**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-Q**
| ** ** | **x**      | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d)**  | ** ** |
|------------|------------|--------------------------------------------------------|------------|
| ** ** | ** ** | **OF THE  SECURITIES EXCHANGE ACT OF 1934**            | ** ** |
| ** ** | ** ** | ** **                                             | ** ** |
| ** ** | ** ** | **For the  quarterly period ended March 31, 2007**     | ** ** |
| ** ** | ** ** | ** **                                             | ** ** |
| ** ** | ** ** | **or**                                                 | ** ** |
| ** ** | ** ** | ** **                                             | ** ** |
| ** ** | **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 or 15(d)** | ** ** |
| ** ** | ** ** | **OF THE  SECURITIES EXCHANGE ACT OF 1934**            | ** ** |

 

**CommissionFile Number 0-556**

**SUREWEST COMMUNICATIONS**

(Exact name ofregistrant as specified in its charter)

| **California**                                | ** ** | **68-0365195**       |
|-----------------------------------------------|------------|----------------------|
| (State or other  jurisdiction                 |       | (IRS Employer        |
| of incorporation  or organization)            |       | Identification  No.) |
|                                          |       |                 |
| **200  Vernon Street, Roseville, California** | ** ** | **95678**            |
| (Address of  principal executive offices)     |       | (Zip Code)           |

 

**(916) 786-6141**

(Registrant’stelephone number, including area code)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes  x       Noo

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer x | Non-accelerated filer o |
|---------------------------|---------------------|-------------------------|

 

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

Yes  o       Nox

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

As of April 30,2007, 14,465,772 shares of the registrant’s Common Stock were outstanding.

 

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**TABLE OF CONTENTS**
|                                     | ** ** | ** **                                                                                  | ** ** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|------------|
| **PART I - FINANCIAL  INFORMATION** |       |                                                                                        |
| Item 1.                             |       | Financial Statements                                                                        |       |       |
| Item 2.                             |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       |       |
| Item 3.                             |       | Quantitative  and Qualitative Disclosures About Market Risk                                 |       |       |
| Item 4.                             |       | Controls And  Procedures                                                                    |       |       |
|                                |       |                                                                                        |       |       |
| **PART II - OTHER  INFORMATION**    |       |                                                                                        |
| Item 1.                             |       | Legal  Proceedings                                                                          |       |       |
| Item  1A.                           |       | Risk  Factors                                                                               |       |       |
| Item 2.                             |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       |       |
| Item 3.                             |       | Defaults Upon  Senior Securities                                                            |       |       |
| Item 4.                             |       | Submission of  Matters to a Vote of Security Holders                                        |       |       |
| Item 5.                             |       | Other Information                                                                           |       |       |
| Item  6.                            |       | Exhibits                                                                                    |       |       |
| SIGNATURES                          |       |                                                                                        |

 

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**PART 1 – FINANCIAL INFORMATION**

**ITEM1.  FINANCIAL STATEMENTS.**

**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

*(Unaudited; Amounts in thousands,except per share amounts)*
| ** **                                                                  | ** ** | **Quarter Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                  | ** ** | **2007**                                   | ** ** | **2006** | ** ** |
|                                                                        |       |                                       |       |   |   |
| Operating revenues:                                                         |       |                                       |       |   |   |
| Telecom                                                                     |       | $                                          | 26,361     |   | $ | 27,101 |   |
| Broadband                                                                   |       | 16,422                                     |       | 13,881 |   |
| Wireless                                                                    |       | 8,201                                      |       | 8,394 |   |
| Total operating  revenues                                                   |       | 50,984                                     |       | 49,376 |   |
|                                                                        |       |                                       |       |   |   |
| Operating expenses:                                                         |       |                                       |       |   |   |
| Cost of services  and products (exclusive of depreciation and amortization) |       | 18,750                                     |       | 17,673 |   |
| Customer  operations and selling                                            |       | 8,875                                      |       | 8,571 |   |
| General and  administrative                                                 |       | 8,581                                      |       | 8,018 |   |
| Depreciation and  amortization                                              |       | 13,788                                     |       | 14,463 |   |
| Total operating  expenses                                                   |       | 49,994                                     |       | 48,725 |   |
|                                                                        |       |                                       |       |   |   |
| Income from operations                                                      |       | 990                                        |       | 651 |   |
|                                                                        |       |                                       |       |   |   |
| Other income (expense):                                                     |       |                                       |       |   |   |
| Interest income                                                             |       | 506                                        |       | 70 |   |
| Interest expense                                                            |       | (1,401                                     | )          | (1,593 | ) |
| Other, net                                                                  |       | (204                                       | )          | (109 | ) |
| Total other  income (expense), net                                          |       | (1,099                                     | )          | (1,632 | ) |
|                                                                        |       |                                       |       |   |   |
| Loss from continuing  operations before income taxes                        |       | (109                                       | )          | (981 | ) |
|                                                                        |       |                                       |       |   |   |
| Income tax benefit                                                          |       | (161                                       | )          | (421 | ) |
|                                                                        |       |                                       |       |   |   |
| Income (loss) from  continuing operations                                   |       | 52                                         |       | (560 | ) |
|                                                                        |       |                                       |       |   |   |
| Discontinued  operations, net of tax                                        |       |                                       |       |   |   |
| Income from  discontinued operations                                        |       | 999                                        |       | 1,759 |   |
| Gain on sale of  discontinued operations                                    |       | 60,182                                     |       | — |   |
| Total  discontinued operations                                              |       | 61,181                                     |       | 1,759 |   |
|                                                                        |       |                                       |       |   |   |
| Net income                                                                  |       | $                                          | 61,233     |   | $ | 1,199 |   |
|                                                                        |       |                                       |       |   |   |
| Basic earnings (loss)  per common share:                                    |       |                                       |       |   |   |
| Income (loss)  from continuing operations                                   |       | $                                          | —     |   | $ | (0.04 | ) |
| Discontinued  operations, net of tax                                        |       | 4.24                                       |       | 0.12 |   |
| Net income per  basic common share                                          |       | $                                          | 4.24       |   | $ | 0.08 |   |
|                                                                        |       |                                       |       |   |   |
| Diluted earnings (loss)  per common share:                                  |       |                                       |       |   |   |
| Income (loss)  from continuing operations                                   |       | $                                          | —     |   | $ | (0.04 | ) |
| Discontinued  operations, net of tax                                        |       | 4.21                                       |       | 0.12 |   |
| Net income per  diluted common share                                        |       | $                                          | 4.21       |   | $ | 0.08 |   |
|                                                                        |       |                                       |       |   |   |
| Dividends per share                                                         |       | $                                          | 0.25       |   | $ | 0.25 |   |
|                                                                        |       |                                       |       |   |   |
| Shares of common stock  used to calculate earnings per share:               |       |                                       |       |   |   |
| Basic                                                                       |       | 14,423                                     |       | 14,575 |   |
| Diluted                                                                     |       | 14,545                                     |       | 14,575 |   |

 

See accompanyingnotes.

1

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**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

*(Unaudited;Amounts in thousands)*
| ** **                                                                                                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                          | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| **ASSETS**                                                                                                                                                          | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                     |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                           |       | $                  | 62,091     |                  | $          | 6,371 |   |
| Short-term investments                                                                                                                                              |       | 53,363             |       | 695                   |       |
| Accounts receivable, net                                                                                                                                            |       | 20,103             |       | 22,014                |       |
| Inventories                                                                                                                                                         |       | 5,766              |       | 5,348                 |       |
| Prepaid expenses                                                                                                                                                    |       | 3,949              |       | 4,275                 |       |
| Deferred income taxes                                                                                                                                               |       | 7,348              |       | 7,685                 |       |
| Assets of discontinued operations                                                                                                                                   |       | —             |       | 5,732                 |       |
| Total current  assets                                                                                                                                               |       | 152,620            |       | 52,120                |       |
|                                                                                                                                                                |       |               |       |                  |       |
| Property, plant  and equipment, net                                                                                                                                 |       | 372,803            |       | 376,364               |       |
|                                                                                                                                                                |       |               |       |                  |       |
| Intangible and  other assets:                                                                                                                                       |       |               |       |                  |       |
| Wireless licenses, net                                                                                                                                              |       | 13,566             |       | 13,566                |       |
| Goodwill                                                                                                                                                            |       | 2,171              |       | 2,171                 |       |
| Intangible asset relating to favorable operating  leases, net                                                                                                       |       | 288                |       | 309                   |       |
| Deferred charges and other assets                                                                                                                                   |       | 1,273              |       | 1,220                 |       |
|                                                                                                                                                                |       | 17,298             |       | 17,266                |       |
|                                                                                                                                                                |       | $                  | 542,721    |                  | $          | 445,750 |   |
| **LIABILITIES  AND SHAREHOLDERS' EQUITY**                                                                                                                           | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current  liabilities:                                                                                                                                               |       |               |       |                  |       |
| Current portion of long-term debt and capital lease  obligations                                                                                                    |       | $                  | 3,642      |                  | $          | 3,642 |   |
| Accounts payable                                                                                                                                                    |       | 2,569              |       | 3,069                 |       |
| Other accrued liabilities                                                                                                                                           |       | 19,557             |       | 21,663                |       |
| Current portion of contractual shareable earnings obligations                                                                                                       |       | 1,720              |       | 1,707                 |       |
| Estimated shareable earnings obligations                                                                                                                            |       | 73                 |       | 73                    |       |
| Advance billings and deferred revenues                                                                                                                              |       | 9,635              |       | 9,374                 |       |
| Accrued income taxes                                                                                                                                                |       | 44,094             |       | 345                   |       |
| Accrued pension benefits                                                                                                                                            |       | 215                |       | 215                   |       |
| Accrued compensation                                                                                                                                                |       | 5,456              |       | 5,167                 |       |
| Liabilities of discontinued operations                                                                                                                              |       | —             |       | 298                   |       |
| Total current  liabilities                                                                                                                                          |       | 86,961             |       | 45,553                |       |
|                                                                                                                                                                |       |               |       |                  |       |
| Long-term debt  and capital lease obligations                                                                                                                       |       | 121,830            |       | 121,831               |       |
| Long-term  contractual shareable earnings obligations                                                                                                               |       | 1,208              |       | 1,891                 |       |
| Deferred income  taxes                                                                                                                                              |       | 34,302             |       | 36,777                |       |
| Other  liabilities and deferred revenues                                                                                                                            |       | 14,844             |       | 13,922                |       |
|                                                                                                                                                                |       |               |       |                  |       |
| Commitments and  contingencies                                                                                                                                      |       |               |       |                  |       |
|                                                                                                                                                                |       |               |       |                  |       |
| Shareholders'  equity:                                                                                                                                              |       |               |       |                  |       |
| Common stock, without par value; 100,000 shares  authorized, 14,466 and 14,465 shares issued and outstanding at March 31, 2007  and December 31, 2006, respectively |       | 158,119            |       | 157,926               |       |
| Accumulated other comprehensive income                                                                                                                              |       | 576                |       | 565                   |       |
| Retained earnings                                                                                                                                                   |       | 124,881            |       | 67,285                |       |
| Total  shareholders' equity                                                                                                                                         |       | 283,576            |       | 225,776               |       |
|                                                                                                                                                                |       | $                  | 542,721    |                  | $          | 445,750 |   |

 

See accompanyingnotes.

2

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**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

*(Unaudited;Amounts in thousands)*
| ** **                                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                          | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                          | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net cash  provided by continuing operations                         |       | $                                                    | 13,329     |   | $ | 8,422 |   |
| Net cash (used  in) provided by discontinued operations             |       | (1,117                                               | )          | 3,037 |   |
| Net cash provided by operating activities                           |       | 12,212                                               |       | 11,459 |   |
|                                                                |       |                                                 |       |   |   |
| Cash flows from  investing activities:                              |       |                                                 |       |   |   |
| Proceeds from sale of discontinued operations                       |       | 110,123                                              |       | — |   |
| Capital expenditures for property, plant and equipment              |       | (10,348                                              | )          | (11,818 | ) |
| Purchases of held-to-maturity investments                           |       | (74,475                                              | )          | — |   |
| Maturities of held-to-maturity investments                          |       | 21,825                                               |       | — |   |
| Net cash provided by (used in) investing activities                 |       | 47,125                                               |       | (11,818 | ) |
|                                                                |       |                                                 |       |   |   |
| Cash flows from  financing activities:                              |       |                                                 |       |   |   |
| Increase in short-term borrowings                                   |       | —                                               |       | 3,000 |   |
| Principal payments of long-term debt and capital  lease obligations |       | (1                                                   | )          | (9 | ) |
| Dividends paid                                                      |       | (3,616                                               | )          | (3,658 | ) |
| Net cash used in financing activities                               |       | (3,617                                               | )          | (667 | ) |
|                                                                |       |                                                 |       |   |   |
| Increase  (decrease) in cash and cash equivalents                   |       | 55,720                                               |       | (1,026 | ) |
|                                                                |       |                                                 |       |   |   |
| Cash and cash  equivalents at beginning of period                   |       | 6,371                                                |       | 7,633 |   |
|                                                                |       |                                                 |       |   |   |
| Cash and cash  equivalents at end of period                         |       | $                                                    | 62,091     |   | $ | 6,607 |   |

 

See accompanyingnotes.

3

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**SUREWEST COMMUNICATIONS**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

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

**1.             SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

**Business and Basis of Accounting**

SureWestCommunications (the “Company”) is a holding company with wholly-ownedsubsidiaries that provide integrated communications services in NorthernCalifornia. The Company’s principal operating subsidiary is SureWest Telephone.SureWest Directories, SureWest Long Distance, SureWest Wireless, SureWestBroadband, SureWest TeleVideo and SureWest TeleVideo of Roseville (collectivelyreferred to as “SureWest Broadband/Residential Services”), SureWest Internetand SureWest Custom Data Services are each subsidiaries of the Company. As discussedin Note 2 below, in February 2007 the Company sold SureWest Directories.Accordingly, the financial results of SureWest Directories have been reportedas discontinued operations for all periods presented in accordance withStatement of Financial Accounting Standards (“SFAS”) No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*.  The notes to condensed consolidated financialstatements reflect historical amounts exclusive of discontinued operations,unless otherwise noted. The Company expects that the sources of its revenuesand its cost structure may be different in future periods, both as a result ofits entry into new communications markets and competitive forces in each of themarkets in which the Company has 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”) 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 principles applicablefor interim periods. Management believes that the disclosures made are adequateto make the information presented not misleading. Interim results are notnecessarily indicative of results for a full year.  The information presented in this 10-Q shouldbe read in conjunction with Management’s Discussion and Analysis of FinancialCondition and Results of Operations and the consolidated financial statementsand notes thereto included in the Company’s 2006 Annual Report on Form 10-Kfiled with the SEC.

**Stock-basedCompensation**

***Stock Plans***

The Company hastwo Equity Incentive Plans (the “Stock Plans”) for certain employees, outsidedirectors and consultants of the Company, which were approved by shareholders.The Company authorized for future issuance under the Stock Plans approximately1.7 million shares (subject to upward adjustment based upon the Company’sissued and outstanding shares) of authorized, but unissued, common stock. TheStock Plans permit issuance by the Company of awards in the form of restrictedcommon stock (“RSAs”), restricted common stock units (“RSUs”), performanceshares, stock options and stock appreciation rights. The exercise price pershare of the Company’s common stock to be purchased under any incentive stockoption shall not be less than 100% of the fair market value of a share of theCompany’s common stock on the date of the grant, and the exercise price under anon-qualified stock option shall not be less than 85% of the fair market valueof the Company’s common stock at the date of the grant. The term of any stockoption shall not exceed 10 years.

***Adoption of Statement of Financial Accounting Standards No. 123(R)***

Effective January2006, the Company adopted SFAS No. 123(R), *Share-Based Payment*,using the modified-prospective-transition method. Since the fair valuerecognition provisions of SFAS No. 123, *Accounting for Stock-BasedCompensation* and SFAS No. 123(R) were materially consistent underthe Company’s Stock Plans, the adoption of SFAS No. 123(R) did not have asignificant impact on the Company’s financial position or results ofoperations.

4

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Prior to theadoption of SFAS No. 123(R), the Company presented all tax benefits ofdeductions resulting from the exercise of share-based payments as operatingcash flows in its statement of cash flows. In accordance with guidance in SFASNo. 123(R), the cash flows resulting from excess tax benefits (tax benefitsrelated to the excess of proceeds from employee’s exercises of share basedpayments over the stock-based compensation cost recognized for those shares)are classified as financing cash flows.

***Restricted Common Stock Awards and Units***

The followingtable summarizes the RSAs and RSUs granted to certain eligible participantsduring the quarters ended March 31, 2007 and 2006:

|               | ** ** | **Quarter Ended March 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | ** **                                 | ** ** | **Grant Date** | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **    | ** ** | **2007**                                   | ** ** | **Fair Value** | ** ** | **2006** | ** ** | **Fair Value** | ** ** |
| ** **    | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| RSAs Granted  |       | 1,338                                      |       | $ | 23.97 |   | 3,000 |   | $ | 27.63 |   |
| RSUs Granted  |       | —                                     |       | $ | — |   | 1,500 |   | $ | 27.63 |   |
| RSU Dividends |       | —                                     |       | $ | — |   | — |   | $ | — |   |
| Total         |       | 1,338                                      |       |   |   | 4,500 |   |   |   |

 

Stock-basedcompensation expense for both RSAs and RSUs of $177 and $289 was recordedduring the quarters ended March 31, 2007 and 2006, respectively. RSAs and RSUsare amortized over their respective vesting periods, which range from immediatevesting to a five-year vesting period. In connection with the adoption of SFASNo. 123(R), the Company records stock-based compensation for RSAs and RSUs on astraight-line basis. The Company will continue to recognize stock-basedcompensation on RSAs and RSUs granted prior to 2006 using the graded vestingmethod. In accordance with the provisions of SFAS No. 123(R), the Company hasestimated expected forfeitures based on historical experience and isrecognizing compensation expense only for those RSAs and RSUs expected to vest.

The followingtable summarizes the RSAs activity during the three-month period ended March31, 2007:
|                            | ** ** | ** ** | ** ** | **Weighted Average**                | ** ** |
|----------------------------|------------|------------|------------|------------------------------------------|------------|
| **Nonvested Shares**  | ** ** | **Shares** | ** ** | **Grant Date Fair Value** | ** ** |
| Nonvested-January  1, 2007 |       | 125,467    |       | $                                        | 27.00      |   |
| Granted                    |       | 1,338      |       | $                                        | 23.97      |   |
| Vested                     |       | (4,237     | )          | $                                        | 26.61      |   |
| Forfeited                  |       | (224       | )          | $                                        | 30.55      |   |
| Nonvested-March 31,  2007  |       | 122,344    |       | $                                        | 26.43      |   |

 

As of March 31,2007, total unrecognized compensation cost related to nonvested restrictedstock was $1,720 and will be recognized over a weighted-average period ofapproximately three years. The total fair value of RSAs and RSUs vested duringthe three-month period ended March 31, 2007 was $113.

5

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***Stock Options Expense***

The Company issuesnew shares of common stock upon exercise of stock options.  The followingtable summarizes stock option activity for the Company’s stock option plans forthe quarter ended March 31, 2007:
| ** **                                    | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted**              | ** ** |
|-----------------------------------------------|------------|------------|------------|--------------|------------|---------------------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | **Average**  | ** ** | **Average**               | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Remaining**             | ** ** |
| **Options**                                   | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Contractual Life** | ** ** |
|                                          |       |       |       |         |       |                      |       |
| Outstanding-January  1, 2007                  |       | 383,714    |       | $            | 40.28      |                      |       |   |
| Forfeited                                     |       | (4,950     | )          | —       |       |                      |       |
| Outstanding-March  31, 2007                   |       | 378,764    |       | $            | 40.28      |                      | 4          |   |
| Vested or  Expected to Vest at March 31, 2007 |       | 378,764    |       | $            | 40.28      |                      | 4          |   |
| Exercisable at March  31, 2007                |       | 378,665    |       | $            | 40.28      |                      | 4          |   |

 

There were nostock options granted, exercised or expired during the quarter ended March 31,2007. In addition, there were no stock options with an exercise price below themarket price of the Company’s stock at that date.

**Per ShareAmounts**

Shares used in thecomputation of basic earnings per share are based on the weighted averagenumber of unrestricted common stock shares, RSAs and RSUs outstanding,excluding unvested RSAs and unvested RSUs. Shares used in the computation ofdiluted earnings per share are based on the weighted average number of unrestrictedcommon stock shares, RSAs and RSUs outstanding, along with other potentiallydilutive securities outstanding in each period, unless their inclusion would beanti-dilutive.

Cash dividends pershare are based on the actual dividends per share (including RSAs but excludingRSUs), as declared by the Company’s Board of Directors. On each date that theCompany pays a cash dividend to the holders of the Company’s common stock, theCompany credits to the holders of RSUs an additional number of RSUs equal to thetotal number of whole RSUs and additional RSUs previously credited to theholders multiplied by the dollar amount of the cash dividend per share ofcommon stock. Any fractional RSUs resulting from such calculation are includedin the additional RSUs.

**Change in Estimate**

During the firstquarter of 2007, the Company completed its triennial review of asset lives thatevaluated the appropriateness of the estimated useful lives of its propertyplant and equipment for all segments. The evaluation considered the Company’s investment and businessstrategy, reliability and historical performance data of certain assets, aswell as the impacts of competition and anticipated technological change. As aresult of this evaluation, effective January 1, 2007, the Companyincreased the estimated useful lives of certain of its customer premiseequipment, circuit equipment, cable plant and towers primarily in the Broadbandsegment. The increase in asset lives primarily ranged between 1 to 4 years,although the change in estimated useful lives for towers was 8 years.  The Company’s revisions to its estimateduseful lives have been supported by an assessment and report from anindependent party with expertise in this area that found the revisions to bereasonable in light of the Company’s plan and useful life estimates incomparable businesses. During the quarter ended March 31, 2007, this change inestimate decreased the consolidated depreciation expense by $948 and increasedconsolidated net income by $645 ($0.04 per share).

**Reclassifications**

Certain amounts inthe Company’s 2006 condensed consolidated financial statements have beenreclassified to conform to the presentation of the Company’s 2007 condensedconsolidated financial statements.

6

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**2.             DISCONTINUED OPERATIONS**

In January 2007,the Company entered into a definitive agreement with GateHouse Media to sellSureWest Directories, its directory publishing business.  As part of the transaction, GateHouse Mediabecame the publisher of the official directory of SureWest Telephone. Thetransaction was consummated on February 28, 2007.  Under the agreement, GateHouse Media acquired100% of the stock of SureWest Directories for an aggregate cash purchase priceof $110,123, resulting in a gain of $101,566, less estimated income taxes of$41,384.

The followingtable summarizes the financial information for SureWest Directories’ operationsfor the two months ended February 28, 2007 and for the quarter ended March 31,2006:

|                                      | ** ** | **Period ended,**          | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **February 28, 2007** | ** ** | **March 31, 2006** | ** ** |
| Directory  advertising revenues      |       | $                               | 2,939      |   | $ | 4,788 |   |
| Income before  income taxes          |       | 1,682                           |       | 2,962 |   |
| Income tax  expense                  |       | 683                             |       | 1,203 |   |
| Income from  discontinued operations |       | $                               | 999        |   | $ | 1,759 |   |

 

**3.             BUSINESS SEGMENTS**

The Company hasthree reportable business segments: Telecommunications (“Telecom”), Broadbandand Wireless. The Telecom segment includes SureWest Telephone and SureWest LongDistance, which provide landline telecommunications services, DigitalSubscriber Line (“DSL”) service, long distance services and certainnon-regulated services. SureWest Telephone, which is the principal operatingsubsidiary of the Telecom segment, provides local services, toll telephoneservices, network access services and certain non-regulated services.  SureWest Long Distance provides long distanceservices.

The Broadbandsegment provides various services, including: high-speed and dial-up Internet;digital video; voice, network access and toll telephone; and managed servicesin the greater Sacramento area, principally to customers residing outside ofSureWest Telephone’s service area. The Company offers high-speed Internet,digital video, voice and long distance phone service as a bundled packagereferred to as fiber-to-the-premise (“FTTP”). The Broadband segment includesthe Company’s subsidiary SureWest Broadband and SureWest Broadband Businessservices, which is comprised, in part, of a division of SureWest Telephoneoperating as a Competitive Local Exchange Carrier.

The Wirelesssegment consists of the Company’s subsidiary SureWest Wireless, which provideswireless services. Wireless revenues include wireless voice services, sales ofhandsets and related accessories, long distance, roaming service and customcalling features. Wireless services are provided on a month-to-month basis andare generally billed in advance for non-contract subscribers and in arrears forcontract subscribers.

In accordance withthe provisions of SFAS No. 131, *Disclosure About Segmentsof an Enterprise and Related Information*, the Company has aggregatedcertain of its operating segments within the Telecom and Broadband segmentsbecause it believes that such operating segments share similar economiccharacteristics.

CorporateOperations are allocated to the appropriate segment, except for cash;investments; certain property, plant, and equipment; and miscellaneous otherassets, which are not allocated to the segments. However, the investment incomeassociated with cash and investments held by Corporate Operations is includedin the results of the operations of the Company’s segments. The Companyevaluates the performance of its segments based on income (loss) fromoperations.

These segments arestrategic business units that offer different products and services. TheCompany accounts for intersegment revenues and expenses at prevailing marketrates. The Company’s business segment information is as follows:

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| ** **                                                | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** ** | **Corporate**  | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|-----------------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                | ** ** | **Telecom** | ** ** | **Broadband** | ** ** | **Wireless** | ** ** | **Operations** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **As of  and for the three months ended March 31, 2007:** | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Operating  revenues from external customers               |       | $           | 26,361     |          | $          | 16,422       |       | $              | 8,201      |             | $          | —           |       | $ | — |   | $ | 50,984 |   |
| Intersegment  revenues                                    |       | 6,972       |       | 520           |       | 784          |       | —         |       | (8,276           | )          | —           |       |
| Operating  expenses*                                      |       | 16,431      |       | 17,778        |       | 10,273       |       | —         |       | (8,276           | )          | 36,206           |       |
| Depreciation and  amortization                            |       | 5,565       |       | 5,186         |       | 3,037        |       | —         |       | —           |       | 13,788           |       |
| Income (loss)  from operations                            |       | 11,337      |       | (6,022        | )          | (4,325       | )          | —         |       | —           |       | 990              |       |
| Income (loss)  from continuing operations                 |       | $           | 6,977      |          | $          | (4,094       | )          | $              | (2,831     | )                | $          | —           |       | $ | — |   | $ | 52 |   |
| Total assets                                              |       | $           | 754,723    |          | $          | 421,380      |       | $              | 153,936    |             | $          | 640,414          |       | $ | (1,427,732 | ) | $ | 542,721 |   |
|                                                      |       |        |       |          |       |         |       |           |       |             |       |             |       |
| **As of  and for the three months ended March 31, 2006:** | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Operating  revenues from external customers               |       | $           | 27,101     |          | $          | 13,881       |       | $              | 8,394      |             | $          | —           |       | $ | — |   | $ | 49,376 |   |
| Intersegment  revenues                                    |       | 7,328       |       | 424           |       | 680          |       | —         |       | (8,432           | )          | -                |       |
| Operating  expenses*                                      |       | 17,018      |       | 16,670        |       | 9,006        |       | —         |       | (8,432           | )          | 34,262           |       |
| Depreciation and  amortization                            |       | 6,303       |       | 5,197         |       | 2,963        |       | —         |       | —           |       | 14,463           |       |
| Income (loss)  from operations                            |       | 11,108      |       | (7,562        | )          | (2,895       | )          | —         |       | —           |       | 651              |       |
| Income (loss)  from continuing operations                 |       | $           | 6,461      |          | $          | (5,089       | )          | $              | (1,932     | )                | $          | —           |       | $ | — |   | $ | (560 | ) |
| Total assets                                              |       | $           | 679,598    |          | $          | 319,999      |       | $              | 148,348    |             | $          | 367,052          |       | $ | (1,069,117 | ) | $ | 445,880 |   |

 

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*Exclusive of depreciation and amortization

**4.             ESTIMATED SHAREABLE EARNINGSOBLIGATIONS**

Certain of the Company’srates are subject to regulation by the Federal Communications Commission (“FCC”)and the California Public Utilities Commission (“CPUC”). Intrastate servicerates are subject to regulation by the CPUC. With respect to toll callsinitiated by interexchange carriers’ customers, the interexchange carriers areassessed access charges based on tariffs filed by SureWest Telephone.Interstate access rates and resultant earnings are subject to regulation by theFCC. With respect to interstate services, SureWest Telephone has detariffed itsDSL services and files its own tariff with the FCC for switched and specialaccess services.  For interstate commonline (“CL”) charges, SureWest Telephone concurs with tariffs filed by theNational Exchange Carrier Association (“NECA”). Pending and future regulatory actions may have a material impact on theCompany’s consolidated financial position and results of operations.

The FCC monitorsSureWest Telephone’s interstate earnings through the use of annual cost separationstudies prepared by SureWest Telephone, which utilize estimated costinformation and projected demand usage. The FCC establishes rules thatcarriers must follow in the preparation of the annual studies. Additionally,under current FCC rules governing rate making, SureWest Telephone isrequired to establish interstate rates based on projected demand usage for itsvarious services and determine the actual earnings from these rates once actualvolumes and costs are known. The Company did not identify any interstateshareable earnings obligations at SureWest Telephone during the quarters endedMarch 31, 2007 or 2006.

As a result ofperiodic cost separation studies, SureWest Telephone changed its estimates fora portion of its interstate shareable earnings obligations and certain NECA CLaccounts receivable balances related to current and prior year monitoringperiods.  For the quarter ended March 31,2007, these changes in estimates increased the Company’s consolidated revenuesby $118 and net income by $81 ($0.01 per share), respectively.  The Company did not record any significantchanges in estimates during the quarter ended March 31, 2006.

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The FCC has a pending rulemaking proceeding tore-examine all regulated forms of intercarrier compensation and develop a moreunified mechanism to govern the payment flows among telecommunicationscarriers.  Intercarrier compensation isthe regulated fees that service providers charge each other to carry andterminate traffic. Reform has been suggested due to the changing nature of theindustry with increasing competition from new technologies, such as Internetand Internet-based services and wireless services.  Various plans have been submitted to the FCCwith divergent approaches to handle intercarrier compensation that may reduceper-minute access and reciprocal compensation charges and replace theserevenues with a combination of increases to the subscriber line charge andrevenues obtained from a new restructure mechanism.  The ultimate results of this proceeding and thepotential effects on SureWest Telephone cannot yet be determined.

The Company wasinvolved in a proceeding at the CPUC that considered the continued need forcertain sharing requirements in the intrastate jurisdiction and, in connectionwith that review, also considered the issue of whether the Company overearnedin the intrastate jurisdiction in recent monitoring periods and the amount ofoverearnings that should be shared with customers. In July 2004, theCompany entered into a settlement agreement (the “settlement agreement”) withthe other parties in the proceeding, the Division of Ratepayer Advocates (“DRA”),and The Utility Reform Network (“TURN”), to resolve all issues in theproceeding. In November 2004, the CPUC approved the settlement agreement.The settlement agreement resolved existing intrastate sharing obligations andrelated earnings issues for the monitoring periods 2000 through 2004, put intoplace a surcredit mechanism for the amount of the settlement, and suspended therequirement for any intrastate sharing for monitoring periods from January 1,2005 through at least December 31, 2010. However, as a result of a decision subsequently adopted by the CPUC thesharing requirement has been eliminated, as discussed below.

In accordance withthe settlement agreement, SureWest Telephone is returning approximately $6,500(“Dividend A”), plus interest at the 90-day commercial paper rate fornon-financial institutions, which was 5.2% as of March 31, 2007, and an imputedrate of 3.15%, to its end users through a consumer dividend over a period ofapproximately four years, which began January 1, 2005. In addition, SureWestTelephone paid a one-time consumer dividend of $2,600 (“Dividend B”), which wasreturned to the consumers to settle the monitoring periods 2000 to 2004 overapproximately two years, which began January 1, 2005 and was completed in March2007. The consumer dividend included an annual imputed interest rate of 3.15%(no stated contractual interest rate). The consumer dividends were recorded as a reduction of the Company’scontractual shareable earnings obligations. At March 31, 2007, the aggregate contractual shareable earningsobligation for these surcredits was $2,928 (which is net of an unamortizeddiscount pertaining to imputed interest of $89 at that date).

The followingtable summarizes the amounts returned to end users through consumer dividendsfor the quarters ended March 31, 2007 and 2006.

|            | ** ** | **Quarter Ended** | ** ** |
|------------|------------|------------------------|------------|
| ** ** | ** ** | **March 31,**     | ** ** |
| ** ** | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Dividend A |       | $                      | 486        |   | $ | 515 |   |
| Dividend B |       | 210                    |       | 301 |   |
| Total      |       | $                      | 696        |   | $ | 816 |   |

 

Further, as partof the settlement agreement SureWest Telephone was to implement an additionalannual consumer dividend of $1,300 on January 1, 2007 to end-users receivingSureWest Telephone services subject to sharing on or after that date.  However, this consumer dividend was subjectto reduction based upon the results of other pending regulatory proceedings andin 2007 has been offset by a reduction in the Company’s draw from theCalifornia High Cost Fund (“CHCF”), as discussed below.

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Prior to 2000,AT&T Inc. (“AT&T”) had been paying SureWest Telephone approximately$11,500 per year for extended area service (“EAS”) pursuant to a SettlementTransition Agreement. In November 2000, the CPUC authorized AT&T toterminate its annual EAS payments to SureWest Telephone effectiveNovember 30, 2000. The CPUC authorized replacement funding to SureWestTelephone on an interim basis using funds from the CHCF. The CHCF is a programdesigned by the CPUC to establish a fair and equitable local rate structure andto reduce any disparity in the rates charged by telephone companies servinghigh-cost areas. The CHCF funding is scheduled to expire January 1, 2009.In addition, the CPUC opened an Order Instituting Investigation (“OII”) for thepurpose of determining whether future recovery of all, none, or a portion ofthe annual payments received from the CHCF should come from SureWest Telephone’sratepayers or other regulatory recovery mechanisms.

In August 2005,the CPUC adopted a decision which (i) authorized SureWest Telephone tocontinue receiving $11,500 annually from the CHCF to offset its intrastateregulated operating expenses on an interim basis, (ii) required SureWestTelephone to prepare and submit within twelve months a cost proxy model (whichis used generally as a basis for CHCF funding) based on its current cost data,including analyses of the resulting impacts on rates, the Universal LifelineTelephone Service (“ULTS”) fund and the CHCF fund and (iii) authorizedSureWest Telephone to file an advice letter with the Commission’sTelecommunications Division to implement reductions to its business access line rates.

In August 2006,the Company filed a petition for modification (the “petition”) of the decisionthat reviewed SureWest Telephone’s revenue requirement, which seeks CPUCauthorization for a graduated phase-down of its $11,500 interim draw from theCHCF over a period of time that is intended to assure the continued maintenanceof good service to SureWest Telephone customers while avoiding precipitous rateincreases.  The Company’s petitionproposed a transitional phase-down over a five-to-ten year period and requestedelimination of the requirement to file its cost proxy model.  The Company will seek to recover theeliminated revenues through rate increases and/or operating efficiencies.  In August 2006, the DRA filed opposition tothe Company’s petition and instead proposed the Company immediately discontinuereceipt of CHCF funds. In October 2006, the Company filed a request for aninterim decision on its petition by which the Company proposed to reduce itsannual interim CHCF draw by a $1,300 consumer dividend required by thesettlement agreement, as described above. In December 2006, the CPUC issued an interim decision approving theCompany’s proposal to offset its draw from the CHCF by the $1,300 consumerdividend.  In January 2007, DRA filed asupplemental response and opposition to immediately discontinue the Company’sCHCF funds or if the CPUC permits a transitional phase-down, that should occurover a period of no more than three years. In February 2007, the Company responded to DRA’s supplemental responseand opposition refuting DRA’s positions and supporting the Company’s previouslyfiled phase-down proposals.  The resultsof this proceeding and the potential effects on SureWest Telephone could impactfuture funding levels through the CHCF.

In June 2006, theCPUC instituted a rulemaking proceeding to review the CHCF program.  The goals of this review include, but are notlimited to, adjusting universal service rate support payments to reflectupdated operating costs, evaluating whether CHCF fund support levels can bereduced and made more predictable while still meeting the goals of the program,ensuring it is competitively neutral, reducing rate disparity in residentialbasic service between urban and rural areas in the state, and making thecurrent administration of the program more efficient.  In addition, the CHCF rulemaking requestedcomments as to whether SureWest Telephone should continue receiving the annualpayments from the CHCF and the advisability and impacts of phasing out the EASpayments gradually over a period of approximately 5 years.  The results of this proceeding and the potentialeffects on SureWest Telephone could impact future funding levels through theCHCF.

In 1996, the CPUCissued a decision that authorized SureWest Telephone to implement a NewRegulatory Framework (“NRF”) for services furnished within SureWest Telephone’sservice area in order to accommodate market and regulatory movement towardcompetition and greater pricing flexibility. Under the NRF, SureWest Telephonewas subject to ongoing monitoring and reporting requirements, and it wasinitially required to share earnings with customers through a reduction ofrevenues if its earned annual rate-of-return exceeded that authorized by theCPUC.

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In April 2005, theCPUC opened a rulemaking proceeding to assess and revise the regulation oftelecommunications utilities to develop a uniform regulatory framework (“URF”)to apply to most providers of regulated telecommunications services, to theextent that it is feasible and in the public interest to do so.  In August 2006, the CPUC adopted Decision06-08-030 (the “URF Decision”) which revises the regulations oftelecommunications utilities, such as SureWest Telephone, which were previouslysubject to the NRF. The URF Decision grants carriers broad pricing freedoms inthe provision of telecommunications services, bundles of services, promotionsand contracts.  The URF Decision, amongother things:  (i) freezes the Company’sbasic residential and lifeline rates until at least January 1, 2009 in order toaddress the subsidy levels supporting these services, subject to review in theCHCF review and public policy programs proceedings, (ii) eliminates priceregulation and allows full pricing flexibility for all new and retail servicesexcept lifeline and basic residential services, (iii) allows bundles andpromotional packages on any telecommunication service, (iv) allocates all gainsand losses from the sale of assets to shareholders and (v) eliminates pricecaps, the annual price cap filing, the productivity factor, and all residualelements of rate of return regulation, including the calculation of shareableearnings.  In accordance with the URFDecision, the CPUC ordered a separate briefing cycle to consider whether todetariff altogether telecommunications services other than basic residentialservice.

In December 2006,the CPUC adopted Decision 06-12-044, an order clarifying the URF Decision andgranting limited rehearing of the URF Decision with respect to the eliminationof all asymmetric requirements concerning marketing, disclosure, oradministrative processes with the exception of conditions relating to basicresidential rates.  Pending the outcomeof this limited rehearing, the rules adopted with respect to the elimination ofasymmetric regulations are suspended.

Pursuant to theURF Decision, further proceedings in this matter will be held during 2007 toaddress detariffing of telephone service other than basic exchange service, thepricing of retail special access services, determination of the extent to whichthe Commission requires monitoring reports in addition to, or different from,the reports carriers routinely file with the FCC, and issues relating to theimplementation of the URF Phase I decision. In addition, pursuant to an assigned commissioner’s ruling issued inDecember 2006 in accordance with Decision 06-12-044, these further proceedingswill also examine customer disclosure rules and the rules adopted governingelimination of asymmetric administrative processes.

Also, in January2007, TURN filed a petition for writ of review in the Court of Appeal of theState of California challenging the URF Decision and seeking an order that theCPUC’s decision be set aside.  Theultimate results of this proceeding and the potential effects on SureWestTelephone cannot yet be determined.

As of March 31,2007, the Company’s consolidated balance sheet reflected aggregate liabilitiesof $73 relating to SureWest Telephone’s estimated interstate shareable earningsobligations. The calculations supporting these liabilities are very complex andinvolve a variety of estimates prior to the ultimate settlement of suchobligations. In addition, SureWest Telephone’s interstate shareable earningsobligations lapse over time if SureWest Telephone’s interexchange carriers andother customers do not claim the amounts ascribed to them. Accordingly, it isreasonably possible that management’s estimates of the Company’s liabilitiesfor interstate shareable earnings obligations could change in the near term,and the amounts involved could be material.

**5.             INCOME TAXES**

On January 1,2007, the Company adopted Financial Accounting Standards Board (“FASB”)Interpretation (“FIN”) No. 48, *Accounting for Uncertaintyin Income Taxes*.  FIN No. 48clarifies the accounting for uncertainty in income taxes recognized in acompany’s financial statements in accordance with FASB No. 109, *Accounting for Income Taxes*. Specifically, the pronouncementprescribes a recognition threshold and a measurement attribute for thefinancial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. FIN No. 48 also provides guidance on de-recognition,classification, interest and penalties, accounting in interim periods,disclosure and transition of uncertain tax positions.

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The adoption ofFIN No. 48 did not have a material impact on the Company’s financial positionor results of operations.  The Companyhad a liability for unrecognized tax benefits of approximately $1,511 and$1,371 at the date of adoption and March 31, 2007, respectively.  The total amount of unrecognized tax benefitsthat, if recognized, would affect the effective tax rate were $1,008 and $868at the date of adoption and March 31, 2007, respectively.

The Company’spolicy is to recognize interest and penalties related to uncertain taxpositions in income tax expense.  As ofMarch 31, 2007, the Company had approximately $221 of accrued interest andpenalties.

Approximately $754of the liability for unrecognized income tax benefits relates to research anddevelopment credits and accrued interest that are affected by statute oflimitations expiring within the next 12 months.

As of March 31, 2007 thefollowing tax years and related taxing jurisdictions were open:
| Tax Year    | ** ** | **Taxing Jurisdiction** |
|-------------|------------|-------------------------|
| 1995        |       | Federal and California  |
| 1996        |       | Federal and California  |
| 2000        |       | California              |
| 2001 - 2006 |       | Federal and California  |

 

**6.             PENSIONAND OTHER POST-RETIREMENT BENEFITS**

The Companysponsors a noncontributory defined benefit pension plan (the “Pension Plan”)covering substantially all of its employees. Benefits are based on years ofservice and the employee’s average compensation during the five highestconsecutive years of the last ten years of credited service. The Company’sfunding policy is to contribute annually an actuarially determined amountconsistent with applicable federal income tax regulations. Contributions areintended to provide for benefits attributed to service to date. Pension Planassets are primarily invested in domestic equity securities, United Statesgovernment and agency securities and international equity securities.

The Company alsohas an unfunded Supplemental Executive Retirement Plan (“SERP”), which providessupplemental retirement benefits to certain executives of the Company. The SERPprovides for incremental pension payments to partially offset the reduction inamounts that would have been payable under the Pension Plan if it were not forlimitations imposed by federal income tax regulations.

In addition, theCompany provides certain post-retirement benefits other than pensions (“OtherBenefits”) to substantially all employees, including life insurance benefitsand a stated reimbursement for Medicare supplemental insurance.

In January 2007,the Company amended the Pension Plan, SERP and Other Benefits (collectively the“Plans”).  As a result, effective April1, 2007, the Company froze the Pension Plan so that no person is eligible toparticipate in the Plans on or following that date and all future benefitaccruals under the Plans cease.  Theamendments to the Plans were accounted for as plan curtailments, resulting inthe recognition of a $574 non-cash pretax curtailment loss ($0.04 per share)reflected in operating expenses in the Company’s consolidated statement ofoperations during the quarter ended December 31, 2006.

InSeptember 2006, the FASB issued SFAS No. 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans*,an Amendment of FASB Statements No’s 87, 88, 106 and 132(R).  SFAS No. 158 requires an employer torecognize the funded status of a defined benefit postretirement plan as anasset or liability in its statement of financial position and to recognizechanges in that funded status in the year in which the changes occur throughcomprehensive income.  SFAS No. 158 requiresan employer with publicly traded equity securities to initially recognize thefunded status of a defined benefit postretirement plan and the requireddisclosures as of the end of the fiscal year ending after December 15,2006.  The Company adopted SFASNo. 158 on December 31, 2006.

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**Componentsof Net Periodic Benefit Cost**

Net periodicpension costs recognized in the condensed consolidated statements of income forthe quarters ended March 31, 2007 and 2006 under the Plans included thefollowing components:
| ** **                                         | ** ** | **Pension Plan and SERP** | ** ** | **Other Benefits** | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **2007**                                 | ** ** | **2006**                | ** ** | **2007** | ** ** | **2006** | ** ** |
| Service  cost-benefits earned during the period    |       | $                                        | 1,200      |                    | $          | 1,546 |   | $ | — |   | $ | 182 |   |
| Interest cost on  projected benefit obligation     |       | 1,800                                    |       | 2,040                   |       | — |   | 185 |   |
| Expected return  on plan assets                    |       | (2,300                                   | )          | (2,165                  | )          | — |   | (80 | ) |
| Amortization of  prior service cost                |       | —                                   |       | 26                      |       | — |   | 13 |   |
| Recognized net  actuarial loss                     |       | —                                   |       | 298                     |       | — |   | 13 |   |
| Expected  disbursement for life insurance premiums |       | —                                   |       | —                  |       | — |   | (16 | ) |
| Net pension cost                                   |       | $                                        | 700        |                    | $          | 1,745 |   | $ | — |   | $ | 297 |   |

 

**7.             COMMITMENTS AND CONTINGENCIES**

**CreditArrangements**

In May 2006, theCompany completed an unsecured Credit Agreement for a Term Loan facility and aRevolving Loan facility (collectively “Loan Facilities”) in principal amountsup to $75,000 and $25,000, respectively. Interest on the Loan Facilities is payable quarterly and based on aLIBOR, variable interest rate, or a fixed interest rate pricing formula, or acombination, as defined in the Credit Agreement. Principal payments on theoutstanding amounts borrowed under the Term Loan facility as of December 31, 2007are due in equal quarterly installments commencing March 31, 2008 through June30, 2016.  The Revolving Loan facilityhas an expiration date of June 30, 2013. As of March 31, 2007 and December 31, 2006, $40,000 was outstandingunder the Term Loan Facility and no amounts were outstanding under theRevolving Loan facility.

TheCompany had a business loan agreement with a bank for a $50,000 line of credit,which was originally due to expire July 1, 2006. As of March 31, 2006, therewas $33,000 under this credit facility at a weighted average interest rate of6.16%, which was based on a LIBOR-based pricing formula. In connection, withthe completion of the Credit Agreement noted above, the Company terminated itsbusiness loan agreement effective May 1, 2006.

Certain of theCompany’s credit arrangements contain financial and operating covenants thatrestrict, among other things, the payment of cash dividends, repurchase of theCompany’s capital stock, the making of certain other restricted payments andthe incurrence of additional indebtedness. The covenants also require theCompany to maintain certain financial ratios and minimum levels of tangible networth. At March 31, 2007 and December 31, 2006, retained earnings ofapproximately $123,576 and $65,776, respectively, were available for thepayment of cash dividends or other restricted payments under the terms of theCompany’s credit arrangements.

**Litigation,Regulatory Proceedings and Other Contingencies**

The Company issubject to certain legal and regulatory proceedings, Internal Revenue Serviceexaminations and other income tax exposures, and other claims arising in theordinary course of its business. In the opinion of management, the ultimateoutcome of these matters will not materially affect the consolidated financialposition, results of operations or cash flows of the Company.

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**8.             RECENT ACCOUNTING PRONOUNCEMENTS**

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities - Including an Amendment of FASBStatement No. 115*. This standard permits an entity to elect tomeasure many financial instruments and certain other items at fair value.Unrealized gains and losses on items for which the fair value option has beenelected will be recognized in earnings at each subsequent reporting date. SFASNo. 159 is effective as of the beginning of an entity’s first fiscal year thatbegins after November 15, 2007.  Early adoption is permitted as of thebeginning of the previous fiscal year provided that the entity makes thatchoice in the first 120 days of that fiscal year and also elects to apply theprovisions of FASB Statement No. 157, *Fair Value Measurements*.The Company is currently evaluating the impact, if any, the adoption of SFASNo. 159 will have on its consolidated financial statements.

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements.  SFAS No. 157 iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and for interim periods within those fiscal years. TheCompany is currently evaluating the impact, if any, the adoption of SFAS No.157 will have on its consolidated financial statements.

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**ITEM 2.****                       MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

*(Amountsin thousands, except selected operating metrics and share and per shareamounts)*

Certaininformation included in this quarterly report on Form 10-Q of SureWestCommunications (the “Company”), including that which relates to the impact onfuture revenue sources and potential sharing obligations of pending and futureregulatory orders, continued expansion of the telecommunications network andexpected changes in the sources of the Company’s revenue and its cost structureresulting from its entrance into new communications markets, are forwardlooking statements and are made pursuant to the safe harbor provisions of theSecurities Litigation Reform Act of 1995. Such forward looking statements aresubject to a number of risks, assumptions and uncertainties that could causethe Company’s actual results to differ from those projected in such forwardlooking statements.

Important factorsthat could cause actual results to differ from those set forth in the forwardlooking statements include, but are not limited to: advances intelecommunications technology, changes in the telecommunications regulatoryenvironment, changes in the financial stability of other telecommunicationsproviders that are customers of the Company, changes in competition in marketsor businesses in which the Company operates, adverse circumstances affectingthe economy in California in general, and in the Sacramento, CaliforniaMetropolitan area in particular, the availability of future financing, changesin the demand for services and products, new product and service developmentand introductions, pending and future litigation, and unanticipated changes inthe growth of the Company’s emerging businesses, including the wireless andbroadband business segments.

**CorporateStructure**

The Company is aholding company with wholly-owned subsidiaries operating in theTelecommunications (“Telecom”), Broadband and Wireless segments.

The Telecomsegment includes SureWest Telephone and SureWest Long Distance, which providelandline telecommunications services, Digital Subscriber Line (“DSL”) service,long distance services and certain non-regulated services. SureWest Telephone,which is the principal operating subsidiary of the Telecom segment, provideslocal services, toll telephone services, network access services and certainnon-regulated services.  SureWest LongDistance is a reseller of long distance services.

In January 2007,the Company entered into a definitive agreement with GateHouse Media to sellSureWest Directories (previously included in the Telecom segment), itsdirectory publishing business.  As partof the transaction, GateHouse Media became the publisher of the officialdirectory of SureWest Telephone. The transaction was consummated on February28, 2007.  Under the agreement, GateHouseMedia acquired 100% of the stock of SureWest Directories for an aggregate cashpurchase price of $110,123, resulting in a gain of $101,566, less estimated incometaxes of $41,384.  The Company continuesto evaluate its businesses and product lines and believes this transaction willpermit the Company to focus more on the strategic growth of its core businessof being a full-service integrated communications provider.

The Broadbandsegment includes the Company’s subsidiaries SureWest Broadband, SureWestTeleVideo and SureWest TeleVideo of Roseville (collectively referred to as “SureWestBroadband/Residential Services”) and SureWest Broadband Business Services, whichis comprised, in part, of a division of SureWest Telephone operating as aCompetitive Local Exchange Carrier (“CLEC”). The Broadband segment providesvarious services, including high-speed and dial-up Internet, digital video,voice, network access, long distance and managed services in the greaterSacramento area, principally to customers residing outside of SureWestTelephone’s service area.

The Wirelesssegment consists of the Company’s subsidiary SureWest Wireless, which provideswireless services. Wireless revenues include wireless voice services, sales ofhandsets and related accessories, long distance, roaming service and customcalling features. Wireless services are provided on a month-to-month basis andare generally billed in advance for non-contract subscribers and in arrears forcontract subscribers.

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The Company expects that the sources of its revenuesand its cost structure may be different in future periods, both as a result ofits entry into new communications markets and competitive forces in each of themarkets in which the Company has operations.

**ConsolidatedNet Income**

Net income for thequarter ended March 31, 2007 was $61,233, or $4.24 per share, substantially allof which ($60,182, or $4.17 per share, net of tax) resulted from the sale ofSureWest Directories on February 28, 2007. In the prior year quarter, the Company’s net income was $1,199 ($0.08per share), of which $1,759 was attributable to the operations of SureWestDirectories (now reported as a discontinued operation).  In the first quarter of 2007, income fromoperations of SureWest Directories (for the two-months ended February 28, 2007)was $999.

Income fromcontinuing operations in the first quarter of 2007 was $52 ($0.00 per share),compared to a loss of $560 ($0.04 per share) in the first quarter of 2006.  A more detailed discussion of consolidatedresults of operations and results by segment follows.

**Resultsof Operations**

**ConsolidatedOverview**

The tables belowreflect certain financial data (on a consolidated and segment basis) andselected operating metrics for each reportable segment as of and for thequarters ended March 31, 2007 and 2006.

**FinancialData**
| ** **                                    | ** ** | **Quarter Ended March 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                   | ** ** | **2006** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **Operating  revenues (1)**                   | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Telecom                                       |       | $                                          | 26,361     |   | $ | 27,101 |   | $ | (740 | ) | (3 | )% |
| Broadband                                     |       | 16,422                                     |       | 13,881 |   | 2,541 |   | 18 |   |
| Wireless                                      |       | 8,201                                      |       | 8,394 |   | (193 | ) | (2 | ) |
| Operating revenues                            |       | 50,984                                     |       | 49,376 |   | 1,608 |   | 3 |   |
|                                          |       |                                       |       |   |   |   |   |   |   |
| **Income  (loss) from operations**            | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Telecom                                       |       | 11,337                                     |       | 11,108 |   | 229 |   | 2 |   |
| Broadband                                     |       | (6,022                                     | )          | (7,562 | ) | 1,540 |   | 20 |   |
| Wireless                                      |       | (4,325                                     | )          | (2,895 | ) | (1,430 | ) | (49 | ) |
| Income from operations                        |       | 990                                        |       | 651 |   | 339 |   | 52 |   |
|                                          |       |                                       |       |   |   |   |   |   |   |
| **Income  (loss) from continuing operations** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Telecom                                       |       | 6,977                                      |       | 6,461 |   | 516 |   | 8 |   |
| Broadband                                     |       | (4,094                                     | )          | (5,089 | ) | 995 |   | 20 |   |
| Wireless                                      |       | (2,831                                     | )          | (1,932 | ) | (899 | ) | (47 | )% |
| Income (loss) from continuing operations      |       | $                                          | 52         |   | $ | (560 | ) | $ | 612 |   | NA |   |

 

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(1) External customers only

16

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**SelectedOperating Metrics**
| ** **                                    | ** ** | **As of March 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | **2007**                           | ** ** | **2006** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| **Telecom**                                   | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Incumbent Local Exchange Carrier access lines |       | 124,368                            |       | 128,459 |   | (4,091 | ) | (3 | )% |
| Long distance lines                           |       | 58,364                             |       | 54,106 |   | 4,258 |   | 8 |   |
|                                          |       |                               |       |   |   |   |   |   |   |
| **Broadband**                                 | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total subscribers (1)                         |       | 60,480                             |       | 51,946 |   | 8,534 |   | 16 |   |
| Broadband Revenue-generating units (2)        |       |                               |       |   |   |   |   |   |   |
| Data                                          |       | 58,130                             |       | 49,429 |   | 8,701 |   | 18 |   |
| Video                                         |       | 20,445                             |       | 17,076 |   | 3,369 |   | 20 |   |
| Voice                                         |       | 19,434                             |       | 16,482 |   | 2,952 |   | 18 |   |
| Business Voice-grade equivalents (3)          |       | 851,700                            |       | 683,500 |   | 168,200 |   | 25 |   |
|                                          |       |                               |       |   |   |   |   |   |   |
| **Wireless**                                  | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Subscribers                                   |       | 52,071                             |       | 53,286 |   | (1,215 | ) | (2 | )% |

 

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(1)          Total subscribers arecustomers who receive one or more of data, video or voice services fromSureWest Broadband.

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

(3)          Business Voice-gradeequivalents (“VGEs”) are calculated by dividing the capacity of all circuits inuse by 64 kilobits (bandwidth representing a voice access line).  DSL VGEsare counted as two 64 kbps channels.

Operating revenuesfrom external customers in the Telecom segment decreased $740 during thequarter ended March 31, 2007 compared to the same period in 2006. SureWestTelephone continues to experience decreases in local and network accessrevenues due to competition from wireless (including SureWest Wireless) andwireline competitors, contributing to an approximate 3% decline in accesslines.  In addition, network access revenues decreased due to a decline inthe rate base, which affects the interstate pool settlements from the NationalExchange Carrier Association (“NECA”) (see *Regulatory Matters*within the *Telecom Segment Results of Operations and CriticalAccounting Policies and Estimates* sections below).  SureWestTelephone’s revenues are also impacted by shareable earnings obligations andchanges in funding levels authorized by the California Public UtilitiesCommission (“CPUC”), which are also discussed below in the Telecom SegmentResults of Operations.

While the Telecomsegment steadily continues to generate a majority of the Company’s revenues,cash flows and net income, the Company believes that the results of the Telecomsegment in recent years (reflected in declining revenues and access lines)support, in part, the Company’s efforts to continue to develop its otherbusiness segments.

Broadbandoperating revenues increased $2,541 during the quarter ended March 31, 2007compared to the same period in 2006 primarily as a result of the continuedexpansion of the broadband network and growth in the demand for data and videoservices.  At March 31, 2007, the Broadband segment had experienced a 16%increase in the number of subscribers from March 31, 2006. In addition,broadband business services realized a 25% increase in VGEs compared to theprior year. While continuing to produce significant revenue increases, theexpansion of the broadband residential services has and will continue torequire significant capital and expense commitments.

17

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Operating revenues from external customers in theWireless segment for the quarter ended March 31, 2007 decreased $193 comparedto the same period in 2006.  The decrease in operating revenues wasattributable to a decline in equipment revenue as a result of a reduction inthe average selling price per handset offset in part by an increase in thequantity of handsets sold.  As theCompany deemphasizes the prepaid market and migrates toward contractsubscribers, the number of wireless subscribers decreased to 52,071 at March31, 2007, a 2% decline from March 31, 2006.  Despite the subscriberdecline, access and feature revenues remained consistent with the prior year asa result of an increase in the average revenue per subscriber and theintroduction of new features during 2006.

The Company’sconsolidated operating expenses, excluding depreciation and amortization,increased $1,944 during the quarter ended March 31, 2007 compared to the sameperiod in 2006 due to an increase in cost of services and products expense of$1,077 as a result of (i) the continued growth in subscribers and serviceswithin the Broadband segment and (ii) an increase in the cost of equipmentsales due to increases in the average cost and quantity of wireless handsetssold.  Customer operations and sellingexpense increased $304 for the quarter ended March 31, 2007 compared to thesame period in 2006 due primarily to an increase in sales and advertising coststo promote subscriber growth and new product offerings within the Broadbandsegment.  General and administrative expenses increased $563 for thequarter ended March 31, 2007 compared to the same period in 2006 primarily as aresult of an increase in consulting and audit fees.

The increase inoperating expenses was offset in part by an approximate $886 decline in costsassociated with the Company’s defined benefit pension plan (the “Pension Plan”),Supplemental Executive Retirement Plan (“SERP”) and certain post-retirementbenefits other than pensions (“Other Benefits”) (collectively the “Plans”) as aresult of amendments to the Plans in January 2007.  The Plan amendments, effective April 1, 2007,froze the Pension Plan so that no person is eligible to participate in thePlans on or following that date and all future benefit accruals under the Planscease.  The amendments to the Plans wereaccounted for as plan curtailments, resulting in the recognition of a $574non-cash pretax curtailment loss ($0.04 per share) reflected in operatingexpenses in the Company’s consolidated statement of operations during thequarter ended December 31, 2006.  As aresult of Pension Plan freeze and associated revised actuarial calculations,the Company recorded $700 in expense related to the Pension and Other Benefitsplans during the quarter ended March 31, 2007, an $865 decline from the prioryear period.

The Company’sconsolidated depreciation and amortization expense decreased $675 during thequarter ended March 31, 2007 compared to the same period in 2006, despite thecontinued network build-out and success-based capital projects undertakenwithin the residential broadband service territories, due to a change inaccounting estimate recorded during the first quarter of 2007.

During the firstquarter of 2007, the Company completed its triennial review of asset lives thatevaluated the appropriateness of the estimated useful lives of its propertyplant and equipment for all segments. The evaluation considered the Company’s investment and businessstrategy, reliability and historical performance data of certain assets, aswell as the impacts of competition and anticipated technological change. As aresult of this evaluation, effective January 1, 2007, the Companyincreased the estimated useful lives of certain of its customer premiseequipment, circuit equipment, cable plant and towers primarily in the Broadbandsegment. The increase in asset lives primarily ranged between 1 to 4 years,although the change in estimated useful lives for towers was 8 years.  The Company’s revisions to its estimateduseful lives have been supported by an assessment and report from anindependent party with expertise in this area that found the revisions to bereasonable in light of the Company’s plan and useful life estimates incomparable businesses. During the quarter ended March 31, 2007, this change inestimate decreased consolidated depreciation expense by $948 and increasedconsolidated net income by $645 ($0.04 per share).

18

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**SegmentResults of Operations**

**Telecom**
| ** **                                        | ** ** | **Quarter Ended March 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                   | ** ** | **2006** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|                                              |       |                                       |       |   |   |   |   |   |   |
| Local service                                     |       | $                                          | 14,779     |   | $ | 15,581 |   | $ | (802 | ) | (5 | )% |
| Network access  service                           |       | 9,192                                      |       | 9,917 |   | (725 | ) | (7 | ) |
| Long distance  service                            |       | 1,426                                      |       | 1,384 |   | 42 |   | 3 |   |
| Other                                             |       | 964                                        |       | 219 |   | 745 |   | 340 |   |
| Total operating  revenues from external customers |       | 26,361                                     |       | 27,101 |   | (740 | ) | (3 | ) |
| Intersegment  revenues                            |       | 6,972                                      |       | 7,328 |   | (356 | ) | (5 | ) |
| Operating  expenses*                              |       | 16,431                                     |       | 17,018 |   | (587 | ) | (3 | ) |
| Depreciation and  amortization                    |       | 5,565                                      |       | 6,303 |   | (738 | ) | (12 | ) |
| Income from  operations                           |       | 11,337                                     |       | 11,108 |   | 229 |   | 2 |   |
| Income from continuing  operations                |       | $                                          | 6,977      |   | $ | 6,461 |   | $ | 516 |   | 8 | % |

 

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*Exclusive ofdepreciation and amortization

*Operating Revenues*

Operating revenuesfrom external customers in the Telecom segment decreased $740 in the quarterended March 31, 2007, compared to the same period in 2006. SureWest Telephonecontinues to experience decreases in local and network access revenues due tocompetition from wireless (including SureWest Wireless) and wireline competitors,contributing to an approximate 3% decline in access lines.  In addition,network access revenues decreased due to a decline in the rate base, whichaffects the interstate pool settlements from the NECA (see *RegulatoryMatters* and Critical Accounting Policies and Estimates sectionsbelow).  SureWest Telephone’s revenues are also impacted by shareableearnings obligations, which are discussed below in the *RegulatoryMatters* section.

*Operating Expenses*

Operating expensesfor the Telecom segment decreased $587 for the quarter ended March 31, 2007,compared to the same period in 2006.  The decrease in operating expenseswas primarily due to a $533 decline in the costs related to the Pension Planand Other Benefits, as described in the Consolidated Overview sectionabove.  In addition, the number of full time equivalent employees in theTelecom segment decreased approximately 15% from March 2006 to March 2007.

Cost of servicesand products (exclusive of depreciation and amortization) decreased $641 for thequarter ended March 31, 2007, compared to the same period in 2006.  Thedecrease was attributable to decreases in network operations and supportexpenses as a result of reductions in the number of employees.  The decreases were partially offset by increasesin long distance access expense as a result of the InfinitAccessTM bundle program and an increase in minutes ofuse.

Customeroperations and selling expense increased $94 for the quarter ended March 31,2007, compared to the same period in 2006, due primarily to an increase inbilling and collection costs, which were impacted by the increase in longdistance access expense previously discussed. The increase was partially offsetby a decrease in labor costs as a result of a reduction in the number of employeesand internal efficiencies resulting from integrated customer support systemsand productivity gains.

Depreciation and amortization decreased $738 for thequarter ended March 31, 2007, compared to the same period in 2006 due primarilyto a significant portion of computer software becoming fully depreciated during2006.

19

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*RegulatoryMatters*

Revenues fromservices subject to regulation constituted approximately 47% and 52% of theCompany’s total operating revenues from continuing operations for the quartersended March 31, 2007 and 2006, respectively.  Local service, networkaccess service and toll service are included in revenues from services subjectto regulation, and are derived from various sources including:

·                  business andresidential subscribers, for basic exchange services;

·                  surcharges,mandated by the CPUC;

·                  long distancecarriers, for network access service;

·                  competitiveaccess providers and subscribers, for network access service;

·                  interstate poolsettlements from NECA;

·                  support paymentsfrom federal or state programs; and

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

Revenues fromcertain telephone services are affected by rates authorized by various regulatoryagencies. Intrastate service rates are subject to regulation by the CPUC. Withrespect to toll calls initiated by interexchange carriers’ customers, theinterexchange carriers are assessed access charges based on tariffs filed bySureWest Telephone. Interstate access rates and resultant earnings are subjectto regulation by the Federal Communications Commission (“FCC”). With respect tointerstate services, SureWest Telephone has detariffed its DSL services andfiles its own tariff with the FCC for switched and special accessservices.  For interstate common line (“CL”) charges, SureWest Telephoneconcurs with tariffs filed by NECA.

The FCC monitorsSureWest Telephone’s interstate earnings through the use of annual costseparation studies prepared by SureWest Telephone, which utilize estimated costinformation and projected demand usage. The FCC establishes rules thatcarriers must follow in the preparation of the annual studies. Additionally,under current FCC rules governing rate making, SureWest Telephone isrequired to establish interstate rates based on projected demand usage for itsvarious services and determine the actual earnings from these rates once actualvolumes and costs are known. The Company did not identify any interstateshareable earnings obligations at SureWest Telephone during the quarters endedMarch 31, 2007 or 2006.

As a result ofperiodic cost separation studies, SureWest Telephone changed its estimates fora portion of its interstate shareable earnings obligations and certain NECA CLaccounts receivable balances related to current and prior year monitoringperiods.  For the quarter ended March 31,2007, these changes in estimates increased the Company’s consolidated revenuesby $118 and net income by $81 ($0.01 per share), respectively.  The Company did not record any significantchanges in estimates during the quarter ended March 31, 2006.

The FCC has apending rulemaking proceeding to re-examine all regulated forms of intercarriercompensation and develop a more unified mechanism to govern the payment flowsamong telecommunications carriers. Intercarrier compensation is the regulated fees that service providerscharge each other to carry and terminate traffic. Reform has been suggested dueto the changing nature of the industry with increasing competition from newtechnologies, such as Internet and Internet-based services and wirelessservices.  Various plans have beensubmitted to the FCC with divergent approaches to handle intercarrier compensationthat may reduce per-minute access and reciprocal compensation charges andreplace these revenues with a combination of increases to the subscriber linecharge and revenues obtained from a new restructure mechanism.  The ultimate results of this proceeding andthe potential effects on SureWest Telephone cannot yet be determined.

20

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The Company was involved in a proceeding at the CPUCthat considered the continued need for certain sharing requirements in theintrastate jurisdiction and, in connection with that review, also consideredthe issue of whether the Company overearned in the intrastate jurisdiction inrecent monitoring periods and the amount of overearnings that should be sharedwith customers. In July 2004, the Company entered into a settlementagreement (the “settlement agreement”) with the other parties in theproceeding, the Division of Ratepayer Advocates (“DRA”), and The Utility ReformNetwork (“TURN”), to resolve all issues in the proceeding. InNovember 2004, the CPUC approved the settlement agreement. The settlementagreement resolved existing intrastate sharing obligations and related earningsissues for the monitoring periods 2000 through 2004, put into place a surcreditmechanism for the amount of the settlement, and suspended the requirement forany intrastate sharing for monitoring periods from January 1, 2005 through atleast December 31, 2010.  However, as aresult of a decision subsequently adopted by the CPUC the sharing requirementhas been eliminated, as discussed below.

In accordance withthe settlement agreement, SureWest Telephone is returning approximately $6,500(“Dividend A”), plus interest at the 90-day commercial paper rate fornon-financial institutions, which was 5.2% as of March 31, 2007, and an imputedrate of 3.15%, to its end users through a consumer dividend over a period ofapproximately four years, which began January 1, 2005. In addition, SureWestTelephone paid a one-time consumer dividend of $2,600 (“Dividend B”), which wasreturned to the consumers to settle the monitoring periods 2000 to 2004 overapproximately two years, which began January 1, 2005 and was completed in March2007. The consumer dividend included an annual imputed interest rate of 3.15%(no stated contractual interest rate). The consumer dividends were recorded as a reduction of the Company’scontractual shareable earnings obligations. At March 31, 2007, the aggregate contractual shareable earningsobligation for these surcredits was $2,928 (which is net of an unamortizeddiscount pertaining to imputed interest of $89 at that date).

The followingtable summarizes the amounts returned to end users through consumer dividendsfor the quarters ended March 31, 2007 and 2006:

|            | ** ** | **Quarter Ended** | ** ** |
|------------|------------|------------------------|------------|
| ** ** | ** ** | **March 31,**     | ** ** |
| ** ** | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Dividend A |       | $                      | 486        |   | $ | 515 |   |
| Dividend B |       | 210                    |       | 301 |   |
| Total      |       | $                      | 696        |   | $ | 816 |   |

 

Further, as partof the settlement agreement SureWest Telephone was to implement an additionalannual consumer dividend of $1,300 on January 1, 2007 to end-users receivingSureWest Telephone services subject to sharing on or after that date.  However, this consumer dividend was subjectto reduction based upon the results of other pending regulatory proceedings andin 2007 has been offset by a reduction in the Company’s draw from the CHCF, asdiscussed below.

Prior to 2000,AT&T Inc. (“AT&T”) had been paying SureWest Telephone approximately$11,500 per year for EAS pursuant to a Settlement Transition Agreement. InNovember 2000, the CPUC authorized AT&T to terminate its annual EASpayments to SureWest Telephone effective November 30, 2000. The CPUCauthorized replacement funding to SureWest Telephone on an interim basis usingfunds from the CHCF. The CHCF is a program designed by the CPUC to establish afair and equitable local rate structure and to reduce any disparity in therates charged by telephone companies serving high-cost areas. The CHCF fundingis scheduled to expire January 1, 2009. In addition, the CPUC opened anOrder Instituting Investigation (“OII”) for the purpose of determining whetherfuture recovery of all, none, or a portion of the annual payments received fromthe CHCF should come from SureWest Telephone’s ratepayers or other regulatoryrecovery mechanisms.

21

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In August 2005, the CPUC adopted a decision which(i) authorized SureWest Telephone to continue receiving $11,500 annuallyfrom the CHCF to offset its intrastate regulated operating expenses on aninterim basis, (ii) required SureWest Telephone to prepare and submitwithin twelve months a cost proxy model (which is used generally as a basis forCHCF funding) based on its current cost data, including analyses of theresulting impacts on rates, the Universal Lifeline Telephone Service (“ULTS”)fund and the CHCF fund and (iii) authorized SureWest Telephone to file anadvice letter with the Commission’s Telecommunications Division toimplement  reductions to its businessaccess line rates.

In August 2006,the Company filed a petition for modification (the “petition”) of the decisionthat reviewed SureWest Telephone’s revenue requirement, which seeks CPUC authorizationfor a graduated phase-down of its $11,500 interim draw from the CHCF over aperiod of time that is intended to assure the continued maintenance of goodservice to SureWest Telephone customers while avoiding precipitous rateincreases.  The Company’s petitionproposed a transitional phase-down over a five-to-ten year period and requestedelimination of the requirement to file its cost proxy model.  The Company will seek to recover theeliminated revenues through rate increases and/or operating efficiencies.  In August 2006, the DRA filed opposition tothe Company’s petition and instead proposed the Company immediately discontinuereceipt of CHCF funds. In October 2006, the Company filed a request for aninterim decision on its petition by which the Company proposed to reduce itsannual interim CHCF draw by a $1,300 consumer dividend required by thesettlement agreement, as described above. In December 2006, the CPUC issued an interim decision approving the Company’sproposal to offset its draw from the CHCF by the $1,300 consumer dividend.  In January 2007, DRA filed a supplementalresponse and opposition to immediately discontinue the Company’s CHCF funds orif the CPUC permits a transitional phase-down, that should occur over a periodof no more than three years.  In February2007, the Company responded to DRA’s supplemental response and oppositionrefuting DRA’s positions and supporting the Company’s previously filedphase-down proposals.  The results ofthis proceeding and the potential effects on SureWest Telephone could impactfuture funding levels through the CHCF.

In June 2006, theCPUC instituted a rulemaking proceeding to review the CHCF program.  The goals of this review include, but are notlimited to, adjusting universal service rate support payments to reflectupdated operating costs, evaluating whether CHCF fund support levels can bereduced and made more predictable while still meeting the goals of the program,ensuring it is competitively neutral, reducing rate disparity in residential basicservice between urban and rural areas in the state, and making the currentadministration of the program more efficient. In addition, the CHCF rulemaking requested comments as to whetherSureWest Telephone should continue receiving the annual payments from the CHCFand the advisability and impacts of phasing out the EAS payments gradually overa period of approximately 5 years.  Theresults of this proceeding and the potential effects on SureWest Telephone couldimpact future funding levels through the CHCF.

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

In April 2005, theCPUC opened a rulemaking proceeding to assess and revise the regulation oftelecommunications utilities to develop a uniform regulatory framework (“URF”)to apply to most providers of regulated telecommunications services, to theextent that it is feasible and in the public interest to do so.  In August 2006, the CPUC adopted Decision06-08-030 (the “URF Decision”) which revises the regulations oftelecommunications utilities, such as SureWest Telephone, which were previouslysubject to the NRF. The URF Decision grants carriers broad pricing freedoms inthe provision of telecommunications services, bundles of services, promotionsand contracts.  The URF Decision, amongother things:  (i) freezes the Company’sbasic residential and lifeline rates until at least January 1, 2009 in order toaddress the subsidy levels supporting these services, subject to review in theCHCF review and public policy programs proceedings, (ii) eliminates price regulationand allows full pricing flexibility for all new and retail services exceptlifeline and basic residential services, (iii) allows bundles and promotionalpackages on any telecommunication service, (iv) allocates all gains and lossesfrom the sale of assets to shareholders and (v) eliminates price caps, theannual price cap filing, the productivity factor, and all residual elements

22

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of rate of returnregulation, including the calculation of shareable earnings.  In accordance with the URF Decision, the CPUCordered a separate briefing cycle to consider whether to detariff altogethertelecommunications services other than basic residential service.

In December 2006,the CPUC adopted Decision 06-12-044, an order clarifying the URF Decision andgranting limited rehearing of the URF Decision with respect to the eliminationof all asymmetric requirements concerning marketing, disclosure, oradministrative processes with the exception of conditions relating to basicresidential rates.  Pending the outcomeof this limited rehearing, the rules adopted with respect to the elimination ofasymmetric regulations are suspended.

Pursuant to the URF Decision, further proceedings inthis matter will be held during 2007 to address detariffing of telephoneservice other than basic exchange service, the pricing of retail special accessservices, determination of the extent to which the Commission requiresmonitoring reports in addition to, or different from, the reports carriersroutinely file with the FCC, and issues relating to the implementation of theURF Phase I decision.  In addition,pursuant to an assigned commissioner’s ruling issued in December 2006 inaccordance with Decision 06-12-044, these further proceedings will also examinecustomer disclosure rules and the rules adopted governing elimination ofasymmetric administrative processes.

Also, in January2007, TURN filed a petition for writ of review in the Court of Appeal of theState of California challenging the URF Decision and seeking an order that theCPUC’s decision be set aside.  Theultimate results of this proceeding and the potential effects on SureWestTelephone cannot yet be determined.

As of March 31,2007, the Company’s consolidated balance sheet reflected aggregate liabilitiesof $73 relating to SureWest Telephone’s estimated interstate shareable earningsobligations. The calculations supporting these liabilities are very complex andinvolve a variety of estimates prior to the ultimate settlement of suchobligations. In addition, SureWest Telephone’s interstate shareable earningsobligations lapse over time if SureWest Telephone’s interexchange carriers andother customers do not claim the amounts ascribed to them. Accordingly, it isreasonably possible that management’s estimates of the Company’s liabilitiesfor interstate shareable earnings obligations could change in the near term,and the amounts involved could be material.

**Broadband**
| ** **                                        | ** ** | **Quarter Ended March 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                   | ** ** | **2006** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|                                              |       |                                       |       |   |   |   |   |   |   |
| Data                                              |       | $                                          | 7,882      |   | $ | 6,905 |   | $ | 977 |   | 14 | % |
| Video                                             |       | 3,627                                      |       | 2,756 |   | 871 |   | 32 |   |
| Voice                                             |       | 2,149                                      |       | 1,729 |   | 420 |   | 24 |   |
| Network access                                    |       | 2,243                                      |       | 2,014 |   | 229 |   | 11 |   |
| Other                                             |       | 521                                        |       | 477 |   | 44 |   | 9 |   |
| Total operating  revenues from external customers |       | 16,422                                     |       | 13,881 |   | 2,541 |   | 18 |   |
| Intersegment  revenues                            |       | 520                                        |       | 424 |   | 96 |   | 23 |   |
| Operating expenses*                               |       | 17,778                                     |       | 16,670 |   | 1,108 |   | 7 |   |
| Depreciation and  amortization                    |       | 5,186                                      |       | 5,197 |   | (11 | ) | (0 | ) |
| Loss from  operations                             |       | (6,022                                     | )          | (7,562 | ) | 1,540 |   | 20 |   |
| Loss from continuing  operations                  |       | $                                          | (4,094     | ) | $ | (5,089 | ) | $ | 995 |   | 20 | % |

 

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*Exclusive ofdepreciation and amortization

*Operating Revenues*

Operating revenuesfrom external customers in the Broadband segment increased $2,541 for thequarter ended March 31, 2007 compared to the same period in 2006. The increasein Broadband revenues was due to the combined effects of (i) an 18% increase inRevenue-generating units of broadband services and (ii) the continued expansionof business broadband services as evidenced by a 25% increase in VGEs.

23

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*Operating Expenses*

Total operatingexpenses in the Broadband segment increased $1,108 for the quarter ended March31, 2007, compared to the same period in 2006. The increase in operatingexpenses was offset in part by a $185 decline in the costs related to thePension Plan and Other Benefits, as described in the Consolidated Overview sectionabove.

Cost of servicesand products (exclusive of depreciation and amortization) increased $635 forthe quarter ended March 31, 2007 compared to the same period in 2006, dueprimarily to (i) an increase in programming and transport costs related to thegrowth in Broadband subscribers and residential broadband Revenue-generatingunits and (ii) an increase in access expense and general support costscorresponding to the increased subscriber count, as well as the expandednetwork footprint.

Customer operationsexpense increased $104 for the quarter ended March 31, 2007 compared to thesame period in 2006.  The increase was attributable to an increase insales and advertising costs to promote new and existing product offeringswithin the Broadband segment.

General andadministrative expense increased $369 for the quarter ended March 31, 2007compared to the same period in 2006, primarily due to (i) increased corporateoverhead costs charged to the Broadband segment resulting from the growth inthe customer base and (ii) increased audit and consulting fees.

Depreciation andamortization decreased $11 for the quarter ended March 31, 2007 compared to thesame period in 2006.  Depreciationexpense in the Broadband segment increased due to the continued network build-outwithin the residential broadband service territories but was offset by a changein accounting estimate recorded during the first quarter of 2007, as discussedbelow.

During the firstquarter of 2007, the Company completed its triennial review of asset lives thatevaluated the appropriateness of the estimated useful lives of its propertyplant and equipment for all segments. The evaluation considered the Company’s investment and businessstrategy, reliability and historical performance data of certain assets, aswell as the impacts of competition and anticipated technological change. As aresult of this evaluation, effective January 1, 2007, the Companyincreased the estimated useful lives of certain of its customer premiseequipment, circuit equipment, cable plant and towers primarily in the Broadbandsegment. The increase in asset lives primarily ranged between 1 to 4 years,although the change in estimated useful lives for the towers was 8 years.  The Company’s revisions to its estimateduseful lives have been supported by an assessment and report from anindependent party with expertise in this area that found the revisions to bereasonable in light of the Company’s plan and useful life estimates incomparable businesses. During the quarter ended March 31, 2007, this change inestimate decreased the Broadband segment depreciation expense by $948 andincreased consolidated net income by $645 ($0.04 per share).

**Wireless**
| ** **                                 | ** ** | **Quarter Ended March 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2007**                                   | ** ** | **2006** | ** ** | **Change** | ** ** | **Change** | ** ** |
| Wireless  revenues from external customers |       | $                                          | 8,201      |   | $ | 8,394 |   | $ | (193 | ) | (2 | )% |
| Intersegment  revenues                     |       | 784                                        |       | 680 |   | 104 |   | 15 |   |
| Operating  expenses*                       |       | 10,273                                     |       | 9,006 |   | 1,267 |   | 14 |   |
| Depreciation and  amortization             |       | 3,037                                      |       | 2,963 |   | 74 |   | 2 |   |
| Loss from  operations                      |       | (4,325                                     | )          | (2,895 | ) | (1,430 | ) | (49 | ) |
| Loss from continuing  operations           |       | $                                          | (2,831     | ) | $ | (1,932 | ) | $ | (899 | ) | (47 | )% |

 

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*Exclusive of depreciation and amortization

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*Operating Revenues*

Operating revenuesfrom external customers in the Wireless segment decreased $193 for the quarterended March 31, 2007 compared to the same period in 2006.  The decrease inrevenue was due primarily to (i) a decline in equipment revenue resulting froma decrease in the average selling price of handsets offset in part by anincrease in the quantity of handsets sold and (ii) an increase in bad debtexpense.  The decrease in revenue waspartially offset by an increase in feature revenues as a result of new featuresintroduced in 2006.

*Operating Expenses*

Total operatingexpenses for the Wireless segment increased $1,267 for the quarter ended March31, 2007, compared to the same period in 2006. The increase in operatingexpenses was offset in part by a $147 decline in the costs related to thePension Plan and Other Benefits, as described in the Consolidated Overviewsection above.

Cost of servicesand products (exclusive of depreciation and amortization) increased $822 forthe quarter ended March 31, 2007 compared to the same period in 2006, primarilydue to increases in (i) the average cost and quantity of handsets sold, (ii)costs associated with additional features introduced in 2006, (iii)interconnect expense due to an increase in lines used and (iv) long distanceexpense due to an increase in the minutes of use.

Customeroperations expense increased $227 for the quarter ended March 31, 2007 comparedto the same period in 2006 due primarily to an increase in sales andadvertising expense as a result of increased promotional campaigns.

General andadministrative expense increased $219 for the quarter ended March 31, 2007 ascompared to the same period in 2006 primarily due to increased audit andconsulting fees.

**Non-operatingItems**

*Other Income and Expense, Net*

Consolidatedinterest income increased $436 during the quarter ended March 31, 2007 comparedto the same period in 2006, due to the increase in cash, cash equivalents andshort-term investments resulting primarily from the proceeds received from thesale of the directory publishing business, as described above.

*Income Taxes*

Income tax benefitdecreased $260 for the quarter ended March 31, 2007 compared to the same periodin 2006, due primarily to a reduction of the income tax liability forunrecognized income tax benefits related to fiscal year 2000 federal researchand development credits. The effective federal and state income tax rates forcontinuing operations were approximately 147.7% and 42.9% for the three-monthperiods ended March 31, 2007 and 2006, respectively.

**Liquidityand Capital Resources**

As reflected inthe Condensed Consolidated Statements of Cash Flows, net cash provided byoperating activities was $12,212 for the three months ended March 31, 2007 dueprimarily to (i)  non-cash charges of $13,788 consisting primarily ofdepreciation and amortization due to capital investments principally in theBroadband segment and (ii) a decrease in trade and miscellaneous accountreceivable balances of $1,911. Cash provided by operating activities was offsetin part by (i) net cash used in discontinued operations of $1,117, (ii) adecrease in accounts payable and accrued liabilities of approximately $2,100due primarily to a decrease in outstanding obligations related to capitalproject expenditures and (iii) a $670 decrease in the Company’s contractualshareable earnings obligations due primarily to amounts returned to end usersthrough consumer dividends resulting from the November 2004 intrastatesettlement agreement (see *Regulatory Matters*within the Telecom Segment Results of Operations).

Net cash providedby investing activities for the three months ended March 31, 2007 was $47,125due primarily to the proceeds from the sale of SureWest Directories of$110,123, offset by capital expenditures pertaining to ongoing plantconstruction projects of $10,348 and a net increase in held-to-maturityinvestments of $52,650.

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Net cash used infinancing activities was $3,617 for the three months ended March 31, 2007 dueprimarily to the payment of dividends.

The Company’sworking capital was $65,659 at March 31, 2007. The increase in working capital during the three months ended March 31,2007 was substantially attributable to the sale of the directory publishingbusiness to Gatehouse Media on February 28, 2007 for an aggregate cash purchaseprice of $110,123.  The sale of thedirectory publishing business resulted in an increase in cash, cash equivalentsand short-term investments, which were offset in part by an increase in accruedincome taxes.  The increase in workingcapital was also partially attributable to a decrease in contractual shareableearnings obligations and accrued liabilities. As discussed below, the Company believes that its working capitalposition, the proceeds from the sale of SureWest Directories, and operatingcash flows and borrowing capacity are sufficient to satisfy its liquidityrequirements in the next twelve months.

The Company’s mostsignificant use of funds in the remainder of 2007 is expected to be for(i) budgeted capital expenditures of approximately $45,000, (ii) estimatedincome tax payments of approximately $44,500 as a result of the sale of thedirectory publishing business, (iii) scheduled payments of long-term debtof $3,636 and (iv) support of the operations of SureWest Wireless up to ananticipated $700. In addition, during 2007 the payment of dividends, which isat the discretion of the Company’s Board of Directors, could be as much as$10,800 based on the Company’s most recent dividend payments. A substantialportion of the 2007 budgeted capital expenditures is at the discretion of theCompany, and dependent upon the Company’s working capital position, operatingcash flows and ability to borrow, as described below. The Company is requiredto comply with its cable franchise agreements to continue its build-out in thefranchise areas.

The Company contributes to the Pension Plan and OtherBenefits Plans, which provide retirement benefits to all employees.Contributions are intended to provide for benefits attributed to service todate. The Company’s funding policy is to contribute annually an actuariallydetermined amount consistent with applicable federal income tax regulations. Asdiscussed in the Consolidated Overview section above, in January 2007 theCompany approved plan amendments which provided that benefits under the Plansstopped accruing for active participants effective April 1, 2007.  The Company believes that future fundingrequirements will decrease significantly as a result of the freeze of thePlans.  The Company will continue toevaluate the future funding requirements of the Plans and fund them as deemednecessary.  As of March 31, 2007, theCompany had not made any contributions to the Plans and does not expect to makeany contributions during the remainder of 2007.

As discussed morefully in the *Regulatory Matters* section above,the CPUC instituted a rulemaking which requests comments as to whether SureWestTelephone should continue receiving the $11,500 annually from the CHCF and theadvisability and impacts of phasing out the EAS payments gradually over aperiod of approximately 5 years.  InAugust 2006, the Company filed a petition which seeks CPUC authorization for agraduated phase-down of its $11,500 interim draw from the CHCF over a period oftime that is intended to assure the continued maintenance of good service toSureWest Telephone customers while avoiding precipitous rate increases.  The Company’s petition proposes atransitional phase-down over a five-to-ten year period and requests eliminationof the requirement to file its cost proxy model.  In December 2006, the CPUC issued an interim decisionproviding for the Company to reduce its annual draw from the CHCF by $1,300 ona monthly prorated basis, to $10,200 in the aggregate from $11,500, to reflecta “consumer dividend” required in another regulatory proceeding which was to beeffective January 1, 2007. The Company will seek to recover the eliminatedrevenues through rate increases and/or operating efficiencies. For a moredetailed discussion, see *Regulatory Matters*within the Telecom Segment Results of Operations.

In May 2006, theCompany completed an unsecured Credit Agreement for a Term Loan facility and aRevolving Loan facility (collectively “Loan Facilities”) in principal amountsup to $75,000 and $25,000, respectively. Interest on the Loan Facilities is payable quarterly and based on aLIBOR, variable interest rate, or a fixed interest rate pricing formula, or acombination, as defined in the Credit Agreement.  Principal payments on the outstanding amountsborrowed under the Term Loan facility as of December 31, 2007 are due in equalquarterly installments commencing March 31, 2008 through June 30, 2016.  The Revolving Loan facility has an expirationdate of June 30, 2013.  As of March 31,2007 and December 31, 2006, $40,000 was outstanding under the Term LoanFacility and no amounts were outstanding under the Revolving Loan facility.

The Company had aliability of $1,371 for unrecognized tax benefits as of March 31, 2007 forwhich it

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cannot at thistime make a reasonably reliable estimate of the period of related futurepayments, if any.

The Company’sBoard of Directors has authorized the repurchase of up to 2.5 million shares ofthe Company’s common stock.  Shares arepurchased from time to time in the open market or through privately negotiatedtransactions, subject to overall financial and market conditions. Through March31, 2007, approximately 1.2 million shares of common stock had beenrepurchased. The Company has remaining authorization from the Board ofDirectors to repurchase an approximate 1.3 million additional outstandingshares.

The Company had cash,cash equivalents and short-term investments at March 31, 2007, of $115,454. OnFebruary 28, 2007, the Company received the pre-tax proceeds from the sale ofits directory publishing business of approximately $110,123, as describedabove.  Accordingly, the Company believesthat its working capital position, the proceeds from the sale of the directorypublishing business, operating cash flows and borrowing capacity are sufficientto satisfy its liquidity requirements for the next twelve months. This includescapital expenditures as required by the Company’s cable franchise agreements,while maintaining adequate cash and cash equivalents. The Company believes,given its financial position and debt-to-equity position, it has substantialadditional short-and long-term borrowing capacity. As indicated above, asubstantial portion of the Company’s 2007 budgeted capital expenditures andcash dividend payments is at the discretion of the Company. Accordingly, theCompany believes that it can modify its planned construction and commitmentsand cash dividend payments if the results of operations or available capital sorequire.

Dividends aredeclared at the discretion of the Company’s Board of Directors. However, theNote Purchase Agreement under which the Company issued its Series A andSeries B Senior Notes, and the Credit Agreement contain financial andoperating covenants that restrict, among other things, the payment of cashdividends, the repurchase of the Company’s capital stock, the making of certainother restricted payments and the incurrence of additional indebtedness. Inaddition, the Company is required to maintain certain financial ratios andminimum levels of tangible net worth. At March 31, 2007 and December 31,2006, retained earnings of approximately $123,576 and $65,776, respectively,were available for the payments described immediately above, under the Company’sNote Purchase Agreement and the Credit Agreement.

**CriticalAccounting Policies and Estimates**

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

·                                          Inaccordance with Statement of Financial Accounting Standards (“SFAS”)No. 142, *Goodwill and Other Intangible Assets*,goodwill and wireless licenses are reviewed for impairment annually or morefrequently if an event occurs or circumstances change that would reduce thefair value below its carrying value. The impairment test for goodwill requiresthe Company to estimate the fair value at the reporting unit level. Todetermine the fair value in 2006, the Company obtained an independent valuationof the Company’s goodwill using a discounted cash flow model. Assumptions usedin this model include the following:

·                  cashflow assumptions regarding investment in network facilities, distributionchannels and customer base (the assumptions underlying these inputs are basedupon a combination of historical results and trends, new industry developmentsand the Company’s business plans);

·                  a15% weighted average cost of capital based on industry weighted averaged costof capital; and

·      no terminal growth rate.

The carrying value of the Company’s goodwill was$2,171 as of December 31, 2006. The fair value of the Company’s goodwillis based on the value associated with the telephone reporting unit, whichbenefits from the goodwill. The telephone reporting unit includes SureWestTelephone and certain related non-regulated services. When determining the fairvalue, the use of different estimates or assumptions within the discounted cashflow model could result in a different fair 

27

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value. For example, the Company used a discount rateof 15.0% and no terminal growth rate in its assessment of fair value in 2006.At November 30, 2006 the fair value of the telephone reporting unit was$199,900 and the associated carrying value was $22,800. If the discount ratewere to increase 2%, the fair value of the telephone reporting unit woulddecrease by approximately $24,000, but would not result in an impairment ofgoodwill.

The Company’s wireless licenses include PersonalCommunications Services (“PCS”) and Local Multipoint Distribution System (“LMDS”)licenses. The carrying values at December 31, 2006 of the PCS and LMDSlicenses were $8,925 and $4,641, respectively. In assessing the recoverabilityof the Company’s PCS licenses, the Company obtained an independent valuation in2006, which reviewed transactions involving sales of comparable wirelesslicenses in the aftermarket, using characteristics of the license and therelated market, including geographic location, market size and megahertzfrequency.

In assessing the recoverability of the Company’s LMDSlicenses, the Company obtained an independent valuation, as comparable licensesales data was not available. The independent valuation estimates fair value ofthe Company’s LMDS licenses using a discounted cash flow model. Assumptionsused in this model include the following:

·                  cashflow assumptions regarding investment in network facilities, distributionchannels and customer base (the assumptions underlying these inputs are basedupon a combination of historical results and trends, new industry developmentsand the Company’s business plans);

·                  a20% weighted average cost of capital based on industry weighted averaged costof capital adjusted to reflect the inherent risks associated with theintroduction of a new service offering; and

·      a 5% terminal value growth rate.

The use of different estimates or assumptions withinthe discounted cash flow model when determining fair value of the Company’sLMDS licenses could result in different values for these licenses. For example,the Company used a discount rate of 20% and a terminal growth rate of 5% in itsassessment of fair value in 2006. If the discount rate were to increase 1%, thefair value of the LMDS licenses would decrease by $1,000, which would result inan impairment charge of approximately $242 based on the carrying value of theLMDS licenses as of December 31, 2006. In addition, the Company’s LMDSlicenses may be impaired in the future if the estimates and assumptions used inthe 2006 LMDS license discounted cash flow model are not met.

If the estimated fair value is less than the carryingvalue, then the carrying value is written down to the fair value. As a resultof the Company’s annual test for 2006, no impairment of either goodwill or PCSor LMDS licenses was indicated. During the quarter ended March 31, 2007, theCompany was unaware of any events or changes in circumstance that would requirea test of impairment that may potentially reduce the fair value below thecarrying value.

·                                          Totalrevenues from telephone services are affected by rates authorized by variousregulatory agencies. The FCC monitors SureWest Telephone’s interstate earningsthrough the use of annual cost separation studies prepared by SureWestTelephone. The FCC establishes rules that carriers must follow in thepreparation of the annual studies. Based on these rules, the Company isrequired to prospectively set its annual interstate rates based on theaforementioned cost separation studies. These cost studies include estimatesand assumptions regarding various financial data including operating expenses,taxes and investment in property, plant and equipment. Non-financial dataestimates are also utilized in the preparation of these cost studies, includingprojected demand usage and detailed network information. The Company must alsomake estimates of the jurisdictional separation of this data to assign currentfinancial and operating data to the interstate or intrastate jurisdiction.These estimates are finalized in future periods as actual data becomesavailable to complete the separation studies. The Company also participates inthe NECA pool for certain interstate revenues. In addition to the estimatesnoted above, the Company’s earned rate-of-return from its participation in theNECA pool can also be impacted by the earnings and data of other carriers whoparticipate in the pool.

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In accordance with the NRF, SureWest Telephone wassubject to ongoing monitoring and reporting requirements by the CPUC, and itwas initially required to share earnings with customers based on its earnedannual rate-of-return.  However, as aresult of a subsequent proceedings discussed above, SureWest Telephone iscurrently regulated under URF which eliminated, among other items, theshareable earnings calculation.

As a result of estimates and assumptions, it isreasonably possible that management’s estimates of SureWest Telephone’sshareable earnings obligations could change in the near term, and the amountsinvolved could be material.

·                                          TheCompany recognizes revenue when (i) persuasive evidence of an arrangementbetween the Company and the customer exists, (ii) delivery of the productto the customer has occurred or service has been provided to the customer,(iii) the price to the customer is fixed or determinable and (iv)collectibility of the sales price is reasonably assured. Revenues based on aflat fee, derived principally from local telephone, dedicated network access,data communications, Internet access service, residential/business broadbandservice and non-contract wireless services, are billed in advance andrecognized in subsequent periods when the services are provided. Contractwireless services are billed in arrears. Revenues based on usage, derivedprimarily from network access, roaming and long distance services, arerecognized monthly as services are provided. Incremental direct costs oftelecommunications service activation are charged to expense in the period inwhich they are incurred.

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

·                                          TheCompany maintains allowances for doubtful accounts for estimated lossesresulting from the potential inability of its customers to make requiredpayments. In evaluating the collectibility of its accounts receivable, theCompany assesses a number of factors including a specific customer’s or carrier’sability to meet its financial obligations to the Company, the length of timethe receivable has been past due and historical and future expectations ofconditions that may impact the Company’s ability to collect its accountsreceivable. If circumstances change or economic conditions worsen such that theCompany’s past collection experience is no longer relevant, the Company’sestimate of the recoverability of its accounts receivable could be furtherreduced from the levels reflected in the Company’s consolidated balance sheet.If uncollectibility of the Company’s billed revenue changes by 1%, the Companywould expect an increase in uncollectible expense of approximately $2,200. Asof March 31, 2007, the Company had three customers that accounted for 7% ofconsolidated accounts receivable, net of allowances. Although managementbelieves that these customers are creditworthy, a severe adverse impact ontheir business operations could have a corresponding material effect on theirability to pay timely and, therefore, on the Company’s results of operations,cash flows and financial condition. In addition, certain revenues are subjectto refund if the customer terminates services or returns equipment within astipulated time period, or if certain performance criteria are not met. Accordingly,the Company maintains accounts receivable allowances and recognizes certaincustomer refund liabilities, through charges to revenues, based on the Company’sbest estimates of the resolution of these contingencies, which are based onhistorical experience.

·                                          TheCompany states its inventories held for sale, primarily wireless handsets, atlower of cost or market. In assessing the ultimate recoverability ofinventories, the Company is required to make estimates regarding futurecustomer demand and technological advances of equipment.

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·                                          Property,plant and equipment are recorded at cost. Retirements and other reductions ofregulated telephone plant and equipment are charged against accumulateddepreciation with no gain or loss recognized in accordance with the compositegroup remaining life methodology utilized for telephone plant assets. Whenproperty applicable to non-telephone operations is sold or retired, the assetand related accumulated depreciation are removed from the accounts and theassociated gain or loss is recognized. Property, plant and equipment isdepreciated or amortized using the straight-line method over their estimatedeconomic lives. The economic lives are estimated at the time the assets areacquired and are based on historical experience with similar assets, as well asanticipated technological or other changes. If technological changes were tooccur more rapidly than anticipated or differently than anticipated, theeconomic lives assigned to these assets may need to be shortened, resulting inthe recognition of increased depreciation and amortization expense in futureperiods. Likewise, if the anticipated technological or other changes occur moreslowly than anticipated, the life of the asset group could be extended based onthe life assigned to new assets added to the group. This could result in areduction of depreciation and amortization expense in future periods. Asdiscussed above in the Broadband segment results of operations, in January 2007the Company revised the estimated useful lives of certain of its central officeand cable and wire facilities assets. During the quarter ended March 31, 2007,this change in estimate decreased the Broadband segment depreciation expense by$948 and increased consolidated net income by $645 ($0.04 per share). TheCompany reviews the estimated useful lives of its property, plant and equipmentonce every three years, or when events or circumstances indicate that thecarrying amount may not be recoverable over the remaining lives of the assets.In assessing the recoverability of the Company’s property, plant and equipment,the Company must make assumptions regarding estimated future cash flows andother factors to determine the fair value of the respective assets.

·                                          TheCompany accounts for asset retirement obligations in accordance with SFASNo. 143, *Accounting for Asset Retirement Obligations*and FASB Interpretation (“FIN”) No. 47, *Accountingfor Conditional Retirement Obligations*, which requires the Companyto recognize a retirement obligation when a legal obligation exists to removean asset at some point in the future or if legislation exists that requiresspecial disposal procedures of the asset. The Company believes it may havepotential retirement obligations relating to its wireless cell sites anddisposal obligations relating to the removal of tenant improvements at certainof its leased facilities and certain building materials containing asbestos.Based on terms outlined in its tower leases, the Company is obligated to returnthe land or facilities to their original condition at the end of the cell sitelease term, should the lease be terminated. Based on the Company’s estimates itbelieves that the disposal requirement relating to the removal of tenantimprovements at certain of its leased facilities and certain building materialscontaining asbestos is the lease termination date or expected retirement dateof the underlying assets. The Company has used a probability-weighted cash flowapproach in estimating its potential retirement obligations. The Companycalculates the net present value of the retirement obligation assuming aninflation rate of 3%, a discount rate of 7% and a market risk premium of 4%.The Company has also assumed the settlement date for its wireless towers to be25 years from the date the asset is placed into service. The Company hasvarious tenant improvements at its leased facilities which expire over the nexttwo to four years. The Company has estimated that the expected retirement dateof its buildings that contain asbestos is 2025. The Company has also used aprobability-weighted assessment to address the uncertainty regarding the timingof future cash flows to settle the potential liability. The Company believesthat utilizing probabilities for its wireless towers of less than 100% isappropriate because the Company believes the likelihood of incurring materialasset retirement expenditures is remote. The Company used a probability factorof 100% for its tenant improvements and building materials containing asbestos.The Company monitors the estimates and assumptions used in determining itspotential asset retirement obligations for its cell sites, tenant improvementsat its various leased facilities and buildings containing asbestos. However,the Company believes it is remote that any future adjustment to its assetretirement liability for obligations existing as of March 31, 2007 will bematerial to the Company’s consolidated financial statements.

·                                          TheCompany accounts for income taxes using the liability method. Under thismethod, deferred tax assets and liabilities are determined based on differencesbetween the financial reporting and

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tax bases of assets and liabilities and are measuredusing the enacted tax rates and laws that are expected to be in effect when thedifferences are expected to reverse. Upon the adoption of FIN No. 48*, Accounting for Uncertainty in Income Taxes*, effectiveJanuary 1, 2007, the Company changed its methodology for estimating itspotential liability for income tax positions for which uncertainty existsregardless of whether taxing authorities will challenge its interpretation ofthe income tax laws.  Under FIN No. 48,the Company does not recognize any benefit in its financial statements for anyuncertain income tax position if it believes the position in the aggregate hasless than a 50% likelihood of being sustained. If the Company believes there is greater than 50% likelihood that theposition will be sustained, a benefit would be recognized in the financialstatements equal to the largest amount that is believed more likely than not tobe sustained upon an audit.

·                                          TheCompany has pension and post-retirement benefit costs and obligations. TheCompany’s pension and post-retirement benefit obligations are actuariallydetermined based on estimates of discount rates, long-term rates of return onplan assets and increases in future compensation levels. Changes in theseestimates and other factors could significantly impact the Company’s pensionand post-retirement benefit costs and obligations. Assumed health care costtrend rates have a significant effect on the amounts reported for the healthcare plans. A one-percentage-point change in assumed health care cost trendrates would have the following effects:
|                                                                            | ** ** | **1-Percentage-**       | ** ** | **1-Percentage-**       | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                 | ** ** | **Point Increase** | ** ** | **Point Decrease** | ** ** |
| Effect on total  2006 post-retirement service and interest cost            |       | $                       | 72         |                    | $          | (63 | ) |
|                                                                       |       |                    |       |                    |       |
| Effect on  post-retirement benefit obligation as of December 31, 2006 |       | $                       | 137        |                    | $          | (130 | ) |

 

For 2006, the discount rates used for the Company’spension and post-retirement benefit obligations were 6.00% and 5.50%,respectively. The discount rates were determined based on current yields onhigh quality corporate fixed-income investments with maturities correspondingto the expected duration of the benefit obligations. The rate used for thepost-retirement benefit obligation reflects heavier weighting for retiredparticipants of shorter durations.

The expected return on assets (“EROA”) rate isdetermined based on the current and projected investment portfolio mix andestimated long-term investment returns for each asset class. The Companyevaluated the appropriateness of the EROA rate for 2006 by analyzing thelong-term returns for domestic and international equities, as well as domesticfixed income instruments. Based on the evaluation the Company decreased theEROA for 2006 to 8.0% from 8.5% in 2005 to better reflect the current economicenvironment. The 0.5% decrease in the EROA rate increased the Company’s 2006pension expense approximately $550, or 9.0%.

The Company’s decision to freeze the Pension Plan alsoaffected the Company’s financial statements and results of operations beginningin 2007.  The freeze, which was effectiveApril 1, 2007, will reduce both the Company’s operating expenses and cashrequirements.  Although the future impactof the freeze has not been determined, for the fiscal years 2003 through 2006,cash contributions to the Pension Plan ranged from $3,000 to $9,000, and annualservice cost averaged approximately $5,000 over the same time period.

·                                          TheCompany is a party to a variety of litigation, regulatory proceedings and othercontingencies that arise in the ordinary course of business. The Company isrequired to assess the likelihood of any adverse judgments or outcomes to thesematters, as well as potential ranges of probable losses for certain of thesematters. The determination of the liabilities required, if any, for losscontingencies is made after careful analysis of each individual issue. In theopinion of management, the ultimate outcome of these matters will notmaterially affect the Company’s

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consolidatedfinancial position and results of operations.

·                                          TheCompany currently sponsors two Equity Incentive Plans (the “Stock Plans”) forcertain employees, outside directors and consultants of the Company, which wereapproved by the Company’s shareholders. The Stock Plans permit issuance by theCompany of awards in the form of restricted shares, stock units, performanceshares, stock options and stock appreciation rights.

Effective January 1, 2006, the Company adopted SFASNo. 123(R), *Share-Based Payment*, using themodified-prospective-transition method. Since the fair value recognition provisions of SFAS No. 123, *Accounting for Stock-Based Compensation* and SFAS No. 123(R)were materially consistent under the Company’s Plans, the adoption of SFAS No.123(R) did not have a significant impact on the Company’s financial position orresults of operations.  The Company hasnot made any stock option grants since 2003 and consequently the compensationexpense resulting from stock option grants prior to 2003 was either fullyexpensed as of January 1, 2006, or not material to the Company’s financialstatements.

Prior to January 1, 2006, the Company accounted forthe Stock Plans under the fair value recognition provisions of SFAS No.123.  Under the provisions of SFAS No.148, *Accounting for Stock-Based Compensation –Transition and Disclosure*, the fair value method of accounting wasapplied to all employee awards granted, modified, or settled after January 1,2003.

As of March 31, 2007, total unrecognized compensationcost related to nonvested restricted stock was $1,720 and will be recognizedover a weighted-average period of approximately three years.  The total fair value of the restricted commonstock and restricted common stock units that vested for the quarter ended March31, 2007 was $113.

Stock based compensation for restricted stock reflectsthe cost of restricted stock that is expected to vest.  The Company calculated an estimatedforfeiture rate based on historic forfeiture experience to date.  If actual forfeitures are not consistent withthe Company’s estimated forfeiture rate, it will be required to recordadjustments to compensation expense.

The Black-Scholes-Merton option-pricing model used tovalue stock option grants includes assumptions regarding dividend yields,expected volatility, expected lives and risk-free interest rates. Theseassumptions reflect management’s best estimates, but these items involveinherent uncertainties based on market conditions generally outside of thecontrol of the Company.

**RecentAccounting Pronouncements**

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities - Including an Amendment of FASBStatement No. 115*. This standard permits an entity to elect tomeasure many financial instruments and certain other items at fair value.Unrealized gains and losses on items for which the fair value option has beenelected will be recognized in earnings at each subsequent reporting date. SFASNo. 159 is effective as of the beginning of an entity’s first fiscal year thatbegins after November 15, 2007.  Early adoption is permitted as of thebeginning of the previous fiscal year provided that the entity makes thatchoice in the first 120 days of that fiscal year and also elects to apply theprovisions of FASB Statement No. 157, Fair Value Measurements. The Company iscurrently evaluating the impact, if any, the adoption of SFAS No. 159 will haveon its consolidated financial statements.

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements.  SFAS No. 157 iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and for interim periods within those fiscal years. TheCompany is currently evaluating the impact, if any, the adoption of SFAS No.157 will have on its consolidated financial statements.

InSeptember 2006, the FASB issued SFAS No. 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans, anAmendment of FASB Statements No. 87, 88, 106 and 132(R)*.  SFAS No. 158 requires an employer torecognize the funded status of a defined benefit postretirement plan as anasset or liability in its statement of financial position and to recognizechanges in that funded status in the year in which the changes occur throughcomprehensive income.  SFAS No. 158requires an employer with publicly traded equity securities to initiallyrecognize the funded status of a defined benefit postretirement

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plan and therequired disclosures as of the end of the fiscal year ending after December 15,2006.  The Company adopted SFASNo. 158 on December 31, 2006.  SeeNote 6 for a more detailed discussion of the effects of applying the provisionsof SFAS No. 158 to the Company’s consolidated financial statements.

Effective January1, 2007 the Company adopted FIN No. 48*, Accounting forUncertainty in Income Taxes*. FIN No. 48 clarifies the accounting for uncertainty in income taxesrecognized in a company’s financial statements in accordance with FASB No. 109,*Accounting for Income Taxes*.  Specifically, the pronouncement prescribes arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return.  This interpretation alsoprovides guidance on de-recognition, classification, interest and penalties,accounting in interim periods, disclosure and transition of uncertain taxpositions.  The interpretation waseffective for fiscal years beginning after December 15, 2006. The adoption ofFIN No. 48 did not have a material effect on the Company’s consolidatedfinancial position, results of operations or cash flow.

**Regulatoryand Legal Matters**

SureWest Telephoneis subject to regulation by the FCC and CPUC. In the past, there have beenvarious proceedings before these agencies to which SureWest Telephone has beena party. In 1996, Congress passed the Telecommunications Act of 1996 (the “Act”),which significantly changed the regulatory environment for telecommunicationscompanies. Beginning in 1996, the FCC conducted proceedings and adopted ordersimplementing the Act’s provisions to open local exchange service markets, suchas the market of SureWest Telephone, to competition. These proceedings andorders address interconnection, intercarrier compensation, access charges,universal service and Internet protocol (“IP”) enabled service. With respect tolocal competition, the FCC rules outline pricing methodologies for thestates to follow when setting rates for incumbent carriers (such as SureWestTelephone) to charge competitors for resale, interconnection and unbundlednetwork elements.

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

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

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

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

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

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

·                              theregulated rates and earnings of SureWest Telephone.

There are a numberof pending and anticipated other regulatory proceedings occurring at thefederal and state levels that may have a material impact on SureWest Telephone.These regulatory proceedings include, but are not limited to, consideration ofchanges to the interstate universal service fund, intercarrier compensationreform, broadband deployment and the regulation of local exchange carriers andtheir competitors, and regulation of IP-enabled services. The outcomes andimpact on SureWest Telephone’s operations of these proceedings and relatedcourt matters cannot be determined at this time.

The eventualimpact on the Company of the effect of all the proceedings described abovecannot presently be determined.

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**ITEM3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

The Company’s 2006Annual Report on Form 10-K contains certain disclosures about the Company’slimited exposure to market risk for changes in interest rates.  There havebeen no material changes to the information provided which would requireadditional disclosures as of the date of this filing.

**ITEM4.  CONTROLS AND PROCEDURES.**

As of the end ofthe period covered by this report, the Company carried out an evaluation, underthe supervision and with the participation of our management, including theChief Executive Officer and Chief Financial Officer, of the effectiveness ofthe design and operation of our disclosure controls and procedures (as definedin Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended).Based upon, and as of the date of this evaluation, the Chief Executive Officerand Chief Financial Officer have concluded that, the Company’s disclosurecontrols and procedures were effective, at the reasonable assurance level, toensure that information required to be disclosed by the Company in reports thatit files or submits under the Securities Exchange Act is authorized, recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission rules and forms.

The Company’smanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting. The Company’s internal control system wasdesigned to provide reasonable assurance to the Company’s management, Board ofDirectors and Audit Committee regarding the reliability of financial reportingand the preparation of published financial statements in accordance withgenerally accepted accounting principles.

**Change inInternal Control over Financial Reporting**

There has been nochange in the Company’s internal control over financial reporting during theperiod ended March 31, 2007 that has materially affected, or is reasonablylikely to materially affect, the Company’s control over financial reporting.

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**PART II –OTHER INFORMATION**

**ITEM 1**.                             **LEGAL PROCEEDINGS. ***(Dollars in thousands)*

Except for theproceedings described below, SureWest Communications (the “Company”) is notaware of any material pending legal proceedings, other than ordinary routinelitigation incidental to its business, to which it is a party or to which anyof its property is subject.

Prior to 2000,AT&T Inc. (“AT&T”) had been paying SureWest Telephone approximately$11,500 per year for extended area service (“EAS”) pursuant to a Settlement TransitionAgreement. In November 2000, the California Public Utilities Commission (“CPUC”)authorized AT&T to terminate its annual EAS payments to SureWest Telephoneeffective November 30, 2000. The CPUC authorized replacement funding toSureWest Telephone on an interim basis using funds from the California HighCost Fund (“CHCF”). The CHCF is a program designed by the CPUC to establish afair and equitable local rate structure and to reduce any disparity in therates charged by telephone companies serving high-cost areas. The CHCF fundingis scheduled to expire January 1, 2009. In addition, the CPUC opened anOrder Instituting Investigation (“OII”) for the purpose of determining whetherfuture recovery of all, none, or a portion of the approximate $11,500 annualpayments previously received from AT&T should come from SureWest Telephone’sratepayers or other regulatory recovery mechanisms.

InAugust 2005, the CPUC adopted a decision which (i) authorizedSureWest Telephone to continue receiving $11,500 annually from the CHCF tooffset its intrastate regulated operating expenses on an interim basis,(ii) required SureWest Telephone to prepare and submit within twelvemonths a cost proxy model (which is used generally as a basis for CHCF funding)based on its current cost data, including analyses of the resulting impacts onrates, on the Universal Lifeline Telephone Service (“ULTS”) fund, and on theCHCF fund and (iii) authorized SureWest Telephone to file an advice letterwith the Commission’s Telecommunications Division to implement reductions toits business access line rates. In August 2006, SureWest Telephone filed apetition for modification (the “petition”) proposing a series of alternativesto the preparation of the cost proxy model. In conjunction with the petition, SureWest Telephone received anextension of the deadline to file the cost proxy model.  SureWest Telephone may be required to makeits cost proxy model filing sixty days after a decision resolving its petition.  In the petition, SureWest Telephone proposesa phased-in elimination of the $11,500 interim CHCF draw in lieu of aproceeding to evaluate the cost proxy model. In December 2006, the CPUC issued Decision 06-12-021, an interim opinionon the petition providing for SureWest Telephone to reduce its annual interimdraw from the CHCF by $1,300 on a monthly pro rata basis to $10,200 in theaggregate from $11,500 to reflect the consumer dividend required by Decision04-11-032, which was to become effective on January 1, 2007 (see above). Theresults of this proceeding and the potential effects on SureWest Telephonecould impact future funding levels through the CHCF.

In 1996, the CPUCissued a decision that authorized SureWest Telephone to implement a NewRegulatory Framework (“NRF”) for services furnished within SureWest Telephone’sservice area in order to accommodate market and regulatory movement towardcompetition and greater pricing flexibility. Under the NRF, SureWest Telephonewas subject to ongoing monitoring and reporting requirements, and it wasinitially required to share earnings with customers through a reduction ofrevenues if its earned annual rate-of-return exceeded that authorized by theCPUC.

In accordance withthe requirements of its general rate case order, SureWest Telephone filed anapplication for review of its NRF in 1999. In connection with this proceeding,the CPUC’s Office of Ratepayer Advocates (“ORA”) undertook a verification auditof SureWest Telephone’s non-regulated and affiliated transactions pursuant tothe general rate case and other CPUC orders. In June 2001, the CPUCadopted its decision in this matter (the “NRF Decision”). The NRF Decision didnot suspend the sharing mechanism as SureWest Telephone had requested, andfurther provided that SureWest Telephone must change the method used toallocate costs for services provided by SureWest Telephone to its affiliates,the treatment of certain directory revenues and the treatment of internal-usesoftware costs. Additionally, in accordance with the provisions of the NRFDecision, the Company recorded certain liabilities and reductions of revenuesrelating to estimated intrastate shareable earnings obligations.

In April 2005, theCPUC opened a rulemaking proceeding to assess and revise the regulation oftelecommunications utilities to develop a uniform regulatory framework (“URF”)to apply to most

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providers ofregulated telecommunications services, to the extent that it is feasible and inthe public interest to do so.  In August2006, the CPUC adopted Decision 06-08-030 (the “URF Decision”), which revisesthe regulations of telecommunications utilities, such as SureWest Telephone,which were previously subject to the NRF. The URF Decision grants carriersbroad pricing freedoms in the provision of telecommunications services, bundlesof services, promotions and contracts. The URF Decision, among other things: (i) freezes the Company’s basic residential and lifeline rates until atleast January 1, 2009 in order to address the subsidy levels supporting theseservices, subject to review in the CHCF review and public policy programsproceedings, (ii) eliminates price regulation and allows full pricingflexibility for all new and retail services except lifeline and basicresidential services, (iii) allows bundles and promotional packages on anytelecommunication service, (iv) allocates all gains and losses from the sale ofassets to shareholders and (v) eliminates price caps, the annual price capfiling, the productivity factor, and all residual elements of rate of returnregulation, including the calculation of shareable earnings.  In accordance with the URF Decision, the CPUCordered a separate briefing cycle to consider whether to detariff altogethertelecommunications services other than basic residential service.

In December 2006,the CPUC adopted Decision 06-12-044, an order clarifying the URF Decision andgranting limited rehearing of the URF Decision with respect to the eliminationof all asymmetric requirements concerning marketing, disclosure, oradministrative processes with the exception of conditions relating to basicresidential rates.  Pending the outcomeof this limited rehearing, the rules adopted with respect to the elimination ofasymmetric regulations are suspended.

Pursuant to theURF Decision, further proceedings in this matter will be held during 2007 toaddress detariffing of telephone service other than basic exchange service, thepricing of retail special access services, determination of the extent to whichthe Commission requires monitoring reports in addition to, or different from,the reports carriers routinely file with the Federal Communications Commission(“FCC”), and issues relating to the implementation of the URF Phase Idecision.  In addition, pursuant to anassigned commissioner’s ruling issued in December 2006 in accordance withDecision 06-12-044, these further proceedings will also examine customerdisclosure rules and the rules adopted governing elimination of asymmetricadministrative processes.

Also, in January2007, The Utility Reform Network filed a petition for writ of review in theCourt of Appeal of the State of California challenging the URF Decision andseeking an order that the CPUC’s decision be set aside.  The ultimate results of this proceeding andthe potential effects on SureWest Telephone cannot yet be determined.

In April 2006, theCPUC released a decision in a proceeding investigating the continued need forthe transport interconnection charge (“TIC”), which is an access chargeelement.  An earlier draft decision wouldhave required all Incumbent Local Exchange Carriers (“ILECs”) operating withinCalifornia to eliminate the TIC element and authorized recovery of lost revenuethrough end users, specifically through an increase in their local ratesurcharge, and use of the CHCF for the small companies.  If SureWest Telephone eliminated the TIC anddid not recover any lost revenues from end users, such a decision couldultimately result in a reduction in revenues of up to $4,200, on a prospectivebasis.  In its final decision, the CPUCdeferred the elimination of the TIC element for SureWest Telephone to the nextphase of the proceeding, which began in May 2006.  The Company thereafter filed testimony in May2006 advocating that the CPUC should not eliminate the TIC for small and mid-sizedILECs due in part to the impending intercarrier compensation proceeding at theFCC.  In March 2007, the CPUC released aproposed decision which would eliminate the TIC and allow SureWest Telephone toimpose a surcharge and increase other rates to recover any loss in accessrevenue.  However, this proposed decisionhas been withdrawn pending further review by the CPUC.  The ultimate results of this proceeding andthe potential effects on SureWest Telephone cannot yet be determined.

In September 2006,the Governor of California signed into law Assembly Bill No. 2987, whichenacted the Digital Infrastructure and Video Competition Act of 2006 (“DIVCA”).  This new law provides an alternative to thelocal franchise process and establishes a procedure for the issuance of statefranchises for the provision of video service, and promotes a more rapid entryby telephone companies into the video business and new competition for cableand Direct Broadcast Satellite providers. Existing cable providers may be able to abrogate their local franchisesand opt into the state franchise process beginning in January 2008.  Specifically, the Company will be able toexit its current local franchise agreements and operate

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under astate-issued franchise if any of the following events occur:  (i) the expiration, prior to any renewal orextension, of the Company’s local franchise; (ii) mutual agreement between thelocal franchising entity and the Company; or (iii) at the time a new videoservice provider initiates video service in all or part of the area within thelocal municipality’s franchise area. This new law also prohibits ILECs that provide video service under astate-issued franchise from increasing basic residential telephone servicerates until January 1, 2009.  In October2006, the CPUC opened a proceeding to develop procedures to be followed toimplement DIVCA, which designates the CPUC as the issuer of state videofranchises.  In March 2007, the CPUCadopted Decision 07-03-014, its decision adopting General Order 169 toimplement DIVCA.  AT&T and Verizonhave submitted applications and have received state issued video franchisespursuant to these rules.  Applicationsfor rehearing of Decision 07-03-014 are pending before the CPUC.  The ultimate results of these proceedings andtheir potential effects on SureWest Telephone cannot yet be determined.

SureWest Telephone’soperations may also be impacted by the Telecommunications Act of 1996 (the “Act”).The Act significantly changed the regulatory environment for telecommunicationscompanies. Beginning in 1996, the FCC conducted proceedings and adopted ordersimplementing the Act’s provisions to open local exchange service markets, suchas the market of SureWest Telephone, to competition. These proceedings andorders address the regulation of competing telecommunications companies,interconnection, access charges, broadband deployment and universal service.

Given the ongoingactivities of the FCC to promulgate rules and regulations on competition,interconnection, access charges, broadband deployment and universal servicereform, and the various on-going legal challenges considering the validity ofthese FCC orders, it is not yet possible to determine fully the impact of theAct and related FCC regulations on SureWest Telephone’s operations.

There are a numberof other regulatory proceedings occurring at the federal and state levels thatmay have a material impact on SureWest Telephone. These regulatory proceedingsinclude, but are not limited to, consideration of changes to the jurisdictionalseparations process, the interstate universal service fund, intercarriercompensation access charge reform, broadband deployment and the regulation oflocal exchange carriers and their competitors, including providers of Internetprotocol-enabled services. The outcomes and impact on SureWest Telephone’soperations of these proceedings and related court matters cannot be determinedat this time.

The regulatoryproceedings occurring at the state and federal levels described above may alsobroaden the scope of competition in the provision of regulated services andchange the rates and rate structure for regulated services furnished bySureWest Telephone, the effects of which on SureWest Telephone cannot yet bedetermined.

**ITEM 1A.****                    RISK FACTORS.**

There have been nomaterial changes from risk factors disclosed in the Company’s Annual Report onForm 10-K for the year ended December 31, 2006, identified in Item 1A of Part Iof the Form 10-K.

**ITEM 2.****                             UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

Not applicable.

**ITEM 3.****                             DEFAULTSUPON SENIOR SECURITIES.**

Not applicable.

**ITEM 4.****                             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.**

Not applicable.

**ITEM 5.****                             OTHERINFORMATION.**

Not applicable.

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**ITEM 6.  EXHIBITS.**

(a)          Index to Exhibits.
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                 | ** ** | **Method  of Filing**     |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 3.1          |       | Articles of Incorporation of Registrant, together  with Certificate of Amendment of Articles of Incorporation dated  January 25, 1996 and Certificate of Amendment of Articles of Incorporation  dated June 21, 1996 (Filed as Exhibit 3(a) to Form 10-Q  Quarterly Report for the quarter ended September 30, 1996)                                                                                              |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 3.2          |       | Certificate of Amendment of Articles of  Incorporation dated May 18, 2001 (Filed as Exhibit 3(b) to  Form 10-Q Quarterly Report for the quarter ended June 30,  2001)                                                                                                                                                                                                                                                  |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 3.3          |       | Bylaws of Registrant (Filed as  Exhibit 3(b) to Form 10-K Annual Report of the  Registrant for the year ended December 31, 2000)                                                                                                                                                                                                                                                                                            |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 4.1          |       | Shareholder Rights Plan (Filed as Exhibit 2.1  to Form 8-A Registration Statement under the Securities Act of  1934)                                                                                                                                                                                                                                                                                                                  |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.1         |       | Note Purchase Agreement for Series A Senior  Notes in the aggregate amount of $40,000,000 dated December 9, 1998  (Filed as Exhibit 10(b) to Form 10-K Annual Report of  Registrant for the year ended December 31, 1998)                                                                                                                                                                                         |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.2         |       | Supplement to Note Purchase Agreement for  Series B Senior Notes in the aggregate amount of $60,000,000 dated  March 13, 2003 (Filed as Exhibit 99.1 to the Form 8-K  filed March 13, 2003)                                                                                                                                                                                                                            |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.3         |       | Credit agreement dated as of May 1, 2006  between SureWest Communications and CoBank, ACB (filed as Exhibit 99.1  to Form 8-K filed May 2, 2006)                                                                                                                                                                                                                                                                            |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.4         |       | Share Purchase Agreement among SureWest  Communications, SureWest Directories and Gatehouse Media, Inc., dated as  of January 28, 2007. Pursuant to Item 601(b)(2) of Regulation S-K,  the Registrant agrees to furnish, supplementally, a copy of any exhibit or  schedule omitted from the Share Purchase Agreement to the Commission upon  request (Filed as Exhibit 10.1 to Form 8-K filed  January 29, 2007) |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.5         |       | 1999 Restricted Stock Bonus Plan (Filed as Exhibit  10(d) to Form 10-K Annual Report of Registrant for the year ended  December 31, 1998)                                                                                                                                                                                                                                                                                             |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.6         |       | 2000 Equity Incentive Plan, as amended (Filed as  Exhibit 10.6 to Form 10-K Annual Report of Registrant for the year ended  December 31, 2006)                                                                                                                                                                                                                                                                                             |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.7         |       | SureWest KSOP (Filed as Exhibit 4.1 to  Registration Statement on Form S-8 [No. 333-87222])                                                                                                                                                                                                                                                                                                                                      |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.8         |       | Letter agreement dated January 16, 2001 between  Registrant and Bill M. DeMuth (Filed as Exhibit 10.14 to Form 10-K/A  Annual Report of Registrant for the year ended December 31, 2003)                                                                                                                                                                                                                                    |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.9         |       | Letter agreement dated January 16, 2001 between  Registrant and Fred A. Arcuri (Filed as Exhibit 10.15 to Form 10-K/A  Annual Report of Registrant for the year ended December 31, 2003)                                                                                                                                                                                                                                    |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                      |
| 10.10        |       | Steven C. Oldham Employment Agreement dated  December 15, 2005 (Filed as Exhibit 99.1 to Form 8-K filed  December 16, 2005)                                                                                                                                                                                                                                                                                                 |       | Incorporated by reference |

 

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| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                                            | ** ** | **Method  of Filing**     |
|--------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|
| 10.11        |       | Letter agreement dated December 15, 2005  between Registrant and Steven C. Oldham (Filed as Exhibit 99.5 to Form 8-K  filed December 16, 2005)                                                                                                                                              |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.12        |       | Letter agreement dated January 16, 2001,  between Registrant and Scott K. Barber (Filed as Exhibit 10.12 to Form  10-K Annual Report of Registrant for the year ended December 31, 2006)                                                                                                    |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.13        |       | Release agreement dated December 15, 2005  between Registrant and Fred A. Arcuri (Filed as Exhibit 99.1 to  Form 8-K filed December 21, 2005)                                                                                                                                          |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.14        |       | Letter agreement dated October 4, 2004 between  Registrant and Philip A. Grybas                                                                                                                                                                                                                       |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.15        |       | Summary of Board of Directors’ Compensation (Filed  as Exhibit 10.15 to Form 10-K Annual Report of Registrant for the year ended  December 31, 2006)                                                                                                                                             |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.16        |       | Summary of Executive Compensation (filed under  Form 8-K filed on December 11, 2006)                                                                                                                                                                                                             |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.17        |       | Restricted Stock Unit Award, dated December 21,  2004, between Registrant and Roger J. Valine (Filed as Exhibit 10.15 to  Form 10-K Annual Report of Registrant for the year ended  December 31, 2004)                                                                                 |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.18        |       | Form of Restricted Stock Unit Award, dated  December 21, 2004, between Registrant and each of Guy R. Gibson, Steven  C. Oldham, John R. Roberts III and Timothy D. Taron (Filed as  Exhibit 10.16 to Form 10-K Annual Report of Registrant for  the year ended December 31, 2004) |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.19        |       | Form of Restricted Stock Unit Award, dated  January 26, 2005, between Registrant and Timothy D. Taron and Roger J.  Valine (Filed as Item 1.01 to Form 8-K filed January 27,  2006)                                                                                                    |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.20        |       | Form of Restricted Stock Unit Award, dated  February 23, 2005, between Registrant and each of Fred A. Arcuri, Bill  M. DeMuth and Jay B. Kinder (Filed as Exhibit 10.18 to Form 10-K  Annual Report of Registrant for the year ended December 31, 2004)                           |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.21        |       | Form of Restricted Stock Unit Award for  Registrant’s 2000 Equity Incentive Plan (Filed as Exhibit 10.19 to  Form 10-K Annual Report of Registrant for the year ended  December 31, 2004)                                                                                         |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.22        |       | Form of Stock Option Agreement for Registrant’s  2000 Equity Incentive Plan (Filed as Exhibit 10.20 to Form 10-K  Annual Report of Registrant for the year ended December 31, 2004)                                                                                               |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 10.23        |       | Form of Restricted Stock Agreement for  Registrant’s 2000 Equity Incentive Plan (Filed as Exhibit 10.21 to  Form 10-K Annual Report of Registrant for the year ended  December 31, 2004)                                                                                          |       | Incorporated by reference |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 31.1         |       | Certification of Steven C. Oldham, President and  Chief Executive Officer, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                      |       | Filed herewith            |
|         |       |                                                                                                                                                                                                                                                                                                       |       |                      |
| 31.2         |       | Certification of Philip A. Grybas, Senior Vice  President and Chief Financial Officer, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                          |       | Filed herewith            |

 

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| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                             | ** ** | **Method  of Filing** |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|
|         |       |                                                                                                                                                                                                        |       |                  |
| 32.1         |       | Certification of Steven C. Oldham, President and  Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002              |       | Filed herewith        |
|         |       |                                                                                                                                                                                                        |       |                  |
| 32.2         |       | Certification of Philip A. Grybas, Senior Vice  President and Chief Financial Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |       | Filed herewith        |

 

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**SIGNATURES**

Pursuant to 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/ PHILIP A.  GRYBAS     |
|   |   | Philip A. Grybas,         |
|   |   | Senior Vice President and |
|   |   | Chief Financial Officer   |

 

Date:  May 3, 2007

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