**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**

 

[X]          QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterlyperiod ended June 30, 2006

or

[   ]          TRANSITION REPORT PURSUANT TO SECTION 13 or15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

Commission FileNumber 0-556

**SUREWEST COMMUNICATIONS**

(Exact name ofregistrant as specified in its charter)
|                          California                          |             68-0365195                                                                    |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (State or other  jurisdiction  of incorporation or organization)                                                                                                                                                                                                                                                       | (IRS Employer  Identification No.)                                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                   |                                                                                                                                                                                                              |
| 200 Vernon  Street, Roseville, California                                                                                                                                                                                                                                                                              |                  95678                  |
| (Address of  principal executive offices)                                                                                                                                                                                                                                                                              | (Zip Code)                                                                                                                                                                                                        |

 

(916) 786-6141(Registrant’s telephone number, including area code)

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

Yes  X         No      

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

 

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

Yes            No  X

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

As of July 28, 2006,14,629,424 shares of the registrant’s Common Stock were outstanding.

 

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**TABLE OF CONTENTS**
|                                     | ** ** | ** **                                                                                  | ** ** | Page   |
|-------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|--------|
| **PART  I - FINANCIAL INFORMATION** |       |                                                                                        |
|                                |       |                                                                                        |
| Item 1.                             |       | Financial Statements                                                                        |       | 3      |
|                                |       |                                                                                        |       |   |
| Item 2.                             |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 17     |
|                                |       |                                                                                        |       |   |
| Item 3.                             |       | Quantitative  and Qualitative Disclosures About Market Risk                                 |       | 35     |
|                                |       |                                                                                        |       |   |
| Item 4.                             |       | Controls And  Procedures                                                                    |       | 36     |
|                                |       |                                                                                        |       |   |
| **PART  II - OTHER INFORMATION**    |       |                                                                                        |
|                                |       |                                                                                        |
| Item 1.                             |       | Legal  Proceedings                                                                          |       | 37     |
|                                |       |                                                                                        |       |   |
| Item 1A.                            |       | Risk Factors                                                                                |       | 39     |
|                                |       |                                                                                        |       |   |
| Item 2.                             |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       | 39     |
|                                |       |                                                                                        |       |   |
| Item 3.                             |       | Defaults Upon  Senior Securities                                                            |       | 39     |
|                                |       |                                                                                        |       |   |
| Item 4.                             |       | Submission of  Matters to a Vote of Security Holders                                        |       | 39     |
|                                |       |                                                                                        |       |   |
| Item 5.                             |       | Other Information                                                                           |       | 39     |
|                                |       |                                                                                        |       |   |
| Item  6.                            |       | Exhibits                                                                                    |       | 40     |
|                                |       |                                                                                        |       |   |
| **SIGNATURES**                      |       |                                                                                        |
|                                     |            |                                                                                             |            |        |  |

 

2

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**PART I — FINANCIALINFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS.**

**SUREWESTCOMMUNICATIONSCONDENSED CONSOLIDATED STATEMENTS OF INCOME***(Unaudited; Amounts in thousands, except per share amounts)*
| ** **                                                                  | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                                  | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Operating revenues:                                                         |       |                                      |       |                                              |       |   |   |   |   |
| Telecom                                                                     |       | $                                         | 32,189     |                                              | $          | 34,058 |   | $ | 64,077 |   | $ | 67,421 |   |
| Broadband                                                                   |       | 15,024                                    |       | 12,105                                            |       | 28,906 |   | 23,701 |   |
| Wireless                                                                    |       | 8,355                                     |       | 8,543                                             |       | 16,956 |   | 16,932 |   |
| Total operating  revenues                                                   |       | 55,568                                    |       | 54,706                                            |       | 109,939 |   | 108,054 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Operating expenses:                                                         |       |                                      |       |                                              |       |   |   |   |   |
| Cost of services  and products (exclusive of depreciation and amortization) |       | 18,791                                    |       | 18,577                                            |       | 37,919 |   | 38,401 |   |
| Customer  operations and selling                                            |       | 8,765                                     |       | 8,771                                             |       | 17,899 |   | 17,447 |   |
| General and  administrative                                                 |       | 8,817                                     |       | 9,075                                             |       | 16,836 |   | 18,641 |   |
| Depreciation and  amortization                                              |       | 15,021                                    |       | 13,386                                            |       | 29,499 |   | 26,099 |   |
| Total operating  expenses                                                   |       | 51,394                                    |       | 49,809                                            |       | 102,153 |   | 100,588 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Income from operations                                                      |       | 4,174                                     |       | 4,897                                             |       | 7,786 |   | 7,466 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Other income (expense):                                                     |       |                                      |       |                                              |       |   |   |   |   |
| Interest income                                                             |       | 110                                       |       | 92                                                |       | 180 |   | 139 |   |
| Interest expense                                                            |       | (1,715                                    | )          | (1,422                                            | )          | (3,308 | ) | (2,624 | ) |
| Other, net                                                                  |       | (271                                      | )          | (47                                               | )          | (379 | ) | (79 | ) |
| Total other  income (expense), net                                          |       | (1,876                                    | )          | (1,377                                            | )          | (3,507 | ) | (2,564 | ) |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Income before income  taxes                                                 |       | 2,298                                     |       | 3,520                                             |       | 4,279 |   | 4,902 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Income tax expense                                                          |       | 894                                       |       | 1,373                                             |       | 1,676 |   | 1,912 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Net income                                                                  |       | $                                         | 1,404      |                                              | $          | 2,147 |   | $ | 2,603 |   | $ | 2,990 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Earnings per share:                                                         |       |                                      |       |                                              |       |   |   |   |   |
| Basic                                                                       |       | $                                         | 0.10       |                                              | $          | 0.15 |   | $ | 0.18 |   | $ | 0.21 |   |
| Diluted                                                                     |       | $                                         | 0.10       |                                              | $          | 0.15 |   | $ | 0.18 |   | $ | 0.20 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Dividends per share                                                         |       | $                                         | 0.25       |                                              | $          | 0.25 |   | $ | 0.50 |   | $ | 0.50 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Shares of common stock  used to calculate earnings per share:               |       |                                      |       |                                              |       |   |   |   |   |
| Basic                                                                       |       | 14,578                                    |       | 14,543                                            |       | 14,578 |   | 14,543 |   |
| Diluted                                                                     |       | 14,690                                    |       | 14,643                                            |       | 14,692 |   | 14,611 |   |

 

See accompanyingnotes.

3

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**SUREWESTCOMMUNICATIONSCONDENSED CONSOLIDATED BALANCE SHEETS***(Unaudited; Amounts in thousands)*
| ** **                                                                                                                                                         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                         | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                    |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                          |       | $                 | 17,067     |                  | $          | 7,633 |   |
| Short-term investments                                                                                                                                             |       | 602               |       | 617                   |       |
| Accounts receivable, net                                                                                                                                           |       | 20,570            |       | 23,234                |       |
| Income taxes receivable                                                                                                                                            |       | 222               |       | —                |       |
| Inventories                                                                                                                                                        |       | 5,862             |       | 5,626                 |       |
| Deferred directory costs                                                                                                                                           |       | 4,057             |       | 5,130                 |       |
| Prepaid expenses                                                                                                                                                   |       | 4,329             |       | 3,918                 |       |
| Deferred income taxes                                                                                                                                              |       | 18,094            |       | 14,502                |       |
| Total current  assets                                                                                                                                              |       | 70,803            |       | 60,660                |       |
|                                                                                                                                                               |       |              |       |                  |       |
| Property, plant  and equipment, net                                                                                                                                |       | 375,966           |       | 381,075               |       |
|                                                                                                                                                               |       |              |       |                  |       |
| Intangible and  other assets:                                                                                                                                      |       |              |       |                  |       |
| Wireless licenses, net                                                                                                                                             |       | 13,566            |       | 13,566                |       |
| Goodwill                                                                                                                                                           |       | 2,171             |       | 2,171                 |       |
| Intangible asset relating to pension plans                                                                                                                         |       | 456               |       | 456                   |       |
| Intangible asset relating to favorable operating  leases, net                                                                                                      |       | 351               |       | 393                   |       |
| Deferred charges and other assets                                                                                                                                  |       | 1,007             |       | 708                   |       |
|                                                                                                                                                               |       | 17,551            |       | 17,294                |       |
|                                                                                                                                                               |       | $                 | 464,320    |                  | $          | 459,029 |   |
| ** **                                                                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                     | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current  liabilities:                                                                                                                                              |       |              |       |                  |       |
| Short-term borrowings                                                                                                                                              |       | $                 | —     |                  | $          | 30,000 |   |
| Current portion of long-term debt and capital lease  obligations                                                                                                   |       | 3,648             |       | 3,669                 |       |
| Accounts payable                                                                                                                                                   |       | 1,562             |       | 3,634                 |       |
| Other accrued liabilities                                                                                                                                          |       | 18,421            |       | 20,496                |       |
| Current portion of contractual shareable earnings  obligations                                                                                                     |       | 2,324             |       | 2,932                 |       |
| Estimated shareable earnings obligations                                                                                                                           |       | 293               |       | 293                   |       |
| Advance billings and deferred revenues                                                                                                                             |       | 10,103            |       | 9,730                 |       |
| Accrued income taxes                                                                                                                                               |       | —            |       | 1,015                 |       |
| Accrued pension benefits                                                                                                                                           |       | 8,250             |       | 7,615                 |       |
| Accrued compensation                                                                                                                                               |       | 6,472             |       | 5,772                 |       |
| Total current  liabilities                                                                                                                                         |       | 51,073            |       | 85,156                |       |
|                                                                                                                                                               |       |              |       |                  |       |
| Long-term debt  and capital lease obligations                                                                                                                      |       | 125,471           |       | 85,473                |       |
| Long-term  contractual shareable earnings obligations                                                                                                              |       | 2,777             |       | 3,695                 |       |
| Deferred income  taxes                                                                                                                                             |       | 44,011            |       | 40,398                |       |
| Other  liabilities and deferred revenues                                                                                                                           |       | 13,407            |       | 12,556                |       |
|                                                                                                                                                               |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                                                     |       |              |       |                  |       |
|                                                                                                                                                               |       |              |       |                  |       |
| Shareholders’  equity:                                                                                                                                        |       |              |       |                  |       |
| Common stock, without par value; 100,000 shares  authorized, 14,628 and 14,629 shares issued and outstanding at June 30, 2006 and  December 31, 2005, respectively |       | 162,891           |       | 164,598               |       |
| Deferred stock-based compensation                                                                                                                                  |       | —            |       | (2,255                | )          |
| Accumulated other comprehensive loss                                                                                                                               |       | (4,885            | )          | (4,909                | )          |
| Retained earnings                                                                                                                                                  |       | 69,575            |       | 74,317                |       |
| Total  shareholders’ equity                                                                                                                                   |       | 227,581           |       | 231,751               |       |
|                                                                                                                                                               |       | $                 | 464,320    |                  | $          | 459,029 |   |

 

See accompanyingnotes.

4

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**SUREWESTCOMMUNICATIONSCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS***(Unaudited; Amounts in thousands)*
| ** **                                                          | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
|                                                                |       |                                          |       |   |   |
| Net cash  provided by operating activities                          |       | $                                             | 31,426     |   | $ | 24,082 |   |
|                                                                |       |                                          |       |   |   |
| Cash flows from  investing activities:                              |       |                                          |       |   |   |
| Capital expenditures for property, plant and  equipment             |       | (24,654                                       | )          | (36,874 | ) |
| Net cash used in investing activities                               |       | (24,654                                       | )          | (36,874 | ) |
|                                                                |       |                                          |       |   |   |
| Cash flows from  financing activities:                              |       |                                          |       |   |   |
| Proceeds from issuance of long-term debt                            |       | 40,000                                        |       | — |   |
| Increase (decrease) in short-term borrowings                        |       | (30,000                                       | )          | 10,000 |   |
| Principal payments of long-term debt and capital  lease obligations |       | (24                                           | )          | (234 | ) |
| Dividends paid                                                      |       | (7,315                                        | )          | (7,295 | ) |
| Other, net                                                          |       | 1                                             |       | (3 | ) |
| Net cash provided by financing activities                           |       | 2,662                                         |       | 2,468 |   |
|                                                                |       |                                          |       |   |   |
| Increase  (decrease) in cash and cash equivalents                   |       | 9,434                                         |       | (10,324 | ) |
|                                                                |       |                                          |       |   |   |
| Cash and cash  equivalents at beginning of period                   |       | 7,633                                         |       | 18,119 |   |
|                                                                |       |                                          |       |   |   |
| Cash and cash  equivalents at end of period                         |       | $                                             | 17,067     |   | $ | 7,795 |   |

 

See accompanyingnotes.

5

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**SUREWESTCOMMUNICATIONSNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS***(Unaudited; Amounts in thousands, except share and per shareamounts)*

**1.****  ****SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

**Business and Basisof Accounting**

SureWestCommunications (the “Company”) is a holding company with wholly-ownedsubsidiaries that provide integrated communications services in NorthernCalifornia. The Company’s principal operating subsidiary is SureWest Telephone.SureWest Directories, SureWest Long Distance, SureWest Wireless, SureWestBroadband, SureWest TeleVideo and SureWest TeleVideo of Roseville (collectivelyreferred to as “SureWest Broadband/Residential Services”), SureWest Internetand SureWest Custom Data Services are each subsidiaries of the Company. The Companyexpects that the sources of its revenues and its cost structure may bedifferent in future periods, both as a result of its entry into newcommunications markets and competitive forces in each of the markets in whichthe Company has operations.

In the opinion ofmanagement, the accompanying condensed consolidated balance sheets and relatedinterim statements of income 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”) for interim financial information and pursuant tothe rules and regulations of the Securities and Exchange Commission (the “SEC”).Certain information and footnote disclosures normally included in annualfinancial statements prepared in accordance with U.S. GAAP have been condensedor omitted pursuant to such SEC rules and regulations and accounting principlesapplicable for interim periods. Management believes that the disclosures madeare adequate to make the information presented not misleading. These condensedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto included in the Company’s2005 Annual Report on Form 10-K filed with the SEC.

**Stock-based Compensation**

***Stock Plans***

TheCompany has two Equity Incentive Plans (the “Plans”) for certain employees,outside directors and consultants of the Company, which were approved byshareholders.  The Company authorized forfuture issuance under the Plans approximately 1.6 million shares (subject toupward adjustment based upon the Company’s issued and outstanding shares) ofauthorized, but unissued, common stock. The Plans permit issuance by the Company of awards in the form ofrestricted common stock (“RSAs”), restricted common stock units (“RSUs”),performance shares, stock options and stock appreciation rights. The exerciseprice per share of the Company’s common stock to be purchased under anyincentive stock option shall not be less than 100% of the fair market value ofa share of the Company’s common stock on the date of the grant, and theexercise price under a non-qualified stock option shall not be less than 85% ofthe fair market value of the Company’s common stock at the date of the grant.The term of any stock option shall not exceed 10 years.

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

Effective January1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 123(R), *Share-Based Payment*,using the modified-prospective-transition method.  Since the fair value recognition provisionsof SFAS No. 123, *Accounting for Stock-BasedCompensation* and SFAS No. 123(R) were materially consistent underthe Company’s Plans, the adoption of SFAS No. 123(R) did not have a significantimpact on the Company’s financial position or results of operations.  The Company has not made any stock optiongrants since 2003 and consequently the compensation expense resulting fromstock option grants prior to 2003 was either fully expensed as of January 1,2006, or not material to the Company’s financial statements.

6

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**1.****  ****SUMMARY OF SIGNIFICANTACCOUNTING POLICIES (continued)**

Prior to January1, 2006, the Company accounted for the Plans under the fair value recognitionprovisions of SFAS No. 123.  Under theprovisions of SFAS No. 148, *Accounting forStock-Based Compensation — Transition and Disclosure*, the fair valuemethod of accounting was applied to all employee awards granted, modified, orsettled after January 1, 2003.

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

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

The following tablesummarizes the RSAs and RSUs granted to certain eligible participants duringthe quarter and six-month periods ended June 30, 2006 and 2005:
| ** **    | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** **     |
|---------------|------------|-------------------------------------------|------------|---------------------------------------------------|----------------|
| ** **    | ** ** | **2006**                                  | ** ** | **Grant Date  Fair Value**              | ** **     | **2005** | ** ** | **Grant Date  Fair Value** | ** ** | **2006** | ** ** | **Grant Date  Fair Value** | ** ** | **2005** | ** ** | **Grant Date  Fair Value** | ** ** |
|          |       |                                      |       |                                              |           |   |   |   |   |   |   |   |   |   |   |   |   |
| RSAs          |       | —                                    |       | —                                            |           | — |   | — |   | 3,000 |   | $27.63 |   | — |   | — |   |
| RSUs Granted  |       | 5,000                                     |       | $22.54                                            |           | 7,225 |   | $23.08 |   | 6,500 |   | $ | 22.54 - $27.63 |   | 52,249 |   | $ | 22.43 -$28.35 |   |
| RSU Dividends |       | 101                                       |       | $                                                 | 18.75 - $19.62 |   | — |   | — |   | 101 |   | $ | 18.75 - $19.62 |   | — |   | — |   |
| Total         |       | 5,101                                     |       |                                              |           | 7,225 |   |   |   | 9,601 |   |   |   | 52,249 |   |   |   |
|               |            |                                           |            |                                                   |                |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Stock-basedcompensation expense for both RSAs and RSUs of $259 and $548 was recordedduring the quarter and six-month period ended June 30, 2006, respectively.  During the same prior year periods theCompany recorded stock based compensation expense of $424 and $712,respectively.  RSAs and RSUs areamortized over their respective vesting periods, which range from immediatevesting to a five-year vesting period. In connection with the adoption of SFAS No. 123(R), the Company recordsstock-based compensation for RSAs and RSUs granted in 2006 on a straight-linebasis.  The Company will continue torecognize stock-based compensation on RSAs and RSUs granted prior to 2006 usingthe graded vesting method.  In accordancewith the provisions of SFAS No. 123(R), the Company has estimated expected forfeituresbased on historical experience and is recognizing compensation expense only forthose RSAs and RSUs expected to vest.  Inaccordance with SFAS No. 123(R), on January 1, 2006 the Company reversed thedeferred stock compensation balance of $2,255 to common stock.

The following table summarizes the restricted commonstock activity during the six-month period ended June 30, 2006:

| Nonvested Shares           | ** ** | **Shares** | ** ** | **Weighted Average  Grant Date Fair Value** | ** ** |   |
|---------------------------------|------------|------------|------------|-----------------------------------------------------------------|------------|--------|
|                            |       |       |       |                                                            |       |   |
| Nonvested—January  1, 2006 |       |       | 128,998    |                                                            |       |   | $ | 29.44 |   |   |
| Granted                         |       |       | 9,601      |                                                            |       |   | 24.89 |   |   |
| Vested                          |       |       | (20,633    | )                                                               |       |   | 24.83 |   |   |
| Forfeited                       |       |       | (7,159     | )                                                               |       |   | 26.29 |   |   |
| Nonvested—June 30, 2006    |       |       | 110,807    |                                                            |       |   | $ | 26.42 |   |   |
|                                 |            |            |            |                                                                 |            |        |  |  |  |  |  |  |

 

As of June 30, 2006, total unrecognized compensation costrelated to nonvested restricted stock was $1,266 and will be recognized over aweighted-average period of approximately three years.  The total fair value of RSAs and RSUs vestedduring the six-month period ended June 30, 2006 was $512.

7

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## **1.  ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)**

***Proforma***

Had the Companyelected to adopt the fair value recognition provisions of SFAS No. 123 as ofits original effective date, pro forma net income and earnings per share for2005 would have been:

|                                                                                                                                       | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                            | ** ** | **2005**                              | ** ** | **2005**                                      | ** ** |
| Net income, as  reported                                                                                                              |       | $                                     | 2,147      |                                          | $          | 2,990 |   |
|                                                                                                                                  |       |                                  |       |                                          |       |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                          |       | 261                                   |       | 440                                           |       |
|                                                                                                                                  |       |                                  |       |                                          |       |
| Deduct:  Stock-based employee compensation expense determined using the fair value  method for all awards, net of related tax effects |       | (270                                  | )          | (470                                          | )          |
|                                                                                                                                  |       |                                  |       |                                          |       |
| Pro forma net  income                                                                                                                 |       | $                                     | 2,138      |                                          | $          | 2,960 |   |
|                                                                                                                                  |       |                                  |       |                                          |       |
| Earnings per  share:                                                                                                                  |       |                                  |       |                                          |       |
| Basic—as reported                                                                                                                |       | $                                     | 0.15       |                                          | $          | 0.21 |   |
| Basic—pro forma                                                                                                                  |       | $                                     | 0.15       |                                          | $          | 0.20 |   |
|                                                                                                                                  |       |                                  |       |                                          |       |
| Diluted—as reported                                                                                                              |       | $                                     | 0.15       |                                          | $          | 0.20 |   |
| Diluted—pro  forma                                                                                                               |       | $                                     | 0.15       |                                          | $          | 0.20 |   |

 

***Stock Options Expense***

The Company issuesnew shares of common stock upon exercise of stock options.  The following table summarizes stock optionactivity for the Company’s stock option plans for the six-month period endedJune 30, 2006:

| Options                                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** |
|----------------------------------------------|------------|------------|------------|----------------------------------------|------------|---------------------------------------------------------|------------|
|                                         |       |       |       |                                   |       |                                                    |       |
| Outstanding—January  1, 2006            |       | 622,313    |       | $                                      | 40.65      |                                                    |       |   |
| Forfeited                                    |       | (195,199   | )          | —                                 |       |                                                    |       |
| Outstanding—June  30, 2006              |       | 427,114    |       | $                                      | 40.22      |                                                    | 5          |   |
|                                         |       |       |       |                                   |       |                                                    |       |
| Vested or  Expected to Vest at June 30, 2006 |       | 427,114    |       | $                                      | 40.22      |                                                    | 5          |   |
| Exercisable at June 30,  2006                |       | 424,515    |       | $                                      | 40.22      |                                                    | 5          |   |

 

There were no stock options granted, exercised orexpired during the six-month period ended June 30, 2006.  In addition, there were no stock options withan exercise price below the market price of the Company’s stock at that date.

8

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

**PerShare Amounts**

Sharesused in the computation of basic earnings per share are based on the weightedaverage number of unrestricted common stock shares, RSAs and RSUs outstanding,excluding unvested RSAs and unvested RSUs. Shares used in the computation ofdiluted earnings per share are based on the weighted average number ofunrestricted common stock shares, RSAs and RSUs outstanding, along with otherpotentially dilutive securities outstanding in each period.

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

**OtherComprehensive Income (Loss)**

As of June 30,2006 and 2005 the accumulated other comprehensive loss was $4,885 and $2,126,respectively, which consisted of minimum pension and post-retirement liabilityadjustments, net of tax, offset in part by unrealized gain on investment, netof tax.  The following table reconcilesnet income to comprehensive income for the quarter and six month periods endedJune 30, 2006 and 2005:

|                                                   | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                  | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Net  Income**                                   |       | $                                         | 1,404      |                                              | $          | 2,147 |   | $ | 2,603 |   | $ | 2,990 |   |
| Unrealized gain  (loss) on investment, net of tax |       | (6                                        | )          | —                                            |       | 23 |   | — |   |
| **Comprehensive Income**                          |       | $                                         | 1,398      |                                              | $          | 2,147 |   | $ | 2,626 |   | $ | 2,990 |   |

 

**Reclassifications**

Certainamounts in the Company’s 2005 condensed consolidated financial statements havebeen reclassified to conform to the presentation of the Company’s 2006condensed consolidated financial statements.

**2.   BUSINESS SEGMENTS**

TheCompany has three reportable business segments: Telecom, Broadband andWireless. The Telecom segment includes SureWest Telephone, SureWest Directoriesand SureWest Long Distance, which provide landline telecommunications services,directory advertising, Digital Subscriber Line (“DSL”) service, long distanceservices and certain non-regulated services. SureWest Telephone, which is theprincipal operating subsidiary of the Telecom segment, provides local services,toll telephone services, network access services and certain non-regulatedservices. SureWest Directories publishes and distributes SureWest Telephone’sdirectory, including the sale of yellow pages advertising. SureWestDirectories is also engaged in the business of producing, publishing anddistributing directories in other Northern California communities outside ofSureWest Telephone’s service area. SureWest Long Distance provides longdistance services.

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

9

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**2.   BUSINESSSEGMENTS (continued)**

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

In accordance withthe provisions of SFAS No. 131, *DisclosureAbout Segments of an Enterprise and Related Information*, the Companyhas aggregated certain of its operating segments within the Telecom andBroadband segments because it believes that such operating segments sharesimilar economic characteristics.

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

Thesesegments are strategic business units that offer different products andservices. The Company accounts for intersegment revenues and expenses atprevailing market rates. The Company’s business segment information is asfollows:
| ** **                                     | ** ** | **Telecom** | ** ** | **Broadband** | ** ** | **Wireless** | ** ** | **Corporate  Operations** | ** ** | **Intercompany  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|---------------------------|------------|--------------------------------|------------|------------------|------------|
| **For the  three months ended June 30, 2006:** |       |        |       |          |       |         |       |                      |       |                           |       |             |       |
| Operating  revenues from external customers    |       | $           | 32,189     |          | $          | 15,024       |       | $                         | 8,355      |                           | $          | —           |       | $ | — |   | $ | 55,568 |   |
| Intersegment  revenues                         |       | 7,450       |       | 312           |       | 695          |       | —                    |       | (8,457                         | )          | —           |       |
| Operating  expenses*                           |       | 18,719      |       | 16,327        |       | 9,784        |       | —                    |       | (8,457                         | )          | 36,373           |       |
| Depreciation and  amortization                 |       | 6,323       |       | 5,721         |       | 2,977        |       | —                    |       | —                         |       | 15,021           |       |
| Income (loss)  from operations                 |       | 14,597      |       | (6,712        | )          | (3,711       | )          | —                    |       | —                         |       | 4,174            |       |
| Net income  (loss)                             |       | $           | 8,599      |          | $          | (4,777       | )          | $                         | (2,418     | )                              | $          | —           |       | $ | — |   | $ | 1,404 |   |
|                                           |       |        |       |          |       |         |       |                      |       |                           |       |             |       |
| **For the  three months ended June 30, 2005:** | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** ** | ** **                | ** ** | ** **                     | ** ** | ** **       | ** ** |
| Operating  revenues from external customers    |       | $           | 34,058     |          | $          | 12,105       |       | $                         | 8,543      |                           | $          | —           |       | $ | — |   | $ | 54,706 |   |
| Intersegment  revenues                         |       | 7,489       |       | 399           |       | 643          |       | —                    |       | (8,531                         | )          | —           |       |
| Operating  expenses*                           |       | 20,955      |       | 14,420        |       | 9,579        |       | —                    |       | (8,531                         | )          | 36,423           |       |
| Depreciation and  amortization                 |       | 6,363       |       | 3,997         |       | 3,026        |       | —                    |       | —                         |       | 13,386           |       |
| Income (loss)  from operations                 |       | 14,229      |       | (5,913        | )          | (3,419       | )          | —                    |       | —                         |       | 4,897            |       |
| Net income  (loss)                             |       | $           | 8,306      |          | $          | (3,882       | )          | $                         | (2,277     | )                              | $          | —           |       | $ | — |   | $ | 2,147 |   |

 
| ** **                                             | ** ** | **Telecom** | ** ** | **Broadband** | ** ** | **Wireless** | ** ** | **Corporate  Operations** | ** ** | **Intercompany  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|---------------------------|------------|--------------------------------|------------|------------------|------------|
| **As of  and for the six months ended June 30, 2006:** |       |        |       |          |       |         |       |                      |       |                           |       |             |       |
| Operating  revenues from external customers            |       | $           | 64,077     |          | $          | 28,906       |       | $                         | 16,956     |                           | $          | —           |       | $ | — |   | $ | 109,939 |   |
| Intersegment  revenues                                 |       | 14,778      |       | 736           |       | 1,375        |       | —                    |       | (16,889                        | )          | —           |       |
| Operating  expenses*                                   |       | 37,548      |       | 32,998        |       | 18,997       |       | —                    |       | (16,889                        | )          | 72,654           |       |
| Depreciation and  amortization                         |       | 12,641      |       | 10,918        |       | 5,940        |       | —                    |       | —                         |       | 29,499           |       |
| Income (loss)  from operations                         |       | 28,666      |       | (14,274       | )          | (6,606       | )          | —                    |       | —                         |       | 7,786            |       |
| Net income  (loss)                                     |       | 16,819      |       | (9,866        | )          | (4,350       | )          | —                    |       | —                         |       | 2,603            |       |
| Total assets                                           |       | $           | 700,936    |          | $          | 352,920      |       | $                         | 149,953    |                           | $          | 412,969          |       | $ | (1,152,458 | ) | $ | 464,320 |   |

 

10

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**2.   BUSINESSSEGMENTS (continued)**
| ** **                                             | ** ** | **Telecom** | ** ** | **Broadband** | ** ** | **Wireless** | ** ** | **Corporate  Operations** | ** ** | **Intercompany  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|---------------------------|------------|--------------------------------|------------|------------------|------------|
| **As of  and for the six months ended June 30, 2005:** | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** ** | ** **                | ** ** | ** **                     | ** ** | ** **       | ** ** |
| Operating  revenues from external customers            |       | $           | 67,421     |          | $          | 23,701       |       | $                         | 16,932     |                           | $          | —           |       | $ | — |   | $ | 108,054 |   |
| Intersegment  revenues                                 |       | 14,473      |       | 841           |       | 1,241        |       | —                    |       | (16,555                        | )          | —           |       |
| Operating  expenses*                                   |       | 43,225      |       | 29,150        |       | 18,669       |       | —                    |       | (16,555                        | )          | 74,489           |       |
| Depreciation and  amortization                         |       | 12,358      |       | 7,631         |       | 6,110        |       | —                    |       | —                         |       | 26,099           |       |
| Income (loss)  from operations                         |       | 26,311      |       | (12,239       | )          | (6,606       | )          | —                    |       | —                         |       | 7,466            |       |
| Net income  (loss)                                     |       | 15,379      |       | (7,983        | )          | (4,406       | )          | —                    |       | —                         |       | 2,990            |       |
| Total assets                                           |       | $           | 641,707    |          | $          | 237,443      |       | $                         | 136,959    |                           | $          | 242,951          |       | $ | (820,197 | ) | $ | 438,863 |   |

 

*Exclusive of depreciation and amortization

**3.****   ESTIMATEDSHAREABLE EARNINGS OBLIGATIONS**

Certainof the Company’s rates are subject to regulation by the Federal CommunicationsCommission (“FCC”) and the California Public Utilities Commission (“CPUC”).Pending and future regulatory actions may have a material impact on the Company’sconsolidated financial position and results of operations.

TheFCC monitors SureWest Telephone’s interstate earnings through the use of annualcost separation studies prepared by SureWest Telephone, which utilize estimatedcost information and projected demand usage. The FCC establishesrules that carriers must follow in the preparation of the annual studies.Additionally, under current FCC rules governing rate making, SureWestTelephone is required to establish interstate rates based on projected demandusage for its various services and determine the actual earnings from theserates once actual volumes and costs are known. Based on preliminary coststudies, the Company recognized liabilities relating to SureWest Telephone’s estimatedinterstate shareable earnings obligations of $80 for the six-month period endedJune 30, 2005 through reductions of revenues (none in 2006).

Asa result of periodic cost separation studies, SureWest Telephone changed itsestimates for a portion of its interstate shareable earnings obligations andcertain National Exchange Carrier Association (“NECA”) Carrier Common Line (“CCL”)accounts receivable balances related to prior year monitoring periods.  These changes in estimates increased theCompany’s consolidated revenues by $57 and $757 and net income by $35 (noeffect on earnings per share) and $462 ($0.03 per share), respectively, for thequarters ended March 31 and June 30, 2005. The Company did not record any significant changes in estimates duringthe quarter and six-month period ended June 30, 2006.

TheFCC has a pending rulemaking proceeding to re-examine all regulated forms ofintercarrier compensation and develop a more unified mechanism to govern thepayment flows among telecommunications carriers.  Intercarrier compensation is the regulatedfees that service providers charge each other to carry and terminate traffic.Reform has been suggested due to the changing nature of the industry withincreasing competition from new technologies, such as Internet andInternet-based services and wireless services. Various plans have been submitted to the FCC with divergent approachesto handle intercarrier compensation that may reduce per-minute access and reciprocalcompensation charges and replaces these revenues with a combination ofincreases to the subscriber line charge and revenues obtained from a newrestructure mechanism.  The ultimateresults of this proceeding and the potential effects on SureWest Telephonecannot yet be determined.

11

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

The Company wasinvolved in a proceeding at the CPUC that considered the continued need forcertain sharing requirements in the intrastate jurisdiction and, in connectionwith that review, also considered the issue of whether the Company overearnedin the intrastate jurisdiction in recent monitoring periods and the amount ofoverearnings that should be shared with customers. In July 2004, theCompany entered into a settlement agreement (“the settlement agreement”) withthe other parties in the proceeding, the Division of Ratepayer Advocates (“DRA”),(formerly Office of Ratepayer Advocates), and The Utility Reform Network (“TURN”),to resolve all issues in the proceeding. In November 2004, the CPUCapproved the settlement agreement. The settlement agreement resolved existingintrastate sharing obligations and related earnings issues for the monitoringperiods 2000 through 2004, put into place a surcredit mechanism for the amountof the settlement, and suspended the requirement for any intrastate sharing formonitoring periods from January 1, 2005 through at least December 31, 2010.

In accordance withthe settlement agreement, SureWest Telephone will return approximately $6,500 (“DividendA”), plus interest at the 90-day commercial paper rate for non-financialinstitutions, which was 5.29% as of June 30, 2006, and an imputed rate of3.15%, to its end users through a consumer dividend over a period of fouryears, which began January 1, 2005. In addition, SureWest Telephone will pay aone-time consumer dividend of $2,600, which will be returned to the consumersto settle the monitoring periods 2000 to 2004. The consumer dividend is recorded as a reduction of the Company’scontractual shareable earnings obligations over two years, which began January1, 2005. The consumer dividend includes an annual imputed interest rate of3.15% (no stated contractual interest rate). At June 30, 2006, the aggregate contractual shareable earningsobligation for these surcredits was $5,102 (which is net of an unamortizeddiscount pertaining to imputed interest of $183 at that date).

The followingtable summarizes the amounts returned to end users through consumer dividendsfor the quarters and six-month periods ended June 30, 2006 and 2005:

|                 | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **      | ** ** | **2006**                                  | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Dividend  A** |       | $                                         | 505        |                                              | $          | 424 |   | $ | 1,020 |   | $ | 819 |   |
| **Dividend  B** |       | 295                                       |       | 310                                               |       | 596 |   | 599 |   |
| **Total**       |       | $                                         | 800        |                                              | $          | 734 |   | $ | 1,616 |   | $ | 1,418 |   |

 

Further,commencing January 1, 2007, SureWest Telephone will implement an annualconsumer dividend of $1,300 to end-users receiving SureWest Telephone servicessubject to sharing on or after that date; however, this consumer dividend issubject to reduction based upon the results of other pending regulatoryproceedings.

During the fourthquarter of 2005, the Company filed an Advice Letter with the CPUC proposing anincrease to the consumer dividends in order to return the amounts entitled per thesettlement agreement. The change in the consumer dividends resulted from theincrease in interest rates during 2005. The increase was effectiveJanuary 1, 2006.

Prior to 2000,AT&T Inc. (“AT&T”) (formerly SBC Communications), had been payingSureWest Telephone approximately $11,500 per year for extended area service (“EAS”)pursuant to a Settlement Transition Agreement. In November 2000, the CPUCauthorized AT&T to terminate its annual EAS payments to SureWest Telephoneeffective November 30, 2000. The CPUC authorized replacement funding toSureWest Telephone on an interim basis using funds from the California HighCost Fund (“CHCF”). The CHCF is a program designed by the CPUC to establish afair and equitable local rate structure and to reduce any disparity in therates charged by telephone companies serving high-cost areas. The CHCF isscheduled to expire January 1, 2009. In addition, the CPUC opened an OrderInstituting Investigation (“OII”) for the purpose of determining whether futurerecovery of all, none, or a portion of the approximate $11,500 annual paymentsreceived from the CHCF should come from SureWest Telephone’s ratepayers orother regulatory recovery mechanisms.

12

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

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

In June 2006, theCPUC instituted a rulemaking proceeding to review the CHCF-B program.  The goals of this review include, but are notlimited to, adjusting universal service rate support payments to reflectupdated operating costs, evaluating whether CHCF-B fund support levels can bereduced and made more predictable while still meeting the goals of the program,ensuring it is competitively neutral, reducing rate disparity in residentialbasic service between urban and rural areas in the state, and making thecurrent administration of the program more efficient.  In addition, the CHCF-B rulemaking requests commentson whether SureWest Telephone should continue receiving the $11,500 annuallyfrom the CHCF-B and the advisability and impacts of phasing out the EASpayments gradually over a period of approximately 5 years.  Comments in the CHCF-B rulemaking are dueSeptember 1, 2006 with reply comments due October 16, 2006.  In August 2006, the Company filed a Petitionfor Modification of D.05-08-004, the decision that reviewed SureWest Telephone’srevenue requirement, which seeks CPUC authorization in a graduated phase downof its $11,500 interim draw from the CHCF-B over a period of time that isintended to assure the continued maintenance of good service to SureWestcustomers while avoiding precipitous rate increases.  The Company’s Petition for Modification proposesa transitional phase down over a five to ten year period and requestselimination of the requirement to file its cost proxy model.  The Company expects to recover the eliminatedrevenues through rate increases and/or operating efficiencies.  The results of this proceeding and thepotential effects on SureWest Telephone could impact future funding levelsthrough the CHCF-B.

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

In April 2005, theCPUC opened a rulemaking proceeding to assess and revise the regulation oftelecommunications utilities to develop a uniform regulatory framework (“URF”)to apply to all providers of regulated telecommunications services, exceptsmall Incumbent Local Exchange Carriers(“ILECs”), to the extent that it is feasible and in the public interestto do so.  The assigned administrativelaw judge issued a proposed decision in this proceeding on July 25, 2006, whichwould revise the regulations of telecommunications utilities, such as SureWestTelephone, which are now subject to the NRF. The proposed decision, if adopted,would grant carriers broad pricing freedoms in the provision oftelecommunications services, bundles of services, promotions andcontracts.  The proposed decision would,among other things:  (i) freeze the ratesof basic residential services for two years at the current rates, subject toreview in the CHCF-B review proceeding, (ii) lift price caps on rates for basicresidential services that are not supported by the CHCF-B two years from theeffective date of the decision, (iii) eliminate price regulation for all retailservices except lifeline and basic residential services, (iv) authorize newservices to be provided with full pricing flexibility, (v) allocate all gainsand losses from the sale of land to shareholders and (vi) eliminate price caps,the annual price cap filing, the productivity factor, and all residual elementsof rate of return regulation, including the calculation of shareable earnings.

13

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

On April 27, 2006, the CPUC released a decision in a proceedinginvestigating the continued need for the transport interconnection charge (“TIC”),which is an access charge element.  Anearlier draft decision required all ILECs operating within California toeliminate the TIC element and authorized recovery of lost revenue through endusers, specifically through an increase in their local rate surcharge, and useof the CHCF-A for the small companies. If SureWest Telephone did not recover any lost revenues from end users,the decision could ultimately result in a loss of revenues of up to $4,400, ona prospective basis. The Company sought modification of the draft decision onthe basis that the CPUC had indicated that it was prepared to act only withrespect to larger ILECs, and thus denied SureWest Telephone due process.  In the final decision, the CPUC deferred theelimination of the TIC element for SureWest to the next phase of theproceeding, which began in May 2006.  TheCompany filed testimony in May 2006 supporting that the CPUC should noteliminate the TIC for small and mid-sized ILECs due to an impending federalintercarrier compensation restructure proceeding at the FCC.  The ultimate results of this proceeding andthe potential effects on SureWest Telephone cannot yet be determined.

Asof June 30, 2006, the Company’s consolidated balance sheet reflected aggregateliabilities of $293 relating to SureWest Telephone’s estimated interstateshareable earnings obligations. The calculations supporting these liabilitiesare very complex and involve a variety of estimates prior to the ultimatesettlement of such obligations. In addition, SureWest Telephone’s interstateshareable earnings obligations lapse over time if SureWest Telephone’sinterexchange carrier and other customers do not claim the amounts ascribed tothem. Accordingly, it is reasonably possible that management’s estimates of theCompany’s liabilities for interstate shareable earnings obligations couldchange in the near term, and the amounts involved could be material.

**4.****   PENSION ANDOTHER POST-RETIREMENT BENEFITS**

**Components of Net Periodic Benefit Cost**

Netperiodic pension costs recognized in the condensed consolidated statements ofincome for the quarters ended June 30, 2006 and 2005 under the defined benefitpension plan (“Pension Plan”), Supplemental Executive Retirement Plan (“SERP”)and post-retirement benefits other than pension (“Other Benefits”) included thefollowing components:
| ** **                                         | ** ** | **Pension Plan and SERP** | ** ** | **Other Benefits** | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **2006**                                 | ** ** | **2005**                | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Quarter  Ended June 30,**                        | ** ** | ** **                               | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service  cost-benefits earned during the period    |       | $                                        | 690        |                    | $          | 1,407 |   | $ | 183 |   | $ | 118 |   |
| Interest cost on  projected benefit obligation     |       | 1,753                                    |       | 1,866                   |       | 185 |   | 88 |   |
| Expected return  on plan assets                    |       | (2,150                                   | )          | (2,183                  | )          | (80 | ) | (38 | ) |
| Amortization of  prior service cost                |       | 21                                       |       | 86                      |       | 12 |   | 10 |   |
| Recognized net  actuarial loss                     |       | 166                                      |       | 176                     |       | 12 |   | — |   |
| Expected  disbursement for life insurance premiums |       | —                                   |       | —                  |       | (16 | ) | (19 | ) |
| Net pension cost                                   |       | $                                        | 480        |                    | $          | 1,352 |   | $ | 296 |   | $ | 159 |   |
| ** **                                         | ** ** | ** **                               | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Six  months ended June 30,**                     |       |                                     |       |                    |       |   |   |   |   |
| Service cost-benefits  earned during the period    |       | $                                        | 2,236      |                    | $          | 2,814 |   | $ | 365 |   | $ | 235 |   |
| Interest cost on  projected benefit obligation     |       | 3,793                                    |       | 3,732                   |       | 370 |   | 176 |   |
| Expected return  on plan assets                    |       | (4,315                                   | )          | (4,366                  | )          | (160 | ) | (76 | ) |
| Amortization of  prior service cost                |       | 47                                       |       | 172                     |       | 25 |   | 21 |   |
| Recognized net  actuarial loss                     |       | 464                                      |       | 352                     |       | 25 |   | — |   |
| Expected  disbursement for life insurance premiums |       | —                                   |       | —                  |       | (32 | ) | (38 | ) |
| Special  termination benefits                      |       | —                                   |       | 51                      |       | — |   | 740 |   |
| Net pension cost                                   |       | $                                        | 2,225      |                    | $          | 2,755 |   | $ | 593 |   | $ | 1,058 |   |

 

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**4.****   PENSION ANDOTHER POST-RETIREMENT BENEFITS (continued)**

Duringthe quarter ended June 30, 2006, the Company’s third party actuary completed anexperience study (the “Study”) utilizing historical information for purposes ofdetermining the continued appropriateness of certain of its assumptions used indetermining the January 1, 2006 actuarial valuation of the pension liabilityand related expense for 2006. Based on the findings of the Study, the Companychanged its estimated costs for 2006 related to its Pension Plan based onrevised actuarial calculations. This change in estimate decreased operatingexpenses by $1,039 and increased net income by $632 ($0.04 per share) duringthe quarter and six months ended June 30, 2006.

In2004, the Company initiated a voluntary enhanced early retirement program (the “REWARDprogram”). The REWARD program was offered to certain eligible employees acrossall business units.  In addition toretirement benefits, eligible employees receive enhanced medical benefits for aspecified period of time.  Prior to the completionof the REWARD program in February 2005, 13 additional employees accepted theREWARD program, and the Company recorded $791 in operating expenses during thefirst quarter of 2005.

**Employer Contributions**

The Companyexpects to contribute $3,000 and $1,300 to the Pension Plan and Other Benefits,respectively, in 2006.  As of June 30,2006, the Company has contributed $1,500 to the Pension Plan (no contributionshave been made to the Other Benefits).

**5.****   COMMITMENTSAND CONTINGENCIES**

**Credit Arrangements**

On May 1, 2006,the Company completed an unsecured Credit Agreement for a Term Loan facilityand a Revolving Loan facility (collectively “Loan Facilities”) in principalamounts up to $75,000 and $25,000, respectively.  Interest on the Loan Facilities is payablequarterly and based on a LIBOR, variable interest rate, or a fixed interestrate pricing formula, or a combination, as defined in the Credit Agreement.  Principal payments on the outstanding amountsborrowed under the Term Loan facility as of December 31, 2007 are due in equalquarterly installments commencing March 31, 2008 through June 30, 2016.  The Revolving Loan facility has an expirationdate of June 30, 2013.  As of June 30,2006, $40,000 was outstanding under the Term Loan Facility while no amountswere outstanding under the Revolving Loan facility at the same date.

TheCompany had a business loan agreement with a bank for a $50,000 line of credit,which was originally due to expire July 1, 2006. As of December 31, 2005, therewas $30,000 outstanding under this credit facility and the weighted averageinterest rate was 5.75%, which was based on a LIBOR-based pricing formula. Inconnection, with the completion of the Credit Agreement noted above, theCompany terminated its business loan agreement effective May 1, 2006.

Certain of theCompany’s credit arrangements contain financial and operating covenants thatrestrict, among other things, the payment of cash dividends, repurchase of theCompany’s capital stock, the making of certain other restricted payments andthe incurrence of additional indebtedness. The covenants also require theCompany to maintain certain financial ratios and minimum levels of tangible networth. At June 30, 2006 and December 31, 2005, retained earnings ofapproximately $67,581, and $28,266, respectively, were available for thepayment of cash dividends or other restricted payments under the terms of theCompany’s credit arrangements.

**Litigation,Regulatory Proceedings and Other Contingencies**

The Company issubject to certain legal and regulatory proceedings, Internal Revenue Serviceexaminations and other income tax exposures, and other claims arising in theordinary course of its business. In the opinion of management, except asotherwise noted, the ultimate outcome of these matters will not materiallyaffect the consolidated financial position, results of operations or cash flowsof the Company.

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**6.****   RECENTACCOUNTING PRONOUNCEMENTS**

In June 2006, theFinancial Accounting Standards Board (“FASB”) issued Interpretation No. (“FIN”)48, *Accounting for Uncertainty in IncomeTaxes.*  FIN No. 48 clarifiesthe accounting for uncertainty in income taxes recognized in a company’sfinancial statements in accordance with FASB No. 109, *Accounting for Income Taxes*.  Specifically, the pronouncement prescribes arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return.  This interpretation alsoprovides guidance on de-recognition, classification, interest and penalties,accounting in interim periods, disclosure and transition of uncertain taxpositions.  The interpretation iseffective for fiscal years beginning after December 15, 2006. The Company iscurrently evaluating the impact that FIN No. 48 will have on its consolidatedfinancial statements.

Effective January1, 2006 the Company adopted SFAS No. 154, *AccountingChanges and Error Corrections. *TheStatement applies to all voluntary changes in accounting principle, and changesthe requirements for accounting for and reporting of a change in accountingprinciple.  The adoption of SFAS No. 154has not had a material effect on the Company’s consolidated financial position,results of operations or cash flows.

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

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

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

Important factorsthat could cause actual results to differ from those set forth in the forwardlooking statements include, but are not limited to: advances intelecommunications technology, changes in the telecommunications regulatoryenvironment, changes in the financial stability of other telecommunicationsproviders who are customers of the Company, changes in competition in marketsin which the Company operates, adverse circumstances affecting the economy inCalifornia in general, and in the Sacramento, California Metropolitan area inparticular, the availability of future financing, changes in the demand forservices and products, new product and service development and introductions,pending and future litigation, and unanticipated changes in the growth of theCompany’s emerging businesses, including the wireless and broadband businesssegments.

**Corporate Structure**

TheCompany is a holding company with wholly-owned subsidiaries operating in theTelecommunications (“Telecom”), Broadband and Wireless segments.

The Telecomsegment includes SureWest Telephone, SureWest Directories, and SureWest LongDistance, which provide landline telecommunications services, directoryadvertising, Digital Subscriber Line (“DSL”) service, long distance servicesand certain non-regulated services. SureWest Telephone, which is the principaloperating subsidiary of the Telecom segment, provides local services, tolltelephone services, network access services and certain non-regulated services.SureWest Directories publishes and distributes SureWest Telephone’s directory,including the sale of yellow pages advertising. SureWest Directories isalso engaged in the business of producing, publishing and distributingdirectories in other Northern California communities outside of SureWestTelephone’s service area. SureWest Long Distance is a reseller of long distanceservices.

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

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

The Companyexpects that the sources of its revenues and its cost structure may bedifferent in future periods, both as a result of its entry into newcommunications markets and competitive forces in each of the markets in whichthe Company has operations.

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**Resultsof Operations**

**ConsolidatedOverview**

The tables belowreflect certain financial data (on a consolidated and segment basis) andselected operating metrics for each reportable segment as of and for thequarters and six-month periods ended June 30, 2006 and 2005.

**Financial Data**
| ** **                   | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                   | ** ** | **2006**                                  | ** ** | **2005**                                          | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **Operating revenues (1)**   |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Telecom                      |       | $                                         | 32,189     |                                              | $          | 34,058 |   | $ | (1,869 | ) |   | (5 | )% |   | $ | 64,077 |   | $ | 67,421 |   | $ | (3,344 | ) |   | (5 | )% |   |
| Broadband                    |       | 15,024                                    |       | 12,105                                            |       | 2,919 |   |   | 24 |   |   | 28,906 |   | 23,701 |   | 5,205 |   |   | 22 |   |   |
| Wireless                     |       | 8,355                                     |       | 8,543                                             |       | (188 | ) |   | (2 | ) |   | 16,956 |   | 16,932 |   | 24 |   |   | — |   |   |
| Total operating revenues     |       | 55,568                                    |       | 54,706                                            |       | 862 |   |   | 2 |   |   | 109,939 |   | 108,054 |   | 1,885 |   |   | 2 |   |   |
|                         |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Operating  income (loss)** |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Telecom                      |       | 14,597                                    |       | 14,229                                            |       | 368 |   |   | 3 |   |   | 28,666 |   | 26,311 |   | 2,355 |   |   | 9 |   |   |
| Broadband                    |       | (6,712                                    | )          | (5,913                                            | )          | (799 | ) |   | (14 | ) |   | (14,274 | ) | (12,239 | ) | (2,035 | ) |   | (17 | ) |   |
| Wireless                     |       | (3,711                                    | )          | (3,419                                            | )          | (292 | ) |   | (9 | ) |   | (6,606 | ) | (6,606 | ) | — |   |   | — |   |   |
| Total operating income       |       | 4,174                                     |       | 4,897                                             |       | (723 | ) |   | (15 | ) |   | 7,786 |   | 7,466 |   | 320 |   |   | 4 |   |   |
|                         |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net  income (loss)**       |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Telecom                      |       | 8,599                                     |       | 8,306                                             |       | 293 |   |   | 4 |   |   | 16,819 |   | 15,379 |   | 1,440 |   |   | 9 |   |   |
| Broadband                    |       | (4,777                                    | )          | (3,882                                            | )          | (895 | ) |   | (23 | ) |   | (9,866 | ) | (7,983 | ) | (1,883 | ) |   | (24 | ) |   |
| Wireless                     |       | (2,418                                    | )          | (2,277                                            | )          | (141 | ) |   | (6 | ) |   | (4,350 | ) | (4,406 | ) | 56 |   |   | 1 |   |   |
| Total net income             |       | $                                         | 1,404      |                                              | $          | 2,147 |   | $ | (743 | ) |   | (35 | )% |   | $ | 2,603 |   | $ | 2,990 |   | $ | (387 | ) |   | (13 | )% |   |

 

(1)            Externalcustomers only

**Selected OperatingMetrics**

|                                                    | ** ** | **As of June 30,** | ** ** |
|----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                         | ** ** | **2006**                          | ** ** | **2005** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| **Telecom**                                        |       |                              |       |   |   |   |   |   |   |   |   |
| Incumbent Local Exchange Carrier access lines      |       | 127,278                           |       | 130,202 |   | (2,924 | ) |   | (2 | )% |   |
| Long distance lines                                |       | 55,637                            |       | 50,094 |   | 5,543 |   |   | 11 |   |   |
|                                               |       |                              |       |   |   |   |   |   |   |   |   |
| **Broadband**                                      |       |                              |       |   |   |   |   |   |   |   |   |
| Internet subscribers (1)                           |       | 30,397                            |       | 26,070 |   | 4,327 |   |   | 17 |   |   |
| Residential Broadband subscribers (2)              |       | 21,530                            |       | 18,041 |   | 3,489 |   |   | 19 |   |   |
| Residential Broadband Revenue-generating units (3) |       | 51,230                            |       | 42,233 |   | 8,997 |   |   | 21 |   |   |
|                                               |       |                              |       |   |   |   |   |   |   |   |   |
| **Wireless**                                       |       |                              |       |   |   |   |   |   |   |   |   |
| Subscribers                                        |       | 52,993                            |       | 53,361 |   | (368 | ) |   | (1 | )% |   |

 

(1)            Internet subscribersare customers who receive data services primarily within SureWest Telephone’sservice area.

(2)            Residential Broadbandsubscribers are customers who receive digital video, voice and/or data servicesfrom broadband residential services.

(3)            TheBroadband segment can deliver multiple services to a customer. Accordingly, theCompany maintains statistical data regarding Revenue-generating units fordigital video, voice and data, in addition to the number of customers. Forexample, a single customer who purchases digital video, voice and data serviceswould be reflected as three Revenue-generating units.

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Operatingrevenues from external customers in the Telecom segment decreased $1,869 and$3,344 during the quarter and six-month period ended June 30, 2006,respectively, compared to thesame periods in 2005. SureWest Telephone continues toexperience decreases in local and network access as a result of competitionfrom wireless (including SureWest Wireless) and wireline competitors and anapproximate 2% decline in access lines. In addition, network access revenues decreased due to a decline in therate base, which affects the interstate pool settlements from National ExchangeCarrier Association (“NECA”) (see *RegulatoryMatters* within the *TelecomSegment Results of Operations and Critical Accounting Policies and Estimates*sections below).  SureWest Telephone’srevenues are also impacted by shareable earnings obligations, which are alsodiscussed below in the *Telecom SegmentResults of Operations.*

Whilethe Telecom segment steadily continues to generate a majority of the Company’srevenues, cash flows and net income, the Company believes that the results ofthe Telecom segment in recent years (reflected in declining revenues and accesslines) support, in part, the Company’s efforts to continue to develop its otherbusiness segments.

Broadbandoperating revenues increased $2,919 and $5,205 during the quarter and six-monthperiod ended June 30, 2006, respectively, compared to the same periods in2005.  During the six-month period endedJune 30, 2006, the Broadband segment experienced a 17% increase in the numberof Internet subscribers compared to the same prior year period. Moresignificantly, during the same period the broadband residential servicesbusiness realized 19% and 21% increases in Broadband Residential subscribersand Revenue-generating units, respectively. While continuing to produce significant revenue increases, the expansionof the broadband residential services has and will continue to requiresignificant capital and expense commitments.

Operatingrevenues from external customers in the Wireless segment for the six-monthperiod ended June 30, 2006 increased $24 compared to the same period in 2005.The modest increase in operating revenues was attributable to an increase inequipment revenue resulting from an increase in both the average selling priceper handset and in the number of handsets sold. Although revenues increased slightly compared to the same prior yearperiod, the average access rate per subscriber has declined by 4% assubscribers shift to lower-priced calling plans.  As the Company deemphasizes the prepaidmarket and migrates toward contract subscribers the number of wirelesssubscribers decreased one percent to 52,993 during the six-month period endedJune 30, 2006 compared to the same prior year period.  In an effort to stimulate future subscribergrowth, the Company implemented new Travel Plans during the quarter ended June30, 2006 to provide subscribers with competitive roaming packages and lowerpriced calling plans.

TheCompany’s consolidated operating expenses, excluding depreciation andamortization, decreased $50 and $1,835 during the quarter and six-month periodended June 30, 2006, respectively, compared to the prior year.  During the quarter ended June 30, 2006, theCompany changed its estimated costs for 2006 related to its non-contributorydefined benefit pension plan (the “Pension Plan”) based on revised actuarialcalculations. This change in estimate decreased operating expenses by $1,039and increased net income by $632 ($0.04 per share) during the quarter and sixmonths ended June 30, 2006.

Inlate 2004, the Company initiated a voluntary enhanced early retirement program(the “REWARD program”). The REWARD program was offered to certain eligibleemployees across all business units.  Inaddition to retirement benefits, eligible employees receive enhanced medicalbenefits for a specified period of time. During the quarter ended March 31, 2005, the Company recorded $791 inoperating expenses attributed to 13 additional employees that accepted theREWARD program in 2005.

During2005, the Company implemented a strategy for driving efficiency and long-termgrowth through cost reduction and workforce consolidation. This strategic planentailed a reduction of operating expenses through a realignment oforganizational structure in order to focus on primary customer segments. Theongoing corporate restructuring has involved a reorganization of stand-alonesegment functions in order to gain operating efficiencies through aconsolidated organizational structure. As a result of this effort, overalllabor costs decreased approximately $1,600 during the six-month period endedJune 30, 2006 compared to the prior year. The Company also expects to continueto identify and eliminate additional functional redundancies, combine duplicateor overlapping work areas, and further reduce overall labor costs.

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Costof services and products expense decreased $482 during the six-month periodended June 30, 2006 due primarily to a decline in expenses for networkoperations as a result of the cost reduction and workforce consolidation.  The decrease in network operations expensewas largely offset by an increase in (i) video license fees as the number ofsubscribers within the Broadband segment continued to grow and (ii) cost ofequipment sales due to increases in the average cost and quantity of wirelesshandsets sold.

Customeroperations and selling expense increased $452 in the current year six-monthperiod due primarily to an increase in sales and advertising costs to promotenew product offerings within the Broadband segment.  General and administrative expense decreased10%, or $1,805, in the current six-month period primarily as a result of adecline in consulting and audit fees related to Sarbanes-Oxley Actimplementation and compliance as well as a result of the cost reduction andworkforce consolidation.

TheCompany’s consolidated depreciation and amortization expense increased $1,635and $3,400 during the quarter and six-month period ended June 30, 2006,respectively, compared to the same periods in 2005 primarily due to thecontinued network build-out and success-based capital within the residentialbroadband service territories.

*Reclassifications*

Certain amounts inthe Company’s 2005 condensed consolidated financial statements have beenreclassified to conform to the presentation of the Company’s 2006 condensedconsolidated financial statements.

**Segment Results of Operations**

**Telecom**
| ** **                                        | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                  | ** ** | **2005**                                          | ** ** | **$  Change** | ** ** | **%  Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **$  Change** | ** ** | **%  Change** | ** ** |
|                                              |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Local service                                     |       | $                                         | 15,854     |                                              | $          | 15,924 |   | $ | (70 | ) |   | — | % |   | $ | 31,673 |   | $ | 31,961 |   | $ | (288 | ) |   | (1 | )% |   |
| Network access  service                           |       | 9,693                                     |       | 11,420                                            |       | (1,727 | ) |   | (15 | ) |   | 19,372 |   | 21,945 |   | (2,573 | ) |   | (12 | ) |   |
| Directory  advertising                            |       | 4,478                                     |       | 4,341                                             |       | 137 |   |   | 3 |   |   | 8,905 |   | 8,636 |   | 269 |   |   | 3 |   |   |
| Long distance  service                            |       | 1,334                                     |       | 1,399                                             |       | (65 | ) |   | (5 | ) |   | 2,718 |   | 2,896 |   | (178 | ) |   | (6 | ) |   |
| Other                                             |       | 830                                       |       | 974                                               |       | (144 | ) |   | (15 | ) |   | 1,409 |   | 1,983 |   | (574 | ) |   | (29 | ) |   |
| Total operating  revenues from external customers |       | 32,189                                    |       | 34,058                                            |       | (1,869 | ) |   | (5 | ) |   | 64,077 |   | 67,421 |   | (3,344 | ) |   | (5 | ) |   |
| Intersegment  revenues                            |       | 7,450                                     |       | 7,489                                             |       | (39 | ) |   | (1 | ) |   | 14,778 |   | 14,473 |   | 305 |   |   | 2 |   |   |
| Operating  expenses*                              |       | 18,719                                    |       | 20,955                                            |       | (2,236 | ) |   | (11 | ) |   | 37,548 |   | 43,225 |   | (5,677 | ) |   | (13 | ) |   |
| Depreciation and  amortization                    |       | 6,323                                     |       | 6,363                                             |       | (40 | ) |   | (1 | ) |   | 12,641 |   | 12,358 |   | 283 |   |   | 2 |   |   |
| Operating income                                  |       | 14,597                                    |       | 14,229                                            |       | 368 |   |   | 3 |   |   | 28,666 |   | 26,311 |   | 2,355 |   |   | 9 |   |   |
| Net income                                        |       | $                                         | 8,599      |                                              | $          | 8,306 |   | $ | 293 |   |   | 4 | % |   | $ | 16,819 |   | $ | 15,379 |   | $ | 1,440 |   |   | 9 | % |   |

*Exclusive of depreciation and amortization

*Operating Revenues*

Operatingrevenues from external customers in the Telecom segment decreased $1,869 and$3,344 for the quarter and six-month period ended June 30, 2006, respectively,compared to the same periods in 2005. SureWest Telephone continues toexperience decreases in local and network access as a result of competitionfrom wireless (including SureWest Wireless) and wireline competitors and anapproximate 2% decline in access lines. In addition, network access revenues decreased due to a decline in therate base, which affects the interstate pool settlements from NECA (see *Regulatory Matters* and *Critical Accounting Policies and Estimates*sections below).  SureWest Telephone’srevenues are also impacted by shareable earnings obligations, which arediscussed below in the *Telecom SegmentResults of Operations*.

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*Operating Expenses*

Operating expenses forthe Telecom segment decreased $2,236 and $5,677 for the quarter and six-monthperiod ended June 30, 2006, respectively, compared to the same periods in2005.  The decrease in operating expenseswas due in large part to labor savings realized through the cost containmentand workforce consolidation plan and the inclusion during the quarter endedMarch 31, 2005 of approximately $640 related to the REWARD program, asdescribed in the *Consolidated Overview*section above.  The decrease in operatingexpenses was also impacted by the change in estimated costs for 2006 related tothe Pension Plan, also described in the *ConsolidatedOverview* section above, which resulted in a $550 reduction tooperating expenses during the quarter ended June 30, 2006.

Costof services and products (exclusive of depreciation and amortization) decreased$1,250 and $3,060 for the quarter and six-month period ended June 30, 2006,respectively, compared to the same periods in 2005.  The decrease was attributable to the laborsavings realized through the cost containment and workforce consolidation planand the inclusion in 2005 of costs related to the REWARD program.  In addition, the change in estimated costsfor 2006 related to the Pension Plan resulted in a $308 decrease in pensionexpense during the quarter ended June 30, 2006.

Customer operations andselling expense decreased $335 and $628 for the quarter and six-month periodended June 30, 2006, respectively, compared to the same periods in 2005, dueprimarily to decreases in labor costs as a result of a reduction in employeeheadcount and internal efficiencies resulting from integrated customer supportsystems and productivity gains.

General andadministrative expense decreased $651 and $1,989 for the quarter and six-monthperiod ended June 30, 2006, respectively, compared to the same periods in 2005due to decreased labor costs resulting from efficiencies gained through theworkforce consolidation plan and a decline in audit and consulting fees relatedto Sarbanes-Oxley Act implementation and compliance.

*Regulatory Matters*

Revenues from servicessubject to regulation constituted approximately 46% of the Company’s totaloperating revenues for the quarter and six-month period ended June 30,2006.  For the same prior year periodsrevenues from services subject to regulation constituted approximately 50% ofthe Company’s total operating revenues. Those revenues, which include local service, network access service andtoll service, are derived from various sources, including:

·               business andresidential subscribers, for basic exchange services;

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

·               long distancecarriers, for network access service;

·               competitive accessproviders and subscribers, for network access services;

·               interstate poolsettlements from NECA;

·               support paymentsfrom federal or state programs; and

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

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

The FCC monitorsSureWest Telephone’s interstate earnings through the use of annual costseparation studies prepared by SureWest Telephone, which utilize estimated costinformation and projected demand usage. The FCC establishes rules thatcarriers must follow in the preparation of the annual studies. Additionally,under current FCC

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rules governingrate making, SureWest Telephone is required to establish interstate rates basedon projected demand usage for its various services and determine the actualearnings from these rates once actual volumes and costs are known. Based onpreliminary cost studies, the Company recognized liabilities relating toSureWest Telephone’s estimated interstate shareable earnings obligations of $80for the six-month period ended June 30, 2005 through reductions of revenues(none in 2006).

As a result of periodiccost separation studies, SureWest Telephone changed its estimates for a portionof its interstate shareable earnings obligations and certain NECA CCL accountsreceivable balances related to prior year monitoring periods.  These changes in estimates increased theCompany’s consolidated revenues by $57 and $757 and net income by $35 (noeffect on earnings per share) and $462 ($0.03 per share), respectively, for thequarters ended March 31 and June 30, 2005. The Company did not record any significant changes in estimates duringthe quarter and six-month period ended June 30, 2006.

The FCC has a pendingrulemaking proceeding to re-examine all regulated forms of intercarriercompensation and develop a more unified mechanism to govern the payment flowsamong telecommunications carriers. Intercarrier compensation is the regulated fees that service providerscharge each other to carry and terminate traffic.  Reform has been suggested due to the changingnature of the industry with increasing competition from new technologies, suchas Internet and Internet-based services and wireless services.  Various plans have been submitted to the FCCwith divergent approaches to handle intercarrier compensation that may reduceper-minute access and reciprocal compensation charges and replaces theserevenues with a combination of increases to the subscriber line charge and revenuesobtained from a new restructure mechanism. The ultimate results of this proceeding and the potential effects onSureWest Telephone cannot yet be determined.

The Company was involvedin a proceeding at the CPUC that considered the continued need for certainsharing requirements in the intrastate jurisdiction and, in connection withthat review, also considered the issue of whether the Company overearned in theintrastate jurisdiction in recent monitoring periods and the amount ofoverearnings that should be shared with customers. In July 2004, theCompany entered into a settlement agreement (“the settlement agreement”) withthe other parties in the proceeding, the Division of Ratepayer Advocates (“DRA”),(formerly Office of Ratepayer Advocates), and The Utility Reform Network (“TURN”),to resolve all issues in the proceeding. In November 2004, the CPUCapproved the settlement agreement. The settlement agreement resolved existingintrastate sharing obligations and related earnings issues for the monitoringperiods 2000 through 2004, put into place a surcredit mechanism for the amountof the settlement, and suspended the requirement for any intrastate sharing formonitoring periods from January 1, 2005 through at least December 31, 2010.

In accordance with thesettlement agreement, SureWest Telephone will return approximately $6,500(“Dividend A”), plus interest at the 90-day commercial paper rate fornon-financial institutions, which was 5.29% as of June 30, 2006, and an imputedrate of 3.15%, to its end users through a consumer dividend over a period offour years, which began January 1, 2005. In addition, SureWest Telephone willpay a one-time consumer dividend of $2,600 (“Dividend B”), which will bereturned to the consumers to settle the monitoring periods 2000 to 2004.  The consumer dividend is recorded as areduction of the Company’s contractual shareable earnings obligations over twoyears, which began January 1, 2005. The consumer dividend includes an annualimputed interest rate of 3.15% (no stated contractual interest rate).  At June 30, 2006, the aggregate contractualshareable earnings obligation for these surcredits was $5,102 (which is net ofan unamortized discount pertaining to imputed interest of $183 at that date).

The following tablesummarizes the amounts returned to end users through consumer dividends for thequarters and six-month periods ended June 30, 2006 and 2005:

|            | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                  | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Dividend A |       | $                                         | 505        |                                              | $          | 424 |   | $ | 1,020 |   | $ | 819 |   |
| Dividend B |       | 295                                       |       | 310                                               |       | 596 |   | 599 |   |
| Total      |       | $                                         | 800        |                                              | $          | 734 |   | $ | 1,616 |   | $ | 1,418 |   |

 

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Further, commencingJanuary 1, 2007, SureWest Telephone will implement an annual consumer dividendof $1,300 to end-users receiving SureWest Telephone services subject to sharingon or after that date; however, this consumer dividend is subject to reductionbased upon the results of other pending regulatory proceedings.

During the fourth quarterof 2005, the Company filed an Advice Letter with the CPUC proposing an increaseto the consumer dividends in order to return the amounts entitled per thesettlement agreement. The change in the consumer dividends resulted from theincrease in interest rates during 2005. The increase was effective January 1,2006.

Prior to 2000, AT&TInc. (“AT&T”) (formerly SBC Communications), had been paying SureWestTelephone approximately $11,500 per year for EAS pursuant to a SettlementTransition Agreement. In November 2000, the CPUC authorized AT&T to terminateits annual EAS payments to SureWest Telephone effective November 30, 2000.The CPUC authorized replacement funding to SureWest Telephone on an interimbasis using funds from the CHCF. The CHCF is a program designed by the CPUC toestablish a fair and equitable local rate structure and to reduce any disparityin the rates charged by telephone companies serving high-cost areas. The CHCFis scheduled to expire January 1, 2009. In addition, the CPUC opened anOrder Instituting Investigation (“OII”) for the purpose of determining whetherfuture recovery of all, none, or a portion of the approximate $11,500 annualpayments received from the CHCF should come from SureWest Telephone’sratepayers or other regulatory recovery mechanisms.

In August 2005, the CPUCadopted a decision which (i) authorized SureWest Telephone to continuereceiving $11,500 annually from the CHCF to offset its intrastate regulatedoperating expenses on an interim basis, (ii) required SureWest Telephoneto prepare and submit a cost proxy model (which is used generally as a basisfor CHCF-B funding) based on its current cost data, including analyses of theresulting impacts on rates, on the Universal Lifeline Telephone Service (“ULTS”)fund, and on the CHCF fund, to be filed by SureWest Telephone within 12 months,and (iii) authorized SureWest Telephone to file an advice letter with theCommission’s Telecommunications Division to implement reductions to itsbusiness access line rates. The results of this proceeding and the potentialeffects on SureWest Telephone could impact future funding levels through theCHCF.

In June 2006, the CPUCinstituted a rulemaking proceeding to review the CHCF-B program.  The goals of this review include, but are notlimited to, adjusting universal service rate support payments to reflectupdated operating costs, evaluating whether CHCF-B fund support levels can bereduced and made more predictable while still meeting the goals of the program,ensuring it is competitively neutral, reducing rate disparity in residentialbasic service between urban and rural areas in the state, and making thecurrent administration of the program more efficient.  In addition, the CHCF-B rulemaking requestscomments on whether SureWest Telephone should continue receiving the $11,500annually from the CHCF-B and the advisability and impacts of phasing out theEAS payments gradually over a period of approximately 5 years.  Comments in the CHCF-B rulemaking are dueSeptember 1, 2006 with reply comments due October 16, 2006.  In August 2006, the Company filed a Petitionfor Modification of D.05-08-004, the decision that reviewed SureWest Telephone’srevenue requirement, which seeks CPUC authorization in a graduated phase downof its $11,500 interim draw from the CHCF-B over a period of time that isintended to assure the continued maintenance of good service to SureWestcustomers while avoiding precipitous rate increases.  The Company’s Petition for Modificationproposes a transitional phase down over a five to ten year period and requestselimination of the requirement to file its cost proxy model.  The Company expects to recover the eliminatedrevenues through rate increases and/or operating efficiencies.  The results of this proceeding and thepotential effects on SureWest Telephone could impact future funding levelsthrough the CHCF-B.

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

In April 2005, the CPUCopened a rulemaking proceeding to assess and revise the regulation oftelecommunications utilities to develop a uniform regulatory framework (“URF”)to apply to all providers of regulated telecommunications services, exceptsmall Incumbent Local Exchange Carriers(“ILECs”), to the extent that it is feasible and in the public interestto do so.  The assigned administrativelaw judge issued a proposed decision in this

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proceeding on July 25,2006, which would revise the regulations of telecommunications utilities, suchas SureWest Telephone, which are now subject to the NRF. The proposed decision,if adopted, would grant carriers broad pricing freedoms in the provision oftelecommunications services, bundles of services, promotions andcontracts.  The proposed decision would,among other things:  (i) freeze the ratesof basic residential services for two years at the current rates, subject toreview in the CHCF-B review proceeding, (ii) lift price caps on rates for basicresidential services that are not supported by the CHCF-B two years from theeffective date of the decision, (iii) eliminate price regulation for all retailservices except lifeline and basic residential services, (iv) authorize newservices to be provided with full pricing flexibility, (v) allocate all gainsand losses from the sale of land to shareholders and (vi) eliminate price caps,the annual price cap filing, the productivity factor, and all residual elementsof rate of return regulation, including the calculation of shareable earnings.

OnApril 27, 2006, the CPUC released a decision in a proceeding investigating thecontinued need for the transport interconnection charge (“TIC”), which is anaccess charge element.  An earlier draftdecision required all ILECs operating within California to eliminate the TICelement and authorized recovery of lost revenue through end users, specificallythrough an increase in their local rate surcharge, and use of the CHCF-A forthe small companies.  If SureWestTelephone did not recover any lost revenues from end users, the decision couldultimately result in a loss of revenues of up to $4,400, on a prospectivebasis. The Company sought modification of the draft decision on the basis thatthe CPUC had indicated that it was prepared to act only with respect to largerILECs, and thus denied SureWest Telephone due process.  In the final decision, the CPUC deferred theelimination of the TIC element for SureWest to the next phase of theproceeding, which began in May 2006.  TheCompany filed testimony in May 2006 supporting that the CPUC should noteliminate the TIC for small and mid-sized ILECs due to an impending federalintercarrier compensation restructure proceeding at the FCC.  The ultimate results of this proceeding andthe potential effects on SureWest Telephone cannot yet be determined.

As of June 30, 2006, theCompany’s consolidated balance sheet reflected aggregate liabilities of $293relating to SureWest Telephone’s estimated interstate shareable earningsobligations. The calculations supporting these liabilities are very complex andinvolve a variety of estimates prior to the ultimate settlement of suchobligations. In addition, SureWest Telephone’s interstate shareable earningsobligations lapse over time if SureWest Telephone’s interexchange carrier andother customers do not claim the amounts ascribed to them. Accordingly, it isreasonably possible that management’s estimates of the Company’s liabilitiesfor interstate shareable earnings obligations could change in the near term,and the amounts involved could be material.

# **Broadband**

| ** **                                        | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                  | ** ** | **2005**                                          | ** ** | **$  Change** | ** ** | **%  Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **$  Change** | ** ** | **%  Change** | ** ** |
|                                              |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Internet service                                  |       | $                                         | 5,064      |                                              | $          | 4,381 |   | $ | 683 |   |   | 16 | % |   | $ | 9,962 |   | $ | 8,693 |   | $ | 1,269 |   |   | 15 | % |   |
| Residential  Broadband service                    |       | 7,287                                     |       | 5,937                                             |       | 1,350 |   |   | 23 |   |   | 13,937 |   | 11,534 |   | 2,403 |   |   | 21 |   |   |
| Business  Broadband service                       |       | 2,673                                     |       | 1,787                                             |       | 886 |   |   | 50 |   |   | 5,007 |   | 3,474 |   | 1,533 |   |   | 44 |   |   |
| Total operating  revenues from external customers |       | 15,024                                    |       | 12,105                                            |       | 2,919 |   |   | 24 |   |   | 28,906 |   | 23,701 |   | 5,205 |   |   | 22 |   |   |
| Intersegment  revenues                            |       | 312                                       |       | 399                                               |       | (87 | ) |   | (22 | ) |   | 736 |   | 841 |   | (105 | ) |   | (12 | ) |   |
| Operating  expenses*                              |       | 16,327                                    |       | 14,420                                            |       | 1,907 |   |   | 13 |   |   | 32,998 |   | 29,150 |   | 3,848 |   |   | 13 |   |   |
| Depreciation and  amortization                    |       | 5,721                                     |       | 3,997                                             |       | 1,724 |   |   | 43 |   |   | 10,918 |   | 7,631 |   | 3,287 |   |   | 43 |   |   |
| Operating loss                                    |       | (6,712                                    | )          | (5,913                                            | )          | (799 | ) |   | (14 | ) |   | (14,274 | ) | (12,239 | ) | (2,035 | ) |   | (17 | ) |   |
| Net loss                                          |       | $                                         | (4,777     | )                                                 | $          | (3,882 | ) | $ | (895 | ) |   | (23 | )% |   | $ | (9,866 | ) | $ | (7,983 | ) | $ | (1,883 | ) |   | (24 | )% |   |

*Exclusive of depreciation and amortization

*OperatingRevenues*

Operating revenues from external customers in the Broadbandsegment increased $2,919 and $5,205 for the quarter and six-month period endedJune 30, 2006, respectively, compared to the same periods in 2005. The increasein Broadband revenues was due to the combined effects of (i) a 19% increase insubscribers of broadband residential services, (ii) a 17% increase in theresidential and business DSL subscriber customer base and (iii) the continuedexpansion of the business broadband services.

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*Operating**Expenses*

Total operating expensesin the Broadband segment increased $1,907 and $3,848 for the quarter andsix-month period ended June 30, 2006, respectively, compared to the sameperiods in 2005.  Cost of services and products(exclusive of depreciation and amortization) increased $1,095 and $2,344 forthe quarter and six-month period ended June 30, 2006, respectively, compared tothe same periods in 2005, due primarily to (i) an increase in programming andtransport costs related to the growth in Broadband subscribers and residentialbroadband Revenue-generating units, (ii) an increase in access expense andgeneral support costs corresponding to the increased subscriber count, as wellas the expanded network footprint and (iii) an increase in property taxespredominantly due to the increase in property, plant and equipment as thenetwork has expanded.  The increase in costof services and products was offset in part by labor savings realized throughthe cost containment and workforce consolidation plan, as described in the *Consolidated Overview* section above.

Customer operationsexpense increased $381 and $1,131 for the quarter and six-month period endedJune 30, 2006, respectively, compared to the same periods in 2005.  The increase was attributable to an increasein sales and advertising costs to promote new product offerings within theBroadband segment.  In addition, customerservice costs increased as a result of the increased call volume caused by theincrease in subscribers of broadband residential services.

General andadministrative expense increased $431 and $373 for the quarter and six-monthperiod ended June 30, 2006, respectively, compared to the same periods in 2005,primarily due to (i) increased corporate overhead costs charged to theBroadband segment resulting from the growth in the customer base and (ii)increased taxes and surcharges.  Theseincreases were offset in part by a decline in audit and consulting fees relatedto Sarbanes-Oxley Act implementation and compliance.

The increase in operatingexpenses was offset in part by the change in estimated costs for 2006 relatedto the Pension Plan, described in the *ConsolidatedOverview* section above, which resulted in approximate $320 reductionto operating expenses during the quarter ended June 30, 2006.

Depreciation andamortization increased $1,724 and $3,287 for the quarter and six-month periodended June 30, 2006, respectively, compared to the same periods in 2005,primarily due to continued network build-out within the residential broadbandservice territories.

# **Wireless**

| ** **                                 | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                  | ** ** | **2005**                                          | ** ** | **$  Change** | ** ** | **%  Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **$  Change** | ** ** | **%  Change** | ** ** |
|                                       | ** ** | ** **                                | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Wireless  revenues from external customers |       | $                                         | 8,355      |                                              | $          | 8,543 |   | $ | (188 | ) |   | (2 | )% |   | $ | 16,956 |   | $ | 16,932 |   | $ | 24 |   |   | — | % |   |
| Intersegment  revenues                     |       | 695                                       |       | 643                                               |       | 52 |   |   | 8 |   |   | 1,375 |   | 1,241 |   | 134 |   |   | 11 |   |   |
| Operating  expenses*                       |       | 9,784                                     |       | 9,579                                             |       | 205 |   |   | 2 |   |   | 18,997 |   | 18,669 |   | 328 |   |   | 2 |   |   |
| Depreciation and  amortization             |       | 2,977                                     |       | 3,026                                             |       | (49 | ) |   | (2 | ) |   | 5,940 |   | 6,110 |   | (170 | ) |   | (3 | ) |   |
| Operating loss                             |       | (3,711                                    | )          | (3,419                                            | )          | (292 | ) |   | (9 | ) |   | (6,606 | ) | (6,606 | ) | — |   |   | — |   |   |
| Net loss                                   |       | $                                         | (2,418     | )                                                 | $          | (2,277 | ) | $ | (141 | ) |   | (6 | )% |   | $ | (4,350 | ) | $ | (4,406 | ) | $ | 56 |   |   | 1 | % |   |

*Exclusive of depreciation and amortization

*OperatingRevenues*

Operating revenues fromexternal customers in the Wireless segment decreased $188 and increased $24 forthe quarter and six-month period ended June 30, 2006, respectively, compared tothe same periods in 2005.  The change inrevenue was attributable to an increase in equipment revenue resulting from anincrease in both the average selling price per handset and the quantity ofhandsets sold.  The increase in equipmentrevenues was mostly offset by a decline in the average revenue per subscriberas a result of (i) a shift in subscribers to lower priced calling plans and(ii) a 1% decline in subscribers due in part to reduced advertising promotionsand a de-emphasis on the prepaid market.

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*Operating Expenses*

Total operating expensesfor the Wireless segment increased $205 and $328 for the quarter and six-monthperiod ended June 30, 2006, respectively, compared to the same periods in2005.  Although the Wireless segment experiencedan overall increase in operating expenses, the increase was offset, in part, byefficiencies gained through the cost containment and workforce consolidationplan, as described in the *ConsolidatedOverview* section above.

Cost of services andproducts (exclusive of depreciation and amortization) increased $349 and $564for the quarter and six-month period ended June 30, 2006, respectively,compared to the same periods in 2005, primarily due to increases in (i) theaverage cost and quantity of handsets sold, (ii) long distance expense due toan increase in the minutes of use and (iii) costs associated with additionalfeatures introduced in 2006. These increases were partially offset by adecrease in labor costs in network operations through the corporaterestructuring.

General andadministrative expense decreased $34 and $188 for the quarter and six-monthperiod ended June 30, 2006, respectively, compared to the same periods in 2005,primarily due to decreased labor costs resulting from efficiencies gainedthrough the corporate restructuring and a decline in audit and consulting feesrelated to Sarbanes-Oxley Act implementation and compliance.

Operating expenses werealso impacted by the change in estimated costs for 2006 related to the PensionPlan, described in the *Consolidated Overview*section above, which resulted in an approximate $160 reduction to operatingexpenses during the quarter ended June 30, 2006.

Depreciation andamortization decreased $49 and $170 for the quarter and six-month period endedJune 30, 2006, respectively, compared to the same periods in 2005, primarilydue to reduced capital expenditures and fully depreciated property, plant andequipment.

**Non-operating Items**

*OtherIncome and Expense, Net*

Interest expenseincreased $293 and $684 during the quarter and six-monthperiod ended June 30, 2006, respectively, compared to the sameperiods in 2005.  The increase ininterest expense was primarily a result of an increase in long-term debt and acorresponding increase in the weighted average cost of debt in the currentyear.

*Income Taxes*

Income taxes for thequarter and six-month period ended June30, 2006, decreased $479 and $236, respectively, compared to the same periodsin 2005, due primarily to corresponding decreases in income subject to tax. Theeffective federal and state income tax rates were approximately 39.17% and39.0% for the six-month periods ended June 30, 2006 and 2005, respectively.

**Liquidity andCapital Resources**

Asreflected in the Condensed Consolidated Statements of Cash Flow, net cashprovided by the Company’s operating activities was $31,426 for the six-monthperiod ended June 30, 2006 primarily due to (i) net income of $2,603, (ii)non-cash charges of $29,499 consisting of depreciation and amortization due tocapital investments principally in the Broadband segment and (iii) a decreasein trade and miscellaneous accounts receivable balances of $2,664 due in partto the timing of a payment received from the CHCF.  These amounts were offset by (i) a decrease inaccounts payable and accrued liabilities of approximately $1,999 primarily dueto a decrease in outstanding obligations related to professional fees andcapital project expenditures and (ii) an approximate $1,526 decrease in theCompany’s estimated and contractual shareable earnings obligations dueprimarily to the surcredit to end users resulting from the intrastatesettlement agreement.

Net cash used inthe Company’s investing activities for the six-month period ended June 30, 2006was $24,654 due to capital expenditures pertaining to ongoing plantconstruction projects.

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Net cash provided by theCompany’s financing activities was $2,662 for the six-month period ended June30, 2006 due primarily to a $10,000 net increase in short and long-termborrowings offset by dividend payments of $7,315.

The Company’s workingcapital was $19,730 at June 30, 2006. The increase in working capital during the six months ended June 30,2006 was due primarily to the retirement of short-term borrowings and anincrease in cash resulting from the incurrence of long-term debt, as describedbelow.  In addition, the increase was dueto a decrease in accounts payable and other accrued liabilities and an increasein deferred income taxes. The increase in working capital was partially offsetby a decrease in net accounts receivable. As discussed below, the Company believes that its working capitalposition, operating cash flows and borrowing capacity are sufficient to satisfyits liquidity requirements in the next twelve months.

The Company’s mostsignificant use of funds in 2006 is expected to be for (i) budgeted capitalexpenditures of approximately $36,000, (ii) scheduled payments of long-termdebt of $3,636, (iii) support of the operations of SureWestBroadband/Residential Services up to an anticipated $1,745 and (iv) support ofthe operations of SureWest Wireless up to an anticipated $463.  In addition, during 2006 the payment ofadditional dividends, which is at the discretion of the Company’s Board ofDirectors, could be as much as $7,300 based on the Company’s most recentdividend payments. A substantial portion of the 2006 budgeted capitalexpenditures is at the discretion of the Company, and dependent upon theCompany’s working capital position, operating cash flows and ability to borrow,as described below. The Company is required to comply with its cable franchiseagreements to continue its build-out in the franchise areas.

The Company currentlyreceives funding of $11,500 annually from the CHCF, a program designed by theCPUC to establish a fair and equitable local rate structure and to reduce anydisparity in the rates charged by certain telephone companies serving high-costareas. In June 2006, the CPUC instituted a rulemaking proceeding to review theCHCF-B program.  Among other things, theCHCF-B rulemaking requests comments on whether SureWest Telephone shouldcontinue receiving the $11,500 annually from the CHCF-B and the advisabilityand impacts of phasing out the EAS payments gradually over a period ofapproximately 5 years.  Comments in theCHCF-B rulemaking are due September 1, 2006 with reply comments due October 16,2006.  In August 2006, the Company fileda Petition for Modification of D.05-08-004, the decision that reviewed SureWestTelephone’s revenue requirement, which seeks CPUC authorization in a graduatedphase down of its $11,500 interim draw from the CHCF-B over a period of timethat is intended to assure the continued maintenance of good service toSureWest customers while avoiding precipitous rate increases.  The Company’s Petition for Modificationproposes a transitional phase down over a five to ten year period and requestselimination of the requirement to file its cost proxy model.  The Company expects to recover the eliminatedrevenues through rate increases and/or operating efficiencies.  For a more detailed discussion, see *Regulatory Matters* within the TelecomSegment Results of Operations.

On May 1, 2006, theCompany completed an unsecured Credit Agreement for a Term Loan facility and aRevolving Loan facility (collectively “Loan Facilities”) in principal amountsup to $75,000 and $25,000, respectively. Interest on the Loan Facilities is payable quarterly and based on aLIBOR, variable interest rate, or a fixed interest rate pricing formula, or acombination, as defined in the Credit Agreement.  Principal payments on the outstanding amountsborrowed under the Term Loan facility as of December 31, 2007 are due in equalquarterly installments commencing March 31, 2008 through June 30, 2016.  The Revolving Loan facility has an expirationdate of June 30, 2013.  As of June 30,2006, $40,000 was outstanding under the Term Loan Facility while no amountswere outstanding under the Revolving Loan facility at the same date.

The Company had abusiness loan agreement with a bank for a $50,000 unsecured line of credit,which was originally due to expire July 1, 2006. As of December 31, 2005, therewas $30,000 outstanding under this credit facility, and the weighted averageinterest rate was 5.75%, which was based on a LIBOR-based pricing formula.  As a result of the availability of the LoanFacility, noted above, the Company terminated its business loan agreementeffective May 1, 2006.

The Company’s Board ofDirectors has authorized the repurchase of up to 1.5 million shares of theCompany’s common stock. The shares are purchased from time to time in the openmarket or through privately negotiated

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transactions, subject tooverall financial and market conditions. Through June 30, 2006 approximatelyone million shares of common stock had been repurchased. The Company hasremaining authorization from the Board of Directors to repurchase an additional465 thousand outstanding shares. The purchase of common shares did not have aneffect on the average number of common shares outstanding or the calculation ofbasic and diluted earnings per share.

The Company had cash andcash equivalents at June 30, 2006, of $17,067. The Company believes that itsworking capital position, additional available funds from the Credit Agreement,operating cash flows and borrowing capacity are sufficient to satisfy itsliquidity requirements in the next twelve months. The Company’s forecastindicates it is likely that the Company will continue to draw on availablefunds during the next twelve months to fund operations and planned capitalexpenditures, including capital expenditures as required by the Company’s cablefranchise agreements, while maintaining adequate cash and cash equivalents.Such draws might be undertaken under the Credit Agreement using the RevolvingCredit facility or the available Term Loan facility, or a combination of thetwo facilities. The Company believes, given its financial position anddebt-to-equity position, it has substantial additional short-and long-termborrowing capacity. As indicated above, a substantial portion of the Company’s2006 budgeted capital expenditures and cash dividend payments are at thediscretion of the Company. Accordingly, the Company believes that it can modifyits planned construction commitments and cash dividend payments if the resultsof operations or available capital so require.

Dividends are declared atthe discretion of the Company’s Board of Directors. However, the Note PurchaseAgreement under which the Company issued its Series A and Series B SeniorNotes, and the Credit Agreement contain financial and operating covenants thatrestrict, among other things, the payment of cash dividends, the repurchase ofthe Company’s capital stock, the making of certain other restricted paymentsand the incurrence of additional indebtedness. In addition, the Company is requiredto maintain certain financial ratios and minimum levels of tangible net worth.Under the Company’s Note Purchase Agreement and the new Credit Agreement,retained earnings of approximately $67,581 would have been available for thepayments described immediately above.

**CriticalAccounting Policies and Estimates**

Below is a summary of the Company’s criticalaccounting policies and estimates. Management has discussed development andselection of critical accounting policies and estimates with the Company’sAudit Committee.

·                                          Inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets,*goodwill and wireless licenses are reviewed for impairment annually, or morefrequently if an event occurs or circumstances change that would reduce thefair value below its carrying value. The impairment test for goodwill requiresthe Company to estimate the fair value at the reporting unit level. Todetermine the fair value in 2005, the Company obtained an independent valuationof the Company’s goodwill using a discounted cash flow model. Assumptions usedin this model include the following:

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

·                  a 14.5% weighted average cost ofcapital based on industry weighted average cost of capital; and

·      noterminal growth rate.

The carrying value of the Company’s goodwill was $2,171 as of December31, 2005. When determining the fair value of the Company’s goodwill, the use ofdifferent estimates or assumptions within the discounted cash flow model couldresult in a different fair value. For example, the Company used a discount rateof 14.5% and no terminal growth rate in its assessment of fair value in 2005.If the discount rate were to increase 2%, the fair value of the goodwill woulddecrease by $40, but would not result in an impairment of goodwill.

The Company’s wireless licenses include Personal CommunicationsServices (“PCS”) and Local Multipoint Distribution Service (“LMDS”) licenses.The carrying value at December 31, 2005 of the PCS

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and LMDS licenses was $8,925 and $4,641, respectively. In assessing therecoverability of the Company’s PCS licenses, the Company obtained anindependent valuation in 2005, which reviewed transactions involving sales ofcomparable wireless licenses in the aftermarket, using characteristics of thelicense and the related market, including geographic location, market size,megahertz frequency and population density.

In assessing the recoverability of the Company’s LMDS licenses, theCompany obtained an independent valuation, as comparable license sales data wasnot available. The independent valuation estimates fair value of the Company’sLMDS licenses using a discounted cash flow model. Assumptions used in thismodel include the following:

·                  cash flow assumptions regardinginvestment in network facilities, distribution channels and customer base (theassumptions underlying these inputs are based upon a combination of historicalresults and trends, new industry developments and the Company’s businessplans);

·                  a 20% weighted average cost ofcapital based on industry weighted average cost of capital adjusted to reflectthe inherent risks associated with the introduction of a new service offering;and

·      a4% terminal value growth rate.

The use of different estimates or assumptions within the discountedcash flow model when determining fair value of the Company’s LMDS licensescould result in different values for these licenses. For example, the Companyused a discount rate of 20% and a terminal growth rate of 4% in its assessmentof fair value in 2005. If the discount rate were to increase 1%, the fair valueof the LMDS licenses would decrease by $700, which would result in animpairment charge of approximately $324 based on the carrying value of the LMDSlicenses as of December 31, 2005. In addition, the Company’s LMDS licensesmay be impaired in the near future if the estimates and assumptions used in the2005 LMDS license discounted cash flow model are not met.

If the estimated fair value is less than the carrying value, then thecarrying value is written down to the fair value. As a result of the Company’sannual test for 2005, no impairment of either goodwill or PCS or LMDS licenseswas indicated. During the six-month period ended June 30, 2006, the Company wasunaware of any events or changes in circumstance that would require a test ofimpairment that may potentially reduce the fair value below the carrying value.

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

In accordance with the NRF, SureWest Telephone is subject to ongoingmonitoring and reporting requirements by the CPUC, and it was initiallyrequired to share earnings with customers based on its earned annualrate-of-return. The Company utilizes models, which rely on estimates regardingthe jurisdictional separation of financial data and operational data into theinterstate jurisdictions as discussed previously for the purposes ofcalculating its earned annual rate-of-return. However, as discussed more fullyin Note 3, SureWest Telephone has entered into a settlement agreement which wasapproved by the CPUC in November 2004, to cease intrastate sharingrequirements beginning January 1, 2005 through at

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least December 31, 2010. The settlement agreement also resolvesexisting sharing obligations and related earnings issues for the monitoringperiods 2000-2004.

As a result of these estimates and assumptions, it is reasonablypossible that management’s estimates of SureWest Telephone’s shareable earningsobligations could change in the near term, and the amounts involved could bematerial.

·                                          The Company recognizes revenue when(i) persuasive evidence of an arrangement between the Company and the customerexists, (ii) delivery of the product to the customer has occurred or servicehas been provided to the customer, (iii) the price to the customer is fixed ordeterminable and (iv) collectibility of the sales price is reasonably assured.

·                                          The Company maintains allowances for doubtfulaccounts for estimated losses resulting from the potential inability of itscustomers to make required payments. In evaluating the collectibility of itsaccounts receivable, the Company assesses a number of factors including aspecific customer’s or carrier’s ability to meet its financial obligations tothe Company, the length of time the receivable has been past due and historicaland future expectations of conditions that may impact the Company’s ability tocollect its accounts receivable. If circumstances change or economic conditionsworsen such that the Company’s past collection experience is no longerrelevant, the Company’s estimate of the recoverability of its accountsreceivable could be further reduced from the levels reflected in the Company’sconsolidated balance sheet. If uncollectibility of the Company’s billed revenuechanges by 1%, the Company would expect an annual increase in uncollectibleexpense of approximately $2,200. As of June 30, 2006, the Company had threecustomers that accounted for 8% of consolidated accounts receivable. Althoughmanagement believes that these customers are creditworthy, a severe adverseimpact on their business operations could have a corresponding material effecton their ability to pay timely and, therefore, on the Company’s results ofoperations, cash flows and financial condition. In addition, certain revenuesare subject to refund if the customer terminates services or returns equipmentwithin a stipulated time period, or if certain performance criteria are notmet. Accordingly, the Company maintains accounts receivable allowances andrecognizes certain customer refund liabilities, through charges to revenues,based on the Company’s best estimates of the resolution of these contingencies,which are based on historical experience.

·                                          The Company states its inventoriesheld for sale at lower of cost or market. In assessing the ultimaterecoverability of inventories, the Company is required to make estimatesregarding future customer demand and technological advances of equipment.

·                                          Property, plant and equipment arerecorded at cost. Retirements and other reductions of regulated telephone plantand equipment are charged against accumulated depreciation with no gain or lossrecognized in accordance with the composite group remaining life methodology utilizedfor telephone plant assets. When property applicable to non-telephoneoperations is sold or retired, the asset and related accumulated depreciationare removed from the accounts and the associated gain or loss is recognized.Property, plant and equipment is depreciated or amortized using thestraight-line method over their estimated economic lives. The economic livesare estimated at the time the assets are acquired and are based on historicalexperience with similar assets, as well as anticipated technological or otherchanges. If technological changes were to occur more rapidly than anticipatedor differently than anticipated, the economic lives assigned to these assetsmay need to be shortened, resulting in the recognition of increased depreciationand amortization expense in future periods. Likewise, if the anticipatedtechnological or other changes occur more slowly than anticipated, the life ofthe asset group could be extended based on the life assigned to new assetsadded to the group. This could result in a reduction of depreciation andamortization expense in future periods. The Company reviews the estimateduseful lives of its property, plant and equipment once every three years, orwhen events or circumstances indicate that the carrying amount may not berecoverable over the remaining lives of the assets. In assessing therecoverability of the Company’s property, plant and equipment, the Company mustmake assumptions regarding estimated future cash flows and other factors todetermine the fair value of the respective assets.

·                                          TheCompany accounts for asset retirement obligations in accordance with SFAS No.143, *Accounting for Asset RetirementObligations*and Financial Accounting Standards Board Interpretation(“FIN”) No. 47, *Accounting for Conditional RetirementObligations*, which requires the Company to recognize a retirement

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obligation when a legal obligation exists to remove anasset at some point in the future or if legislation exists that requiresspecial disposal procedures of the asset. The Company believes it may havepotential retirement obligations relating to its wireless cell sites anddisposal obligations relating to certain building materials containingasbestos. Based on terms outlined in its tower leases, the Company is obligatedto return the land or facilities to their original condition at the end of thecell site lease term, should the lease be terminated. Based on the Company’sestimates it believes that the disposal requirement relating to certainbuilding materials containing asbestos is the expected retirement date of theunderlying assets. The Company has used a probability-weighted cash flowapproach in estimating its potential retirement obligations. The Companycalculates the net present value of the retirement obligation assuming aninflation rate of 3%, a discount rate of 7% and a market risk premium of 4%.The Company has also assumed the settlement date for its wireless towers to be25 years from the date the asset is placed into service. The Company hasestimated that the expected retirement date of its buildings that containasbestos is 2025. The Company has also used a probability-weighted assessmentto address the uncertainty regarding the timing of future cash flows to settlethe potential liability. The Company believes that utilizing probabilities forits wireless towers of less than 100% is appropriate because the Companybelieves the likelihood of incurring material asset retirement expenditures isremote. The Company used a 100% probability factor of its building materialscontaining asbestos. The Company monitors the estimates and assumptions used indetermining its potential asset retirement obligations for its cell sites andbuildings containing asbestos. However, the Company believes it is remote thatany future adjustment to its asset retirement liability for obligationsexisting as of June 30, 2006 will be material to the Company’s consolidatedfinancial statements.

·                                          The Company accounts for incometaxes using the liability method. Under this method, deferred tax assets andliabilities are determined based on differences between the financial reportingand tax bases of assets and liabilities and are measured using the enacted taxrates and laws that are expected to be in effect when the differences are expectedto reverse. The Company does not have a valuation allowance on its deferred taxasset as of June 30, 2006 and December 31, 2005 because it believes it is morelikely than not that such deferred tax asset will be realized. Should theCompany determine that it would not be able to realize all or part of itsdeferred tax asset in the future, an adjustment to the deferred tax asset wouldbe charged to income in the period in which the determination was made.

·                                          The Company has pension andpost-retirement benefit costs and obligations. The Company’s pension andpost-retirement benefit obligations are actuarially determined based onestimates of discount rates, long-term rates of return on plan assets andincreases in future compensation levels. Changes in these estimates and otherfactors could significantly impact the Company’s pension and post-retirementbenefit costs and obligations. Assumed health care cost trend rates have asignificant effect on the amounts reported for the health care plans. A one-percentage-pointchange in assumed health care cost trend rates would have the followingeffects:

|                                                                       | ** ** | **1-Percentage-  Point Increase** | ** ** | **1-Percentage-  Point Decrease** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| Effect on total  2005 post-retirement service and interest cost       |       | $109                                   |       | $(92                                   | )          |
| Effect on  post-retirement benefit obligation as of December 31, 2005 |       | $664                                   |       | $(575                                  | )          |

 

For 2005, the discount rates used for the Company’s pension andpost-retirement benefit obligations were 5.75% and 5.50%, respectively. Thediscount rates were determined based on current yields on high qualitycorporate fixed-income investments with maturities corresponding to theexpected duration of the benefit obligations. The rate used for thepost-retirement benefit obligation reflects heavier weighting for retiredparticipants of shorter durations.

The expected return on assets (“EROA”) rate is determined based on thecurrent and projected investment portfolio mix and estimated long-terminvestment returns for each asset class. In 2005, the Company used an EROA of8.5%. The Company evaluated the appropriateness of the EROA rate for 2006 byanalyzing the long-term returns for domestic and international equities, aswell as domestic fixed income instruments.

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Based on the evaluation, the Company decreased the EROA for 2006 to8.0% to better reflect the current economic environment. The 0.5% decrease inthe EROA rate will increase the Company’s 2006 pension expense approximately$550, or 9.0%.

During the quarter ended June 30, 2006, the Company’s third partyactuary completed an experience study (the “Study”) utilizing historicalinformation for purposes of determining the continued appropriateness ofcertain of its assumptions used in determining the January 1, 2006 actuarialvaluation of the pension liability and related expense for 2006. Based on theresults of the Study, certain assumptions, including both demographic andbenefit assumptions, used in the valuation to estimate the Company’s pensioncost were revised resulting in estimated pension expense for 2006 of $4,209,which is $2,541 lower than the previous estimate.

·                                          The Company is a party to a varietyof litigation, regulatory proceedings and other contingencies that arise in theordinary course of business. The Company is required to assess the likelihoodof any adverse judgments or outcomes to these matters, as well as potentialranges of probable losses for certain of these matters. The determination ofthe liabilities required, if any, for loss contingencies is made after carefulanalysis of each individual issue. In the opinion of management, the ultimateoutcome of these matters will not materially affect the Company’s consolidatedfinancial position and results of operations.

·                                          TheCompany currently sponsors two Equity Incentive Plans (the “Plans”) for certainemployees, outside directors and consultants of the Company, which wereapproved by the Company’s shareholders. The Plans permit issuance by the Company of awards in the form ofrestricted shares, stock units, performance shares, stock options and stockappreciation rights.

Effective January 1, 2006, the Company adopted SFAS No. 123(R), *Share-Based Payment*, using themodified-prospective-transition method. Since the fair value recognition provisions of SFAS No. 123, *Accounting for Stock-Based Compensation*and SFAS No. 123(R) were materially consistent under the Company’s Plans, theadoption of SFAS No. 123(R) did not have a significant impact on the Company’sfinancial position or results of operations. The Company has not made any stock option grants since 2003 andconsequently the compensation expense resulting from stock option grants priorto 2003 was either fully expensed as of January 1, 2006, or not material to theCompany’s financial statements.

Prior to January 1, 2006, the Company accounted for the Plans under thefair value recognition provisions of SFAS No. 123.  Under the provisions of SFAS No. 148, *Accounting for Stock-Based Compensation — Transitionand Disclosure*, the fair value method of accounting was applied toall employee awards granted, modified, or settled after January 1, 2003.

Asof June 30, 2006, total unrecognized compensation cost related to nonvestedrestricted stock was $1,266 and will be recognized over a weighted-averageperiod of approximately three years.  Thetotal fair value of the restricted common stock and restricted common stockunits that vested for the quarter and six-month period ended June 30, 2006 was$266 and $512, respectively.

Stockbased compensation for restricted stock reflects the cost of restricted stockthat is expected to vest.  The Companycalculated an estimated forfeiture rate based on historic forfeiture experienceto date.  If actual forfeitures are notconsistent with the Company’s estimated forfeiture rate, it will be required torecord adjustments to compensation expense.

TheBlack-Scholes-Merton option-pricing model used to value stock option grantsincludes assumptions regarding dividend yields, expected volatility, expectedlives and risk-free interest rates. These assumptions reflect management’s bestestimates, but these items involve inherent uncertainties based on marketconditions generally outside of the control of the Company.

**Recent AccountingPronouncements**

In June 2006, theFinancial Accounting Standards Board (“FASB”) issued FIN No. 48, *Accounting for Uncertainty in Income Taxes.*  FIN No. 48 clarifies the accounting foruncertainty in income taxes recognized in a company’s

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financial statements inaccordance with FASB No. 109, *Accounting forIncome Taxes*.  Specifically,the pronouncement prescribes a recognition threshold and a measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return.  This interpretation also provides guidance onde-recognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition of uncertain tax positions.  The interpretation is effective for fiscalyears beginning after December 15, 2006. The Company is currently evaluatingthe impact that FIN No. 48 will have on its consolidated financial statements.

Effective January 1, 2006the Company adopted SFAS No. 154, *AccountingChanges and Error Corrections. *TheStatement applies to all voluntary changes in accounting principle, and changesthe requirements for accounting for and reporting of a change in accountingprinciple.  The adoption of SFAS No. 154has not had a material effect on the Company’s consolidated financial position,results of operations or cash flows.

**Factors That CouldAffect Future Results**

As a result of thefollowing factors, as well as other variables affecting our operating results,past financial performance may not be a reliable indicator of futureperformance, and historical trends should not necessarily be used to anticipateresults or trends in future periods.

Representative examplesof these factors include (without limitation) the following:

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

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

*We are subject to acomplex and uncertain regulatory environment.**  *Someparts of our business are extensively regulated, and the nature of regulationcontinues to undergo fundamental change and reinterpretation. Many businessesthat compete with the Company are comparatively less regulated. Manysignificant regulatory decisions have had to be accommodated in recent years,and there are pending decisions on issues affecting the Company that are ofgreat importance.

*Our operations haveundergone material changes, and our actual operating results can be expected todiffer from the results indicated in our historical financial statements.*   As a result of our 2002 acquisition ofassets, which launched our residential broadband business, and the subsequentexpansion of our cable television business, our mix of operating assets differsfrom those operations upon which our historical financial statements are based.Consequently, our historical financial statements may not be reliable as anindicator of future results.

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*Our success depends uponour ability to manage our growth and expansion. If our recent acquisitions andgrowth initiatives are not successful, we could suffer an adverse effect on ourbusiness and results of operations.*   Our growth strategy will continue to requireus to invest significant capital in facilities and services that may notachieve the desired returns. Our future success depends, in part, upon ourability to manage our growth, including our ability to build network andrelated facilities to serve new customers, integrate our operations to takeadvantage of new capabilities and systems, attract and retain skilled personnelacross the Company, effectively manage the demands of day to day operations innew areas while attempting to execute our business strategy, and realize theprojected growth and revenue targets developed by Company management.

*We receive support fromvarious funds established under federal and state law and the continued receiptof that support is not assured.*   While we do not receive any supportfrom the rural or non-rural Federal Universal Service high cost loop fund, wedo receive payments from various other federal or state programs. These includeinterstate common line support, CHCF—B and the Lifeline, Education andLibraries programs. These governmental programs are reviewed and amended fromtime to time, and are likely to change in the near future. As described in *Regulatory Matters* within the TelecomSegment Results of Operations, the Company currently receives funding of$11,500 annually from the CHCF, a program designed by the CPUC to establish afair and equitable local rate structure and to reduce any disparity in therates charged by certain telephone companies serving high-cost areas. Theamount of this support from the CHCF is the subject of pending regulatoryproceedings, and its continuation is dependent upon many factors. In addition,the state legislative authorization for the CHCF is scheduled to expireJanuary 1, 2009. The outcome and impact on the Company’s operationsresulting from future changes to these governmental programs cannot bedetermined at this time.

*We could be harmed by therecent developments affecting other communications companies.*   There have been numerous bankruptciesand other financial difficulties experienced by other carriers and suppliers inthe telecommunications and Internet sectors. Similar situations with oursuppliers, some of whom provide products and services for which there are fewsubstitutes, could cause us to experience delays, service interruptions oradditional expenses. Situations with carrier and other customers could affectour ability to collect services that have been provided.

*We depend on thirdparties, over whom we have no control, to deliver our services.*   Because of the interconnected nature ofthe telecommunications industry, we depend heavily on other local telephonecompanies, long-distance carriers, and numerous other third parties to deliverour services. In addition, we are dependent on easements, franchises andlicenses from various private parties such as established telephone companiesand other utilities, railroads, long-distance companies, and from state highwayauthorities, local governments and transit authorities for access to aerialpole space, underground conduits and other rights-of-way in order to constructand operate our networks. The failure to maintain in effect the necessary thirdparty arrangements on acceptable terms would have an adverse effect on ourability to conduct our business.

*We are subject tocorporate governance and internal control reporting requirements, and ourfailure to comply with existing and future requirements could adversely affectour business.*   Pursuant to Section 404of the Sarbanes-Oxley Act of 2002 (“Section 404”) and related Securitiesand Exchange Commission (“SEC”) rules, we have issued a report of management’sassessment of the effectiveness of our internal controls at December 31,2005. In addition, our Independent Registered Public Accounting Firm auditedand reported on management’s assessment. Management concluded that the Company’sinternal control over financial reporting was effective at December 31,2005. If we are unable to maintain effective internal controls or if futuredeficiencies are not adequately addressed, we could experience accountingerrors that could result in misstatements of our financial position and resultsof operations, potential restatements of our financial statements or otherwiseadversely affect our business, reputation and results of operations. Inferiorinternal controls could also cause investors to lose confidence in our reportedfinancial information, which could have a negative effect on the trading priceof our securities.

**Regulatory andLegal Matters**

SureWest Telephone issubject to regulation by the FCC and CPUC. In the past, there have been variousproceedings before these agencies to which SureWest Telephone has been a party.In 1996, Congress passed the Telecommunications Act of 1996 (the “Act”), whichsignificantly changed the regulatory environment for

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telecommunicationscompanies. Beginning in 1996, the FCC conducted proceedings and adopted ordersimplementing the Act’s provisions to open local exchange service markets, suchas the market of SureWest Telephone, to competition. These proceedings andorders address interconnection, intercarrier compensation, access charges,universal service and Internet protocol (“IP”) enabled service. With respect tolocal competition, the FCC rules outline pricing methodologies for thestates to follow when setting rates for incumbent carriers (such as SureWestTelephone) to charge competitors for resale, interconnection and unbundlednetwork elements.

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

The Company’s financialcondition and results of operations have been and will be affected by recentand future proceedings before the CPUC and FCC. Pending before the FCC and CPUCare proceedings, which are considering:

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

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

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

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

·               The regulated rates and earningsof SureWest Telephone.

The Company has beeninvolved in a proceeding at the CPUC that has considered the continued need forcertain sharing requirements in the intrastate jurisdiction, and in connectionwith that review, has also considered the issues of whether the Companyoverearned in the intrastate jurisdiction in recent monitoring periods, and ifso, the amount of such overearnings that should be shared with customers. InJuly 2004, the Company entered into a settlement agreement with the otherparties in the proceeding, the DRA and TURN, to resolve all issues in theproceeding. In November 2004, the CPUC approved the settlement agreement.Among other things, the settlement agreement resolves all earnings issues forthe monitoring periods 2000 through 2004, put into place a surcredit mechanismfor the amount of the settlement, and suspends the requirement for anyintrastate sharing for later monitoring periods from January 1, 2005through at least December 31, 2010.

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. Theseregulatory proceedings include, but are not limited to, consideration ofchanges to the interstate universal service fund, intercarrier compensation, reformand the regulation of local exchange carriers and their competitors, andregulation of IP-enabled services. The outcomes and impact on SureWestTelephone’s operations of these proceedings and related court matters cannot bedetermined at this time.

The eventual impact onthe Company of the effect of all the proceedings described above cannotpresently be determined.

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK.**

**The Company’s 2005 Annual Report onForm 10-K contains certain disclosures about the Company’s limited exposure tomarket risk for changes in interest rates. There have been no material changes to the information provided whichwould require additional disclosures as of the date of this filing.**

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**ITEM 4.  CONTROLS AND PROCEDURES.**

As of the end of the period covered by this report, the Company carriedout an evaluation, under the supervision and with the participation of ourmanagement, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rule 13a-15(e) under the Securities Exchange Actof 1934, as amended). Based upon, and as of the date of this evaluation, theChief Executive Officer and Chief Financial Officer have concluded that, theCompany’s disclosure controls and procedures were effective, at the reasonableassurance level, to ensure that information required to be disclosed by theCompany in reports that it files or submits under the Securities Exchange Actis authorized, recorded, processed, summarized and reported within the timeperiods specified in SEC rules and forms.

The Company’s managementis responsible for establishing and maintaining adequate internal control overfinancial reporting. The Company’s internal control system was designed toprovide reasonable assurance to the Company’s management, Board of Directorsand Audit Committee regarding the reliability of financial reporting and thepreparation of published financial statements in accordance with generallyaccepted accounting principles.

**Change in InternalControl over Financial Reporting**

Effective June 1, 2006,the Company’s Vice President, Sales entered into a Separation Agreement withthe Company.  Other members of the Company’smanagement have assumed the responsibilities of the former Vice President,Sales.  On May 9, 2006, the Company hireda Vice President, Treasurer with oversight responsibilities related to thetreasury, human resources and investor relations functions.  Based on the Company’s interim controltesting and management’s continual assessment of the Company’s internal controlenvironment to date, it appears the changes in the Company’s upper levelmanagement have not adversely impacted the Company’s internal controls orcontrol environment.

As reported in the Company’s previous periodic reports, in February2005 the Company announced that it began a search for a President and CEO as aresult of the indication by Brian H. Strom of his desire to ultimately retirefrom those positions. The Company conducted a search for a successor that wouldallow the new President and CEO to serve with Mr. Strom prior to hisformal retirement to assure an effective and smooth transition. EffectiveJanuary 1, 2006, Steven C. Oldham was elected President and CEO while Mr. Stromremained an employee until March 31, 2006. Based on the Company’s interim control testing and management’scontinual assessment of the Company’s internal control environment to date, itappears that the transition of the officer has not adversely impacted theCompany’s internal controls or control environment.

Exceptfor the items discussed above, there has been no change in the Company’sinternal control over financial reporting during the period ended June 30, 2006that has materially affected, or is reasonably likely to materially affect, theCompany’s control over financial reporting.

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**PART II — OTHERINFORMATION**

**ITEM 1.**                    LEGALPROCEEDINGS.  *(Dollars in thousands)*

Except for theproceedings described below, the Company is not aware of any material pendinglegal proceedings, other than ordinary routine litigation incidental to itsbusiness, to which it is a party or to which any of its property is subject.

Prior to January 1,2002, SureWest Telephone billed AT&T Inc. (“AT&T”), (formerly SBCCommunications), various charges for certain local service and network accessservice revenues in accordance with certain agreements as described below. In1999, AT&T expressed interest in withdrawing from the designated carrierplan (“DCP”) for SureWest Telephone’s toll traffic. The DCP was a compensationarrangement between SureWest Telephone and AT&T for certain intrastate tollservices. SureWest Telephone and AT&T agreed to allow the DCP arrangementto expire in December 2001. The termination of the DCP did not have amaterial impact on the Company’s consolidated financial position as ofDecember 31, 2002 or results of operations for the year then ended.

Prior to 2000, AT&Thad been paying SureWest Telephone approximately $11,500 per year for extendedarea service (“EAS”) pursuant to a Settlement Transition Agreement. InNovember 2000, the California Public Utilities Commission (“CPUC”)authorized AT&T to terminate its annual EAS payments to SureWest Telephoneeffective November 30, 2000. The CPUC authorized replacement funding toSureWest Telephone on an interim basis using funds from the California HighCost Fund (“CHCF”). The CHCF is a program designed by the CPUC to establish afair and equitable local rate structure and to reduce any disparity in therates charged by telephone companies serving high-cost areas. The CHCF isscheduled to expire January 1, 2009. In addition, the CPUC opened an OrderInstituting Investigation (“OII”) for the purpose of determining whether futurerecovery of all, none, or a portion of the approximate $11,500 annual paymentsreceived from the CHCF should come from SureWest Telephone’s ratepayers orother regulatory recovery mechanisms.

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

In June 2006, the CPUCinstituted a rulemaking proceeding to review the CHCF-B program.  The goals of this review include, but are notlimited to, adjusting universal service rate support payments to reflectupdated operating costs, evaluating whether CHCF-B fund support levels can bereduced and made more predictable while still meeting the goals of the program,ensuring it is competitively neutral, reducing rate disparity in residentialbasic service between urban and rural areas in the state, and making thecurrent administration of the program more efficient.  In addition, the CHCF-B rulemaking requestscomments on whether SureWest Telephone should continue receiving the $11,500annually from the CHCF-B and the advisability and impacts of phasing out theEAS payments gradually over a period of approximately 5 years.  Comments in the CHCF-B rulemaking are dueSeptember 1, 2006 with reply comments due October 16, 2006.  In August 2006, the Company filed a Petitionfor Modification of D.05-08-004, the decision that reviewed SureWest Telephone’srevenue requirement, which seeks CPUC authorization in a graduated phase downof its $11,500 interim draw from the CHCF-B over a period of time that isintended to assure the continued maintenance of good service to SureWestcustomers while avoiding precipitous rate increases.  The Company’s Petition for Modificationproposes a transitional phase down over a five to ten year period and requestelimination of the requirement to file its cost proxy model.  The Company expects to recover the eliminatedrevenues through rate increases and/or operating efficiencies. The results ofthis proceeding and the potential effects on SureWest Telephone could impactfuture funding levels through the CHCF-B.

In 1996, the CPUC issueda decision that authorized SureWest Telephone to implement a New RegulatoryFramework (“NRF”) for services furnished within SureWest Telephone’s servicearea in order to accommodate market and regulatory movement toward competitionand greater pricing flexibility. Under the NRF, SureWest

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Telephone is subject toongoing monitoring and reporting requirements, and it was initially required toshare earnings with customers through a reduction of revenues if its earnedannual rate-of-return exceeds that authorized by the CPUC.

In accordance with therequirements of its general rate case order, SureWest Telephone filed anapplication for review of its NRF in 1999. In connection with this proceeding,the CPUC’s Division of Ratepayer Advocates (“DRA”), (formerly Office ofRatepayer Advocates), undertook a verification audit of SureWest Telephone’snon-regulated and affiliated transactions pursuant to the general rate case andother CPUC orders. In June 2001, the CPUC adopted its decision in thismatter (the “Decision”). The Decision did not suspend the sharing mechanism asSureWest Telephone had requested, and further provided that SureWest Telephonemust change the method used to allocate costs for services provided by SureWestTelephone to its affiliates, the treatment of certain directory revenues andthe treatment of internal-use software costs. Additionally, in accordance withthe provisions of the Decision, the Company recorded certain liabilities andreductions of revenues relating to estimated intrastate shareable earningsobligations.

In April 2005, the CPUCopened a rulemaking proceeding to assess and revise the regulation oftelecommunications utilities to develop a uniform regulatory framework (“URF”)to apply to all providers of regulated telecommunications services, exceptsmall Incumbent Local Exchange Carriers,to the extent that it is feasible and in the public interest to do so.  The assigned administrative law judge issueda proposed decision in this proceeding on July 25, 2006, which would revise theregulations of telecommunications utilities, such as SureWest Telephone, whichare now subject to the NRF. The proposed decision, if adopted, would grantcarriers broad pricing freedoms in the provision of telecommunicationsservices, bundles of services, promotions and contracts.  The proposed decision would, among otherthings:  (i) freeze the rates of basicresidential services for two years at the current rates, subject to review inthe CHCF-B review proceeding, (ii) lift price caps on rates for basicresidential services that are not supported by the CHCF-B two years from theeffective date of the decision, (iii) eliminate price regulation for all retailservices except lifeline and basic residential services, (iv) authorize newservices to be provided with full pricing flexibility, (v) allocate all gainsand losses from the sale of land to shareholders and (vi) eliminate price caps,the annual price cap filing, the productivity factor, and all residual elementsof rate of return regulation, including the calculation of shareable earnings.

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

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

There are a number ofother regulatory proceedings occurring at the federal and state levels that mayhave a material impact on SureWest Telephone. These regulatory proceedingsinclude, but are not limited to, consideration of changes to the jurisdictionalseparations process, the interstate universal service fund, intercarriercompensation access charge reform and the regulation of local exchange carriersand their competitors, including providers of Internet protocol (“IP”) enabledservices. The outcomes and impact on SureWest Telephone’s operations of theseproceedings and related court matters cannot be determined at this time.

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

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**ITEM1A.    RISK FACTORS.**

Therehave been no material changes from risk factors disclosed in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2005,identified in Item 1A of Part I of the Form 10-K.

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

**Not applicable.**

**ITEM 3.**                    DEFAULTS UPONSENIOR SECURITIES.

Not applicable.

**ITEM 4.**                    SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS.

(a)                On May 9, 2006,the Company held its Annual Meeting of Shareholders, at which the shareholderselected a Board of seven Directors.

(b)               The nomineesto serve as directors, which constituted seven members of the Company’s Boardof Directors at the date of the meeting, were all reelected to serve asdirectors by the following votes (out of 14,630,656):
| **Director**         | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** | **Broker  Non-Votes  and Abstentions** | ** ** |
|----------------------|------------|--------------------|------------|-------------------------|------------|---------------------------------------------|------------|
| Kirk C. Doyle        |       | 11,662,971         |       | 294,082                 |       | 2,673,603                                   |       |
| Steven C. Oldham     |       | 11,642,926         |       | 314,127                 |       | 2,673,603                                   |       |
| John R. Roberts  III |       | 11,631,539         |       | 325,514                 |       | 2,673,603                                   |       |
| Timothy D. Taron     |       | 11,668,366         |       | 288,687                 |       | 2,673,603                                   |       |
| Guy R. Gibson        |       | 11,556,565         |       | 400,488                 |       | 2,673,603                                   |       |
| Roger J. Valine      |       | 11,661,830         |       | 295,223                 |       | 2,673,603                                   |       |
| Robert D. Kittredge  |       | 11,657,647         |       | 299,406                 |       | 2,673,603                                   |       |

 

**ITEM 5.**                    OTHERINFORMATION.

Not applicable.

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**ITEM 6.  EXHIBITS.**

(a)          Index to Exhibits.
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | **Method  of Filing**      |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|
| 3.1          |       | Articles of Incorporation of Registrant, together  with Certificate of Amendment of Articles of Incorporation dated  January 25, 1996 and Certificate of Amendment of Articles of  Incorporation dated June 21, 1996 (Filed as Exhibit 3(a) to  Form 10-Q Quarterly Report for the quarter ended  September 30, 1996)                                                                                                                                                                                                                                                               |       | Incorporated by  reference |
| 3.2          |       | Certificate of Amendment of Articles of  Incorporation dated May 18, 2001 (Filed as Exhibit 3(b) to  Form 10-Q Quarterly Report for the quarter ended June 30,  2001)                                                                                                                                                                                                                                                                                                                                                                                                                    |       | Incorporated by  reference |
| 3.3          |       | Bylaws of Registrant (Filed as  Exhibit 3(b) to Form 10-K Annual Report of the  Registrant for the year ended December 31, 2000)                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | Incorporated by  reference |
| 4.1          |       | Shareholder Rights Plan (Filed as Exhibit 2.1  to Form 8-A Registration Statement under the Securities Act of  1934)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |       | Incorporated by  reference |
| 10.1         |       | Note Purchase Agreement for Series A Senior  Notes in the aggregate amount of $40,000,000 dated December 9, 1998  (Filed as Exhibit 10(b) to Form 10-K Annual Report of  Registrant for the year ended December 31, 1998)                                                                                                                                                                                                                                                                                                                                                           |       | Incorporated by  reference |
| 10.2         |       | Supplement to Note Purchase Agreement for  Series B Senior Notes in the aggregate amount of $60,000,000 dated  March 13, 2003 (Filed as Exhibit 99.1 to the Form 8-K  filed March 13, 2003)                                                                                                                                                                                                                                                                                                                                                                                              |       | Incorporated by  reference |
| 10.3         |       | Business Loan Agreement of Registrant with Bank of  America, dated March 15, 2000, as amended by Amendment No. 1 dated  as of April 10, 2000 (Filed as Exhibit 10(f) to Form 10-Q  Quarterly Report of Registrant for the quarter ended March 31, 2000), as  amended by Amendment No. 2 dated as of September 15, 2000, Amendment  No. 3 dated as of July 17, 2001, and Amendment No. 4 dated as  of June 26, 2000 (Filed as Exhibit 10(l) to Form 10-Q  Quarterly Report of Registrant for the Quarter ended June 30, 2002) |       | Incorporated by  reference |
| 10.4         |       | Amendment No. 5 to Business Loan Agreement  dated February 26, 2003 (Filed as Exhibit 10(e) to  Form 10-K Annual Report of Registrant for the year ended  December 31, 2002)                                                                                                                                                                                                                                                                                                                                                                                                        |       | Incorporated by  reference |
| 10.5         |       | Amendment No. 6 to Business Loan Agreement  dated as of January 13, 2004 (Filed as Exhibit 10.6 to Form 10-K/A  Annual Report of Registrant for the year ended December 31, 2003)                                                                                                                                                                                                                                                                                                                                                                                                        |       | Incorporated by  reference |
| 10.6         |       | Amendment No. 7 to Business Loan Agreement  dated as of March 25, 2004 (Filed as Exhibit 10.7 to Form 10-K/A  Annual Report of Registrant for the year ended December 31, 2003)                                                                                                                                                                                                                                                                                                                                                                                                          |       | Incorporated by  reference |
| 10.7         |       | Amendment No. 8 to Business Loan Agreement  dated as of December 31, 2004 (Filed as Exhibit 10.7 to Form 10-K Annual  Report of Registrant for the year ended December 31, 2004)                                                                                                                                                                                                                                                                                                                                                                                                                        |       | Incorporated by  reference |
| 10.8         |       | Credit Agreement dated May 1, 2006, between CoBank,  ACB and Registrant (Filed as Exhibit 99.1 to Form 8-K filed May 2, 2006)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       | Incorporated by  reference |
| 10.9         |       | 1999 Restricted Stock Bonus Plan (Filed as  Exhibit 10(d) to Form 10-K Annual Report of Registrant  for the year ended December 31, 1998)                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       | Incorporated by  reference |
| 10.10        |       | 2000 Equity Incentive Plan, as amended (Filed as  Exhibit 10.9 to Form 10-Q Quarterly Report for the quarter  ended June 30, 2005)                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |       | Incorporated by  reference |
| 10.11        |       | SureWest KSOP (Filed as Exhibit 4.1 to  Registration Statement on Form S-8 [No. 333-87222])                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |       | Incorporated by  reference |
| 10.12        |       | Letter agreement dated January 16, 2001 between  Registrant and Brian H. Strom (Filed as Exhibit 10(g) to Form 10-K  Annual Report of Registrant for the year ended December 31, 2000)                                                                                                                                                                                                                                                                                                                                                                                                                       |       | Incorporated by  reference |
| 10.13        |       | Letter agreement dated January 16, 2001 between  Registrant and Jay B. Kinder (Filed as Exhibit 10(i) to Form 10-K  Annual Report of Registrant for the year ended December 31, 2000)                                                                                                                                                                                                                                                                                                                                                                                                                             |       | Incorporated by  reference |

 

40

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| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                  | ** ** | **Method  of Filing**      |
|--------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|
| 10.14        |       | Letter agreement dated January 16, 2001 between  Registrant and Bill M. DeMuth (Filed as Exhibit 10.14 to Form 10-K/A  Annual Report of Registrant for the year ended December 31, 2003)                                                                     |       | Incorporated by  reference |
| 10.15        |       | Letter agreement dated January 16, 2001 between  Registrant and Fred A. Arcuri (Filed as Exhibit 10.15 to Form 10-K/A  Annual Report of Registrant for the year ended December 31, 2003)                                                                                         |       | Incorporated by  reference |
| 10.16        |       | Separation Agreement dated October 6, 2005 between  Registrant and Robert M. Burger (Filed as Exhibit 99.1 to Form 8-K  filed October 7, 2005)                                                                                                                              |       | Incorporated by  reference |
| 10.17        |       | Steven C. Oldham Employment Agreement dated December  15, 2005 (Filed as Exhibit 99.1 to Form 8-K filed  December 16, 2005)                                                                                                                                            |       | Incorporated by  reference |
| 10.18        |       | Letter agreement dated December 15, 2005 between  Registrant and Steven C. Oldham (Filed as Exhibit 99.5 to Form 8-K  filed December 16, 2005)                                                                                                                              |       | Incorporated by  reference |
| 10.19        |       | Letter agreement dated December 15, 2005 between  Registrant and Brian H. Strom (Filed as Exhibit 99.2 to Form 8-K filed  December 16, 2005)                                                                                                                                     |       | Incorporated by  reference |
| 10.20        |       | Letter agreement dated December 15, 2005 between  Registrant and Jay B. Kinder (Filed as Exhibit 99.3 to Form 8-K filed  December 16, 2005)                                                                                                                                      |       | Incorporated by  reference |
| 10.21        |       | Release agreement dated December 15, 2005 between  Registrant and Fred A. Arcuri (Filed as Exhibit 99.1 to Form 8-K filed  December 21, 2005)                                                                                                                                    |       | Incorporated by  reference |
| 10.22        |       | Letter agreement dated October 4, 2004 between  Registrant and Philip A. Grybas (Filed as Exhibit 10.23 to Form 10-K Annual  Report of Registrant for the year ended December 31, 2005)                                                                                          |       | Incorporated by  reference |
| 10.23        |       | Separation Agreement dated June 1, 2006 between  Registrant and Mark W. Triplett (Filed as Exhibit 99.1 to Form 8-K  filed June 15, 2006)                                                                                                                                   |       | Incorporated by  reference |
| 10.24        |       | Summary of Board of Directors’ Compensation (Filed  as Exhibit 99.1 to Form 8-K filed January 26, 2006)                                                                                                                                                                     |       | Incorporated by  reference |
| 10.25        |       | Restricted Stock Unit Award, dated December 21,  2004, between Registrant and Roger J. Valine (Filed as Exhibit 10.15 to Form  10-K Annual Report of Registrant for the year ended December 31, 2004)                                                                            |       | Incorporated by  reference |
| 10.26        |       | Form of Restricted Stock Unit Award, dated December  21, 2004, between Registrant and each of Guy R. Gibson, Steven C. Oldham,  John R. Roberts III and Timothy D. Taron (Filed as Exhibit 10.16 to Form 10-K  Annual Report of Registrant for the year ended December 31, 2004) |       | Incorporated by  reference |
| 10.27        |       | Form of Restricted Stock Unit Award, dated February  23, 2005, between Registrant and Brian H. Strom (Filed as Exhibit 10.17 to Form  10-K Annual Report of Registrant for the year ended December 31, 2004)                                                                     |       | Incorporated by  reference |
| 10.28        |       | Form of Restricted Stock Unit Award, dated  January 26, 2006, between Registrant and Timothy D. Taron and Roger J. Valine  (Filed as Item 1.01 to Form 8-K filed January 27, 2006)                                                                                     |       | Incorporated by  reference |
| 10.29        |       | Form of Restricted Stock Unit Award, dated February  23, 2005, between Registrant and each of Fred A. Arcuri, Bill M. DeMuth and  Jay B. Kinder (Filed as Exhibit 10.18 to Form 10-K Annual Report of  Registrant for the year ended December 31, 2004)                          |       | Incorporated by  reference |
| 10.30        |       | Form of Stock Option Agreement for Registrant’s 2000  Equity Incentive Plan (Filed as Exhibit 10.20 to Form 10-K Annual  Report of Registrant for the year ended December 31, 2004)                                                                                         |       | Incorporated by  reference |
| 10.31        |       | Form of Restricted Stock Agreement for Registrant’s  2000 Equity Incentive Plan (Filed as Exhibit 10.21 to Form 10-K  Annual Report of Registrant for the year ended December 31, 2004)                                                                                |       | Incorporated by  reference |
| 31.1         |       | Certification of Steven C. Oldham, President and  Chief Executive Officer, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                 |       | Filed herewith             |
| 31.2         |       | Certification of Philip A. Grybas, Senior Vice  President and Chief Financial Officer, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002                                                                                                                     |       | Filed herewith             |

 

41

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

 

42

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|        |   | SUREWEST COMMUNICATIONS |                                                                   |
|--------|--------|-------------------------|------------------------------------------------------------------------|
|   |   | (Registrant)            |                                                                   |
|   |   |                    |                                                                   |
|   |   |                    |                                                                   |
|   |   | By:                     | /s/ STEVEN C.  OLDHAM                                                  |
|   |   |                    | Steven C.  Oldham,  President and Chief  Executive Officer             |
|   |   |                    |                                                                   |
|   |   | By:                     | /s/ PHILIP A.  GRYBAS                                                  |
|   |   |                    | Philip A.  Grybas,  Senior Vice President and  Chief Financial Officer |
|        |        |                         |                                                                        |  |

 

Date:  August 3,2006

43

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