Tableof Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

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

 

**For the quarterly period ended June 30,2008**

** **

**or**

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

 

**Commission File Number 0-556**

 

**SUREWESTCOMMUNICATIONS**

(Exact name of registrant as specified in itscharter)

 

| **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’s telephone number, includingarea code)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes    x                 No    o

 

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

 

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

 

Yes    o                 No    x

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

As of July 30, 2008, 13,954,433 shares of the registrant’s CommonStock were outstanding.

 

 

 

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Table of Contents

 

**TABLEOF CONTENTS**

 
| ** **                               | **Page**                                                                                    |
|------------------------------------------|---------------------------------------------------------------------------------------------|
| ** **                               | ** **                                                                                  |
| **PART I -  FINANCIAL INFORMATION** |
| ** **                               | ** **                                                                                  |
| Item 1.                                  | Financial Statements                                                                        | 1 |
|                                     |                                                                                        |   |
| Item 2.                                  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 19 |
|                                     |                                                                                        |   |
| Item 3.                                  | Quantitative and Qualitative Disclosures  About Market Risk                                 | 34 |
|                                     |                                                                                        |   |
| Item 4.                                  | Controls and Procedures                                                                     | 35 |
|                                     |                                                                                        |   |
| **PART II - OTHER  INFORMATION**    |
| ** **                               | ** **                                                                                  | ** ** |
| Item 1.                                  | Legal Proceedings                                                                           | 37 |
|                                     |                                                                                        |   |
| Item 1A.                                 | Risk Factors                                                                                | 37 |
|                                     |                                                                                        |   |
| Item 2.                                  | Unregistered Sales of Equity Securities and  Use of Proceeds                                | 37 |
|                                     |                                                                                        |   |
| Item 3.                                  | Defaults Upon Senior Securities                                                             | 37 |
|                                     |                                                                                        |   |
| Item 4.                                  | Submission of Matters to a Vote of Security  Holders                                        | 37 |
|                                     |                                                                                        |   |
| Item 5.                                  | Other Information                                                                           | 37 |
|                                     |                                                                                        |   |
| Item 6.                                  | Exhibits                                                                                    | 38 |
|                                     |                                                                                        |   |
| SIGNATURES                               |                                                                                        | 39 |

 

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Table of Contents

 

**PART 1– FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS.**

 

**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

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

 
| ** **                                                                  | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2008**                                  | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Operating revenues:**                                                     |       |                                      |       |                                              |       |   |   |   |   |
| Broadband                                                                   |       | $                                         | 35,600     |                                              | $          | 17,193 |   | $ | 62,642 |   | $ | 33,718 |   |
| Telecom                                                                     |       | 24,650                                    |       | 27,249                                            |       | 49,228 |   | 53,610 |   |
| Total operating revenues                                                    |       | 60,250                                    |       | 44,442                                            |       | 111,870 |   | 87,328 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Operating expenses:**                                                     |       |                                      |       |                                              |       |   |   |   |   |
| Cost of services and products (exclusive of  depreciation and amortization) |       | 22,994                                    |       | 13,566                                            |       | 41,962 |   | 28,420 |   |
| Customer operations and selling                                             |       | 8,754                                     |       | 6,552                                             |       | 16,324 |   | 13,316 |   |
| General and administrative                                                  |       | 8,416                                     |       | 8,777                                             |       | 18,673 |   | 17,217 |   |
| Depreciation and amortization                                               |       | 14,192                                    |       | 11,447                                            |       | 26,376 |   | 22,522 |   |
| Total operating expenses                                                    |       | 54,356                                    |       | 40,342                                            |       | 103,335 |   | 81,475 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Income from operations**                                                  |       | 5,894                                     |       | 4,100                                             |       | 8,535 |   | 5,853 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Other income (expense):                                                     |       |                                      |       |                                              |       |   |   |   |   |
| Interest income                                                             |       | 224                                       |       | 1,131                                             |       | 558 |   | 1,628 |   |
| Interest expense                                                            |       | (3,186                                    | )          | (1,716                                            | )          | (5,941 | ) | (3,144 | ) |
| Other, net                                                                  |       | (44                                       | )          | (100                                              | )          | (43 | ) | (151 | ) |
| Total other income (expense), net                                           |       | (3,006                                    | )          | (685                                              | )          | (5,426 | ) | (1,667 | ) |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Income from continuing operations before  income taxes                      |       | 2,888                                     |       | 3,415                                             |       | 3,109 |   | 4,186 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Income tax expense                                                          |       | 1,191                                     |       | 745                                               |       | 1,423 |   | 904 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Income from continuing operations**                                       |       | 1,697                                     |       | 2,670                                             |       | 1,686 |   | 3,282 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| Discontinued operations, net of tax:                                        |       |                                      |       |                                              |       |   |   |   |   |
| Income (loss) from discontinued operations                                  |       | 211                                       |       | (885                                              | )          | 505 |   | (445 | ) |
| Gain (loss) on sale of discontinued operations                              |       | 18,977                                    |       | (279                                              | )          | 18,977 |   | 59,902 |   |
| Total discontinued operations                                               |       | 19,188                                    |       | (1,164                                            | )          | 19,482 |   | 59,457 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Net income**                                                              |       | $                                         | 20,885     |                                              | $          | 1,506 |   | $ | 21,168 |   | $ | 62,739 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Basic earnings per common share:**                                        |       |                                      |       |                                              |       |   |   |   |   |
| Income from continuing operations                                           |       | $                                         | 0.12       |                                              | $          | 0.18 |   | $ | 0.12 |   | $ | 0.22 |   |
| Discontinued operations, net of tax                                         |       | 1.35                                      |       | (0.08                                             | )          | 1.37 |   | 4.12 |   |
| Net income per basic common share                                           |       | $                                         | 1.47       |                                              | $          | 0.10 |   | $ | 1.49 |   | $ | 4.34 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Diluted earnings per common share:**                                      |       |                                      |       |                                              |       |   |   |   |   |
| Income from continuing operations                                           |       | $                                         | 0.12       |                                              | $          | 0.18 |   | $ | 0.12 |   | $ | 0.22 |   |
| Discontinued operations, net of tax                                         |       | 1.35                                      |       | (0.08                                             | )          | 1.37 |   | 4.11 |   |
| Net income per diluted common share                                         |       | $                                         | 1.47       |                                              | $          | 0.10 |   | $ | 1.49 |   | $ | 4.33 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Dividends per share**                                                     |       | $                                         | 0.25       |                                              | $          | 0.25 |   | $ | 0.50 |   | $ | 0.50 |   |
|                                                                        |       |                                      |       |                                              |       |   |   |   |   |
| **Shares of common stock used to calculate earnings  per share:**           |       |                                      |       |                                              |       |   |   |   |   |
| Basic                                                                       |       | 14,141                                    |       | 14,440                                            |       | 14,226 |   | 14,432 |   |
| Diluted                                                                     |       | 14,149                                    |       | 14,492                                            |       | 14,234 |   | 14,482 |   |

 

See accompanying notes.

 

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**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

*(Unaudited;Amounts in thousands)*

 
| ** **                                                                                                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| **ASSETS**                                                                                                                                                                    |       |              |       |                  |       |
| Current assets:                                                                                                                                                               |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                    |       | $                 | 11,836     |                  | $          | 31,114 |   |
| Short-term  investments                                                                                                                                                       |       | 641               |       | 21,151                |       |
| Accounts  receivable, net                                                                                                                                                     |       | 21,933            |       | 19,223                |       |
| Income tax  receivable                                                                                                                                                        |       | 5,318             |       | 1,786                 |       |
| Inventories                                                                                                                                                                   |       | 7,748             |       | 4,251                 |       |
| Prepaid expenses                                                                                                                                                              |       | 4,412             |       | 3,462                 |       |
| Deferred income  taxes                                                                                                                                                        |       | 4,604             |       | 9,480                 |       |
| Other current  assets                                                                                                                                                         |       | 4,754             |       | 1,309                 |       |
| Assets of  discontinued operations                                                                                                                                            |       | —            |       | 41,147                |       |
| Total current  assets                                                                                                                                                         |       | 61,246            |       | 132,923               |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Property, plant  and equipment, net                                                                                                                                           |       | 509,730           |       | 346,740               |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Intangible and  other assets:                                                                                                                                                 |       |              |       |                  |       |
| Customer  relationships, net                                                                                                                                                  |       | 6,224             |       | —                |       |
| Goodwill                                                                                                                                                                      |       | 55,340            |       | 2,171                 |       |
| Deferred charges  and other assets                                                                                                                                            |       | 6,898             |       | 2,933                 |       |
|                                                                                                                                                                          |       | 68,462            |       | 5,104                 |       |
|                                                                                                                                                                          |       | $                 | 639,438    |                  | $          | 484,767 |   |
|                                                                                                                                                                          |       |              |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                |       |              |       |                  |       |
| Current  liabilities:                                                                                                                                                         |       |              |       |                  |       |
| Short-term  borrowings                                                                                                                                                        |       | $                 | 30,000     |                  | $          | — |   |
| Current portion  of long-term debt and capital lease obligations                                                                                                              |       | 15,643            |       | 3,642                 |       |
| Accounts payable                                                                                                                                                              |       | 5,696             |       | 2,544                 |       |
| Other accrued  liabilities                                                                                                                                                    |       | 22,896            |       | 19,661                |       |
| Current portion  of contractual shareable earnings obligations                                                                                                                |       | 770               |       | 1,597                 |       |
| Advance billings  and deferred revenues                                                                                                                                       |       | 9,012             |       | 7,288                 |       |
| Accrued  compensation and pension benefits                                                                                                                                    |       | 9,349             |       | 8,755                 |       |
| Liabilities of  discontinued operations                                                                                                                                       |       | —            |       | 8,969                 |       |
| Total current  liabilities                                                                                                                                                    |       | 93,366            |       | 52,456                |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Long-term debt  and capital lease obligations                                                                                                                                 |       | 186,185           |       | 118,189               |       |
| Deferred income  taxes                                                                                                                                                        |       | 64,006            |       | 26,030                |       |
| Other  liabilities and deferred revenues                                                                                                                                      |       | 17,072            |       | 17,089                |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                                                                |       |              |       |                  |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Shareholders’  equity:                                                                                                                                                   |       |              |       |                  |       |
| Common stock,  without par value; 100,000 shares authorized, 14,003 and 14,514 shares issued  and outstanding at June 30, 2008 and December 31, 2007,  respectively |       | 147,541           |       | 158,870               |       |
| Accumulated  other comprehensive loss                                                                                                                                         |       | (4,133            | )          | (3,530                | )          |
| Retained  earnings                                                                                                                                                            |       | 135,401           |       | 115,663               |       |
| Total  shareholders’ equity                                                                                                                                              |       | 278,809           |       | 271,003               |       |
|                                                                                                                                                                          |       | $                 | 639,438    |                  | $          | 484,767 |   |

 

See accompanyingnotes.

 

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**SUREWESTCOMMUNICATIONS**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

*(Unaudited;Amounts in thousands)*

 
| ** **                                                          | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                          | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| ** **                                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net cash  provided by continuing operations                         |       | $                                                 | 26,179     |   | $ | 21,679 |   |
| Net cash provided  by (used in) discontinued operations             |       | 307                                               |       | (41,771 | ) |
| Net cash  provided by (used in) operating activities                |       | 26,486                                            |       | (20,092 | ) |
|                                                                |       |                                              |       |   |   |
| Cash flows from  investing activities:                              |       |                                              |       |   |   |
| Business acquisition,  net of cash acquired                         |       | (181,646                                          | )          | — |   |
| Proceeds from  sale of discontinued operations                      |       | 66,391                                            |       | 110,123 |   |
| Capital  expenditures for property, plant and equipment             |       | (43,635                                           | )          | (21,424 | ) |
| Purchases of  available-for-sale securities                         |       | —                                            |       | (121,275 | ) |
| Proceeds from  sale of available-for-sale securities                |       | 16,650                                            |       | 91,525 |   |
| Net cash (used  in) provided by continuing operations               |       | (142,240                                          | )          | 58,949 |   |
| Net cash used in  discontinued operations                           |       | (280                                              | )          | (1,079 | ) |
| Net cash (used  in) provided by investing activities                |       | (142,520                                          | )          | 57,870 |   |
|                                                                |       |                                              |       |   |   |
| Cash flows from  financing activities:                              |       |                                              |       |   |   |
| Proceeds from  issuance of long-term debt                           |       | 96,000                                            |       | — |   |
| Principal  payments of long-term debt and capital lease obligations |       | (16,003                                           | )          | (3 | ) |
| Proceeds from  short-term borrowings                                |       | 60,000                                            |       | — |   |
| Repayment of  short-term borrowings                                 |       | (30,000                                           | )          | — |   |
| Dividends paid                                                      |       | (7,124                                            | )          | (7,233 | ) |
| Repurchase of  common stock                                         |       | (6,117                                            | )          | — |   |
| Net cash  provided by (used in) financing activities                |       | 96,756                                            |       | (7,236 | ) |
|                                                                |       |                                              |       |   |   |
| (Decrease)  increase in cash and cash equivalents                   |       | (19,278                                           | )          | 30,542 |   |
|                                                                |       |                                              |       |   |   |
| Cash and cash  equivalents at beginning of period                   |       | 31,114                                            |       | 6,371 |   |
|                                                                |       |                                              |       |   |   |
| Cash and cash  equivalents at end of period                         |       | $                                                 | 11,836     |   | $ | 36,913 |   |

 

See accompanyingnotes.

 

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**SUREWESTCOMMUNICATIONS**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

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

** **

**1.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

** **

**Businessand Basis of Accounting**

 

SureWest Communications(the “Company”, “we” or “our”) is a holding company with wholly-ownedsubsidiaries that provide communications services in Northern California andthe greater Kansas City, Kansas and Missouri areas (“Kansas City area”). TheCompany’s operating subsidiaries are SureWest Broadband, SureWest TeleVideo,SureWest TeleVideo of Roseville, SureWest Internet, SureWest Custom DataServices, Everest Broadband, Inc., SureWest Telephone and SureWest LongDistance. As discussed in Note 2, in May 2008 the Company sold theoperating assets of its Wireless business, SureWest Wireless, and in February 2007the Company sold its wholly-owned subsidiary SureWest Directories. Accordingly,the financial results of SureWest Wireless and SureWest Directories have beenreported as discontinued operations for all periods presented in accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*.The notes to the condensed consolidated financial statements reflect historicalamounts exclusive of discontinued operations, unless otherwise noted. TheCompany expects that the sources of its revenues and its cost structure may bedifferent in future periods, both as a result of its entry into newcommunications markets and competitive forces in each of the markets in whichthe Company has operations.

 

In the opinion ofmanagement, the accompanying condensed consolidated balance sheets and relatedinterim statements of income and cash flows include all adjustments, 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 principlesapplicable for interim periods. Management believes that the disclosures madeare adequate to make the information presented not misleading. Interim resultsare not necessarily indicative of results for a full year.  The information presented in this Form10-Qshould be read in conjunction with Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and the consolidated financialstatements and notes thereto included in the Company’s 2007 Annual Report on Form 10-Kfiled with the SEC.

** **

**Fair Value of Financial Instruments**

 

TheCompany adopted SFAS No. 157, *Fair Value Measurements*(“SFAS 157”) effective January 1, 2008 for financial assets andliabilities measured on a recurring basis. SFAS 157 applies to allfinancial assets and financial liabilities that are measured and reported on afair value basis. There was no impact for adoption of SFAS No. 157 to theCompany’s condensed consolidated financial statements. SFAS 157 requiresdisclosure that establishes a framework for measuring fair value and expandsdisclosure about fair value measurements.

 

SFAS157 establishes a valuation hierarchy for disclosure of the inputs to valuationused to measure fair value. This hierarchy prioritizes the inputs into threebroad levels as follows. Level 1 inputs are quoted prices (unadjusted) inactive markets for identical assets or liabilities. Level 2 inputs are quotedprices for similar assets and liabilities in active markets or inputs that areobservable for the asset or liability, either directly or indirectly throughmarket corroboration, for substantially the full term of the financialinstrument. Level 3 inputs are unobservable inputs based on management’s ownassumptions used to measure assets and liabilities at fair value. A financialasset or liability’s classification within the hierarchy is determined based onthe lowest level input that is significant to the fair value measurement.

 

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Thefollowing table summarizes the Company’s financial assets (cash equivalents andinvestments) measured at fair value on a recurring basis:

 
| ** **               | ** ** | **As of June 30, 2008,** | ** ** |
|--------------------------|------------|----------------------------------------------|------------|
| ** **               | ** ** | **Total**                                    | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Money market  funds      |       | $                                            | 3,244      |   | $ | 3,244 |   | $ | — |   | $ | — |   |
| Equity  securities       |       | 641                                          |       | 641 |   | — |   | — |   |
| Auction rate  securities |       | 2,846                                        |       | — |   | — |   | 2,846 |   |
|                     |       | $                                            | 6,731      |   | $ | 3,885 |   | $ | — |   | $ | 2,846 |   |

 

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

 
| ** **                                                | ** ** | **Auction Rate  Securities** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------|------------|
| Beginning  Balance at December 31, 2007              |       | $                                 | —     |   |
| Transfers in  and/or out of Level 3                       |       | 3,700                             |       |
| Unrealized  losses included in other comprehensive income |       | (854                              | )          |
| Ending Balance  at June 30, 2008                     |       | $                                 | 2,846      |   |

 

At June 30, 2008, the Company held one auction rate security (“ARS”)with an estimated fair value of $2,846, which was measured using Level 3inputs. The ARS is collateralized by student loans that are guaranteedprimarily by an insurance company and partially by the Federal Family EducationLoan Program (“FFELP”). The monthly auctions have historically provided aliquid market for these securities. The ARS in the Company’s portfolio had asuccessful auction in January 2008 and as such, its fair value would havebeen measured using Level 1 inputs at January 1, 2008. However, since February 2008,there has not been a successful auction for this ARS, therefore the Companytransferred this ARS from the Level 1 to the Level 3 category.

 

The Company obtained a Level 3 valuation from an investment advisor,which used a discounted cash flow model to estimate the fair value of the ARSat June 30, 2008.  The significantinputs that were used in the model were the credit quality of the issuer, thepercentage and the types of guarantees (such as an insurance company andFFELP), interest rates, expected holding period of the ARS and an illiquiditydiscount factor. Changes in the assumptions of the model based on dynamicmarket conditions could have a significant impact on the valuation of thissecurity, which may lead the Company in the future to take an impairment chargefor this security.  Based on the Company’sreview of the model, the inputs to the model and the assessment of fair value,as of June 30, 2008, the Company determined there was a decline in the fairvalue of its ARS investment of $854, which was deemed temporary as the Companycurrently has the ability and intent to hold this ARS investment until asuccessful auction, we sell the security in a secondary market which currentlyis not active, or it is redeemed by the issuer. As a result, the Companyreclassified the entire ARS investment balance from short-term investments tolong-term other assets on its condensed consolidated balance sheet. The Companywill continue to analyze its auction rate security each reporting period forimpairment and may be required to record an impairment charge in the statementof operations if the decline in fair value is determined to be other thantemporary.

** **

**Intangible Assets**

 

Goodwill and intangible assets that are not subject to amortization aretested for impairment at least annually or when events or changes incircumstances indicate that the asset might be impaired in accordance with SFASNo. 142, *Goodwill and Other Intangible Assets*(“SFAS142”). Normally, the Company performs the annual impairment test as of November 30.  However, as a result of recent declines inthe market price of the Company’s common stock, at June 30, 2008, theCompany concluded that this was an indicator of potential impairment ofgoodwill and therefore, the Company performed an interim goodwill impairmenttest.

 

The Company completed the first step of its interim impairment test,which indicated that the estimated fair value of the reporting units wasgreater than the net carrying value of the reporting units.  As such, the Company concluded that itsgoodwill was not impaired as of June 30, 2008 and the Company was notrequired to perform the second step of the evaluation.

 

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**Stock-basedCompensation**

*** ***

***StockPlans***

 

The Company has twoEquity Incentive Plans (the “Stock Plans”) for certain employees, outsidedirectors and consultants of the Company, which were approved by shareholders.The Company authorized for future issuance under the Stock Plans approximately1.9 million shares (subject to upward adjustment based upon the Company’sissued and outstanding shares) of authorized, but unissued, common stock. TheStock Plans permit issuance by the Company of awards in the form of restrictedcommon stock (“RSAs”), restricted common stock units (“RSUs”), performanceshares, stock options and stock appreciation rights. The exercise price pershare of the Company’s common stock to be purchased under any incentive stockoption shall not be less than 100% of the fair market value of a share of theCompany’s common stock on the date of the grant, and the exercise price under anon-qualified stock option shall not be less than 85% of the fair market valueof the Company’s common stock at the date of the grant. The term of any stockoption shall not exceed 10 years.

 

The Company accounts for stock-based compensation for both RSAs andRSUs in accordance with the provisions of SFAS No. 123(R), *Share-Based Payments*(“SFAS 123(R)”), which requires theCompany to measure the cost of employee services received in exchange for allequity awards granted, including stock options, RSUs and restricted shares,based on the fair market value of the award as of the grant date.  The Company will continue to recognizestock-based compensation on RSAs and RSUs granted prior to the adoption of SFAS123(R) using the graded vesting method. In accordance with the provisionsof SFAS 123(R), the Company has estimated expected forfeitures based onhistorical experience and is recognizing compensation expense only for thoseRSAs and RSUs expected to vest.

 

***RestrictedCommon Stock Awards and Units***

 

The following table summarizes the RSAs and RSUs granted to certaineligible participants during the quarters and six-month periods ended June 30,2008 and 2007:

 
| ** **    | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **    | ** ** | **2008**                                  | ** ** | **Grant Date  Fair Value**              | ** ** | **2007** | ** ** | **Grant Date  Fair Value** | ** ** | **2008** | ** ** | **Grant Date  Fair Value** | ** ** | **2007** | ** ** | **Grant Date  Fair Value** | ** ** |
|          |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| RSAs Granted  |       | —                                    |       | $                                                 | —     |   | — |   | $ | — |   | 7,056 |   | $ | 15.59 |   | 1,338 |   | $ | 23.97 |   |
| RSUs Granted  |       | 22,240                                    |       | $                                                 | 8.43       |   | 5,000 |   | $ | 26.21 |   | 22,240 |   | $ | 8.43 |   | 5,000 |   | $ | 26.21 |   |
| RSU Dividends |       | 802                                       |       | $                                                 | 8.88       |   | — |   | $ | — |   | 802 |   | $ | 8.88 |   | — |   | $ | — |   |
| Total         |       | 23,042                                    |       |                                              |       | 5,000 |   |   |   | 30,098 |   |   |   | 6,338 |   |   |   |

 

Stock-based compensationexpense for both RSAs and RSUs of $345 and $486 was recorded during the quarterand six-month period ended June 30, 2008, respectively. During the sameprior year periods, the Company recorded stock based compensation expense of$477 and $654, respectively.  RSAs andRSUs are amortized over their respective vesting periods, which range fromimmediate vesting to a five-year vesting period.

 

The following tablesummarizes the RSAs activity during the six-month period June 30, 2008:

 
| **Nonvested Shares**       | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|---------------------------------|------------|------------|------------|---------------------------------------------------------|------------|
|                            |       |       |       |                                                    |       |
| Nonvested-January 1,  2008 |       | 144,935    |       | $21.85                                                  |       |
| Granted                         |       | 30,098     |       | $10.12                                                  |       |
| Vested                          |       | (28,489    | )          | $11.85                                                  |       |
| Forfeited                       |       | (18,470    | )          | $24.08                                                  |       |
| Nonvested-June 30,  2008   |       | 128,074    |       |                                                    |       |

 

As of June 30, 2008,total unrecognized compensation cost related to nonvested restricted stock was$1,866 and will be recognized over a weighted-average period of approximatelytwo years. The total fair value of RSAs and RSUs vested during the six-monthperiod ended June 30, 2008 was $338.

 

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***StockOptions Expense***

 

The Company issuesnew shares of common stock upon exercise of stock options.  The followingtable summarizes stock option activity for the Company’s stock option plans forthe six-month period ended June 30, 2008:

 
| ** **                                    | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted**              | ** ** |
|-----------------------------------------------|------------|------------|------------|--------------|------------|---------------------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | **Average**  | ** ** | **Average**               | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Remaining**             | ** ** |
| **Options**                                   | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Contractual Life** | ** ** |
|                                          |       |       |       |         |       |                      |       |
| Outstanding-January 1,  2008             |       | 362,039    |       | $40.38       |       |                      |       |
| Forfeited                                     |       | (24,400    | )          | $40.57       |       |                      |       |
| Outstanding-June 30,  2008               |       | 337,639    |       | $40.36       |       | 3                         |       |
|                                          |       |       |       |         |       |                      |       |
| Vested and  Exercisable at June 30, 2008 |       | 337,639    |       | $40.36       |       | 3                         |       |

 

There were nostock options granted, exercised or expired during the six-month period ended June 30,2008. In addition, there were no stock options with an exercise price below themarket price of the Company’s stock at that date.

** **

**Per Share Amounts**

 

Sharesused in the computation of basic earnings (loss) per share are based on theweighted average number of common shares and RSUs outstanding, excludingunvested restricted common shares and unvested RSUs. Shares used in thecomputation of diluted earnings per share are based on the weighted averagenumber of common shares, restricted common shares and RSUs outstanding, alongwith other potentially dilutive securities outstanding in each period. Sharesused in the computation of diluted loss per share are based on the weightedaverage number of vested common shares and vested RSUs and exclude potentialdilutive common shares, unvested restricted common shares and unvested RSUsoutstanding, as the effect is anti-dilutive.

 

Cashdividends per share are based on the actual dividends per share, as declared bythe Company’s Board of Directors. On each date that the Company pays a cashdividend to the holders of the Company’s common stock, the Company credits tothe holders of RSUs an additional number of RSUs equal to the total number ofwhole RSUs and additional RSUs previously credited to the holders, multipliedby the dollar amount of the cash dividend per share of common stock. Anyfractional RSUs resulting from such calculation are included in the additionalRSUs.

 

**Comprehensive Income**

 

Significant components of the Company’s comprehensive income are asfollows:

 
| ** **                                                 | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                  | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                                 |       | $                                         | 20,885     |                                              | $          | 1,506 |   | $ | 21,168 |   | $ | 62,739 |   |
| Unrealized  (loss) gain on investment, net of income taxes |       | (257                                      | )          | 35                                                |       | (603 | ) | 46 |   |
| Comprehensive  income                                      |       | $                                         | 20,628     |                                              | $          | 1,541 |   | $ | 20,565 |   | $ | 62,785 |   |

 

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

** **

**Statements of Cash FlowsInformation**

 

During the six monthsended June 30, 2008 and 2007, the Company made income tax payments of$1,500 and $45,815, respectively.   Thedecrease in income taxes paid (and corresponding increase in net cash providedby operating activities) was due to additional estimated income tax payments in2007 primarily as a result of the gain on the sale of SureWest Directories, asdiscussed in Note 2 below.

 

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**Reclassifications**

 

Certainamounts in the Company’s 2007 condensed consolidated financial statements havebeen reclassified to conform to the presentation of the Company’s 2008condensed consolidated financial statements, which consist of the effects ofreclassifications from presentation of the Company’s Wireless business as adiscontinued operation.

 

**2.     ACQUISITION &DIVESTITURES**

 

***Acquisition***

 

*EverestBroadband, Inc.*

 

Effective February 13, 2008, the Company acquired 100% of theissued and outstanding stock of Everest Broadband, Inc. (“Everest”) for atotal purchase price of $182,100, including estimated transactions costs.Everest is a competitive provider of high-speed data, video and voice servicesin the greater Kansas City area.

 

The acquisition has been accounted for using the purchase method inaccordance with SFAS No. 141, *BusinessCombinations*. Accordingly, net assets acquired were recorded attheir estimated fair values, and operating results are included in ourfinancial statements from the date of acquisition.

 

The following tablesummarizes the estimated fair values of the assets acquired and the liabilitiesassumed at the date of acquisition. These values are derived from a preliminarypurchase price allocation, which is subject to change based on the finalvaluations of the acquired real and intangible assets, final working capitaladjustments and the completion of final tax returns.  During the second quarter of 2008, theCompany increased its valuation of goodwill by $4,100.  The increase wasthe result of a decreased valuation of property, plant and equipment of $6,500and the deferred tax asset of $400, offset by a decrease of the deferred taxliability of $2,800. The Company expects to complete its purchase accountingrelating to the Everest acquisition in the fourth quarter of 2008.

 
| Current assets                 |   | $       | 10,400  |   |
|--------------------------------|--------|---------|---------|--------|
| Property, plant  and equipment |   | 146,800 |    |
| Intangible  assets             |   | 6,700   |    |
| Goodwill                       |   | 53,200  |    |
| Other long-term  assets        |   | 1,200   |    |
| Total assets  acquired         |   | 218,300 |    |
|                           |   |    |    |
| Current  liabilities           |   | 9,700   |    |
| Long-term  liabilities         |   | 1,400   |    |
| Deferred income  taxes         |   | 25,100  |    |
| Total  liabilities acquired    |   | 36,200  |    |
| Net assets  acquired           |   | $       | 182,100 |   |

 

The acquired intangible assets of approximately $6,700 were derivedfrom the associated value of a significant number of residential and businesscustomers.  The intangible assets arebeing amortized over the estimated useful life of 5 years. During thequarter and six-month period ended June 30, 2008, the Company recordedamortization expense of approximately $337 and $507, respectively, relating tothe customer relationships.  Goodwill of$53,200 has been accounted for as an indefinite lived asset and will be testedannually for impairment at November 30 or at interim dates if potentialimpairment indicators arise.  For furtherdiscussion regarding the June 30, 2008 goodwill impairment testing, seethe Intangible Assets section in Note 1 above.

 

The Company accrued in its preliminary purchase accounting a liabilityof $1,200 relating to the termination (the “Severance Plan”) of certain membersof management of Everest.  The SeverancePlan calls for payments to be made over a course of nine to eighteen months andis expected to be completed by August 2009.  For the quarter and six-month period ended June 30,2008, $0 and $362, respectively, was paid relating to the Severance Plan.

** **

**Unaudited Pro Forma Results**

 

The following unaudited pro forma information presents the results of operationsof the Company as if the acquisition of Everest occurred at the beginning ofthe fiscal periods presented.  The proforma information below

 

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does not purport to present what the actual results would have been ifthe acquisition had in fact occurred at the beginning of the fiscal periodspresented, nor does the information project results for any future period.

 
| ** **                          | ** ** | **Quarter Ended** | ** ** | ** **        | ** ** | ** **                                        | ** ** |
|-------------------------------------|------------|------------------------|------------|-------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **March 31,**     | ** ** | **June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
| ** **                          | ** ** | **2008**               | ** ** | **2007**          | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Operating  revenues                 |       | $                      | 59,177     |              | $          | 57,165                                            |       | $ | 59,404 |   | $ | 119,427 |   | $ | 116,569 |   |
| Income from  operations             |       | 4,287                  |       | 3,741             |       | 5,730                                             |       | 10,181 |   | 9,471 |   |
| Income from  continuing operations  |       | 343                    |       | 1                 |       | 1,988                                             |       | 2,040 |   | 1,989 |   |
| Net income                          |       | $                      | 637        |              | $          | 60,623                                            |       | $ | 824 |   | $ | 21,522 |   | $ | 61,447 |   |
|                                |       |                   |       |              |       |                                              |       |   |   |   |   |
| Basic earnings per  common share:   |       |                   |       |              |       |                                              |       |   |   |   |   |
| Income from  continuing operations  |       | $                      | 0.02       |              | $          | —                                            |       | $ | 0.14 |   | $ | 0.14 |   | $ | 0.14 |   |
| Net income                          |       | $                      | 0.04       |              | $          | 4.20                                              |       | $ | 0.06 |   | $ | 1.51 |   | $ | 4.26 |   |
|                                |       |                   |       |              |       |                                              |       |   |   |   |   |
| Diluted earnings  per common share: |       |                   |       |              |       |                                              |       |   |   |   |   |
| Income from  continuing operations  |       | $                      | 0.02       |              | $          | —                                            |       | $ | 0.14 |   | $ | 0.14 |   | $ | 0.14 |   |
| Net income                          |       | $                      | 0.04       |              | $          | 4.18                                              |       | $ | 0.06 |   | $ | 1.51 |   | $ | 4.24 |   |

 

***Discontinued Operations***

 

*SureWest Wireless*

 

On May 9, 2008, the Company completed the sale of the operatingassets of its Wireless business, SureWest Wireless, to Verizon Wireless (“Verizon”)for an aggregate cash purchase price of $69,841, resulting in a gain of$31,829, less estimated income taxes of $12,852.  Under the agreement, Verizon acquired thespectrum licenses and operating assets of SureWest Wireless, excluding theCompany’s owned communication towers.

 

A portion of the purchase price equal to $3,450 was placed in escrow,half of which will be available after twelve months and the balance of whichwill be available twenty-four months following the closing, less the amount ofany pending claims, in each case, to be held as security for certain losses, ifany, incurred by Verizon in the event of (i) any breach of therepresentations and warranties set forth in the agreement, (ii) any breachor nonperformance of covenants set forth in the agreement and (iii) certainother specified events. The actual gain on sale could vary based on futureclaims, if any, made against the amounts held in escrow.

 

The results of SureWest Wireless are reported as a discontinuedoperation in the Company’s condensed consolidated financial statements for allperiods presented. The operations of the Company’s owned communication towersto be retained are included within the Broadband business segment.

 

At December 31, 2007, the major components ofSureWest Wireless’ assets and liabilities to be sold were as follows:

 
| ** **                                      | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|
| Accounts  receivable, net                       |       | $                               | 3,422      |   |
| Inventories                                     |       | 894                             |       |
| Prepaid expenses                                |       | 816                             |       |
| Property, plant  and equipment, net             |       | 27,090                          |       |
| Wireless  licenses, net                         |       | 8,925                           |       |
| Total assets                                    |       | $                               | 41,147     |   |
|                                            |       |                            |       |
| Accounts payable  and other accrued liabilities |       | $                               | 2,209      |   |
| Accrued  compensation                           |       | 259                             |       |
| Advance billings  and deferred revenues         |       | 2,805                           |       |
| Deferred income  taxes                          |       | 3,696                           |       |
| Total  liabilities                              |       | $                               | 8,969      |   |

 

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The followingtable summarizes the financial information for SureWest Wireless’ operations:

 
| ** **                                                  | ** ** | **Period Ended**     | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------|------------|---------------------------------------------------|------------|
| ** **                                                  | ** ** | **May 9, 2008** | ** ** | **June 30, 2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Operating  revenues                                         |       | $                         | 2,928      |                                              | $          | 7,991 |   | $ | 10,055 |   | $ | 16,089 |   |
| Operating  expenses including depreciation and amortization |       | 2,585                     |       | 9,669                                             |       | 9,277 |   | 18,530 |   |
| Income (loss)  from operations                              |       | 343                       |       | (1,678                                            | )          | 778 |   | (2,441 | ) |
| Other income  (expense)                                     |       | (11                       | )          | 74                                                |       | (7 | ) | (43 | ) |
| Income tax  expense (benefit)                               |       | 121                       |       | (719                                              | )          | 266 |   | (1,040 | ) |
| Income (loss)  from discontinued operations                 |       | $                         | 211        |                                              | $          | (885 | ) | $ | 505 |   | $ | (1,444 | ) |
|                                                        |       |                      |       |                                              |       |   |   |   |   |
| Gain on sale of  discontinued operations, net of tax        |       | $                         | 18,977     |                                              | $          | — |   | $ | 18,977 |   | $ | — |   |

 

In connection with the sale, the Company entered into a short-termTransition Services Agreement (“TSA”) with Verizon to provide certain operatingservices during the transition of the Wireless business to Verizon.  The TSA is expected to conclude in the latterpart of 2008.  During the transitionperiod, the Company’s Telecom and Broadband segments will provide certainservices such as long distance and interconnect services to Verizon.  Such services provided to SureWest Wirelessprior to the sale and eliminated in the condensed consolidated financialstatements were $545 and $1,869 for the quarter and six-month period ended June 30,2008, respectively, and $1,466 and $3,008 for the same prior year periods. TheCompany anticipates that the services provided to Verizon and related revenueswill diminish as Verizon migrates customers onto its network at the conclusionof the transition period.

 

*SureWest Directories*

 

In February 2007,GateHouse Media acquired 100% of the stock of SureWest Directories (previouslyincluded in the Telecom segment), its directory publishing business, for anaggregate cash purchase price of $110,123, resulting in a gain as of December 31,2007 of $101,286, less estimated income taxes of $41,130. As part of thetransaction, GateHouse Media became the publisher of the official directory ofSureWest Telephone.  The results ofSureWest Directories are reported as a discontinued operation in theconsolidated financial statements for all years presented.

 

As part of the sale agreementwith GateHouse Media, the Company performed certain administrative and otherfunctions on behalf of GateHouse Media for a period following the sale date,pursuant to a TSA.  The services renderedby the Company pursuant to the TSA concluded on December 31, 2007, and aninvoice for $2,200 owed to the Company pursuant to the TSA has been submittedto GateHouse Media for payment. Gatehouse Media is currently disputing the amount and is performing anindependent analysis. In the event that the amount ultimately paid by GateHouseMedia differs from the amount owed to the Company under the terms of the TSA,the gain on the sale will be adjusted accordingly.  Management believes that the Company is incompliance with the terms of the TSA and does not believe that the amount ofany such adjustment will be material to the gain on sale reflected in the 2007consolidated statement of income.

 

The followingtable summarizes the financial information for SureWest Directories’ operationsfor the quarters and six-month periods ended June 30, 2008 and 2007:

 
| ** **                                                    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Directory  advertising revenues                               |       | $                                                   | —     |                                              | $          | — |   | $ | — |   | $ | 2,939 |   |
| Income before  income taxes                                   |       | —                                              |       | —                                            |       | — |   | 1,682 |   |
| Income tax  expense                                           |       | —                                              |       | —                                            |       | — |   | 683 |   |
| Income from  discontinued operations                          |       | —                                              |       | —                                            |       | — |   | 999 |   |
| (Loss) gain on  sale of discontinued operations, net of taxes |       | $                                                   | —     |                                              | $          | (279 | ) | $ | — |   | $ | 59,902 |   |

 

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**3.     BUSINESS SEGMENTS**

 

The Company has tworeportable business segments: Broadband and Telecommunications (“Telecom”). TheCompany has aggregated certain of its operating segments within the Broadbandand Telecom segments because it believes that such operating segments sharesimilar economic characteristics.  Wemeasure and evaluate the performance of our segments based on income (loss) fromoperations. Corporate Operations are allocated to the appropriate segment,except for cash; investments; certain property, plant, and equipment; andmiscellaneous other assets, which are not allocated to the segments. However,the investment income associated with cash and investments held by CorporateOperations is included in the results of the operations of the Company’ssegments.

 

The Broadband segmentutilizes fiber-to-the-premise and fiber-to-the-node networks to offer bundledresidential and commercial services that include IP-based digital andhigh-definition television, high-speed internet, Voice over IP, and local andlong distance telephone in the greater Sacramento, California and greaterKansas City area.

 

The Telecom segment offers landline telecommunications services,Digital Subscriber Line (“DSL”) service, long distance services and certainnon-regulated services operating only in the greater Sacramento area. SureWestTelephone, which is the principal operating subsidiary of the Telecom segment,provides local services, toll telephone services, network access services andcertain non-regulated services. SureWest Long Distance is a reseller of longdistance services.

 

As discussed in Note 2, in May 2008, the Company sold theoperating assets of its Wireless business, SureWest Wireless, which waspreviously reported as a separate reportable segment. The Wireless businesssold has been presented as a discontinued operation for all periods presented.The operations of the Company’s owned communication towers to be retained areincluded within the Broadband business segment.

 

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 segmentinformation is as follows:

 
| ** **                                          | ** ** | ** **    | ** ** | ** **  | ** ** | **Corporate**  | ** ** | **Discontinued** | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|-----------------------------------------------------|------------|---------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                          | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **For the  three months ended June 30, 2008:** |       |          |       |        |       |           |       |             |       |             |       |             |       |
| Operating  revenues from external customers         |       | $             | 35,600     |        | $          | 24,650         |       | $                | —     |             | $          | —           |       | $ | — |   | $ | 60,250 |   |
| Intersegment  revenues                              |       | 141           |       | 4,566       |       | —         |       | —           |       | (4,707           | )          | —           |       |
| Operating  expenses*                                |       | 31,351        |       | 13,520      |       | —         |       | —           |       | (4,707           | )          | 40,164           |       |
| Depreciation and  amortization                      |       | 10,446        |       | 3,746       |       | —         |       | —           |       | —           |       | 14,192           |       |
| Income (loss)  from operations                      |       | (6,056        | )          | 11,950      |       | —         |       | —           |       | —           |       | 5,894            |       |
| Income (loss)  from continuing operations           |       | $             | (5,462     | )           | $          | 7,159          |       | $                | —     |             | $          | —           |       | $ | — |   | $ | 1,697 |   |

 

----

*Exclusiveof depreciation and amortization

 
| ** **                                          | ** ** | ** **    | ** ** | ** **  | ** ** | **Corporate**  | ** ** | **Discontinued** | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|-----------------------------------------------------|------------|---------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                          | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **For the  three months ended June 30, 2007:** |       |          |       |        |       |           |       |             |       |             |       |             |       |
| Operating  revenues from external customers         |       | $             | 17,193     |        | $          | 27,249         |       | $                | —     |             | $          | —           |       | $ | — |   | $ | 44,442 |   |
| Intersegment  revenues                              |       | 162           |       | 4,633       |       | —         |       | —           |       | (4,795           | )          | —           |       |
| Operating  expenses*                                |       | 17,765        |       | 15,925      |       | —         |       | —           |       | (4,795           | )          | 28,895           |       |
| Depreciation and  amortization                      |       | 5,679         |       | 5,768       |       | —         |       | —           |       | —           |       | 11,447           |       |
| Income (loss)  from operations                      |       | (6,089        | )          | 10,189      |       | —         |       | —           |       | —           |       | 4,100            |       |
| Income (loss)  from continuing operations           |       | $             | (4,459     | )           | $          | 7,129          |       | $                | —     |             | $          | —           |       | $ | — |   | $ | 2,670 |   |

 

----

*Exclusive of depreciation and amortization

 

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| ** **                                                  | ** ** | ** **    | ** ** | ** **  | ** ** | **Corporate**  | ** ** | **Discontinued** | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|-------------------------------------------------------------|------------|---------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                  | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **As of  and for the six months ended June 30, 2008:** |       |          |       |        |       |           |       |             |       |             |       |             |       |
| Operating  revenues from external customers                 |       | $             | 62,642     |        | $          | 49,228         |       | $                | —     |             | $          | —           |       | $ | — |   | $ | 111,870 |   |
| Intersegment  revenues                                      |       | 281           |       | 8,909       |       | —         |       | —           |       | (9,190           | )          | —           |       |
| Operating  expenses*                                        |       | 57,613        |       | 28,536      |       | —         |       | —           |       | (9,190           | )          | 76,959           |       |
| Depreciation and  amortization                              |       | 18,962        |       | 7,414       |       | —         |       | —           |       | —           |       | 26,376           |       |
| Income (loss)  from operations                              |       | (13,652       | )          | 22,187      |       | —         |       | —           |       | —           |       | 8,535            |       |
| Income (loss)  from continuing operations                   |       | $             | (11,314    | )           | $          | 13,000         |       | $                | —     |             | $          | —           |       | $ | — |   | $ | 1,686 |   |
| Total Assets                                                |       | $             | 802,599    |        | $          | 994,372        |       | $                | 614,809    |             | $          | —           |       | $ | (1,772,342 | ) | $ | 639,438 |   |

 

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*Exclusive of depreciation and amortization

 
| ** **                                                  | ** ** | ** **    | ** ** | ** **  | ** ** | **Corporate**  | ** ** | **Discontinued** | ** ** | **Intercompany** | ** ** | ** **       | ** ** |
|-------------------------------------------------------------|------------|---------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                  | ** ** | **Broadband** | ** ** | **Telecom** | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **As of  and for the six months ended June 30, 2007:** |       |          |       |        |       |           |       |             |       |             |       |             |       |
| Operating  revenues from external customers                 |       | $             | 33,718     |        | $          | 53,610         |       | $                | —     |             | $          | —           |       | $ | — |   | $ | 87,328 |   |
| Intersegment  revenues                                      |       | 321           |       | 9,067       |       | —         |       | —           |       | (9,388           | )          | —           |       |
| Operating  expenses*                                        |       | 36,864        |       | 31,477      |       | —         |       | —           |       | (9,388           | )          | 58,953           |       |
| Depreciation and  amortization                              |       | 11,104        |       | 11,418      |       | —         |       | —           |       | —           |       | 22,522           |       |
| Income (loss)  from operations                              |       | (13,929       | )          | 19,782      |       | —         |       | —           |       | —           |       | 5,853            |       |
| Income (loss)  from continuing operations                   |       | $             | (9,721     | )           | $          | 13,003         |       | $                | —     |             | $          | —           |       | $ | — |   | $ | 3,282 |   |
| Total Assets                                                |       | $             | 453,228    |        | $          | 802,382        |       | $                | 784,994    |             | $          | 46,313           |       | $ | (1,593,245 | ) | $ | 493,672 |   |

 

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*Exclusive of depreciation and amortization

 

**4.****              REGULATORYMATTERS AND ESTIMATED SHAREABLE EARNINGS OBLIGATIONS**

 

Certainof the Company’s rates are subject to regulation by the Federal CommunicationsCommission (“FCC”) and the State Commissions. Intrastate service rates aresubject to regulation by State Commissions. With respect to toll callsinitiated by interexchange carriers’ customers, the interexchange carriers areassessed access charges based on tariffs filed by the Company. Interstateaccess rates and resultant earnings are subject to regulation by the FCC. Withrespect to interstate services, SureWest Telephone has detariffed its DSLservices and files its own tariff with the FCC for switched and special accessservices. For interstate common line (“CL”) charges, SureWest Telephone concurswith tariffs filed by the National Exchange Carrier Association (“NECA”).Pending and future regulatory actions may have a material impact on the Company’sconsolidated financial position and results of operations.

 

*FCC Matters*

 

TheFCC monitors SureWest Telephone’s interstate earnings through the use of annualcost separation studies prepared by SureWest Telephone, which utilize estimatedcost information and projected demand usage. The FCC 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.

 

As a result of periodiccost separation studies required by the FCC, SureWest Telephone changed its estimatesfor certain NECA CL accounts receivable balances related to current and prioryear monitoring periods.  During thequarter and six-month period ended June 30, 2007, these changes inestimates increased the Company’s consolidated revenues by $688 and $806 andnet income by $473 ($0.03 per share) and $555 ($0.04 per share),respectively.  The Company did not recordany significant changes in estimates during the quarter and six-month periodended June 30, 2008.

 

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*California Public UtilityCommission (“CPUC”) Matters*

 

In 2004, the Companyentered into a settlement agreement (the “Settlement Agreement”), which wasultimately approved by the CPUC, to resolve an ongoing regulatory proceedingwith various parties.  The SettlementAgreement resolved past sharing liabilities and suspended future sharingrequirements in the intrastate jurisdiction. In accordance with the Settlement Agreement, SureWest Telephone isreturning approximately $6,500 (“Dividend A”), plus interest at the 90-daycommercial paper rate for non-financial institutions, which was 2.21% as of June 30,2008, and an imputed rate of 3.15%, to its end users through a consumerdividend and is recorded as a reduction of the Company’s contractual shareableearnings obligations over a period of approximately four years, which began January 1,2005.  In addition, SureWest Telephonepaid a one-time consumer dividend of $2,600 (“Dividend B”) to consumers tosettle the monitoring periods 2000 to 2004 payable over approximately twoyears, which began January 1, 2005 and was completed in March 2007.  At June 30, 2008, the aggregatecontractual shareable earnings obligation for Dividend A was $770 (which is netof an unamortized discount pertaining to imputed interest of $8 at that date).

 

The following tablesummarizes the amounts returned to end users through consumer dividends for thequarters and six-month periods ended June 30, 2008 and 2007:

 
| ** ** | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
| ** ** | ** ** | **2008**                              | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Dividend A |       | $                                     | 418        |                                          | $          | 475 |   | $ | 849 |   | $ | 961 |   |
| Dividend B |       | —                                |       | —                                        |       | — |   | 210 |   |
| Total      |       | $                                     | 418        |                                          | $          | 475 |   | $ | 849 |   | $ | 1,171 |   |

 

As part of the SettlementAgreement, SureWest Telephone was to implement an additional annual consumerdividend of $1,300 on January 1, 2007 to end-users receiving SureWestTelephone services subject to sharing on or after that date. However, thisconsumer dividend was subject to reduction based upon the results of otherpending regulatory proceedings. Pursuant to a CPUC order in December 2006,beginning in 2007 this dividend was offset by a reduction in the Company’sinterim draw from the California High Cost Fund (“CHCF”). The interim draw fromthe CHCF was previously authorized by a CPUC decision in August 2005 whichallowed SureWest Telephone to continue receiving $11,500 annually from the CHCFto offset its intrastate regulated operating expenses on an interim basis. In August 2006,the Company requested permission from the CPUC to implement a graduatedphase-down of its annual $11,500 interim draw. In December 2006, the CPUCauthorized the Company to offset its interim draw from the CHCF with theaforementioned $1,300 consumer dividend. In September 2007, the CPUCissued Decision 07-09-002 which provides for SureWest Telephone to phase-downits annual CHCF draw over a five-year period, to end on January 1, 2012. Thephase-down of the interim draw began in January 2007, initially reducingthe annual $11,500 interim draw by the aforementioned $1,300 consumer dividendto $10,200. Starting in 2008, the interim CHCF draw is being incrementallyreduced by approximately $2,000 annually.

 

In 2006, the CPUCinitiated a Rulemaking pursuant to Senate Bill 1276 commencing a review of theCHCF-B program. The goals of this review included, but were not limited to,adjusting universal service rate support payments to reflect updated operatingcosts, evaluating whether CHCF-B support levels can be reduced and made morepredictable and making the current administration of the program moreefficient. In September 2007, the CPUC approved a decision reforming theindustry CHCF-B program which significantly reduced the CHCF-B program fund andits associated surcharge. The decision reduces the current industry CHCF-Bfunding level by approximately 74% and orders the reduction to be transitionedover an 18-month period, which began in January 2008 and will end in July 2009.The Company received approximately $600 in 2007. Based on this level ofreceipts and the threshold transition schedule outlined in the decision, theCompany’s CHCF-B fund will be reduced approximately 91% and 100% in July 2008and January 2009, respectively. Accordingly, the Company’s general CHCF-Bfund draw will be approximately $323 and $0 in 2008 and 2009, respectively. Furthermore,the decision lifts the freeze on basic residential rates beginning in January 2009;however, the decision establishes a Phase II of the proceeding in which theCPUC may determine the amount by which the Company may increase basicresidential rates over time, among other issues. The Company will continue toevaluate this matter and the potential effects on its consolidated financialposition and results of operations.

 

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In an ongoing proceedingrelating to the New Regulatory Framework (under which SureWest Telephone hasbeen regulated since 1996), the CPUC adopted decision 06-08-030 in 2006, whichgrants carriers broader pricing freedom in the provision of telecommunicationsservices, bundling of services, promotions and customer contracts. Thisdecision adopted a new regulatory framework, the Uniform Regulatory Framework,which among other things (i) eliminates price regulation and allows fullpricing flexibility for all new and retail services except lifeline and basicresidential services which will remain capped at current levels until January 1,2009, (ii) allows new forms of bundles and promotional packages oftelecommunication services, (iii) allocates all gains and losses from thesale of assets to shareholders and (iv) eliminates almost all elements ofrate of return regulation, including the calculation of shareable earnings.

 

**5.     INCOME TAXES**

 

On January 1, 2007,the Company adopted Financial Accounting Standards Board (“FASB”)Interpretation No. 48 (“FIN 48”), *Accounting for Uncertaintyin Income Taxes*. FIN 48 clarifies the accounting for uncertainty inincome taxes recognized in a company’s financial statements in accordance withFASB No. 109, *Accounting for IncomeTaxes*. Specifically, the pronouncement prescribes a recognitionthreshold and a measurement attribute for the financial statement recognitionand measurement of a tax position taken or expected to be taken in a taxreturn. FIN 48 also provides guidance on de-recognition, classification,interest and penalties, accounting in interim periods, disclosure andtransition of uncertain tax positions.

 

The Company had aliability for unrecognized tax benefits of approximately $334 and $305 at June 30,2008 and December 31, 2007, respectively. The following table provides areconciliation of the beginning and ending amount of unrecognized tax benefitsduring the six-month period ended June 30, 2008:

 
| Balance as of  December 31, 2007               |   | $  | 305    |   |
|-----------------------------------------------------|--------|----|--------|--------|
| Increases based  on tax positions prior to 2008     |   | 29 |   |
| Unrecognized tax  benefits as of June 30, 2008 |   | $  | 334    |   |

 

The total amount ofunrecognized tax benefits that, if recognized, would affect the effective taxrate were $118 and $121 at January 1, 2008 and June 30, 2008,respectively. It is reasonably possible that a reduction of up to $192 of unrecognizedtax benefits related to state deduction and credit issues and associatedinterest may occur within twelve months as a result of the expiration of thestatute of limitations and payment of taxes and interest with amended returnsexpected to be filed prior to the end of 2008.

 

The Company’s policy isto recognize interest and penalties related to uncertain tax positions inincome tax expense. The Company did not accrue significant amounts of interestand penalties related to unrecognized tax benefits during the quarter orsix-month period ended June 30, 2008. As of June 30, 2008, theCompany had approximately $101 of accrued interest and penalties in theunrecognized tax benefits above.

 

As of June 30,2008, the following tax years and related taxing jurisdictions were open:

 
| **Tax Year** | ** ** | **Taxing Jurisdiction** |
|-------------------|------------|------------------------------|
| 2002              |       | Federal                      |
| 2003 - 2007       |       | Federal and California       |
| 2006-2007         |       | Kansas and Missouri          |

 

For the quarter andsix-month period ended June 30, 2008, the Company’s actual tax expensediffered from the federal statutory rate due to state taxes, the benefit ofcertain permanent tax deductions and an increase to state deferred tax expensedue to changes in the Company’s state tax apportionment factors, interest andpenalties. For the quarter and six-month period ended June 30, 2007, theCompany’s actual tax expense differed from the federal statutory rate due tostate taxes and the benefit of certain permanent tax deductions.

** **

**6.     PENSION AND OTHER POST-RETIREMENT BENEFITS**

 

TheCompany sponsors a noncontributory defined benefit pension plan (the “PensionPlan”) which covers certain eligible employees. Benefits are based on years ofservice and the employee’s average compensation during the five highestconsecutive years of the last ten years of credited service. The Company’sfunding policy is to contribute

 

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annuallyan actuarially determined amount consistent with applicable federal income taxregulations. Contributions are intended to provide for benefits attributed toservice to date. Pension Plan assets are primarily invested in domestic equitysecurities, United States government and agency securities and internationalequity securities.

 

The Company also has an unfunded Supplemental ExecutiveRetirement Plan (“SERP”), which provides supplemental retirement benefits tocertain retired executives of the Company. The SERP provides for incrementalpension payments to partially offset the reduction in amounts that would havebeen payable under the Pension Plan if it were not for limitations imposed byfederal income tax regulations.

 

Inaddition, the Company provides certain post-retirement benefits other thanpensions (“Other Benefits”) to certain eligible employees, including lifeinsurance benefits and a stated reimbursement for Medicare supplementalinsurance.

 

In recent years, the Company’s managementsubstantially modified its employee compensation structure in order to attractand retain the right mix of talent necessary to successfully support a companywhich is significantly expanding and growing. For that reason, the Companyamended its Pension Plan, SERP and Other Benefits (collectively the “Plans”). ThePlans amendments, effective April 1, 2007, froze the Pension Plan so thatno person is eligible to become a new participant in the Plans on or followingthat date and all future benefit accruals for existing participants under thePlans cease. The amendments to the Plans were accounted for as plancurtailments, resulting in the recognition of a $574 non-cash pretaxcurtailment loss ($0.04 per share) reflected in operating expenses in theCompany’s consolidated statement of income during the year ended December 31,2006.

 

The Company accounts for its Pension Planin accordance with SFAS No. 158, *Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans, an Amendment of FASBStatements No’s 87, 88, 106 and 132(R)* (“SFAS 158”). SFAS 158requires an employer to recognize the funded status of a defined benefitpostretirement plan as an asset or liability in its statement of financialposition and to recognize changes in that funded status in the year in whichthe changes occur through comprehensive income. The Statement also requires anemployer to measure the funded status of a plan as of the date of its year-endstatement of financial position.

** **

**Components of Net Periodic Pension Cost**

 

Net periodic pension costs recognized in the condensed consolidatedstatements of income for the quarters and six-month periods ended June 30,2008 and 2007 under the Pension Plan and SERP included the followingcomponents:

 
| **Quarter ended June 30,**      | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Service cost                                   |       | $        | —     |     | $          | (107 | ) |
| Interest cost on  projected benefit obligation |       | 1,769    |       | 1,829    |       |
| Expected return  on plan assets                |       | (2,282   | )          | (2,330   | )          |
| Amortization of:                               |       |     |       |     |       |
| Prior service  cost                            |       | —   |       | 1        |       |
| Net actuarial  loss                            |       | 5        |       | 10       |       |
| Net periodic pension  (income)                 |       | $        | (508       | )        | $          | (597 | ) |

 
| **Six months ended June 30,** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Service cost                                      |       | $        | —     |     | $          | 1,093 |   |
| Interest cost on  projected benefit obligation    |       | 3,577    |       | 3,629    |       |
| Expected return  on plan assets                   |       | (4,532   | )          | (4,630   | )          |
| Amortization of:                                  |       |     |       |     |       |
| Prior service  cost                               |       | 1        |       | 1        |       |
| Net actuarial  loss                               |       | 11       |       | 10       |       |
| Net periodic pension  (income)/cost               |       | $        | (943       | )        | $          | 103 |   |

 

Net periodicbenefit costs related to the Other Benefits were not significant to thecondensed consolidated financial statements of the Company for the quarters andsix-month periods ended June 30, 2008 or 2007.

 

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**7.     COMMITMENTS AND CONTINGENCIES**

** **

**Credit Arrangements**

 

In May 2007, the Company entered into an Amended and RestatedCredit Agreement (“Old Credit Agreement”) to restate and replace the May 2006credit agreement. The Old Credit Agreement revised both the Term Loan facilityand the Revolving Loan facility (collectively “Loan Facilities”) to principalamounts of $40,000 and up to $60,000, respectively. Principal payments on theoutstanding amounts borrowed under the Loan Facilities were due and payable on May 1,2012. There were no material changes to interest calculations, interestpayments or financial covenants as a result of the Old Credit Agreement.

 

In February 2008,the Company entered into a Second Amended and Restated Credit Agreement (“CreditAgreement”) to restate and replace the Old Credit Agreement. The CreditAgreement terms, among other things: (i) revised the amount availableunder the Term Loan A facility from $40,000 to $120,000, (ii) issued a1-year $60,000 Term Loan B facility and (iii) modified certain financialcovenants. No significant changes were made to the existing Revolving Loanfacility. The credit facilities were used in part to acquire Everest and areavailable for general corporate purposes. The Term Loan A facility and theRevolving Loan facility are due and payable on May 1, 2012.

 

The Term Loan A facility, prior to this new agreement, which had$40,000 outstanding, was extinguished resulting in a loss on extinguishment ofdebt of $607, which was recorded in the first quarter of 2008. $40,000 of thenew borrowings bears interest at a fixed rate of 6.29%. The remaining $80,000of the new borrowings bears interest based, at the Company’s election, on theLondon Interbank Offered Rate (“LIBOR”) or the bank’s Prime Rate plus, ineither case, an applicable margin. The Term Loan B facility is due and payableon February 12, 2009 and includes an automatic increase to the applicableinterest margins on August 12, 2008 to LIBOR or the bank’s Prime Rateplus, in either case, an applicable margin plus 75 basis points. On May 14,2008, the Company repaid $30,000 of the Term Loan B and $16,000 of theRevolving facility with proceeds from the sale of SureWest Wireless. As of June 30,2008, $120,000, $30,000, and $0 were outstanding on the Term Loan A, Term LoanB, and Revolving facilities, respectively. As of December 31, 2007, $40,000was outstanding on the Term Loan A facility and no amounts were outstandingunder the Revolving facility.

 

The Company’s Series Aand Series B Senior Notes and the Credit Agreement contain financial andoperating covenants that may restrict, among other things, repurchase of theCompany’s capital stock, the making of certain other restricted payments andthe incurrence of additional indebtedness. The covenants also require theCompany to maintain certain financial ratios and minimum levels of tangible networth. At June 30, 2008 and December 31, 2007, retained earnings of$118,809 and $111,003, respectively, were available for the payments.

** **

**Litigation,Regulatory Proceedings and Other Contingencies**

 

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

 

The Company is alsosubject to a number of regulatory proceedings occurring at the federal andstate levels that may have a material impact on its operations. Theseregulatory proceedings include, but are not limited to, consideration ofchanges to the jurisdictional separations process, the interstate universalservice fund, intercarrier compensation access charge reform, broadbanddeployment, the regulation of local exchange carriers and their competitors,including providers of Internet protocol-enabled services, and the provision ofvideo services and competition in the market. The outcomes and impact on theCompany’s operations of these proceedings and related court matters cannot bedetermined at this time.

 

The FCC continues topromulgate rules and regulations on competition, interconnection, accesscharges, broadband deployment and universal service reform, and the variouson-going legal challenges considering the validity of these FCC orders and itis not yet possible to determine fully the impact of the related FCCregulations on the Company’s operations.

 

The regulatoryproceedings occurring at the state and federal levels described above may alsoauthorize new competition in the provision of regulated services and change therates and rate structure for regulated services furnished by the Company, theeffects of which on the Company cannot yet be determined.

 

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**8.     RECENT ACCOUNTING PRONOUNCEMENTS**

** **

**Recently IssuedAccounting Pronouncements**

 

In June 2008, theFASB issued FASB Staff Position (“FSP”) EmergingIssues Task Force (“EITF”) 03-6-1, *Determining WhetherInstruments Granted in Share-Based Payment Transactions Are ParticipatingSecurities* (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whetherinstruments granted in share-based payment transactions are participatingsecurities prior to vesting and, therefore, need to be included in the earningsallocation in computing earnings per share under the two-class method asdescribed in SFAS No. 128, *Earnings per Share*.Under the guidance in FSP EITF 03-6-1, unvested share-based payment awards thatcontain non-forfeitable rights to dividends or dividend equivalents (whetherpaid or unpaid) are participating securities and shall be included in thecomputation of earnings per share pursuant to the two-class method. FSP EITF03-6-1 is effective for financial statements issued for fiscal years beginningafter December 15, 2008, and interim periods within those years. Earlyapplication is not permitted. The Company is currently evaluating the potentialimpact, if any, of adopting FSP EITF 03-6-1.

 

In May 2008, theFASB issued SFAS No. 162,*The Hierarchyof Generally Accepted Accounting Principles* (“SFAS 162”). SFAS 162identifies a consistent framework, or hierarchy, for selecting accountingprinciples to be used in preparing financial statements that are presented inconformity with U.S. generally accepted accounting principles fornongovernmental entities (the “Hierarchy”). The Hierarchy within SFAS 162 isconsistent with that previously defined in the AICPA Statement on AuditingStandards No. 69, *The Meaning ofPresent Fairly in Conformity With Generally Accepted Accounting Principle*(“SAS 69”). SFAS 162 is effective 60 days following the United States SEC’sapproval of the Public Company Accounting Oversight Board amendments to AU Section 411,*The Meaning of Present Fairly in Conformity WithGenerally Accepted Accounting Principles*. The Company is currently evaluating the potential impact, if any, ofadopting SFAS 162.

 

In April 2008, theFASB issued FSP No. FAS 142-3,*Determination of the Useful Life of Intangible Assets* (“FSP FAS142-3”). FSP FAS 142-3 amends the factors that should be considered indeveloping renewal or extension assumptions used for purposes of determiningthe useful life of a recognized intangible asset under FASB Statement No. 142,*Goodwill and Other Intangible Assets* (“SFAS142”). FSP FAS 142-3 is intended to improve the consistency between the usefullife of a recognized intangible asset under SFAS 142 and the period of expectedcash flows used to measure the fair value of the asset under SFAS 141(R) andother U.S. generally accepted accounting principles. FSP FAS 142-3 is effectivefor fiscal years beginning after December 15, 2008. Earlier application isnot permitted. The Company is currently evaluating the potential impact, ifany, of adopting FSP FAS 142-3.

 

In December 2007,the FASB issued SFAS No. 141(R), *BusinessCombinations* (“SFAS 141(R)”), which establishes principles andrequirements for how the acquirer: (a) recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumedand any noncontrolling interest in the acquiree; (b) recognizes andmeasures the goodwill acquired in the business combination or a gain from abargain purchase; and (c) determines what information to disclose toenable users of the financial statements to evaluate the nature and financialeffects of the business combination. SFAS 141(R) requires contingentconsideration to be recognized at its fair value on the acquisition date and,for certain arrangements, changes in fair value to be recognized in earningsuntil settled. SFAS 141(R) also requires acquisition-related transactionand restructuring costs to be expensed rather than treated as part of the costof the acquisition. SFAS 141(R) applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008. TheCompany is currently evaluating the impact this statement will have on itsfinancial position and results of operations, however, the effect will bedependent upon the acquisitions that are made in the future.

 

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**Recently AdoptedAccounting Pronouncements**

 

In September 2006,the FASB issued SFAS No. 157,*Fair Value Measurements*(“SFAS157”)*,* which defines fair value, establishesa framework for measuring fair value in generally accepted accountingprinciples and expands disclosures about fair value measurements. In February 2008,the FASB issued FSP No. FAS 157-2, *Effective Date of FASBStatement No. 157*(“FSP FAS 157-2”). FSP FAS 157-2 amends SFAS157 to delay the effective date for nonfinancial assets and nonfinancialliabilities, except for items that are recognized or disclosed at fair value inthe financial statements on a recurring basis, at least annually. SFAS 157, asamended, is effective for financial statements issued for fiscal yearsbeginning after November 15, 2008, and for interim periods within thosefiscal years. Effective for 2008 the Company adopted SFAS 157, except as itapplies to those non-financial assets and non-financial liabilities as noted inFSP FAS 157-2. The partial adoption of SFAS 157 did not have a material impacton the Company’s condensed consolidated financial statements. For a moredetailed discussion of the effects of applying the provisions of SFAS 157 referto the Fair Value of Financial Instruments section of Note 1.

 

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*(“SFAS 159”)*.*This standard permits an entity to elect to measure manyfinancial instruments and certain other items at fair value that are notcurrently required to be measured at fair value. SFAS 159 also establishesrecognition, presentation and disclosure requirements. The Company adopted SFAS159 effective January 1, 2008 and has not elected the fair value optionfor its financial instruments. The adoption of SFAS 159 did not have a materialeffect on the Company’s condensed consolidated financial statements.

## ** **

## **In June 2007,the EITF ratified EITF Issue No. 06-11, *Accountingfor Income Tax Benefits of Dividends on Share-Based Payment*(“EITF06-11”). EITF 06-11 provides that realized income tax benefits from dividendsor dividend equivalents that are charged to retained earnings and are paid toemployees for equity classified nonvested equity shares, nonvested equity shareunits and outstanding equity share options should be recognized as an increasein additional paid-in capital. The Company adopted EITF Issue 06-11 effective January 1,2008. The adoption of this standard did not have a material impact on theCompany’s consolidated financial position and results of operations.**

 

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** **

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

* *

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

 

Certain statementsincluded in this report, including that which relates to the impact on futurerevenue sources and potential sharing obligations of pending and futureregulatory orders, continued expansion of the telecommunications network andexpected changes in the sources of the Company’s revenue and its cost structureresulting from its entrance into new communications markets, areforward-looking statements and are made pursuant to the safe harbor provisionsof the Securities Litigation Reform Act of 1995. These forward lookingstatements generally are identified by the words “believe”, “expect”, “anticipate”,“estimate”, “intend”, “should”, “may”, “will”, “would”, “will be”, “willcontinue” or similar expressions. Such forward looking statements involve knownand unknown risks, uncertainties and other factors that may cause actualresults, performance or achievements of SureWest Communications to be differentfrom those expressed or implied in the forward-looking statements. A detaileddiscussion of these and other risks and uncertainties that could cause actualresults and events to differ materially from such forward—looking statements isincluded in the Company’s 2007 Annual Report on Form 10-K filed with the Securitiesand Exchange Commission (“SEC”). We disclaim any intention or obligation toupdate or revise publicly any forward-looking statements.

** **

**CorporateStructure**

 

SureWest Communications(the “Company”, “we” or “our”) is one of the nation’s leading integratedcommunications providers and is the bandwidth leader in the markets weserve.  We classify our operations in tworeportable segments: Broadband and Telecommunications (“Telecom”).

 

The Broadband segment, which generated approximately 56% and 39% of ourconsolidated revenue for the six-month periods ended June 30, 2008 and2007, respectively, utilizes fiber-to-the-premise and fiber-to-the-nodenetworks to offer bundled residential and commercial services that includeIP-based digital and high-definition television, high-speed internet, Voiceover Internet Protocol (“VoIP”), and local and long distance telephone in thegreater Sacramento, California and greater Kansas City, Kansas and Missouriareas (“Kansas City area”).

 

In December 2007, the Company entered into a definitive agreementto purchase Everest Broadband, Inc. (“Everest” or “Kansas City”). On February 13,2008, the Company acquired 100% of the issued and outstanding stock of Everestfor a total purchase price of $182,100, including estimated transaction costs.Subsequent to the acquisition, the Kansas City operations have been included inthe Company’s Broadband segment. Everest is a competitive provider ofhigh-speed data, video and voice services in the greater Kansas City area. Theacquisition of Everest accelerates the Company’s growth strategy and builds onits status as a leading provider of network services to residential andbusiness customers.

 

The Telecom segment offers landline telecommunications services,Digital Subscriber Line (“DSL”) service, long distance services and certainnon-regulated services operating only in the greater Sacramento area. SureWestTelephone, which is the principal operating subsidiary of the Telecom segment,provides local services, toll telephone services, network access services andcertain non-regulated services. SureWest Long Distance is a reseller of longdistance services.

 

In May 2008, the Company sold the operating assets of its Wirelessbusiness, SureWest Wireless, to Verizon Wireless (“Verizon”) for an aggregatecash purchase price of $69,841, resulting in a gain of $31,829, less estimatedincome taxes of $12,852.  Under theagreement, Verizon acquired the spectrum licenses and operating assets ofSureWest Wireless, excluding the Company’s owned communication towers. SureWestWireless was previously reported as a separate reportable segment.

 

In February 2007, GateHouse Media acquired 100% of the stock ofSureWest Directories (previously included in the Telecom segment), itsdirectory publishing business, for an aggregate cash purchase price of$110,123, resulting in a gain as of December 31, 2007 of $101,286, lessestimated income taxes of $41,130. As part of the transaction, GateHouse Mediabecame the publisher of the official directory of SureWest Telephone.

 

The Company expects that the sources of its revenues and its coststructure may be different in future periods, as a result of its entry into newcommunications markets, the disposition of non-strategic investments andregulatory and competitive forces in each of the markets in which the Companyhas operations.

 

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**Results of Operations**

** **

**Consolidated Overview**

 

The tables below reflectcertain financial data (on a consolidated and segment basis) and selectoperating metrics for each of our reportable segments as of and for thequarters and six months ended June 30, 2008 and 2007.

 

**FinancialData**

 
| ** **                                    | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                | ** ** | ** **                                        | ** ** | **$** | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                    | ** ** | **2008**                                  | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** | **Change** | ** ** |
| **Operating  revenues (1)**                   |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband                                     |       | $                                         | 35,600     |                                              | $          | 17,193 |   | $ | 18,407 |   | 107 | % | $ | 62,642 |   | $ | 33,718 |   | $ | 28,924 |   | 86 | % |
| Telecom                                       |       | 24,650                                    |       | 27,249                                            |       | (2,599 | ) | (10 | ) | 49,228 |   | 53,610 |   | (4,382 | ) | (8 | ) |
| Operating  revenues                           |       | 60,250                                    |       | 44,442                                            |       | 15,808 |   | 36 |   | 111,870 |   | 87,328 |   | 24,542 |   | 28 |   |
|                                          |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Income  (loss) from operations**            |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband                                     |       | (6,056                                    | )          | (6,089                                            | )          | 33 |   | 1 |   | (13,652 | ) | (13,929 | ) | 277 |   | 2 |   |
| Telecom                                       |       | 11,950                                    |       | 10,189                                            |       | 1,761 |   | 17 |   | 22,187 |   | 19,782 |   | 2,405 |   | 12 |   |
| Income from  operations                       |       | 5,894                                     |       | 4,100                                             |       | 1,794 |   | 44 |   | 8,535 |   | 5,853 |   | 2,682 |   | 46 |   |
|                                          |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Income  (loss) from continuing operations** |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband                                     |       | (5,462                                    | )          | (4,459                                            | )          | (1,003 | ) | (22 | ) | (11,314 | ) | (9,721 | ) | (1,593 | ) | (16 | ) |
| Telecom                                       |       | 7,159                                     |       | 7,129                                             |       | 30 |   | 0 |   | 13,000 |   | 13,003 |   | (3 | ) | 0 |   |
| Income from  continuing operations            |       | $                                         | 1,697      |                                              | $          | 2,670 |   | $ | (973 | ) | (36 | )% | $ | 1,686 |   | $ | 3,282 |   | $ | (1,596 | ) | (49 | )% |

 

----

(1) External customers only

 

**SelectOperating Metrics**

** **
| ** **                                          | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **2008**                          | ** ** | **2007** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| **Broadband**                                       |       |                              |       |   |   |   |   |   |   |
| Total  residential subscribers (1)                  |       | 99,000                            |       | 56,500 |   | 42,500 |   | 75 | % |
| Broadband  residential Revenue-generating units (2) |       | 207,700                           |       | 93,300 |   | 114,400 |   | 123 |   |
| Data                                                |       | 94,000                            |       | 54,000 |   | 40,000 |   | 74 |   |
| Video                                               |       | 57,100                            |       | 19,800 |   | 37,300 |   | 188 |   |
| Voice                                               |       | 56,600                            |       | 19,500 |   | 37,100 |   | 190 |   |
| Total business  customers (3)                       |       | 6,200                             |       | 4,000 |   | 2,200 |   | 55 |   |
| ** **                                          | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Telecom**                                         |       |                              |       |   |   |   |   |   |   |
| Voice  Revenue-generating units (4)                 |       | 62,900                            |       | 74,500 |   | (11,600 | ) | (16 | ) |
| Total business  customers (3)                       |       | 9,600                             |       | 9,900 |   | (300 | ) | (3 | )% |

** **

----

(1)   Totalresidential subscribers are customers who receive one or more residential data,video or voice services from SureWest Broadband.

(2)   TheCompany can deliver multiple services to a customer. Accordingly, the Companymaintains statistical data regarding Revenue-generating units (“RGUs”) fordigital video, voice and data, in addition to the number of subscribers. Forexample, a single customer who purchases digital video, voice and data serviceswould be reflected as three Revenue-generating units.

(3)   Totalbusiness customers are customers who receive business data, voice or videoservices and represent a unique customer account.

(4)   VoiceRGUs are residential customers who subscribe to one or more voice access lines.

 

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Operating revenues for the Broadband segment increased $18,407 and$28,924 during the quarter and six-month period ended June 30, 2008,respectively, compared to the same periods in 2007. The Broadband segmentresults of operations and select operating metrics in the current year comparedto the same prior year periods have been impacted by the effects of the Everestacquisition, as described above, in February 2008.  The Kansas City operations contributedapproximately $16,191and $24,541 of operating revenues during the quarter andsix-month period ended June 30, 2008, respectively.  At June 30, 2008, the Kansas Cityoperations accounted for 38,100, 103,300 and 1,800 of the residentialsubscribers, residential RGUs and business customers, respectively.

 

At June 30, 2008, the Broadband segment experienced a 75% annualincrease in the number of residential subscribers compared to the same date inthe prior year. In the Sacramento market, both data and video RGUs increased 9%and 14%, respectively, which was reflective of the Company’s ability to offersubscribers high-speed data, HDTV, HD DVR and other enhanced services.  In addition, Broadband operating revenuesincreased due to the continued expansion of the broadband network and growth inthe demand for digital video, voice and data offered as a bundled triple-playpackage.

 

In March 2008, the Company launched its new VoIP Digital Phoneproduct in the Sacramento market, including the Telecom segment serviceterritory.  The Company anticipates thatthis offering will result in elevated take rates and an increase in broadbandresidential triple-play RGUs, while successfully mitigating access line lossesin the Telecom segment by migrating these customers to voice RGUs in theBroadband segment.

 

The Company will continue to invest in success-based capital andbuilding and deploying the broadband infrastructure while focusing on thegeneration of new customers and increasing residential penetration on existingmarketable homes.

 

Operating revenues in the Telecom segment decreased$2,599 and $4,382 during the quarter and six-month period ended June 30,2008, respectively, compared to the same periods in 2007. Residential revenuesaccounted for nearly all of the decrease in operating revenues in the currentyear.  Residential services were largelyimpacted by customer’s migration toward alternative communication services,including those offered by the Company’s Broadband segment, such as VoIP, whichcontributed to an approximate 16% decline in voice RGUs as of June 30,2008 compared to June 30, 2007.  Thedecrease in operating revenues was also impacted by continued scheduledreductions in California High Cost Fund subsidies of approximately $510 and$1,020 during the quarter and six-month period ended June 30, 2008,respectively, compared to the same prior year periods.  As well, some competitors initiated marketingcampaigns to include voice services targeted directly to residential subscriberswithin SureWest Telephone’s service area. In an effort to mitigate futureoperating revenue and voice RGU declines, the Company now offers variousflat-rate and bundled service packages and has introduced a broadband VoIPservice to customer’s residing within SureWest Telephone’s service area.

 

Consolidated operating expenses, excluding depreciation andamortization, increased $11,269 and $18,006 during the quarter and six-monthperiod ended June 30, 2008, respectively, compared to the same periods in 2007.The Company’s Broadband segment accounted for substantially all of theincreases in the Company’s consolidated operating expenses primarily as aresult of the Kansas City operations, which accounted for $11,445 and $16,838of the quarter and six-month period increase, respectively. Cost of servicesand products expense increased $9,428 and $13,542 during the quarter andsix-month period ended June 30, 2008, respectively, compared to the sameperiods in 2007 primarily as a result of the Kansas City operations as well asincreases in programming and vehicle costs related to the growth in Broadbandsubscribers. Customer operations and selling expense increased $2,202 and$3,008 during the quarter and six-month period ended June 30, 2008,respectively, compared to the same periods in 2007 due primarily to an increasein sales and advertising costs to promote subscriber growth and new productofferings within the Broadband segment. General and administrative expensesdecreased $361 and increased $1,456 during the quarter and six-month periodended June 30, 2008, respectively, compared to the same periods in 2007.Excluding the addition of the operations for Kansas City, general andadministrative expenses decreased $1,236 and increased $69 from the respectiveprior year periods primarily as a result of (i) a decline in legal feesdue to additional fees incurred in the prior year period related to newregulatory framework matters and (ii) a decline in salaries and wages dueto a reduction in headcount and overhead costs.

 

The Company’s consolidated depreciation and amortization expenseincreased $2,745 and $3,854 during the quarter and six-month period ended June 30,2008, respectively, compared to the same periods in 2007 due to the continuednetwork build-out and success-based capital projects undertaken within theresidential broadband service territories and the Kansas City operations.

 

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*Reclassification*

 

Certain amounts in the Company’s 2007 condensed consolidated financialstatements have been reclassified to conform to the presentation of the Company’s2008 condensed consolidated financial statements, which consist of the effectsof reclassifications from presentation of the Company’s Wireless business as adiscontinued operation. In addition, the calculation of certain selectoperating metrics has been revised over time to reflect the current view of theCompany’s business. Accordingly, where necessary, prior period metriccalculations have been revised to conform to current practice.

 

*Effectsof Strategic Corporate Actions*

* *

The Company’s acquisition of Everest and divestiture of SureWestWireless will yield various impacts to the Company’s financial statements andresults of operations in 2008.

 

As discussed above, the Company purchased Everest in February 2008.  As a result, the Broadband segment operatingrevenues and income from operations increased approximately $24,541 and $2,028,respectively, during the six-month period ended June 30, 2008 compared tothe same period in 2007. The Everest acquisition has facilitated the rapidexpansion of our geographic footprint and overall services targeted tobusinesses, while more than doubling the number of our triple-play residentialsubscribers, as evidenced by the increase in RGUs of nearly 123% at June 30,2008 compared to the same period last year. The acquisition was largely financed by the Second Amended and RestatedCredit Agreement entered into by the Company in February 2008.  Accordingly, subsequent to the closing of thetransaction the Company experienced increased interest expense resulting fromthe financing agreement.  The Company’sability to successfully integrate the Kansas City operations will depend on anumber of factors, including our ability to devote adequate personnel to theintegration process while still managing our current operations effectively.The Company does not anticipate difficulties integrating the acquired business;however such difficulties could increase our costs or adversely impact ourability to operate our business.

 

The sale of the operating assets of the Company’s Wireless business,SureWest Wireless, has also affected our financial statements and results ofoperations subsequent to the closing of the transaction, which occurred on May 9,2008.  The results of SureWest Wirelessare reported as a discontinued operation in the Company’s condensedconsolidated financial statements for all periods presented.  Income (loss) from discontinued operationswas $211 and $505 for the quarter and six-month period ended June 30,2008, respectively, and $(885) and $(1,444) for the same prior yearperiods.  See Note 2 for a summary of theWireless business operating results included in discontinued operations.

 

In connection with the sale, the Company entered into a short-termTransition Services Agreement with Verizon to provide certain operatingservices during the transition of the Wireless business to Verizon. During thetransition period, the Company’s Telecom and Broadband segments will recordadditional business revenues in association with the operating servicesprovided to Verizon. The Company anticipates that the services provided toVerizon and related revenues will diminish as Verizon migrates customers ontoits network at the end of the transition period, which is expected to concludeduring the latter part of 2008.

 

The Company amended its defined benefit pension plan (the “Pension Plan”),Supplemental Executive Retirement Plan and certain post-retirement benefitsother than pensions (“Other Benefits”) (collectively the “Plans”). The Plansamendments, effective April 1, 2007, froze the Pension Plan so that noperson is eligible to become a new participant in the Plans on or followingthat date and all future benefit accruals for existing participants under thePlans cease. The Company’s decision to freeze the Pension Plan also affectedits financial statements and results of operations beginning in 2007. Thefreeze reduced the Company’s operating expenses by approximately $4,100 for theyear ended December 31, 2007. For the quarters ended June 30, 2008and 2007, the Company recorded income of $486 and $662 respectively, and forthe six-month periods ended June 30, 2008 and 2007, the Company recorded$838 in income and $64 in expense, respectively, related to the Plans. Inaddition, the Company did not make any contributions to the Pension Plan in2007 and does not expect to make any contributions during 2008. Historically,for the fiscal years 2004 through 2006, the Company’s cash contributions to thePension Plan ranged from $3,000 to $5,000, and the annual service cost averagedapproximately $4,000 over the same time period. See Note 6 for moreinformation on the Plans.

 

Recently, the Company’smanagement substantially modified its employee compensation structure in orderto attract and retain the right mix of talent necessary to successfully supporta company which is significantly expanding and growing. The program encouragesemployees to achieve the Company’s financial, operational and strategic targetsby fostering superior employee performance and job satisfaction.

 

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**SegmentResults of Operations**

** **

**Broadband**

 
| ** **                                         | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                         | ** ** | ** **                                | ** ** | ** **                                        | ** ** | **$** | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                         | ** ** | **2008**                                  | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                               |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Data                                               |       | $                                         | 10,248     |                                              | $          | 6,710 |   | $ | 3,538 |   | 53 | % | $ | 18,996 |   | $ | 13,160 |   | $ | 5,836 |   | 44 | % |
| Video                                              |       | 10,519                                    |       | 3,705                                             |       | 6,814 |   | 184 |   | 17,953 |   | 7,251 |   | 10,702 |   | 148 |   |
| Voice                                              |       | 5,292                                     |       | 2,039                                             |       | 3,253 |   | 160 |   | 8,988 |   | 4,049 |   | 4,939 |   | 122 |   |
| Total  residential revenues                        |       | 26,059                                    |       | 12,454                                            |       | 13,605 |   | 109 |   | 45,937 |   | 24,460 |   | 21,477 |   | 88 |   |
| Business                                           |       | 8,345                                     |       | 4,265                                             |       | 4,080 |   | 96 |   | 14,686 |   | 8,339 |   | 6,347 |   | 76 |   |
| Access                                             |       | 392                                       |       | 71                                                |       | 321 |   | 452 |   | 626 |   | 139 |   | 487 |   | 350 |   |
| Other                                              |       | 804                                       |       | 403                                               |       | 401 |   | 100 |   | 1,393 |   | 780 |   | 613 |   | 79 |   |
| Total operating  revenues from  external customers |       | 35,600                                    |       | 17,193                                            |       | 18,407 |   | 107 |   | 62,642 |   | 33,718 |   | 28,924 |   | 86 |   |
| Intersegment  revenues                             |       | 141                                       |       | 162                                               |       | (21 | ) | (13 | ) | 281 |   | 321 |   | (40 | ) | (12 | ) |
| Operating  expenses*                               |       | 31,351                                    |       | 17,765                                            |       | 13,586 |   | 76 |   | 57,613 |   | 36,864 |   | 20,749 |   | 56 |   |
| Depreciation and  amortization                     |       | 10,446                                    |       | 5,679                                             |       | 4,767 |   | 84 |   | 18,962 |   | 11,104 |   | 7,858 |   | 71 |   |
| Loss from  operations                              |       | (6,056                                    | )          | (6,089                                            | )          | 33 |   | 1 |   | (13,652 | ) | (13,929 | ) | 277 |   | 2 |   |
| Loss from continuing  operations                   |       | $                                         | (5,462     | )                                                 | $          | (4,459 | ) | $ | (1,003 | ) | (22 | )% | $ | (11,314 | ) | $ | (9,721 | ) | $ | (1,593 | ) | (16 | )% |

 

----

*Exclusive of depreciation and amortization

* *

*Operating Revenues*

 

Operating revenues from external customers in the Broadband segmentincreased $18,407 and $28,924 in the quarter and six-month period ended June 30,2008, respectively, compared to the same periods in 2007.  The Company’s Kansas City operations, asdescribed above, contributed $16,191 and $24,541 of operating revenues in thequarter and six-month period ended June 30, 2008, respectively.

 

Broadband residential revenues increased $13,605 and $21,477 in thequarter and six-month period ended June 30, 2008, respectively, comparedto the same periods in 2007; of which $12,381 and $18,817, was attributable tothe Kansas City operations.  Broadbandresidential subscribers and RGUs increased 75% and 123%, respectively, as of June 30,2008 compared to the same period in 2007. The Company anticipates continued growth in residential broadband RGUsand average revenue per user resulting from the HD DVR and SureWest DigitalPhone services, which were recently launched in the Sacramento market.  SureWest Digital Phone presents the Companywith a more competitive triple-play offering with increased options andmultiple packages.

 

Residential data revenues increased $3,538 and $5,836 in the quarterand six-month period ended June 30, 2008, respectively, compared to thesame periods in 2007.  Data RGUs in theSacramento market increased 9% as of June 30, 2008 compared to the sameperiod in 2007, which was reflective of the Company’s ability to offersubscribers superior high-speed data products and other enhanced services.  The reliability and high speeds of the dataservice in both the Sacramento and Kansas City markets enhance other servicessuch as the SureWest Digital Phone, where customers manage phone servicesthrough the online SureWest portal.  Theremaining increase in Data revenues was due to the Kansas City operations.

 

Residential video revenues increased $6,814 and $10,702 in the quarterand six-month period ended June 30, 2008, respectively, compared to thesame periods in 2007.  In the Sacramentomarket, the Broadband segment experienced a 14% growth in Video RGUs as ofJune 30, 2008 compared to the same period in 2007 due in part to demandfor the Company’s new product offerings and other enhanced services andfeatures such as HD DVR and additional high definition content.  In addition, effective January 2008video rates increased 10%.  The remainingincrease was the result of the Kansas City operations.

 

The increase in residential voice revenues in the quarter and six-monthperiod ended June 30, 2008 was due in part to the growth in voice RGUs, ofwhich the growth in the Sacramento market was 18%.  In March 2008, the Company launched itsnew VoIP Digital Phone product in the Sacramento market, including the Telecomservice territory.  The Companyanticipates that this offering will result in elevated take rates and anincrease in Broadband residential triple-play RGUs.

 

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Business revenues increased $4,080 and $6,347 in the quarter andsix-month period ended June 30, 2008, respectively, compared to the sameperiods in 2007.  Business customersincreased 55% as of June 30, 2008 compared to the same period in2007.  The Company continues to expandits business broadband services in Sacramento; however a significant portion ofthe business revenue growth was due to the Kansas City operations.

* *

*Operating Expenses*

 

Total operating expensesin the Broadband segment increased $13,586 and $20,749 in the quarter andsix-month period ended June 30, 2008, respectively, compared to the sameperiods in 2007.  The increase inoperating expenses was offset in part by a decline in the costs related to thePlans of $338 for the six months ended June 30, 2008, as described in theConsolidated Overview section above.

 

Cost of services andproducts (exclusive of depreciation and amortization) increased $9,282 and$13,828 in the quarter and six-month period ended June 30, 2008,respectively, compared to the same periods in 2007.  The increase in costs in the current yearperiods was primarily due to Kansas City operations, contributing $8,515 and$12,611 in additional expenses, respectively. The increase was also attributable to (i) an increase inprogramming, transport and access costs related to the growth in Broadbandsubscribers, residential broadband Revenue-generating units and businesscustomers and (ii) an increase in maintenance costs corresponding to theincreased subscriber count, as well as the expanded network footprint.

 

Customer operationsexpense increased $2,677 and $3,673 in the quarter and six-month period ended June 30,2008, respectively, compared to the same periods in 2007.  Although the Company experienced modestincreases in sales and advertising costs to promote new and existing productofferings, substantially all of the increase in the current year period wasattributable to Kansas City operations.

 

General and administrative expense increased $1,627 and $3,248 in thequarter and six-month period ended June 30, 2008, respectively, comparedto the same periods in 2007 primarily due to increases in (i) informationtechnology costs related to system maintenance and development, includingintegration of Kansas City operations and increased production support projectsand (ii) consulting and advisory fees.  During the quarter and  six-month period ended June 30, 2008,Kansas City operations contributed $875 and $1,387, respectively, to theincrease in general and administrative expenses.

 

Depreciation andamortization increased $4,767 and $7,858 in the quarter and six-month periodended June 30, 2008, respectively, compared to the same periods in 2007due to the continued expansion of the broadband network and success basedcapital projects.  Kansas City operationsincreased depreciation and amortization expense by $3,633 and $5,675 during thequarter and six-month period ended June 30, 2008, respectively.

 

**Telecom**

 
| ** **                                         | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                         | ** ** | ** **                                | ** ** | ** **                                        | ** ** | **$** | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                         | ** ** | **2008**                                  | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                               |       |                                      |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential                                        |       | $                                         | 8,523      |                                              | $          | 10,330 |   | $ | (1,807 | ) | (17 | )% | $ | 17,425 |   | $ | 20,873 |   | $ | (3,448 | ) | (17 | )% |
| Business                                           |       | 9,796                                     |       | 9,571                                             |       | 225 |   | 2 |   | 18,843 |   | 18,788 |   | 55 |   | 0 |   |
| Access                                             |       | 6,041                                     |       | 7,010                                             |       | (969 | ) | (14 | ) | 12,383 |   | 13,392 |   | (1,009 | ) | (8 | ) |
| Other                                              |       | 290                                       |       | 338                                               |       | (48 | ) | (14 | ) | 577 |   | 557 |   | 20 |   | 4 |   |
| Total operating  revenues from  external customers |       | 24,650                                    |       | 27,249                                            |       | (2,599 | ) | (10 | ) | 49,228 |   | 53,610 |   | (4,382 | ) | (8 | ) |
| Intersegment  revenues                             |       | 4,566                                     |       | 4,633                                             |       | (67 | ) | (1 | ) | 8,909 |   | 9,067 |   | (158 | ) | (2 | ) |
| Operating  expenses*                               |       | 13,520                                    |       | 15,925                                            |       | (2,405 | ) | (15 | ) | 28,536 |   | 31,477 |   | (2,941 | ) | (9 | ) |
| Depreciation and  amortization                     |       | 3,746                                     |       | 5,768                                             |       | (2,022 | ) | (35 | ) | 7,414 |   | 11,418 |   | (4,004 | ) | (35 | ) |
| Income from  operations                            |       | 11,950                                    |       | 10,189                                            |       | 1,761 |   | 17 |   | 22,187 |   | 19,782 |   | 2,405 |   | 12 |   |
| Income from  continuing operations                 |       | $                                         | 7,159      |                                              | $          | 7,129 |   | $ | 30 |   | 0 | % | $ | 13,000 |   | $ | 13,003 |   | $ | (3 | ) | (0 | )% |

 

----

*Exclusive of depreciation and amortization

 

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*Operating Revenues*

 

Operating revenues from external customers in theTelecom segment decreased $2,599 and $4,382 in the quarter and six-month periodended June 30, 2008, respectively, compared to the same periods in 2007.SureWest Telephone continues to experience decreases in residential revenue dueto competition from wireless, wireline competitors and cable providers,contributing to an approximate 16% decline in voice RGUs.  In addition, some competitors initiatedmarketing campaigns to include voice services targeted directly to residentialsubscribers within SureWest Telephone’s service area.  In an effort to mitigate future voiceservices and operating revenue declines, the Company now offers variousflat-rate and bundled voice service packages. In March 2008, the Companyalso began offering VoIP phone service to customers within the Telecom servicearea through its SureWest Broadband segment. As a result, the Company expects a portion of voice revenue to continueto migrate to the VoIP service being offered by the Company’s Broadbandsegment.

 

Business revenues have also been impacted by thecompetitive pressures as discussed above, which has caused a 4% decline inbusiness customers.  However, the declinein business revenues was partially offset by continued strong demand for dataservices. In addition, subsequent to the sale of the Company’s Wirelessbusiness on May 9, 2008 to Verizon, SureWest Telephone recorded additionalbusiness revenues of approximately $450 for certain operating services providedto Verizon during the transition of the wireless business to Verizon.  The Company anticipates that the servicesprovided to Verizon and related revenues will diminish as Verizon migratescustomers onto its network at the conclusion of the transition period, which isexpected to conclude during the latter part of 2008.

 

Access revenues, which include switched access revenue, interstatecommon line (“CL”) revenue and draws from the California High Cost Fund (“CHCF”)decreased by $969 and $1,009 during the quarter and six months ended June 30,2008, respectively, compared to the same prior year periods.  As anticipated, subsidies received from theCHCF have decreased, as discussed in the Regulatory Matters section below.  Switched access revenues also declined withthe reduction of residential voice services. These decreases were partially offset during the first quarter of 2008by an increase in interstate CL settlements received from National ExchangeCarrier Association (“NECA”) as a result of an increase in regulatory costs andassociated rate base (see Regulatory Matters**sectionbelow).

 

*Operating Expenses*

 

Operating expenses for the Telecom segment decreased $2,405 and $2,941in the quarter and six-month period ended June 30, 2008, respectively,compared to the same periods in 2007.  The decrease was due in part to$564 in cost savings realized through the Plans, during the six months ended June 30,2008, as described in the Consolidated Overview section above.

 

Cost of services and products (exclusive of depreciation andamortization) increased $57 and decreased $465 in the quarter and six-monthperiod ended June 30, 2008, respectively, compared to the same periods in2007. The decrease in the current year six-month period compared to the sameprior year period was due primarily to the decline in local and long distanceexpenses as a result of the decrease in (i) residential and business servicesand (ii) long distance minutes of use.

 

Customer operations expense decreased $446 and $644 in the quarter andsix-month period ended June 30, 2008, respectively, compared to the sameperiods in 2007.  The decrease wasprimarily due to (i) a decline in labor costs resulting from reduction inheadcount and (ii) an increase in capitalized project support costs in2008.

 

General and administrative expense decreased $2,016 and $1,832 in thequarter and six-month period ended June 30, 2008, respectively, comparedto the same periods in 2007.  Thedecrease was primarily due to additional costs incurred in 2007 for: (i) informationtechnology costs associated with various system developments and automationprojects and related maintenance contracts and (ii) legal and advisory feesrelated to new regulatory framework matters. 

 

Depreciation and amortization decreased $2,022 and $4,004 in thequarter and six-month period ended June 30, 2008, respectively, comparedto the same periods in 2007 due primarily to a majority of the circuit anddigital switch equipment becoming fully depreciated during the second half of2007.

 

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**Regulatory Matters**

 

Revenues from services subject to regulationconstituted approximately 39% and 36% of the Company’s total operating revenuesfrom continuing operations for the quarter and six-month period ended June 30,2008, respectively.  For the same prioryear periods, revenues and services subject to regulation constitutedapproximately 56% of the Company’s total operating revenues from continuingoperations. Those revenues, which include local service, network access serviceand toll service, are derived from various sources, including:

 

·                  business andresidential subscribers, for basic exchange services;

·                  surcharges,mandated by State Commissions;

·                  long distancecarriers, for network access service;

·                  competitiveaccess providers and commercial enterprises, for network access service;

·                  interstate poolsettlements from NECA;

·                  support paymentsfrom federal or state programs, and

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

 

Significant portions of the Company’s telephone ratesand charges are subject to regulation by the Federal Communications Commission(“FCC”) and State Commissions. Rates and charges are based on various tariffsfiled by the Company and others, including those filed by the NECA forinterstate CL charges. Pending and future regulatory actions, with respect tothese and other matters and the filing of new or amended tariffs, may have amaterial impact on the Company’s consolidated financial position and results ofoperations.

 

Certainof the Company’s rates are subject to regulation by the FCC and StateCommissions. Intrastate service rates are subject to regulation by StateCommissions. With respect to toll calls initiated by interexchange carriers’customers, the interexchange carriers are assessed access charges based ontariffs filed by the Company. Interstate access rates and resultant earningsare subject to regulation by the FCC. With respect to interstate services,SureWest Telephone has detariffed its DSL services and files its own tariffwith the FCC for switched and special access services. For interstate CLcharges, SureWest Telephone concurs with tariffs filed by NECA. Pending andfuture regulatory actions may have a material impact on the Company’sconsolidated financial position and results of operations.

 

*FCC Matters*

 

TheFCC monitors SureWest Telephone’s interstate earnings through the use of annualcost separation studies prepared by SureWest Telephone, which utilize estimatedcost information and projected demand usage. The FCC 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.

 

As a result of periodic cost separation studies required by the FCC,SureWest Telephone changed its estimates for certain NECA CL accountsreceivable balances related to current and prior year monitoring periods.  During the quarter and six-month period endedJune 30, 2007, these changes in estimates increased the Company’sconsolidated revenues by $688 and $806 and net income by $473 ($0.03 per share)and $555 ($0.04 per share), respectively. The Company did not record anysignificant changes in estimates during the quarter and six-month period ended June 30,2008.

 

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

 

In 2004, the Company entered into a settlement agreement (the “SettlementAgreement”), which was ultimately approved by the CPUC, to resolve an ongoingregulatory proceeding with various parties. The Settlement Agreement resolved past sharing liabilities and suspendedfuture sharing requirements in the intrastate jurisdiction.  In accordance with the Settlement Agreement,SureWest Telephone is returning approximately $6,500 (“Dividend A”), plusinterest at the 90-day commercial paper rate for non-financial institutions,which was 2.21% as of June 30, 2008, and an imputed rate of 3.15%, to itsend users through a consumer dividend and is recorded as a reduction of theCompany’s contractual shareable earnings obligations over a period ofapproximately four years, which began January 1, 2005.  In addition, SureWest Telephone paid aone-time consumer dividend of $2,600 (“Dividend B”) to consumers to settle themonitoring periods 2000 to 2004 payable over approximately two years, whichbegan January 1, 2005 and was completed in March 2007.  At June 30, 2008, the aggregate contractualshareable earnings obligation for Dividend A was $770 (which is net of anunamortized discount pertaining to imputed interest of $8 at that date).

 

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Thefollowing table summarizes the amounts returned to end users through consumerdividends for the quarters ended June 30, 2008 and 2007:

 
| ** ** | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
| ** ** | ** ** | **2008**                              | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Dividend A |       | $                                     | 418        |                                          | $          | 475 |   | $ | 849 |   | $ | 961 |   |
| Dividend B |       | —                                |       | —                                        |       | — |   | 210 |   |
| Total      |       | $                                     | 418        |                                          | $          | 475 |   | $ | 849 |   | $ | 1,171 |   |

 

As part of the Settlement Agreement, SureWest Telephone was toimplement an additional annual consumer dividend of $1,300 on January 1,2007 to end-users receiving SureWest Telephone services subject to sharing onor after that date. However, this consumer dividend was subject to reductionbased upon the results of other pending regulatory proceedings. Pursuant to aCPUC order in December 2006, beginning in 2007 this dividend was offset bya reduction in the Company’s interim draw from CHCF. The interim draw from theCHCF was previously authorized by a CPUC decision in August 2005 whichallowed SureWest Telephone to continue receiving $11,500 annually from the CHCFto offset its intrastate regulated operating expenses on an interim basis. In August 2006,the Company requested permission from the CPUC to implement a graduatedphase-down of its annual $11,500 interim draw. In December 2006, the CPUCauthorized the Company to offset its interim draw from the CHCF with theaforementioned $1,300 consumer dividend. In September 2007, the CPUCissued Decision 07-09-002 which provides for SureWest Telephone to phase-downits annual CHCF draw over a five-year period, to end on January 1, 2012. Thephase-down of the interim draw began in January 2007, initially reducingthe annual $11,500 interim draw by the aforementioned $1,300 consumer dividendto $10,200. Starting in 2008, the interim CHCF draw is being incrementallyreduced by approximately $2,000 annually.

 

In 2006, the CPUC initiated a Rulemaking pursuant to Senate Bill 1276commencing a review of the CHCF-B program. The goals of this review included,but were not limited to, adjusting universal service rate support payments toreflect updated operating costs, evaluating whether CHCF-B support levels canbe reduced and made more predictable and making the current administration ofthe program more efficient. Comments in the CHCF-B rulemaking were filed in September 2006and in April 2007. In September 2007, the CPUC approved a decisionreforming the industry CHCF-B program which significantly reduced the CHCF-Bprogram fund and its associated surcharge. The decision reduces the currentindustry CHCF-B funding level by approximately 74% and orders the reduction tobe transitioned over an 18-month period, which began in January 2008 andwill end in July 2009. The Company received approximately $600 in 2007. Basedon this level of receipts and the threshold transition schedule outlined in thedecision, the Company’s CHCF-B fund will be reduced approximately 91% and 100%in July 2008 and January 2009, respectively. Accordingly, the Company’sgeneral CHCF-B fund draw will be approximately $323 and $0 in 2008 and 2009,respectively. Furthermore, the decision lifts the freeze on basic residentialrates beginning in January 2009; however, the decision establishes a PhaseII of the proceeding in which the CPUC may determine the amount by which theCompany may increase basic residential rates over time, among other issues. TheCompany will continue to evaluate this matter and the potential effects on itsconsolidated financial position and results of operations.

 

In an ongoing proceeding relating to the New Regulatory Framework(under which SureWest Telephone has been regulated since 1996), the CPUCadopted decision 06-08-030 in 2006, which grants carriers broader pricingfreedom in the provision of telecommunications services, bundling of services,promotions and customer contracts. This decision adopted a new regulatoryframework, the Uniform Regulatory Framework, which among other things (i) eliminatesprice regulation and allows full pricing flexibility for all new and retailservices except lifeline and basic residential services which will remaincapped at current levels until January 1, 2009, (ii) allows new formsof bundles and promotional packages of telecommunication services, (iii) allocatesall gains and losses from the sale of assets to shareholders and (iv) eliminatesalmost all elements of rate of return regulation, including the calculation ofshareable earnings.

 

*OtherRegulatory Matters*

 

There are a number of other regulatory proceedingsoccurring at the federal and state levels that may have a material impact onthe Company. These regulatory proceedings include, but are not limited to,consideration of changes to the jurisdictional separations process, theinterstate universal service fund, intercarrier compensation access charge

 

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reform, broadband deployment, the regulation of localexchange carriers and their competitors, including providers of Internetprotocol-enabled services and the provision of video services and competitionin the market. The outcomes and impact on the Company’s operations of theseproceedings and related court matters cannot be determined at this time.

 

The regulatory proceedings occurring at the state andfederal levels described above may also authorize new competition in theprovision of regulated services and change the rates and rate structure forregulated services furnished by the Company, the effects of which on theCompany cannot yet be determined.

** **

**Non-operating Items**

 

*Other Income and Expense, Net*

 

Consolidated interest income decreased $907 and $1,070during the quarter and six-month period ended June 30, 2008, respectively,compared to the same periods in 2007 due to the use of cash and short-terminvestments to fund the acquisition of Everest. Consolidated interest expenseincreased $1,470 and $2,797 during the quarter and six-month period endedJune 30, 2008, respectively, compared to the same periods in 2007. Theincrease was primarily due to increased principal balances.

 

*Income Taxes*

 

Income taxes increased $446 and $519 for the quarter and six-monthperiod ended June 30, 2008, respectively, compared to the same periods in2007. The effective federal and state income tax rates for continuingoperations were approximately 45.8% and 21.6% for the six-month periods ended June 30,2008 and 2007, respectively. The increase in income tax expense and tax ratesin the current year period compared to the prior year period was due primarilyto an increase in deferred state income tax expense related to state taxapportionment changes.

 

**Liquidity and Capital Resources**

** **

**Overview**

 

The Company generates a significant cash flow from operating activities.The proceeds from monetizing our non strategic investments have also providedus with a significant source of cash flow. We believe that we will be able tomeet our current and long-term liquidity and capital requirements, through ourcash flow from operating activities, existing cash, cash equivalents andinvestments; through available borrowings under our existing credit facilities;and through our ability to obtain future external financing. The Company’sprimary use of cash in 2008 has been for the acquisition of Everest, capitalexpenditures, scheduled payments of long-term debt, planned share repurchasesand the payment of cash dividends. We anticipate continuing to use asubstantial portion of our cash flow to fund our capital expenditures, investin new business opportunities, fund network expansion and modernization, and fundthe authorized share repurchase plan.

 

The following table summarizes our cash flows:

 
| ** **                                        | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                          | ** ** | **2007** | ** ** | **$** | ** Change** | ** ** |
| Cash Flows  Provided By (Used In)                 |       |                                              |       |   |   |   |   |
| Operating  Activities:                            |       |                                              |       |   |   |   |   |
| Continuing  operations                            |       | $                                                 | 26,179     |   | $ | 21,679 |   | $ | 4,500 |   |
| Discontinued  operations                          |       | 307                                               |       | (41,771 | ) | 42,078 |   |
|                                              |       |                                              |       |   |   |   |   |
| Investing  Activities:                            |       |                                              |       |   |   |   |   |
| Continuing  operations                            |       | (142,240                                          | )          | 58,949 |   | (201,189 | ) |
| Discontinued  operations                          |       | (280                                              | )          | (1,079 | ) | 799 |   |
|                                              |       |                                              |       |   |   |   |   |
| Financing  Activities:                            |       |                                              |       |   |   |   |   |
| Continuing  operations                            |       | 96,756                                            |       | (7,236 | ) | 103,992 |   |
|                                              |       |                                              |       |   |   |   |   |
| (Decrease)  Increase In Cash and Cash Equivalents |       | $                                                 | (19,278    | ) | $ | 30,542 |   | $ | (49,820 | ) |

 

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**Cash Flows Provided By Operating Activities**

 

Net cash from continuing operating activities was $26,179 for thesix-month period ended June 30, 2008. Significant adjustments to netincome to arrive at cash provided by operating activities include (i) non-cashcharges of $26,376 consisting primarily of depreciation and amortization due tocapital investments principally in the Broadband segment and (ii) adecrease in trade and miscellaneous accounts receivable of $2,493 as a resultof the timing in the collection of receivables from regulatory agencies. Cashprovided by operating activities was offset in part by a decrease in (i) accruedliabilities of $1,200 related to the timing of outstanding obligations forinventory and capital project expenditures, (ii) accrued compensation andpension benefits of $1,321 and (iii) shareable earnings obligations of$826.

 

Net cash provided by discontinued operations increased $42,078 due toadditional estimated income tax payments made in 2007 primarily as a result ofthe gain on the sale of SureWest Directories.

** **

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

 

Net cash used in continuing investing activities for the six-monthperiod ended June 30, 2008 was $142,240. The increase in cash used ininvesting activities was primarily attributable to the acquisition of Everestfor $181,646, net of cash acquired, but was offset in part by the proceeds of$66,391 received from the sale of SureWest Wireless.

 

*Sale of SureWest Wireless*

 

In May 2008, the Company sold the operatingassets of its Wireless business, SureWest Wireless, to Verizon for an aggregatecash purchase price of $69,841. A portion of the purchase price equal to $3,450was placed in escrow, half of which will be available after twelve months andthe balance of which will be available twenty-four months following theclosing. See Note 2 for more information on the escrow. Proceeds from the saleof the Wireless business were, in part, used to repay a portion of the CreditAgreement described below.

** **

*Auction Rate Security*

 

At June 30, 2008, the Company held one auctionrate security (“ARS”) with an estimated fair value of $2,846. This ARS iscollateralized by student loans that are guaranteed primarily by an insurancecompany and partially by the Federal Family Education Loan Program (“FFELP”).The monthly auctions have historically provided a liquid market for thesesecurities. The ARS in the Company’s portfolio had a successful auction in January 2008however, since February 2008 there has not been a successful auction forthis ARS. The Company obtained a valuation from an investment advisor, whichused a discounted cash flow model to estimate the fair value of the ARS at June 30,2008. The significant inputs that were used in the model were the creditquality of the issuer, the percentage and the types of guarantees (such as aninsurance company and FFELP), interest rates, expected holding period of theARS and an illiquidity discount factor. Changes in the assumptions of the modelbased on dynamic market conditions could have a significant impact on thevaluation of this security, which may lead the Company in the future to take animpairment charge for this security. Based on the Company’s review of themodel, the inputs to the model and the assessment of fair value, as of June 30,2008, the Company determined there was a decline in the fair value of its ARSinvestment of $854, which was deemed temporary as the Company currently has theability and intent to hold this ARS investment until a successful auction, wesell the security in a secondary market which currently is not active, or it isredeemed by the issuer. As a result, the Company reclassified the entire ARSinvestment balance from short-term investments to long-term other assets on itscondensed consolidated balance sheet. The Company will continue to analyze itsauction rate security each reporting period for impairment and may be requiredto record an impairment charge in the statement of operations if the decline infair value is determined to be other than temporary.

 

**Cash Flows Provided By Financing Activities**

 

Net cash provided by financing activities consists primarily of ourproceeds from short and long-term borrowings offset by cash payment fordividends and planned repurchases of the Company’s common stock.

 

*Long-term Debt*

 

In February 2008, the Company entered into a Second Amended andRestated Credit Agreement (“Credit Agreement”) to restate and replace thecredit agreement entered into by the Company in May 2007. The CreditAgreement terms, among other things: (i) revised the amount availableunder the Term Loan A facility from $40,000 to $120,000, (ii) issued a1-year $60,000 Term Loan B facility and (iii) modified certain financialcovenants. No significant changes were made to the existing Revolving Loanfacility. The credit facilities were used in part to acquire Everest and areavailable for general corporate purposes. The Term Loan A facility and theRevolving Loan facility are due and payable on May 1, 2012.

 

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The Term Loan A facility, prior to this new agreement, which had$40,000 outstanding, was extinguished resulting in a loss on extinguishment ofdebt of $607, which was recorded in the first quarter of 2008. $40,000 of thenew borrowings bears interest at a fixed rate of 6.29%. The remaining $80,000of the new borrowings bears interest based, at the Company’s election, on theLondon Interbank Offered Rate (“LIBOR”) or the bank’s Prime Rate plus, ineither case, an applicable margin. The Term Loan B facility is due and payableon February 12, 2009 and includes an automatic increase to the applicableinterest margins on August 12, 2008 to LIBOR or the bank’s Prime Rateplus, in either case, an applicable margin plus 75 basis points. On May 14,2008, the Company repaid $30,000 of the Term Loan B and $16,000 of theRevolving facility with proceeds from the sale of SureWest Wireless. As of June 30,2008, $120,000, $30,000, and $0 were outstanding on the Term Loan A, Term LoanB, and Revolving facilities, respectively. As of December 31, 2007,$40,000 was outstanding on the Term Loan A facility and no amounts wereoutstanding under the Revolving facility.

* *

*Debt Covenants*

 

The Company’s Series A and Series B SeniorNotes and the Credit Agreement contain financial and operating covenants thatmay restrict, among other things, repurchase of the Company’s capital stock,the making of certain other restricted payments and the incurrence ofadditional indebtedness. The covenants also require the Company to maintaincertain financial ratios and minimum levels of tangible net worth. At June 30,2008 and December 31, 2007, retained earnings of $118,809 and $111,003,respectively, were available for the payments described above. As of June 30,2008, we were in compliance with all of our debt covenants.

* *

*Share Repurchase Program andDividends*

 

The Company’s Board of Directors has authorized therepurchase of up to 2.5 million shares of the Company’s common stock.Shares are purchased from time to time in the open market or through privatelynegotiated transactions, subject to overall financial and market conditions.Starting in the first quarter of 2000 through June 30, 2008, approximately1.7 million shares of common stock had been repurchased. As of June 30,2008, the Company had remaining authorization from the Board of Directors torepurchase approximately 767 thousand additional outstanding shares. TheCompany repurchased approximately 236 thousand and 505 thousand shares in thequarter and six months ended June 30, 2008, respectively. The Company didnot repurchase any shares during the same prior year periods. The purchase ofcommon shares did not have substantive effect on the average number of commonshares outstanding or the calculation of basic and diluted earnings per sharefor the quarters or six month periods ended June 30, 2008 or 2007.

 

In April 2008, the Company’s Board of Directorsannounced the decision to discontinue dividend payments for the foreseeablefuture in an effort to foster the Company’s growth strategy by reinvesting theapproximate $14,500 of annual dividend distributions back into the Company. Thecash dividend of $0.25 per share, paid on June 16, 2008 to shareholders ofrecord at the close of business on May 15, 2008, was the last dividendpaid to shareholders in the foreseeable future. The reinstatement of futuredividend payments is at the discretion of the Company’s Board of Directors.

** **

**Sufficiency of Cash Resources**

 

The Company had cash, cash equivalents and short-term investments at June 30,2008 of $12,477. The Company believes given its financial position anddebt-to-equity position, it has substantial additional short and long-termborrowing capacity. Accordingly, the Company believes the proceeds from thesale of SureWest Wireless, operating cash flows from the Company and itsborrowing capacity are sufficient to satisfy its liquidity requirements for thenext twelve months, while maintaining adequate cash and cash equivalents.

 

A substantial portion of the 2008 budgeted capitalexpenditures is at the discretion of the Company and dependent upon the Company’sworking capital position, operating cash flows and ability to borrow. TheCompany can modify its planned construction and commitments if the results ofoperations or available capital so require. The Company is required to complywith its cable franchise agreements to continue its build-out in the franchiseareas.

 

The Company’s most significant use of funds in theremainder of 2008 is expected to be for (i) budgeted capital expendituresof up to $37,000 and (ii) scheduled payments of long-term debt of $3,636.As discussed below, throughout the year the Company may repurchase shares ofits common stock in the open market at the prevailing market price up to anamount authorized by the Board of Directors.

 

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**Working Capital**

 

The Company’s working capital deficit was $32,120 at June 30,2008. The decrease in working capital during the six months ended June 30,2008 was primarily attributable to the acquisition of Everest in February 2008for $182,100 as discussed in Note 2. The purchase of Everest resulted in adecrease in cash, cash equivalents, short-term investments and an increase indebt, as described above.

 

As noted above, in May 2008 the Company sold theoperating assets of its Wireless business for an aggregate cash purchase priceof $69,841 and used $46,000 of the proceeds from the sale to repay a portion ofthe Credit Agreement. See Notes 2 and 7 for more information on the Wirelessbusiness and Credit Agreements.

 

Other factors affecting working capital at June 30, 2008 were asfollows: (i) principal payments on the Company’s Series B Notes,which will commence in March 2009, have been classified as short term, (ii) repurchasesof the Company’s common stock and (iii) the payment of dividends.

** **

**Contractual Obligations**

 

There have been no significant changes to our “Contractual Obligations”table in Part II, Item 7, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” included in the Company’s 2007Annual Report on Form 10-K, other than those resulting from changes in theamount of outstanding debt. As of the six-month period ended June 30,2008, debt increased by $110,000, as compared to December 31, 2007, from$121,818 to $231,818. The increase in long-term and short-term debt was usedprimarily to fund the acquisition in February 2008 and general corporatepurposes. As of June 30, 2008, future debt payments plus interest were asfollows:

 
| ** **      | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|-----------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Short-term debt |       | $        | 847        |     | $          | 30,206   |       | $        | —     |     | $          | —         |       | $         | —     |   | $ | — |   | $ | 31,053 |   |
| Long-term debt  |       | 8,899    |       | 25,597   |       | 24,799   |       | 24,001   |       | 139,036  |       | 16,150         |       | 238,482   |       |
|                 |            |          |            |          |            |          |            |          |            |          |            |                |            |           |            |  |  |  |  |  |  |  |

 

*Defined Benefit Pension Plan*

 

As required, the Company contributes to the PensionPlan and Other Benefits Plans, which provide retirement benefits to certaineligible employees. Contributions are intended to provide for benefitsattributed to service to date. The Company’s funding policy is to contributeannually an actuarially determined amount consistent with applicable federalincome tax regulations. As discussed in the Consolidated Overview section above,the Company stopped accruing benefits for active participants effective April 1,2007. The Company believes that future funding requirements will decreasesignificantly as a result of the freeze of the Plans. The Company will continueto evaluate the future funding requirements of the Plans and fund them asdeemed necessary. The Company does not expect to make any contributions during2008. See Note 6 of the Notes to the Condensed Consolidated FinancialStatements for a more detailed discussion on the Company’s Pension and OtherBenefits Plans.

** **

**Regulatory Matters**

 

As discussed more fully in the Regulatory Matters section above, the CPUC issued certain finaldecisions which will (i) phase down the Company’s current annual CHCF drawof $11,500, over a 5-year period ending on January 1, 2012 and (ii) decreasethe CHCF-B industry funding level, which will reduce the Company’s currentannual receipt of approximately $560 to zero over an 18-month periodanticipated to end in 2009.

** **

**Critical Accounting Estimates**

 

The Company’s condensedconsolidated financial statements and accompanying notes are prepared inaccordance with accounting principles generally accepted in the United States.Preparing financial statements requires management to make estimates and assumptionsthat affect the reported amounts of assets, liabilities, revenue, and expenses.These estimates and assumptions are affected by management’s application ofaccounting policies. The Company’s judgments are based on historical experienceand on various other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making estimates aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. For a full discussion of our accounting estimates andassumptions that the Company has identified as critical in the preparation ofour condensed consolidated financial statements, please refer to our 2007Annual Report on Form 10-K.

 

As discussed inNote 1 of the condensed consolidated financial statements, in accordancewith Statement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets (*“SFAS 142”), goodwillis

 

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reviewed for impairmentannually or more frequently if an event occurs or circumstances change thatwould reduce the fair value below its carrying value. However, as a result ofrecent declines in the market price of the Company’s common stock, at June 30,2008, the Company concluded that this was an indicator of potential impairmentof goodwill and therefore, the Company performed an interim goodwill impairmenttest.

 

The impairment test forgoodwill requires the Company to estimate the fair value at the reporting unitlevel. The Company has allocated its goodwill to the Telephone reporting unitand the Kansas City Broadband reporting unit. The Telephone reporting unit includesSureWest Telephone and certain related non-regulated services. The Kansas CityBroadband reporting unit is comprised of the Kansas City Broadband operatingsegment which is a component of the Broadband reporting segment. At June 30,2008, the Company performed a valuation to determine the fair value of itsgoodwill using a discounted cash flow model. Assumptions used in this modelinclude the following:

 

·                  cash flow assumptions regarding investment in networkfacilities, distribution channels and customer base (the assumptions underlyingthese inputs are based upon a combination of historical results and trends, newindustry developments and the Company’s business plans);

·                  a 14% weighted average cost of capitalbased on industry weighted averaged cost of capital;

·                  a terminal growth rate of -4% for theTelephone reporting unit; and

·                  an exit Earning Before Interest, Taxes,Depreciation and Amortization (“EBITDA”) multiple of 7.0 for the Kansas CityBroadband reporting unit.

 

The carrying value of theCompany’s goodwill allocated to the Telephone reporting unit was $2,171 as of June 30,2008. When determining the fair value, the use of different estimates orassumptions within the discounted cash flow model could result in a differentfair value. For example, the Company used a discount rate of 14.0% and aterminal growth rate of –4% in its assessment of fair value in 2008, which wasconsistent with the Company’s November 30, 2007 valuation. At June 30,2008 the fair value of the Telephone reporting unit was $178,600 and theassociated carrying value was $21,500. If the discount rate were to increase2%, the fair value of the Telephone reporting unit would decrease byapproximately $13,000, but would not result in an impairment of goodwill.

 

The carrying value of theCompany’s goodwill allocated to the Kansas City Broadband reporting unit was$53,169 as of June 30, 2008. When determining the fair value, the use ofdifferent estimates or assumptions within the discounted cash flow model couldresult in a different fair value. For example, the Company used a discount rateof 14.0% and an exit EBITDA multiple of 7.0 in its assessment of fair value in2008. At June 30, 2008 the fair value of the Kansas City Broadbandreporting unit was $255,400 and the associated carrying value was $182,100. Ifthe discount rate were to increase 2%, the fair value of the Kansas CityBroadband reporting unit would decrease by approximately $22,300, but would notresult in an impairment of goodwill.

** **

**Recent Accounting Pronouncements**

** **

**Recently IssuedAccounting Pronouncements**

 

In June 2008, the Financial Accounting Standards Board (“FASB”)issued FASB Staff Position (“FSP”) EmergingIssues Task Force (“EITF”) 03-6-1, *Determining WhetherInstruments Granted in Share-Based Payment Transactions Are ParticipatingSecurities* (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whetherinstruments granted in share-based payment transactions are participatingsecurities prior to vesting and, therefore, need to be included in the earningsallocation in computing earnings per share under the two-class method asdescribed in SFAS No. 128, *Earnings per Share*.Under the guidance in FSP EITF 03-6-1, unvested share-based payment awards thatcontain non-forfeitable rights to dividends or dividend equivalents (whetherpaid or unpaid) are participating securities and shall be included in thecomputation of earnings per share pursuant to the two-class method. FSP EITF03-6-1 is effective for financial statements issued for fiscal years beginningafter December 15, 2008, and interim periods within those years. Allprior-period earnings per share data presented shall be adjustedretrospectively. Early application is not permitted. The Company is currentlyevaluating the potential impact, if any, of adopting FSP EITF 03-6-1.

 

In May 2008, the FASB issued SFAS No. 162,*The Hierarchy of Generally Accepted AccountingPrinciples* (“SFAS 162”). SFAS 162 identifies a consistent framework,or hierarchy, for selecting accounting principles to be used in preparingfinancial statements that are presented in conformity with U.S. generallyaccepted accounting principles for nongovernmental entities (the “Hierarchy”).The Hierarchy within SFAS 162 is consistent with that previously defined in theAICPA Statement on Auditing Standards No. 69, *The Meaning of Present Fairly in Conformity With Generally AcceptedAccounting Principle* (“SAS 69”). SFAS 162 is effective 60 daysfollowing the United States

 

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SEC approval of the Public Company Accounting Oversight Boardamendments to AU Section 411,*TheMeaning of Present Fairly in Conformity With Generally Accepted AccountingPrinciples*. The Company iscurrently evaluating the potential impact, if any, of adopting SFAS 162.

 

In April 2008, the FASB issued FSP No. FAS 142-3,*Determination of the Useful Life of IntangibleAssets* (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors thatshould be considered in developing renewal or extension assumptions used forpurposes of determining the useful life of a recognized intangible asset underFASB Statement No. 142,*Goodwill andOther Intangible Assets* (“SFAS 142”). FSP FAS 142-3 is intended toimprove the consistency between the useful life of a recognized intangibleasset under SFAS 142 and the period of expected cash flows used to measure the fairvalue of the asset under SFAS 141(R) and other U.S. generally acceptedaccounting principles. FSP FAS 142-3 is effective for fiscal years beginningafter December 15, 2008. Earlier application is not permitted. The Companyis currently evaluating the potential impact, if any, of adopting FSP FAS142-3.

 

In December 2007, the FASB issued SFAS No. 141(R), *Business Combinations* (“SFAS 141(R)”),which establishes principles and requirements for how the acquirer: (a) recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed and any noncontrolling interest in the acquiree; (b) recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase; and (c) determines what information to disclose toenable users of the financial statements to evaluate the nature and financialeffects of the business combination. SFAS 141(R) requires contingentconsideration to be recognized at its fair value on the acquisition date and,for certain arrangements, changes in fair value to be recognized in earningsuntil settled. SFAS 141(R) also requires acquisition-related transactionand restructuring costs to be expensed rather than treated as part of the costof the acquisition. SFAS 141(R) applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008. TheCompany is currently evaluating the impact this statement will have on itsfinancial position and results of operations, however, the effect will bedependent upon the acquisitions that are made in the future.

** **

**Recently AdoptedAccounting Pronouncements**

 

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*(“SFAS 157”)*,*which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles and expands disclosures about fairvalue measurements. In February 2008, the FASB issued FSP No. FAS157-2, *Effective Date of FASB Statement No. 157*(“FSPFAS 157-2”). FSP FAS 157-2 amends SFAS 157 to delay the effective date fornonfinancial assets and nonfinancial liabilities, except for items that arerecognized or disclosed at fair value in the financial statements on arecurring basis, at least annually. SFAS 157, as amended, is effective forfinancial statements issued for fiscal years beginning after November 15,2008, and for interim periods within those fiscal years. Effective for 2008 theCompany adopted SFAS 157, except as it applies to those non-financial assetsand non-financial liabilities as noted in FSP FAS 157-2. The partial adoptionof SFAS 157 did not have a material impact on the Company’s condensedconsolidated financial statements. For a more detailed discussion of theeffects of applying the provisions of SFAS 157 refer to the Fair Value ofFinancial Instruments section of Note 1.

 

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*(“SFAS159”)*.*This standard permits an entity toelect to measure many financial instruments and certain other items at fairvalue that are not currently required to be measured at fair value. SFAS 159also establishes recognition, presentation and disclosure requirements. TheCompany adopted SFAS 159 effective January 1, 2008 and has not elected thefair value option for its financial instruments. The adoption of SFAS 159 didnot have a material effect on the Company’s condensed consolidated financialstatements.

## ** **

## **In June 2007, the EITFratified EITF Issue No. 06-11, *Accounting for Income TaxBenefits of Dividends on Share-Based Payment*(“EITF 06-11”). EITF06-11 provides that realized income tax benefits from dividends or dividendequivalents that are charged to retained earnings and are paid to employees forequity classified nonvested equity shares, nonvested equity share units andoutstanding equity share options should be recognized as an increase inadditional paid-in capital. The Company adopted EITF Issue 06-11 effective January 1,2008. The adoption of this standard did not have a material impact on theCompany’s consolidated financial position and results of operations.**

 

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**Regulatory and Legal Matters**

 

Significant portions of the Company’s telephone rates and charges aresubject to regulation by the FCC and State Commissions.  Rates and charges are based on varioustariffs filed by SureWest and others, including those filed by the NECA for CLcharges.  Pending and future regulatoryactions, with respect to these and other matters and the filing of new oramended tariffs, may have a material impact on the Company’s consolidatedfinancial position and results of operations.

 

The Company’s financial condition and results of operations have beenand will be affected by recent and future proceedings before State Commissionsand FCC. Pending before the FCC and State Commissions are proceedings, whichare considering:

 

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

 

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

 

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

 

·                              rules that will providenon-discriminatory access by competing service providers to the networkcapabilities of local exchange carriers; and

 

·                              the regulated rates and earnings ofSureWest Telephone.

 

There are a number of pending and anticipated other regulatoryproceedings occurring at the federal and state levels that may have a materialimpact on the Company. These regulatory proceedings also include newer issues,such as consideration of broadband deployment and regulation of InternetProtocol-enabled services. The outcomes and impact of these proceedings andrelated court matters on the Company’s operations and the Company cannot bedetermined at this time.

 

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

 

The Company’s 2007 Annual Report on Form 10-K contains certaindisclosures about the Company’s limited exposure to market risk for changes ininterest rates.  There have been no material changes to the informationprovided which would require additional disclosures as of the date of thisfiling except as noted below.

 

At June 30, 2008, the Company held one auctionrate security (“ARS”) with an estimated fair value of $2,846, which wasmeasured using Level 3 inputs under the requirements of SFAS No. 157.  This ARS is collateralized by student loansthat are guaranteed primarily by an insurance company and partially by theFederal Family Education Loan Program (“FFELP”). The monthly auctions havehistorically provided a liquid market for these securities. The ARS in theCompany’s portfolio had a successful auction in January 2008 and as such,its fair value would have been measured using Level 1 inputs at January 1,2008. However, since February 2008, there has not been a successfulauction for this ARS, therefore the Company transferred this ARS from the Level1 to the Level 3 category.

 

The Company obtained a Level 3 valuation from aninvestment advisor, which used a discounted cash flow model to estimate thefair value of the ARS at June 30, 2008. The significant inputs that were used in the model were the creditquality of the issuer, the percentage and the types of guarantees (such as aninsurance company and FFELP), interest rates, expected holding period of theARS and an illiquidity discount factor. Changes in the assumptions of the modelbased on dynamic market conditions could have a significant impact on thevaluation of this security, which may lead the Company in the future to take animpairment charge for this security. Based on the Company’s review of the model, the inputs to the model andthe assessment of fair value, as of June 30, 2008, the Company determinedthere was a decline in the fair value of its ARS investment of $854, which wasdeemed temporary as the Company currently has the ability and intent to holdthis ARS investment until a successful auction, we sell the security in asecondary market which currently is not active, or it is redeemed by theissuer. As a result, the Company reclassified the entire ARS investment balancefrom short-term investments to long-term other assets on its condensedconsolidated balance sheet.  The Companywill continue to analyze its auction rate security each 

 

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reporting period for impairment and may be required torecord an impairment charge in the statement of operations if the decline infair value is determined to be other than temporary.

 

**ITEM 4.  CONTROLS ANDPROCEDURES.**

 

**Evaluation of disclosure controls and procedures**

 

As of the end of the period covered by this report, the Company carriedout an evaluation, under the supervision and with the participation of ourmanagement, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rule 13a-15(e) under the SecuritiesExchange Act of 1934, as amended). Based upon, and as of the date of thisevaluation, the Chief Executive Officer and Chief Financial Officer haveconcluded that, the Company’s disclosure controls and procedures wereeffective, at the reasonable assurance level, to ensure that informationrequired to be disclosed by the Company in reports that it files or submitsunder the Securities Exchange Act is authorized, recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission (the “SEC”) rules and forms.

 

Our assessment of the internal control structure excluded EverestBroadband, Inc. (“Everest”) which was acquired on February 13,2008.  For the period subsequent to thepurchase date, Everest had net revenues of $24,541 and total assets of $219,900,which are included in the condensed consolidated financial statements of theCompany as of and for the six months ended June 30, 2008. Under guidelinesestablished by the SEC, companies are allowed to exclude acquisitions fromtheir assessment of internal control over financial reporting during the firstyear of an acquisition while integrating the acquired company.

 

The Company’s management is responsible for establishing andmaintaining adequate internal control over financial reporting. The Company’sinternal control system was designed to provide reasonable assurance to theCompany’s management, Board of Directors and Audit Committee regarding thereliability of financial reporting and the preparation of published financialstatements in accordance with generally accepted accounting principles.

 

**Change in internal control over financialreporting**

 

During the period ended June 30, 2008, the Company had thefollowing changes relating to its controls over financial reporting:

 

·                  In January 2008, the Company announced the saleof the assets of SureWest Wireless.  TheCompany has concluded that the announcement of the sale and subsequentcompletion of the sale on May 9, 2008, has not materially affected theCompany’s internal controls over financial reporting.

 

·                  In February 2008, the Company completed itsoutsourcing of its payroll function.  Aspart of the outsourcing assessment process, management has reviewed thecontrols in place at the outsource providers’ locations and evaluated theCompany’s internal controls over financial reporting.  Based on theCompany’s review and assessment of the controls over the payroll process, theCompany has concluded that the outsourcing of the payroll process has notmaterially affected the Company’s internal controls over financial reporting.

 

·                  As noted above, our assessment of the internal controlstructure excluded Everest which was acquired on February 13, 2008. Underguidelines established by the SEC, companies are permitted to excludeacquisitions from their assessment of internal control over financial reportingduring the first year of an acquisition while integrating the acquiredcompany.  During the integration periodmanagement is developing additional controls to ensure the financialinformation provided by Everest is complete and accurate in all materialrespects.

 

·                  The Company’s Principal Financial Officer, Senior VicePresident and Chief Financial Officer Philip A. Grybas, resigned from hisposition on March 25, 2008. The Company’s Vice President, Finance, DanBessey, assumed the position of the Principal Financial Officer on that samedate.  The Company believes that thechange in officers has not materially affected the Company’s internal controlsover financial reporting or disclosure controls and procedures.  The Company will continue to monitor thischange in officers for any potential impacts to the Company’s internalcontrols.

 

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·                  Except as noted above, there have been no otherchanges in the Company’s internal control over financial reporting during thesix-month period ended June 30, 2008 that has materially affected, or isreasonably likely to materially affect, the Company’s control over financialreporting.

 

**Limitations on the effectiveness of controls**

 

The Company’s management is responsible forestablishing and maintaining adequate internal control over financialreporting. The Company’s internal control system was designed to providereasonable assurance to the Company’s management, Board of Directors and AuditCommittee regarding the reliability of financial reporting and the preparationof published financial statements in accordance with generally acceptedaccounting principles.

 

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**PART II –OTHERINFORMATION**

 

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

 

Refer to Notes 4 and 7 to our condensed consolidated financialstatements of the Quarterly Report on Form 10-Q for a discussion of recentdevelopments related to our regulatory and legal proceedings.

 

**ITEM 1A.        RISK FACTORS.**

 

There have been no material changes from risk factors disclosed in theCompany’s Annual Report on Form 10-K for the year ended December 31,2007, identified in Item 1A of Part I of the Form 10-K.

 

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

 
| **Period**                                | ** ** | **(a)Total Number   of Shares   Purchased** | ** ** | **(b) Average   Price Paid   per Share** | ** ** | **(c) Total Number of   Shares Purchased as Part   of Publicly Announced   Plan** | ** ** | **(d) Shares Available   for Repurchase   under the Plan** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| April 1,  2008 - April 30, 2008 |       | —                                                          |       | $                                                                 | —     |                                                                                                                                     | 1,496,804  |                                                                                          | 1,003,196  |   |
| May 1, 2008  - May 31, 2008     |       | 148,415                                                         |       | $                                                                 | 9.97       |                                                                                                                                     | 1,645,219  |                                                                                          | 854,781    |   |
| June 1,  2008 - June 30, 2008   |       | 87,458                                                          |       | $                                                                 | 8.81       |                                                                                                                                     | 1,732,677  |                                                                                          | 767,323    |   |

 

**ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.**

 

Not applicable.

 

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

 

OnMay 13, 2008, the Company held its Annual Meeting of Shareholders.  The matters that were voted upon at themeeting, and the number of votes cast for, against or withheld, as well as thenumber of abstentions and broker non-votes, as applicable, are set forth below.

 

(a)          Electionof a Board of seven Directors;

 

Theseven nominees to serve as directors, which constituted the entire Board ofDirectors as of the meeting date, were all reelected to serve as directors bythe following votes:

 
| ** **           | ** ** | **Votes**  | ** ** | **Broker Non-Votes** | ** ** |
|----------------------|------------|------------|------------|---------------------------|------------|
| **Director**         | ** ** | **For**    | ** ** | **Withheld**              | ** ** | **and Abstentions** | ** ** |
| Kirk C. Doyle        |       | 10,050,374 |       | 1,258,678                 |       | 2,942,821 |   |
| Steven C. Oldham     |       | 9,398,074  |       | 1,910,978                 |       | 2,942,821 |   |
| John R. Roberts  III |       | 9,387,658  |       | 1,921,394                 |       | 2,942,821 |   |
| Timothy D. Taron     |       | 9,420,694  |       | 1,888,358                 |       | 2,942,821 |   |
| Guy R.Gibson         |       | 9,334,768  |       | 1,974,284                 |       | 2,942,821 |   |
| Roger J. Valine      |       | 9,383,022  |       | 1,926,030                 |       | 2,942,821 |   |
| Robert D.  Kittredge |       | 9,422,996  |       | 1,886,056                 |       | 2,942,821 |   |

 

(b)         Ratificationof the appointment of Ernst and Young LLP as the Company’s independent registeredpublic accounting firm for 2008.

 
| **Votes** | ** ** |
|-----------|------------|
| **For**   | ** ** | **Withheld** | ** ** | **Against** | ** ** | **Broker Non-Votes   and Abstentions** | ** ** |
| 9,535,986 |       | NA |   | 706,338 |   | 4,009,549 |   |

 

**ITEM 5.  OTHER INFORMATION.**

 

Not applicable.

 

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**ITEM6.  EXHIBITS.**

 

(a)          Index to Exhibits.

 
| Exhibit   No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                     | ** ** | **Method   of Filing** |
|--------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|
| ** **         | ** ** | ** **                                                                                                                                                                                                                                                                                                                                          | ** ** | ** **                       |
| 3.1                |       | Articles  of Incorporation of Registrant, together with Certificate of Amendment of  Articles of Incorporation dated January 25, 1996 and Certificate of  Amendment of Articles of Incorporation dated June 21, 1996 (Filed as  Exhibit 3(a) to Form 10-Q Quarterly Report for the quarter  ended September 30, 1996) |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 3.2                |       | Certificate  of Amendment of Articles of Incorporation dated May 18, 2001 (Filed as  Exhibit 3(b) to Form 10-Q Quarterly Report for the quarter  ended June 30, 2001)                                                                                                                                                      |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 3.3                |       | Bylaws  of Registrant (Filed as Exhibit 3(b) to Form 10-K Annual  Report of the Registrant for the year ended December 31, 2000)                                                                                                                                                                                                |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 4.1                |       | Amended  and Restated Rights Agreement, inclusive of Amendment 1 (Filed as  Exhibit 4.1 to Form 8-A/A filed March 12, 2008 and as  Exhibit 9.01 to Form 8-K filed May 1, 2008)                                                                                                                                        |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 10.1               |       | Second  Amended and Restated Credit Agreement dated as of February 13, 2008  among SureWest Communications and CoBank, ACB (Filed as Exhibit 10.1 to  Form 8-K filed February 15, 2008)                                                                                                                                         |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 10.2               |       | Change  in Control Agreement dated January 31, 2008 between Registrant and  Steven C. Oldham (Filed as Exhibit 10.11 to Form 10-K Annual Report  of the Registrant for the year ended December 31, 2007)                                                                                                                        |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 10.3               |       | Change  in Control Agreement dated January 31, 2008 between Registrant and  Officers (Filed as Exhibit 10.12 to Form 10-K Annual Report of the  Registrant for the year ended December 31, 2007)                                                                                                                                |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 10.4               |       | Asset  Purchase Agreement among SureWest Wireless, West Coast PCS LLC, SureWest Communications  and Cellco Partnership d/b/a Verizon Wireless dated January 18, 2008  (Filed as Exhibit 2.1 to Form 8-K filed January 22, 2008)                                                                                                 |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 10.5               |       | Purchase  and Sale Agreement among Everest Broadband, Inc., the Equity Holders of  Everest Broadband, Inc. and SureWest Communications dated  December 6, 2007 (Filed as Exhibit 2.1 to Form 8-K filed  December 7, 2007)                                                                                             |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 10.6               |       | Severance  Agreement dated March 25, 2008 between SureWest Communications and  Philip A. Grybas (Filed as Exhibit 10.6 to Form 10-Q Quarterly  Report for the quarter ended March 31, 2008)                                                                                                                                     |       | Incorporated by  reference       |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 31.1               |       | Certification  of Steven C. Oldham, President and Chief Executive Officer, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                               |       | Filed herewith                   |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 31.2               |       | Certification  of Dan T. Bessey, Vice President and Chief Financial Officer, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                             |       | Filed herewith                   |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 32.1               |       | Certification  of Steven C. Oldham, President and Chief Executive Officer, pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                     |       | Filed herewith                   |
|               |       |                                                                                                                                                                                                                                                                                                                                                |       |                             |
| 32.2               |       | Certification  of Dan T. Bessey, Vice President and Chief Financial Officer, pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                   |       | Filed herewith                   |

 

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**SIGNATURES**

 

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

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

 

 

Date: August 4, 2008

 

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