**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

WASHINGTON, D.C.20549

 

## **FORM 10-Q**

## ** **

[X ]        QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d)

OF THE SECURITIESEXCHANGE ACT OF 1934

 

For the quarterlyperiod ended March 31, 2006

 

or

 

[     ]        TRANSITIONREPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIESEXCHANGE ACT OF 1934

 

Commission FileNumber 0-556

 

### **SUREWEST COMMUNICATIONS**

(Exact name ofregistrant as specified in its charter)

 

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

 

(916) 786-6141

(Registrant’stelephone number, including area code)

 

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

 

| Large accelerated filer        |   | Accelerated  filer   X   |   | Non-accelerated  filer       |
|-------------------------------------------------------------------|--------|---------------------------------------------------|--------|------------------------------------------------------------|

 

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

 

|   | Yes       |   | No   X   |
|--------|-----------------------------------------|--------|-----------------------------------|

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

As of April 27, 2006,14,630,512 shares of the registrant’s Common Stock were outstanding.

 

 

**TABLEOF 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 | 15         |   |
|                               |                                                                                        |       |   |
| Item 3.                            | Quantitative  and Qualitative Disclosures About Market Risk                                 | 32         |   |
|                               |                                                                                        |       |   |
| Item 4.                            | Controls And  Procedures                                                                    | 32         |   |
|                               |                                                                                        |       |   |
| **PART II - OTHER INFORMATION**    | ** **                                                                                  | ** ** |
| ** **                         | ** **                                                                                  | ** ** | ** ** |
| Item 1.                            | Legal  Proceedings                                                                          | 33         |   |
|                               |                                                                                        |       |   |
| Item 1A.                           | Risk Factors                                                                                | 34         |   |
|                               |                                                                                        |       |   |
| Item 2.                            | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 34         |   |
|                               |                                                                                        |       |   |
| Item 3.                            | Defaults  Upon Senior Securities                                                            | 34         |   |
|                               |                                                                                        |       |   |
| Item 4.                            | Submission  of Matters to a Vote of Security Holders                                        | 34         |   |
|                               |                                                                                        |       |   |
| Item 5.                            | Other Information                                                                           | 34         |   |
|                               |                                                                                        |       |   |
| Item  6.                           | Exhibits                                                                                    | 35         |   |
|                               |                                                                                        |       |   |
| SIGNATURES                         | 38                                                                                          |       |
|                                    |                                                                                             |            |  |  |

 

2

 

**PART I – FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS.**

 

**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

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

 
| ** **                                                                  | ** ** | **Quarter  Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                     | ** ** | **2005** | ** ** |
|                                                                        |       |                         |       |   |   |
| Operating  revenues:                                                        |       |                         |       |   |   |
| Telecom                                                                     |       | $                            | 31,889     |   |   | $ | 33,471 |   |   |
| Broadband                                                                   |       | 13,881                       |       |   | 11,597 |   |   |
| Wireless                                                                    |       | 8,601                        |       |   | 8,388 |   |   |
| Total operating  revenues                                                   |       | 54,371                       |       |   | 53,456 |   |   |
|                                                                        |       |                         |       |   |   |   |   |
| Operating  expenses:                                                        |       |                         |       |   |   |   |   |
| Cost of services  and products (exclusive of depreciation and amortization) |       | 19,128                       |       |   | 19,933 |   |   |
| Customer  operations and selling                                            |       | 9,134                        |       |   | 8,675 |   |   |
| General and  administrative                                                 |       | 8,018                        |       |   | 9,566 |   |   |
| Depreciation and  amortization                                              |       | 14,478                       |       |   | 12,713 |   |   |
| Total operating  expenses                                                   |       | 50,758                       |       |   | 50,887 |   |   |
|                                                                        |       |                         |       |   |   |   |   |
| Income from  operations                                                     |       | 3,613                        |       |   | 2,569 |   |   |
|                                                                        |       |                         |       |   |   |   |   |
| Other income  (expense):                                                    |       |                         |       |   |   |   |   |
| Interest income                                                             |       | 70                           |       |   | 46 |   |   |
| Interest expense                                                            |       | (1,593                       | )          |   | (1,203 | ) |   |
| Other, net                                                                  |       | (109                         | )          |   | (31 | ) |   |
| Total other  income (expense), net                                          |       | (1,632                       | )          |   | (1,188 | ) |   |
|                                                                        |       |                         |       |   |   |   |   |
| Income before  income taxes                                                 |       | 1,981                        |       |   | 1,381 |   |   |
|                                                                        |       |                         |       |   |   |   |   |
| Income tax  expense                                                         |       | 782                          |       |   | 538 |   |   |
|                                                                        |       |                         |       |   |   |   |   |
| Net income                                                                  |       | $                            | 1,199      |   |   | $ | 843 |   |   |
|                                                                        |       |                         |       |   |   |   |   |
| Earnings per  share:                                                        |       |                         |       |   |   |   |   |
| Basic                                                                       |       | $                            | 0.08       |   |   | $ | 0.06 |   |   |
| Diluted                                                                     |       | $                            | 0.08       |   |   | $ | 0.06 |   |   |
|                                                                        |       |                         |       |   |   |   |   |
| Dividends per  share                                                        |       | $                            | 0.25       |   |   | $ | 0.25 |   |   |
|                                                                        |       |                         |       |   |   |   |   |
| Shares of common  stock used to calculate earnings per share:               |       |                         |       |   |   |   |   |
| Basic                                                                       |       | 14,575                       |       |   | 14,542 |   |   |
| Diluted                                                                     |       | 14,701                       |       |   | 14,595 |   |   |

 

See accompanyingnotes.

 

3

 

**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

*(Unaudited;Amounts in thousands)*

 
| ** **                                                                                                                                                          | ** ** | **March  31,  2006** | ** ** | **December  31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                                                          | ** ** | ** **           | ** ** | ** **              | ** ** |
| Current assets:                                                                                                                                                     |       |                 |       |                    |       |
| Cash and cash equivalents                                                                                                                                           |       | $                    | 6,607      |                    |       | $ | 7,633 |   |   |
| Short-term  investments                                                                                                                                             |       | 612                  |       |                    | 617        |   |   |
| Accounts  receivable, net                                                                                                                                           |       | 20,914               |       |                    | 23,234     |   |   |
| Inventories                                                                                                                                                         |       | 5,883                |       |                    | 5,626      |   |   |
| Deferred  directory costs                                                                                                                                           |       | 4,474                |       |                    | 5,130      |   |   |
| Prepaid expenses                                                                                                                                                    |       | 3,313                |       |                    | 3,918      |   |   |
| Deferred income  taxes                                                                                                                                              |       | 14,502               |       |                    | 14,502     |   |   |
| Total current  assets                                                                                                                                               |       | 56,305               |       |                    | 60,660     |   |   |
|                                                                                                                                                                |       |                 |       |                    |       |   |   |
| Property, plant  and equipment, net                                                                                                                                 |       | 378,143              |       |                    | 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                                                                                                       |       | 372                  |       |                    | 393        |   |   |
| Deferred charges  and other assets                                                                                                                                  |       | 751                  |       |                    | 708        |   |   |
|                                                                                                                                                                |       | 17,316               |       |                    | 17,294     |   |   |
|                                                                                                                                                                |       | $                    | 451,764    |                    |       | $ | 459,029 |   |   |
| ** **                                                                                                                                                          | ** ** | ** **           | ** ** | ** **              | ** ** | ** ** | ** ** |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                      | ** ** | ** **           | ** ** | ** **              | ** ** | ** ** | ** ** |
| Current  liabilities:                                                                                                                                               |       |                 |       |                    |       |   |   |
| Short-term  borrowings                                                                                                                                              |       | $                    | —     |                    |       | $ | 30,000 |   |   |
| Current portion  of long-term debt and capital lease obligations                                                                                                    |       | 3,661                |       |                    | 3,669      |   |   |
| Accounts payable                                                                                                                                                    |       | 1,397                |       |                    | 3,634      |   |   |
| Other accrued  liabilities                                                                                                                                          |       | 15,777               |       |                    | 20,496     |   |   |
| Current portion  of contractual shareable earnings obligations                                                                                                      |       | 2,629                |       |                    | 2,932      |   |   |
| Estimated  shareable earnings obligations                                                                                                                           |       | 293                  |       |                    | 293        |   |   |
| Advance billings  and deferred revenues                                                                                                                             |       | 10,827               |       |                    | 9,730      |   |   |
| Accrued income  taxes                                                                                                                                               |       | 546                  |       |                    | 1,015      |   |   |
| Accrued pension  benefits                                                                                                                                           |       | 8,575                |       |                    | 7,615      |   |   |
| Accrued  compensation                                                                                                                                               |       | 4,982                |       |                    | 5,772      |   |   |
| Total current  liabilities                                                                                                                                          |       | 48,687               |       |                    | 85,156     |   |   |
|                                                                                                                                                                |       |                 |       |                    |       |   |   |
| Short-term  borrowings refinanced on a long-term basis                                                                                                              |       | 33,000               |       |                    | —     |   |   |
| Long-term debt  and capital lease obligations                                                                                                                       |       | 85,472               |       |                    | 85,473     |   |   |
| Long-term  contractual shareable earnings obligations                                                                                                               |       | 3,230                |       |                    | 3,695      |   |   |
| Deferred income  taxes                                                                                                                                              |       | 38,923               |       |                    | 40,398     |   |   |
| Other  liabilities and deferred revenues                                                                                                                            |       | 12,865               |       |                    | 12,556     |   |   |
|                                                                                                                                                                |       |                 |       |                    |       |   |   |
| Commitments and  contingencies                                                                                                                                      |       |                 |       |                    |       |   |   |
|                                                                                                                                                                |       |                 |       |                    |       |   |   |
| Shareholders’  equity:                                                                                                                                         |       |                 |       |                    |       |   |   |
| Common stock,  without par value; 100,000 shares authorized, 14,631 and 14,629 shares issued  and outstanding at March 31, 2006 and December 31, 2005, respectively |       | 162,625              |       |                    | 164,598    |   |   |
| Deferred stock-based  compensation                                                                                                                                  |       | —               |       |                    | (2,255     | ) |   |
| Accumulated  other comprehensive loss                                                                                                                               |       | (4,879               | )          |                    | (4,909     | ) |   |
| Retained  earnings                                                                                                                                                  |       | 71,841               |       |                    | 74,317     |   |   |
| Total  shareholders’ equity                                                                                                                                    |       | 229,587              |       |                    | 231,751    |   |   |
|                                                                                                                                                                |       | $                    | 451,764    |                    |       | $ | 459,029 |   |   |

 

See accompanyingnotes.

 

4

 

**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

*(Unaudited;Amounts in thousands)*

 
|                                                                | ** ** | **Three  Months Ended   March 31,** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------|------------|
|                                                                | ** ** | **2006**                            | ** ** | **2005** | ** ** |
|                                                                |       |                                |       |   |   |
| Net cash  provided by operating activities                          |       | $                                   | 11,459     |   |   | $ | 14,243 |   |   |
|                                                                |       |                                |       |   |   |   |   |
| Cash flows from  investing activities:                              |       |                                |       |   |   |   |   |
| Capital  expenditures for property, plant and equipment             |       | (11,818                             | )          |   | (19,090 | ) |   |
| Net cash used in  investing activities                              |       | (11,818                             | )          |   | (19,090 | ) |   |
|                                                                |       |                                |       |   |   |   |   |
| Cash flows from  financing activities:                              |       |                                |       |   |   |   |   |
| Increase in  short-term borrowings                                  |       | 3,000                               |       |   | — |   |   |
| Principal  payments of long-term debt and capital lease obligations |       | (9                                  | )          |   | (135 | ) |   |
| Dividends paid                                                      |       | (3,658                              | )          |   | (3,648 | ) |   |
| Net cash used in  financing activities                              |       | (667                                | )          |   | (3,783 | ) |   |
|                                                                |       |                                |       |   |   |   |   |
| Decrease in cash  and cash equivalents                              |       | (1,026                              | )          |   | (8,630 | ) |   |
|                                                                |       |                                |       |   |   |   |   |
| Cash and cash  equivalents at beginning of period                   |       | 7,633                               |       |   | 18,119 |   |   |
|                                                                |       |                                |       |   |   |   |   |
| Cash and cash  equivalents at end of period                         |       | $                                   | 6,607      |   |   | $ | 9,489 |   |   |

 

See accompanyingnotes.

 

5

 

**SUREWESTCOMMUNICATIONS**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

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

 

## **1.**                   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

## ** **

**Business and Basis of Accounting**

** **

SureWest Communications(the “Company”) is a holding company with wholly-owned subsidiaries thatprovide integrated communications services in Northern California. The Company’sprincipal operating subsidiary is SureWest Telephone. SureWest Directories,SureWest Long Distance, SureWest Wireless, SureWest Broadband, SureWestTeleVideo and SureWest TeleVideo of Roseville (collectively referred to as “SureWestBroadband/Residential Services”), SureWest Internet and SureWest Custom DataServices are each subsidiaries of the Company. The Company expects that thesources of its revenues and its cost structure may be different in futureperiods, both as a result of its entry into new communications markets andcompetitive forces in each of the markets in which the Company has operations.

 

In the opinion ofmanagement, the accompanying condensed consolidated balance sheets and relatedinterim statements of income and cash flows include all adjustments, consistingonly of normal recurring items, necessary for their fair presentation inconformity with accounting principles generally accepted in the United States (“U.S.GAAP”) for interim financial information and pursuant to the rules andregulations of the Securities and Exchange Commission (the “SEC”). Certaininformation and footnote disclosures normally included in annual financialstatements prepared in accordance with U.S. GAAP have been condensed or omittedpursuant to such SEC rules and regulations and accounting principles applicablefor interim periods. Management believes that the disclosures made are adequateto make the information presented not misleading. These condensed consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and notes thereto included in the Company’s 2005 AnnualReport on Form 10-K filed with the SEC.

 

**Stock-based Compensation**

 

***Stock Plans***

 

The Company has twoEquity Incentive Plans (the “Plans”) for certain employees, outside directorsand consultants of the Company, which were approved by shareholders. TheCompany authorized for future issuance under the Plans approximately 1.6million shares (subject to upward adjustment based upon the Company’s issuedand outstanding shares) of authorized, but unissued, common stock. The Planspermit issuance by the Company of awards in the form of restricted commonshares, restricted common stock units (“RSUs”), performance shares, stockoptions and stock appreciation rights. The exercise price per share of theCompany’s common stock to be purchased under any incentive stock option shallnot be less than 100% of the fair market value of a share of the Company’scommon stock on the date of the grant, and the exercise price under anon-qualified stock option shall not be less than 85% of the fair market valueof the Company’s common stock at the date of the grant. The term of any stockoption shall not exceed 10 years.

 

***Adoption of Statement of FinancialAccounting Standards No. 123(R)***

 

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standards (“SFASNo.”) 123(R), *Share-Based Payment*,using the modified-prospective-transition method. Because the fair valuerecognition provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation* and SFAS No. 123(R) were materiallyconsistent under the Company’s Plans, the adoption of SFAS No. 123(R) did nothave a significant impact on the Company’s financial position or results ofoperations. 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.

 

6

 

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

## ** **

Prior to January 1, 2006,the Company accounted for the Plans under the fair value recognition provisionsof 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.

 

Prior to the adoption ofSFAS No. 123(R), the Company presented all tax benefits of deductions resultingfrom the exercise of stock options as operating cash flows in its statement ofcash flows. In accordance with guidance in SFAS No. 123(R), the cash flowsresulting from excess tax benefits (tax benefits related to the excess ofproceeds from employee’s exercises of stock options over the stock-basedcompensation cost recognized for those options) will be classified as financingcash flows.

 

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

 

TheCompany granted 3,000 shares of restricted common stock during the quarterended March 31, 2006, which had a fair market value of $27.63 per share at thedate of grant to certain employees. No restricted common stock was grantedduring the quarter ended March 31, 2005.

 

TheCompany granted 1,500 RSUs during the quarter ended March 31, 2006, which had afair market value of $27.63 per unit at the date of grant to certain members ofthe Company’s Board of Directors. During the quarter ended March 31, 2005, theCompany granted 45,024 RSUs with fair market values ranging from $22.43 to$28.35 per unit at the dates of grant to members of the Company’s Board ofDirectors and certain members of management.

 

Stock-based compensationexpense for both restricted common stock and RSUs of $289 was recorded duringthe quarter ended March 31, 2006 and 2005. Restricted common stock and RSUs areamortized over their respective vesting periods, which range from immediatevesting to a five-year vesting period. In connection with the adoption of SFASNo. 123(R), the Company will record stock-based compensation for restrictedcommon stock and RSUs granted in 2006 on a straight-line basis. The Companywill continue to recognize stock-based compensation on restricted common stockand RSUs granted prior to 2006 using the graded vesting method. In accordancewith the provisions of SFAS No. 123(R), the Company has estimated expectedforfeitures based on historical experience and is recognizing compensationexpense only for those restricted common stock 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.

 

Thefollowing table summarizes the restricted stock activity during the quarterended March 31, 2006:

 
| **Nonvested  Shares**           |   | **Shares** | ** ** | **Weighted  Average   Grant Date Fair Value** | ** ** |
|---------------------------------|--------|------------|------------|-----------------------------------------------|------------|
|                            |   |       |       |                                          |       |
| Nonvested–January  1, 2006 |   | 128,998    |       |                                          | $29.44     |   |
| Granted                         |   | 4,500      |       |                                          | 27.63      |   |
| Vested                          |   | (9,294     | )          |                                          | 26.51      |   |
| Forfeited                       |   | -          |       |                                          | -          |   |
| Nonvested–March  31, 2006  |   | 124,204    |       |                                          | $28.65     |   |

 

As ofMarch 31, 2006, total unrecognized compensation cost related to nonvestedrestricted stock was $1,934 and will be recognized over a weighted-averageperiod of approximately three years. The total fair value of shares vestedduring the first quarter ended March 31, 2006 was $246.

 

7

 

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

## ** **

***Proforma***

 

Had the Company electedto adopt the fair value recognition provisions of SFAS No. 123 as of itsoriginal effective date, pro forma net income and earnings per share would havebeen:

 
|                                                                                                                                  | ** ** | **Quarter  Ended  March 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
|                                                                                                                                  |       |                                |       |
| Net income, as  reported                                                                                                              |       | $                                   | 843        |   |   |
|                                                                                                                                  |       |                                |       |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                          |       | 179                                 |       |   |
|                                                                                                                                  |       |                                |       |   |
| Deduct:  Stock-based employee compensation expense determined using the fair value  method for all awards, net of related tax effects |       | (201                                | )          |   |
|                                                                                                                                  |       |                                |       |   |
| Pro forma net  income                                                                                                                 |       | $                                   | 821        |   |   |
|                                                                                                                                  |       |                                |       |   |
| Earnings per  share:                                                                                                                  |       |                                |       |   |
|                                                                                                                                  |       |                                |       |   |
| Basic—as  reported                                                                                                               |       | $                                   | 0.06       |   |   |
| Basic—pro forma                                                                                                                  |       | $                                   | 0.06       |   |   |
|                                                                                                                                  |       |                                |       |   |
| Diluted—as reported                                                                                                              |       | $                                   | 0.06       |   |   |
| Diluted—pro  forma                                                                                                               |       | $                                   | 0.06       |   |   |

 

***Stock Compensation Expense***

 

The Company issues newshares of common stock upon exercise of stock options.  The following table summarizes stock optionactivity for the Company’s stock option plans for the quarter ended March 31,2006:

 
| **Options**                                   |   | **Shares** | ** ** | **Weighted    Average   Exercise   Price** | ** ** | **Weighted    Average   Remaining   Contractual Life** | ** ** |
|-----------------------------------------------|--------|------------|------------|--------------------------------------------|------------|--------------------------------------------------------|------------|
|                                          |   |       |       |                                       |       |                                                   |       |
| Outstanding–January  1, 2006             |   | 622,313    |       |                                       | $40.65     |                                                   |       |   |
| Forfeited                                     |   |       | (84,849    | )                                          |       |                                                   |       |   |   |
| Outstanding-March  31, 2006                   |   |       | 537,464    |                                       |       | $40.49                                                 |       | 5 |   |
|                                          |   |       |       |                                       |       |                                                   |       |   |   |
| Vested or  Expected to Vest at March 31, 2006 |   |       | 537,464    |                                       |       | $40.49                                                 |       | 5 |   |
|                                          |   |       |       |                                       |       |                                                   |       |   |   |
| Exercisable at  March 31, 2006                |   |       | 531,951    |                                       |       | $40.52                                                 |       | 5 |   |

 

There were no stock options granted, exercised orexpired during the quarter ended March 31, 2006. In addition, there were nostock options with an exercise price below the market price of the Company’sstock at that date.

 

8

 

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

## ** **

**Per Share Amounts**

 

Shares used in thecomputation of basic earnings per share are based on the weighted averagenumber of common shares and RSUs outstanding, excluding unvested restrictedcommon shares and unvested RSUs. Shares used in the computation of dilutedearnings per share are based on the weighted average number of common shares,restricted common shares and RSUs outstanding, along with other potentiallydilutive securities outstanding in each period.

 

Cash dividends per shareare based on the actual dividends per share, as declared by the Company’s Boardof Directors. On each date that the Company pays a cash dividend to the holdersof the Company’s common stock, the Company credits to the holders of RSUs anadditional number of RSUs equal to the total number of whole RSUs andadditional RSUs previously credited to the holders multiplied by the dollaramount of the cash dividend per share of common stock. Any fractional RSUsresulting from such calculation are included in the additional RSUs.

 

**Other Comprehensive Income (Loss)**

 

The Company’scomprehensive income for the quarters ended March 31, 2006 and 2005 was $1,229and $843, respectively.

 

As of March 31, 2006, theaccumulated other comprehensive loss was $4,879, which consisted of minimumpension and post-retirement benefit liability adjustments and unrealized gainon short-term investments, net of income taxes.

 

##### **Reclassifications**

##### ** **

Certainrevenues 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

## ** **

The Company has threereportable business segments: Telecom, Broadband and Wireless. 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 principal operatingsubsidiary of the Telecom segment, provides local services, toll telephoneservices, network access services and certain non-regulated services. SureWestDirectories publishes and distributes SureWest Telephone’s directory, includingthe sale of yellow pages advertising. SureWest Directories is also engagedin the business of producing, publishing and distributing directories in otherNorthern California communities outside of SureWest Telephone’s service area.SureWest Long Distance provides long distance services.

 

The Broadband segmentprovides various services, including: high-speed and dial-up Internet; digitalvideo; voice, network access and toll telephone; and managed services in thegreater Sacramento 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 Broadband segment includes the Company’ssubsidiary SureWest Broadband and SureWest Broadband Business services, whichis comprised, in part, of a division of SureWest Telephone operating as aCompetitive Local Exchange Carrier.

 

The Wireless segmentconsists of the Company’s subsidiary SureWest Wireless, which provides wirelessservices. Wireless revenues include wireless voice services, sales of handsetsand related accessories, long distance, roaming service and custom callingfeatures. Wireless services are provided on a month-to-month basis and aregenerally billed in advance for non-contract subscribers and in arrears forcontract subscribers.

 

9

 

**2.****                   BUSINESSSEGMENTS (continued)**

 

In accordance with theprovisions of SFAS No. 131, *Disclosure AboutSegments of an Enterprise and Related Information*, the Company hasaggregated certain of its operating segments within the Telecom and Broadbandsegments because it believes that such operating segments share similareconomic characteristics.

 

Corporate Operations areallocated to the appropriate segment, except for cash; investments; certainproperty, plant, and equipment; and miscellaneous other assets, which are notallocated to the segments. However, the investment income associated with cashand investments held by Corporate Operations is included in the results of theoperations of the Company’s segments. The Company evaluates the performance ofits segments based on income (loss) from operations.

 

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

 
|                                                      | ** ** | **Telecom** | ** ** | **Broadband** | ** ** | **Wireless** | ** ** | **Corporate    Operations** | ** ** | **Intercompany    Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|-----------------------------|------------|----------------------------------|------------|------------------|------------|
| **As of  and for the three months ended March 31, 2006:** |       |        |       |          |       |         |       |                        |       |                             |       |             |       |
| Operating  revenues from external customers               |       | $           | 31,889     |          | $          | 13,881       |       | $                           | 8,601      |                             | $          | —           |       | $ | — |   | $ | 54,371 |   |
| Intersegment  revenues                                    |       | 7,328       |       | 424           |       | 680          |       | —                      |       | (8,432                           | )          | —           |       |
| Operating  expenses*                                      |       | 18,829      |       | 16,670        |       | 9,213        |       | —                      |       | (8,432                           | )          | 36,280           |       |
| Depreciation and  amortization                            |       | 6,318       |       | 5,197         |       | 2,963        |       | —                      |       | —                           |       | 14,478           |       |
| Income (loss)  from operations                            |       | 14,070      |       | (7,562        | )          | (2,895       | )          | —                      |       | —                           |       | 3,613            |       |
| Net Income  (loss)                                        |       | $           | 8,220      |          | $          | (5,089       | )          | $                           | (1,932     | )                                | $          | —           |       | $ | — |   | $ | 1,199 |   |
| Total assets                                              |       | $           | 685,482    |          | $          | 319,999      |       | $                           | 148,348    |                             | $          | 367,052          |       | $ | (1,069,117 | ) | $ | 451,764 |   |
|                                                      |       |        |       |          |       |         |       |                        |       |                             |       |             |       |
| **As of  and for the three months ended March 31, 2005:** | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** ** | ** **                  | ** ** | ** **                       | ** ** | ** **       | ** ** |
| Operating  revenues from external customers               |       | $           | 33,471     |          | $          | 11,597       |       | $                           | 8,388      |                             | $          | —           |       | $ | — |   | $ | 53,456 |   |
| Intersegment  revenues                                    |       | 6,876       |       | 443           |       | 598          |       | —                      |       | (7,917                           | )          | —           |       |
| Operating  expenses*                                      |       | 22,269      |       | 14,732        |       | 9,090        |       | —                      |       | (7,917                           | )          | 38,174           |       |
| Depreciation and  amortization                            |       | 5,995       |       | 3,634         |       | 3,084        |       | —                      |       | —                           |       | 12,713           |       |
| Income (loss)  from operations                            |       | 12,083      |       | (6,326        | )          | (3,188       | )          | —                      |       | —                           |       | 2,569            |       |
| Net Income  (loss)                                        |       | $           | 7,073      |          | $          | (4,101       | )          | $                           | (2,129     | )                                | $          | —           |       | $ | — |   | $ | 843 |   |
| Total assets                                              |       | $           | 630,230    |          | $          | 215,973      |       | $                           | 135,453    |                             | $          | 204,989          |       | $ | (750,949 | ) | $ | 435,696 |   |

*        Exclusiveof depreciation and amortization

 

## **3.**                   ESTIMATED SHAREABLE EARNINGS OBLIGATIONS

## ** **

Certain of the Company’srates are subject to regulation by the Federal Communications Commission (“FCC”)and the California Public Utilities Commission (“CPUC”). Pending and futureregulatory actions may have a material impact on the Company’s consolidatedfinancial position and results of operations.

 

Revenues from certaintelephone services are affected by rates authorized by various regulatoryagencies. Intrastate service rates are subject to regulation by the CPUC. Withrespect to toll calls initiated by interexchange carriers’ customers, theinterexchange carriers are assessed access charges based on tariffs filed bySureWest Telephone. Interstate access rates and resultant earnings are subjectto regulation by the FCC. With respect to interstate services, SureWestTelephone has filed its own tariff with the FCC for all elements of accessservices except carrier common line charges, for which SureWest Telephone concurswith tariffs filed by the National Exchange Carrier Association (“NECA”).

 

10

 

**3.****                  ****ESTIMATED SHAREABLE EARNINGS OBLIGATIONS (continued)**

 

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, undercurrent FCC rules governing rate making, SureWest Telephone is required toestablish interstate rates based on projected demand usage for its variousservices and determine the actual earnings from these rates once actual volumesand costs are known. Based on preliminary cost studies, the Company recognizedliabilities relating to SureWest Telephone’s estimated interstate shareableearnings obligations of $80 for the quarter ended March 31, 2005 throughreductions of revenues (none in 2006).

 

Prior to 2000, AT&TInc. (“AT&T”) (formerly SBC Communications), had been paying SureWestTelephone 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 paymentspreviously received from AT&T and currently received from the CHCF, shouldcome from SureWest Telephone’s ratepayers or other regulatory recoverymechanisms.

 

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 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.

 

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 of overearningsthat should be shared with customers. In July 2004, the Company entered into asettlement agreement (“the settlement agreement”) with the other parties in theproceeding, the Division of Ratepayer Advocates (“DRA”), (formerly Office ofRatepayer Advocates) and The Utility Reform Network (“TURN”), to resolve allissues in the proceeding. In November 2004, the CPUC approved the settlementagreement. The settlement agreement resolved existing intrastate sharingobligations and related earnings issues for the monitoring periods 2000 through2004, put into place a surcredit mechanism for the amount of the settlement,and suspended the requirement for any intrastate sharing for monitoring periodsfrom January 1, 2005 through at least December 31, 2010.

 

In accordance with thesettlement agreement, SureWest Telephone will return approximately $6,500, plusinterest at the 90-day commercial paper rate for non-financial institutions,which was 4.76% as of March 31, 2006, and an imputed rate of 3.15%, to its endusers through a consumer dividend over a period of four years, which beganJanuary 1, 2005. For the quarters ended March 31, 2006 and 2005, approximately$515 and $395 was returned to the end users, respectively. In addition,SureWest Telephone will pay a one-time consumer dividend of $2,600, whichincludes an annual imputed interest rate of 3.15% (no stated contractualinterest rate), over two years, which began 

 

11

 

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

 

January 1, 2005 to settlethe monitoring periods 2000 to 2004. For the quarters ended March 31, 2006 and2005, approximately $301 and $289, respectively, was returned to the consumersand was recorded as a reduction of the Company’s contractual shareable earningsobligations. At March 31, 2006, the aggregate contractual shareable earningsobligation for these surcredits was $5,859 (which is net of an unamortizeddiscount pertaining to imputed interest of $226 at that date).

 

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 effectiveJanuary 1, 2006.

 

As a result of periodiccost separation studies, SureWest Telephone may change its estimates for aportion of its interstate shareable earnings obligations related to prior yearmonitoring periods. The Company did not record any significant changes inestimates during the quarters ended March 31, 2006 and 2005.

 

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 draft decision required all Incumbent LocalExchange Carriers (“ILECs”) operating within California to eliminate the TIC elementand authorized recovery of lost revenue through end users, specifically throughan increase in their local rate surcharge, and use of the CHCF-A for the smallcompanies. If SureWest Telephone did not recover any lost revenues from endusers, the decision could ultimately result in a loss of revenues of up to$4,400 on a prospective basis. The Company sought modification of the draftdecision on the basis that the CPUC had indicated that it was prepared to actonly with respect to larger ILECs, and thus denied SureWest Telephone dueprocess. In the final decision, the CPUC deferred the elimination of the TICelement for SureWest to the next phase of the proceeding. The ultimate resultsof this proceeding and the potential effects on SureWest Telephone cannot yetbe determined.

 

As of March 31, 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 and othercustomers 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.

 

12

 

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

 

**Components of Net Periodic Benefit Cost**

 

Net periodic pensioncosts recognized in the condensed consolidated statements of income for the quartersended March 31, 2006 and 2005 under the defined benefit pension plan (“PensionPlan”), Supplemental Executive Retirement Plan (“SERP”) and post-retirementbenefits other than pension (“Other Benefits”) plan included the followingcomponents:

 
|                                               | ** ** | **Pension  Plan and SERP** | ** ** | **Other  Benefits** | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|---------------------|------------|
| **Quarter  Ended March 31,**                       | ** ** | **2006**                   | ** ** | **2005**            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                               |       |                       |       |                |       |   |   |   |   |
| Service  cost-benefits earned during the period    |       |                       | $          | 1,546               |       |   | $ | 1,407 |   |   | $ | 182 |   |   | $ | 117 |   |
| Interest cost on  projected benefit obligation     |       |                       | 2,040      |                |       | 1,866 |   |   | 185 |   |   | 88 |   |
| Expected return  on plan assets                    |       |                       | (2,165     | )                   |       | (2,183 | ) |   | (80 | ) |   | (38 | ) |
| Amortization of  prior service cost                |       |                       | 26         |                |       | 86 |   |   | 13 |   |   | 11 |   |
| Recognized net  actuarial loss                     |       |                       | 298        |                |       | 176 |   |   | 13 |   |   | — |   |
| Expected  disbursement for life insurance premiums |       |                       | —     |                |       | — |   |   | (16 | ) |   | (19 | ) |
| Special  termination benefits                      |       |                       | —     |                |       | 51 |   |   | — |   |   | 740 |   |
| Net pension cost                                   |       |                       | $          | 1,745               |       |   | $ | 1,403 |   |   | $ | 297 |   |   | $ | 899 |   |

 

In 2004, the Companyinitiated a voluntary enhanced early retirement program (the “REWARD program”).The REWARD program was offered to certain eligible employees across allbusiness units. In addition to retirement benefits, eligible employees receiveenhanced medical benefits for a specified period of time. Prior to thecompletion of the REWARD program in February 2005, 13 additional employeesaccepted the REWARD program, and the Company recorded $791 in operatingexpenses during the first quarter of 2005.

 

**Employer Contributions**

 

The Company expects tocontribute $3,000 and $1,300 to the Pension Plan and Other Benefits plan,respectively, in 2006. As of March 31, 2006, the Company has contributed $750to the Pension Plan (no contributions have been made to the Other BenefitsPlan).

 

## **5.**                   COMMITMENTS AND CONTINGENCIES

## ** **

**Credit Arrangements**

 

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 ispayable quarterly and based on a LIBOR-based, variable interest rate, or afixed interest rate pricing formula, or a combination, as defined in the CreditAgreement. Principal payments on the outstanding amounts borrowed under theTerm Loan facility as of December 31, 2007 are due in equal quarterlyinstallments commencing March 31, 2008 through June 30, 2016. The RevolvingLoan facility has an expiration date of June 30, 2013. The Company used theTerm Loan facility to retire short-term borrowings with an outstandingprincipal balance of $33,000 as of March 31, 2006. Consequently, suchshort-term borrowings have been presented as a long-term liability in theaccompanying condensed consolidated balance sheet as of March 31, 2006.

 

The Company had abusiness loan agreement with a bank for a $50,000 line of credit, which wasoriginally due to expire July 1, 2006. As of March 31, 2006 and December 31,2005, there was $33,000 and $30,000 outstanding, respectively, under thiscredit facility and the weighted average interest rate was 6.16% and 5.75%,respectively, which was based on a LIBOR-based pricing formula. In connection,with the completion of the Credit Agreement noted above, the Company terminatedits business loan agreement effective May 1, 2006.

 

13

 

## **5.**                   COMMITMENTS AND CONTINGENCIES (continued)

## ** **

Certain of the Company’scredit arrangements contain financial and operating covenants that restrict,among other things, the payment of cash dividends, repurchase of the Company’scapital stock, the making of certain other restricted payments and theincurrence of additional indebtedness. The bank line of credit agreementrequired that the Company obtain written consent to exceed $100,000 in totaldebt with maturities greater than five years. The covenants also require theCompany to maintain certain financial ratios and minimum levels of tangible networth. At March 31, 2006 and December 31, 2005, retained earnings ofapproximately $26,137, and $28,266, respectively, were available for the paymentof cash dividends or other restricted payments under the terms of the Company’scredit arrangements.

 

TheCompany has various cable television franchise agreements with associatedletters of credit totaling $150 in the aggregate as of March 31, 2006.

 

**Litigation,Regulatory Proceedings and Other Contingencies**

 

The Company is subject tocertain legal and regulatory proceedings, Internal Revenue Service examinationsand other income tax exposures, and other claims arising in the ordinary courseof its business. In the opinion of management, except as otherwise noted, theultimate outcome of these matters will not materially affect the consolidatedfinancial position, results of operations or cash flows of the Company.

 

**6.****                  ****RECENT ACCOUNTING PRONOUNCEMENTS**

 

Effective January 1, 2006the Company adopted SFAS No. 154, *AccountingChanges and Error Corrections.*The Statement applies to allvoluntary changes in accounting principle, and changes the requirements foraccounting for and reporting of a change in accounting principle. The adoptionof SFAS No. 154 has not had a material effect on the Company’s consolidatedfinancial position, results of operations or cash flows.

 

14

 
| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.** |
|-------------|------------|--------------------------------------------------------------------------------------------------|

 

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

* *

Certain informationincluded in this quarterly report on Form 10-Q of SureWest Communications(the “Company”), including that which relates to the impact on future revenuesources and potential sharing obligations of pending and future regulatoryorders, continued expansion of the telecommunications network and expectedchanges in the sources of 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 factors thatcould 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 business segments.

 

**Corporate Structure**

 

The Company is a holdingcompany with wholly-owned subsidiaries operating in the Telecommunications (“Telecom”),Broadband and Wireless segments.

 

The Telecom segmentincludes SureWest Telephone, SureWest Directories, and SureWest Long Distance,which provide landline telecommunications services, directory advertising,Digital Subscriber Line (“DSL”) service, long distance services and certainnon-regulated services. SureWest Telephone, which is the principal operatingsubsidiary of the Telecom segment, provides local services, toll telephoneservices, network access services and certain non-regulated services. SureWestDirectories publishes and distributes SureWest Telephone’s directory, includingthe sale of yellow pages advertising. SureWest Directories is also engagedin the business of producing, publishing and distributing directories in otherNorthern California communities outside of SureWest Telephone’s service area.SureWest Long Distance is a reseller of long distance services.

 

The Broadband segmentincludes the Company’s subsidiaries SureWest Broadband, SureWest TeleVideo andSureWest 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 Wireless segmentconsists of the Company’s subsidiary SureWest Wireless, which provides wirelessservices. Wireless revenues include wireless voice services, sales of handsetsand related accessories, long distance, roaming service and custom callingfeatures. Wireless services are provided on a month-to-month basis and aregenerally billed in advance for non-contract subscribers and in arrears forcontract subscribers.

 

The Company expects thatthe sources of its revenues and its cost structure may be different in futureperiods, both as a result of its entry into new communications markets andcompetitive forces in each of the markets in which the Company has operations.

 

15

 

**Resultsof Operations**

 

#### **Consolidated Overview**

#### ** **

The tables below reflectcertain financial data (on a consolidated and segment basis) and selectedoperating metrics for each reportable segment as of and for the quarters endedMarch 31, 2006 and 2005. The growth in operating revenues and the selectedoperating metrics demonstrate the continuing increasing contributions of theCompany’s Broadband and Wireless segments.

 

**Financial Data**

 
|                                 | ** ** | **Quarter  Ended March 31,** | ** ** |
|--------------------------------------|------------|------------------------------|------------|
|                                 | ** ** | **2006**                     | ** ** | **2005** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **Operating  revenues** (1)     |       |                         |       |   |   |   |   |   |   |
| Telecom                              |       | $                            | 31,889     |   |   | $ | 33,471 |   |   | $ | (1,582 | ) |   | (5 | )% |   |
| Broadband                            |       | 13,881                       |       |   | 11,597 |   |   | 2,284 |   |   | 20 |   |   |
| Wireless                             |       | 8,601                        |       |   | 8,388 |   |   | 213 |   |   | 3 |   |   |
| Total operating  revenues            |       | 54,371                       |       |   | 53,456 |   |   | 915 |   |   | 2 |   |   |
|                                 |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| **Income  (loss) from operations**   |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Telecom                              |       | 14,070                       |       |   | 12,083 |   |   | 1,987 |   |   | 16 |   |   |
| Broadband                            |       | (7,562                       | )          |   | (6,326 | ) |   | (1,236 | ) |   | (20 | ) |   |
| Wireless                             |       | (2,895                       | )          |   | (3,188 | ) |   | 293 |   |   | 9 |   |   |
| Total income  (loss) from operations |       | 3,613                        |       |   | 2,569 |   |   | 1,044 |   |   | 41 |   |   |
|                                 |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| **Net  income (loss)**               |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Telecom                              |       | 8,220                        |       |   | 7,073 |   |   | 1,147 |   |   | 16 |   |   |
| Broadband                            |       | (5,089                       | )          |   | (4,101 | ) |   | (988 | ) |   | (24 | ) |   |
| Wireless                             |       | (1,932                       | )          |   | (2,129 | ) |   | 197 |   |   | 9 |   |   |
| Total net income  (loss)             |       | $                            | 1,199      |   |   | $ | 843 |   |   | $ | 356 |   |   | 42 | % |   |

 

(1)  Externalcustomers only

 

**Selected Operating Metrics**

 
|                                                | ** ** | **As of  March 31,** | ** ** |
|-----------------------------------------------------|------------|----------------------|------------|
|                                                | ** ** | **2006**             | ** ** | **2005** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| **Telecom**                                         |       |                 |       |   |   |   |   |   |   |
| Incumbent Local  Exchange Carrier access lines      |       | 128,459              |       |   | 131,133 |   |   | (2,674 | ) |   | (2 | )% |   |
| Long distance  lines                                |       | 54,106               |       |   | 48,936 |   |   | 5,170 |   |   | 11 |   |   |
|                                                |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| **Broadband**                                       |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Internet  subscribers (1)                           |       | 29,306               |       |   | 25,104 |   |   | 4,202 |   |   | 17 |   |   |
| Residential  Broadband subscribers (2)              |       | 20,963               |       |   | 16,623 |   |   | 4,340 |   |   | 26 |   |   |
| Residential  Broadband Revenue-generating units (3) |       | 49,709               |       |   | 38,818 |   |   | 10,891 |   |   | 28 |   |   |
|                                                |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| **Wireless**                                        |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Subscribers                                         |       | 53,286               |       |   | 52,887 |   |   | 399 |   |   | 1 | % |   |

 

(1)     Internetsubscribers are customers who receive data services primarily within SureWestTelephone’s service area.

(2)     ResidentialBroadband subscribers are customers who receive digital video, voice and/ordata services from 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.

 

16

 

Operatingrevenues from external customers in the Telecom segment decreased $1,582 forthe quarter ended March 31, 2006 compared to the same period in 2005. SureWestTelephone continues to experience decreases in local and network access as aresult of competition from wireless (including SureWest Wireless) and wirelinecompetitors and an approximate 2% decline in access lines. In addition, networkaccess revenues decreased due to a decline in the rate base, which affects theinterstate pool settlements from National Exchange Carrier Association (“NECA”)(see *Regulatory Matters* withinthe *Telecom Segment Results of Operationsand Critical Accounting Policies and Estimates* sections below). SureWestTelephone’s revenues are also impacted by shareable earnings obligations, whichis also discussed below in the *TelecomSegment Results 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 $2,284 for the quarter ended March 31, 2006compared to the same period in 2005. At March 31, 2006, the Broadband segmentexperienced a 17% annual increase in the number of Internet subscribers. Moresignificantly, at the same date, the broadband residential services businessrealized 26% and 28% annual increases in Broadband Residential subscribers andRevenue-generating units, respectively. While continuing to produce significantrevenue increases, the expansion of the broadband residential services has andwill continue to require significant capital and expense commitments.

 

Operatingrevenues from external customers in the Wireless segment for the quarter endedMarch 31, 2006 increased $213 compared to the same period in 2005. The numberof wireless subscribers increased to 53,286 at March 31, 2006, a 1% increasefrom March 31, 2005. The increase in operating revenues was also due to anincrease in equipment revenue resulting from an increase in the average sellingprice per handset and an increase in the number of handsets sold.

 

TheCompany’s consolidated operating expenses, excluding depreciation andamortization, decreased $1,894 in 2006 compared to the prior year. In late2004, 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 to retirement benefits, eligible employeesreceive enhanced medical benefits for a specified period of time. During the quarterended March 31, 2005, the Company recorded $791 in operating expensesattributed to 13 additional employees that accepted the REWARD 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 $900 in 2006 compared to the prior year. TheCompany also expects to continue to identify and eliminate additionalfunctional redundancies, combine duplicate or overlapping work areas, andfurther reduce overall labor costs.

 

Costof services and products expense decreased $805 due primarily to a decline inexpenses for network operations as a result of the cost reduction and workforceconsolidation. The decrease in network operations expense was largely offset by(i) an increase in video license fees as the number of subscribers within theBroadband segment continued to grow and (ii) a 10% increase in the average costof wireless handsets related to an increase in Wireless equipment sales. Customeroperations and selling expense increased $459 in the current year due primarilyto an increase in sales and advertising costs to promote new product offeringswithin the Broadband segment. General and administrative expenses decreased$1,548 primarily as a result of a decline in consulting and audit fees relatedto Sarbanes-Oxley Act implementation and compliance as well as a result of thecost reduction and workforce consolidation.

 

TheCompany’s consolidated depreciation and amortization expense increased $1,765during the first quarter in 2006 compared to the same period in 2005 primarilydue to the continued network build-out within the residential broadband serviceterritories.

 

17

 

*Reclassifications*

 

Certain revenues in theCompany’s 2005 condensed consolidated financial statements have beenreclassified to conform to the presentation of the Company’s 2006 condensedconsolidated financial statements.

 

**SegmentResults of Operations**

 

**Telecom**

 
|                                              | ** ** | **Quarter  Ended March 31,** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|
|                                              | ** ** | **2006**                     | ** ** | **2005** | ** ** | **$   Change** | ** ** | **%   Change** | ** ** |
|                                              |       |                         |       |   |   |   |   |   |   |
| Local service                                     |       | $                            | 15,819     |   |   | $ | 16,037 |   |   | $ | (218 | ) |   | (1 | )% |   |
| Network access  service                           |       | 9,679                        |       |   | 10,633 |   |   | (954 | ) |   | (9 | ) |   |
| Directory  advertising                            |       | 4,428                        |       |   | 4,295 |   |   | 133 |   |   | 3 |   |   |
| Long distance  service                            |       | 1,384                        |       |   | 1,497 |   |   | (113 | ) |   | (8 | ) |   |
| Other                                             |       | 579                          |       |   | 1,009 |   |   | (430 | ) |   | (43 | ) |   |
| Total operating  revenues from external customers |       | 31,889                       |       |   | 33,471 |   |   | (1,582 | ) |   | (5 | ) |   |
| Intersegment  revenues                            |       | 7,328                        |       |   | 6,876 |   |   | 452 |   |   | 7 |   |   |
| Operating  expenses*                              |       | 18,829                       |       |   | 22,269 |   |   | (3,440 | ) |   | (15 | ) |   |
| Depreciation and  amortization                    |       | 6,318                        |       |   | 5,995 |   |   | 323 |   |   | 5 |   |   |
| Income from  operations                           |       | 14,070                       |       |   | 12,083 |   |   | 1,987 |   |   | 16 |   |   |
| Net income                                        |       | $                            | 8,220      |   |   | $ | 7,073 |   |   | $ | 1,147 |   |   | 16 | % |   |

*Exclusive of depreciation and amortization

 

*OperatingRevenues*

 

Operatingrevenues from external customers in the Telecom segment decreased $1,582 forthe quarter ended March 31, 2006 compared to the same period in 2005. SureWestTelephone continues to experience decreases in local and network access as aresult of competition from wireless (including SureWest Wireless) and wirelinecompetitors and an approximate 2% decline in access lines. In addition, networkaccess revenues decreased due to a decline in the rate base, which affects theinterstate pool settlements from NECA (see *RegulatoryMatters* and *Critical AccountingPolicies and Estimates* sections below). SureWest Telephone’srevenues are also impacted by shareable earnings obligations, which is alsodiscussed below in the *Telecom SegmentResults of Operations*.

 

*Operating Expenses*

 

Operatingexpenses for the Telecom segment decreased $3,440 for the quarter ended March31, 2006 compared to the same period in 2005. This decrease in operatingexpense was due in large part to labor savings realized through the costcontainment and workforce consolidation plan, as described in the *Consolidated Overview* section above. Thesesavings were partially offset by operating expenses of approximately $640related to the REWARD program, as described in the *Consolidated Overview* section above.

 

Cost of services andproducts (exclusive of depreciation and amortization) decreased $1,810 for thequarter ended March 31, 2006 compared to the same period in 2005. The decreasewas attributable to the labor savings realized through the cost containment andworkforce consolidation plan and the inclusion in 2005 of costs related to theREWARD program.

 

Customeroperations and selling expense decreased $293 for the quarter ended March 31,2006 compared to the same period in 2005, due primarily to decreases in laborcosts for product management and customer and operator services as a result ofa reduction in employee headcount and internal efficiencies resulting fromintegrated customer support systems and productivity gains.

 

18

 

Generaland administrative expense decreased $1,337 for the quarter ended March 31,2006 compared to the same period in 2005 as a result of a decline in audit andconsulting fees related to Sarbanes-Oxley Act implementation and compliance.

 

*RegulatoryMatters*

 

Revenues from servicessubject to regulation constituted approximately 47% and 50% of the Company’stotal operating revenues for the quarters ended March 31, 2006 and 2005,respectively. Those revenues, which include local service, network accessservice and toll service, are derived from various sources, including:

 

•                                             businessand residential subscribers, for basic exchange services;

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

•                                             longdistance carriers, for network access service;

•                                             competitiveaccess providers and subscribers, for network access services;

•                                             interstatepool settlements from NECA;

•                                             supportpayments from federal or state programs; and

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

 

Revenues from certaintelephone services are affected by rates authorized by various regulatoryagencies. Intrastate service rates are subject to regulation by the CPUC. Withrespect to toll calls initiated by interexchange carriers’ customers, theinterexchange carriers are assessed access charges based on tariffs filed bySureWest Telephone. Interstate access rates and resultant earnings are subjectto regulation by the FCC. With respect to interstate services, SureWestTelephone has filed its own tariff with the FCC for all elements of accessservices except carrier common line charges, for which SureWest Telephoneconcurs with tariffs filed by NECA.

 

The FCC monitorsSureWest Telephone’s interstate earnings through the use of annual costseparation studies prepared by SureWest Telephone, which utilize estimated costinformation and projected demand usage. The FCC establishes rules thatcarriers must follow in the preparation of the annual studies. Additionally,under current FCC rules governing rate making, SureWest Telephone isrequired to establish interstate rates based on projected demand usage for itsvarious services and determine the actual earnings from these rates once actualvolumes and costs are known. Based on preliminary cost studies, the Companyrecognized liabilities relating to SureWest Telephone’s estimated interstateshareable earnings obligations of $80 for the quarter ended March 31, 2005through reductions of revenues (none in 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 toterminate its annual EAS payments to SureWest Telephone effective November 30,2000. The CPUC authorized replacement funding to SureWest Telephone on aninterim basis using funds from the CHCF. The CHCF is a program designed by theCPUC to establish a fair and equitable local rate structure and to reduce anydisparity in the rates charged by telephone companies serving high-cost areas.The CHCF is scheduled to expire January 1, 2009. In addition, the CPUCopened an Order Instituting Investigation (“OII”) for the purpose ofdetermining whether future recovery of all, none, or a portion of theapproximate $11,500 annual payments previously received from AT&T andcurrently 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.

 

19

 

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.

 

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, plusinterest at the 90-day commercial paper rate for non-financial institutions,which was 4.76% as of March 31, 2006, and an imputed rate of 3.15%, to its endusers through a consumer dividend over a period of four years, which beganJanuary 1, 2005. For the quarters ended March 31, 2006 and 2005, approximately$515 and $395, was returned to the end users, respectively. In addition,SureWest Telephone will pay a one-time consumer dividend of $2,600, whichincludes an annual imputed interest rate of 3.15% (no stated contractualinterest rate), over two years, which began January 1, 2005 to settle themonitoring periods 2000 to 2004. For the quarters ended March 31, 2006 and 2005approximately $301 and $289, respectively, was returned to the consumers andwas recorded as a reduction of the Company’s contractual shareable earningsobligations. At March 31, 2006, the aggregate contractual shareable earningsobligation for these surcredits was $5,859 (which is net of an unamortizeddiscount pertaining to imputed interest of $226 at that date).

 

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 effectiveJanuary 1, 2006.

 

As a result of periodiccost separation studies, SureWest Telephone may change its estimates for aportion of its interstate shareable earnings obligations related to prior yearmonitoring periods. The Company did not record any significant changes inestimates during the quarters ended March 31, 2006 and 2005.

 

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 draft decision required all Incumbent LocalExchange Carriers (“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 SureWest Telephone did not recover any lost revenuesfrom end users, the decision could ultimately result in a loss of revenues ofup to $4,400 on a prospective basis. The Company sought modification of thedraft decision on the basis that the CPUC had indicated that it was prepared toact only with respect to larger ILECs, and thus denied SureWest Telephone dueprocess. In the final decision, the CPUC deferred the elimination of the TICelement for SureWest to the next phase of the proceeding. The ultimate resultsof this proceeding and the potential effects on SureWest Telephone cannot yetbe determined.

 

As of March 31, 2006, theCompany’s consolidated balance sheet reflected aggregate liabilities of $293relating to SureWest Telephone’s estimated interstate shareable earningsobligations. The calculations supporting these

 

20

 

liabilities are verycomplex and involve a variety of estimates prior to the ultimate settlement ofsuch obligations. In addition, SureWest Telephone’s interstate shareableearnings obligations lapse over time if SureWest Telephone’s interexchangecarrier and other customers do not claim the amounts ascribed to them.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.

 

# **Broadband**

 
|                                              | ** ** | **Quarter  Ended March 31,** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|
|                                              | ** ** | **2006**                     | ** ** | **2005** | ** ** | **$   Change** | ** ** | **%   Change** | ** ** |
|                                              |       |                         |       |   |   |   |   |   |   |
| Internet service                                  |       | $                            | 4,898      |   |   | $ | 4,313 |   |   | $ | 585 |   |   | 14 | % |   |
| Residential  Broadband service                    |       | 6,650                        |       |   | 5,597 |   |   | 1,053 |   |   | 19 |   |   |
| Business  Broadband service                       |       | 2,333                        |       |   | 1,687 |   |   | 646 |   |   | 38 |   |   |
| Total operating  revenues from external customers |       | 13,881                       |       |   | 11,597 |   |   | 2,284 |   |   | 20 |   |   |
| Intersegment  revenues                            |       | 424                          |       |   | 443 |   |   | (19 | ) |   | (4 | ) |   |
| Operating expenses*                               |       | 16,670                       |       |   | 14,732 |   |   | 1,938 |   |   | 13 |   |   |
| Depreciation and  amortization                    |       | 5,197                        |       |   | 3,634 |   |   | 1,563 |   |   | 43 |   |   |
| Loss from  operations                             |       | (7,562                       | )          |   | (6,326 | ) |   | (1,236 | ) |   | (20 | ) |   |
| Net loss                                          |       | $                            | (5,089     | ) |   | $ | (4,101 | ) |   | $ | (988 | ) |   | (24 | )% |   |

*Exclusive of depreciation and amortization

 

*OperatingRevenues*

 

Operating revenues from external customers in the Broadbandsegment increased $2,284 for the quarter ended March 31, 2006 compared to thesame period in 2005. The increase in Broadband revenues was due to the combinedeffects of (i) a 26% increase in subscribers of broadband residential services,(ii) a 17% increase in the residential and business DSL subscriber customerbase and (iii) the continued expansion of the business broadband services.

 

*Operating Expenses*

 

Totaloperating expenses in the Broadband segment increased $1,938 for the quarterended March 31, 2006 compared to the same period in 2005. Costof services and products (exclusive of depreciation and amortization) increased$1,248 for the quarter ended March 31, 2006 compared to the same period in2005, due primarily to (i) an increase in programming and transport costsrelated to the growth in Broadband subscribers and residential broadbandRevenue-generating units, (ii) an increase in access expense and general supportcosts corresponding to the increased subscriber count, as well as the expandednetwork footprint and (iii) an increase in property taxes predominantly due tothe increase in property, plant and equipment as the network has expanded. Theincrease in cost of services and products was offset in part by labor savingsrealized through the cost containment and workforce consolidation plan, asdescribed in the *Consolidated Overview*section above.

 

Customeroperations expense increased $749 for the quarter ended March 31, 2006 comparedto the same period in 2005. The increase was attributable to an increase insales and advertising costs to promote new product offerings within theBroadband segment. In addition, customer service costs increased as a result ofthe increased call volume caused by the increase in subscribers of broadbandresidential services.

 

Generaland administrative expense decreased $59 for the quarter ended March 31, 2006compared to the same period in 2005 as a result of a decline in audit andconsulting fees related to Sarbanes-Oxley Act implementation and compliance.

 

Depreciationand amortization increased $1,563 for the quarter ended March 31, 2006 comparedto the same period in 2005, primarily due to continued network build-out withinthe residential broadband service territories.

 

21

 

# **Wireless**

 
|                                       | ** ** | **Quarter  Ended March 31,** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
|                                       | ** ** | **2006**                     | ** ** | **2005** | ** ** | **$  Change** | ** ** | **%  Change** | ** ** |
| ** **                                 | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Wireless  revenues from external customers |       | $                            | 8,601      |   |   | $ | 8,388 |   |   | $ | 213 |   |   | 3 | % |   |
| Intersegment  revenues                     |       | 680                          |       |   | 598 |   |   | 82 |   |   | 14 |   |   |
| Operating  expenses*                       |       | 9,213                        |       |   | 9,090 |   |   | 123 |   |   | 1 |   |   |
| Depreciation and  amortization             |       | 2,963                        |       |   | 3,084 |   |   | (121 | ) |   | (4 | ) |   |
| Loss from  operations                      |       | (2,895                       | )          |   | (3,188 | ) |   | 293 |   |   | 9 |   |   |
| Net loss                                   |       | $                            | (1,932     | ) |   | $ | (2,129 | ) |   | $ | 197 |   |   | 9 | % |   |

*   Exclusiveof depreciation and amortization

 

*Operating Revenues*

 

Operating revenues from external customers in theWireless segment increased $213 for the quarter ended March 31, 2006 comparedto the same period in 2005. Although the subscriber base grew 1% at 2006quarter-end over prior year, the average access rate per contract subscriberdeclined by 2% as subscribers shift to lower-priced calling plans. The increasein operating revenues was also due to an increase in equipment revenueresulting from an increase in the average selling price per handset and anincrease in the number of handsets sold.

 

*Operating Expenses*

 

Totaloperating expenses for the Wireless segment increased $123 for the quarterended March 31, 2006 compared to the same period in 2005. Although the Wirelesssegment experienced an overall increase in operating expenses, the increase wasoffset, in part, by efficiencies gained through the cost containment andworkforce consolidation plan, as described in the *Consolidated Overview* section above.

 

Costof services and products (exclusive of depreciation and amortization) increased$215 for the quarter ended March 31, 2006 compared to the same period in 2005,primarily due to increases in (i) the average cost and quantity of handsetssold and (ii) long distance expense due to an increase in the minutes of use.These increases were mostly offset by a decrease in labor costs in networkoperations through the corporate restructuring.

 

Generaland administrative expense decreased $154 for the quarter ended March 31, 2006compared to the same period in 2005, due primarily to a decrease in labor costsand as a result of a decline in audit and consulting fees related toSarbanes-Oxley Act implementation and compliance.

 

Depreciationand amortization decreased $121 for the quarter ended March 31, 2006 ascompared to the same period in 2005, primarily due to (i) property andequipment reaching full depreciation and (ii) reduced capital expenditures.

 

**Non-operatingItems**

 

*Other Income and Expense, Net*

 

Interest expenseincreased $390 for the quarter ended March 31, 2006 compared to the same periodin 2005. The increase in interest expense was due to both increases inshort-term borrowings and the weighted average cost of debt during the currentyear compared to the same prior year period.

 

*Income Taxes*

 

Incometaxes increased $244 for the quarter ended March 31, 2006 compared to the sameperiod in 2005, due primarily to corresponding increases in income subject totax. The effective federal and state income tax rates were approximately 39.5%and 39.0% for the quarters ended March 31, 2006 and 2005, respectively.

 

22

 

## **Liquidityand Capital Resources**

## ** **

Asreflected in the Condensed Consolidated Statements of Cash Flow, net cashprovided by the Company’s operating activities was $11,459 for the three-monthperiod ended March 31, 2006 primarily due to (i) net income of $1,199, (ii)non-cash charges of $14,478 consisting of depreciation and amortization due tocapital investments principally in the Broadband segment and (iii) a decreasein trade and miscellaneous accounts receivable balances of $2,320 due in partto the timing of a payment received from the CHCF. These amounts were offset by(i) a decrease in accounts payable and accrued liabilities of approximately$6,200 primarily due to a decrease in outstanding obligations related toprofessional fees, capital project expenditures and directory production costsand (ii) an approximate $768 decrease in the Company’s estimated andcontractual shareable earnings obligations due primarily to the surcredit toend users resulting from the November 2004 intrastate settlement agreement.

 

Net cash used in theCompany’s investing activities for the three-month period ended March 31, 2006 was $11,818 due tocapital expenditures pertaining to ongoing plant construction projects.

 

Net cash used in theCompany’s financing activities was $667 for the three-month period ended March 31,2006 due primarily to dividend payments of $3,658 offset by a $3,000 increasein short-term borrowings.

 

The Company’s workingcapital was $7,618 at March 31, 2006. The increase compared to the prior yearwas primarily attributable to the reclassification of short-term borrowings tolong-term debt as a result of borrowings under the Credit Agreement describedbelow, in addition to a decrease in accounts payable and other accruedliabilities. The increase in working capital was offset by a decrease in cashand short-term investments used to fund operations and other cash needs asdescribed above, in addition to a decrease in net accounts receivables and anincrease in deferred revenues. As discussed below, the Company believes thatits working capital position, operating cash flows and borrowing capacity aresufficient to satisfy its 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 $49,000, (ii) scheduled payments of long-termdebt of $3,636, (iii) support of the operations of SureWestBroadband/Residential Services up to an anticipated $4,020 and (iv) support ofthe operations of SureWest Wireless up to an anticipated $114. In addition,during 2006 the payment of additional dividends, which is at the discretion ofthe Company’s Board of Directors, could be as much as $11,000 based on theCompany’s most recent dividend and payments. A substantial portion of the 2006budgeted capital expenditures is at the discretion of the Company, anddependent upon the Company’s working capital position, operating cash flows andability to borrow, as described below. The Company is required to comply withits cable franchise agreements to continue its build-out in the franchiseareas.

 

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. The amount of this support from the CHCF is the subject of pendingregulatory proceedings (for a more detailed discussion, see *Regulatory Matters* within the TelecomSegment Results of Operations). In addition, the CHCF is scheduled to expireJanuary 1, 2009.

 

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 ispayable quarterly and based on a LIBOR-based, variable interest rate, or afixed interest rate pricing formula, or a combination, as defined in the CreditAgreement. Principal payments on the outstanding amounts borrowed under the TermLoan facility as of December 31, 2007 are due in equal quarterly installmentscommencing March 31, 2008 through June 30, 2016. The Revolving Loan facilityhas an expiration date of June 30, 2013. The Company used the Term Loanfacility to retire short-term borrowings with an outstanding principal balanceof $33,000 as of March 31, 2006.

 

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 March 31, 2006 and December31, 2005, there was $33,000 and $30,000 outstanding under this credit facility,respectively, and the weighted average interest rate was 6.16% and 5.75%,

 

23

 

respectively, which wasbased on a LIBOR-based pricing formula. As a result of the availabillity of theLoan Facility, 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 transactions, subject to overallfinancial and market conditions. Through March 31, 2006 approximately onemillion shares of common stock had been repurchased. The Company has remainingauthorization from the Board of Directors to repurchase an additional 466thousand 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 March 31, 2006, of $6,607. Subsequently, the Companyreceived the proceeds from the Credit Agreement, described above. The Companyinitially received the principal amount of $40,000 from the Term Loan facility,of which the Company used $33,000 of the proceeds to terminate the bank line ofcredit. Accordingly, the Company believes that its working capital position,additional available funds from the Credit Agreement, operating cash flows andborrowing capacity are sufficient to satisfy its liquidity requirements in thenext twelve months. The Company’s forecast indicates it is likely that theCompany will continue to draw on available funds during the next twelve monthsto fund operations and planned capital expenditures, including capitalexpenditures as required by the Company’s cable franchise agreements, whilemaintaining adequate cash and cash equivalents. Such draws might be undertakenunder the Credit Agreement using the Revolving Credit facility or the availableTerm Loan facility, or a combination of the two facilities. The Companybelieves, given its financial position and debt-to-equity position, it hassubstantial additional short-and long-term borrowing capacity. As indicatedabove, a substantial portion of the Company’s 2006 budgeted capitalexpenditures and cash dividend payments are at the discretion of the Company.Accordingly, the Company believes that it can modify its planned constructioncommitments and cash dividend payments if the results of operations oravailable 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 isrequired to maintain certain financial ratios and minimum levels of tangiblenet worth. Under the Company’s Note Purchase Agreement and the new CreditAgreement, retained earnings of approximately $69,590 would have been availablefor the payments described immediately above.

 

The Company has variouscable television franchise agreements with associated letters of credittotaling $150 in the aggregate as of March 31, 2006.

 

**RelatedParty Transaction**

 

BeginningJanuary 1, 2005, the Company’s employees were covered under an eye care benefitplan from an entity, of which one of the Company’s Board Members is a directorand also an executive officer. Negotiations regarding the benefit plan werecompleted before that entity’s director and executive officer was elected tothe Company’s Board of Directors and without his involvement or knowledge. TheCompany’s payments to such entity approximated $4 and $3 during the quartersended March 31, 2006 and 2005, respectively.

 

## **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:

 

24

 

•                  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);

•                  a14.5% weighted average cost of capital based on industry weighted average costof capital; and

•                  noterminal growth rate.

 

The carrying value of theCompany’s goodwill was $2,171 as of March 31, 2006. When determining the fairvalue, the use of different estimates or assumptions within the discounted cashflow model when determining fair value of the Company’s goodwill could resultin a different fair value. For example, the Company used a discount rate of14.5% and no terminal growth rate in its assessment of fair value in 2005. Ifthe 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 wirelesslicenses include Personal Communications Services (“PCS”) and Local MultipointDistribution Service (“LMDS”) licenses. The carrying value at December 31, 2005of the PCS and LMDS licenses was $8,925 and $4,641, respectively. In assessingthe recoverability 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 therecoverability of the Company’s LMDS licenses, the Company obtained anindependent valuation, as comparable license sales data was not available. Theindependent valuation estimates fair value of the Company’s LMDS licenses usinga discounted cash flow model. Assumptions used in this model include thefollowing:

 

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

•                  a20% weighted average cost of capital based on industry weighted average cost ofcapital adjusted to reflect the inherent risks associated with the introductionof a new service offering; and

•                  a4% terminal value growth rate.

 

The use of differentestimates or assumptions within the discounted cash flow model when determiningfair value of the Company’s LMDS licenses could result in different values forthese licenses. For example, the Company used a discount rate of 20% and aterminal growth rate of 4% in its assessment of fair value in 2005. If thediscount rate were to increase 1%, the fair value of the LMDS licenses woulddecrease by $700, which would result in an impairment charge of approximately$324 based on the carrying value of the LMDS licenses as of December 31,2005. In addition, the Company’s LMDS licenses may be impaired in the nearfuture if the estimates and assumptions used in the 2005 LMDS licensediscounted cash flow model are not met.

 

If the estimated fairvalue is less than the carrying value, then the carrying value is written downto the fair value. As a result of the Company’s annual test for 2005, noimpairment of either goodwill or PCS or LMDS licenses was indicated. During thequarter ended March 31, 2006, the Company was unaware of any events or changesin circumstance that would require a test of impairment that may potentiallyreduce 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 isrequired to prospectively set its annual interstate rates based on theaforementioned cost separation studies. These cost studies include estimatesand assumptions regarding various financial data including operating expenses,taxes and investment in

 

25

 

property, plant andequipment. Non-financial data estimates are also utilized in the preparation ofthese cost studies, including projected demand usage and detailed networkinformation. The Company must also make estimates of the jurisdictionalseparation of this data to assign current financial and operating data to theinterstate or intrastate jurisdiction. These estimates are finalized in futureperiods as actual data becomes available to complete the separation studies.The Company also participates in the NECA pool for certain interstate revenues.In addition to the estimates noted above, the Company’s earned rate-of-returnfrom its participation in the NECA pool can also be impacted by the earningsand data of other carriers who participate in the pool.

 

In accordance with theNRF, SureWest Telephone is subject to ongoing monitoring and reportingrequirements by the CPUC, and it was initially required to share earnings withcustomers based on its earned annual rate-of-return. The Company utilizesmodels, which rely on estimates regarding the jurisdictional separation offinancial data and operational data into the interstate jurisdictions asdiscussed previously for the purposes of calculating its earned annualrate-of-return. However, as discussed more fully in Note 3, SureWest Telephonehas entered into a settlement agreement which was approved by the CPUC in November 2004,to cease intrastate sharing requirements beginning January 1, 2005 through atleast December 31, 2010. The settlement agreement also resolves existingsharing obligations and related earnings issues for the monitoring periods 2000-2004.

 

As a result of theseestimates and assumptions, it is reasonably possible that management’sestimates of SureWest Telephone’s shareable earnings obligations could changein the near term, and the amounts involved could be material.

 

•                                          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.

 

•                                          TheCompany maintains allowances for doubtful accounts for estimated lossesresulting from the potential inability of its customers to make requiredpayments. In evaluating the collectibility of its accounts receivable, theCompany assesses a number of factors including a specific customer’s or carrier’sability to meet its financial obligations to the Company, the length of timethe receivable has been past due and historical and future expectations ofconditions that may impact the Company’s ability to collect its accountsreceivable. If circumstances change or economic conditions worsen such that theCompany’s past collection experience is no longer relevant, the Company’sestimate of the recoverability of its accounts receivable could be furtherreduced from the levels reflected in the Company’s consolidated balance sheet.If uncollectibility of the Company’s billed revenue changes by 1%, the Companywould expect an increase in uncollectible expense of approximately $2,200. Asof March 31, 2006, the Company had three customers that accounted for 5% ofconsolidated accounts receivable. Although management believes that thesecustomers are creditworthy, a severe adverse impact on their businessoperations could have a corresponding material effect on their ability to paytimely and, therefore, on the Company’s results of operations, cash flows andfinancial condition. In addition, certain revenues are subject to refund if thecustomer terminates services or returns equipment within a stipulated timeperiod, or if certain performance criteria are not met. Accordingly, theCompany maintains accounts receivable allowances and recognizes certaincustomer refund liabilities, through charges to revenues, based on the Company’sbest estimates of the resolution of these contingencies, which are based onhistorical experience.

 

•                                          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 methodologyutilized for 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.

 

26

 

Property,plant and equipment is depreciated or amortized using the straight-line methodover their estimated economic lives. The economic lives are estimated at thetime the assets are acquired and are based on historical experience withsimilar assets, as well as anticipated technological or other changes. Iftechnological changes were to occur more rapidly than anticipated ordifferently than anticipated, the economic lives assigned to these assets mayneed 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 retirementobligation when a legal obligation exists to remove an asset at some point inthe future or if legislation exists that requires special disposal proceduresof the asset. The Company believes it may have potential retirement obligationsrelating to its wireless cell sites and disposal obligations relating tocertain building materials containing asbestos. Based on terms outlined in itstower leases, the Company is obligated to return the land or facilities totheir original condition at the end of the cell site lease term, should thelease be terminated. Based on the Company’s estimates it believes that thedisposal requirement relating to certain building materials containing asbestosis the expected retirement date of the underlying assets. The Company has useda probability-weighted cash flow approach in estimating its potentialretirement obligations. The Company calculates the net present value of theretirement obligation assuming an inflation rate of 3%, a discount rate of 7%and a market risk premium of 4%. The Company has also assumed the settlementdate for its wireless towers to be 25 years from the date the asset is placedinto service. The Company has estimated that the expected retirement date ofits buildings that contain asbestos is 2025. The Company has also used aprobability-weighted assessment to address the uncertainty regarding the timingof future cash flows to settle the potential liability. The Company believesthat utilizing probabilities for its wireless towers of less than 100% isappropriate because the Company believes the likelihood of incurring materialasset retirement expenditures is remote. The Company used a 100% probabilityfactor of its building materials containing asbestos. The Company monitors theestimates and assumptions used in determining its potential asset retirementobligations for its cell sites and buildings containing asbestos. However, theCompany believes it is remote that any future adjustment to its assetretirement liability for obligations existing as of March 31, 2006 will bematerial to the Company’s consolidated financial 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 areexpected to reverse. The Company does not have a valuation allowance on itsdeferred tax asset as of March 31, 2006 and December 31, 2005 because itbelieves it is more likely than not that such deferred tax asset will berealized. Should the Company determine that it would not be able to realize allor part of its deferred tax asset in the future, an adjustment to the deferredtax asset would be charged to income in the period in which the determinationwas 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. Aone-percentage-point change in assumed health care cost trend rates would havethe following effects:

 

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|                                                                  |   | 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 discountrates used for the Company’s pension and post-retirement benefit obligationswere 5.75% and 5.50%, respectively. The discount rates were determined based oncurrent yields on high quality corporate fixed-income investments withmaturities corresponding to the expected duration of the benefit obligations.The rate used for the post-retirement benefit obligation reflects heavierweighting for retired participants of shorter durations.

 

The expected return onassets (“EROA”) rate is determined based on the current and projectedinvestment portfolio mix and estimated long-term investment returns for eachasset class. In 2005, the Company used an EROA of 8.5%. The Company evaluatedthe appropriateness of the EROA rate for 2006 by analyzing the long-termreturns for domestic and international equities, as well as domestic fixedincome instruments. Based on the evaluation the Company decreased the EROA for2006 to 8.0% to better reflect the current economic environment. The 0.5%decrease in the EROA rate will increase the Company’s 2006 pension expenseapproximately $550, or 9.0%.

 

The future compensationlevels are based on recent experience as well as future expectations. As ofDecember 31, 2005 and during 2006, the Company expects its future compensationlevel to remain consistent at 5.0%, which is consistent with the prior year.

 

•                                          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.

 

•                                          The Companycurrently 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 theCompany of awards in the form of restricted shares, stock units, performanceshares, stock options and stock appreciation rights.

 

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standards (“SFASNo.”) 123(R), *Share-Based Payment*,using the modified-prospective-transition method. Because the fair valuerecognition provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation* and SFAS No. 123(R) were materiallyconsistent under the Company’s Plans, the adoption of SFAS No. 123(R) did nothave a significant impact on the Company’s financial position or results ofoperations. 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 the fair value recognition provisionsof 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 March 31, 2006, total unrecognized compensation cost related to nonvestedrestricted stock was $1,934 and will be recognized over a weighted-averageperiod of approximately three years. The total fair value of restricted stockshares that vested during the first quarter ended March 31, 2006 was $246.

 

Stockbased compensation for restricted stock reflects the cost of restricted stockthat is expected to vest. The Company calculated an estimated forfeiture ratebased on historic forfeiture experience to date. If

 

28

 

actualforfeitures are not consistent with the Company’s estimated forfeiture rate, itwill be required to record adjustments to compensation expense.

 

TheBlack-Scholes-Merton option-pricing model used to value stock option grants includesassumptions regarding dividend yields, expected volatility, expected lives andrisk-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.

 

## **RecentAccounting Pronouncements**

## ** **

EffectiveJanuary 1, 2006 the Company adopted SFAS No. 154, *Accounting Changes and Error Corrections.*The Statementapplies to all voluntary changes in accounting principle, and changes therequirements for accounting for and reporting of a change in accountingprinciple. The adoption of SFAS No. 154 has not had a material effect on theCompany’s consolidated financial position, results of operations or cash flows.

 

## **FactorsThat Could Affect 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 to face significant competitionin all parts of our business and the level of competition is expected tointensify.*   The telecommunications industry is highly competitive. We face actual orpotential competition from many existing and emerging companies, includingother incumbent and competitive local telephone companies, long-distancecarriers and resellers, wireless telephone companies, Internet serviceproviders, satellite companies and cable television companies. We may not beable to successfully anticipate and respond to various competitive factorsaffecting the industry, including regulatory changes that may affect ourcompetitors and us differently, new technologies and services that may beintroduced, changes in consumer preferences, demographic trends and discountpricing strategies by competitors. As the incumbent carrier in Sacramento,AT&T Inc. enjoys certain business advantages, including its size, financialresources, favorable regulatory position, brand recognition and connection tovirtually all of our customers and potential customers there. As the largestcable operator in Sacramento and Placer County, Comcast enjoys certain businessadvantages, including its size, financial resources, ownership or superioraccess 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 rapid technological change.*   Technological developments couldincrease our costs and cause a decline in demand for our services. In addition,technology changes can reduce the costs of entry for others and givecompetitors significant new advantages. If we do not replace or upgrade technologyand equipment that becomes obsolete, we will be unable to compete effectivelybecause we will not be able to meet the needs or expectations of our customers,and we may be placed at a cost disadvantage in offering our services.Additionally, replacing or upgrading our infrastructure in the future couldresult in significant capital expenditures.

 

*We are subject to a complex and uncertain regulatoryenvironment.**  *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 have undergone material changes, andour actual operating results can be expected to differ from the resultsindicated 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

 

29

 

ofoperating assets differs from those operations upon which our historicalfinancial statements are based. Consequently, our historical financialstatements may not be reliable as an indicator of future results.

 

*Our success depends upon our ability to manage ourgrowth and expansion. If our recent acquisitions and growth initiatives are notsuccessful, we could suffer an adverse effect on our business and results ofoperations.*   Our growth strategy will continue to require us to invest significantcapital in facilities and services that may not achieve the desired returns.Our future success depends, in part, upon our ability to manage our growth,including our ability to build network and related facilities to serve newcustomers, integrate our operations to take advantage of new capabilities andsystems, attract and retain skilled personnel across the Company, effectivelymanage the demands of day to day operations in new areas while attempting toexecute our business strategy, and realize the projected growth and revenuetargets developed by Company management.

 

*We receive support from various funds establishedunder federal and state law and the continued receipt of that support is notassured.*   Whilewe do not receive any support from the rural or non-rural Federal UniversalService high cost loop fund, we do receive payments from various other federalor state programs. These include interstate common line support, CHCF–B and theLifeline, Education and Libraries programs. These governmental programs arereviewed and amended from time to time, and are likely to change in the nearfuture. As described in *Regulatory Matters*within the Telecom Segment Results of Operations, 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. The amount of this support from the CHCF is the subject of pendingregulatory proceedings, and its continuation is dependent upon many factors. Inaddition, the state legislative authorization for the CHCF is scheduled toexpire January 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 the recent developmentsaffecting 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 third parties, over whom we have nocontrol, 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 to corporate governance and internalcontrol reporting requirements, and our failure to comply with existing andfuture requirements could adversely affect our business.*   Pursuant toSection 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”) andrelated Securities and Exchange Commission rules, we have issued a report ofmanagement’s assessment of the effectiveness of our internal controls atDecember 31, 2005. In addition, our Independent Registered PublicAccounting Firm audited and reported on management’s assessment. Managementconcluded that the Company’s internal control over financial reporting waseffective at December 31, 2005. If we are unable to maintain effectiveinternal controls or if future deficiencies are not adequately addressed, wecould experience accounting errors that could result in misstatements of ourfinancial position and results of operations, potential restatements of ourfinancial statements or otherwise adversely affect our business, reputation andresults of operations. Inferior internal controls could also cause investors tolose confidence in our reported financial information, which could have anegative effect on the trading price of our securities.

 

##### **Regulatory and LegalMatters**

 

30

 

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 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

•                                            Theregulated rates and earnings of 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 of pendingand anticipated other regulatory proceedings occurring at the federal and statelevels that may have a material impact on SureWest Telephone. These regulatoryproceedings include, but are not limited to, consideration of changes to theinterstate universal service fund, intercarrier compensation, reform and theregulation of local exchange carriers and their competitors, and regulation ofIP-enabled services. The outcomes and impact on SureWest Telephone’s operationsof these proceedings and related court matters cannot be determined at thistime.

 

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

 

 

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----

 

 

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

 

The Company’s****2005 Annual Report on Form 10-K containscertain disclosures about the Company’s limited exposure to market risk forchanges in interest rates. There have been no material changes to theinformation provided which would require additional disclosures as of the dateof this filing.

** **

**ITEM4. CONTROLS AND PROCEDURES.**

 

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

 

**Changein Internal Control over Financial Reporting**

 

As reported in theCompany’s previous periodic reports, in February 2005 the Company announcedthat it began a search for a President and CEO as a result of the indication byBrian H. Strom of his desire to ultimately retire from those positions. TheCompany conducted a search for a successor that would allow the new Presidentand CEO to serve with Mr. Strom prior to his formal retirement to assurean effective and smooth transition. Effective January 1, 2006, Steven C. Oldhamwas elected President and CEO while Mr. Strom remained an employee until March31, 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.

 

Except for the itemsdiscussed above, there has been no change in the Company’s internal controlover financial reporting during the quarter ended March 31, 2006 that hasmaterially affected, or is reasonably likely to materially affect, the Company’scontrol over financial reporting.

 

32

 

**PART II**

 

**ITEM 1.****                 LEGAL PROCEEDINGS.***(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 paymentspreviously received from AT&T should come from SureWest Telephone’sratepayers or other 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 advice letterwith the Commission’s Telecommunications Division to implement reductions toits business access line rates. The results of this proceeding and thepotential effects on SureWest Telephone could impact future funding levelsthrough the CHCF.

 

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 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 this matter(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.

 

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

 

33

 

Federal CommunicationsCommission (“FCC”) conducted proceedings and adopted orders implementing theAct’s provisions to open local exchange service markets, such as the market ofSureWest Telephone, to competition. These proceedings and orders address theregulation of competing telecommunications companies, interconnection, accesscharges and universal 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 IP-enabled services. The outcomesand impact on SureWest Telephone’s operations of these proceedings and relatedcourt 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.

 

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

 

There have been no materialchanges from risk factors disclosed in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005, identified in Item 1A of Part I of theForm 10-K.

 

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

 

Not applicable.

 

**ITEM 3.****                             DEFAULTS UPON SENIORSECURITIES.**

 

Not applicable.

 

**ITEM 4.****                             SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS.**

 

Not applicable.

 

**ITEM 5.****                             OTHER INFORMATION.**

 

Not applicable.

 

34

 

**ITEM 6. EXHIBITS.**

 

(a)          Indexto 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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       | 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 |

 

35

 
| **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            |       | Summary of Board of  Directors’ Compensation (Filed as Exhibit 99.1 to Form 8-K filed January 26,  2006)                                                                                                                                                                     |       | Incorporated by  reference |
| 10.24            |       | 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 |
| 10.25            |       | 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  |
| 10.26            |       | 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 |
| 10.27            |       | Form of Restricted  Stock Unit Award, dated January 26, 2005, between Registrant and Timothy D.  Taron and Roger J. Valine (Filed as Item 1.01 to Form 8-K filed  January 27, 2006)                                                                                     |       | Incorporated by  reference |
| 10.28            |       | 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 |
| 10.29            |       | 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 |
| 10.30            |       | 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             |
| 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             |

 

36

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                   | ** ** | **Method    of Filing** |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|
| 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          |

 

37

 

**SIGNATURES**

 

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

 
|   | SUREWEST COMMUNICATIONS    |                  |
|--------|----------------------------|-----------------------|
|   |                       | (Registrant)          |
|   |                       |
|   | By:                        | /s/ STEVEN C.  OLDHAM |   |
|   | Steven C.  Oldham,         |                  |
|   | President and  Chief       |                  |
|   | Executive  Officer         |                  |
|   |                       |
|   |                       |
|   | By:                        | /s/ PHILIP A.  GRYBAS |   |
|   | Philip A.  Grybas,         |                  |
|   | Senior Vice  President and |                  |
|   | Chief Financial  Officer   |                  |
|        |                            |                       |  |  |

 

Date:  May 1, 2006

 

38