cash equivalents                  |       | (507                                  | )          | (1,162 | ) |
|                                                    |       |                                  |       |   |   |
| Cash  and cash equivalents at beginning of period       |       | 7,489                                 |       | 2,840 |   |
|                                                    |       |                                  |       |   |   |
| Cash  and cash equivalents at end of period             |       | $                                     | 6,982      |   | $ | 1,678 |   |

 

See accompanyingnotes.

 

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**SUREWESTCOMMUNICATIONS**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

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

 

**1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Businessand Basis of Accounting**

 

SureWest Communications(the “Company”, “we” or “our”) is a holding company with operating subsidiariesthat provide communications services in Northern California, primarily thegreater Sacramento region, and the greater Kansas City, Kansas and Missouriareas (“Kansas City area”). Our operating subsidiaries are SureWest Broadband,SureWest TeleVideo, SureWest Internet, SureWest Custom Data Services, SureWestKansas, Inc. (“SureWest Kansas” or the “Kansas City operations”), SureWestTelephone and SureWest Long Distance.

 

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

 

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

 

In the opinion ofmanagement, the accompanying condensed consolidated balance sheets and relatedinterim statements of income and cash flows include all adjustments, consistingonly of normal recurring items, necessary for their fair presentation inconformity with accounting principles generally accepted in the United States (“U.S.GAAP” or “GAAP”) for interim financial information and pursuant to the rules andregulations of the Securities and Exchange Commission (the “SEC”). Certaininformation and footnote disclosures normally included in annual financialstatements prepared in accordance with U.S. GAAP have been condensed or omittedpursuant to such SEC rules and regulations and accounting principlesapplicable for interim periods. Events subsequent to the balance sheet datehave been evaluated for inclusion in the accompanying condensed consolidatedfinancial statements through the date of issuance.  Management believesthat the disclosures made are adequate to make the information presented notmisleading. Interim results are not necessarily indicative of results for afull year.  The information presented inthis Form 10-Q should be read in conjunction with Management’s Discussionand Analysis of Financial Condition and Results of Operations and theconsolidated financial statements and notes thereto included in our 2009 AnnualReport on Form 10-K filed with the SEC.

 

**Reclassifications**

 

Certainamounts in our 2009 condensed consolidated financial statements have beenreclassified to conform to the presentation of our 2010 condensed consolidatedfinancial statements.  Thereclassification consists of the effects on the condensed consolidated balancesheets of the reclassification of inventories from current assets to property,plant and equipment.  Inventories consistprimarily of network construction materials and supplies that when issued arecapitalized as part of new customer installations and the construction of thenetwork. The proportion of the items included in inventories that arecapitalized to property, plant and equipment has increased as a result of thegrowth in the Broadband business.

 

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**Property,Plant and Equipment**

 

Property, plantand equipment consisted of the following:

 
| ** **                                      | ** ** | **March 31,   2010** | ** ** | **December 31,  2009** | ** ** | **Estimated   Useful Lives** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Land                                            |       | $                         | 2,824      |                        | $          | 2,824                        |       |   |   |
| Buildings                                       |       | 76,382                    |       | 76,363                      |       | 35 years                     |       |
| Central  office equipment                       |       | 313,735                   |       | 312,338                     |       | 3-12 years                   |       |
| Outside  plant equipment                        |       | 484,325                   |       | 481,099                     |       | 5-40 years                   |       |
| Internal-use  software                          |       | 59,122                    |       | 58,714                      |       | 5-7 years                    |       |
| Other                                           |       | 56,702                    |       | 56,974                      |       | 3-25 years                   |       |
| Total  plant in service                         |       | 993,090                   |       | 988,312                     |       |                         |       |
| Less  accumulated depreciation and amortization |       | 488,692                   |       | 481,639                     |       |                         |       |
| Plant  in service                               |       | 504,398                   |       | 506,673                     |       |                         |       |
| Plant  under construction                       |       | 9,413                     |       | 10,557                      |       |                         |       |
| Construction  inventory                         |       | 6,432                     |       | 5,263                       |       |                         |       |
| Property  plant and equipment, net              |       | $                         | 520,243    |                        | $          | 522,493                      |       |   |   |

 

Construction inventories,which are stated at weighted average cost, consist primarily of networkconstruction materials and supplies that when issued are capitalized as part ofnew customer installations and the construction of the network.

 

During the first quarterof 2010, we completed our triennial review of asset lives that evaluated theappropriateness of the estimated useful lives of our property, plant andequipment for all segments.  Theevaluation considered our investment and business strategy, reliability andhistorical performance data of certain assets, as well as the impacts ofcompetition and anticipated technological change. As a result of thisevaluation, effective January 1, 2010, we increased the estimated usefullives of general purpose software, general purpose hardware and certain centraloffice equipment. We decreased the lives of certain of our customer premiseequipment and outside plant categories. During the quarter ended March 31,2010, this change in estimate did not have a material effect to consolidateddepreciation expense or net income and is not expected to have a materialimpact for the year ended December 31, 2010.

 

**Stock-based Compensation**

 

***StockPlan***

*** ***

Our Board of Directorsmay grant share-based awards from our shareholder approved Equity IncentivePlan; the 2000 Equity Incentive Plan (the “Stock Plan”) to certain of ouremployees, outside directors and consultants. The Stock Plan permits issuanceof awards in the form of restricted common stock (“RSAs”), restricted commonstock units (“RSUs”), performance shares, stock options and stock appreciationrights. Under the Stock Plan, approximately 2.1 million shares of our commonstock were authorized for issuance, including those outstanding as of March 31,2010.

 

***RestrictedCommon Stock Awards and Units***

*** ***

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

 

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Thefollowing table summarizes the grants that occurred under the Stock Plan duringthe quarters ended March 31, 2010 and 2009:

 

| ** **     | ** ** | **Quarter Ended March 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | ** **                                 | ** ** | **Grant Date** | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **     | ** ** | **2010**                                   | ** ** | **Fair Value** | ** ** | **2009** | ** ** | **Fair Value** | ** ** |
|           |       |                                       |       |   |   |   |   |   |   |
| RSAs  Granted  |       | 217,575                                    |       | $ | 9.95 |   | 166,506 |   | $ | 11.56 |   |
| RSUs  Granted  |       | 92,709                                     |       | $ | 9.95 |   | 72,443 |   | $ | 11.56 |   |
| RSU  Dividends |       | —                                     |       | $ | — |   | 7,037 |   | $ | 9.84 |   |
| Total          |       | 310,284                                    |       |   |   | 245,986 |   |   |   |

 

RSUDividends consist of dividends that were previously granted to the holders ofRSUs, which have fully vested and were released during the quarter ended March 31,2009 (none in the quarter ended March 31, 2010) in accordance with theunderlying award agreement.  Stock-basedcompensation expense for both RSAs and RSUs of $800 and $608 was recordedduring the quarters ended March 31, 2010 and 2009, respectively.

 

**The following table summarizes the RSA and RSUactivity during the quarter ended March 31, 2010:**

 

| ** **                      | ** ** | ** ** | ** ** | **Weighted Average**      | ** ** |
|---------------------------------|------------|------------|------------|---------------------------|------------|
| **Nonvested Shares**            | ** ** | **Shares** | ** ** | **Grant Date Fair Value** | ** ** |
|                            |       |       |       |                      |       |
| Nonvested-January 1,  2010 |       | 349,916    |       | $                         | 12.90      |   |
| Granted                         |       | 310,284    |       | $                         | 9.95       |   |
| Vested                          |       | (20,470    | )          | $                         | 10.45      |   |
| Nonvested-March 31,  2010  |       | 639,730    |       |                      |       |

 

Asof March 31, 2010, total unrecognized compensation costs related tononvested restricted stock was $6,674 and will be recognized over aweighted-average period of approximately 2.95 years. The total fair value ofRSAs and RSUs vested during the quarter ended March 31, 2010 was $214.

 

***StockOptions***

*** ***

In2003, we ceased granting stock options and have since granted RSAs and RSUs aspart of our equity compensation plan. We issue new shares of common stock uponexercise of stock options. The exercise price per share of the Company’s commonstock to be purchased under any incentive stock option shall not be less than100% of the fair market value of a share of the Company’s common stock on thedate of the grant, and the exercise price under a non-qualified stock option shallnot be less than 85% of the fair market value of the Company’s common stock atthe date of the grant. The term of any stock option shall not exceed ten years.

 

Nostock options were granted, exercised or expired during the quarters ended March 31,2010 and 2009. As of March 31, 2010, 318,389 outstanding options werevested and exercisable at a weighted average exercise price of $40.45 with aweighted average remaining contractual life of one year. The aggregateintrinsic value is calculated as the difference between the exercise price ofthe stock options and the quoted price of our common stock.  There were no options that were in-the-moneyas of March 31, 2010 and 2009.

 

**EarningsPer Share**

 

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

 

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**Other****Comprehensive Income**

 

Significant components of our other comprehensive income are asfollows:

 
| ** **                                                                                            | ** ** | **Quarter Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                            | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Net  income                                                                                           |       | $                                | 527        |   | $ | 2,518 |   |
| Unrealized  loss on available-for-sale investments, net of income taxes of $16 and $24,  respectively |       | (23                              | )          | (35 | ) |
| Comprehensive  income                                                                                 |       | $                                | 504        |   | $ | 2,483 |   |

 

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

 

**2.   FAIR VALUE MEASUREMENTS & FINANCIALINSTRUMENTS**

 

*Investments*

 

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

 
| ** **         | ** ** | **As of March 31, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|--------------------|------------|-------------------------------|------------|----------------------------------|------------|
| ** **         | ** ** | **Adjusted  Cost**            | ** ** | **Gross  Unrealized  Gains**     | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Market  Value** | ** ** | **Adjusted  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Market  Value** | ** ** |
| Equity  securities |       | $                             | 663        |                             | $          | — |   | $ | (62 | ) | $ | 601 |   | $ | 654 |   | $ | — |   | $ | (23 | ) | $ | 631 |   |
|                    |            |                               |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Asof March 31, 2010 and December 31, 2009, the decline in the fair valueof our short-term available-for-sale investments had been in a continuous lossposition for more than twelve months.  Weconcluded that the gross unrealized losses of our equity securities weretemporary, as the extent of the decline, both in dollars and percentages ofcost were not considered significant and we have the ability and intent to holdthe investments until at least substantially all of the costs of the investmentis recovered.  The unrealized losses, netof tax, on our short-term available-for-sale investments were recorded as acomponent of other comprehensive income at such dates. We determined the fairvalue of our short-term equity security investments by quoted market prices.

 

*Cost Method Investments*

 

We held $1,115 and $772in cost method investments which were included in other long-term assets in thecondensed consolidated balance sheets as of March 31, 2010 and December 31,2009, respectively. The cost method investments primarily represent ourinvestment in CoBank, ACB (“CoBank”) and are related to patronage distributionsof restricted equity.  This is a requiredinvestment in accordance with our Credit Agreement (see Note 8) held byCoBank.  We periodically monitor ourinvestments for impairment and will record reductions in carrying values if andwhen necessary.  We did not estimate thefair value of the cost method investments as no events or changes incircumstances that may have a significant adverse effect on the fair value ofthe investment were identified during the three months ended March 31,2010. We determined, in accordance with ASC Topic 825, *FinancialInstruments* (formerly SFAS No. 107, *Fair ValueDisclosures About Financial Instruments)*, that it was notpracticable to estimate the fair value of the investments.

 

*Fair Value of FinancialInstruments*

 

In accordance with ASCTopic 820, *Fair Value Measurements and Disclosures*(“ASC 820”) (formerly SFAS No. 157, *Fair Value Measurements*),we measure our cash equivalents (money market funds) and short-term investments(equity securities, auction rate security (“ARS”) and put option) at fairvalue.  ASC 820 clarifies that fair valueis an exit price, representing the amount that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants. As such, fair value is a market-based measurement that should bedetermined based on assumptions that market participants would use in pricingan asset or a liability. A financial asset or liability’s classification withinthe hierarchy is determined based on the lowest level input that is significantto the fair 

 

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value measurement. As abasis for considering such assumptions, ASC 820 establishes a three-tier valuehierarchy, which prioritizes the inputs used in the valuation methodologies inmeasuring fair value:

 

Level 1– Observable inputs that reflect quoted prices (unadjusted) for identicalassets or liabilities in active markets.

 

Level 2– Inputs that reflect quoted prices in active markets for similar assets orliabilities, quoted prices for identical or similar assets or liabilities ininactive markets and inputs other than quoted prices that are directly orindirectly observable in the marketplace.

 

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

 

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

 
| ** **          | ** ** | **As of March 31, 2010** | ** ** |
|---------------------|------------|-------------------------------|------------|
| ** **          | ** ** | **Total**                     | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Money  market funds |       | $                             | 345        |   | $ | 345 |   | $ | — |   | $ | — |   |
| Equity  securities  |       | 601                           |       | 601 |   | — |   | — |   |
|                |       | $                             | 946        |   | $ | 946 |   | $ | — |   | $ | — |   |

 

Fair values for cashequivalents and equity securities in short-term investments were determined byquoted market prices.

 

The following tableprovides a reconciliation of the beginning and ending balances for the assetsmeasured at fair value using significant unobservable inputs (Level 3):

 
| ** **                             | ** ** | **2010**       | ** ** | **2009**                     | ** ** |
|----------------------------------------|------------|----------------|------------|------------------------------|------------|
| ** **                             | ** ** | **Put Option** | ** ** | **Auction Rate  Securities** | ** ** | **Put Option** | ** ** | **Auction Rate  Securities** | ** ** |
| Beginning  balance at January 1st |       | $              | 621        |                         | $          | 3,054 |   | $ | 1,383 |   | $ | 2,125 |   |
| Sale  of auction rate security         |       | —         |       | (3,700                       | )          | — |   | — |   |
| Gains  (losses) included in earnings   |       | (621           | )          | 646                          |       | (745 | ) | 745 |   |
| Balance  at March 31st            |       | $              | —     |                         | $          | — |   | $ | 638 |   | $ | 2,870 |   |

 

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

 

As of December 31,2009, the ARS and Right were classified as current assets in short-terminvestments on our consolidated balance sheet, as a result of our put optionperiod under the Right. During 2009 we continued to earn and receive intereston our ARS, as specified in the terms of the prospectus.

 

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

 

*Fair Value of Debt*

 

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

 
| ** **                                     | ** ** | **As of March 31, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|------------------------------------------------|------------|-------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **Carrying Value**            | ** ** | **Fair Value**                   | ** ** | **Carrying Value** | ** ** | **Fair Value** | ** ** |
| Long-term  debt (including current maturities) |       | $                             | 215,045    |                             | $          | 214,059 |   | $ | 223,045 |   | $ | 221,323 |   |
|                                                |            |                               |            |                                  |            |  |  |  |  |  |  |  |  |

 

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**3.   DIVESTITURES**

 

*SureWest Wireless*

 

In May 2008, wecompleted the sale of the operating assets of our Wireless business, SureWestWireless, to Verizon Wireless (“Verizon”) for an aggregate cash purchase priceof $69,746, resulting in a gain of $18,864, net of tax.  During the quarter ended March 31, 2009,the gain on sale was increased by $43, net of taxes, as a result of changes inestimated transaction costs. As part of the sale, Verizon acquired the spectrumlicenses and operating assets of SureWest Wireless, excluding our ownedcommunication towers.  See theCommunication Tower Assets section below for further discussion regarding ourowned communication towers.  SureWestWireless was previously reported as a separate reportable segment.

 

A portion of the purchaseprice equal to $3,450 was placed in escrow, half of which was received duringthe quarter ended June 30, 2009 and the balance of which will be availableduring the second quarter of 2010, less the amount of any pending claims, ineach case, to be held as security for certain losses, if any, incurred byVerizon in the event of (i) any breach of the representations andwarranties set forth in the agreement, (ii) any breach or nonperformanceof covenants set forth in the agreement and (iii) certain other specifiedevents. The actual gain on sale could vary based on future claims, if any, madeagainst the amounts held in escrow. As of the date of this report, there havebeen no claims made against the escrow account.

 

*Communication Tower Assets*

 

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

 

The results of theTower Assets have been reported as a discontinued operation in our condensedconsolidated financial statements for all periods presented.

 

The following tablesummarizes the financial information for the operations of the Tower Assets:

 
| ** **                                                       | ** ** | **Quarter Ended  March 31, 2009** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------|------------|
| Operating  revenues                                              |       | $                                      | 249        |   |
| Operating  expenses including depreciation and amortization      |       | 365                                    |       |
| Loss  from operations                                            |       | (116                                   | )          |
| Income  tax benefit                                              |       | (47                                    | )          |
| Loss  from discontinued operations                               |       | $                                      | (69        | ) |
|                                                             |       |                                   |       |
| Gain  on sale of discontinued operations, net of taxes of $1,643 |       | $                                      | 2,465      |   |

 

*AssetsHeld For Sale*

 

In connection with ourefforts to evaluate and potentially monetize excess assets, during 2009 weidentified and began to actively market for sale certain of our real estateassets.  These regulated assets, which are included in theTelecommunications (“Telecom”) Segment, include 21 acres of undeveloped landand an office building.  During the quarter ended December 31, 2009,we completed our plan to sell these assets and as a result they were classifiedas assets held for sale.  The followingis the carrying value of the assets held for sale as of March 31, 2010 andDecember 31, 2009:

 
| ** **        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|--------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Undeveloped  land |       | $                  | 1,556      |                  | $          | 1,556 |   |
| Office  building  |       | 4,453              |       | 4,453                 |       |
|              |       | $                  | 6,009      |                  | $          | 6,009 |   |

 

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We expect that the landwill sell in the range of $3,000 to $5,000. In connection with theclassification to assets held for sale, the carrying value of the officebuilding was reduced to its estimated fair value, less selling costs, based onthe current market conditions and listed selling price. As a result, animpairment charge of $1,199 was recorded against accumulated depreciationduring the quarter ended December 31, 2009, in accordance with regulatedtelephone plant and equipment composite group remaining life methodology.  We evaluated the estimated fair value of theassets held for sale as of March 31, 2010 and determined there was not asignificant change.  Therefore, noadditional impairment charge was recorded during the quarter ended March 31,2010.

 

**4.   BUSINESS SEGMENTS**

 

We have two reportablebusiness segments: Broadband and Telecom. We have aggregated certain of ouroperating segments within the Broadband and Telecom segments because we believethat such operating segments share similar economic characteristics.  We measure and evaluate the performance ofour segments based on income (loss) from operations. Corporate Operations areallocated to the appropriate segment, except for cash; investments; certainproperty, plant, and equipment; and miscellaneous other assets, which are notallocated to the segments. However, the interest income associated with cashand investments held by Corporate Operations is included in the results of theoperations of our segments.

 

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

 

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

 

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

 
| ** **                                           | ** ** | ** **    | ** ** | ** **  | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|------------------------------------------------------|------------|---------------|------------|-------------|------------|------------------|------------|------------------|------------|
| ** **                                           | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **For the three months ended March 31,  2010:** |       |          |       |        |       |             |       |             |       |
| Operating revenues from external customers           |       | $             | 42,577     |        | $          | 17,611           |       | $                | —     |   | $ | 60,188 |   |
| Intersegment revenues                                |       | 168           |       | 4,919       |       | (5,087           | )          | —           |       |
| Operating expenses                                   |       |          |       |        |       |             |       |             |       |
| Cost of services and products*                       |       | 23,593        |       | 5,705       |       | (4,380           | )          | 24,918           |       |
| Customer operations and selling                      |       | 6,391         |       | 2,390       |       | (572             | )          | 8,209            |       |
| General and administrative                           |       | 5,153         |       | 3,795       |       | (135             | )          | 8,813            |       |
| Depreciation and amortization                        |       | 12,180        |       | 2,926       |       | —           |       | 15,106           |       |
| Income (loss) from operations                        |       | (4,572        | )          | 7,714       |       | —           |       | 3,142            |       |
| Income (loss) from continuing operations             |       | $             | (3,720     | )           | $          | 4,247            |       | $                | —     |   | $ | 527 |   |

 

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*Exclusive of depreciation and amortization

 

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| ** **                                           | ** ** | ** **    | ** ** | ** **  | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|------------------------------------------------------|------------|---------------|------------|-------------|------------|------------------|------------|------------------|------------|
| ** **                                           | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **For the three months ended March 31,  2009:** |       |          |       |        |       |             |       |             |       |
| Operating revenues from external customers           |       | $             | 39,222     |        | $          | 21,720           |       | $                | —     |   | $ | 60,942 |   |
| Intersegment revenues                                |       | 91            |       | 4,874       |       | (4,965           | )          | —           |       |
| Operating expenses                                   |       |          |       |        |       |             |       |             |       |
| Cost of services and products*                       |       | 22,900        |       | 6,268       |       | (4,154           | )          | 25,014           |       |
| Customer operations and selling                      |       | 6,260         |       | 2,641       |       | (666             | )          | 8,235            |       |
| General and administrative                           |       | 5,535         |       | 4,173       |       | (145             | )          | 9,563            |       |
| Depreciation and amortization                        |       | 11,620        |       | 3,190       |       | —           |       | 14,810           |       |
| Income (loss) from operations                        |       | (7,002        | )          | 10,322      |       | —           |       | 3,320            |       |
| Income (loss) from continuing operations             |       | $             | (5,398     | )           | $          | 5,477            |       | $                | —     |   | $ | 79 |   |

 

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*Exclusive of depreciation and amortization

 

**5.   REGULATORY MATTERS**

 

Certainof our interstate telecommunications service rates are subject to regulation bythe Federal Communications Commission (“FCC”). Interstate switched and specialaccess rates are established through a SureWest Telephone tariff filed with theFCC.  For interstate common line (“CL”)charges, SureWest Telephone concurs with tariffs filed by the National ExchangeCarrier Association (“NECA”).  Intrastateservice rates are subject to regulation by state commissions.  Prices for intrastate telecommunicationsservices are established through tariffs or through other regulatorymechanisms, including, in California, service guides.  Pending and future regulatory actions mayhave a material impact on our consolidated financial position and results ofoperations.

 

*FCC Matters*

 

Undercurrent FCC rules governing rate making, SureWest Telephone is required toestablish rates for its interstate telecommunications services based onprojected demand usage for the various services.   SureWest Telephone projects its earningsthrough the use of annual cost separation studies, which utilize estimatedtotal cost information and projected demand usage. Carriers are required tofollow FCC rules in the preparation of these annual studies.  SureWest Telephone determines actual earningsfrom its interstate rates as actual volumes and costs become known.  The FCC monitors SureWest Telephone’sinterstate earnings.

 

*California Public UtilityCommission (“CPUC”) Matters*

 

In 2004, we entered intoa settlement agreement (the “Settlement Agreement”), which was ultimatelyapproved by the CPUC, to resolve an ongoing regulatory proceeding with variousparties.  The Settlement Agreementresolved past sharing liabilities and suspended future sharing requirements inthe intrastate jurisdiction.  Inaccordance with the Settlement Agreement, SureWest Telephone returnedapproximately $6,500, plus interest, to its end-users through a consumerdividend.  The surcredit was recorded asa reduction of our contractual shareable earnings obligations over a period ofapproximately four years, which began January 1, 2005.  During the first quarter of 2009 and prior tothe cessation of the surcredit on February 9, 2009, we returnedapproximately $165.

 

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

 

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

 

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things (i) eliminatesprice regulation and allows full pricing flexibility for all new and retailservices except basic residential services, which limits increases to $3.25 peryear during 2009 and 2010, (ii) allows new forms of bundles andpromotional packages of telecommunication services, (iii) allocates allgains and losses from the sale of assets to shareholders and (iv) eliminatesalmost all elements of rate of return regulation, including the calculation ofshareable earnings.  Beginning January 1,2011, the URF Incumbent Local Exchange Carriers will be allowed full pricing flexibilityfor the basic residential rate.

 

**6.   INCOME TAXES**

 

Our effective federalincome tax rates for continuing operations were 61.0% and 91.8% for thethree-month periods ended March 31, 2010 and 2009, respectively. For thethree-month period ended March 31, 2010, our actual tax expense differedfrom the federal statutory rate primarily attributable to state taxes and achange to state deferred tax expense due to anticipated changes in our statetax apportionment factors.

 

Our policy is torecognize interest and penalties related to uncertain tax positions asadditional income tax expense.  We didnot accrue significant amounts of interest and penalties related tounrecognized tax benefits during the three-month periods ended March 31,2010 and 2009.  As of March 31,2010, we had approximately $95 of accrued interest and approximately $28 ofpenalties in the amount disclosed below for unrecognized tax benefits.

 

We had a liability forunrecognized tax benefits of approximately $222 and $203 at March 31, 2010and December 31, 2009, respectively. The following table provides a reconciliation of the beginning andending amount of unrecognized tax benefits during three-month period ended March 31,2010:

 
| Balance  at December 31, 2009           |   | $  | 203    |   |
|----------------------------------------------|--------|----|--------|--------|
| Additions  based on prior year tax positions |   | 19 |   |
| Balance  at March 31, 2010              |   | $  | 222    |   |

 

The total amount ofunrecognized tax benefits that, if recognized, would affect the effective taxrate were $148 and $129 at March 31, 2010 and December 31, 2009,respectively.

 

As of March 31,2010, the following tax years and related taxing jurisdictions were open:

 
| **Tax Year** | ** ** | **Taxing Jurisdiction** | ** ** |
|--------------|------------|-------------------------|------------|
| 2002 - 2009  |       | Federal                 |       |
| 2004 - 2009  |       | California              |       |
| 2006 - 2009  |       | Kansas and Missouri     |       |

 

**7.   PENSION PLAN AND OTHER POST-RETIREMENT BENEFITS**

 

Wemaintain a noncontributory defined benefit pension plan (the “Pension Plan”)which covers certain eligible employees. Benefits are based on years of serviceand the employee’s average compensation during the five highest consecutiveyears of the last ten years of credited service. Our funding policy is tocontribute annually an actuarially determined amount consistent with applicablefederal income tax regulations. Contributions are intended to provide forbenefits attributed to service to date. Pension Plan assets are primarilyinvested in domestic equity securities, fixed income and international equitysecurities.

 

We also maintain an unfunded Supplemental ExecutiveRetirement Plan (“SERP”), which provides supplemental retirement benefits tocertain of our retired executives. The SERP provides for incremental pensionpayments to partially offset the reduction in amounts that would have beenpayable under the Pension Plan if it were not for limitations imposed byfederal income tax regulations.

 

Inaddition, we provide certain post-retirement benefits other than pensions (“OtherBenefits Plan”) to certain eligible employees of our California location,including life insurance benefits and a stated reimbursement for Medicaresupplemental insurance.

 

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

 

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Weaccount for our Pension Plan in accordance with ASC Topic 715, *Compensation — Retirement Benefits* (“ASC 715”) (formerlySFAS No. 158, *Employers’ Accounting forDefined Benefit Pension and Other Post-retirement Plans, an Amendment of FASBStatements No. 87, 88, 106 and 132(R)*).  ASC 715 requires an employer to recognize theoverfunded or underfunded status of a defined benefit post-retirement plan asan asset or liability in its statement of financial position, to recognizechanges in that funded status in the year in which the changes occur throughcomprehensive income and to measure the funded status of a plan as of the dateof its year-end statement of financial position.

 

**Components of Net PeriodicPension Cost**

 

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

 
| ** **                                     | ** ** | **2010** | ** ** | **2009** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| **Quarter ended March 31,**               |       |     |       |     |       |
| Interest  cost on projected benefit obligation |       | $        | 1,806      |     | $          | 1,808 |   |
| Expected  return on plan assets                |       | (1,825   | )          | (1,675   | )          |
| Amortization  of:                              |       |     |       |     |       |
| Prior  service cost                            |       | 1        |       | 1        |       |
| Net  actuarial loss                            |       | 557      |       | 730      |       |
| Net  periodic pension expense                  |       | $        | 539        |     | $          | 864 |   |

 

Net periodicbenefit costs related to the Other Benefits Plan were not significant to ourcondensed consolidated financial statements for the quarters ended March 31,2010 and 2009.

 

**8.   CREDIT ARRANGEMENTS**

 

A summary of ourlong-term debt is as follows:

 
| ** **                            | ** ** | **March 31,** | ** **                                                          | **December 31,** | ** ** |
|---------------------------------------|------------|--------------------|---------------------------------------------------------------------|-----------------------|------------|
| ** **                            | ** ** | **2010**           | ** **                                                          | **2009**              | ** ** |
| ** **                            | ** ** | ** **         | ** **                                                          | ** **            | ** ** |
| Series A  Senior Notes           | ** ** | $                  |            14,545 |                  | $          |            14,545 |   |
| Series B  Senior Notes           |       | 36,000             |                                                                | 48,000                |       |
| Term  Loan A credit facility          |       | 120,000            |                                                                | 120,000               |       |
| Term  Loan B credit facility          |       | 30,000             |                                                                | 30,000                |       |
| Revolving  Loan credit facility       |       | 14,500             |                                                                | 10,500                |       |
| Total  long-term debt                 |       | 215,045            |                                                                | 223,045               |       |
| Less  current portion                 |       | 15,636             |                                                                | 15,636                |       |
| Total  long-term debt, net of current |       | $                  | 199,409                                                             |                  | $          | 207,409 |   |

 

Our long-term debtconsists of unsecured Senior Notes and an unsecured Third Amended and RestatedCredit Agreement (“Credit Agreement”) with CoBank. The Credit Agreementincludes term and revolving loan facilities.

 

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

 

On January 29, 2010,we entered into a letter agreement with CoBank amending certain terms of theCredit Agreement, including (i) an increase in the total Revolving Loanfacility of $7,500, (ii) CoBank’s share of the Revolving Loan facilitywill be permanently reduced by $5,000 (rather than $7,500) on December 31,2010 and (iii) the total Revolving Loan facility be $57,500.  As a result of this letter agreement, ourcombined revolving commitment balance on our Revolving Loan and Swingline Loanfacilities is $60,000 and our available balance as of March 31, 2010,which was less our outstanding balance of $14,500, was approximately $45,500.

 

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Our Series A and Series BSenior Notes and the Credit Agreement contain financial and operating covenantsthat may restrict, among other things, the repurchase of the Company’s commonstock, the payment of dividends, the making of certain other restrictedpayments and the incurrence of additional indebtedness. The covenants alsorequire us to maintain certain financial ratios and minimum levels of tangiblenet worth. If we fail to comply with the covenants and other restrictions, suchas making timely interest or principal payments, it could lead to an event ofdefault and the acceleration of our obligations under those agreements. As of March 31,2010, we were in compliance with all of our debt covenants.

 

Our financial covenantsas defined in the Series A and Series B Senior Notes and the CreditAgreement, measured quarterly, are as follows:

 
| **Financial Covenant**   | ** ** | **Required Ratio Level** | ** ** | **Actual Performance   at March 31, 2010** | ** ** |
|--------------------------|------------|--------------------------|------------|-------------------------------------------------|------------|
| Leverage  ratio          |       | Not more than  3.75      |       | 2.83                                            |       |
| Interest  coverage ratio |       | Not less than  3.00      |       | 7.13                                            |       |
| Consolidated  net worth  |       | Not less than  $160,000  |       | $                                               | 270,484    |   |
| Debt  to capitalization  |       | Not more than  0.55      |       | 0.44                                            |       |
|                          |            |                          |            |                                                 |            |  |

 

At March 31, 2010and December 31, 2009, retained earnings of $110,484 and $109,183,respectively, were available for the payments described above.

 

**9.   COMMITMENTS AND CONTINGENCIES**

 

**Litigation,Regulatory Proceedings and Other Contingencies**

 

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

 

We are also subject to anumber of regulatory proceedings occurring at the federal and state levels thatmay have a material impact on our operations. The FCC and state commissionshave authority to issue rules and regulations related to ourbusiness.  A number of proceedings arepending or anticipated that are related to such telecommunications issues ascompetition, interconnection, access charges, intercarrier compensation, broadbanddeployment, consumer protection and universal service reform.  Some proceedings may authorize new servicesto compete with our existing services. Proceedings that relate to our cable television operations includerulemakings on set top boxes, carriage of programming, industry consolidationand ways to promote additional competition. There are various on-going legal challenges to the scope or validity ofFCC orders that have been issued.  As aresult, it is not yet possible to determine fully the impact of the related FCCrules and regulations on our operations.

 

**10.****      ****RECENT ACCOUNTING PRONOUNCEMENTS**

 

**Recently Issued Accounting Pronouncements**

** **

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

 

**Recently Adopted Accounting Pronouncements**

** **

In February 2010,the FASB issued ASU No. 2010-09, *Subsequent Events**(Topic 855) — Amendments to Certain Recognition andDisclosure Requirements* (“ASU 2010-09”). ASU 2010-09 amends ASCTopic 855 to remove the requirement for an SEC filer to disclose the datethrough which subsequent events have been evaluated both in issued and revisedfinancial statements.  ASU 2010-09 waseffective immediately.  Our adoption ofthis guidance had no impact on our condensed consolidated financial positionand results of operations.

 

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In January 2010, theFASB issued ASU No. 2010-06, *Fair Value Measurementsand Disclosures (Topic 820) — Improving Disclosures about Fair ValueMeasurements* (“ASU 2010-06”). ASU 2010-06 amends ASC 820 to require additional disclosures regardingfair value measurements. Specifically, ASU 2010-06 requires entities todisclose additional information regarding (i) the reconciliation ofrecurring Level 3 measurements about purchases, sales, issuances andsettlements on a gross basis, (ii) the amounts of significant transfersbetween Level 1 and Level 2 of the fair value hierarchy and the reasons forthese transfers and (iii) the reasons for any transfers in or out of Level3. In addition to these new disclosure requirements, ASU 2010-06 also amendsASC 820 to further clarify existing guidance pertaining to the level ofdisaggregation at which fair value disclosures should be made and therequirements to disclose information about the valuation techniques and inputsused in estimating Level 2 and Level 3 fair value measurements. Our adoption ofthe requirements of this guidance on January 1, 2010, except for the requirementto separately disclose information about purchases, sales, issuances, andsettlements in the reconciliation of recurring Level 3 measurements on a grossbasis which becomes effective for fiscal years (and interim periods withinthose fiscal years) beginning after December 15, 2010, did not have amaterial impact on our condensed consolidated financial position or results ofoperations.

 

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

 

*(Amounts in thousands, exceptselect operating metrics and share and per share amounts)*

 

Certain statements included in this report, including that whichrelates to the impact on future revenue sources and potential sharingobligations of pending and future regulatory orders, continued expansion of thetelecommunications network and expected changes in the sources of our revenueand cost structure resulting from our entrance into new communications markets,are forward-looking statements and are made pursuant to the safe harborprovisions of the Securities Litigation Reform Act of 1995. These forwardlooking statements generally are identified by the words “believe”, “expect”, “anticipate”,“estimate”, “intend”, “should”, “may”, “will”, “would”, “will be”, “willcontinue” or similar expressions. Such forward looking statements involve knownand unknown risks, the impact of current economic conditions, uncertainties andother factors that may cause actual results, performance or achievements ofSureWest Communications (the “Company”, “we” or “our”) to be different fromthose expressed or implied in the forward-looking statements. A detaileddiscussion of these and other risks and uncertainties that could cause actualresults and events to differ materially from such forward—looking statements isincluded in our 2009 Annual Report on Form 10-K filed with the Securitiesand Exchange Commission (“SEC”). We disclaim any intention or obligation toupdate or revise publicly any forward-looking statements. Management’sDiscussion and Analysis should be read in conjunction with our unauditedcondensed consolidated financial statements and accompanying notes to thefinancial statements (“Notes”) as of and for the three months ended March 31,2010 included in Item 1 of this Quarterly Report on Form 10-Q.

 

**Overview**

 

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

** **

Our Broadband segment earns revenues primarily through subscriptions toour video, high-speed Internet and phone services.  Our video services range from a limited basicservice to our newest product offering Advanced Digital TV (“ADTV”), powered byMicrosoft® MediaroomTM.  Many of ourservices are delivered utilizing FTTH and FTTN networks, which allow us tooffer a high quality experience with our digital TV Packages. ADTV was launchedin the Sacramento region in January 2010 and enhancements were completedon existing copper network marketable homes to provide this new video service,resulting in an increase of 21,300 video marketable homes.  This enhanced video product includes a WholeHome digital video recorder (“DVR”) (which allows subscribers to watch andrecord up to four programs at the same time and pause, replay and rewind “live”television), instant channel changes and an intuitive, user-friendly guide. OurADTV product provides access to over 335 channels in our Californiamarket.  Our full digital cable servicein the Kansas City area provides access to over 300 channels and additionaldigital cable services, including a DVR. Our video product offerings include access to high-definition (“HD”)television (“HDTV”), which provides multiple channels in high definition,premium and pay-per-view channels (which include concerts, wrestling, boxing,sporting events and movies); video on demand (“VOD”) service (which allowsaccess to a library of movies and the ability to start a selection at any timeand to pause, rewind and fast-forward and replay); premium VOD channels, musicchannels and an interactive, on-screen program guide (which allows thesubscriber to navigate the channel lineup and the VOD library).  As of March 31, 2010, approximately 22%of the homes in the areas we serve subscribed to one of our video services.

 

Our high-speed Internetservice can provide Internet access at symmetrical speeds of up to 50 Mbps,depending on the nature of the network facilities that are available, the levelof service selected and the location.  Asof March 31, 2010, approximately 32% of the homes in the areas we servesubscribed to one of our high-speed Internet services.  Our Voice over Internet-Protocol (“VoIP”)digital phone product is available in the Sacramento market in packages rangingfrom basic service to unlimited local and domestic long distance callingplans.  Nearly all of our VoIP phone 

 

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service plans include anextensive array of calling features including caller identification and callwaiting, Find Me/Follow Me, sequential ringing and selective call acceptanceand rejection.  As of March 31,2010, approximately 15% of the homes in our Sacramento market have subscribedto our VoIP phone service. We also offer traditional circuit-switched voiceservices in some of the areas we serve. The total voice penetration in the markets we serve was 23% as of March 31,2010.

 

Our Telecom segment, which operates only in theSacramento area, offers a broad selection of telecommunications servicesincluding traditional circuit-switched voice services, long distance servicesand a number of lightly-regulated or non-regulated services. Customers in theTelecom segment can select individual services or bundled packages that mayinclude unlimited local calling or unlimited local and domestic long distancecalling plans.  Our voice products alsoinclude value-added services such as voicemail, call waiting, calleridentification and many other calling feature options.  Most long distance services are offered byour subsidiary SureWest Long Distance, which is a reseller of long distanceservices.

 

**CurrentBusiness Developments**

 

In connection with our efforts to evaluate and potentially monetizeexcess assets, during 2009 we identified and began to actively market for salecertain of our real estate assets.  Theseregulated assets, which are included in the Telecom Segment, include 21 acresof undeveloped land and an office building. During the quarter ended December 31, 2009, we completed our planto sell these assets and as a result they were classified as assets held forsale.  We expect the land will sell inthe range of $3,000 to $5,000. In connection with the classification to assetsheld for sale, the carrying value of the office building was reduced to itsestimated fair value, less selling costs, based on the current marketconditions and listed selling price. As a result, an impairment charge of$1,199 was recorded against accumulated depreciation during the quarter ended December 31,2009, in accordance with regulated telephone plant and equipment compositegroup remaining life methodology.  Weevaluated the estimated fair value of the assets held for sale as of March 31,2010 and determined there was not a significant change.  Therefore, no additional impairment chargewas recorded during the quarter ended March 31, 2010.

 

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

 

**Resultsof Operations**

 

The tables below reflect certain financial data (on a consolidated andsegment basis) and select operating metrics for each of our reportable segmentsas of and for the quarters ended March 31, 2010 and 2009.

 

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**Financial Data**

 
| ** **                                    | ** ** | **Quarter Ended March 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | ** **                       | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                    | ** ** | **2010**                         | ** ** | **2009** | ** ** | **Change** | ** ** | **Change** | ** ** |
| **Operating  revenues****(1)**                |       |                             |       |   |   |   |   |   |   |
| Broadband                                     |       | $                                | 42,577     |   | $ | 39,222 |   | $ | 3,355 |   | 9 | % |
| Telecom                                       |       | 17,611                           |       | 21,720 |   | (4,109 | ) | (19 | ) |
| Operating  revenues                           |       | 60,188                           |       | 60,942 |   | (754 | ) | (1 | ) |
|                                          |       |                             |       |   |   |   |   |   |   |
| **Income  (loss) from operations**            |       |                             |       |   |   |   |   |   |   |
| Broadband                                     |       | (4,572                           | )          | (7,002 | ) | 2,430 |   | 35 |   |
| Telecom                                       |       | 7,714                            |       | 10,322 |   | (2,608 | ) | (25 | ) |
| Income from  operations                       |       | 3,142                            |       | 3,320 |   | (178 | ) | (5 | ) |
|                                          |       |                             |       |   |   |   |   |   |   |
| **Income  (loss) from continuing operations** |       |                             |       |   |   |   |   |   |   |
| Broadband                                     |       | (3,720                           | )          | (5,398 | ) | 1,678 |   | 31 |   |
| Telecom                                       |       | 4,247                            |       | 5,477 |   | (1,230 | ) | (22 | ) |
| Income (loss)  from continuing operations     |       | 527                              |       | 79 |   | 448 |   | 567 |   |
|                                          |       |                             |       |   |   |   |   |   |   |
| **Adjusted  EBITDA****(2)**                   |       |                             |       |   |   |   |   |   |   |
| Broadband                                     |       | 8,199                            |       | 5,249 |   | 2,950 |   | 56 |   |
| Telecom                                       |       | 11,269                           |       | 14,244 |   | (2,975 | ) | (21 | ) |
| Adjusted EBITDA                               |       | 19,468                           |       | 19,493 |   | (25 | ) | (0 | ) |
|                                               |            |                                  |            |  |  |  |  |  |  |  |  |  |

 

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(1)             Externalcustomers only.

(2)             AdjustedEBITDA represents net income (loss) from continuing operations excludingamounts for income taxes; depreciation and amortization; non-cash pension andcertain post-retirement benefits; non-cash stock compensation; and all othernon-operating income and expenses. Adjusted EBITDA is a common measure of operating performance in thetelecommunications industry. Adjusted EBITDA helps us evaluate our performanceby removing from our operating results items which do not relate to our coreoperating performance.  The presentationof Adjusted EBITDA is not a measure of financial performance under UnitedStates generally accepted accounting principles (“U.S. GAAP” or “GAAP”) andshould not be considered in isolation or as a substitute for consolidated netincome (loss) as a measure of performance and may not be comparable tosimilarly titled measures used by other companies.  The following table is a reconciliation ofour income (loss) from continuing operations to Adjusted EBITDA on aconsolidated and segment basis for the quarters ended March 31, 2010 and2009:

 
| ** **                                   | ** ** | **Quarter Ended March 31, 2010** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **Broadband**                         | ** ** | **Telecom** | ** ** | **Consolidated** | ** ** |
| Income (loss) from continuing operations     |       | $                                     | (3,720     | ) | $ | 4,247 |   | $ | 527 |   |
| Add (subtract):                              |       |                                  |       |   |   |   |   |
| Income tax expense (benefit)                 |       | (2,504                                | )          | 3,328 |   | 824 |   |
| Other (income) expense                       |       | 1,652                                 |       | 139 |   | 1,791 |   |
| Depreciation and amortization                |       | 12,180                                |       | 2,926 |   | 15,106 |   |
| Non-cash pension and post-retirement expense |       | 205                                   |       | 215 |   | 420 |   |
| Non-cash stock compensation expense          |       | 386                                   |       | 414 |   | 800 |   |
| Adjusted EBITDA                              |       | $                                     | 8,199      |   | $ | 11,269 |   | $ | 19,468 |   |

 

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| ** **                                   | ** ** | **Quarter Ended March 31, 2009** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **Broadband**                         | ** ** | **Telecom** | ** ** | **Consolidated** | ** ** |
| Income (loss) from continuing operations     |       | $                                     | (5,398     | ) | $ | 5,477 |   | $ | 79 |   |
| Add (subtract):                              |       |                                  |       |   |   |   |   |
| Income tax expense (benefit)                 |       | (3,656                                | )          | 4,540 |   | 884 |   |
| Other (income) expense                       |       | 2,052                                 |       | 305 |   | 2,357 |   |
| Depreciation and amortization                |       | 11,620                                |       | 3,190 |   | 14,810 |   |
| Non-cash pension and post-retirement expense |       | 327                                   |       | 428 |   | 755 |   |
| Non-cash stock compensation expense          |       | 304                                   |       | 304 |   | 608 |   |
| Adjusted EBITDA                              |       | $                                     | 5,249      |   | $ | 14,244 |   | $ | 19,493 |   |

 

**Select Operating Metrics**

 
| ** **                                          | ** ** | **As of March 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------|------------|
| ** **                                          | ** ** | **2010**                 | ** ** | **2009** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| **Broadband**                                       |       |                     |       |   |   |   |   |   |   |
| Total  residential subscribers (1)                  |       | 102,000                  |       | 102,800 |   | (800 | ) | (1 | )% |
| Broadband  residential revenue-generating units (2) |       | 228,500                  |       | 224,400 |   | 4,100 |   | 2 |   |
| Data                                                |       | 97,800                   |       | 98,100 |   | (300 | ) | (0 | ) |
| Video                                               |       | 58,600                   |       | 60,000 |   | (1,400 | ) | (2 | ) |
| Voice                                               |       | 72,100                   |       | 66,300 |   | 5,800 |   | 9 |   |
| Total business  customers (3)                       |       | 7,200                    |       | 6,700 |   | 500 |   | 7 |   |
|                                                | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Telecom**                                         |       |                     |       |   |   |   |   |   |   |
| Voice  revenue-generating units (4)                 |       | 35,500                   |       | 49,500 |   | (14,000 | ) | (28 | ) |
| Total business  customers (3)                       |       | 8,300                    |       | 9,000 |   | (700 | ) | (8 | ) |

 

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(1)             Total residential subscribersare customers who receive one or more residential data, video or voice servicesfrom one of our subsidiaries in the Broadband segment.

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

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

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

 

**Consolidated Overview**

 

*OperatingRevenues*

 

Operating revenues in the Broadband segment increased$3,355 in the quarter ended March 31, 2010 compared to the same period in2009. Broadband residential revenues increased $2,123 due in part to a 2%growth in RGUs. Broadband residential revenues also increased as a result ofhigher pricing for video and data services in 2010, which were effective in November 2009.

 

We offer a broadband VoIP digital phone service (“VoIPphone service”) in the Sacramento market, including in the Telecom segmentservice territory.  The VoIP phoneservice provides us with a competitive triple-play offering and has mitigatedpast declines in consolidated operating revenue and voice RGUs by allowing usto migrate those customers to voice RGUs in the Broadband segment rather thanlosing those customers to competitors. Broadband voice RGUs in the Sacramento market increased 23% as of March 31,2010 compared to the same prior year period.

 

Broadband business revenues increased $985, or 10%, inthe quarter ended March 31, 2010 compared to the same period in 2009.Business customers increased 7% as of March 31, 2010 compared to the sameperiod in 2009 as a result of growth primarily in the Kansas City market.  The variety of our product offerings and ourability to offer customized service packages to businesses of all sizes as wellas superior business customer satisfaction levels contributed to the currentyear growth in business revenue and will continue to provide us with newopportunities in the commercial market.

 

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We will continue to invest in success-based capital tocapitalize on new opportunities as they emerge, and to develop and enhance thebroadband infrastructure and the services we offer, while focusing on thegeneration of new customers and increasing residential penetration on existingmarketable homes.

 

Operating revenues in theTelecom segment decreased $4,109 in the quarter ended March 31, 2010compared to the same period in 2009. Residential services, which decreased$1,994, were largely impacted by our customer’s migration toward alternativecommunication services, including those offered by our Broadband segment, asdiscussed above, which contributed to a 28% decline in the Telecom segmentvoice RGUs as of March 31, 2010 compared to 2009.  Business revenues decreased $630 as a resultof an 8% decline in business customers due to the economic impact on small andmedium sized businesses in the California market. The decrease in operatingrevenues was also impacted by the scheduled reduction in support received fromthe California High Cost Fund (“CHCF”) of $510 during the quarter ended March 31,2010 compared to the same period in 2009. See the Regulatory Matters section below for a further discussionregarding the regulatory subsidies we receive.

 

The Telecom segmentprovides wholesale access and Digital Subscriber Line (“DSL”) services throughthe use of its network to the Broadband segment, which enables the Broadbandsegment to offer high-speed internet, VoIP and video services to thosecustomers within SureWest Telephone’s service area. These wholesale servicesare included as intersegment revenues and expenses in each of the respectivesegments and eliminated in the consolidated statements of income.

 

*OperatingExpenses*

 

Consolidated operating expenses, excludingdepreciation and amortization, decreased $872 during the quarter ended March 31,2010 compared to the same period in 2009. The decline in our consolidatedoperating expenses was primarily a result of improved operating efficienciesand a decrease in labor costs through a 3% reduction in headcount. In addition,costs associated with our defined benefit pension plan (the “Pension Plan”)decreased consolidated operating expenses by $276 during the quarter ended March 31,2010 compared to the same period in 2009.

 

Cost of services and products expense decreased $96 inthe current year period compared to the same period in 2009.  The decrease in expenses in the current yearperiod was largely due to savings in maintenance and repair costs and adecrease in labor costs as a result of the reduction in headcount; however,these cost savings were reduced in part by an increase in programming andnetwork costs related to providing video and data services resulting from anincrease in programming fees per subscriber and the growth in businessservices.

 

Customer operations and selling expense decreased $26during the quarter ended March 31, 2010 compared to the same period in2009.  The decrease in expenses in thecurrent year period was largely due to reduction in labor costs; however, wasoffset in part by an increase in advertising and promotion expense related tothe launch of our new ADTV product during the current year period.

 

General and administrative expenses decreased $750during the quarter ended March 31, 2010 compared to the same period in2009 primarily as a result of a decrease in labor costs due to a decline inpension expense and information technology project support costs.

 

Our consolidated depreciation and amortization expenseincreased $296 during the quarter ended March 31, 2010 compared to thesame period in 2009.  The increase indepreciation and amortization expense was primarily due to the continuedexpansion of the network and success-based capital projects undertaken withinthe residential and business broadband service territories; however, waspartially offset by certain Telecom assets becoming fully depreciated during2009.

 

*Reclassifications*

 

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

 

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**Segment Results of Operations**

 

**Broadband**

 
| ** **                                        | ** ** | **Quarter Ended March 31,** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | ** **                       | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                        | ** ** | **2010**                         | ** ** | **2009** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                              |       |                             |       |   |   |   |   |   |   |
| Data                                              |       | $                                | 12,248     |   | $ | 10,763 |   | $ | 1,485 |   | 14 | % |
| Video                                             |       | 12,219                           |       | 11,689 |   | 530 |   | 5 |   |
| Voice                                             |       | 6,507                            |       | 6,399 |   | 108 |   | 2 |   |
| Total  residential revenues                       |       | 30,974                           |       | 28,851 |   | 2,123 |   | 7 |   |
| Business                                          |       | 10,570                           |       | 9,585 |   | 985 |   | 10 |   |
| Access                                            |       | 727                              |       | 384 |   | 343 |   | 89 |   |
| Other                                             |       | 306                              |       | 402 |   | (96 | ) | (24 | ) |
| Total operating  revenues from external customers |       | 42,577                           |       | 39,222 |   | 3,355 |   | 9 |   |
| Intersegment  revenues                            |       | 168                              |       | 91 |   | 77 |   | 85 |   |
| Operating  expenses                               |       |                             |       |   |   |   |   |   |   |
| Cost of services  and products*                   |       | 23,593                           |       | 22,900 |   | 693 |   | 3 |   |
| Customer  operations and selling                  |       | 6,391                            |       | 6,260 |   | 131 |   | 2 |   |
| General and  administrative                       |       | 5,153                            |       | 5,535 |   | (382 | ) | (7 | ) |
| Depreciation and  amortization                    |       | 12,180                           |       | 11,620 |   | 560 |   | 5 |   |
| Loss from  operations                             |       | (4,572                           | )          | (7,002 | ) | 2,430 |   | 35 |   |
| Loss from  continuing operations                  |       | (3,720                           | )          | (5,398 | ) | 1,678 |   | 31 |   |
|                                                   |            |                                  |            |  |  |  |  |  |  |  |  |  |

 

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*Exclusive ofdepreciation and amortization

 

**BroadbandSegment Operating Revenues**

 

Operating revenues from external customers in theBroadband segment increased $3,355 in the quarter ended March 31, 2010compared to the same period in 2009.  Theincrease in operating revenues was due in part to the growth in residentialRGUs and business customers.

 

**Residential Revenues**

 

Broadband residential revenues increased $2,123 in thequarter ended March 31, 2010 compared to the same period in 2009.  Broadband residential RGUs increased 2% as ofMarch 31, 2010 compared to the same period in 2009 due to a 9% growth invoice RGUs, as discussed below.  Weanticipate continued growth in residential broadband RGUs and average revenueper user resulting from our HD DVR, VoIP phone service and the launch in January 2010of our ADTV product powered by Microsoft® MediaroomTM.  ADTV iscurrently deployed through our copper and fiber networks in the greaterSacramento area.  The integration of thenew MediaroomTM platform includes a Whole HomeDVR, which allows customers the ability to watch recorded shows on anytelevision in the house, record multiple shows at one time and utilize anintuitive on-screen guide and user interface.

 

*Data*

 

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

 

Our residential data revenues increased $1,485 in thequarter ended March 31, 2010 compared to the same period in 2009 as aresult of higher price points on our data services, which were effective November 2009.

 

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*Video*

 

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

 

Residential video revenues increased $530 in thequarter ended March 31, 2010 compared to the same period in 2009.  Revenues increased as a result of both higherpricing on many of our video service offerings, which were effective November 2009,and new demand for enhanced video offerings such as VOD, DVR and HDTV.

 

*Voice*

 

We offer phone services that provide local andlong-distance calling and include features such as caller ID and call waiting.As of March 31, 2010, approximately 23% of the homes in the areas we servesubscribed to one of our phone services.

 

Our VoIP phone service is offered in the Sacramentomarket and is available in packages ranging from basic telephone service tounlimited local and domestic long distance calling plans.  Nearly all of our VoIP phone service plansinclude enhanced calling features such as Find Me/Follow Me, sequential ringingand selective call acceptance and rejection. Voice RGUs in the Sacramento market increased 23% as of March 31,2010 compared to the same period in 2009. As of March 31, 2010, approximately 15% of the homes in ourSacramento market have subscribed to our VoIP phone service.  Our VoIP phone service in the Sacramentomarket offers our customers, including those in the Telecom service territory,an alternative to traditional circuit switched land line service and presentsour customers with a more competitive triple-play offering with increasedoptions and multiple packages.

 

Residential voice revenues increased $108 in thequarter ended March 31, 2010 compared to the same period in 2009 primarilyas a result of growth in voice RGUs of 9% in that same time period.  Average revenue per voice user declined toapproximately $30.25 as of March 31, 2010 from approximately $32.85compared to the same period in 2009, due to customers receiving service as apart of a promotional offer or in a bundled service offering.

 

**Business Revenues**

 

We provide a variety of business communicationsservices to small, medium and large business customers.  The services we offer to our business customersinclude: fiber-optics-based high-speed Internet, customized data and Ethernettransport services, data center and disaster recovery solutions, traditionallandline and VoIP phone services and digital TV.

 

Business revenues increased $985 in the quarter ended March 31,2010 compared to the same period in 2009. This increase was due primarily to a 7% increase in business customersas of March 31, 2010 compared to the same period in 2009.  Our Kansas City operations contributed asignificant portion of the business revenue growth.

 

**Access Revenues**

 

Access revenues increased $343 in the quarter ended March 31, 2010compared to the same period in 2009.  Theincrease was mostly attributable to cash settlements received during thequarter ended March 31, 2010 from certain telecommunications carriersrelating to disputed carrier access charges which were fully reserved in prioryear periods.

 

**BroadbandSegment Operating Expenses**

 

Total operating expenses in the Broadband segment increased $442 in thequarter ended March 31, 2010 compared to the same period in 2009.

 

Cost of services and products (exclusive of depreciation andamortization) increased $693 in the quarter ended March 31, 2010 comparedto the same period in 2009.  The increasein costs in the current year period was largely due to direct costs incurred toprovide our voice, video and data services. Video programming costs have been increasing over the last several yearsprimarily due to the expansion of channels and an increase in costs on a persubscriber basis and per program channel, particularly for local televisionbroadcast stations, sports and HD channels. Costs to 

 

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provide data and voice services increased due to the additionalcapacity required to handle the increasing volume of data usage, including ourVoIP phone service in the Sacramento market. The increase was offset in part by declines in maintenance and repaircosts and a decrease in labor due to improved operating efficiencies.

 

Customer operations expense increased $131 in the quarter ended March 31,2010 compared to the same period in 2009. The increase in the current year period was mostly attributable to anincrease in salaries and wages, commissions and advertising costs resultingfrom the launch of our new ADTV product. The increase was offset in part by a decline in labor costs resultingfrom improved operating efficiencies.

 

General and administrative expense decreased $382 inthe quarter ended March 31, 2010 compared to the same period in 2009primarily due to decreases in (i) information technology costs related tosystem maintenance and development and increased production support projects inthe prior year period and (ii) a decline in labor costs resulting fromimproved operating efficiencies in the current year period.

 

Depreciation and amortization increased $560 in the quarter ended March 31,2010 compared to the same period in 2009 due primarily to the continuedexpansion of the broadband network and success-based capital projects.

 

**Telecom**

 
| ** **                                        | ** ** | **Quarter Ended March 31,** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | ** **                       | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                        | ** ** | **2010**                         | ** ** | **2009** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                              |       |                             |       |   |   |   |   |   |   |
| Residential                                       |       | $                                | 4,868      |   | $ | 6,862 |   | $ | (1,994 | ) | (29 | )% |
| Business                                          |       | 8,418                            |       | 9,048 |   | (630 | ) | (7 | ) |
| Access                                            |       | 4,160                            |       | 5,647 |   | (1,487 | ) | (26 | ) |
| Other                                             |       | 165                              |       | 163 |   | 2 |   | 1 |   |
| Total operating  revenues from external customers |       | 17,611                           |       | 21,720 |   | (4,109 | ) | (19 | ) |
| Intersegment  revenues                            |       | 4,919                            |       | 4,874 |   | 45 |   | 1 |   |
| Operating  expenses                               |       |                             |       |   |   |   |   |   |   |
| Cost of services  and products*                   |       | 5,705                            |       | 6,268 |   | (563 | ) | (9 | ) |
| Customer  operations and selling                  |       | 2,390                            |       | 2,641 |   | (251 | ) | (10 | ) |
| General and  administrative                       |       | 3,795                            |       | 4,173 |   | (378 | ) | (9 | ) |
| Depreciation and  amortization                    |       | 2,926                            |       | 3,190 |   | (264 | ) | (8 | ) |
| Income from  operations                           |       | 7,714                            |       | 10,322 |   | (2,608 | ) | (25 | ) |
| Income from  continuing operations                |       | 4,247                            |       | 5,477 |   | (1,230 | ) | (22 | ) |
|                                                   |            |                                  |            |  |  |  |  |  |  |  |  |  |

 

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*Exclusive ofdepreciation and amortization

 

**TelecomSegment Operating Revenues**

 

Operating revenues from external customers in theTelecom segment decreased $4,109 in the quarter ended March 31, 2010compared to the same period in 2009. The decrease in operating revenues was duein part to the decline in voice RGUs, business customers and regulatorysubsidies.

 

**Residential Revenues**

 

SureWest Telephone offers several different phone service options, frombasic local service packages to unlimited California and nationwide flat-rateplans.  All of the plans include optionsfor voicemail and other calling features such as caller ID and call forwarding.* *SureWest Telephoneresidential revenues decreased $1,994 in the quarter ended March 31, 2010compared to the same period in 2009 as we continue to experience decreases inrevenue due to competition from wireless, wireline, and digital phonecompetitors (including SureWest Broadband). Residential subscribers and voice RGUs declined approximately 28% as of March 31,2010 compared to the same period in 2009. We continue to mitigate additional voice access line and operatingrevenue losses through our VoIP phone service now offered to customers withinthe Telecom service area through our Broadband segment.  As a result, we expect a portion of theTelecom segment’s voice revenue will continue to shift to the VoIP servicebeing offered by our Broadband segment. As reflected in the Select Operating Metrics section above, as of March 31,2010, nearly half of the decline in Telecom voice RGUs is due to customers whohave transferred to SureWest Broadband’s VoIP phone service rather than beinglost to competitors.  See the Broadbandsegment residential revenue section above for a more detailed discussionregarding VoIP and other services offered by SureWest Broadband.

 

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***BusinessRevenues***

* *

We provide a variety of business service offerings to small, medium andlarge business customers, including many services over our advanced fibernetwork.  The services we offer to ourbusiness customers include, but are not limited to fiber-optics-basedhigh-speed Internet, customized data and Ethernet transport services, datacenter and disaster recovery solutions, traditional landline and scalable IPcommunication systems.

 

SureWest Telephone business revenues decreased by $630 in the quarterended March 31, 2010 compared to the same period in 2009 largely due tothe current economic impact on small to medium sized businesses and continuedstrong competitive pressures, as discussed above. While our Telecom segmentbusiness customer base declined 8% as of March 31, 2010 compared to thesame period in 2009, average monthly revenue per user (“ARPU”) remainedrelatively flat.

 

**Access Revenues**

 

Accessrevenues, which include interstate and intrastate switched and special accessrevenue, interstate common line (“CL”) revenue and declining support paymentsfrom the CHCF, decreased $1,487 in the quarter ended March 31, 2010compared to the same period in 2009. As anticipated, CHCF support receivedduring the first quarter of 2010 decreased by $510 compared to the same periodin 2009. Switched access revenues declined by approximately $222 in the quarterended March 31, 2010 compared to the same period in 2009 due to declinesin minutes of use associated with the reduction of residential voice servicespreviously discussed.  Interstate CLsettlements received from the National Exchange Carrier Association (“NECA”)decreased by $330 in the quarter ended March 31, 2010 compared to the sameperiod in 2009. Revenue recovery from the NECA pool declined as a result of thereduced customer base and a lower rate base due to cost reductions in theTelecom segment.  See the RegulatoryMatters**section below for a more detaileddiscussion regarding SureWest Telephone’s regulated revenues.

 

**Telecom Segment OperatingExpenses**

 

Total operating expenses for the Telecom segment decreased $1,192 inthe quarter ended March 31, 2010 compared to the same period in2009.  As discussed in the Residential Revenue section above, during 2010we experienced a decline in voice RGUs due in part to subscribers opting toinitiate VoIP phone service offered by our Broadband segment.  As a result, certain of the operating costsassociated with these subscribers are now included in the Broadbandsegment.  As described in theConsolidated Overview section above, costs related to our Pension Plandecreased approximately $179 in the quarter ended March 31, 2010 comparedto the same period in 2009.

 

Cost of services and products (exclusive of depreciation andamortization) decreased $563 in the quarter ended March 31, 2010 comparedto the same period in 2009. Local and long distance expenses declined as aresult of decreases in residential voice RGUs and business customers, as of March 31,2010 compared to the same period in 2009, as discussed above.  Additionally, in the current year period,rent and utility costs have declined due to a consolidation of office space.

 

Customer operations expense decreased $251 in the quarter ended March 31,2010 compared to the same period in 2009. This decrease was primarily due tothe decline in voice RGUs and the business customer base, as discussed above,and reduced spending on sales and advertising, which included radio andtelevision advertising in the current year period in the Telecom segmentservice territory.

 

General and administrative expense decreased $378 in the quarter ended March 31,2010 compared to the same period in 2009. The decrease was primarily due to a decline in costs associated with ourPension Plan and information technology project support costs.

 

Depreciation and amortization decreased $264 in the quarter ended March 31,2010 compared to the same period in 2009. This decrease was due predominately to a portion of aerial andunderground cable becoming fully depreciated during 2009.

 

**Regulatory Matters**

 

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

 

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·                  business and residential subscribers ofbasic exchange services;

·                  surcharges mandated by state commissions;

·                  long distance carriers, for networkaccess service;

·                  competitive access providers andcommercial enterprises for network access service;

·                  interstate pool settlements from NECA;

·                  support payments from federal or stateprograms; and

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

 

Certainof our interstate telecommunications service rates are subject to regulation bythe Federal Communications Commission (“FCC”). Interstate switched and specialaccess rates are established through a SureWest Telephone tariff filed with theFCC.  For interstate CL charges, SureWestTelephone concurs with tariffs filed by NECA. Intrastate service rates are subject to regulation by statecommissions.  Prices for intrastate telecommunicationsservices are established through tariffs or through other regulatorymechanisms, including, in California, service guides.  Pending and future regulatory actions mayhave a material impact on our consolidated financial position and results ofoperations.

 

*FCC Matters*

 

Undercurrent FCC rules governing rate making, SureWest Telephone is required toestablish rates for its interstate telecommunications services based onprojected demand usage for the various services.  SureWest Telephone projects its earningsthrough the use of annual cost separation studies, which utilize estimatedtotal cost information and projected demand usage. Carriers are required tofollow FCC rules in the preparation of these annual studies.  SureWest Telephone determines actual earningsfrom its interstate rates as actual volumes and costs become known.  The FCC monitors SureWest Telephone’sinterstate earnings.

 

The FCC wasdirected by Congress to develop a National Broadband Plan (“NBP”) as part ofthe American Recovery and Reinvestment Act of 2009.  On March 16, 2010, after takingextensive public comment, the FCC released the full text of its NBP, whichcontains policy recommendations on a variety of issues that the FCC has linkedto expanded broadband deployment.  The policy recommendations includeguiding principles to foster competition in broadband, telephone, wireless andcable services over the next decade, including recommendations related touniversal service fund (“USF”) reform, intercarrier compensation, cable set-topboxes and spectrum reallocation, among others.  The NBP recommendationsmost relevant to the company include shifting the current USF mechanisms thatsupport universal voice telephone services to support of universal broadbanddeployment, and the phased reduction of intercarrier access compensation levelsto local reciprocal compensation levels, with a potential phase-out of all suchcompensation within ten years.  Some of these recommendations only restatepre-existing FCC proposals in current rulemakings while others raise newissues.  The FCC did not actually take action on any issue in the NBPitself.  Approximately half of these issues will require separate FCCrulemaking action, and the remainder consists of policy recommendations for actionby Congress or other governmental entities.  The FCC is already beginningsome separate proceedings.  Action to deal with issues addressed by theNBP may have a material impact on us.  We will continue to monitor thesematters and their potential impact on our consolidated financial position andresults of operations.

 

*California PublicUtility Commission (“CPUC”) Matters*

* *

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

 

As part of the Settlement Agreement, SureWest Telephone was required toimplement an additional annual consumer dividend of $1,300 on January 1,2007 to end-users receiving SureWest Telephone services subject to sharing onor after that date.  In December 2006,the CPUC authorized us to offset our annual $11,500 interim draw from the CHCFwith the aforementioned $1,300 consumer dividend Settlement Agreement.  The CHCF was previously authorized by theCPUC on an interim basis to offset certain of SureWest Telephone’s intrastateregulated operating expenses that previously had been recovered through directcarrier payments. In September 2007, the CPUC issued Decision 07-09-002which provides for SureWest Telephone to phase-down its annual CHCF interimdraw over a five-year period, to 

 

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end on January 1, 2012.  In2009, our interim CHCF draw was $6,120 and is being incrementally reduced by$2,040 annually.  We anticipate our 2010interim CHCF draw will be $4,080.

 

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

* *

*Other Regulatory Matters*

* *

We are also subject to a number of regulatory proceedings occurring atthe federal and state levels that may have a material impact on our operations.The FCC and state commissions have authority to issue rules andregulations related to our business.  Anumber of proceedings are pending or anticipated that are related to suchtelecommunications issues as competition, interconnection, access charges,intercarrier compensation, broadband deployment, consumer protection anduniversal service reform.  Someproceedings may authorize new services to compete with our existingservices.  Proceedings that relate to ourcable television operations include rulemakings on set top boxes, carriage ofprogramming, industry consolidation and ways to promote additionalcompetition.  There are various on-goinglegal challenges to the scope or validity of FCC orders that have beenissued.  As a result, it is not yetpossible to determine fully the impact of the related FCC rules andregulations on our operations.

 

**Non-Operating Items**

 

*Other Income andExpense, Net*

* *

Consolidated interest expense decreased $667 in thequarter ended March 31, 2010 compared to the same period in 2009,primarily due to decreased principal balances. Further, decreases in interest rates on our outstanding debt balances,subject to London Interbank Offered Rates, have also contributed to thereduction of interest expense.

 

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

 

*Income Taxes*

* *

Income taxes decreased $60 during the quarter ended March 31, 2010compared to the same period in 2009.  Theeffective federal income tax rates for continuing operations were 61.0% and91.8% for the quarters ended March 31, 2010 and 2009, respectively.  The decline in income taxes and our effectiverate was due to a decrease in permanent differences resulting from the decreasebetween the grant and vesting prices of restricted common stock and restrictedcommon stock units that vested during the three-month period ended March 31,2010 offset in part by an increase in income before income taxes and changes inour state apportionment factors.

 

**Liquidity and Capital Resources**

 

**Overview**

 

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

 

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The following table summarizes our cash flows:

 
| ** **                             | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|
| ** **                             | ** ** | **2010**                              | ** ** | **2009** | ** ** | **$ Change** | ** ** |
| Cash Flows  Provided By (Used In)      |       |                                  |       |   |   |   |   |
| Operating Activities:                  |       |                                  |       |   |   |   |   |
| Continuing  operations                 |       | $                                     | 16,341     |   | $ | 9,983 |   | $ | 6,358 |   |
| Discontinued  operations               |       | —                                |       | (439 | ) | 439 |   |
|                                   |       |                                  |       |   |   |   |   |
| Investing  Activities:                 |       |                                  |       |   |   |   |   |
| Continuing  operations                 |       | (8,845                                | )          | (9,130 | ) | 285 |   |
|                                   |       |                                  |       |   |   |   |   |
| Financing  Activities:                 |       |                                  |       |   |   |   |   |
| Continuing  operations                 |       | (8,003                                | )          | (1,576 | ) | (6,427 | ) |
| Decrease in Cash  and Cash Equivalents |       | $                                     | (507       | ) | $ | (1,162 | ) | $ | 655 |   |

 

**Cash Flows Provided By Operating Activities**

 

Net cash provided by continuing operating activities was $16,341 duringthe three-month period ended March 31, 2010.  Significant adjustments to net income toarrive at cash provided by operating activities primarily include (i) non-cashcharges of $16,546 consisting primarily of (a) depreciation andamortization of $15,106 due to capital investments principally in the Broadbandsegment, (b) deferred income taxes of $640 and (c) stock compensationexpense of $800 and (ii) a decrease in trade and miscellaneous accountsreceivable of $1,618 due primarily to the timing in the collection ofreceivables from regulatory agencies. Cash provided by operating activities was offset in part by a decreasein accrued compensation of $2,406 related to the payment in the current year of2009 incentive compensation.

 

**Cash Flows Used In Investing Activities***.*

 

Net cash used in continuing investing activities was $8,845 during thethree-month period ended March 31, 2010 and was primarily related tocapital expenditures that were partially offset by proceeds from the sale ofour auction rate security (“ARS”).

 

*Capital Expenditures*

 

Capital expenditures continue to be our primary recurring investingactivity and were $12,536 in the three-month period ended March 31, 2010.We invest a significant portion of our capital spending in our Broadbandsegment as a result of business growth, the introduction of new products andservices and the expansion of the network.

 

*Auction Rate Security*

 

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

 

As of December 31, 2009, the ARS and Right wereclassified as current assets in short-term investments on our consolidatedbalance sheet, as a result of our put option period under the Right. Wecontinued to earn and receive interest on our ARS, as specified in the terms ofthe prospectus, during 2009.

 

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

 

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**Cash Flows Provided By Financing Activities**

 

Net cash used in financing activities consists primarily of ourproceeds and principal payments on long-term borrowings.

 

*Long-term Debt*

 

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

 

As of March 31, 2010, $14,545 and $36,000 wereoutstanding on the Series A and Series B Senior Notes, respectively.As of March 31, 2010, $120,000, $30,000, $14,500 and zero were outstandingon the CoBank Term Loan A, Term Loan B, Revolving Loan and Swingline Loanfacilities, respectively. We had no short-term borrowings as of March 31,2010.

 

On January 29, 2010, we entered into a letter agreement with CoBankamending certain terms of the Credit Agreement, including (i) an increasein the total Revolving Loan facility of $7,500, (ii) CoBank’s share of theRevolving Loan facility will be permanently reduced by $5,000 (rather than$7,500) on December 31, 2010 and (iii) the total Revolving Loanfacility be $57,500.  As a result of thisletter agreement, our combined revolving commitment balance on our RevolvingLoan and Swingline Loan facilities was $60,000 and our available balance as of March 31,2010, which is less our outstanding balance of $14,500, was approximately$45,500.

 

*Debt Covenants*

 

Our Series A and Series B Senior Notes and the CreditAgreement contain financial and operating covenants that may restrict, amongother things, the repurchase of the Company’s common stock, the payment ofdividends, the making of certain other restricted payments and the incurrenceof additional indebtedness. The covenants also require us to maintain certainfinancial ratios and minimum levels of tangible net worth. If we fail to complywith the covenants and other restrictions, such as making timely interest orprincipal payments, it could lead to an event of default and the accelerationof our obligations under those agreements. As of March 31, 2010, we werein compliance with all of our debt covenants.

 

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

 
| **Financial  Covenant**  | ** ** | **Required Ratio Level** | ** ** | **Actual Performance   at March 31, 2010** | ** ** |
|--------------------------|------------|--------------------------|------------|-------------------------------------------------|------------|
| Leverage ratio           |       | Not more than 3.75       |       | 2.83                                            |       |
| Interest  coverage ratio |       | Not less than 3.00       |       | 7.13                                            |       |
| Consolidated net  worth  |       | Not less than $160,000   |       | $                                               | 270,484    |   |
| Debt to  capitalization  |       | Not more than 0.55       |       | 0.44                                            |       |
|                          |            |                          |            |                                                 |            |  |

 

At March 31, 2010 and 2009, retained earnings of $110,484 and$109,183, respectively, were available for the payments described above.

 

*Share Repurchase Program*

 

Our Board of Directors has authorized the repurchaseof up to 2.5 million shares of our common stock. Shares are purchased fromtime to time in the open market or through privately negotiated transactions,subject to overall financial and market conditions. Starting in the firstquarter of 2000 through March 31, 2010, approximately 1.9 million sharesof common stock had been repurchased. As of March 31, 2010, we hadremaining authorization from the Board of Directors to repurchase approximately611 thousand additional outstanding shares. We did not repurchase any sharesduring the quarters ended March 31, 2010 and 2009.

 

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**Sufficiency of Cash Resources**

 

We had cash, cash equivalents and short-terminvestments at March 31, 2010 of $7,583. As discussed in the Long-term debt section above, we have additionallong-term borrowing capacity of approximately $60,000 available to us throughour Revolving Loan facility; of which, $14,500 was outstanding as of March 31,2010.  We believe our operating cashflows and our borrowing capacity are sufficient to satisfy our liquidityrequirements for the next twelve months, while maintaining adequate cash andcash equivalents.

 

Our most significant use of funds in the remainder of2010 is expected to be for (i) budgeted capital expenditures of $42,000 to$47,000, (ii) scheduled payments of long-term debt of $3,636 and (iii) anticipatedinterest payments of $8,100. As discussed above, throughout the year we mayrepurchase shares of the Company’s common stock in the open market at theprevailing market price up to an amount authorized by the Board of Directors.

 

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

 

*Defined Benefit Pension Plan*

 

As required, we contribute to the Pension Plan,Supplemental Executive Retirement Plan and certain post-retirement benefitsother than pensions (“Other Benefits Plan”) (collectively the “Plans”), whichprovide retirement benefits to certain eligible employees. Contributions areintended to provide for benefits attributed to service to date. Our fundingpolicy is to contribute annually an actuarially determined amount consistentwith applicable federal income tax regulations. We stopped accruing benefitsfor active participants effective April 1, 2007 and we anticipate thatfuture funding requirements will decrease significantly as a result of thefreeze of the Plans.  However, thesignificant decline in the equity markets precipitated by the recent creditcrisis and financial system instability has negatively affected the value ofour Pension Plan assets.  Our minimumfunding requirement for 2010 related to the Pension Plan is approximately$2,700; however, due to a carryover credit balance of approximately $4,400, nocash contribution will be required.  Wewill continue to evaluate the future funding requirements of the Plans and fundthem as necessary. See Note 7 for a more detailed discussion regarding ourPension Plan and Other Benefits Plan.

 

*Income Taxes*

 

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

 

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

 

Historically, pre-tax earnings for financial reporting purposes haveexceeded the amount of taxable income reported for income tax purposes. Thishas primarily occurred due to the acceleration of depreciation deductions forincome tax reporting purposes.

 

**Regulatory Matters**

 

As discussed more fully in the Regulatory Matters section above, the CPUC issued a final decisionwhich will phase down our annual CHCF interim draw by approximately $2,040annually, over a 5-year period ending on January 1, 2012.

 

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**Critical Accounting Estimates**

 

Our condensed consolidated financial statements and accompanying notesare prepared in accordance with GAAP. Preparing financial statements requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenue, and expenses. These estimates and assumptionsare affected by management’s application of accounting policies. Our judgmentsare based on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making estimates about the carrying values of assets andliabilities that are not readily apparent from other sources. For a fulldiscussion of our accounting estimates and assumptions that we have identifiedas critical in the preparation of our condensed consolidated financialstatements, refer to our 2009 Annual Report on Form 10-K.

 

**Recent Accounting Pronouncements**

 

**Recently IssuedAccounting Pronouncements**

** **

In October 2009, the Financial Accounting Standards Board (“FASB”)issued Accounting Standards Update (“ASU”) No. 2009-13, *Revenue Recognition (Topic 605): Multiple-Deliverable RevenueArrangements—a consensus of the FASB Emerging Issues Task Force*(“ASU2009-13”).  ASU 2009-13 addresses theaccounting for multiple-deliverable arrangements to enable vendors to accountfor products or services separately rather than as a combined unit and modifiesthe manner in which the transaction consideration is allocated across theseparately identified deliverables.  ASU2009-13 significantly expands the disclosure requirements formultiple-deliverable revenue arrangements. ASU 2009-13 will be effective for the first annual reporting periodbeginning on or after June 15, 2010, and may be applied retrospectivelyfor all periods presented or prospectively to arrangements entered into ormaterially modified after the adoption date. Early adoption is permitted, provided that the guidance is retroactivelyapplied to the beginning of the year of adoption. We are currently evaluatingthe impact this update will have on our condensed consolidated financialstatements.

 

**Recently AdoptedAccounting Pronouncements**

** **

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

 

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

 

**Regulatoryand Legal Matters**

** **

Significant portions of our telecommunication rates and charges aresubject to regulation by the FCC and state commissions.  Many of these rates and charges are based onvarious tariffs or service guides filed by SureWest and others, including thosefiled by the NECA for CL charges. Pending and future regulatory actions, with respect to these and othermatters and the filing of new or amended tariffs, may have a material impact onour consolidated financial position and results of operations.  In addition, the emergence of a range ofproducts and services that operate partially or entirely outside traditionalregulatory frameworks but that compete with regulated service offerings hascreated new challenges for both us and the regulators.

 

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

 

·                              additional rules governing theopening of markets to competition and the regulation of the competingtelecommunications providers;

·                              the nature and extent of thecompensation, if any, to be paid by carriers and other providers to one anotherfor network use, and the sums to be recovered through end users and othersources;

·                              the goals and definition of universaltelephone service in a changing environment, including examination of subsidysupport mechanisms for subscribers of different carriers (including incumbentcarriers) and in various geographic areas;

·                              rules that will provide non-discriminatoryaccess by competing service providers to the network capabilities of localexchange carriers; and

·                              the regulated rates and earnings ofSureWest Telephone.

 

There are a number of pending and anticipated other regulatoryproceedings occurring at the federal and state levels that may have a materialimpact on SureWest Telephone and also on subsidiaries in the Broadband segment.These regulatory proceedings also include newer issues, such as considerationof broadband deployment and regulation of IP-enabled services. The outcomes andimpact of these proceedings and related court matters on the Telecom segment,the Broadband segment and the Company as a whole cannot be determined at thistime.

 

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**ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

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

 

**ITEM 4.  CONTROLS ANDPROCEDURES.**

 

**Evaluation of disclosure controls and procedures**

 

Our management, with theparticipation of our Chief Executive Officer and Chief Financial Officer,evaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934, as amended) as of the end of the periodcovered by this Quarterly Report on Form 10-Q. Based upon, and as of thedate of this evaluation, the Chief Executive Officer and Chief FinancialOfficer have concluded that our disclosure controls and procedures wereeffective, at the reasonable assurance level, to ensure that informationrequired to be disclosed by us in reports that we file or submit under theSecurities Exchange Act is authorized, recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission rules andforms.

 

**Changein internal control over financial reporting**

 

There has been no changein our internal control over financial reporting during the quarter ended March 31,2010.

 

**Limitations on the effectiveness of controls**

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Our internal control system was designed to providereasonable assurance to our management, Board of Directors and Audit Committeeregarding the reliability of financial reporting and the preparation ofpublished financial statements in accordance with generally accepted accountingprinciples.

 

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**PART II —OTHERINFORMATION**

 

**ITEM 1**.      **LEGAL PROCEEDINGS.**

 

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

 

**ITEM6.  EXHIBITS.**

 

(a)          Index to Exhibits.

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                            | ** ** | **Method  of Filing**      |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|
|             |       |                                                                                                                                                                                                                                                                       |       |                       |
| 10.1             |       | Form of Indemnification Agreement for  directors, officers and key employees of SureWest Communications, effective  March 24, 2010 (Filed as Exhibit 10.1 to Form 8-K filed  March 26, 2010)                                                      |       | Incorporated by  reference |
|             |       |                                                                                                                                                                                                                                                                       |       |                       |
| 10.2             |       | Letter Agreement dated as of January 29, 2010  amending the Third Amended and Restated Credit Agreement dated as of  September 19, 2008 among SureWest Communications and CoBank, ACB (Filed  as Exhibit 10.1 to Form 8-K filed February 1, 2010) |       | Incorporated by  reference |
|             |       |                                                                                                                                                                                                                                                                       |       |                       |
| 31.1             |       | Certification of Steven C. Oldham, President and  Chief Executive Officer, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                      |       | Filed herewith             |
|             |       |                                                                                                                                                                                                                                                                       |       |                       |
| 31.2             |       | Certification of Dan T. Bessey, Vice President and  Chief Financial Officer, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                    |       | Filed herewith             |
|             |       |                                                                                                                                                                                                                                                                       |       |                       |
| 32.1             |       | Certification of Steven C. Oldham, President and  Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                             |       | Filed herewith             |
|             |       |                                                                                                                                                                                                                                                                       |       |                       |
| 32.2             |       | Certification of Dan T. Bessey, Vice President and  Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                           |       | Filed herewith             |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                      |   | SUREWEST COMMUNICATIONS                                                                    |
|---------------------------|--------|--------------------------------------------------------------------------------------------|
|                      |   | (Registrant)              |
|                      |   |                                                                                       |
|                      |   |                                                                                       |
|                      | By:    | /s/ STEVEN C. OLDHAM                                                                       |
|                      |   | Steven C. Oldham,  President and Chief  Executive Officer                                  |
|                      |   |                                                                                       |
|                      |   |                                                                                       |
|                      | By:    | /s/ DAN T. BESSEY                                                                          |
|                      |   | Dan T. Bessey,                                                                             |
|                      |   | Vice President and                                                                         |
|                      |   | Chief Financial Officer                                                                    |
|                      |   |                                                                                       |
|                      |   |                                                                                       |
| Date: April 30, 2010 |   |                                                                                       |

 

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