Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**x  QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For thequarterly period ended June 30, 2010**

 

**or**

 

**o  TRANSITIONREPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**CommissionFile Number 000-29660**

 

**SureWestCommunications**

(Exactname of registrant as specified in its charter)

 

| **California**                                                 | ** ** | **68-0365195**       |
|----------------------------------------------------------------|------------|----------------------|
| (State  or other jurisdiction                                  |       | (IRS  Employer       |
| of  incorporation or organization)                             |       | Identification  No.) |
|                                                           |       |                 |
| **8150  Industrial Avenue, Building A, Roseville, California** | ** ** | **95678**            |
| (Address  of principal executive offices)                      |       | (Zip  Code)          |

 

**(916)786-6141**

(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x   No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o   Noo

 

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

 

| Large  accelerated filer o                                               |   | Accelerated  filer x         |
|--------------------------------------------------------------------------|--------|------------------------------|
|                                                                     |   |                         |
| Non-accelerated  filer o

(Do  not check if a smaller reporting company) |   | Smaller  reporting company o |

 

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

 

On July 19, 2010, theregistrant had 13,970,465 shares of Common Stock outstanding.

 

 

 

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** **

**TABLE OF CONTENTS**

 
| ** **                              | ** **                                                                                  | **Page** |
|-----------------------------------------|---------------------------------------------------------------------------------------------|----------|
|                                    |                                                                                        |     |
| **PART I - FINANCIAL INFORMATION** |                                                                                        |
|                                    |                                                                                        |     |
| Item 1.                                 | Financial  Statements                                                                       | 1        |
|                                    |                                                                                        |     |
| Item 2.                                 | Management’s Discussion and Analysis  of Financial Condition and Results of Operations | 17       |
|                                    |                                                                                        |     |
| Item 3.                                 | Quantitative  and Qualitative Disclosures About Market Risk                                 | 36       |
|                                    |                                                                                        |     |
| Item 4.                                 | Controls and  Procedures                                                                    | 36       |
|                                    |                                                                                        |     |
| **PART II  - OTHER INFORMATION**   |                                                                                        |
|                                    |                                                                                        |     |
| Item 1.                                 | Legal Proceedings                                                                           | 37       |
|                                    |                                                                                        |     |
| Item 2.                                 | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 37       |
|                                    |                                                                                        |     |
| Item 6.                                 | Exhibits                                                                                    | 37       |
|                                    |                                                                                        |     |
| SIGNATURES                              | 38                                                                                          |

 

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**PART 1 — FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS.**

 

**SUREWEST COMMUNICATIONS**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

*(Unaudited; Amounts in thousands, except per shareamounts)*

* *
| ** **                                                                         | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                        | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| **Operating revenues:**                                                            |       |                            |       |                               |       |   |   |   |   |
| Broadband                                                                          |       | $                               | 43,076     |                               | $          | 40,259 |   | $ | 85,653 |   | $ | 79,481 |   |
| Telecom                                                                            |       | 17,472                          |       | 20,671                             |       | 35,083 |   | 42,391 |   |
| Total  operating revenues                                                          |       | 60,548                          |       | 60,930                             |       | 120,736 |   | 121,872 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| **Operating expenses:**                                                            |       |                            |       |                               |       |   |   |   |   |
| Cost  of services and products (exclusive of depreciation and amortization)        |       | 26,261                          |       | 25,118                             |       | 51,179 |   | 50,132 |   |
| Customer  operations and selling                                                   |       | 8,225                           |       | 8,345                              |       | 16,434 |   | 16,580 |   |
| General  and administrative                                                        |       | 8,763                           |       | 8,624                              |       | 17,576 |   | 18,187 |   |
| Depreciation  and amortization                                                     |       | 15,262                          |       | 14,228                             |       | 30,368 |   | 29,038 |   |
| Total  operating expenses                                                          |       | 58,511                          |       | 56,315                             |       | 115,557 |   | 113,937 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| **Income from operations**                                                         |       | 2,037                           |       | 4,615                              |       | 5,179 |   | 7,935 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| Other  income (expense):                                                           |       |                            |       |                               |       |   |   |   |   |
| Interest  income                                                                   |       | 28                              |       | 34                                 |       | 46 |   | 71 |   |
| Interest  expense                                                                  |       | (2,235                          | )          | (3,046                             | )          | (3,878 | ) | (5,356 | ) |
| Other,  net                                                                        |       | (167                            | )          | (88                                | )          | (333 | ) | (172 | ) |
| Total  other income (expense), net                                                 |       | (2,374                          | )          | (3,100                             | )          | (4,165 | ) | (5,457 | ) |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| Income  (loss) from continuing operations before income taxes                      |       | (337                            | )          | 1,515                              |       | 1,014 |   | 2,478 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| Income  tax expense                                                                |       | 190                             |       | 616                                |       | 1,014 |   | 1,500 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| **Income (loss) from continuing operations**                                       |       | (527                            | )          | 899                                |       | — |   | 978 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| Discontinued  operations, net of tax:                                              |       |                            |       |                               |       |   |   |   |   |
| Loss  from discontinued operations                                                 |       | —                          |       | —                             |       | — |   | (69 | ) |
| Gain  on sale of discontinued operations                                           |       | —                          |       | 60                                 |       | — |   | 2,568 |   |
| Total  discontinued operations                                                     |       | —                          |       | 60                                 |       | — |   | 2,499 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| **Net income (loss)**                                                              |       | $                               | (527       | )                                  | $          | 959 |   | $ | — |   | $ | 3,477 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| **Basic and diluted earnings per common share:**                                   |       |                            |       |                               |       |   |   |   |   |
| Income  (loss) from continuing operations                                          |       | $                               | (0.04      | )                                  | $          | 0.06 |   | $ | — |   | $ | 0.07 |   |
| Discontinued  operations, net of tax                                               |       | —                          |       | 0.01                               |       | — |   | 0.18 |   |
| Net  income (loss) per basic and diluted common share                              |       | $                               | (0.04      | )                                  | $          | 0.07 |   | $ | — |   | $ | 0.25 |   |
|                                                                               |       |                            |       |                               |       |   |   |   |   |
| **Shares of common stock used to calculate basic and diluted  earnings per share** |       | 13,913                          |       | 14,020                             |       | 13,958 |   | 13,992 |   |

 

Seeaccompanying notes.

 

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**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

*(Unaudited;Amounts in thousands)*

* *
| ** **                                                                                                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| **ASSETS**                                                                                                                                                                    |       |              |       |                  |       |
| Current  assets:                                                                                                                                                              |       |              |       |                  |       |
| Cash  and cash equivalents                                                                                                                                                    |       | $                 | 6,154      |                  | $          | 7,489 |   |
| Short-term  investments                                                                                                                                                       |       | 551               |       | 4,306                 |       |
| Accounts  receivable, net                                                                                                                                                     |       | 19,074            |       | 19,734                |       |
| Income  tax receivable                                                                                                                                                        |       | 2,156             |       | 2,221                 |       |
| Prepaid  expenses                                                                                                                                                             |       | 3,938             |       | 3,704                 |       |
| Deferred  income taxes                                                                                                                                                        |       | 9,030             |       | 3,373                 |       |
| Other  current assets                                                                                                                                                         |       | —            |       | 1,760                 |       |
| Assets  held for sale                                                                                                                                                         |       | 6,009             |       | 6,009                 |       |
| Total  current assets                                                                                                                                                         |       | 46,912            |       | 48,596                |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Property,  plant and equipment, net                                                                                                                                           |       | 519,137           |       | 522,493               |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Intangible  and other assets:                                                                                                                                                 |       |              |       |                  |       |
| Customer  relationships, net                                                                                                                                                  |       | 3,240             |       | 3,847                 |       |
| Goodwill                                                                                                                                                                      |       | 45,814            |       | 45,814                |       |
| Deferred  charges and other assets                                                                                                                                            |       | 2,674             |       | 2,113                 |       |
|                                                                                                                                                                          |       |  51,728      |       | 51,774                |       |
|                                                                                                                                                                          |       | $                 | 617,777    |                  | $          | 622,863 |   |
|                                                                                                                                                                          |       |              |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                 |       |              |       |                  |       |
| Current  liabilities:                                                                                                                                                         |       |              |       |                  |       |
| Current  portion of long-term debt                                                                                                                                            |       | $                 | 15,636     |                  | $          | 15,636 |   |
| Accounts  payable                                                                                                                                                             |       | 1,785             |       | 2,547                 |       |
| Other  accrued liabilities                                                                                                                                                    |       | 15,084            |       | 18,315                |       |
| Advance  billings and deferred revenues                                                                                                                                       |       | 8,056             |       | 8,580                 |       |
| Accrued  compensation                                                                                                                                                         |       | 6,062             |       | 9,172                 |       |
| Total  current liabilities                                                                                                                                                    |       | 46,623            |       | 54,250                |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Long-term  debt                                                                                                                                                               |       | 203,409           |       | 207,409               |       |
| Deferred  income taxes                                                                                                                                                        |       | 61,532            |       | 54,856                |       |
| Accrued  pension and other post-retirement benefits                                                                                                                           |       | 33,284            |       | 32,451                |       |
| Other  liabilities and deferred revenues                                                                                                                                      |       | 4,668             |       | 4,714                 |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Commitments  and contingencies                                                                                                                                                |       |              |       |                  |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Shareholders’  equity:                                                                                                                                                   |       |              |       |                  |       |
| Common  stock, without par value; 100,000 shares authorized, 13,970 and 14,148 shares  issued and outstanding at June 30, 2010 and December 31, 2009,  respectively |       | 144,427           |       | 146,844               |       |
| Accumulated  other comprehensive loss                                                                                                                                         |       | (15,338           | )          | (15,280               | )          |
| Retained  earnings                                                                                                                                                            |       | 139,172           |       | 137,619               |       |
| Total  shareholders’ equity                                                                                                                                              |       | 268,261           |       | 269,183               |       |
|                                                                                                                                                                          |       | $                 | 617,777    |                  | $          | 622,863 |   |

 

Seeaccompanying notes.

 

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** **

**SUREWEST COMMUNICATIONS**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

*(Unaudited;Amounts in thousands)*

 
| ** **                                              | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                              | ** ** | **2010**                           | ** ** | **2009** | ** ** |
|                                                    |       |                               |       |   |   |
| Net  cash provided by continuing operations             |       | $                                  | 26,427     |   | $ | 32,291 |   |
| Net  cash used in discontinued operations               |       | —                             |       | (507 | ) |
| Net  cash provided by operating activities              |       | 26,427                             |       | 31,784 |   |
|                                                    |       |                               |       |   |   |
| Cash  flows from investing activities:                  |       |                               |       |   |   |
| Proceeds  from sale of discontinued operations          |       | 1,725                              |       | 10,947 |   |
| Capital  expenditures for property, plant and equipment |       | (26,414                            | )          | (29,522 | ) |
| Proceeds  from sale of available-for-sale securities    |       | 3,700                              |       | — |   |
| Purchases  of available-for-sale securities             |       | (18                                | )          | (16 | ) |
| Net  cash used in investing activities                  |       | (21,007                            | )          | (18,591 | ) |
|                                                    |       |                               |       |   |   |
| Cash  flows from financing activities:                  |       |                               |       |   |   |
| Proceeds  from issuance of long-term debt               |       | 8,069                              |       | 10,500 |   |
| Principal  payments on long-term debt                   |       | (12,069                            | )          | (15,503 | ) |
| Repurchases  and surrenders of common stock             |       | (2,755                             | )          | (1,151 | ) |
| Net  cash used in financing activities                  |       | (6,755                             | )          | (6,154 | ) |
|                                                    |       |                               |       |   |   |
| Increase  (decrease) in cash and cash equivalents       |       | (1,335                             | )          | 7,039 |   |
|                                                    |       |                               |       |   |   |
| Cash  and cash equivalents at beginning of period       |       | 7,489                              |       | 2,840 |   |
|                                                    |       |                               |       |   |   |
| Cash  and cash equivalents at end of period             |       | $                                  | 6,154      |   | $ | 9,879 |   |

 

See accompanying notes.

 

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**SUREWESTCOMMUNICATIONS**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

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

 

**1.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Businessand Basis of Accounting**

 

SureWest Communications (the“Company”, “we” or “our”) is a holding company with operating subsidiaries thatprovide communications services in Northern California, primarily the greaterSacramento region, and the greater Kansas City, Kansas and Missouri areas (“KansasCity area”). Our operating subsidiaries are SureWest Broadband, SureWestTeleVideo, SureWest Kansas, Inc. (“SureWest Kansas” or the “Kansas Cityoperations”), SureWest Telephone and SureWest Long Distance.

 

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

 

We expect that the sourcesof our revenues and our cost structure may be different in future periods, bothas a result of our entry into new communications markets and competitive forcesin each of the markets in which we have operations.

 

In the opinion ofmanagement, the accompanying condensed consolidated balance sheets and relatedinterim statements of operations and cash flows include all adjustments,consisting only of normal recurring items, necessary for their fairpresentation in conformity with accounting principles generally accepted in theUnited States (“U.S. GAAP” or “GAAP”) for interim financial information andpursuant to the rules and regulations of the Securities and ExchangeCommission (the “SEC”). Certain information and footnote disclosures normallyincluded in annual financial statements prepared in accordance with U.S. GAAPhave been condensed or omitted pursuant to such SEC rules and regulationsand accounting principles applicable for interim periods. Events subsequent tothe balance sheet date have been evaluated for inclusion in the accompanyingcondensed consolidated financial statements through the date of issuance. Management believes that the disclosures made are adequate to make theinformation presented not misleading. Interim results are not necessarilyindicative of results for a full year. The information presented in this Form 10-Q should be read in conjunctionwith Management’s Discussion and Analysis of Financial Condition and Results ofOperations and the consolidated financial statements and notes thereto includedin our 2009 Annual Report on Form 10-K filed with the SEC.

 

**Reclassifications**

 

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

 

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**Property, Plant and Equipment**

 

Property, plant andequipment consisted of the following:

 
| ** **                                      | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** | **Estimated  Useful Lives** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Land                                            |       | $                       | 2,824      |                        | $          | 2,824                       |       |   |   |
| Buildings                                       |       | 76,482                  |       | 76,363                      |       | 35  years                   |       |
| Central  office equipment                       |       | 323,570                 |       | 312,338                     |       | 3-12  years                 |       |
| Outside  plant equipment                        |       | 487,291                 |       | 481,099                     |       | 5-40  years                 |       |
| Internal-use  software                          |       | 59,369                  |       | 58,714                      |       | 5-7  years                  |       |
| Other                                           |       | 57,183                  |       | 56,974                      |       | 3-25  years                 |       |
| Total  plant in service                         |       | 1,006,719               |       | 988,312                     |       |                        |       |
| Less  accumulated depreciation and amortization |       | 500,836                 |       | 481,639                     |       |                        |       |
| Plant  in service                               |       | 505,883                 |       | 506,673                     |       |                        |       |
| Plant  under construction                       |       | 8,005                   |       | 10,557                      |       |                        |       |
| Construction  inventory                         |       | 5,249                   |       | 5,263                       |       |                        |       |
| Property,  plant and equipment, net             |       | $                       | 519,137    |                        | $          | 522,493                     |       |   |   |

 

Construction inventory,which is stated at weighted average cost, consists primarily of networkconstruction materials and supplies that when issued are predominatelycapitalized as part of new customer installations and the construction of thenetwork.

 

During the first quarter of2010, we completed our triennial review that evaluated the appropriateness ofthe estimated useful lives of our property, plant and equipment for allsegments.  The evaluation considered ourinvestment and business strategy, reliability and historical performance dataof certain assets, as well as the impacts of competition and anticipatedtechnological change. As a result of this evaluation, effective January 1,2010, we increased the estimated useful lives of general purpose software,general purpose hardware and certain central office equipment. We decreased thelives of certain of our customer premise equipment and outside plantcategories. During the quarter and six-month period ended June 30, 2010,this change in estimate did not have a material effect to consolidateddepreciation expense or net income and is not expected to have a materialimpact for the year ended December 31, 2010.

 

**Intangible Assets**

 

Goodwill and intangible assetsthat are not subject to amortization are tested for impairment at leastannually or when events or changes in circumstances indicate that the assetmight be impaired in accordance with FASB ASC Topic 350, *Intangibles-Goodwilland Other*(“ASC Topic 350”)(formerly SFAS No. 142, *Goodwill andother Intangible Assets*). Normally, we perform the annualimpairment test as of November 30. However, as a result of recent declines in the market price of theCompany’s common stock at June 30, 2010, we concluded that this was anindicator of potential impairment of goodwill and therefore, we performed aninterim goodwill impairment test.

 

We completed the first stepof the interim impairment test, which indicated that the estimated fair valueof the reporting units was greater than the net carrying value of the reportingunits.  As such, we concluded thatgoodwill was not impaired as of June 30, 2010 and we were not required toperform the second step of the evaluation.

 

**Stock-based Compensation**

 

***Stock Plan***

 

Our Board of Directors maygrant share-based awards from our shareholder approved Equity Incentive Plan;the 2000 Equity Incentive Plan (the “Stock Plan”) to certain of our employees,outside directors and consultants. The Stock Plan permits issuance of awards inthe form of restricted common stock (“RSAs”), restricted common stock units (“RSUs”),performance shares, stock options and stock appreciation rights. Under theStock Plan, approximately 2.1 million shares of our common stock wereauthorized for issuance, including those outstanding as of June 30, 2010.

 

***Restricted Common Stock Awardsand Units***

 

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

 

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Thefollowing table summarizes the grants that occurred under the Stock Plan duringthe quarters and six-month periods ended June 30, 2010 and 2009:

 
| ** **     | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------|------------|-------------------------------------------|------------|------------------------------------|------------|
| ** **     | ** ** | ** **                                | ** ** | **Grant Date**                | ** ** | ** ** | ** ** | **Grant Date** | ** ** | ** ** | ** ** | **Grant Date** | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **     | ** ** | **2010**                                  | ** ** | **Fair Value**                | ** ** | **2009** | ** ** | **Fair Value** | ** ** | **2010** | ** ** | **Fair Value** | ** ** | **2009** | ** ** | **Fair Value** | ** ** |
| RSAs  Granted  |       | —                                    |       | $                                  | —     |   | — |   | $ | — |   | 217,575 |   | $ | 9.95 |   | 166,506 |   | $ | 11.56 |   |
| RSUs  Granted  |       | —                                    |       | $                                  | —     |   | — |   | $ | — |   | 92,709 |   | $ | 9.95 |   | 72,443 |   | $ | 11.56 |   |
| RSU  Dividends |       | —                                    |       | $                                  | —     |   | 933 |   | $ | 8.29 |   | — |   | $ | — |   | 7,970 |   | $ | 9.66 |   |
| Total          |       | —                                    |       |                               |       | 933 |   |   |   | 310,284 |   |   |   | 246,919 |   |   |   |

 

RSUDividends consist of dividends that were previously granted to the holders ofRSUs, which have fully vested and were released during the quarter andsix-month period ended June 30, 2009 (none in the quarter or six-monthperiod ended June 30, 2010) in accordance with the underlying awardagreement.  Stock-based compensationexpense for both RSAs and RSUs of $1,144 and $1,944 was recorded during thequarter and six-month period ended June 30, 2010, respectively.  During the same prior year periods, werecorded stock-based compensation expense of $464 and $1,072, respectively.

 

The following table summarizes theRSA and RSU activity during the six-month period ended June 30, 2010:

 
| ** **                      | ** ** | ** ** | ** ** | **Weighted Average**      | ** ** |
|---------------------------------|------------|------------|------------|---------------------------|------------|
| ** **                      | ** ** | **Shares** | ** ** | **Grant Date Fair Value** | ** ** |
|                            |       |       |       |                      |       |
| Nonvested-January 1,  2010 |       | 349,916    |       | $                         | 12.90      |   |
| Granted                         |       | 310,284    |       | $                         | 9.95       |   |
| Vested                          |       | (147,354   | )          | $                         | 11.39      |   |
| Nonvested-June 30,  2010   |       | 512,846    |       | $                         | 11.55      |   |

 

Asof June 30, 2010, total unrecognized compensation costs related tononvested restricted stock was $5,549 and will be recognized over aweighted-average period of approximately 2.75 years. The total fair value ofRSAs and RSUs vested during the six-month period ended June 30, 2010 was$1,678.

 

***Stock Options***

 

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

 

Duringthe six-month periods ended June 30, 2010 and 2009, no stock options weregranted or exercised.  During the sameperiods 110,475 and 11,650 unexercised options expired, respectively.  As of June 30, 2010, 207,914 outstandingoptions were vested and exercisable at a weighted average exercise price of$41.08 with a weighted average remaining contractual life of one year. Theaggregate intrinsic value is calculated as the difference between the exerciseprice of the stock options and the quoted price of our common stock.  There were no options that were in-the-moneyas of June 30, 2010 and 2009.

 

**Earnings Per Share**

 

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

 

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**Other****Comprehensive Income**

 

Significant components ofour other comprehensive income are as follows:

 
| ** **                                                                 | ** ** | **Quarter Ended June 30,**                                             | ** **                                                  | **Six Months Ended June 30,**                                                          | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------|-------------------------------------------------------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2010**                                                               | ** **                                                  | **2009**                                                                               | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net  income (loss)                                                         |       | $                                                                      |  (527                                                  | )                                                                                      | $          | 959 | ** ** | $ |   — |   | $ |  3,477 |   |
| Unrealized  gain (loss) on available-for-sale investments, net of tax      |       |             (35 | )                                                           |                1 |       |             (58 | ) |             (34 | ) |
| Reclassification  adjustment for losses included in net income, net of tax |       |  —                                                           |                                                        |              16            |       |  — |   |              16 |   |
| Comprehensive  income (loss)                                               |       | $                                                                      |           (562 | )                                                                                      | $          |  976 | ** ** | $ |   (58 | ) | $ | 3,459 |   |

 

Accumulated othercomprehensive loss consists of adjustments, net of tax, related to unrealizedlosses on available-for-sale securities and minimum pension and post-retirementbenefits.

** **

**Severance and Termination Costs**

 

In an effort to improveoperating efficiencies and align operating costs, during the quarter ended June30, 2010 we implemented a workforce reduction initiative in which approximately60 positions were eliminated.  Affectedemployees were provided a range of benefits and resources, including severancepayments (collectively “severance costs”). As a result, estimated severance costs of $1,640 were recorded to thestatements of operations during the quarter ended June 30, 2010, primarily togeneral and administrative expense. Estimated severance costs of approximately $720 and $920 were recordedto the Broadband and Telecom segments, respectively. As of June 30, 2010, wehad an accrued liability of $365 relating to the severance costs. We anticipatemost of the remaining severance costs will be paid during the third quarter of2010 and will be finalized prior to December 31, 2010.

 

**2.   FAIR VALUE MEASUREMENTS & FINANCIAL INSTRUMENTS**

 

*Investments*

 

The following is a summaryof our short-term available-for-sale investments:

 
| ** **         | ** ** | **As of June 30, 2010** | ** ** | **As of December 31, 2009**  | ** ** |
|--------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **         | ** ** | **Adjusted  Cost**      | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Market  Value** | ** ** | **Adjusted  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Market  Value** | ** ** |
| Equity  securities |       | $                       | 672        |                         | $          | — |   | $ |        (121 | ) | $ | 551 |   | $ | 654 |   | $ | — |   | $ |  (23 | ) | $ | 631 |   |
|                    |            |                         |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Asof June 30, 2010 and December 31, 2009, the decline in the fair value of ourshort-term available-for-sale investments had been in a continuous lossposition for more than twelve months.  Weconcluded that the gross unrealized losses of our equity securities weretemporary, as the extent of the decline, both in dollars and percentages ofcost were not considered significant and we have the ability and intent to holdthe investments until at least substantially all of the costs of the investmentare recovered.  The unrealized losses,net of tax, on our short-term available-for-sale investments were recorded as acomponent of other comprehensive income. We determined the fair value of ourshort-term equity security investments by quoted market prices.

 

*CostMethod Investments*

 

Weheld $1,115 and $772 in cost method investments which were included in otherlong-term assets in the condensed consolidated balance sheets as of June 30,2010 and December 31, 2009, respectively. The cost method investmentsprimarily represent our investment in CoBank, ACB (“CoBank”) and are related topatronage distributions of restricted equity. This is a required investment in accordance with our Credit Agreement(see Note 8) held by CoBank.  We periodicallymonitor our investments for impairment and will record reductions in carryingvalues if and when necessary.  We did notestimate the fair value of the cost method investments as no events or changesin circumstances that may have a significant adverse effect on the fair valueof the investment were identified during the quarter or six-month periods endedJune 30, 2010. We determined, in accordance with ASC Topic 825, *Financial Instruments* (formerly SFAS No. 107, *Fair Value Disclosures About Financial Instruments)*, that itwas not practicable to estimate the fair value of the investments.

 

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*Fair Value of Financial Instruments*

 

In accordance with ASC Topic820, *Fair Value Measurements and Disclosures*(“ASC 820”) (formerly SFAS No. 157, *Fair Value Measurements*),we measure our cash equivalents (money market funds) and short-term investments(equity securities, auction rate security (“ARS”) and put option) at fairvalue.  ASC 820 clarifies that fair valueis an exit price, representing the amount that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants. As such, fair value is a market-based measurement that should bedetermined based on assumptions that market participants would use in pricingan asset or a liability. A financial asset or liability’s classification withinthe hierarchy is determined based on the lowest level input that is significantto the fair value measurement. As a basis for considering such assumptions, ASC820 establishes a three-tier value hierarchy, which prioritizes the inputs usedin the valuation methodologies in measuring fair value:

 

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

 

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

 

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

 

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

 
| ** **          | ** ** | **As of June 30, 2010** | ** ** |
|---------------------|------------|-------------------------|------------|
| ** **          | ** ** | **Total**               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Money  market funds |       | $                       | 392        |   | $ | 392 |   | $ | — |   | $ | — |   |
| Equity  securities  |       | 551                     |       | 551 |   | — |   | — |   |
|                |       | $                       | 943        |   | $ | 943 |   | $ | — |   | $ | — |   |

 
| ** **               | ** ** | **As of December 31, 2009** | ** ** |
|--------------------------|------------|-----------------------------|------------|
| ** **               | ** ** | **Total**                   | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Money  market funds      |       | $                           | 5,346      |   | $ | 5,346 |   | $ | — |   | $ | — |   |
| Equity  securities       |       | 631                         |       | 631 |   | — |   | — |   |
| Auction  rate securities |       | 3,054                       |       | — |   | — |   | 3,054 |   |
| Put  option (Right)      |       | 621                         |       | — |   | — |   | 621 |   |
|                     |       | $                           | 9,652      |   | $ | 5,977 |   | $ | — |   | $ | 3,675 |   |

 

Fairvalues for cash equivalents and equity securities in short-term investmentswere determined by quoted market prices. Fair value of the ARS and put optionwere determined based on discounted cash flow models.  See discussion below regarding the ARS andput option.

 

Thefollowing table provides a reconciliation of the beginning and ending balancesfor the assets measured at fair value using significant unobservable inputs(Level 3):

 
| ** **                           | ** ** | **2010**       | ** ** | **2009**                     | ** ** |
|--------------------------------------|------------|----------------|------------|------------------------------|------------|
| ** **                           | ** ** | **Put Option** | ** ** | **Auction Rate  Securities** | ** ** | **Put Option** | ** ** | **Auction Rate  Securities** | ** ** |
| Beginning  balance at January 1st    |       | $              |       | 621                          |       | $ |   | 3,054 |   | $ |   | 1,383 |   | $ |   | 2,125 |   |
| Sale  of auction rate security       |       | —         |       | (3,700                       | )          | — |   | — |   |
| Gains  (losses) included in earnings |       | (621           | )          | 646                          |       | (745 | ) | 745 |   |
| Balance  at March 31st               |       | $              |       | —                       |       | $ |   | — |   | $ |   | 638 |   | $ |   | 2,870 |   |
| Gains  (losses) included in earnings |       | —         |       | —                       |       | (41 | ) | 162 |   |
| Balance  at June 30th                |       | $              |       | —                       |       | $ |   | — |   | $ |   | 597 |   | $ |   | 3,032 |   |

 

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Asof December 31, 2009, we held one $3,700 par value ARS purchased from UBSFinancial Services, Inc., a subsidiary of UBS AG (“UBS”) with an estimated fairvalue of $3,054, which was measured using Level 3 inputs. This ARS wascollateralized by student loans that are guaranteed primarily by a monolineinsurance company and partially by the Federal Family Education Loan Program (“FFELP”).As of December 31, 2009, we also held an offer (“Right” or “put option”)entitling us to sell at par our ARS anytime during a two-year period fromJune 30, 2010 through July 2, 2012.

 

As of December 31, 2009, theARS and Right were classified as current assets in short-term investments onour consolidated balance sheet, as a result of our put option period under theRight. We continued to earn and receive interest on our ARS, as specified inthe terms of the prospectus, during 2009.

 

On January 6, 2010, UBSexercised their rights under the Right to purchase our ARS at par of $3,700 andwe recorded a gain of $646 on the ARS to other income (expense), other, net inthe condensed consolidated statements of income during the quarter ended March31, 2010.  The gain was largely offset bya loss of $621 recorded on the Right resulting from the cancellation of our putoption under the Right.

 

*FairValue of Debt*

 

We had no short-termborrowings as of June 30, 2010 and December 31, 2009. The fair value ofour long-term debt was estimated using discounted cash flow analyses based onincremental borrowing rates for similar types of borrowing arrangements.

 
| ** **                                     | ** ** | **As of June 30, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **Carrying Value**      | ** ** | **Fair Value**              | ** ** | **Carrying Value** | ** ** | **Fair Value** | ** ** |
| Long-term  debt (including current maturities) |       | $                       | 219,045    |                        | $          | 216,961 |   | $ | 223,045 |   | $ | 221,323 |   |
|                                                |            |                         |            |                             |            |  |  |  |  |  |  |  |  |

 

**3.   DIVESTITURES**

 

*SureWestWireless*

 

In May 2008, we completedthe sale of the operating assets of our Wireless business, SureWest Wireless,to Verizon Wireless (“Verizon”) for an aggregate cash purchase price of$69,746, resulting in a gain of $18,864, net of tax.  A portion of the purchase price equal to$3,450 was placed in escrow, half of which was received during the quarterended June 30, 2009 and the balance of which was received during the quarterended June 30, 2010.  During the quarterended March 31, 2009, the gain on sale was increased by $43, net of tax, as aresult of changes in estimated transaction costs. As part of the sale, Verizonacquired the spectrum licenses and operating assets of SureWest Wireless,excluding our owned communication towers. See the Communication Tower Assets section below for further discussionregarding our owned communication towers. SureWest Wireless was previously reported as a separate reportablesegment.

 

*CommunicationTower Assets*

 

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

 

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

 

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

 
| ** **                                                  | ** ** | **Quarter Ended  June 30, 2009** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|-------------------------------------|------------|
| Operating  revenues                                         |       | $                                | —     |                                | $          | 249 |   |
| Operating  expenses including depreciation and amortization |       | —                           |       | 365                                 |       |
| Loss  from operations                                       |       | —                           |       | (116                                | )          |
| Income  tax benefit                                         |       | —                           |       | (47                                 | )          |
| Loss  from discontinued operations                          |       | $                                | —     |                                | $          | (69 | ) |
|                                                        |       |                             |       |                                |       |
| Gain  on sale of discontinued operations, net of tax        |       | $                                | 60         |                                | $          | 2,525 |   |

 

*AssetsHeld For Sale*

 

In connection with ourefforts to evaluate and potentially monetize excess assets, during 2009 weidentified and began to actively market for sale certain of our real estateassets.  These regulated assets, which are included in theTelecommunications (“Telecom”) Segment, include 21 acres of undeveloped landand an office building.  During the quarter ended December 31, 2009, wecompleted our plan to sell these assets and as a result they were classified asassets held for sale.  The following isthe carrying value of the assets held for sale as of June 30, 2010 and December31, 2009:

 

| ** **        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|--------------|------------|------------------|------------|
| ** **        | ** ** | **2010**     | ** ** | **2009**         | ** ** |
| Undeveloped  land |       | $            | 1,556      |             | $          | 1,556 |   |
| Office  building  |       | 4,453        |       | 4,453            |       |
|              |       | $            | 6,009      |             | $          | 6,009 |   |

 

We expect that the land willsell in the range of $3,000 to $5,000. In connection with the classification toassets held for sale, the carrying value of the office building was reduced toits estimated fair value, less selling costs, based on the current marketconditions and listed selling price. As a result, an impairment charge of$1,199 was recorded against accumulated depreciation during the quarter endedDecember 31, 2009, in accordance with regulated telephone plant and equipmentcomposite group remaining life methodology. We evaluated the estimated fair value of the assets held for sale as ofJune 30, 2010 and determined there was not a significant change.  Therefore, no additional impairment chargewas recorded during the quarter ended June 30, 2010.

 

**4.   BUSINESS SEGMENTS**

 

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

 

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

 

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

 

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These segments are strategicbusiness units that offer different products and services. The accountingpolicies of these segments are the same as those described in Note 1 (refer tonotes to the consolidated financial statements included in our 2009 AnnualReport on Form 10-K filed with the SEC for a more detailed discussion of ouraccounting policies). We account for intersegment revenues and expenses atprevailing market rates.  Our businesssegment information is as follows:

 
| ** **                                    | ** ** | ** **    | ** ** | ** **  | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|-----------------------------------------------|------------|---------------|------------|-------------|------------|------------------|------------|------------------|------------|
| ** **                                    | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **For the three months ended June 30, 2010:** |       |          |       |        |       |             |       |             |       |
| Operating  revenues from external customers   |       | $             | 43,076     |        | $          | 17,472           |       | $                | —     |   | $ | 60,548 |   |
| Intersegment  revenues                        |       | 145           |       | 5,091       |       | (5,236           | )          | —           |       |
| Operating  expenses                           |       |          |       |        |       |             |       |             |       |
| Cost  of services and products*               |       | 25,145        |       | 5,656       |       | (4,540           | )          | 26,261           |       |
| Customer  operations and selling              |       | 6,106         |       | 2,678       |       | (559             | )          | 8,225            |       |
| General  and administrative                   |       | 4,752         |       | 4,148       |       | (137             | )          | 8,763            |       |
| Depreciation  and amortization                |       | 12,140        |       | 3,122       |       | —           |       | 15,262           |       |
| Income  (loss) from operations                |       | (4,922        | )          | 6,959       |       | —           |       | 2,037            |       |
| Income  (loss) from continuing operations     |       | $             | (4,269     | )           | $          | 3,742            |       | $                | —     |   | $ | (527 | ) |

 

----

*Exclusiveof depreciation and amortization

 
| ** **                                    | ** ** | ** **    | ** ** | ** **  | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|-----------------------------------------------|------------|---------------|------------|-------------|------------|------------------|------------|------------------|------------|
| ** **                                    | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **For the three months ended June 30, 2009:** |       |          |       |        |       |             |       |             |       |
| Operating  revenues from external customers   |       | $             | 40,259     |        | $          | 20,671           |       | $                | —     |   | $ | 60,930 |   |
| Intersegment  revenues                        |       | 94            |       | 4,981       |       | (5,075           | )          | —           |       |
| Operating  expenses                           |       |          |       |        |       |             |       |             |       |
| Cost  of services and products*               |       | 22,823        |       | 6,566       |       | (4,271           | )          | 25,118           |       |
| Customer  operations and selling              |       | 6,468         |       | 2,535       |       | (658             | )          | 8,345            |       |
| General  and administrative                   |       | 5,003         |       | 3,767       |       | (146             | )          | 8,624            |       |
| Depreciation  and amortization                |       | 11,283        |       | 2,945       |       | —           |       | 14,228           |       |
| Income  (loss) from operations                |       | (5,224        | )          | 9,839       |       | —           |       | 4,615            |       |
| Income  (loss) from continuing operations     |       | $             | (4,884     | )           | $          | 5,783            |       | $                | —     |   | $ | 899 |   |

 

----

*Exclusiveof depreciation and amortization

 
| ** **                                  | ** ** | ** **    | ** ** | ** **  | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|---------------------------------------------|------------|---------------|------------|-------------|------------|------------------|------------|------------------|------------|
| ** **                                  | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **For the six months ended June 30, 2010:** |       |          |       |        |       |             |       |             |       |
| Operating  revenues from external customers |       | $             | 85,653     |        | $          | 35,083           |       | $                | —     |   | $ | 120,736 |   |
| Intersegment  revenues                      |       | 313           |       | 10,010      |       | (10,323          | )          | —           |       |
| Operating  expenses                         |       |          |       |        |       |             |       |             |       |
| Cost  of services and products*             |       | 48,738        |       | 11,361      |       | (8,920           | )          | 51,179           |       |
| Customer  operations and selling            |       | 12,497        |       | 5,068       |       | (1,131           | )          | 16,434           |       |
| General  and administrative                 |       | 9,905         |       | 7,943       |       | (272             | )          | 17,576           |       |
| Depreciation  and amortization              |       | 24,320        |       | 6,048       |       | —           |       | 30,368           |       |
| Income  (loss) from operations              |       | (9,494        | )          | 14,673      |       | —           |       | 5,179            |       |
| Income  (loss) from continuing operations   |       | $             | (7,989     | )           | $          | 7,989            |       | $                | —     |   | $ | — |   |

 

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*Exclusiveof depreciation and amortization

 

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| ** **                                  | ** ** | ** **    | ** ** | ** **  | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|---------------------------------------------|------------|---------------|------------|-------------|------------|------------------|------------|------------------|------------|
| ** **                                  | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **For the six months ended June 30, 2009:** |       |          |       |        |       |             |       |             |       |
| Operating  revenues from external customers |       | $             | 79,481     |        | $          | 42,391           |       | $                | —     |   | $ | 121,872 |   |
| Intersegment  revenues                      |       | 185           |       | 9,855       |       | (10,040          | )          | —           |       |
| Operating  expenses                         |       |          |       |        |       |             |       |             |       |
| Cost  of services and products*             |       | 45,723        |       | 12,834      |       | (8,425           | )          | 50,132           |       |
| Customer  operations and selling            |       | 12,728        |       | 5,176       |       | (1,324           | )          | 16,580           |       |
| General  and administrative                 |       | 10,538        |       | 7,940       |       | (291             | )          | 18,187           |       |
| Depreciation  and amortization              |       | 22,903        |       | 6,135       |       | —           |       | 29,038           |       |
| Income  (loss) from operations              |       | (12,226       | )          | 20,161      |       | —           |       | 7,935            |       |
| Income  (loss) from continuing operations   |       | $             | (10,282    | )           | $          | 11,260           |       | $                | —     |   | $ | 978 |   |

 

----

*Exclusiveof depreciation and amortization

 

**5.   REGULATORY MATTERS**

 

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

 

*FCC Matters*

 

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

 

*California Public Utility Commission (“CPUC”) Matters*

 

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

 

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

 

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

 

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things (i) eliminates priceregulation and allows full pricing flexibility for all new and retail servicesexcept basic residential services, which limits increases to $3.25 per yearduring 2009 and 2010, (ii) allows new forms of bundles and promotional packagesof telecommunication services, (iii) allocates all gains and losses from thesale of assets to shareholders and (iv) eliminates almost all elements of rateof return regulation, including the calculation of shareable earnings.  Beginning January 1, 2011, the URF IncumbentLocal Exchange Carriers will be allowed full pricing flexibility for the basicresidential rate.

 

**6.   INCOME TAXES**

 

Our effective federal incometax rates for continuing operations were 100.0% and 60.5% for the six-monthperiods ended June 30, 2010 and 2009, respectively. For the six-month periodended June 30, 2010, our actual tax expense differed from the federal statutoryrate primarily due to state taxes, permanent differences resulting from thedecrease between the grant and vesting prices of RSAs and RSUs that vestedduring the period and a change to state deferred tax expense attributable toapportionment changes.

 

Our policy is to recognizeinterest and penalties related to uncertain tax positions as additional incometax expense.  We did not accruesignificant amounts of interest and penalties related to unrecognized taxbenefits during the six-month periods ended June 30, 2010 and 2009.  As of June 30, 2010, we had approximately$114 of accrued interest and approximately $28 of penalties in the amountdisclosed below for unrecognized tax benefits.

 

We had a liability forunrecognized tax benefits of approximately $241 and $203 at June 30, 2010 andDecember 31, 2009, respectively.  Thefollowing table provides a reconciliation of the beginning and ending amount ofunrecognized tax benefits during the six-month period ended June 30, 2010:

 

| Balance  at December 31, 2009                |   | $  | 203    |   |
|----------------------------------------------|--------|----|--------|--------|
| Additions  based on prior year tax positions |   | 38 |   |
| Balance  at June 30, 2010                    |   | $  | 241    |   |

 

The total amount ofunrecognized tax benefits that, if recognized, would affect the effective taxrate were $168 and $129 at June 30, 2010 and December 31, 2009, respectively.

 

As of June 30, 2010, thefollowing tax years and related taxing jurisdictions were open:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

**Components of Net PeriodicPension Cost**

 

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

 

| **Quarter  ended June 30,**                    | ** ** | **2010** | ** ** | **2009** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Interest  cost on projected benefit obligation |       | $        | 1,778      |     | $          | 1,809 |   |
| Expected  return on plan assets                |       | (1,815   | )          | (1,667   | )          |
| Amortization  of:                              |       |     |       |     |       |
| Net  actuarial loss                            |       | 530      |       | 566      |       |
| Net  periodic pension expense                  |       | $        | 493        |     | $          | 708 |   |

 

| **Six months  ended June 30,**                 | ** ** | **2010** | ** ** | **2009** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Interest  cost on projected benefit obligation |       | $        | 3,584      |     | $          | 3,617 |   |
| Expected  return on plan assets                |       | (3,640   | )          | (3,342   | )          |
| Amortization  of:                              |       |     |       |     |       |
| Prior  service cost                            |       | 1        |       | 1        |       |
| Net  actuarial loss                            |       | 1,087    |       | 1,296    |       |
| Net  periodic pension expense                  |       | $        | 1,032      |     | $          | 1,572 |   |

 

Net periodic benefit costsrelated to the Other Benefits Plan were not significant to our condensedconsolidated financial statements for the quarters or six-month periods endedJune 30, 2010 and 2009.

 

**8.   CREDIT ARRANGEMENTS**

 

A summary of our long-termdebt is as follows:

 

| ** **                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|--------------|------------|------------------|------------|
| ** **                            | ** ** | **2010**     | ** ** | **2009**         | ** ** |
| Series A  Senior Notes           |       | $            | 14,545     |             | $          | 14,545 |   |
| Series  B Senior Notes                |       | 36,000       |       | 48,000           |       |
| Term  Loan A credit facility          |       | 120,000      |       | 120,000          |       |
| Term  Loan B credit facility          |       | 30,000       |       | 30,000           |       |
| Revolving  Loan credit facility       |       | 18,500       |       | 10,500           |       |
| Total  long-term debt                 |       | 219,045      |       | 223,045          |       |
| Less  current portion                 |       | 15,636       |       | 15,636           |       |
| Total  long-term debt, net of current |       | $            | 203,409    |             | $          | 207,409 |   |

 

Our long-term debt consistsof unsecured Senior Notes and an unsecured Third Amended and Restated CreditAgreement (“Credit Agreement”) with CoBank. The Credit Agreement includes termand revolving loan facilities.

 

In September 2008, weentered into the Credit Agreement to restate and replace a February 2008 creditagreement. The Credit Agreement terms, among other things (i) reflected therepayment of $30,000 of the Term Loan B facility under the February 2008 creditagreement to reduce the principal balance from $60,000 to $30,000, (ii)modified interest margins, (iii) extended the maturity date of the Term Loan Bfacility to May 1, 2012, (iv) separated the total revolving commitments of$60,000 into a Revolving Loan facility of $57,500 and a Swingline Loan facilityof $2,500 and (v) required permanent reductions of the Revolving Loan facilityof $7,500 at December 31, 2009 and 2010.

 

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On January 29, 2010, weentered into a letter agreement with CoBank amending certain terms of theCredit Agreement, including (i) an increase in the total Revolving Loanfacility of $7,500, (ii) CoBank’s share of the Revolving Loan facility will bepermanently reduced by $5,000 (rather than $7,500) on December 31, 2010 and(iii) the total Revolving Loan facility will be $57,500.  As a result of this letter agreement, ourcombined revolving commitment balance on our Revolving Loan and Swingline Loanfacilities is $60,000 and our available balance as of June 30, 2010, which wasless our outstanding balance of $18,500, was approximately $41,500.

 

Our Series A and Series BSenior Notes and the Credit Agreement contain financial and operating covenantsthat may restrict, among other things, the repurchase of the Company’s commonstock, the payment of dividends, the making of certain other restrictedpayments and the incurrence of additional indebtedness. The covenants alsorequire us to maintain certain financial ratios and minimum levels of tangiblenet worth. If we fail to comply with the covenants and other restrictions, suchas making timely interest or principal payments, it could lead to an event ofdefault and the acceleration of our obligations under those agreements. As ofJune 30, 2010, we were in compliance with all of our debt covenants.

 

Our financial covenants asdefined in the Series A and Series B Senior Notes and the Credit Agreement,measured quarterly, are as follows:

 

| **Financial  Covenant**  | ** ** | **Required Ratio Level** | ** ** | **Actual Performance  at June 30, 2010** | ** ** |
|--------------------------|------------|--------------------------|------------|------------------------------------------|------------|
| Leverage  ratio          |       | Not  more than 3.75      |       | 2.92                                     |       |
| Interest  coverage ratio |       | Not  less than 3.00      |       | 7.62                                     |       |
| Consolidated  net worth  |       | Not  less than $160,000  |       | $268,261                                 |       |
| Debt  to capitalization  |       | Not  more than 0.55      |       | 0.45                                     |       |

 

At June 30, 2010 andDecember 31, 2009, retained earnings of $108,261 and $109,183, respectively,were available for the payments described above.

 

**9.   COMMITMENTS AND CONTINGENCIES**

 

**Litigation, RegulatoryProceedings and Other Contingencies**

 

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

 

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

 

**10.**** ****RECENTACCOUNTING PRONOUNCEMENTS**

 

**Recently Issued Accounting Pronouncements**

 

In October 2009, the FASBissued Accounting Standards Update (“ASU”) No. 2009-13, *RevenueRecognition (Topic 605): Multiple-Deliverable Revenue Arrangements—a consensusof the FASB Emerging Issues Task Force*(“ASU 2009-13”).  ASU 2009-13 addresses the accounting formultiple-deliverable arrangements to enable vendors to account for products orservices separately rather than as a combined unit and modifies the manner inwhich the transaction consideration is allocated across the separatelyidentified deliverables.  ASU 2009-13significantly expands the disclosure requirements for multiple-deliverablerevenue arrangements.  ASU 2009-13 willbe effective for the first annual reporting period beginning on or after June15, 2010, and may be applied retrospectively for all periods presented orprospectively to arrangements entered into or materially modified after theadoption date.  Early adoption ispermitted, provided that the guidance is retroactively applied to the beginningof the year of adoption. We are currently evaluating the impact this updatewill have on our condensed consolidated financial statements.

 

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**Recently Adopted Accounting Pronouncements**

 

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

 

In January 2010, the FASBissued ASU No. 2010-06, *Fair Value Measurementsand Disclosures (Topic 820) — Improving Disclosures about Fair ValueMeasurements* (“ASU 2010-06”). ASU 2010-06 amends ASC 820 to require additional disclosures regardingfair value measurements. Specifically, ASU 2010-06 requires entities todisclose additional information regarding (i) the reconciliation of recurringLevel 3 measurements about purchases, sales, issuances and settlements on agross basis, (ii) the amounts of significant transfers between Level 1 andLevel 2 of the fair value hierarchy and the reasons for these transfers and (iii)the reasons for any transfers in or out of Level 3. In addition to these newdisclosure requirements, ASU 2010-06 also amends ASC 820 to further clarifyexisting guidance pertaining to the level of disaggregation at which fair valuedisclosures should be made and the requirements to disclose information aboutthe valuation techniques and inputs used in estimating Level 2 and Level 3 fairvalue measurements. Our adoption of the requirements of this guidance onJanuary 1, 2010, except for the requirement to separately disclose informationabout purchases, sales, issuances, and settlements in the reconciliation ofrecurring Level 3 measurements on a gross basis which becomes effective forfiscal years (and interim periods within those fiscal years) beginning afterDecember 15, 2010, did not have a material impact on our condensed consolidatedfinancial position or results of operations.

 

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

*(Amountsin thousands, except select operating metrics and share and per share amounts)*

 

Certain statements includedin this report, including that which relates to the impact on future revenuesources and potential sharing obligations of pending and future regulatoryorders, continued expansion of the telecommunications network and expectedchanges in the sources of our revenue and cost structure resulting from ourentrance into new communications markets, are forward-looking statements andare made pursuant to the safe harbor provisions of the Securities Litigation ReformAct of 1995. These forward looking statements generally are identified by thewords “believe”, “expect”, “anticipate”, “estimate”, “intend”, “should”, “may”,“will”, “would”, “will be”, “will continue” or similar expressions. Suchforward looking statements involve known and unknown risks, the impact ofcurrent economic conditions, uncertainties and other factors that may causeactual results, performance or achievements of SureWest Communications (the “Company”,“we” or “our”) to be different from those expressed or implied in theforward-looking statements. A detailed discussion of these and other risks anduncertainties that could cause actual results and events to differ materiallyfrom such forward—looking statements is included in our 2009 Annual Report on Form 10-Kfiled with the Securities and Exchange Commission (“SEC”). We disclaim anyintention or obligation to update or revise publicly any forward-lookingstatements. Management’s Discussion and Analysis should be read in conjunctionwith our unaudited condensed consolidated financial statements and accompanyingnotes to the financial statements (“Notes”) as of and for the six months ended June 30,2010 included in Item 1 of this Quarterly Report on Form 10-Q.

 

**Overview**

 

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

 

Our Broadband segment earnsrevenues primarily through subscriptions to our video, high-speed Internet andphone services.  Our video services rangefrom a limited basic service to our newest product offering Advanced Digital TV(“ADTV”), powered by Microsoft® MediaroomTM.  Many of our services are delivered utilizingFTTH and FTTN networks, which allow us to offer a high quality experience withour digital TV Packages. ADTV was launched in the Sacramento region in January 2010and enhancements were completed on existing copper network marketable homes toprovide this new video service, resulting in an increase of 24,000 videomarketable homes as of June 30, 2010. This enhanced video product includes a Whole Home digital video recorder(“DVR”) (which allows subscribers to watch and record up to four programs atthe same time and pause, replay and rewind “live” television), instant channelchanges and an intuitive, user-friendly guide. Our ADTV product provides accessto over 335 channels in our California market. Our full digital cable service in the Kansas City area provides accessto over 300 channels and additional digital cable services, including aDVR.  Our video product offerings includeaccess to high-definition (“HD”) television (“HDTV”), which provides multiple channelsin high definition, premium and pay-per-view channels (which include concerts,wrestling, boxing, sporting events and movies); video on demand (“VOD”) service(which allows access to a library of movies and the ability to start aselection at any time and to pause, rewind and fast-forward and replay);premium VOD channels, music channels and an interactive, on-screen programguide (which allows the subscriber to navigate the channel lineup and the VODlibrary).  As of June 30, 2010,approximately 23% of the homes in the areas we serve subscribed to one of ourvideo services.

 

Ourhigh-speed Internet service can provide Internet access at symmetrical speedsof up to 50 Mbps, depending on the nature of the network facilities that areavailable, the level of service selected and the location.  As of June 30, 2010, approximately 32%of the homes in the areas we serve subscribed to one of our high-speed Internetservices.  Our Voice over InternetProtocol (“VoIP”) digital phone product is available in the Sacramento marketin packages ranging from basic service to unlimited local and domestic longdistance calling plans.  Nearly all ofour VoIP phone 

 

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serviceplans include an extensive array of calling features including calleridentification and call waiting, Find Me/Follow Me, sequential ringing andselective call acceptance and rejection. As of June 30, 2010, approximately 16% of the homes in ourSacramento market have subscribed to our VoIP phone service. We also offertraditional circuit-switched voice services in some of the areas we serve.  The total voice penetration in the markets weserve was approximately 24% as of June 30, 2010.

 

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

 

**Current Business Developments**

 

In connection with ourefforts to evaluate and potentially monetize excess assets, during 2009 weidentified and began to actively market for sale certain of our real estateassets.  These regulated assets, whichare included in the Telecom Segment, include 21 acres of undeveloped land andan office building.  During the quarterended December 31, 2009, we completed our plan to sell these assets and asa result they were classified as assets held for sale.  We expect the land will sell in the range of$3,000 to $5,000. In connection with the classification to assets held forsale, the carrying value of the office building was reduced to its estimatedfair value, less selling costs, based on the current market conditions andlisted selling price. As a result, an impairment charge of $1,199 was recordedagainst accumulated depreciation during the quarter ended December 31,2009, in accordance with regulated telephone plant and equipment compositegroup remaining life methodology.  Weevaluated the estimated fair value of the assets held for sale as of June 30,2010 and determined there was not a significant change.  Therefore, no additional impairment chargewas recorded during the quarter or six-month period ended June 30, 2010.

 

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

 

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**Results of Operations**

 

The tables below reflectcertain financial data (on a consolidated and segment basis) and selectoperating metrics for each of our reportable segments as of and for thequarters and six months ended June 30, 2010 and 2009.

 

**FinancialData**

 
| ** **                                   | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                                   | ** ** | ** **                      | ** ** | ** **                         | ** ** | **$** | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                   | ** ** | **2010**                        | ** ** | **2009**                           | ** ** | **Change** | ** ** | **Change** | ** ** | **2010** | ** ** | **2009** | ** ** | **Change** | ** ** | **Change** | ** ** |
| **Operating revenues****(1)**                |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband                                    |       | $                               | 43,076     |                               | $          | 40,259 |   | $ | 2,817 |   | 7 | % | $ | 85,653 |   | $ | 79,481 |   | $ | 6,172 |   | 8 | % |
| Telecom                                      |       | 17,472                          |       | 20,671                             |       | (3,199 | ) | (15 | ) | 35,083 |   | 42,391 |   | (7,308 | ) | (17 | ) |
| Operating  revenues                          |       | 60,548                          |       | 60,930                             |       | (382 | ) | (1 | ) | 120,736 |   | 121,872 |   | (1,136 | ) | (1 | ) |
|                                         |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Income (loss) from operations**            |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband                                    |       | (4,922                          | )          | (5,224                             | )          | 302 |   | 6 |   | (9,494 | ) | (12,226 | ) | 2,732 |   | 22 |   |
| Telecom                                      |       | 6,959                           |       | 9,839                              |       | (2,880 | ) | (29 | ) | 14,673 |   | 20,161 |   | (5,488 | ) | (27 | ) |
| Income  from operations                      |       | 2,037                           |       | 4,615                              |       | (2,578 | ) | (56 | ) | 5,179 |   | 7,935 |   | (2,756 | ) | (35 | ) |
|                                         |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Income (loss) from continuing operations** |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband                                    |       | (4,269                          | )          | (4,884                             | )          | 615 |   | 13 |   | (7,989 | ) | (10,282 | ) | 2,293 |   | 22 |   |
| Telecom                                      |       | 3,742                           |       | 5,783                              |       | (2,041 | ) | (35 | ) | 7,989 |   | 11,260 |   | (3,271 | ) | (29 | ) |
| Income  (loss) from continuing operations    |       | (527                            | )          | 899                                |       | (1,426 | ) | (159 | ) | — |   | 978 |   | (978 | ) | (100 | ) |
|                                         |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Adjusted EBITDA****(2)**                   |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband                                    |       | 8,409                           |       | 6,346                              |       | 2,063 |   | 33 |   | 16,608 |   | 11,595 |   | 5,013 |   | 43 |   |
| Telecom                                      |       | 11,519                          |       | 13,513                             |       | (1,994 | ) | (15 | ) | 22,788 |   | 27,757 |   | (4,969 | ) | (18 | ) |
| Adjusted  EBITDA                             |       | 19,928                          |       | 19,859                             |       | 69 |   | 0 |   | 39,396 |   | 39,352 |   | 44 |   | 0 |   |
|                                              |            |                                 |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)    Externalcustomers only.

(2)             Adjusted EBITDArepresents net income (loss) from continuing operations excluding amounts forincome taxes; depreciation and amortization; non-cash pension and certainpost-retirement benefits; non-cash stock compensation; severance and otherrelated termination costs; and all other non-operating income andexpenses.  Adjusted EBITDA is a commonmeasure of operating performance in the telecommunications industry. AdjustedEBITDA helps us evaluate our performance by removing from our operating resultsitems which do not relate to our core operating performance.  The presentation of Adjusted EBITDA is not ameasure of financial performance under United States generally acceptedaccounting principles (“U.S. GAAP” or “GAAP”) and should not be considered inisolation or as a substitute for consolidated net income (loss) as a measure ofperformance and may not be comparable to similarly titled measures used byother companies.  The following tablesare a reconciliation of our income (loss) from continuing operations toAdjusted EBITDA on a consolidated and segment basis for the quarters andsix-month periods ended June 30, 2010 and 2009:

 
| ** **                                         | ** ** | **Quarter Ended June 30, 2010** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                         | ** ** | **Broadband**                        | ** ** | **Telecom** | ** ** | **Consolidated** | ** ** |
| Income  (loss) from continuing operations          |       | $                                    | (4,269     | ) | $ | 3,742 |   | $ | (527 | ) |
| Add  (subtract):                                   |       |                                 |       |   |   |   |   |
| Income  tax expense (benefit)                      |       | (2,867                               | )          | 3,057 |   | 190 |   |
| Other  (income) expense                            |       | 2,214                                |       | 160 |   | 2,374 |   |
| Depreciation  and amortization                     |       | 12,140                               |       | 3,122 |   | 15,262 |   |
| Non-cash  pension and post-retirement expense      |       | 162                                  |       | 179 |   | 341 |   |
| Non-cash  stock compensation expense               |       | 560                                  |       | 584 |   | 1,144 |   |
| Severance  and other related termination costs (a) |       | 469                                  |       | 675 |   | 1,144 |   |
| Adjusted  EBITDA                                   |       | $                                    | 8,409      |   | $ | 11,519 |   | $ | 19,928 |   |

 

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| ** **                                         | ** ** | **Six Months Ended June 30, 2010** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                         | ** ** | **Broadband**                           | ** ** | **Telecom** | ** ** | **Consolidated** | ** ** |
| Income  (loss) from continuing operations          |       | $                                       | (7,989     | ) | $ | 7,989 |   | $ | — |   |
| Add  (subtract):                                   |       |                                    |       |   |   |   |   |
| Income  tax expense (benefit)                      |       | (5,371                                  | )          | 6,385 |   | 1,014 |   |
| Other  (income) expense                            |       | 3,866                                   |       | 299 |   | 4,165 |   |
| Depreciation  and amortization                     |       | 24,320                                  |       | 6,048 |   | 30,368 |   |
| Non-cash  pension and post-retirement expense      |       | 367                                     |       | 394 |   | 761 |   |
| Non-cash  stock compensation expense               |       | 946                                     |       | 998 |   | 1,944 |   |
| Severance  and other related termination costs (a) |       | 469                                     |       | 675 |   | 1,144 |   |
| Adjusted  EBITDA                                   |       | $                                       | 16,608     |   | $ | 22,788 |   | $ | 39,396 |   |

 

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(a)              As discussed inthe Consolidated Overview section below, severance and other relatedtermination costs were incurred as a result of the workforce reductioninitiative implemented during the quarter ended June 30, 2010 in whichapproximately 60 positions were eliminated. Amounts exclude the terminationcosts related to stock compensation expense, which are included in non-cashstock compensation expense of the Adjusted EBITDA reconciliation.

 
| ** **                                    | ** ** | **Quarter Ended June 30, 2009** | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **Broadband**                        | ** ** | **Telecom** | ** ** | **Consolidated** | ** ** |
| Income  (loss) from continuing operations     |       | $                                    | (4,884     | ) | $ | 5,783 |   | $ | 899 |   |
| Add  (subtract):                              |       |                                 |       |   |   |   |   |
| Income  tax expense (benefit)                 |       | (3,312                               | )          | 3,928 |   | 616 |   |
| Other  (income) expense                       |       | 2,972                                |       | 128 |   | 3,100 |   |
| Depreciation  and amortization                |       | 11,283                               |       | 2,945 |   | 14,228 |   |
| Non-cash  pension and post-retirement expense |       | 56                                   |       | 496 |   | 552 |   |
| Non-cash  stock compensation expense          |       | 231                                  |       | 233 |   | 464 |   |
| Adjusted  EBITDA                              |       | $                                    | 6,346      |   | $ | 13,513 |   | $ | 19,859 |   |

 
| ** **                                    | ** ** | **Six Months Ended June 30, 2009** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                    | ** ** | **Broadband**                           | ** ** | **Telecom** | ** ** | **Consolidated** | ** ** |
| Income  (loss) from continuing operations     |       | $                                       | (10,282    | ) | $ | 11,260 |   | $ | 978 |   |
| Add  (subtract):                              |       |                                    |       |   |   |   |   |
| Income  tax expense (benefit)                 |       | (6,968                                  | )          | 8,468 |   | 1,500 |   |
| Other  (income) expense                       |       | 5,024                                   |       | 433 |   | 5,457 |   |
| Depreciation  and amortization                |       | 22,903                                  |       | 6,135 |   | 29,038 |   |
| Non-cash  pension and post-retirement expense |       | 383                                     |       | 924 |   | 1,307 |   |
| Non-cash  stock compensation expense          |       | 535                                     |       | 537 |   | 1,072 |   |
| Adjusted EBITDA                               |       | $                                       | 11,595     |   | $ | 27,757 |   | $ | 39,352 |   |

 

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**SelectOperating Metrics**

 
| ** **                                          | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **2010**                | ** ** | **2009** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| **Broadband**                                       |       |                    |       |   |   |   |   |   |   |
| Total  residential subscribers (1)                  |       | 103,100                 |       | 101,800 |   | 1,300 |   | 1 | % |
| Broadband  residential revenue-generating units (2) |       | 233,700                 |       | 224,800 |   | 8,900 |   | 4 |   |
| Data                                                |       | 99,200                  |       | 97,700 |   | 1,500 |   | 2 |   |
| Video                                               |       | 60,300                  |       | 59,100 |   | 1,200 |   | 2 |   |
| Voice                                               |       | 74,200                  |       | 68,000 |   | 6,200 |   | 9 |   |
| Total  business customers (3)                       |       | 7,300                   |       | 6,800 |   | 500 |   | 7 |   |
| ** **                                          | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Telecom**                                         |       |                    |       |   |   |   |   |   |   |
| Voice  revenue-generating units (4)                 |       | 32,800                  |       | 45,100 |   | (12,300 | ) | (27 | ) |
| Total  business customers (3)                       |       | 8,200                   |       | 8,900 |   | (700 | ) | (8 | ) |

 

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(1)             Total residentialsubscribers are customers who receive one or more residential data, video orvoice services from one of our subsidiaries in the Broadband segment.

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

(3)             Total business customers arecustomers who receive business data, voice or video services and represent adistinct customer account.

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

 

**Consolidated Overview**

 

*Operating Revenues*

 

Operating revenues in theBroadband segment increased $2,817 and $6,172 during the quarter and six-monthperiod ended June 30, 2010, respectively, compared to the same periods in2009. Broadband residential revenues increased $1,138 and $3,261 during thequarter and six-month period ended June 30, 2010, respectively, comparedto the same periods in 2009 due in part to a 4% growth in RGUs. Broadbandresidential revenues also increased as a result of higher pricing for video anddata services in 2010, which were effective in November 2009.

 

We offer a broadband VoIPdigital phone service (“VoIP phone service”) in the Sacramento market,including in the Telecom segment service territory.  The VoIP phone service provides us with acompetitive triple-play offering and has mitigated past declines inconsolidated operating revenue and voice RGUs by allowing us to migrate thosecustomers to voice RGUs in the Broadband segment rather than losing thosecustomers to competitors.  Broadbandvoice RGUs in the Sacramento market increased 21% as of June 30, 2010compared to the same prior year period.

 

Broadband business revenuesincreased $1,638 and $2,623 during the quarter and six-month period ended June 30,2010, respectively, compared to the same periods in 2009. Business customersincreased 7% as of June 30, 2010 compared to the same period in 2009 as aresult of growth primarily in the Kansas City market.  The variety of our product offerings and ourability to offer customized service packages to businesses of all sizes as wellas superior business customer satisfaction levels contributed to the currentyear growth in business revenue and will continue to provide us with newopportunities in the commercial market.

 

We will continue to investin new opportunities as they emerge in order to develop and enhance thebroadband infrastructure and the services we offer, such as wireless carrierbackhaul and data center services, while focusing on the generation of newcustomers and increasing residential penetration on existing marketable homes.

 

Operating revenues in theTelecom segment decreased $3,199 and $7,308 during the quarter and six-monthperiod ended June 30, 2010, respectively, compared to the same periods in2009. Residential services decreased $1,928 and $3,922 during the quarter andsix-month period ended June 30, 2010, respectively, compared to the sameperiods in 2009 and were largely impacted by our customer’s migration towardalternative communication services, including those offered by our Broadbandsegment, as discussed above, which contributed to a 27% decline in the Telecomsegment voice RGUs as of June 30, 2010 compared to 2009.  Business revenues decreased $689 and $1,319during the quarter and six-month period ended June 30, 2010, respectively,compared to the same periods in 2009 as a result 

 

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of an 8% decline in businesscustomers due to the economic impact on small and medium sized businesses inthe California market. The decrease in operating revenues was also impacted bythe scheduled reduction in support received from the California High Cost Fund(“CHCF”) of $510 and $1,020 during the quarter and six-month period ended June 30,2010, respectively, compared to the same periods in 2009.  See the Regulatory Matters section below fora further discussion regarding the regulatory subsidies we receive.

 

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

 

*Operating Expenses*

 

Consolidated operatingexpenses, excluding depreciation and amortization, increased $1,162 and $290during the quarter and six-month period ended June 30, 2010, respectively,compared to the same periods in 2009. During the quarter ended June 30,2010, we implemented a workforce reduction initiative in which approximately 60positions were eliminated as we continue to improve operating efficiencies andalign operating costs with the decline in Telecom revenues, while enhancing ourfocus on the growth of our broadband services. Affected employees were provided a range of benefits and resources,including severance. As a result, estimated severance and other relatedtermination costs of approximately $1,640 were incurred during the quarterended June 30, 2010.  The change inconsolidated operating expenses was also impacted by a decrease in costsassociated with our defined benefit pension plan (the “Pension Plan”) of $133and $409 during the quarter and six-month period ended June 30, 2010,respectively, compared to the same periods in 2009.

 

Cost of services andproducts expense increased $1,143 and $1,047 during the quarter and six-monthperiod ended June 30, 2010, respectively, compared to the same periods in2009.  The increase in expenses in thecurrent year periods was largely due to increases in programming and networkcosts related to providing video and data services.  These costs result from an increase inprogramming fees per subscriber and the growth in business services.

 

Customer operations andselling expense decreased $120 and $146 during the quarter and six-month periodended June 30, 2010, respectively, compared to the same periods in2009.  The decrease in expenses in thecurrent year periods was largely due to a reduction in labor and customersupport costs; however was offset in part by an increase in selling costsrelated to the launch and promotion of our new ADTV product during the currentyear periods.

 

General and administrativeexpenses increased $139 and decreased $611 during the quarter and six-monthperiod ended June 30, 2010, respectively, compared to the same periods in2009 primarily as a result of employee severance costs of approximately $1,146incurred during the quarter ended June 30, 2010 related to the workforcereduction initiative.  These costs weremitigated by a reduction in professional fees as a result of lower annual ratesand a decrease in labor costs due to a decline in pension expense andinformation technology project support costs in the current year.

 

Our consolidateddepreciation and amortization expense increased $1,034 and $1,330 during thequarter and six-month period ended June 30, 2010, respectively, comparedto the same periods in 2009.  Theincrease in depreciation and amortization expense was primarily due to thecontinued expansion of the network and success-based capital projectsundertaken within the residential and business broadband service territories.

 

*Reclassifications*

 

Certain amounts in our 2009condensed consolidated financial statements have been reclassified to conformto the presentation of our 2010 condensed consolidated financial statements.

 

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**Segment Results of Operations**

 

**Broadband**

 
| ** **                                        | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                                        | ** ** | ** **                      | ** ** | ** **                         | ** ** | **$** | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                        | ** ** | **2010**                        | ** ** | **2009**                           | ** ** | **Change** | ** ** | **Change** | ** ** | **2010** | ** ** | **2009** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                              |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Data                                              |       | $                               | 12,145     |                               | $          | 11,184 |   | $ | 961 |   | 9 | % | $ | 24,393 |   | $ | 21,947 |   | $ | 2,446 |   | 11 | % |
| Video                                             |       | 12,166                          |       | 11,995                             |       | 171 |   | 1 |   | 24,385 |   | 23,684 |   | 701 |   | 3 |   |
| Voice                                             |       | 6,600                           |       | 6,594                              |       | 6 |   | 0 |   | 13,107 |   | 12,993 |   | 114 |   | 1 |   |
| Total  residential revenues                       |       | 30,911                          |       | 29,773                             |       | 1,138 |   | 4 |   | 61,885 |   | 58,624 |   | 3,261 |   | 6 |   |
| Business                                          |       | 11,253                          |       | 9,615                              |       | 1,638 |   | 17 |   | 21,823 |   | 19,200 |   | 2,623 |   | 14 |   |
| Access                                            |       | 541                             |       | 398                                |       | 143 |   | 36 |   | 1,268 |   | 782 |   | 486 |   | 62 |   |
| Other                                             |       | 371                             |       | 473                                |       | (102 | ) | (22 | ) | 677 |   | 875 |   | (198 | ) | (23 | ) |
| Total  operating revenues from external customers |       | 43,076                          |       | 40,259                             |       | 2,817 |   | 7 |   | 85,653 |   | 79,481 |   | 6,172 |   | 8 |   |
| Intersegment  revenues                            |       | 145                             |       | 94                                 |       | 51 |   | 54 |   | 313 |   | 185 |   | 128 |   | 69 |   |
| Operating  expenses                               |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost  of services and products*                   |       | 25,145                          |       | 22,823                             |       | 2,322 |   | 10 |   | 48,738 |   | 45,723 |   | 3,015 |   | 7 |   |
| Customer  operations and selling                  |       | 6,106                           |       | 6,468                              |       | (362 | ) | (6 | ) | 12,497 |   | 12,728 |   | (231 | ) | (2 | ) |
| General  and administrative                       |       | 4,752                           |       | 5,003                              |       | (251 | ) | (5 | ) | 9,905 |   | 10,538 |   | (633 | ) | (6 | ) |
| Depreciation  and amortization                    |       | 12,140                          |       | 11,283                             |       | 857 |   | 8 |   | 24,320 |   | 22,903 |   | 1,417 |   | 6 |   |
| Loss  from operations                             |       | (4,922                          | )          | (5,224                             | )          | 302 |   | 6 |   | (9,494 | ) | (12,226 | ) | 2,732 |   | 22 |   |
| Loss  from continuing operations                  |       | (4,269                          | )          | (4,884                             | )          | 615 |   | 13 |   | (7,989 | ) | (10,282 | ) | 2,293 |   | 22 |   |
|                                                   |            |                                 |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

*Exclusiveof depreciation and amortization

 

**Broadband Segment Operating Revenues**

 

Operating revenues fromexternal customers in the Broadband segment increased $2,817 and $6,172 duringthe quarter and six-month period ended June 30, 2010, respectively,compared to the same periods in 2009. The increase in operating revenues was due in part to the growth inresidential RGUs and business customers.

 

**Residential Revenues**

 

Broadband residentialrevenues increased $1,138 and $3,261 during the quarter and six-month periodended June 30, 2010, respectively, compared to the same periods in2009.  Broadband residential RGUsincreased 4% as of June 30, 2010 compared to the same period in 2009 dueto a 9% growth in voice RGUs, as discussed below.  We anticipate continued growth in residentialbroadband RGUs and average revenue per user resulting from our HD DVR, VoIPphone service and the launch in January 2010 of our ADTV product poweredby Microsoft® MediaroomTM.  ADTV is currently deployed through our copperand fiber networks in the greater Sacramento area.  The integration of the new MediaroomTM platform includes a Whole Home DVR, whichallows customers the ability to watch recorded shows on any television in thehouse, record multiple shows at one time and utilize an intuitive on-screen guideand user interface.

 

*Data*

 

We offer high speed Internetaccess at symmetrical speeds of up to 50 Mbps, depending on the nature of thenetwork facilities that are available, the level of service selected and thelocation.  The reliability and high speedsof the data service in both the Sacramento and Kansas City markets enhanceother services such as VoIP and Digital Phone, where customers manage phoneservices through the online SureWest portal. Through the SureWest portal, customers can manage their VoIP or DigitalPhone service and access a variety of value added features and enhancementsthat are designed to take advantage of the speed of the Internet service weprovide.

 

Our residential datarevenues increased $961 and $2,446 during the quarter and six-month periodended June 30, 2010, respectively, compared to the same periods in 2009 asa result of higher price points on our data services, which were effectiveNovember 2009.

 

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*Video*

 

Ourvideo services range from limited basic cable service to our newest productoffering ADTV.  Our services increasinglyare delivered utilizing FTTH and FTTN networks, which allow us to offer a highquality experience with digital TV Packages. Our full digital cable service provides access to over 335 and 300channels in our California and Kansas City markets, respectively, includingpremium and pay-per-view channels, VOD service, premium VOD channels, musicchannels and an interactive, on-screen program guide. Digital cable subscriberscan also subscribe to additional digital cable services, including a DVR andHDTV.

 

Residential video revenuesincreased $171 and $701 during the quarter and six-month period ended June 30,2010, respectively, compared to the same periods in 2009.  Revenues increased as a result of both higherpricing on many of our video service offerings, which were effective November 2009,and new demand for enhanced video offerings such as VOD, DVR and HDTV.

 

*Voice*

 

We offer phone services thatprovide local and long-distance calling and include features such as caller IDand call waiting. As of June 30, 2010, approximately 24% of the homes inthe areas we serve subscribed to one of our phone services.

 

Our VoIP phone service isoffered in the Sacramento market and is available in packages ranging frombasic telephone service to unlimited local and domestic long distance callingplans.  Nearly all of our VoIP phoneservice plans include enhanced calling features such as Find Me/Follow Me,sequential ringing and selective call acceptance and rejection.  Voice RGUs in the Sacramento market increased21% as of June 30, 2010 compared to the same period in 2009.  As of June 30, 2010, approximately 16%of the homes in our Sacramento market have subscribed to our VoIP phoneservice.  Our VoIP phone service in theSacramento market offers our customers, including those in the Telecom serviceterritory, an alternative to traditional circuit switched land line service andpresents our customers with a more competitive triple-play offering withincreased options and multiple packages.

 

Residential voice revenuesincreased $6 and $114 during the quarter and six-month period ended June 30,2010, respectively, compared to the same periods in 2009 primarily as a resultof growth in voice RGUs of 9% in that same time period.  Average revenue per voice user declined toapproximately $30.01 as of June 30, 2010 from approximately $32.69compared to the same period in 2009, due to customers receiving service as apart of a promotional offer or in a bundled service offering.

 

**Business Revenues**

 

We provide a variety ofbusiness communications services to small, medium and large businesscustomers.  The services we offer to ourbusiness customers include: fiber-optics-based high-speed Internet, customizeddata and Ethernet transport services, data center and disaster recovery solutions,traditional landline and VoIP phone services, wireless backhaul and digital TV.

 

Business revenues increased$1,638 and $2,623 during the quarter and six-month period ended June 30,2010, respectively, compared to the same periods in 2009.  This increase was due primarily to a 7%increase in business customers as of June 30, 2010 compared to the sameperiod in 2009.  Our Kansas Cityoperations contributed a significant portion of the business revenue growth.

 

Wireless backhaul revenuecontributed slightly to the growth in the business revenue during the quarterand six-month period ended June 30, 2010. We anticipate backhaul revenue will grow during the remainder of 2010 aswireless carriers, faced with escalating consumer and business demand formobile broadband traffic, are forced to increase backhaul capacity.

 

**Access Revenues**

 

Access revenues increased$143 and $486 during the quarter and six-month period ended June 30, 2010,respectively, compared to the same periods in 2009.  The increase was mostly attributable to cashsettlements received during the quarter ended March 31, 2010 from certaintelecommunications carriers relating to disputed carrier access charges whichwere fully reserved in prior year periods.

 

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**Broadband Segment Operating Expenses**

 

Total operating expenses inthe Broadband segment increased $1,709 and $2,151 during the quarter andsix-month period ended June 30, 2010, respectively, compared to the sameperiods in 2009.

 

Cost of services andproducts (exclusive of depreciation and amortization) increased $2,322 and$3,015 during the quarter and six-month period ended June 30, 2010,respectively, compared to the same periods in 2009.  The increase in costs in the current yearperiods was largely due to direct costs incurred to provide our voice, videoand data services.

 

Video programming fees arepaid to programming networks to license the programming we distribute to our videocustomers.  Video programming costs havebeen increasing over the last several years primarily due to the expansion ofchannels and an increase in costs on a per subscriber basis and per programchannel, particularly for local television broadcast stations, sports and HDchannels.

 

We incur network access andtransport costs to provide data and voice services to our customers.  Due to the increasing demand for our VoIPproduct in the Sacramento market and the additional capacity required to handlethe increasing volume of data usage, costs have increased in the current yearperiods.  Network access costs includecosts paid to external vendors as well as our Telecom segment, in accordancewith the provisions of a wholesale access agreement. The wholesale accessagreement enables the Broadband segment to offer high-speed Internet, VoIP,video and wireless backhaul services to its customers within the Telecomsegment territory.

 

Customer operations expensedecreased $362 and $231 during the quarter and six-month period ended June 30,2010, respectively, compared to the same periods in 2009.  The decrease in the current year period wasmostly attributable to a decrease in labor for customer support services as aresult of reduction in headcount.  Thedecrease was offset in part by an increase in selling expenses, primarilysalaries and wages, commissions and customer events to promote the launch ofour new ADTV product in the current year periods.

 

General and administrativeexpense decreased $251 and $633 during the quarter and six-month period ended June 30,2010, respectively, compared to the same periods in 2009.  The decrease in costs were primarily due to (i) adecline in labor costs resulting from improved operating efficiencies in thecurrent year period, (ii) a decrease in professional fees and (iii) theincurrence in the prior year period of information technology costs related tosystem maintenance and development and increased production supportprojects.  The decrease in costs wasoffset in part by severance costs of approximately $558 incurred during thequarter ended June 30, 2010 related to the workforce reduction initiative,as discussed in the consolidated overview section above.

 

Depreciation andamortization increased $857 and $1,417 during the quarter and six-month periodended June 30, 2010, respectively, compared to the same periods in 2009due primarily to the continued expansion of the broadband network andsuccess-based capital projects.

 

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**Telecom**

 
| ** **                                        | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                                        | ** ** | ** **                      | ** ** | ** **                         | ** ** | **$** | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                        | ** ** | **2010**                        | ** ** | **2009**                           | ** ** | **Change** | ** ** | **Change** | ** ** | **2010** | ** ** | **2009** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                              |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential                                       |       | $                               | 4,479      |                               | $          | 6,407 |   | $ | (1,928 | ) | (30 | )% | $ | 9,347 |   | $ | 13,269 |   | $ | (3,922 | ) | (30 | )% |
| Business                                          |       | 8,400                           |       | 9,089                              |       | (689 | ) | (8 | ) | 16,818 |   | 18,137 |   | (1,319 | ) | (7 | ) |
| Access                                            |       | 4,408                           |       | 4,953                              |       | (545 | ) | (11 | ) | 8,568 |   | 10,600 |   | (2,032 | ) | (19 | ) |
| Other                                             |       | 185                             |       | 222                                |       | (37 | ) | (17 | ) | 350 |   | 385 |   | (35 | ) | (9 | ) |
| Total  operating revenues from external customers |       | 17,472                          |       | 20,671                             |       | (3,199 | ) | (15 | ) | 35,083 |   | 42,391 |   | (7,308 | ) | (17 | ) |
| Intersegment  revenues                            |       | 5,091                           |       | 4,981                              |       | 110 |   | 2 |   | 10,010 |   | 9,855 |   | 155 |   | 2 |   |
| Operating  expenses                               |       |                            |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost  of services and products*                   |       | 5,656                           |       | 6,566                              |       | (910 | ) | (14 | ) | 11,361 |   | 12,834 |   | (1,473 | ) | (11 | ) |
| Customer  operations and selling                  |       | 2,678                           |       | 2,535                              |       | 143 |   | 6 |   | 5,068 |   | 5,176 |   | (108 | ) | (2 | ) |
| General  and administrative                       |       | 4,148                           |       | 3,767                              |       | 381 |   | 10 |   | 7,943 |   | 7,940 |   | 3 |   | 0 |   |
| Depreciation  and amortization                    |       | 3,122                           |       | 2,945                              |       | 177 |   | 6 |   | 6,048 |   | 6,135 |   | (87 | ) | (1 | ) |
| Income  from operations                           |       | 6,959                           |       | 9,839                              |       | (2,880 | ) | (29 | ) | 14,673 |   | 20,161 |   | (5,488 | ) | (27 | ) |
| Income  from continuing operations                |       | 3,742                           |       | 5,783                              |       | (2,041 | ) | (35 | ) | 7,989 |   | 11,260 |   | (3,271 | ) | (29 | ) |
|                                                   |            |                                 |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*Exclusive of depreciationand amortization

 

**Telecom Segment Operating Revenues**

 

Operating revenues fromexternal customers in the Telecom segment decreased $3,199 and $7,308 duringthe quarter and six-month period ended June 30, 2010, respectively,compared to the same periods in 2009. The decrease in operating revenues wasdue in part to the decline in voice RGUs, business customers and regulatorysubsidies.

 

**Residential Revenues**

 

SureWest Telephone offersseveral different phone service options, from basic local service packages tounlimited California and nationwide flat-rate plans.  All of the plans include options forvoicemail and other calling features such as caller ID and call forwarding.* *SureWest Telephoneresidential revenues decreased $1,928 and $3,922 during the quarter andsix-month period ended June 30, 2010, respectively, compared to the sameperiods in 2009 as we continue to experience decreases in revenue due tocompetition from wireless, wireline, and digital phone competitors (includingSureWest Broadband).  Residentialsubscribers and voice RGUs declined approximately 27% as of June 30, 2010compared to the same period in 2009.  Wecontinue to mitigate additional voice access line and operating revenue lossesthrough our VoIP phone service now offered to customers within the Telecomservice area through our Broadband segment. As a result, we expect a portion of the Telecom segment’s voice revenuewill continue to shift to the VoIP service being offered by our Broadbandsegment.  As reflected in the SelectOperating Metrics section above, as of June 30, 2010, nearly half of thedecline in Telecom voice RGUs is due to customers who have transferred toSureWest Broadband’s VoIP phone service rather than being lost tocompetitors.  See the Broadband segmentresidential revenue section above for a more detailed discussion regarding VoIPand other services offered by SureWest Broadband.

 

**Business Revenues**

 

We provide a variety ofbusiness service offerings to small, medium and large business customers,including many services over our advanced fiber network.  The services we offer to our businesscustomers include, but are not limited to fiber-optics-based high-speedInternet, customized data and Ethernet transport services, data center anddisaster recovery solutions, traditional landline and scalable IP communicationsystems.

 

SureWest Telephone businessrevenues decreased $689 and $1,319 during the quarter and six-month periodended June 30, 2010, respectively, compared to the same periods in 2009largely due to the current economic impact on small to medium sized businessesand continued strong competitive pressures, as discussed above. While ourTelecom segment business customer base declined 8% as of June 30, 2010compared to the same period in 2009, average monthly revenue per user (“ARPU”)remained relatively flat.

 

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**Access Revenues**

 

Accessrevenues, which include interstate and intrastate switched and special accessrevenue, interstate common line (“CL”) revenue and declining support paymentsfrom the CHCF, decreased $545 and $2,032 during the quarter and six-monthperiod ended June 30, 2010, respectively, compared to the same periods in2009. As anticipated, CHCF support received during the quarter and six-monthperiod ended June 30, 2010 decreased $510 and $1,020, respectively,compared to the same periods in 2009. Interstate CL settlements received fromthe National Exchange Carrier Association (“NECA”) decreased $35 and $364during the quarter and six-month period ended June 30, 2010, respectively,compared to the same periods in 2009. Revenue recovery from the NECA pooldeclined as a result of the reduced customer base and a lower rate base due tocost reductions in the Telecom segment. See the Regulatory Matters**section belowfor a more detailed discussion regarding SureWest Telephone’s regulatedrevenues.

 

**Intersegment Revenues**

 

Intersegment revenuesconsist predominately of revenues earned through a wholesale access agreementbetween the Telecom and Broadband segments. The Telecom segment supplies wholesale access and DSL services throughits network to the Broadband segment, which enables the Broadband segment tooffer high-speed internet, VoIP, video and wireless backhaul services tocustomers residing within the Telecom service territory.  Wholesale access and DSL intersegment revenueincreased in the current year periods compared to the same periods in 2009 andis anticipated to continue to increase with heightened demand for the Broadbandsegment’s VoIP and ADTV products offered in the Telecom segment serviceterritory.  See the Broadband operatingrevenue section above for more detailed discussion of the Broadband revenuesand product offerings.

 

**TelecomSegment Operating Expenses**

 

Total operating expenses forthe Telecom segment decreased $386 and $1,578 during the quarter and six-monthperiod ended June 30, 2010, respectively, compared to the same periods in2009.  As discussed in the Residential Revenue section above, during 2010we experienced a decline in voice RGUs due in part to subscribers opting toinitiate VoIP phone service offered by our Broadband segment.  As a result, certain of the operating costsassociated with these subscribers are now included in the Broadbandsegment.  In addition, costs related toour Pension Plan decreased approximately $278 and $457 during the quarter andsix-month period ended June 30, 2010, respectively, compared to the same periodsin 2009.

 

Cost of services andproducts (exclusive of depreciation and amortization) decreased $910 and $1,473during the quarter and six-month period ended June 30, 2010, respectively,compared to the same periods in 2009.  Asof June 30, 2010 compared to the same period in 2009 and as discussedabove, local and long distance expenses declined as a result of decreases inresidential voice RGUs and business customers. Additionally, in the current year periods, rent and utility costs havedeclined due to a consolidation of office space.  The decrease in costs was offset in part byseverance costs of approximately $299 incurred during the quarter ended June 30,2010 related to the workforce reduction initiative, as discussed in theconsolidated overview section above.

 

Customer operations expenseincreased $143 and decreased $108 during the quarter and six-month period endedJune 30, 2010, respectively, compared to the same periods in 2009.  The decrease in expenses during the sixmonths ended June 30, 2010 was largely due to the decline in voice RGUsand business customer base, as discussed above, and a reduction in laborcosts.  The decrease in costs was offsetin part by an increase in advertising and promotion costs to support productofferings in the Telecom segment service territory.

 

General and administrativeexpense increased $381 during the quarter ended June 30, 2010 compared tothe same period in 2009.  The increase incosts was the result of severance costs of approximately $588 incurred duringthe quarter ended June 30, 2010 related to the workforce reductioninitiative, as discussed in the consolidated overview section above.  The increase in costs was offset in part by areduction in professional fees.

 

Depreciation andamortization increased $177 and decreased $87 during the quarter and six-monthperiod ended June 30, 2010, respectively, compared to the same periods in2009.  The increase in costs during thequarter ended June 30, 2010 was due to i) plant additions for customerswith digital VoIP service and ii) enhancements to the existing copper networkmarketable homes to support the ADTV product offered by the Broadbandsegment.  The decrease during the sixmonths ended June 30, 2010 was due predominately to a portion of aerialand underground cable becoming fully depreciated during 2009.

 

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**Regulatory Matters**

 

Revenues subject toregulation, which include such telecommunications services as local telephoneservice, network access service and toll service, are derived from varioussources, including:

 

·                  business andresidential subscribers of basic exchange services;

·                  surchargesmandated by state commissions;

·                  long distancecarriers, for network access service;

·                  competitiveaccess providers and commercial enterprises for network access service;

·                  interstate poolsettlements from NECA;

·                  supportpayments from federal or state programs; and

·                  supportpayments from the CHCF, recovering costs of services including extended areaservice.

 

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

 

*FCC Matters*

 

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

 

TheFCC was directed by Congress to develop a National Broadband Plan (“NBP”) aspart of the American Recovery and Reinvestment Act of 2009.  In March 2010, after taking extensivepublic comment, the FCC released the full text of its NBP, which containspolicy recommendations on a variety of issues that the FCC has linked toexpanded broadband deployment.  The policy recommendations include guidingprinciples to foster competition in broadband, telephone, wireless and cableservices over the next decade, including recommendations related to universalservice fund (“USF”) reform, intercarrier compensation, cable set-top boxes andspectrum reallocation, among others.  The NBP recommendations mostrelevant to the Company include shifting the current USF mechanisms thatsupport universal voice telephone services to support of universal broadbanddeployment and the phased reduction of intercarrier access compensation levelsto local reciprocal compensation levels, with a potential phase-out of all suchcompensation within ten years.  Some of these recommendations only restatepre-existing FCC proposals in current rulemakings while others raise newissues.  The FCC did not actually take action on any issue in the NBPitself. Approximately half of these issues will require separate FCC rulemakingaction and the remainder consists of policy recommendations for action byCongress or other governmental entities.  The FCC is already beginningsome separate proceedings.  Most recently, in response to a recent FederalAppeals Court decision which found that the FCC lacked authority over certainInternet-related practices of Comcast, the FCC opened proceedings to reassessthe nature of Internet-related activities of Internet providers and to considerrules related to such activities. Among other things, the FCC indicated it will consider possibleredefinition of some forms of Internet “connectivity” which could make theseactivities subject to new regulation under Title II of the Act.  The FCC’s actions in these proceedings couldlead to new rules and a significant increase in governmentregulation.  These proceedings are alsocreating significant new regulatory uncertainties for participants across theInternet sector. Action to deal with this and other issues addressed by the NBPmay have a material impact on us.  We will continue to monitor thesematters and their potential impact on our consolidated financial position andresults of operations.

 

*California Public UtilityCommission (“CPUC”) Matters*

 

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

 

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As part of the SettlementAgreement, SureWest Telephone was required to implement an additional annualconsumer dividend of $1,300 on January 1, 2007 to end-users receivingSureWest Telephone services subject to sharing on or after that date.  In December 2006, the CPUC authorized usto offset our annual $11,500 interim draw from the CHCF with the aforementioned$1,300 consumer dividend Settlement Agreement. The CHCF was previously authorized by the CPUC on an interim basis tooffset certain of SureWest Telephone’s intrastate regulated operating expensesthat previously had been recovered through direct carrier payments. In September 2007,the CPUC issued Decision 07-09-002 which provides for SureWest Telephone tophase-down its annual CHCF interim draw over a five-year period, to end on January 1,2012.  In 2009, our interim CHCF draw was$6,120 and is being incrementally reduced by $2,040 annually.  We anticipate our 2010 interim CHCF draw willbe $4,080, of which through June 30 we have received $2,040.

 

In an ongoing proceedingrelating to the New Regulatory Framework (under which SureWest Telephone hasbeen regulated since 1996), the CPUC adopted Decision 06-08-030 in 2006, whichgrants carriers broader pricing freedom in the provision of telecommunicationsservices, bundling of services, promotions and customer contracts.  This decision adopted a new regulatoryframework, the Uniform Regulatory Framework (“URF”), which among other things (i) eliminatesprice regulation and allows full pricing flexibility for all new and retailservices except basic residential services, which limits increases to $3.25 peryear during 2009 and 2010, (ii) allows new forms of bundles andpromotional packages of telecommunication services, (iii) allocates allgains and losses from the sale of assets to shareholders and (iv) eliminatesalmost all elements of rate of return regulation, including the calculation ofshareable earnings.  Beginning January 1,2011, the URF Incumbent Local Exchange Carriers will be allowed full pricingflexibility for the basic residential rate.

 

*Other Regulatory Matters*

 

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

 

**Non-Operating Items**

 

*Other Income and Expense, Net*

 

Consolidated interestexpense decreased $811 and $1,478 during the quarter and six-month period endedJune 30, 2010, respectively, compared to the same periods in 2009,primarily due to a decrease in long-term debt. A decline in interest rates on our outstanding debt subject to LondonInterbank Offered Rates also contributed to the reduction in interest expense.

 

We received a patronagedividend of $979 and $963 during the quarters ended March 31, 2010 and2009, respectively. We earn patronage dividends from CoBank, ACB (“CoBank”)based on our share of the net income earned by CoBank.  We record the receipt of the patronagedividends against interest expense.

 

*Income Taxes*

 

Income taxes decreased $426and $486 during the quarter and six-month period ended June 30, 2010,respectively, compared to the same periods in 2009.  The decrease in income taxes in the currentyear periods was due primarily to a reduction in income before incometaxes.  The effective federal income taxrates for continuing operations were 100.0% and 60.5% for the six-month periodsended June 30, 2010 and 2009, respectively.  The increase in the effective tax rate in thecurrent year compared to the same period in 2009 was due primarily to deferredstate income tax related to apportionment changes and permanent differencesresulting from the decrease between the grant and vesting prices of restrictedcommon stock and restricted common stock units that vested during the six-monthperiod ended June 30, 2010.  Changesin state apportionment factors, based on operational results, may affect ourfuture effective tax rates.

 

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**Liquidity and Capital Resources**

 

**Overview**

 

We generate significant cashflows from operating activities.  Webelieve that we will be able to meet our current and long-term liquidity andcapital requirements through our cash flow from operating activities, existingcash, cash equivalents and investments; through available borrowings under ourexisting credit facilities; and through our ability to obtain future externalfinancing.  Our primary use of cash in2010 has been for capital expenditures and scheduled payments of long-term debt(including interest). We anticipate continuing to use a substantial portion ofour cash flow to fund our capital expenditures, invest in new businessopportunities, fund network expansion, meet scheduled payments of long-termdebt and may fund the share repurchase plan.

 

The following tablesummarizes our cash flows:

 
| ** **                                        | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                                        | ** ** | **2010**                           | ** ** | **2009** | ** ** | **$ Change** | ** ** |
| Cash  Flows Provided By (Used In)                 |       |                               |       |   |   |   |   |
| Operating  Activities:                            |       |                               |       |   |   |   |   |
| Continuing  operations                            |       | $                                  | 26,427     |   | $ | 32,291 |   | $ | (5,864 | ) |
| Discontinued  operations                          |       | —                             |       | (507 | ) | 507 |   |
|                                              |       |                               |       |   |   |   |   |
| Investing  Activities:                            |       |                               |       |   |   |   |   |
| Continuing  operations                            |       | (21,007                            | )          | (18,591 | ) | (2,416 | ) |
|                                              |       |                               |       |   |   |   |   |
| Financing  Activities:                            |       |                               |       |   |   |   |   |
| Continuing  operations                            |       | (6,755                             | )          | (6,154 | ) | (601 | ) |
| Increase  (Decrease) in Cash and Cash Equivalents |       | $                                  | (1,335     | ) | $ | 7,039 |   | $ | (8,374 | ) |

 

**Cash Flows Provided By OperatingActivities**

 

Net cash provided bycontinuing operating activities was $26,427 during the six-month period endedJune 30, 2010.  Significantadjustments to net income to arrive at cash provided by operating activitiesprimarily include non-cash charges of $32,312 consisting primarily of (a) depreciationand amortization of $30,368 due to capital investments principally in theBroadband segment and (b) stock compensation expense of $1,944. Cashprovided by operating activities was offset in part by a decrease in (i) accruedcompensation of $3,110 related in part to the payment in the current year of2009 incentive compensation and (ii) accrued liabilities of $3,330 relatedto the timing of various expenditures in the current year.

 

**Cash Flows Used InInvesting Activities**

 

Net cash used in continuinginvesting activities was $21,007 during the six-month period ended June 30,2010 and was primarily related to capital expenditures that were partiallyoffset by proceeds from the sale of our auction rate security (“ARS”).

 

*Capital Expenditures*

 

Capital expenditurescontinue to be our primary recurring investing activity and were $26,414 in thesix-month period ended June 30, 2010. We invest a significant portion ofour capital spending in our Broadband segment as a result of business growth,the introduction of new products and services and the expansion of the network.

 

*Proceeds from Sale ofDiscontinued Operations*

 

In May 2008, we soldthe operating assets of our Wireless business, SureWest Wireless, to Verizonfor an aggregate cash purchase price of $69,746. A portion of the purchaseprice equal to $3,450 was placed in escrow, half of which was received duringthe quarter ended June 30, 2009 and the balance of which was receivedduring the quarter ended June 30, 2010.

 

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* *

*Auction Rate Security*

 

Asof December 31, 2009, we held one $3,700 par value ARS purchased from UBSFinancial Services, Inc., a subsidiary of UBS AG (“UBS”) with an estimatedfair value of $3,054, which was measured using Level 3 inputs. This ARS wascollateralized by student loans that are guaranteed primarily by a monolineinsurance company and partially by the Federal Family Education Loan Program(“FFELP”). As of December 31, 2009, we also held an offer (“Right” or “putoption”) entitling us to sell at par our ARS anytime during a two-year periodfrom June 30, 2010 through July 2, 2012.

 

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

 

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

 

**Cash Flows Provided By FinancingActivities**

 

Net cash used in financingactivities consists primarily of our proceeds and principal payments onlong-term borrowings and planned repurchases of our common stock.

 

*Long-term Debt*

 

In September 2008, weentered into a Third Amended and Restated Credit Agreement (“Credit Agreement”)with CoBank to restate and replace a February 2008 Agreement. The CreditAgreement terms, among other things (i) reflected the repayment of $30,000of the Term Loan B facility under the February 2008 Agreement to reducethe principal balance from $60,000 to $30,000, (ii) modified interestmargins, (iii) extended the maturity date of the Term Loan B facility toMay 1, 2012, (iv) separated the total revolving commitments of$60,000 into a Revolving Loan facility of $57,500 and a Swingline Loan facilityof $2,500 and (v) required permanent reductions of the Revolving Loanfacility of $7,500 at December 31, 2009 and 2010.

 

On January 29, 2010, weentered into a letter agreement with CoBank amending certain terms of theCredit Agreement, including (i) an increase in the total Revolving Loanfacility of $7,500, (ii) CoBank’s share of the Revolving Loan facilitywill be permanently reduced by $5,000 (rather than $7,500) on December 31,2010 and (iii) the total Revolving Loan facility will be $57,500.  As a result of this letter agreement, ourcombined revolving commitment balance on our Revolving Loan and Swingline Loanfacilities was $60,000 and our available balance as of June 30, 2010,which is less our outstanding balance of $18,500, was approximately $41,500.

 

As of June 30, 2010,$14,545 and $36,000 were outstanding on the Series A and Series BSenior Notes, respectively. As of June 30, 2010, $120,000, $30,000,$18,500 and zero were outstanding on the CoBank Term Loan A, Term Loan B,Revolving Loan and Swingline Loan facilities, respectively. We had noshort-term borrowings as of June 30, 2010.

 

*Debt Covenants*

 

Our Series A and Series BSenior Notes and the Credit Agreement contain financial and operating covenantsthat may restrict, among other things, the repurchase of the Company’s commonstock, the payment of dividends, the making of certain other restrictedpayments and the incurrence of additional indebtedness. The covenants alsorequire us to maintain certain financial ratios and minimum levels of tangiblenet worth. If we fail to comply with the covenants and other restrictions, suchas making timely interest or principal payments, it could lead to an event ofdefault and the acceleration of our obligations under those agreements. As of June 30,2010, we were in compliance with all of our debt covenants.

 

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

 
| **Financial  Covenant**  | ** ** | **Required Ratio Level** | ** ** | **Actual Performance  at June 30, 2010** | ** ** |
|--------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|
| Leverage  ratio          |       | Not  more than 3.75      |       | 2.92                                          |       |
| Interest  coverage ratio |       | Not  less than 3.00      |       | 7.62                                          |       |
| Consolidated  net worth  |       | Not  less than $160,000  |       | $268,261                                      |       |
| Debt  to capitalization  |       | Not  more than 0.55      |       | 0.45                                          |       |

 

At June 30, 2010 andDecember 31, 2009, retained earnings of $108,261 and $109,183,respectively, were available for the payments described above.

 

*Share Repurchase Program*

 

Our Board of Directors hasauthorized the repurchase of up to 2.5 million shares of our common stock.Shares are purchased from time to time in the open market or through privatelynegotiated transactions, subject to overall financial and market conditions.Starting in the first quarter of 2000 through June 30, 2010, approximately2.2 million shares of common stock had been repurchased. As of June 30,2010, we had remaining authorization from the Board of Directors to repurchaseapproximately 253 thousand additional outstanding shares. We repurchasedapproximately 358 thousand shares during the quarter ended June 30, 2010(none during the quarter ended March 31, 2010).  We did not repurchase any shares during thequarter or six-month period ended 2009. The purchase of common shares did nothave a substantive effect on the average number of common shares outstanding orthe calculation of basic and diluted earnings per share for the quarters orsix-month period ended June 30, 2010.

 

**Sufficiency of Cash Resources**

 

We had cash, cashequivalents and short-term investments at June 30, 2010 of $6,705.  As discussed in the Long-term debt sectionabove, we have additional long-term borrowing capacity of approximately $60,000available to us through our Revolving Loan facility; of which, $18,500 wasoutstanding as of June 30, 2010.  Webelieve our operating cash flows and our borrowing capacity are sufficient tosatisfy our liquidity requirements for the next twelve months, whilemaintaining adequate cash and cash equivalents.

 

Our most significant use offunds in the remainder of 2010 is expected to be for (i) budgeted capitalexpenditures of up to approximately $29,000, (ii) scheduled payments oflong-term debt of $3,636 and (iii) anticipated interest payments of$4,500. As discussed above, throughout the year we may repurchase shares of theCompany’s common stock in the open market at the prevailing market price up toan amount authorized by the Board of Directors.

 

A portion of the 2010budgeted capital expenditures is at our discretion and dependent upon ourworking capital position, operating cash flows and ability to borrow. We canmodify our planned construction and commitments if the results of operations oravailable capital so require. A significant portion of our 2010 budgetedcapital expenditures are success based and is partially dependent on ourability to manage our growth and expansion. We are required to comply with ourcable franchise agreements to continue our build-out in the franchise areas.

 

*Defined Benefit Pension Plan*

 

As required, we contributeto the Pension Plan, Supplemental Executive Retirement Plan and certainpost-retirement benefits other than pensions (“Other Benefits Plan”)(collectively the “Plans”), which provide retirement benefits to certaineligible employees. Contributions are intended to provide for benefitsattributed to service to date. Our funding policy is to contribute annually anactuarially determined amount consistent with applicable federal income taxregulations. We stopped accruing benefits for active participants effectiveApril 1, 2007 and we anticipate that future funding requirements willdecrease significantly as a result of the freeze of the Plans.  However, the significant decline in theequity markets precipitated by the recent credit crisis and financial systeminstability has negatively affected the value of our Pension Plan assets.  Our minimum funding requirement for 2010related to the Pension Plan is $2,620; however, due to a carryover creditbalance of $4,461, no cash contribution will be required.  We will continue to evaluate the futurefunding requirements of the Plans and fund them as necessary. See Note 7for a more detailed discussion regarding our Pension Plan and Other BenefitsPlan.

 

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*Income Taxes*

 

The timing of cash paymentsfor income taxes, which is governed by the Internal Revenue Service and othertaxing jurisdictions, will differ from the timing of recording tax expense anddeferred income taxes, which are reported in accordance with GAAP. For example,tax laws in effect for 2009 regarding accelerated or “bonus” depreciation fortax reporting resulted in less cash payments than the GAAP tax expense oncontinuing and discontinued operations. Acceleration of tax deductions couldeventually result in situations where cash payments will exceed GAAP taxexpense. Changes in tax laws create uncertainty as to when or if this situationwill occur within the next three years.

 

Our deferred tax assets areexpected to be realized through the reversal of deferred tax liabilities andthrough the generation of future taxable income from ordinary and recurringoperations. Deferred tax assets that are dependent on specific businesssegments generating future taxable income were determined to be more likelythan not to be realized since those segments have at least 10 years in which togenerate the estimated required taxable income. Approximately $1,500 of futuretaxable income is estimated to be required to realize these deferred taxassets.

 

Historically, pre-taxearnings for financial reporting purposes have exceeded the amount of taxableincome reported for income tax purposes. This has primarily occurred due to theacceleration of depreciation deductions for income tax reporting purposes.

 

**Regulatory Matters**

 

As discussed more fully inthe Regulatory Matters sectionabove, the CPUC issued a final decision which will phase down our annual CHCFinterim draw by approximately $2,040 annually, over a 5-year period ending onJanuary 1, 2012.  In addition,SureWest Telephone’s intrastate access element, the transport interconnectioncharge (“TIC”), will be eliminated effective January 1, 2011 in accordancewith previous CPUC final decisions.  We anticipate a reduction in our 2011intrastate access revenues of up to approximately $2,150 when the TIC iseliminated. SureWest Telephone will have an opportunity to recover all or partof the lost TIC revenue elsewhere, including residential rate adjustments.

 

**CriticalAccounting Estimates**

 

Our condensed consolidatedfinancial statements and accompanying notes are prepared in accordance withGAAP. Preparing financial statements requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenue,and expenses. These estimates and assumptions are affected by management’sapplication of accounting policies. Our judgments are based on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the basis for makingestimates about the carrying values of assets and liabilities that are notreadily apparent from other sources. For a full discussion of our accountingestimates and assumptions that we have identified as critical in thepreparation of our condensed consolidated financial statements, refer to our2009 Annual Report on Form 10-K.

 

Asdiscussed more fully in Note 1 of the condensed consolidated financialstatements, in accordance with FASB Accounting Standards Codification (“ASC”)Topic 350, *Intangibles-Goodwill and Other*(“ASCTopic 350”) (formerly SFAS No. 142, *Goodwilland other Intangible Assets*)*,*goodwill is reviewed for impairment annually or more frequently if an eventoccurs or circumstances change that would reduce the fair value below itscarrying value. As a result of recent declines in the market price of theCompany’s common stock, at June 30, 2010 we concluded that this was anindicator of potential impairment of goodwill and performed an interim goodwillimpairment test.

 

Theimpairment test for goodwill requires us to estimate the fair value at thereporting unit level. Our goodwill is allocated goodwill to the Telephonereporting unit and the Kansas City operations reporting unit. The Telecomsegment includes the Telephone reporting unit. The Broadband segment includes the Kansas City operations reportingunit. At June 30, 2010 the goodwill allocated to the Telephone reportingunit and the Kansas City operations reporting unit was $2,171 and $43,643,respectively. The June 30, 2010 interim goodwill impairment test was onlyperformed on the goodwill recorded at the Kansas City operations reportingunit. At November 30, 2009 the Telephone reporting unit’s fair value was$102,000 and the associated carrying value was $(39,065).

 

Forthe Kansas City operations reporting unit, the estimated fair value of thereporting unit is determined using a combination of a discounted cash flow (“DCF”)model and a market based approach. The assumptions used in the estimate of fairvalue are based upon a combination of historical results and trends, newindustry developments, future cash flow projections, as well as relevantcomparable company earnings multiples for the market based approach. Suchassumptions are subject to change as a result of changing economic andcompetitive conditions.  We use a

 

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weightedaverage of the various models to estimate the fair value of the Kansas Cityoperating reporting unit.  At June 30,2010, we performed a valuation to determine the fair value of our goodwillusing a DCF model. Assumptions used in this model include the following:

 

·      cash flow assumptions regarding investment innetwork facilities, distribution channels and customer base (the assumptionsunderlying these inputs are based upon a combination of historical results andtrends, new industry developments and the Company’s business plans);

·      a 14% weighted average cost of capital based onindustry weighted averaged cost of capital; and

·      a 4% terminal growth rate.

 

Thecarrying value of the goodwill allocated to the Kansas City operationsreporting unit was $43,643 as of June 30, 2010.  When determining the fair value, the use ofdifferent estimates or assumptions within the DCF model or other market basedapproaches could result in a different fair value. For example, in our DCFmodel we used a discount rate of 14% and a terminal growth rate of 4% in ourassessment of fair value in 2010.  At June 30,2010 the fair value of the Kansas City operating unit was $225,000 and theassociated carrying value was $200,000. If the discount rate in our DCF modelwere to increase 2%, the fair value of $225,000 would decrease by approximately$19,000, which would not result in an impairment of goodwill recorded at theKansas City operations reporting unit, assuming there are no changes to themarket-based approaches used in the valuation. Assuming the discount rate inour DCF model was to increase 2% and the market-based valuation approachesdecreased by 5%, the fair value of $225,000 would decrease by approximately$25,000, and would equal the June 30, 2010 carrying value. As discussedabove, the other market-based approaches are subject to change as a result ofchanging economic and competitive conditions. Negative changes relating to theKansas City operations could result in a potential impairment of goodwillrecorded at the Kansas City operations reporting unit.

 

**RecentAccounting Pronouncements**

 

**Recently Issued Accounting Pronouncements**

 

In October 2009, theFinancial Accounting Standards Board (“FASB”) issued Accounting StandardsUpdate (“ASU”) No. 2009-13, *Revenue Recognition (Topic605): Multiple-Deliverable Revenue Arrangements—a consensus of the FASBEmerging Issues Task Force*(“ASU 2009-13”).  ASU 2009-13 addresses the accounting formultiple-deliverable arrangements to enable vendors to account for products orservices separately rather than as a combined unit and modifies the manner inwhich the transaction consideration is allocated across the separatelyidentified deliverables.  ASU 2009-13significantly expands the disclosure requirements for multiple-deliverablerevenue arrangements.  ASU 2009-13 willbe effective for the first annual reporting period beginning on or after June 15,2010, and may be applied retrospectively for all periods presented orprospectively to arrangements entered into or materially modified after theadoption date.  Early adoption ispermitted, provided that the guidance is retroactively applied to the beginningof the year of adoption. We are currently evaluating the impact this updatewill have on our condensed consolidated financial statements.

 

**Recently Adopted Accounting Pronouncements**

 

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

 

In January 2010, theFASB issued ASU No. 2010-06, *Fair Value Measurementsand Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements*(“ASU 2010-06”).  ASU 2010-06 amends ASCTopic 820, *Fair Value Measurements and Disclosures*(“ASC820”) to require additional disclosures regarding fair value measurements.Specifically, ASU 2010-06 requires entities to disclose additional informationregarding (i) the reconciliation of recurring Level 3 measurements aboutpurchases, sales, issuances and settlements on a gross basis, (ii) theamounts of significant transfers between Level 1 and Level 2 of the fair valuehierarchy and the reasons for these transfers and (iii) the reasons forany transfers in or out of Level 3. In addition to these new disclosurerequirements, ASU 2010-06 also amends ASC 820 to further clarify existingguidance pertaining to the level of disaggregation at which fair valuedisclosures should be made and the requirements to disclose information aboutthe valuation techniques and inputs used in estimating Level 2 and Level 3 fairvalue measurements. Our adoption of the

 

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requirements of thisguidance on January 1, 2010, except for the requirement to separatelydisclose information about purchases, sales, issuances, and settlements in thereconciliation of recurring Level 3 measurements on a gross basis which becomeseffective for fiscal years (and interim periods within those fiscal years)beginning after December 15, 2010, did not have a material impact on ourcondensed consolidated financial position or results of operations.

 

**Regulatory and Legal Matters**

 

Significant portions of ourtelecommunication rates and charges are subject to regulation by the FCC andstate commissions.  Many of these ratesand charges are based on various tariffs or service guides filed by SureWestand others, including those filed by the NECA for CL charges.  Pending and future regulatory actions, withrespect to these and other matters and the filing of new or amended tariffs,may have a material impact on our consolidated financial position and resultsof operations.  In addition, theemergence of a range of products and services that operate partially orentirely outside traditional regulatory frameworks but that compete withregulated service offerings has created new challenges for both us and theregulators.

 

Our consolidated financialcondition and results of operations have been and will be affected by recentand future proceedings before the state commissions and FCC. Pending before theFCC and state commissions are proceedings that, among other things, areconsidering:

 

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

·                              the nature andextent of the compensation, if any, to be paid by carriers and other providersto one another for network use, and the sums to be recovered through end usersand other sources;

·                              the goals anddefinition of universal telephone service in a changing environment, includingexamination of subsidy support mechanisms for subscribers of different carriers(including incumbent carriers) and in various geographic areas;

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

·                              the regulatedrates and earnings of SureWest Telephone.

 

There are a number ofpending and anticipated other regulatory proceedings occurring at the federaland state levels that may have a material impact on SureWest Telephone and alsoon subsidiaries in the Broadband segment. These regulatory proceedings also includenewer issues, such as consideration of broadband deployment and regulation ofIP-enabled services. The outcomes and impact of these proceedings and relatedcourt matters on the Telecom segment, the Broadband segment and the Company asa whole cannot be determined at this time.

 

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

 

Our 2009 Annual Report on Form 10-Kcontains certain disclosures about our limited exposure to market risk forchanges in interest rates.  There have been no material changes to theinformation provided which would require additional disclosures as of the dateof this filing.

 

**ITEM 4.  CONTROLS ANDPROCEDURES.**

 

**Evaluation of disclosure controlsand procedures**

 

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

 

OnMay 25, 2010, we announced a plan to reduce our workforce by approximately60 positions, which included seven open and unfilled positions. The affectedpositions were comprised of a range of levels across the Company, includingmanagement.  The responsibilities of theaffected employees were assumed by remaining employees and management, asdeemed necessary.  In addition, on May 28,2010, we announced that Bill M. DeMuth, Senior Vice President and ChiefTechnology Officer would be leaving the Company on June 30, 2010 pursuantto a Severance Agreement.  Based on ourinterim control testing and management’s continual assessment of our internalcontrol environment to date, it appears that the changes to our employee baseand management team have not adversely impacted our internal controls orcontrol environment, however we will continue to monitor our internal controlsfor any adverse impacts.

 

Therehas been no change in our internal control over financial reporting during thequarter and six-month period ended June 30, 2010 that has materiallyaffected, or is reasonably likely to materially affect, our control overfinancial reporting.  However, beginningin the second quarter of 2010, we commenced certain strategic projects to moveour cash management services from our existing financial institutions to twonew financial institutions. The movement of these services will likely becompleted in the third quarter of 2010. As part of these projects, management will be evaluating our internalcontrols over financial reporting after the completion of all of the cashmanagement changes.

 

**Limitations on the effectivenessof controls**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting. Our internal control system was designed toprovide reasonable assurance to our management, Board of Directors and AuditCommittee regarding the reliability of financial reporting and the preparationof published financial statements in accordance with generally acceptedaccounting principles.

 

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**PART II —OTHER INFORMATION**

 

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

 

Refer to Notes 5 and 9 toour condensed consolidated financial statements of the Quarterly Report on Form 10-Qfor a discussion of recent developments related to our regulatory and legalproceedings.

 

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

 
| **Period**                                | ** ** | **(a) Total Number  of Shares  Purchased** | ** ** | **(b) Average  Price Paid  per Share** | ** ** | **(c) Total Number of**

**Shares Purchased as  Part of Publicly  Announced Plan** | ** ** | **(d) Shares  Available for  Repurchase under  the Plan** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| April 1,  2010 - April 30, 2010 |       | —                                          |       | $                                           | —     |                                                                                         | 1,888,767  |                                                           | 611,233    |   |
| May 1,  2010 - May 31, 2010     |       | 149,474                                         |       | $                                           | 7.65       |                                                                                         | 2,038,241  |                                                           | 461,759    |   |
| June 1,  2010 - June 30, 2010   |       | 208,622                                         |       | $                                           | 6.59       |                                                                                         | 2,246,863  |                                                           | 253,137    |   |

 

**ITEM 6.  EXHIBITS.**

 

(a)          Index toExhibits.

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                   | ** ** | **Method  of Filing** |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|
| 10.1             |       | Severance  Agreement dated June 22, 2010 between SureWest Communications and Bill  DeMuth                                                                                                    |       | Filed herewith        |
|             |       |                                                                                                                                                                                              |       |                  |
| 31.1             |       | Certification  of Steven C. Oldham, President and Chief Executive Officer, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                             |       | Filed herewith        |
|             |       |                                                                                                                                                                                              |       |                  |
| 31.2             |       | Certification  of Dan T. Bessey, Vice President and Chief Financial Officer, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                           |       | Filed herewith        |
|             |       |                                                                                                                                                                                              |       |                  |
| 32.1             |       | Certification  of Steven C. Oldham, President and Chief Executive Officer, pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002   |       | Filed herewith        |
|             |       |                                                                                                                                                                                              |       |                  |
| 32.2             |       | Certification  of Dan T. Bessey, Vice President and Chief Financial Officer, pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |       | Filed herewith        |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

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

 

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