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EX-32.1 - EX-32.1 - SUREWEST COMMUNICATIONSa10-17411_1ex32d1.htm
EX-32.2 - EX-32.2 - SUREWEST COMMUNICATIONSa10-17411_1ex32d2.htm

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND 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 September 30, 2010

 

or

 

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

 

Commission File Number 000-29660

 

 

SureWest Communications

(Exact name of registrant as specified in its charter)

 

California

 

68-0365195

(State or other jurisdiction

 

(IRS Employer

of incorporation or organization)

 

Identification No.)

 

8150 Industrial Avenue, Building A, Roseville, California

 

95678

(Address of principal executive offices)

 

(Zip Code)

 

(916) 786-6141

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of 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 (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

On October 19, 2010, the registrant had 13,891,745 shares of Common Stock outstanding.

 

 

 




Table of Contents

 

PART 1 — FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS.

 

SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

 

 

 

Quarter Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Operating revenues:

 

 

 

 

 

 

 

 

 

Broadband

 

$

43,861

 

$

40,175

 

$

129,514

 

$

119,656

 

Telecom

 

17,256

 

19,354

 

52,339

 

61,745

 

Total operating revenues

 

61,117

 

59,529

 

181,853

 

181,401

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of services and products (exclusive of depreciation and amortization)

 

26,672

 

25,450

 

78,771

 

77,264

 

Customer operations and selling

 

7,028

 

8,130

 

22,542

 

23,028

 

General and administrative

 

6,720

 

8,073

 

24,296

 

26,260

 

Depreciation and amortization

 

15,680

 

15,260

 

46,048

 

44,298

 

Total operating expenses

 

56,100

 

56,913

 

171,657

 

170,850

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

5,017

 

2,616

 

10,196

 

10,551

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

16

 

28

 

62

 

99

 

Interest expense

 

(2,311

)

(3,046

)

(6,189

)

(8,402

)

Other, net

 

10

 

205

 

(323

)

33

 

Total other income (expense), net

 

(2,285

)

(2,813

)

(6,450

)

(8,270

)

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

2,732

 

(197

)

3,746

 

2,281

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

1,328

 

14

 

2,342

 

1,514

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

1,404

 

(211

)

1,404

 

767

 

 

 

 

 

 

 

 

 

 

 

Discontinued operations, net of tax:

 

 

 

 

 

 

 

 

 

Loss from discontinued operations

 

 

 

 

(69

)

Gain on sale of discontinued operations

 

 

 

 

2,568

 

Total discontinued operations

 

 

 

 

2,499

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

1,404

 

$

(211

)

$

1,404

 

$

3,266

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

0.10

 

$

(0.02

)

$

0.10

 

$

0.05

 

Discontinued operations, net of tax

 

 

 

 

0.18

 

Net income (loss) per basic and diluted common share

 

$

0.10

 

$

(0.02

)

$

0.10

 

$

0.23

 

 

 

 

 

 

 

 

 

 

 

Shares of common stock used to calculate basic and diluted earnings per share

 

13,736

 

13,936

 

13,883

 

13,973

 

 

See accompanying notes.

 

1



Table of Contents

 

SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; Amounts in thousands)

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

3,215

 

$

7,489

 

Short-term investments

 

690

 

4,306

 

Accounts receivable, net

 

20,581

 

19,734

 

Income tax receivable

 

916

 

2,221

 

Prepaid expenses

 

3,673

 

3,704

 

Deferred income taxes

 

3,926

 

3,373

 

Other current assets

 

 

1,760

 

Assets held for sale

 

6,009

 

6,009

 

Total current assets

 

39,010

 

48,596

 

 

 

 

 

 

 

Property, plant and equipment, net

 

516,923

 

522,493

 

 

 

 

 

 

 

Intangible and other assets:

 

 

 

 

 

Customer relationships, net

 

2,936

 

3,847

 

Goodwill

 

45,814

 

45,814

 

Deferred charges and other assets

 

2,370

 

2,113

 

 

 

51,120

 

51,774

 

 

 

$

607,053

 

$

622,863

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt

 

$

15,636

 

$

15,636

 

Accounts payable

 

1,657

 

2,547

 

Other accrued liabilities

 

16,105

 

18,315

 

Advance billings and deferred revenues

 

8,272

 

8,580

 

Accrued compensation

 

7,470

 

9,172

 

Total current liabilities

 

49,140

 

54,250

 

 

 

 

 

 

 

Long-term debt

 

193,409

 

207,409

 

Deferred income taxes

 

56,535

 

54,856

 

Accrued pension and other post-retirement benefits

 

33,704

 

32,451

 

Other liabilities and deferred revenues

 

4,627

 

4,714

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, without par value; 100,000 shares authorized, 13,908 and 14,148 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively

 

143,696

 

146,844

 

Accumulated other comprehensive loss

 

(15,282

)

(15,280

)

Retained earnings

 

141,224

 

137,619

 

Total shareholders’ equity

 

269,638

 

269,183

 

 

 

$

607,053

 

$

622,863

 

 

See accompanying notes.

 

2



Table of Contents

 

SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; Amounts in thousands)

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Net cash provided by continuing operations

 

$

46,509

 

$

52,571

 

Net cash used in discontinued operations

 

 

(514

)

Net cash provided by operating activities

 

46,509

 

52,057

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from sale of discontinued operations

 

1,725

 

10,947

 

Capital expenditures for property, plant and equipment

 

(39,271

)

(43,363

)

Proceeds from sale of property and equipment

 

 

850

 

Proceeds from sale of available-for-sale securities

 

3,700

 

 

Purchases of available-for-sale securities

 

(28

)

(25

)

Net cash used in investing activities

 

(33,874

)

(31,591

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

8,069

 

10,500

 

Principal payments on long-term debt

 

(22,069

)

(25,505

)

Repurchases and surrenders of common stock

 

(2,909

)

(1,163

)

Net cash used in financing activities

 

(16,909

)

(16,168

)

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

(4,274

)

4,298

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

7,489

 

2,840

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

3,215

 

$

7,138

 

 

See accompanying notes.

 

3



Table of Contents

 

SUREWEST COMMUNICATIONS

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

 

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Business and Basis of Accounting

 

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

 

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

 

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

 

In the opinion of management, the accompanying condensed consolidated balance sheets and related interim statements of operations and cash flows include all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States (“U.S. GAAP” or “GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such SEC rules and regulations and accounting principles applicable for interim periods. Events subsequent to the balance sheet date have been evaluated for inclusion in the accompanying condensed consolidated financial statements through the date of issuance.  Management believes that the disclosures made are adequate to make the information presented not misleading. Interim results are not necessarily indicative of results for a full year.  The information presented in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included in our 2009 Annual Report on Form 10-K filed with the SEC.

 

Reclassifications

 

Certain amounts in our 2009 condensed consolidated financial statements have been reclassified to conform to the presentation of our 2010 condensed consolidated financial statements.  The reclassifications consist of the following:

 

Inventories have been reclassified from current assets to property, plant and equipment on the condensed consolidated balance sheets.  Inventories consist primarily of network construction materials and supplies that when issued are capitalized as part of new customer installations and the construction of the network. The proportion of the items included in inventories that are capitalized to property, plant and equipment has increased as a result of the growth in the Broadband business.

 

Operating expenses on the condensed consolidated statements of operations have been reclassified for a change in the classification during the third quarter of 2010 of customer technical support costs from customer operations and selling to cost of services and products. Prior period costs have been reclassified to conform to the current year presentation.

 

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Table of Contents

 

Property, Plant and Equipment

 

Property, plant and equipment consisted of the following:

 

 

 

September 30,
2010

 

December 31,
2009

 

Estimated
Useful Lives

 

Land

 

$

2,824

 

$

2,824

 

 

 

Buildings

 

76,526

 

76,363

 

35 years

 

Central office equipment

 

328,953

 

312,338

 

3-12 years

 

Outside plant equipment

 

491,476

 

481,099

 

5-40 years

 

Internal-use software

 

59,431

 

58,714

 

5-7 years

 

Other

 

58,558

 

56,974

 

3-25 years

 

Total plant in service

 

1,017,768

 

988,312

 

 

 

Less accumulated depreciation and amortization

 

514,159

 

481,639

 

 

 

Plant in service

 

503,609

 

506,673

 

 

 

Plant under construction

 

8,268

 

10,557

 

 

 

Construction inventory

 

5,046

 

5,263

 

 

 

Property, plant and equipment, net

 

$

516,923

 

$

522,493

 

 

 

 

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

 

During the first quarter of 2010, we completed our triennial review that evaluated the appropriateness of the estimated useful lives of our property, plant and equipment for all segments.  The evaluation considered our investment and business strategy, reliability and historical performance data of certain assets, as well as the impacts of competition and anticipated technological change. As a result of this evaluation, effective January 1, 2010, we increased the estimated useful lives of general purpose software, general purpose hardware and certain central office equipment. We decreased the lives of certain of our customer premise equipment and outside plant categories. During the quarter and nine-month period ended September 30, 2010, this change in estimate did not have a material effect to consolidated depreciation expense or net income and is not expected to have a material impact for the year ended December 31, 2010.

 

Intangible Assets

 

Goodwill and intangible assets that are not subject to amortization are tested for impairment at least annually or when events or changes in circumstances indicate that the asset might be impaired in accordance with FASB ASC Topic 350, Intangibles-Goodwill and Other (“ASC 350”) (formerly SFAS No. 142, Goodwill and other Intangible Assets). Normally, we perform the annual impairment test as of November 30.  However, as a result of declines in the market price of the Company’s common stock during the quarter ended June 30, 2010, we concluded that this was an indicator of potential impairment of goodwill and for that reason we performed an interim goodwill impairment test.

 

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

 

At September 30, 2010, we reviewed the various inputs and assumptions applied in our June 30, 2010 impairment test to determine if any significant changes had occurred during the third quarter that would impact the analysis.  Based on this review, we concluded that goodwill was not impaired as of September 30, 2010.  The Company will perform the required annual goodwill impairment test as of November 30, 2010, as mentioned above.

 

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Table of Contents

 

Stock-based Compensation

 

Stock Plan

 

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

 

Restricted Common Stock Awards and Units

 

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

 

The following table summarizes the grants that occurred under the Stock Plan during the quarters and nine-month periods ended September 30, 2010 and 2009:

 

 

 

Quarter Ended September 30,

 

Nine Months Ended September 30,

 

 

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

2010

 

Fair Value

 

2009

 

Fair Value

 

2010

 

Fair Value

 

2009

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RSAs Granted

 

 

$

 

 

$

 

217,575

 

$

9.95

 

166,506

 

$

11.56

 

RSUs Granted

 

 

$

 

 

$

 

92,709

 

$

9.95

 

72,443

 

$

11.56

 

RSU Dividends

 

 

$

 

500

 

$

11.86

 

 

$

 

8,470

 

$

9.79

 

Total

 

 

 

 

500

 

 

 

310,284

 

 

 

247,419

 

 

 

 

RSU Dividends consist of dividends that were previously granted to the holders of RSUs, which have fully vested and were released during the quarter and nine-month period ended September 30, 2009 (none in the quarter or nine-month period ended September 30, 2010) in accordance with the underlying award agreement.  Stock-based compensation expense for both RSAs and RSUs of $267 and $2,211, which included the costs to accelerate certain RSAs in accordance with the workforce reduction initiative as described below, was recorded during the quarter and nine-month period ended September 30, 2010, respectively.  During the same prior year periods, we recorded stock-based compensation expense of $443 and $1,515, respectively.

 

The following table summarizes the RSA and RSU activity during the nine-month period ended September 30, 2010:

 

 

 

 

 

Weighted Average

 

 

 

Shares

 

Grant Date Fair Value

 

 

 

 

 

 

 

Nonvested-January 1, 2010

 

349,916

 

$

12.90

 

Granted

 

310,284

 

$

9.95

 

Vested

 

(152,792

)

$

11.40

 

Forfeited

 

(4,813

)

$

11.03

 

Nonvested-September 30, 2010

 

502,595

 

$

11.55

 

 

As of September 30, 2010, total unrecognized compensation costs related to nonvested restricted stock was $4,930 and will be recognized over a weighted-average period of approximately 2.53 years. The total fair value of RSAs and RSUs vested during the nine-month period ended September 30, 2010 was $1,742.

 

Stock Options

 

In 2003, we ceased granting stock options and have since granted RSAs and RSUs as part of our equity compensation plan. We issue new shares of common stock upon exercise of stock options. The exercise price per share of the Company’s common stock to be purchased under any incentive stock option shall not be less than 100% of the fair market value of a share of the Company’s common stock on the date of the grant, and the exercise price under a non-qualified stock option shall not be less than 85% of the fair market value of the Company’s common stock at the date

 

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Table of Contents

 

of the grant. The term of any stock option shall not exceed ten years.  There were no stock options granted or exercised during the quarters or nine-month periods ended September 30, 2010 and 2009. The aggregate intrinsic value is calculated as the difference between the exercise price of the stock options and the quoted price of our common stock.  There were no options that were in-the-money as of September 30, 2010 and 2009.

 

The following table summarizes stock option activity for the nine-month period ended September 30, 2010:

 

 

 

 

 

Weighted

 

Weighted

 

 

 

 

 

Average

 

Average

 

 

 

 

 

Exercise

 

Remaining

 

Options

 

Shares

 

Price

 

Contractual Life

 

 

 

 

 

 

 

 

 

Outstanding-January 1, 2010

 

318,389

 

$

40.45

 

 

 

Expired

 

(155,337

)

 

 

 

Outstanding-September 30, 2010

 

163,052

 

$

40.92

 

1

 

Vested and Exercisable at September 30, 2010

 

163,052

 

$

40.92

 

1

 

 

Earnings Per Share

 

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

 

Other Comprehensive Income

 

Significant components of our other comprehensive income are as follows:

 

 

 

Quarter Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income (loss)

 

$

1,404

 

$

(211

)

$

1,404

 

$

3,266

 

Unrealized gain (loss) on available-for-sale investments, net of tax

 

56

 

(5

)

(2

)

(40

)

Reclassification adjustment for losses included in net income, net of tax

 

 

 

 

16

 

Comprehensive income (loss)

 

$

1,460

 

$

(216

)

$

1,402

 

$

3,242

 

 

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

 

Severance and Termination Costs

 

In an effort to improve operating efficiencies and align operating costs, during the quarter ended June 30, 2010 we implemented a workforce reduction initiative in which approximately 60 positions were eliminated.  Affected employees were provided a range of benefits and resources, including severance payments and the acceleration of unvested stock awards (collectively “severance costs”).  As a result, severance costs of $1,428 were recorded to the statements of operations during the nine months ended September 30, 2010, primarily to general and administrative expense.  Severance costs of approximately $613 and $815 were recorded to the Broadband and Telecommunications (“Telecom”) segments, respectively. During the quarter and nine months ended September 30, 2010, the liability for accrued severance costs was reduced by $346 and $1,125, respectively.  As of September 30, 2010, we had an accrued liability of $19 relating to the severance costs. We anticipate the remaining severance costs will be finalized prior to December 31, 2010.

 

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Table of Contents

 

2.     FAIR VALUE MEASUREMENTS & FINANCIAL INSTRUMENTS

 

Investments

 

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

 

 

 

As of September 30, 2010

 

As of December 31, 2009

 

 

 

Adjusted
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair
Market
Value

 

Adjusted
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair
Market
Value

 

Equity securities

 

$

717

 

$

 

$

(27

)

$

690

 

$

654

 

$

 

$

(23

)

$

631

 

 

As of September 30, 2010 and December 31, 2009, the decline in the fair value of our short-term available-for-sale investments had been in a continuous loss position for more than twelve months.  We concluded that the gross unrealized losses of our equity securities were temporary and we have the ability and intent to hold the investments until at least substantially all of the costs of the investment are recovered.  The unrealized losses, net of tax, on our short-term available-for-sale investments were recorded as a component of other comprehensive income. We determined the fair value of our short-term equity security investments by quoted market prices.

 

Cost Method Investments

 

We held $1,115 and $772 in cost method investments which were included in other long-term assets in the condensed consolidated balance sheets as of September 30, 2010 and December 31, 2009, respectively. Our cost method investments primarily consist of our investment in CoBank, ACB (“CoBank”) and is related to patronage distributions of restricted equity.  Our investment in CoBank is required in accordance with the provisions of our Credit Agreement (see Note 8) held by CoBank.  We periodically monitor our investments for impairment and will record reductions in carrying values if and when necessary.  We did not estimate the fair value of the cost method investments as no events or changes in circumstances that may have a significant adverse effect on the fair value of the investment were identified during the quarter or nine-month period ended September 30, 2010. We determined, in accordance with ASC Topic 825, Financial Instruments (formerly SFAS No. 107, Fair Value Disclosures About Financial Instruments), that it was not practicable to estimate the fair value of the investments.

 

Fair Value of Financial Instruments

 

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

 

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

 

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

 

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

 

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

 

 

 

As of September 30, 2010

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Money market funds

 

$

83

 

$

83

 

$

 

$

 

Equity securities

 

690

 

690

 

 

 

 

 

$

773

 

$

773

 

$

 

$

 

 

 

 

As of December 31, 2009

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Money market funds

 

$

5,346

 

$

5,346

 

$

 

$

 

Equity securities

 

631

 

631

 

 

 

Auction rate securities

 

3,054

 

 

 

3,054

 

Put option (Right)

 

621

 

 

 

621

 

 

 

$

9,652

 

$

5,977

 

$

 

$

3,675

 

 

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

 

The following table provides a reconciliation of the beginning and ending balances for the assets measured at fair value using significant unobservable inputs (Level 3):

 

 

 

2010

 

2009

 

 

 

Put Option

 

Auction Rate
Securities

 

Put Option

 

Auction Rate
Securities

 

Beginning balance at January 1st

 

$

621

 

$

3,054

 

$

1,383

 

$

2,125

 

Sale of auction rate security

 

 

(3,700

)

 

 

Gains (losses) included in earnings

 

(621

)

646

 

(745

)

745

 

Balance at March 31st

 

$

 

$

 

$

638

 

$

2,870

 

Gains (losses) included in earnings

 

 

 

(41

)

162

 

Balance at June 30th

 

$

 

$

 

$

597

 

$

3,032

 

Gains (losses) included in earnings

 

 

 

24

 

22

 

Balance at September 30th

 

$

 

$

 

$

621

 

$

3,054

 

 

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

 

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

 

On January 6, 2010, UBS exercised their rights under the Right to purchase our ARS at par of $3,700 and we recorded a gain of $646 on the ARS to other income (expense), other, net in the condensed consolidated statements of income during the quarter ended March 31, 2010.  The gain was largely offset by a loss of $621 recorded on the Right resulting from the cancellation of our put option under the Right.

 

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Fair Value of Debt

 

We had no short-term borrowings as of September 30, 2010 and December 31, 2009. The fair value of our long-term debt was estimated using discounted cash flow analyses based on incremental borrowing rates for similar types of borrowing arrangements.

 

 

 

As of September 30, 2010

 

As of December 31, 2009

 

 

 

Carrying Value

 

Fair Value

 

Carrying Value

 

Fair Value

 

Long-term debt (including current maturities)

 

$

209,045

 

$

213,953

 

$

223,045

 

$

221,323

 

 

3.     DIVESTITURES

 

SureWest Wireless

 

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

 

Communication Tower Assets

 

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

 

The results of the Tower Assets have been reported as a discontinued operation in our condensed consolidated financial statements for all periods presented.

 

The following table summarizes the financial information for the operations of the Tower Assets:

 

 

 

Nine Months Ended
September 30, 2009

 

Operating revenues

 

$

249

 

Operating expenses including depreciation and amortization

 

365

 

Loss from operations

 

(116

)

Income tax benefit

 

(47

)

Loss from discontinued operations

 

$

(69

)

 

 

 

 

Gain on sale of discontinued operations, net of tax

 

$

2,525

 

 

Assets Held For Sale

 

In connection with our efforts to evaluate and potentially monetize excess assets, during 2009 we identified and began to actively market for sale certain of our real estate assets.  These regulated assets, which are included in the Telecom Segment, include 21 acres of undeveloped land and an office building.  During the quarter ended December 31, 2009, we completed our plan to sell these assets and as a result they were classified as assets held for sale.

 

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The following is the carrying value of the assets held for sale as of September 30, 2010 and December 31, 2009:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Undeveloped land

 

$

1,556

 

$

1,556

 

Office building

 

4,453

 

4,453

 

 

 

$

6,009

 

$

6,009

 

 

We expect that the land will sell in the range of $3,000 to $5,000. In connection with the classification to assets held for sale, the carrying value of the office building was reduced to its estimated fair value, less selling costs, based on the current market conditions and listed selling price. As a result, an impairment charge of $1,199 was recorded against accumulated depreciation during the quarter ended December 31, 2009, in accordance with regulated telephone plant and equipment composite group remaining life methodology.  We evaluated the estimated fair value of the assets held for sale as of September 30, 2010 and determined there was not a significant change.  Therefore, no additional impairment charge was recorded during the quarter or nine month period ended September 30, 2010.

 

4.     BUSINESS SEGMENTS

 

We have two reportable business segments: Broadband and Telecom. We have aggregated certain of our operating segments within the Broadband and Telecom segments because we believe that such operating segments share similar economic characteristics.  We measure and evaluate the performance of our segments based on income (loss) from operations. Corporate Operations are allocated to the appropriate segment, except for cash; investments; certain property, plant, and equipment; and miscellaneous other assets, which are not allocated to the segments. However, the interest income associated with cash and investments held by Corporate Operations is included in the results of the operations of our segments.

 

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

 

The Telecom segment, which operates only in the Sacramento area, offers a broad selection of telecommunications services including traditional circuit-switched voice services, long distance services and a number of lightly-regulated or non-regulated services. Customers in the Telecom segment can select individual services or bundled packages that may include unlimited local calling or unlimited local and domestic long distance calling plans.  Our voice products also include value-added services such as voicemail, call waiting, caller identification and many other calling feature options.  Most long distance services are offered by our subsidiary SureWest Long Distance, which is a reseller of long distance services.

 

These segments are strategic business units that offer different products and services. The accounting policies of these segments are the same as those described in Note 1 (refer to notes to the consolidated financial statements included in our 2009 Annual Report on Form 10-K filed with the SEC for a more detailed discussion of our accounting policies). We account for intersegment revenues and expenses at prevailing market rates.

 

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Our business segment information is as follows:

 

 

 

 

 

 

 

Intercompany

 

 

 

 

 

Broadband

 

Telecom

 

Eliminations

 

Consolidated

 

For the three months ended September 30, 2010:

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

43,861

 

$

17,256

 

$

 

$

61,117

 

Intersegment revenues

 

110

 

5,275

 

(5,385

)

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

25,719

 

5,677

 

(4,724

)

26,672

 

Customer operations and selling

 

4,940

 

2,621

 

(533

)

7,028

 

General and administrative

 

3,645

 

3,203

 

(128

)

6,720

 

Depreciation and amortization

 

12,609

 

3,071

 

 

15,680

 

Income (loss) from operations

 

(2,942

)

7,959

 

 

5,017

 

Income (loss) from continuing operations

 

$

(3,082

)

$

4,486

 

$

 

$

1,404

 

 


*Exclusive of depreciation and amortization

 

 

 

 

 

 

 

Intercompany

 

 

 

 

 

Broadband

 

Telecom

 

Eliminations

 

Consolidated

 

For the three months ended September 30, 2009:

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

40,175

 

$

19,354

 

$

 

$

59,529

 

Intersegment revenues

 

93

 

5,043

 

(5,136

)

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

23,320

 

6,478

 

(4,348

)

25,450

 

Customer operations and selling

 

6,532

 

2,240

 

(642

)

8,130

 

General and administrative

 

4,763

 

3,456

 

(146

)

8,073

 

Depreciation and amortization

 

12,199

 

3,061

 

 

15,260

 

Income (loss) from operations

 

(6,546

)

9,162

 

 

2,616

 

Income (loss) from continuing operations

 

$

(5,619

)

$

5,408

 

$

 

$

(211

)

 


*Exclusive of depreciation and amortization

 

 

 

 

 

 

 

Intercompany

 

 

 

 

 

Broadband

 

Telecom

 

Eliminations

 

Consolidated

 

For the nine months ended September 30, 2010:

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

129,514

 

$

52,339

 

$

 

$

181,853

 

Intersegment revenues

 

423

 

15,285

 

(15,708

)

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

75,008

 

17,407

 

(13,644

)

78,771

 

Customer operations and selling

 

16,886

 

7,320

 

(1,664

)

22,542

 

General and administrative

 

13,550

 

11,146

 

(400

)

24,296

 

Depreciation and amortization

 

36,929

 

9,119

 

 

46,048

 

Income (loss) from operations

 

(12,436

)

22,632

 

 

10,196

 

Income (loss) from continuing operations

 

$

(11,071

)

$

12,475

 

$

 

$

1,404

 

 


*Exclusive of depreciation and amortization

 

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Table of Contents

 

 

 

 

 

 

 

Intercompany

 

 

 

 

 

Broadband

 

Telecom

 

Eliminations

 

Consolidated

 

For the nine months ended September 30, 2009:

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

119,656

 

$

61,745

 

$

 

$

181,401

 

Intersegment revenues

 

278

 

14,898

 

(15,176

)

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

70,074

 

19,963

 

(12,773

)

77,264

 

Customer operations and selling

 

18,229

 

6,765

 

(1,966

)

23,028

 

General and administrative

 

15,301

 

11,396

 

(437

)

26,260

 

Depreciation and amortization

 

35,102

 

9,196

 

 

44,298

 

Income (loss) from operations

 

(18,772

)

29,323

 

 

10,551

 

Income (loss) from continuing operations

 

$

(15,901

)

$

16,668

 

$

 

$

767

 

 


*Exclusive of depreciation and amortization

 

5.     REGULATORY MATTERS

 

Certain of our interstate telecommunications service rates are subject to regulation by the Federal Communications Commission (“FCC”). Interstate switched and special access rates are established through a SureWest Telephone tariff filed with the FCC.  For interstate common line (“CL”) charges, SureWest Telephone concurs with tariffs filed by the National Exchange Carrier Association (“NECA”).  Intrastate service rates are subject to regulation by state commissions.  Prices for intrastate telecommunications services are established through tariffs or through other regulatory mechanisms, including, in California, service guides.  Pending and future regulatory actions may have a material impact on our consolidated financial position and results of operations.

 

FCC Matters

 

Under current FCC rules governing rate making, SureWest Telephone is required to establish rates for its interstate telecommunications services based on projected demand usage for the various services.  SureWest Telephone projects its earnings through the use of annual cost separation studies, which utilize estimated total cost information and projected demand usage. Carriers are required to follow FCC rules in the preparation of these annual studies.  SureWest Telephone determines actual earnings from its interstate rates as actual volumes and costs become known.  The FCC monitors SureWest Telephone’s interstate earnings.

 

As a result of periodic cost separation studies required by the FCC, SureWest Telephone changed its estimates for certain NECA CL accounts receivable balances related to the current and prior year monitoring periods.  During the quarter and nine-month period ended September 30, 2009, these changes in estimates decreased our consolidated revenues and income from continuing operations by $583 and $562 and net income by $335 ($0.02 per share) and $323 ($0.02 per share), respectively.  We did not record any significant changes in estimates during the quarter and nine-month period ended September 30, 2010.

 

California Public Utility Commission (“CPUC”) Matters

 

In 2004, we entered into a settlement agreement (the “Settlement Agreement”), which was ultimately approved by the CPUC, to resolve an ongoing regulatory proceeding with various parties.  The Settlement Agreement resolved past sharing liabilities and suspended future sharing requirements in the intrastate jurisdiction.  In accordance with the Settlement Agreement, SureWest Telephone returned approximately $6,500, plus interest, to its end-users through a consumer dividend.  The surcredit was recorded as a reduction of our contractual shareable earnings obligations over a period of approximately four years, which began January 1, 2005.  During the first quarter of 2009 and prior to the cessation of the surcredit on February 9, 2009, we returned approximately $165.

 

As part of the Settlement Agreement, SureWest Telephone was required to implement an additional annual consumer dividend of $1,300 on January 1, 2007 to end-users receiving SureWest Telephone services subject to sharing on or after that date.  In December 2006, the CPUC authorized us to offset our annual $11,500 interim draw from the California High Cost Fund (“CHCF”) with the aforementioned $1,300 consumer dividend Settlement Agreement.  The CHCF was previously authorized by the CPUC on an interim basis to offset certain of SureWest Telephone’s intrastate regulated operating expenses that previously had been recovered through direct carrier payments.  In September 2007, the CPUC issued Decision 07-09-002 which provides for SureWest Telephone to phase-down its

 

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annual CHCF interim draw over a five-year period, to end on January 1, 2012.  In 2009, our interim CHCF draw was $6,120 and is being incrementally reduced by $2,040 annually.

 

In an ongoing proceeding relating to the New Regulatory Framework (under which SureWest Telephone has been regulated since 1996), the CPUC adopted Decision 06-08-030 in 2006, which grants carriers broader pricing freedom in the provision of telecommunications services, bundling of services, promotions and customer contracts.  This decision adopted a new regulatory framework, the Uniform Regulatory Framework (“URF”), which among other things (i) eliminates price regulation and allows full pricing flexibility for all new and retail services except basic residential services, which limits increases to $3.25 per year during 2009 and 2010, (ii) allows new forms of bundles and promotional packages of telecommunication services, (iii) allocates all gains and losses from the sale of assets to shareholders and (iv) eliminates almost all elements of rate of return regulation, including the calculation of shareable earnings.  Beginning January 1, 2011, the URF Incumbent Local Exchange Carriers will be allowed full pricing flexibility for the basic residential rate.

 

6.     INCOME TAXES

 

Our effective federal income tax rates for continuing operations were 62.5% and 66.4% for the nine-month periods ended September 30, 2010 and 2009, respectively. For the nine-month period ended September 30, 2010, our actual tax expense differed from the federal statutory rate primarily due to state taxes, permanent differences resulting from the decrease between the grant and vesting prices of RSAs and RSUs that vested during the period and a change to state deferred tax expense attributable to apportionment changes.

 

Our policy is to recognize interest and penalties related to uncertain tax positions as additional income tax expense.  We did not accrue significant amounts of interest and penalties related to unrecognized tax benefits during the nine-month periods ended September 30, 2010 and 2009.  As of September 30, 2010, we had approximately $133 of accrued interest and approximately $28 of penalties in the amount disclosed below for unrecognized tax benefits.

 

We had a liability for unrecognized tax benefits of approximately $261 and $203 at September 30, 2010 and December 31, 2009, respectively.  The following table provides a reconciliation of the beginning and ending amount of unrecognized tax benefits during the nine-month period ended September 30, 2010:

 

Balance at December 31, 2009

 

$

203

 

Additions based on prior year tax positions

 

58

 

Balance at September 30, 2010

 

$

261

 

 

The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate were $187 and $129 at September 30, 2010 and December 31, 2009, respectively.

 

As of September 30, 2010, the following tax years and related taxing jurisdictions were open:

 

Tax Year

 

Taxing Jurisdiction

 

2002 - 2009

 

Federal

 

2004 - 2009

 

California

 

2006 - 2009

 

Kansas and Missouri

 

 

7.     PENSION PLAN AND OTHER POST-RETIREMENT BENEFITS

 

We maintain a noncontributory defined benefit pension plan (the “Pension Plan”) which covers certain eligible employees. Benefits are based on years of service and the employee’s average compensation during the five highest consecutive years of the last ten years of credited service. Our funding policy is to contribute annually an actuarially determined amount consistent with applicable federal income tax regulations. Contributions are intended to provide for benefits attributed to service to date. Pension Plan assets are primarily invested in domestic equity securities, fixed income and international equity securities.

 

We also maintain an unfunded Supplemental Executive Retirement Plan (“SERP”), which provides supplemental retirement benefits to certain of our retired executives. The SERP provides for incremental pension payments to partially offset the reduction in amounts that would have been payable under the Pension Plan if it were not for limitations imposed by federal income tax regulations.

 

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In addition, we provide certain post-retirement benefits other than pensions (“Other Benefits Plan”) to certain eligible employees of our California location, including life insurance benefits and a stated reimbursement for Medicare supplemental insurance.

 

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

 

We account for our Pension Plan in accordance with ASC Topic 715, Compensation — Retirement Benefits (“ASC 715”) (formerly SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Post-retirement Plans, an Amendment of FASB Statements No. 87, 88, 106 and 132(R)).  ASC 715 requires an employer to recognize the overfunded or underfunded status of a defined benefit post-retirement plan as an asset or liability in its statement of financial position, to recognize changes in that funded status in the year in which the changes occur through comprehensive income and to measure the funded status of a plan as of the date of its year-end statement of financial position.

 

Components of Net Periodic Pension Cost

 

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

 

Quarter ended September 30,

 

2010

 

2009

 

Interest cost on projected benefit obligation

 

$

1,792

 

$

1,809

 

Expected return on plan assets

 

(1,820

)

(1,672

)

Amortization of:

 

 

 

 

 

Prior Service Cost

 

1

 

1

 

Net actuarial loss

 

543

 

648

 

Net periodic pension expense

 

$

516

 

$

786

 

 

Nine months ended September 30,

 

2010

 

2009

 

Interest cost on projected benefit obligation

 

$

5,376

 

$

5,426

 

Expected return on plan assets

 

(5,460

)

(5,014

)

Amortization of:

 

 

 

 

 

Prior service cost

 

2

 

2

 

Net actuarial loss

 

1,630

 

1,944

 

Net periodic pension expense

 

$

1,548

 

$

2,358

 

 

Net periodic benefit costs related to the Other Benefits Plan were not significant to our condensed consolidated financial statements for the quarters or nine-month periods ended September 30, 2010 and 2009.

 

8.     CREDIT ARRANGEMENTS

 

A summary of our long-term debt is as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Series A Senior Notes

 

$

14,545

 

$

14,545

 

Series B Senior Notes

 

36,000

 

48,000

 

Term Loan A credit facility

 

120,000

 

120,000

 

Term Loan B credit facility

 

30,000

 

30,000

 

Revolving Loan credit facility

 

8,500

 

10,500

 

Total long-term debt

 

209,045

 

223,045

 

Less current portion

 

15,636

 

15,636

 

Total long-term debt, net of current

 

$

193,409

 

$

207,409

 

 

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

 

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On January 29, 2010, we entered into a letter agreement with CoBank amending certain terms of the Credit Agreement. The Credit Agreement included a provision which required permanent reductions of the Revolving Loan facility of $7,500 at December 31, 2009 and 2010. The letter agreement amended those provisions and included (i) an increase in the total Revolving Loan facility of $7,500, (ii) CoBank’s share of the Revolving Loan facility will be permanently reduced by $5,000 (rather than $7,500) on December 31, 2010 and (iii) the total Revolving Loan facility will be $57,500.  As a result of this letter agreement, our combined revolving commitment balance on our Revolving Loan and Swingline Loan facilities is $60,000 and our available balance as of September 30, 2010, which was less our outstanding balance of $8,500, was approximately $51,500.

 

Our Series A and Series B Senior Notes and the Credit Agreement contain financial and operating covenants that may restrict, among other things, the repurchase of the Company’s common stock, the payment of dividends, the making of certain other restricted payments and the incurrence of additional indebtedness. The covenants also require us to maintain certain financial ratios and minimum levels of tangible net worth. If we fail to comply with the covenants and other restrictions, such as making timely interest or principal payments, it could lead to an event of default and the acceleration of our obligations under those agreements. As of September 30, 2010, we were in compliance with all of our debt covenants.

 

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

 

Financial Covenant

 

Required Ratio Level

 

Actual Performance at
September 30, 2010

 

Leverage ratio

 

Not more than 3.75

 

2.7

 

Interest coverage ratio

 

Not less than 3.00

 

8.5

 

Consolidated net worth

 

Not less than $160,000

 

$269,638

 

Debt to capitalization

 

Not more than 0.55

 

0.44

 

 

At September 30, 2010 and December 31, 2009, retained earnings of $109,638 and $109,183, respectively, were available for the payments described above.

 

9.     COMMITMENTS AND CONTINGENCIES

 

Litigation, Regulatory Proceedings and Other Contingencies

 

We are subject to certain legal proceedings, Internal Revenue Service examinations and other income tax exposures and other claims arising in the ordinary course of our business. In the opinion of management, the ultimate outcome of these matters will not materially affect our consolidated financial position, results of operations or cash flows.

 

We are also subject to a number of regulatory proceedings at the federal and state levels that may have a material impact on our operations. The FCC and state commissions have authority to issue rules and regulations related to our business.  A number of proceedings are pending or anticipated that are related to such telecommunications issues as competition, interconnection, access charges, intercarrier compensation, broadband deployment, consumer protection and universal service reform.  Proceedings that relate to our cable television operations include rulemakings on set top boxes, access to and carriage of programming, industry consolidation and ways to promote additional competition.  The FCC has also initiated proceedings related to the terms and conditions under which Internet access is offered.  Some FCC proceedings may authorize new services to compete with one or more of our services.  There are various on-going legal challenges to the scope or validity of regulatory orders that have been issued.  As a result, it is not yet possible to determine fully the impact of the related FCC and state rules and regulations on our operations.

 

10.       RECENT ACCOUNTING PRONOUNCEMENTS

 

Recently Issued Accounting Pronouncements

 

In July 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-20, Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”). ASU 2010-20 requires entities to provide additional disclosures concerning financing receivables and allowance for credit losses.  Specifically, the new disclosures include (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) the factors considered in analyzing such risk in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Public entities are required to adopt the provisions of ASU 2010-20 related to disclosures of financing receivables as of the end of a reporting

 

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period for interim or annual reporting periods ending on or after December 15, 2010.  The financing receivables disclosures related to activity that occurs during a reporting period are effective for interim or annual reporting periods beginning on or after December 15, 2010.  We are currently evaluating the impact this update will have on our condensed consolidated financial statements.

 

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”).  ASU 2009-13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit and modifies the manner in which the transaction consideration is allocated across the separately identified deliverables.  ASU 2009-13 significantly expands the disclosure requirements for multiple-deliverable revenue arrangements.  ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, and may be applied retrospectively for all periods presented or prospectively to arrangements entered into or materially modified after the adoption date.  Early adoption is permitted, provided that the guidance is retroactively applied to the beginning of the year of adoption. We are currently evaluating the impact this update will have on our condensed consolidated financial statements.

 

Recently Adopted Accounting Pronouncements

 

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855) — Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”). ASU 2010-09 amends ASC Topic 855 to remove the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated both in issued and revised financial statements.  ASU 2010-09 was effective immediately.  Our adoption of this guidance had no impact on our condensed consolidated financial position and results of operations.

 

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements (“ASU 2010-06”).  ASU 2010-06 amends ASC 820 to require additional disclosures regarding fair value measurements. Specifically, ASU 2010-06 requires entities to disclose additional information regarding (i) the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis, (ii) the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers and (iii) the reasons for any transfers in or out of Level 3. In addition to these new disclosure requirements, ASU 2010-06 also amends ASC 820 to further clarify existing guidance pertaining to the level of disaggregation at which fair value disclosures should be made and the requirements to disclose information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. Our adoption of the requirements of this guidance on January 1, 2010, except for the requirement to separately disclose information about purchases, sales, issuances, and settlements in the reconciliation of recurring Level 3 measurements on a gross basis which becomes effective for fiscal years (and interim periods within those fiscal years) beginning after December 15, 2010, did not have a material impact on our condensed consolidated financial position or results of operations.

 

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

 

(Amounts in thousands, except select operating metrics and share and per share amounts)

 

Certain statements included in this report, including that which relates to the impact on future revenue sources and potential sharing obligations of pending and future regulatory orders, continued expansion of the telecommunications network and expected changes in the sources of our revenue and cost structure resulting from our entrance into new communications markets, are forward-looking statements and are made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. These forward looking statements generally are identified by the words “believe”, “expect”, “anticipate”, “estimate”, “intend”, “should”, “may”, “will”, “would”, “will be”, “will continue” or similar expressions. Such forward looking statements involve known and unknown risks, the impact of current economic conditions, uncertainties and other factors that may cause actual results, performance or achievements of SureWest Communications (the “Company”, “we” or “our”) to be different from those expressed or implied in the forward-looking statements. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward—looking statements is included in our 2009 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”). We disclaim any intention or obligation to update or revise publicly any forward-looking statements. Management’s Discussion and Analysis should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes to the financial statements (“Notes”) as of and for the nine months ended September 30, 2010 included in Item 1 of this Quarterly Report on Form 10-Q.

 

Overview

 

We are one of the leading integrated communications providers and are the bandwidth leader in the markets we serve.  We provide voice, video and data services, either individually or as a part of bundled services to residential and business customers in the greater Sacramento, California and greater Kansas City, Kansas and Missouri areas (“Kansas City area”). We continue to expand the use of optical fiber in our networks.  We increasingly deploy our services by combining fiber-to-the-home (“FTTH”) and fiber-to-the-node (“FTTN”) facilities with the use of Internet Protocol (“IP”) based communications protocol.  Our advanced telecommunications networks give us a competitive edge that enables us to provide our customers with higher data speeds for Internet service and deploy multiple services at superior quality through our high bandwidth capacity.  Our IP based communication protocol enables us to provide dedicated bandwidth at symmetrical data speeds to each of our customers in the greater Sacramento, California area.  We classify our operations in two reportable segments: Broadband and Telecommunications (“Telecom”).

 

Our Broadband segment earns revenues primarily through subscriptions to our video, high-speed Internet and phone services.  Our video services range from a limited basic service to our newest product offering Advanced Digital TV (“ADTV”), powered by Microsoft® Mediaroom.  Many of our services are delivered utilizing FTTH and FTTN networks, which allow us to offer a high quality experience with our digital TV Packages. ADTV was launched in the Sacramento region in January 2010 and enhancements were completed on existing copper network marketable homes to provide this new video service, resulting in an increase of 26,600 video marketable homes as of September 30, 2010.  This enhanced video product includes a Whole Home digital video recorder (“DVR”) (which allows subscribers to watch and record up to four programs at the same time and pause, replay and rewind “live” television), instant channel changes and an intuitive, user-friendly guide. Our ADTV product provides access to approximately 330 channels in our California market.  Our full digital cable service in the Kansas City area provides access to approximately 315 channels and additional digital cable services, including a DVR.  Our video product offerings include access to high-definition (“HD”) television (“HDTV”), which provides multiple channels in high definition, premium and pay-per-view channels (which include concerts, wrestling, boxing, sporting events and movies); video on demand (“VOD”) service (which allows access to a library of movies and the ability to start a selection at any time and to pause, rewind and fast-forward and replay); premium VOD channels, music channels and an interactive, on-screen program guide (which allows the subscriber to navigate the channel lineup and the VOD library).  As of September 30, 2010, approximately 23% of the homes in the areas we serve subscribed to one of our video services.

 

Our high-speed Internet service can provide Internet access at symmetrical speeds of up to 50 Mbps, depending on the nature of the network facilities that are available, the level of service selected and the location.  As of September 30, 2010, approximately 32% of the homes in the areas we serve subscribed to one of our high-speed Internet services.  Our Voice over Internet Protocol (“VoIP”) digital phone product is available in the Sacramento market in packages ranging from basic service to unlimited local and domestic long distance calling plans.  Nearly all of our VoIP phone

 

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service plans include an extensive array of calling features including caller identification and call waiting, Find Me/Follow Me, sequential ringing and selective call acceptance and rejection.  As of September 30, 2010, approximately 17% of the homes in our Sacramento market have subscribed to our VoIP phone service. We also offer traditional circuit-switched voice services in some of the areas we serve.  The total voice penetration in the markets we serve was approximately 24% as of September 30, 2010.

 

Our Telecom segment, which operates only in the Sacramento area, offers a broad selection of telecommunications services including traditional circuit-switched voice services, long distance services and a number of lightly-regulated or non-regulated services. Customers in the Telecom segment can select individual services or bundled packages that may include unlimited local calling or unlimited local and domestic long distance calling plans.  Our voice products also include value-added services such as voicemail, call waiting, caller identification and many other calling feature options.  Most long distance services are offered by our subsidiary SureWest Long Distance, which is a reseller of long distance services.

 

Current Business Developments

 

In connection with our efforts to evaluate and potentially monetize excess assets, during 2009 we identified and began to actively market for sale certain of our real estate assets.  These regulated assets, which are included in the Telecom Segment, include 21 acres of undeveloped land and an office building.  During the quarter ended December 31, 2009, we completed our plan to sell these assets and as a result they were classified as assets held for sale.  We expect the land will sell in the range of $3,000 to $5,000. In connection with the classification to assets held for sale, the carrying value of the office building was reduced to its estimated fair value, less selling costs, based on the current market conditions and listed selling price. As a result, an impairment charge of $1,199 was recorded against accumulated depreciation during the quarter ended December 31, 2009, in accordance with regulated telephone plant and equipment composite group remaining life methodology.  We evaluated the estimated fair value of the assets held for sale as of September 30, 2010 and determined there was not a significant change.  Therefore, no additional impairment charge was recorded during the quarter or nine-month period ended September 30, 2010.

 

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

 

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Results of Operations

 

The tables below reflect certain financial data (on a consolidated and segment basis) and select operating metrics for each of our reportable segments as of and for the quarters and nine months ended September 30, 2010 and 2009.

 

Financial Data

 

 

 

Quarter Ended September 30,

 

Nine Months Ended September 30,

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

$

 

%

 

 

 

2010

 

2009

 

Change

 

Change

 

2010

 

2009

 

Change

 

Change

 

Operating revenues (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

$

43,861

 

$

40,175

 

$

3,686

 

9

%

$

129,514

 

$

119,656

 

$

9,858

 

8

%

Telecom

 

17,256

 

19,354

 

(2,098

)

(11

)

52,339

 

61,745

 

(9,406

)

(15

)

Operating revenues

 

61,117

 

59,529

 

1,588

 

3

 

181,853

 

181,401

 

452

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

(2,942

)

(6,546

)

3,604

 

55

 

(12,436

)

(18,772

)

6,336

 

34

 

Telecom

 

7,959

 

9,162

 

(1,203

)

(13

)

22,632

 

29,323

 

(6,691

)

(23

)

Income from operations

 

5,017

 

2,616

 

2,401

 

92

 

10,196

 

10,551

 

(355

)

(3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

(3,082

)

(5,619

)

2,537

 

45

 

(11,071

)

(15,901

)

4,830

 

30

 

Telecom

 

4,486

 

5,408

 

(922

)

(17

)

12,475

 

16,668

 

(4,193

)

(25

)

Income (loss) from continuing operations

 

1,404

 

(211

)

1,615

 

765

 

1,404

 

767

 

637

 

83

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

10,008

 

6,071

 

3,937

 

65

 

26,616

 

17,666

 

8,950

 

51

 

Telecom

 

11,327

 

12,890

 

(1,563

)

(12

)

34,115

 

40,647

 

(6,532

)

(16

)

Adjusted EBITDA

 

21,335

 

18,961

 

2,374

 

13

 

60,731

 

58,313

 

2,418

 

4

 

 


(1)    External customers only.

(2)             Adjusted EBITDA represents net income (loss) from continuing operations excluding amounts for income taxes; depreciation and amortization; non-cash pension and certain post-retirement benefits; non-cash stock compensation; severance and other related termination costs; and all other non-operating income and expenses.  Adjusted EBITDA is a common measure of operating performance in the telecommunications industry. Adjusted EBITDA helps us evaluate our performance by removing from our operating results non-cash items and items which do not relate to our core operating performance.  The presentation of Adjusted EBITDA is not a measure of financial performance under United States generally accepted accounting principles (“U.S. GAAP” or “GAAP”) and should not be considered in isolation or as a substitute for consolidated net income (loss) as a measure of performance and may not be comparable to similarly titled measures used by other companies.  The following tables are a reconciliation of our income (loss) from continuing operations to Adjusted EBITDA on a consolidated and segment basis for the quarters and nine-month periods ended September 30, 2010 and 2009:

 

 

 

Quarter Ended September 30, 2010

 

 

 

Broadband

 

Telecom

 

Consolidated

 

Income (loss) from continuing operations

 

$

(3,082

)

$

4,486

 

$

1,404

 

Add (subtract):

 

 

 

 

 

 

 

Income tax expense (benefit)

 

(2,066

)

3,394

 

1,328

 

Other (income) expense

 

2,206

 

79

 

2,285

 

Depreciation and amortization

 

12,609

 

3,071

 

15,680

 

Non-cash pension and post-retirement expense

 

181

 

190

 

371

 

Non-cash stock compensation expense

 

160

 

107

 

267

 

Adjusted EBITDA

 

$

10,008

 

$

11,327

 

$

21,335

 

 

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Nine Months Ended September 30, 2010

 

 

 

Broadband

 

Telecom

 

Consolidated

 

Income (loss) from continuing operations

 

$

      (11,071

)

$

        12,475

 

$

          1,404

 

Add (subtract):

 

 

 

 

 

 

 

Income tax expense (benefit)

 

(7,437

)

9,779

 

2,342

 

Other (income) expense

 

6,072

 

378

 

6,450

 

Depreciation and amortization

 

36,929

 

9,119

 

46,048

 

Non-cash pension and post-retirement expense

 

548

 

584

 

1,132

 

Non-cash stock compensation expense

 

1,106

 

1,105

 

2,211

 

Severance and other related termination costs (a)

 

469

 

675

 

1,144

 

Adjusted EBITDA

 

$

        26,616

 

$

        34,115

 

$

        60,731

 

 


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

 

 

 

Quarter Ended September 30, 2009

 

 

 

Broadband

 

Telecom

 

Consolidated

 

Income (loss) from continuing operations

 

$

        (5,619

)

$

          5,408

 

$

           (211

)

Add (subtract):

 

 

 

 

 

 

 

Income tax expense (benefit)

 

(3,810

)

3,824

 

14

 

Other (income) expense

 

2,883

 

(70

)

2,813

 

Depreciation and amortization

 

12,199

 

3,061

 

15,260

 

Non-cash pension and post-retirement expense

 

197

 

445

 

642

 

Non-cash stock compensation expense

 

221

 

222

 

443

 

Adjusted EBITDA

 

$

          6,071

 

$

        12,890

 

$

        18,961

 

 

 

 

Nine Months Ended September 30, 2009

 

 

 

Broadband

 

Telecom

 

Consolidated

 

Income (loss) from continuing operations

 

$

      (15,901

)

$

        16,668

 

$

             767

 

Add (subtract):

 

 

 

 

 

 

 

Income tax expense (benefit)

 

(10,778

)

12,292

 

1,514

 

Other (income) expense

 

7,907

 

363

 

8,270

 

Depreciation and amortization

 

35,102

 

9,196

 

44,298

 

Non-cash pension and post-retirement expense

 

580

 

1,369

 

1,949

 

Non-cash stock compensation expense

 

756

 

759

 

1,515

 

Adjusted EBITDA

 

$

        17,666

 

$

        40,647

 

$

        58,313

 

 

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Select Operating Metrics

 

 

 

As of September 30,

 

 

 

2010

 

2009

 

Change

 

% Change

 

Broadband

 

 

 

 

 

 

 

 

 

Total residential subscribers (1)

 

104,000

 

103,000

(5)

1,000

 

1

%

Broadband residential revenue-generating units (2)

 

235,300

 

226,600

(5)

8,700

 

4

 

Data

 

99,200

 

97,600

(5)

1,600

 

2

 

Video

 

61,200

 

59,000

(5)

2,200

 

4

 

Voice

 

74,900

 

70,000

(5)

4,900

 

7

 

Total business customers (3)

 

7,700

 

7,200

(5)

500

 

7

 

 

 

 

 

 

 

 

 

 

 

Telecom

 

 

 

 

 

 

 

 

 

Voice revenue-generating units (4)

 

30,700

 

41,300

 

(10,600

)

(26

)

Total business customers (3)

 

8,000

 

8,700

 

(700

)

(8

)

 


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

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

(3)             Total business customers are customers who receive business data, voice or video services and represent a distinct customer account.

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

(5)             During the third quarter of 2010, we revised our methodology of counting Broadband residential subscribers, RGUs and business customer counts.  The revised methodology facilitates the consistent application of customer counts within the Broadband segment.  Accordingly, the Broadband segment metrics previously reported for 2009 have been revised to conform to current practice.

 

Consolidated Overview

 

Operating Revenues

 

Operating revenues in the Broadband segment increased $3,686 and $9,858 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009. Broadband residential revenues increased $1,566 and $4,827 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009 due in part to a 4% growth in RGUs. Broadband residential revenues also increased as a result of higher pricing for video and data services in 2010, which were effective in November 2009 and September 2010.

 

We offer a broadband VoIP phone service in the Sacramento market, including in the Telecom segment service territory.  The VoIP phone service provides us with a competitive triple-play offering and has mitigated past declines in consolidated operating revenue and voice RGUs by allowing us to migrate those customers to voice RGUs in the Broadband segment rather than losing those customers to competitors.  Broadband voice RGUs in the Sacramento market increased 16% as of September 30, 2010 compared to the same prior year period.

 

Broadband business revenues increased $1,961 and $4,584 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009. Business customers increased 7% as of September 30, 2010 compared to the same period in 2009 as a result of growth primarily in the Kansas City market.  The variety of our product offerings and our ability to offer customized service packages to businesses of all sizes as well as superior business customer satisfaction levels contributed to the current year growth in business revenue and will continue to provide us with new opportunities in the commercial market.

 

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

 

Operating revenues in the Telecom segment decreased $2,098 and $9,406 during the quarter and nine-month period

 

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ended September 30, 2010, respectively, compared to the same periods in 2009. Residential services decreased $1,771 and $5,693 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009 and were largely impacted by our customer’s migration toward alternative communication services, including those offered by our Broadband segment, as discussed above, which contributed to a 26% decline in the Telecom segment voice RGUs as of September 30, 2010 compared to 2009.  Business revenues increased $63 and decreased $1,256 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009 as a result of an 8% decline in business customers due to the economic impact on small and medium sized businesses in the California market. However, the decline was mitigated by higher pricing for data services in 2010, which were implemented during the current quarter. The decrease in operating revenues was also impacted by the scheduled reduction in support received from the California High Cost Fund (“CHCF”) of $510 and $1,530 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  See the Regulatory Matters section below for a further discussion regarding the regulatory subsidies we receive.

 

The Telecom segment provides wholesale access and Digital Subscriber Line (“DSL”) services through the use of its network to the Broadband segment, which enables the Broadband segment to offer high-speed Internet, VoIP, video and wireless backhaul services to those customers within SureWest Telephone’s service area. These wholesale services are included as intersegment revenues and expenses in each of the respective segments and eliminated in the consolidated statements of income.

 

Operating Expenses

 

Consolidated operating expenses, excluding depreciation and amortization, decreased $1,233 and $943 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009. During the quarter ended June 30, 2010, we implemented a workforce reduction initiative in which approximately 60 positions were eliminated as we continue to improve operating efficiencies and align operating costs with the decline in Telecom revenues, while enhancing our focus on the growth of our broadband services.  Affected employees were provided a range of benefits and resources, including severance. As a result, severance and other related termination costs of $1,428 were incurred during the nine months ended September 30, 2010.

 

The change in consolidated operating expenses was also impacted by a decrease in the costs associated with our defined benefit pension plan (the “Pension Plan”) of $205 and $614 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The decrease in net periodic pension costs for 2010 compared to 2009 was predominately due to an actual higher rate of return on pension plan assets for 2009 than what was anticipated.

 

Cost of services and products expense increased $1,222 and $1,507 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The increase in expenses in the current year periods was largely due to increases in programming and network costs related to providing video and data services.  These costs result from an increase in programming fees per subscriber and the growth in business services. However, labor costs have declined as a result of a reduction in headcount through the workforce reduction initiative and the outsourcing of certain network and property maintenance services in 2010.

 

Customer operations and selling expense decreased $1,102 and $486 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The decrease in expenses in the current year periods was largely due to a decline in sales and advertising costs as result of a reduction in radio advertising in the current year periods. However, selling costs, primarily sales labor and commissions, increased related to the launch and promotion of our new ADTV product during the first and second quarters of 2010.

 

General and administrative expenses decreased $1,353 and $1,964 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009. Labor costs decreased resulting from a decline in pension expense and a reduction in headcount, but was offset in part by employee severance costs of $934 incurred during the nine months ended September 30, 2010 related to the workforce reduction initiative. Professional fees also decreased as a result of lower annual rates and a reduction in information technology project support costs in the current year.

 

Our consolidated depreciation and amortization expense increased $420 and $1,750 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The increase in depreciation and amortization expense was primarily due to the continued expansion of the network and success-based capital projects undertaken within the residential and business broadband service territories.

 

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Reclassifications

 

Certain amounts in our 2009 condensed consolidated financial statements have been reclassified to conform to the presentation of our 2010 condensed consolidated financial statements. Operating expenses have been reclassified for a change during the third quarter of 2010 in the classification of customer technical support costs from customer operations and selling to cost of services and products. Prior period costs have been reclassified to conform to the current year presentation.

 

In addition, the calculation of certain select operating metrics has been revised to reflect the consistent application of customer counts within the Broadband segment. Accordingly, where necessary, prior period metric calculations have been revised to conform to current practice.

 

Segment Results of Operations

 

Broadband

 

 

 

Quarter Ended September 30,

 

Nine Months Ended September 30,

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

$

 

%

 

 

 

2010

 

2009

 

Change

 

Change

 

2010

 

2009

 

Change

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Data

 

$

12,100

 

$

11,236

 

$

864

 

8

%

$

36,493

 

$

33,183

 

$

3,310

 

10

%

Video

 

12,151

 

11,711

 

440

 

4

 

36,536

 

35,395

 

1,141

 

3

 

Voice

 

6,704

 

6,442

 

262

 

4

 

19,811

 

19,435

 

376

 

2

 

Total residential revenues

 

30,955

 

29,389

 

1,566

 

5

 

92,840

 

88,013

 

4,827

 

5

 

Business

 

11,979

 

10,018

 

1,961

 

20

 

33,802

 

29,218

 

4,584

 

16

 

Access

 

481

 

427

 

54

 

13

 

1,749

 

1,209

 

540

 

45

 

Other

 

446

 

341

 

105

 

31

 

1,123

 

1,216

 

(93

)

(8

)

Total operating revenues from external customers

 

43,861

 

40,175

 

3,686

 

9

 

129,514

 

119,656

 

9,858

 

8

 

Intersegment revenues

 

110

 

93

 

17

 

18

 

423

 

278

 

145

 

52

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

25,719

 

23,320

 

2,399

 

10

 

75,008

 

70,074

 

4,934

 

7

 

Customer operations and selling

 

4,940

 

6,532

 

(1,592

)

(24

)

16,886

 

18,229

 

(1,343

)

(7

)

General and administrative

 

3,645

 

4,763

 

(1,118

)

(23

)

13,550

 

15,301

 

(1,751

)

(11

)

Depreciation and amortization

 

12,609

 

12,199

 

410

 

3

 

36,929

 

35,102

 

1,827

 

5

 

Loss from operations

 

(2,942

)

(6,546

)

3,604

 

55

 

(12,436

)

(18,772

)

6,336

 

34

 

Loss from continuing operations

 

(3,082

)

(5,619

)

2,537

 

45

 

(11,071

)

(15,901

)

4,830

 

30

 

 


*Exclusive of depreciation and amortization

 

Broadband Segment Operating Revenues

 

Operating revenues from external customers in the Broadband segment increased $3,686 and $9,858 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The increase in operating revenues was due in part to the growth in residential RGUs and business customers.

 

Residential Revenues

 

Broadband residential revenues increased $1,566 and $4,827 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The increase in Broadband operating revenues in the current year periods was due in part to the growth of Broadband residential RGUs of 4% as of September 30, 2010 compared to the same period in 2009.  Broadband residential revenues also increased as a result of higher pricing for video and data services in 2010, which were effective in November 2009 and September 2010.  We anticipate continued growth in residential broadband RGUs and average revenue per user resulting from our HD DVR, VoIP phone service and the launch in January 2010 of our ADTV product powered by Microsoft® Mediaroom.

 

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Data

 

We offer high speed Internet access at symmetrical speeds of up to 50 Mbps, depending on the nature of the network facilities that are available, the level of service selected and the location.  The reliability and high speeds of the data service in both the Sacramento and Kansas City markets enhance other services such as VoIP and Digital Phone, where customers manage phone services through the online SureWest portal.  Through the SureWest portal, customers can manage their VoIP or Digital Phone service and access a variety of value added features and enhancements that are designed to take advantage of the speed of the Internet service we provide.

 

Our residential data revenues increased $864 and $3,310 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009 primarily as a result of higher price points on our data services, as discussed above.

 

Video

 

Our video services range from limited basic cable service to our newest product offering ADTV.  ADTV is currently deployed through our copper and fiber networks in the greater Sacramento area.  The integration of the new Mediaroom™ platform includes a Whole Home DVR, which allows customers the ability to watch recorded shows on any television in the house, record multiple shows at one time and utilize an intuitive on-screen guide and user interface.  Our services primarily are delivered utilizing FTTH and FTTN networks, which allow us to offer a high quality experience with digital TV Packages.  Our full digital cable service provides access to approximately 330 and 315 channels in our California and Kansas City markets, respectively, including premium and pay-per-view channels, VOD service, premium VOD channels, music channels and an interactive, on-screen program guide. Digital cable subscribers can also subscribe to additional digital cable services, including a DVR and HDTV.

 

Residential video revenues increased $440 and $1,141 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  Revenues increased as a result of both higher pricing on many of our video service offerings, as discussed above, and new demand for enhanced video offerings such as VOD, DVR and HDTV.

 

Voice

 

We offer phone services that provide local and long-distance calling and include features such as caller ID and call waiting. As of September 30, 2010, approximately 24% of the homes in the areas we serve subscribed to one of our phone services.

 

Our VoIP phone service is offered in the Sacramento market and is available in packages ranging from basic telephone service to unlimited local and domestic long distance calling plans.  Nearly all of our VoIP phone service plans include enhanced calling features such as Find Me/Follow Me, sequential ringing and selective call acceptance and rejection.  Voice RGUs in the Sacramento market increased 16% as of September 30, 2010 compared to the same period in 2009.  As of September 30, 2010, approximately 17% of the homes in our Sacramento market have subscribed to our VoIP phone service.  Our VoIP phone service in the Sacramento market offers our customers, including those in the Telecom service territory, an alternative to traditional circuit switched land line service and presents our customers with a more competitive triple-play offering with increased options and multiple packages.

 

Residential voice revenues increased $262 and $376 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009 primarily as a result of growth in voice RGUs of 7% in that same time period.  Average revenue per voice user declined to approximately $19.84 as of September 30, 2010 from approximately $31.01 compared to the same period in 2009, due to customers receiving service as a part of a promotional offer or in a bundled service offering.

 

Business Revenues

 

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

 

Business revenues increased $1,961 and $4,584 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  This increase was due primarily to a 7% increase in business customers as of September 30, 2010 compared to the same period in 2009.  Our Kansas City operations contributed a significant portion of the business revenue growth.

 

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Wireless backhaul revenue also contributed to the growth in the business revenue during the quarter and nine-month period ended September 30, 2010.  We anticipate backhaul revenue will grow during the remainder of 2010 as wireless carriers, faced with escalating consumer and business demand for mobile broadband traffic, are forced to increase backhaul capacity.

 

Access Revenues

 

Access revenues increased $54 and $540 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The increase was mostly attributable to cash settlements received during the quarter ended March 31, 2010 from certain telecommunications carriers relating to disputed carrier access charges which were fully reserved in prior year periods.

 

Broadband Segment Operating Expenses

 

Total operating expenses in the Broadband segment decreased $311 and increased $1,840 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.

 

Cost of services and products (exclusive of depreciation and amortization) increased $2,399 and $4,934 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The increase in costs in the current year periods was largely due to direct costs incurred to provide our voice, video and data services.

 

Video programming fees are paid to programming networks to license the programming we distribute to our video customers.  Video programming costs have been increasing over the last several years primarily due to the expansion of channels and an increase in costs on a per subscriber basis and per program channel, particularly for local television broadcast stations, sports and HD channels.

 

We incur network access and transport costs to provide data and voice services to our customers.  Due to the rising demand for our VoIP product in the Sacramento market and the additional capacity required to handle the increasing volume of data usage, costs have increased in the current year periods.  Network access costs include costs paid to external vendors as well as our Telecom segment, in accordance with the provisions of a wholesale access agreement. The wholesale access agreement enables the Broadband segment to offer high-speed Internet, VoIP, video and wireless backhaul services to its customers within the Telecom segment territory.

 

Customer operations expense decreased $1,592 and $1,343 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The decrease in the current year periods was mostly attributable to a decline in product marketing and advertising costs as a result of a reduction in headcount and reduced expenditures on radio advertising in the current year periods.  The decrease was offset in part by an increase in selling expenses, primarily salaries and wages, commissions and customer events to promote the launch of our new ADTV product in the current year periods.

 

General and administrative expense decreased $1,118 and $1,751 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The decrease in costs were primarily due to (i) a decline in labor costs resulting from improved operating efficiencies in the current year period, (ii) a decrease in professional fees and (iii) the incurrence in the prior year period of information technology costs related to system maintenance and development and increased production support projects.  The decrease in costs was offset in part by severance costs of approximately $451 incurred during the nine months ended September 30, 2010 related to the workforce reduction initiative, as discussed in the consolidated overview section above.

 

Depreciation and amortization increased $410 and $1,827 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009 due primarily to the continued expansion of the broadband network and success-based capital projects.

 

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Table of Contents

 

Telecom

 

 

 

Quarter Ended September 30,

 

Nine Months Ended September 30,

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

$

 

%

 

 

 

2010

 

2009

 

Change

 

Change

 

2010

 

2009

 

Change

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

$

4,086

 

$

5,857

 

$

(1,771

)

(30

)%

$

13,433

 

$

19,126

 

$

(5,693

)

(30

)%

Business

 

8,750

 

8,687

 

63

 

1

 

25,568

 

26,824

 

(1,256

)

(5

)

Access

 

4,274

 

4,604

 

(330

)

(7

)

12,842

 

15,204

 

(2,362

)

(16

)

Other

 

146

 

206

 

(60

)

(29

)

496

 

591

 

(95

)

(16

)

Total operating revenues from external customers

 

17,256

 

19,354

 

(2,098

)

(11

)

52,339

 

61,745

 

(9,406

)

(15

)

Intersegment revenues

 

5,275

 

5,043

 

232

 

5

 

15,285

 

14,898

 

387

 

3

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of services and products*

 

5,677

 

6,478

 

(801

)

(12

)

17,407

 

19,963

 

(2,556

)

(13

)

Customer operations and selling

 

2,621

 

2,240

 

381

 

17

 

7,320

 

6,765

 

555

 

8

 

General and administrative

 

3,203

 

3,456

 

(253

)

(7

)

11,146

 

11,396

 

(250

)

(2

)

Depreciation and amortization

 

3,071

 

3,061

 

10

 

0

 

9,119

 

9,196

 

(77

)

(1

)

Income from operations

 

7,959

 

9,162

 

(1,203

)

(13

)

22,632

 

29,323

 

(6,691

)

(23

)

Income from continuing operations

 

4,486

 

5,408

 

(922

)

(17

)

12,475

 

16,668

 

(4,193

)

(25

)

 


*Exclusive of depreciation and amortization

 

Telecom Segment Operating Revenues

 

Operating revenues from external customers in the Telecom segment decreased $2,098 and $9,406 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009. The decrease in operating revenues was due in part to the decline in voice RGUs, business customers and regulatory subsidies.

 

Residential Revenues

 

SureWest Telephone offers several different phone service options, from basic local service packages to unlimited California and nationwide flat-rate plans.  All of the plans include options for voicemail and other calling features such as caller ID and call forwarding.  SureWest Telephone residential revenues decreased $1,771 and $5,693 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009 as we continue to experience decreases in revenue due to competition from wireless, wireline, and digital phone competitors (including SureWest Broadband).  Residential subscribers and voice RGUs declined approximately 26% as of September 30, 2010 compared to the same period in 2009.  We continue to mitigate additional voice access line and operating revenue losses through our VoIP phone service now offered to customers within the Telecom service area through our Broadband segment.  As a result, we expect a portion of the Telecom segment’s voice revenue will continue to shift to the VoIP service being offered by our Broadband segment.  As of September 30, 2010, approximately 40% of the decline in Telecom voice RGUs in 2010 was due to customers who have transferred to SureWest Broadband’s VoIP phone service rather than being lost to competitors.  See the Broadband segment residential revenue section above for a more detailed discussion regarding VoIP and other services offered by SureWest Broadband.

 

Business Revenues

 

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

 

SureWest Telephone business revenues increased $63 and decreased $1,256 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The decrease in revenue was mostly due to the 8% decline in business customers which resulted from the strained economic conditions for small and medium sized businesses and continued strong competitive pressures, as discussed above. The decrease in business revenue was offset in part by a rate increase for data services effective during the quarter ended September 30, 2010 resulting in an increase to average monthly revenue per user (“ARPU”) of 3% and 9% for the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.

 

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Table of Contents

 

Access Revenues

 

Access revenues, which include interstate and intrastate switched and special access revenue, interstate common line (“CL”) revenue and support payments from the CHCF, decreased $330 and $2,362 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009. As anticipated, CHCF support received during the quarter and nine-month period ended September 30, 2010 decreased $510 and $1,530, respectively, compared to the same periods in 2009. The decrease in access revenue was offset in part by an a increase in Interstate CL settlements received from the National Exchange Carrier Association (“NECA”) of $473 and $109 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009. Revenue recovery from the NECA pool increased during 2010 as a result of a higher rate base attributable to (i) plant additions for digital VoIP service customers and (ii) enhancements to the existing copper network marketable homes to support the ADTV product offered by the Broadband segment. See the Regulatory Matters section below for a more detailed discussion regarding SureWest Telephone’s regulated revenues.

 

Intersegment Revenues

 

Intersegment revenues consist predominately of revenues earned through a wholesale access agreement between the Telecom and Broadband segments.  The Telecom segment supplies wholesale access and DSL services through its network to the Broadband segment, which enables the Broadband segment to offer high-speed internet, VoIP, video and wireless backhaul services to customers residing within the Telecom service territory.  Wholesale access and DSL intersegment revenue increased in the current year periods compared to the same periods in 2009 and is anticipated to continue to increase with heightened demand for the Broadband segment’s VoIP and ADTV products offered in the Telecom segment service territory.  See the Broadband operating revenue section above for more detailed discussion of the Broadband revenues and product offerings.

 

Telecom Segment Operating Expenses

 

Total operating expenses for the Telecom segment decreased $673 and $2,251 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  As discussed in the Residential Revenue section above, during 2010 we experienced a decline in voice RGUs due in part to subscribers opting to initiate VoIP phone service offered by our Broadband segment.  As a result, certain of the operating costs associated with these subscribers are now included in the Broadband segment.  In addition, costs related to our Pension Plan decreased approximately $203 and $660 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009, as discussed in the consolidated overview section above.

 

Cost of services and products (exclusive of depreciation and amortization) decreased $801 and $2,556 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  Costs to support local and long distance services declined as a result of decreases in residential voice RGUs and business customers.  Additionally, in the current year periods, rent and utility costs have declined due to a consolidation of office space.  The decrease was offset in part by severance costs of approximately $299 incurred during the nine months ended September 30, 2010 related to the workforce reduction initiative, as discussed in the consolidated overview section above.

 

Customer operations expense increased $381 and $555 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The increase in the current year period was mostly attributable to an increase in advertising and promotion costs to support product offerings in the Telecom segment service territory.

 

General and administrative expense decreased $253 and $250 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The decrease in costs was due primarily to (i) a reduction in professional fees as a result of lower annual rates, (ii) the decline in pension plan costs discussed previously and (iii) lower information project support costs in the current year.  The decrease was offset in part by employee severance costs of approximately $483 incurred during the nine months ended September 30, 2010 related to the workforce reduction initiative, as discussed in the consolidated overview section above.

 

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Table of Contents

 

Regulatory Matters

 

Revenues subject to regulation, which include such telecommunications services as local telephone service, network access service and toll service, are derived from various sources, including:

 

·                  business and residential subscribers of basic exchange services;

·                  surcharges mandated by state commissions;

·                  long distance carriers, for network access service;

·                  competitive access providers and commercial enterprises for network access service;

·                  interstate pool settlements from NECA;

·                  support payments from federal or state programs; and

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

 

Certain of our interstate telecommunications service rates are subject to regulation by the Federal Communications Commission (“FCC”). Interstate switched and special access rates are established through a SureWest Telephone tariff filed with the FCC.  For interstate CL charges, SureWest Telephone concurs with tariffs filed by NECA.  Intrastate service rates are subject to regulation by state commissions.  Prices for intrastate telecommunications services are established through tariffs or through other regulatory mechanisms, including, in California, service guides.  Pending and future regulatory actions may have a material impact on our consolidated financial position and results of operations.

 

FCC Matters

 

Under current FCC rules governing rate making, SureWest Telephone is required to establish rates for its interstate telecommunications services based on projected demand usage for the various services.  SureWest Telephone projects its earnings through the use of annual cost separation studies, which utilize estimated total cost information and projected demand usage. Carriers are required to follow FCC rules in the preparation of these annual studies.  SureWest Telephone determines actual earnings from its interstate rates as actual volumes and costs become known.  The FCC monitors SureWest Telephone’s interstate earnings.

 

As a result of periodic cost separation studies required by the FCC, SureWest Telephone changed its estimates for certain NECA CL accounts receivable balances related to the current and prior year monitoring periods.  During the quarter and nine-month period ended September 30, 2009, these changes in estimates decreased our consolidated revenues and income from continuing operations by $583 and $562 and net income by $335 ($0.02 per share) and $323 ($0.02 per share), respectively.  We did not record any significant changes in estimates during the quarter and nine-month period ended September 30, 2010.

 

The FCC was directed by Congress to develop a National Broadband Plan (“NBP”) as part of the American Recovery and Reinvestment Act of 2009.  In March 2010, after taking extensive public comment, the FCC released the full text of its NBP, which contains policy recommendations on a variety of issues that the FCC has linked to expanded broadband deployment.  The policy recommendations include guiding principles to foster competition in broadband, telephone, wireless and cable services over the next decade, including recommendations related to universal service fund (“USF”) reform, intercarrier compensation, cable set-top boxes and spectrum reallocation, among others.  The NBP recommendations most relevant to the Company include shifting the current USF mechanisms that support universal voice telephone services to support of universal broadband deployment and the phased reduction of intercarrier access compensation levels to local reciprocal compensation levels, with a potential phase-out of all such compensation within ten years.  Some of these recommendations only restate pre-existing FCC proposals in current rulemakings while others raise new issues.  The FCC did not actually take action on any issue in the NBP itself. Approximately half of these issues will require separate FCC rulemaking action and the remainder consists of policy recommendations for action by Congress or other governmental entities.  The FCC is already beginning some separate proceedings.  Most recently, in response to a recent Federal Appeals Court decision which found that the FCC lacked authority over certain Internet-related practices of Comcast, the FCC opened proceedings to reassess the nature of Internet-related activities of Internet providers and to consider rules related to such activities.  Among other things, the FCC indicated it will consider possible redefinition of some forms of Internet “connectivity” which could make these activities subject to new regulation under Title II of the Act.  The FCC’s actions in these proceedings could lead to new rules and a significant increase in government regulation.  These proceedings are also creating significant new regulatory uncertainties for participants across the Internet sector. Action to deal with this and other issues addressed by the NBP may have a material impact on us.  We will continue to monitor these matters and their potential impact on our consolidated financial position and results of operations.

 

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Table of Contents

 

California Public Utility Commission (“CPUC”) Matters

 

In 2004, we entered into a settlement agreement (the “Settlement Agreement”), which was ultimately approved by the CPUC, to resolve an ongoing regulatory proceeding with various parties.  The Settlement Agreement resolved past sharing liabilities and suspended future sharing requirements in the intrastate jurisdiction.  In accordance with the Settlement Agreement, SureWest Telephone returned approximately $6,500, plus interest, to its end-users through a consumer dividend.  The surcredit was recorded as a reduction of our contractual shareable earnings obligations over a period of approximately four years, which began January 1, 2005.  During the first quarter of 2009 and prior to the cessation of the surcredit on February 9, 2009, we returned approximately $165.

 

As part of the Settlement Agreement, SureWest Telephone was required to implement an additional annual consumer dividend of $1,300 on January 1, 2007 to end-users receiving SureWest Telephone services subject to sharing on or after that date.  In December 2006, the CPUC authorized us to offset our annual $11,500 interim draw from the CHCF with the aforementioned $1,300 consumer dividend Settlement Agreement.  The CHCF was previously authorized by the CPUC on an interim basis to offset certain of SureWest Telephone’s intrastate regulated operating expenses that previously had been recovered through direct carrier payments. In September 2007, the CPUC issued Decision 07-09-002 which provides for SureWest Telephone to phase-down its annual CHCF interim draw over a five-year period, to end on January 1, 2012.  In 2009, our interim CHCF draw was $6,120 and is being incrementally reduced by $2,040 annually.  We anticipate our 2010 interim CHCF draw will be $4,080, of which through September 30 we have received $3,060.

 

In an ongoing proceeding relating to the New Regulatory Framework (under which SureWest Telephone has been regulated since 1996), the CPUC adopted Decision 06-08-030 in 2006, which grants carriers broader pricing freedom in the provision of telecommunications services, bundling of services, promotions and customer contracts.  This decision adopted a new regulatory framework, the Uniform Regulatory Framework (“URF”), which among other things (i) eliminates price regulation and allows full pricing flexibility for all new and retail services except basic residential services, which limits increases to $3.25 per year during 2009 and 2010, (ii) allows new forms of bundles and promotional packages of telecommunication services, (iii) allocates all gains and losses from the sale of assets to shareholders and (iv) eliminates almost all elements of rate of return regulation, including the calculation of shareable earnings.  Beginning January 1, 2011, the URF Incumbent Local Exchange Carriers will be allowed full pricing flexibility for the basic residential rate.

 

Other Regulatory Matters

 

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

 

Non-Operating Items

 

Other Income and Expense, Net

 

Consolidated interest expense decreased $735 and $2,213 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009, primarily due to a decrease in long-term debt.  A decline in interest rates on our outstanding debt subject to London Interbank Offered Rates also contributed to the reduction in interest expense.

 

We received a patronage dividend of $979 and $963 during the quarters ended March 31, 2010 and 2009, respectively. We earn patronage dividends from CoBank, ACB (“CoBank”) based on our share of the net income earned by CoBank.  We record the receipt of the patronage dividends against interest expense.

 

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Income Taxes

 

Income taxes increased $1,314 and $828 during the quarter and nine-month period ended September 30, 2010, respectively, compared to the same periods in 2009.  The increase in income taxes in the current year periods was due primarily to an increase in income before income taxes.  The effective federal income tax rates for continuing operations were 62.5% and 66.4% for the nine-month periods ended September 30, 2010 and 2009, respectively.  The decrease in the effective tax rate in the current year compared to the same period in 2009 was due primarily to deferred permanent differences resulting from the decrease between the grant and vesting prices of restricted common stock and restricted common stock units that vested and state income tax related to apportionment changes.  Changes in state apportionment factors, based on operational results, may affect our future effective tax rates.

 

Liquidity and Capital Resources

 

Overview

 

We generate significant cash flows from operating activities.  We believe that we will be able to meet our current and long-term liquidity and capital requirements through our cash flow from operating activities, existing cash, cash equivalents and investments; through available borrowings under our existing credit facilities; and through our ability to obtain future external financing.  Our primary use of cash in 2010 has been for capital expenditures and scheduled payments of long-term debt (including interest). We anticipate continuing to use a substantial portion of our cash flow to fund our capital expenditures, invest in new business opportunities, fund network expansion, meet scheduled payments of long-term debt and fund the share repurchase plan.

 

The following table summarizes our cash flows:

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

$ Change

 

Cash Flows Provided By (Used In)

 

 

 

 

 

 

 

Operating Activities:

 

 

 

 

 

 

 

Continuing operations

 

$

46,509

 

$

52,571

 

$

(6,062

)

Discontinued operations

 

 

(514

)

514

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

 

Continuing operations

 

(33,874

)

(31,591

)

(2,283

)

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

 

Continuing operations

 

(16,909

)

(16,168

)

(741

)

Increase (Decrease) in Cash and Cash Equivalents

 

$

(4,274

)

$

4,298

 

$

(8,572

)

 

Cash Flows Provided By Operating Activities

 

Net cash provided by continuing operating activities was $46,509 during the nine-month period ended September 30, 2010.  Significant adjustments to net income to arrive at cash provided by operating activities primarily include non-cash charges of $48,259 consisting primarily of (i) depreciation and amortization of $46,048 due to capital investments principally in the Broadband segment and (ii) stock compensation expense of $2,211. Cash provided by operating activities was offset in part by a decrease in (i) accrued compensation of $1,702 related in part to the payment in the current year of 2009 incentive compensation and (ii) accrued liabilities of $2,546 related to the timing of various expenditures in the current year.

 

Cash Flows Used In Investing Activities

 

Net cash used in continuing investing activities was $33,874 during the nine-month period ended September 30, 2010 and was primarily related to capital expenditures that were partially offset by proceeds from the sale of our auction rate security (“ARS”).

 

Capital Expenditures

 

Capital expenditures of $39,271 continue to be our primary recurring investing activity in the nine-month period ended September 30, 2010. A significant portion of our capital spending has been invested into success based capital projects within our Broadband segment in an effort to increase our residential RGUs and business customers.

 

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Proceeds from Sale of Discontinued Operations

 

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

 

Auction Rate Security

 

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

 

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

 

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

 

Cash Flows Provided By Financing Activities

 

Net cash used in financing activities consists primarily of our proceeds and principal payments on long-term borrowings and planned repurchases of our common stock.

 

Long-term Debt

 

On January 29, 2010, we entered into a letter agreement with CoBank amending certain terms of the Third Amended and Restated Credit Agreement (“Credit Agreement”). The Credit Agreement included a provision which required permanent reductions of the Revolving Loan facility of $7,500 at December 31, 2009 and 2010. The letter agreement amended those provisions and included (i) an increase in the total Revolving Loan facility of $7,500, (ii) CoBank’s share of the Revolving Loan facility will be permanently reduced by $5,000 (rather than $7,500) on December 31, 2010 and (iii) the total Revolving Loan facility will be $57,500.  As a result of this letter agreement, our combined revolving commitment balance on our Revolving Loan and Swingline Loan facilities was $60,000 and our available balance as of September 30, 2010, which is less our outstanding balance of $8,500, was approximately $51,500.

 

As of September 30, 2010, $14,545 and $36,000 were outstanding on the Series A and Series B Senior Notes, respectively. As of September 30, 2010, $120,000, $30,000, $8,500 and zero were outstanding on the CoBank Term Loan A, Term Loan B, Revolving Loan and Swingline Loan facilities, respectively. We had no short-term borrowings as of September 30, 2010.

 

Debt Covenants

 

Our Series A and Series B Senior Notes and the Credit Agreement contain financial and operating covenants that may restrict, among other things, the repurchase of the Company’s common stock, the payment of dividends, the making of certain other restricted payments and the incurrence of additional indebtedness. The covenants also require us to maintain certain financial ratios and minimum levels of tangible net worth. If we fail to comply with the covenants and other restrictions, such as making timely interest or principal payments, it could lead to an event of default and the acceleration of our obligations under those agreements. As of September 30, 2010, we were in compliance with all of our debt covenants.

 

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

 

Financial Covenant

 

Required Ratio Level

 

Actual Performance at 
September 30, 2010

 

Leverage ratio

 

Not more than 3.75

 

2.7

 

Interest coverage ratio

 

Not less than 3.00

 

8.5

 

Consolidated net worth

 

Not less than $160,000

 

$269,638

 

Debt to capitalization

 

Not more than 0.55

 

0.44

 

 

At September 30, 2010 and December 31, 2009, retained earnings of $109,638 and $109,183, respectively, were available for the payments described above.

 

Share Repurchase Program

 

In September 2010, our Board of Directors authorized the repurchase of up to an additional 1 million shares of our common stock, supplementing the previously authorized share repurchase program.  The share repurchase program was originally approved in February 2000, and expanded in June 2002 and November 2006.  This additional authorization increases the total number of shares available for repurchase under the program to 3.5 million.  Shares are purchased from time to time in the open market or through privately negotiated transactions, subject to overall financial and market conditions. As of September 30, 2010, under the share repurchase program approximately 2.3 million shares of common stock have been repurchased and approximately 1.2 million additional outstanding shares remain authorized for repurchase by the Board of Directors.

 

We repurchased approximately 55 thousand and 413 thousand shares during the quarter and nine-month period ended September 30, 2010, respectively, and 108 thousand shares during the nine months ended September 30, 2009 (none during the quarter ended September 30, 2009).  Approximately 42 thousand shares of our shares repurchased in September 2010 did not settle until October 2010.  The purchase of common shares did not have a substantive effect on the average number of common shares outstanding or the calculation of basic and diluted earnings per share for the quarters or nine-month periods ended September 30, 2010 or 2009.

 

Sufficiency of Cash Resources

 

We had cash, cash equivalents and short-term investments at September 30, 2010 of $3,905.  As discussed in the Long-term debt section above, we have additional long-term borrowing capacity of approximately $60,000 available to us through our Revolving Loan facility; of which, $8,500 was outstanding as of September 30, 2010.  We believe our operating cash flows and our borrowing capacity are sufficient to satisfy our liquidity requirements for the next twelve months, while maintaining adequate cash and cash equivalents.

 

Our most significant use of funds in the remainder of 2010 is expected to be for (i) budgeted capital expenditures of up to approximately $15,000, (ii) scheduled payments of long-term debt of $3,636 and (iii) anticipated interest payments of $2,609. As discussed above, throughout the year we may repurchase shares of the Company’s common stock in the open market at the prevailing market price up to an amount authorized by the Board of Directors.

 

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

 

Defined Benefit Pension Plan

 

As required, we contribute to the Pension Plan, Supplemental Executive Retirement Plan and certain post-retirement benefits other than pensions (“Other Benefits Plan”) (collectively the “Plans”), which provide retirement benefits to certain eligible employees. Contributions are intended to provide for benefits attributed to service to date. Our funding policy is to contribute annually an actuarially determined amount consistent with applicable federal income tax regulations. We stopped accruing benefits for active participants effective April 1, 2007 and we anticipate that future funding requirements will decrease significantly as a result of the freeze of the Plans.  However, the significant decline in the equity markets precipitated by the recent credit crisis and financial system instability has negatively affected the value of our Pension Plan assets.  Our minimum funding requirement for 2010 related to the Pension Plan

 

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is $2,620; however, due to a carryover credit balance of $4,461, no cash contribution will be required.  We will continue to evaluate the future funding requirements of the Plans and fund them as necessary. See Note 7 for a more detailed discussion regarding our Pension Plan and Other Benefits Plan.

 

Income Taxes

 

The timing of cash payments for income taxes, which is governed by the Internal Revenue Service and other taxing jurisdictions, will differ from the timing of recording tax expense and deferred income taxes, which are reported in accordance with GAAP. For example, tax laws currently in effect for 2010 regarding accelerated or “bonus” depreciation for tax reporting may result in less cash payments than the GAAP tax expense on continuing and discontinued operations. Acceleration of tax deductions could eventually result in situations where cash payments will exceed GAAP tax expense. Changes in tax laws create uncertainty as to when or if this situation will occur within the next three years.

 

Our deferred tax assets are expected to be realized through the reversal of deferred tax liabilities and through the generation of future taxable income from ordinary and recurring operations. Deferred tax assets that are dependent on specific business segments generating future taxable income were determined to be more likely than not to be realized since those segments have at least 10 years in which to generate the estimated required taxable income. Approximately $1,500 of future taxable income is estimated to be required to realize these deferred tax assets.

 

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

 

Regulatory Matters

 

As discussed more fully in the Regulatory Matters section above, the CPUC issued a final decision which will phase down our annual CHCF interim draw by approximately $2,040 annually, over a 5-year period ending on January 1, 2012.  In addition, SureWest Telephone’s intrastate access element, the transport interconnection charge (“TIC”), will be eliminated effective January 1, 2011 in accordance with previous CPUC final decisions.  We anticipate a reduction in our 2011 intrastate access revenues of approximately $2,025 when the TIC is eliminated. SureWest Telephone will have an opportunity to recover all or part of the lost TIC revenue elsewhere, including residential rate adjustments.

 

Critical Accounting Estimates

 

Our condensed consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Our judgments are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making estimates about the carrying values of assets and liabilities that are not readily apparent from other sources. For a full discussion of our accounting estimates and assumptions that we have identified as critical in the preparation of our condensed consolidated financial statements, refer to our 2009 Annual Report on Form 10-K.

 

As discussed more fully in Note 1 of the condensed consolidated financial statements, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, Intangibles-Goodwill and Other (“ASC 350”) (formerly Statement of Financial Accounting Standards No. 142, Goodwill and other Intangible Assets), goodwill is reviewed for impairment annually or more frequently if an event occurs or circumstances change that would reduce the fair value below its carrying value.

 

The impairment test for goodwill requires us to estimate the fair value at the reporting unit level. Our goodwill is allocated to the Telephone reporting unit and the Kansas City operations reporting unit. The Telecom segment includes the Telephone reporting unit.  The Broadband segment includes the Kansas City operations reporting unit. At June 30, 2010 and September 30, 2010, the goodwill allocated to the Telephone reporting unit and the Kansas City operations reporting unit was $2,171 and $43,643, respectively. As a result of declines in the market price of the Company’s common stock during the quarter ended June 30, 2010, we concluded that this was an indicator of potential impairment of goodwill and performed an interim goodwill impairment test as of June 30, 2010 on the goodwill recorded at the Kansas City operations reporting unit.

 

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At June 30, 2010 and September 30 2010, the carrying value of the Kansas City operations reporting unit included $43,643 of goodwill.  For the Kansas City operations reporting unit, the estimated fair value of the reporting unit is determined using a combination of a discounted cash flow (“DCF”) model and a market based approach. The assumptions used in the estimate of fair value are based upon a combination of historical results and trends, new industry developments, future cash flow projections, as well as relevant comparable company earnings multiples for the market based approach. Such assumptions are subject to change as a result of changing economic and competitive conditions.  We use a weighted average of the various models to estimate the fair value of the Kansas City operating reporting unit.  At June 30, 2010, we performed a valuation to determine the fair value of our goodwill using a DCF model. Assumptions used in this model include the following:

 

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

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

·      a 4% terminal growth rate.

 

When determining the fair value of the reporting units, the use of different estimates or assumptions within the DCF model or other market based approaches could result in a different fair value. For example, in our DCF model we used a discount rate of 14% and a terminal growth rate of 4% in our assessment of fair value in 2010.  At June 30, 2010, the fair value of the Kansas City operating unit was $225,000 and the associated carrying value was $200,000. If the discount rate in our DCF model were to increase 2%, the fair value of $225,000 would decrease by approximately $19,000, which would not result in an impairment of goodwill recorded at the Kansas City operations reporting unit, assuming there are no changes to the market-based approaches used in the valuation. Assuming the discount rate in our DCF model was to increase 2% and the market-based valuation approaches decreased by 5%, the fair value of $225,000 would decrease by approximately $25,000, and would equal the June 30, 2010 carrying value. As discussed above, the other market-based approaches are subject to change as a result of changing economic and competitive conditions. Negative changes relating to the Kansas City operations could result in a potential impairment of goodwill recorded at the Kansas City operations reporting unit.

 

At September 30, 2010, we reviewed the various inputs and assumptions applied in our June 30, 2010 interim impairment test of the goodwill recorded at the Kansas City operations reporting unit to determine if any significant changes occurred during the quarter ended September 30, 2010 that would impact the June 30, 2010 results.  Based on this review, we have concluded that the goodwill was not impaired as of September 30, 2010.  We will perform our annual goodwill impairment test as of November 30, 2010.

 

Recent Accounting Pronouncements

 

Recently Issued Accounting Pronouncements

 

In July 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-20, Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”). ASU 2010-20 requires entities to provide additional disclosures concerning financing receivables and allowance for credit losses.  Specifically, the new disclosures include (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) the factors considered in analyzing such risk in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Public entities are required to adopt the provisions of ASU 2010-20 related to disclosures of financing receivables as of the end of a reporting period for interim or annual reporting periods ending on or after December 15, 2010.  The financing receivables disclosures related to activity that occurs during a reporting period are effective for interim or annual reporting periods beginning on or after December 15, 2010.  We are currently evaluating the impact this update will have on our condensed consolidated financial statements.

 

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”).  ASU 2009-13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit and modifies the manner in which the transaction consideration is allocated across the separately identified deliverables.  ASU 2009-13 significantly expands the disclosure requirements for multiple-deliverable revenue arrangements.  ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, and may be applied retrospectively for all periods presented or prospectively to

 

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arrangements entered into or materially modified after the adoption date.  Early adoption is permitted, provided that the guidance is retroactively applied to the beginning of the year of adoption. We are currently evaluating the impact this update will have on our condensed consolidated financial statements.

 

Recently Adopted Accounting Pronouncements

 

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855) — Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”). ASU 2010-09 amends ASC Topic 855 to remove the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated both in issued and revised financial statements.  ASU 2010-09 was effective immediately.  Our adoption of this guidance had no impact on our condensed consolidated financial position and results of operations.

 

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements (“ASU 2010-06”).  ASU 2010-06 amends ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”) to require additional disclosures regarding fair value measurements. Specifically, ASU 2010-06 requires entities to disclose additional information regarding (i) the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis, (ii) the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers and (iii) the reasons for any transfers in or out of Level 3. In addition to these new disclosure requirements, ASU 2010-06 also amends ASC 820 to further clarify existing guidance pertaining to the level of disaggregation at which fair value disclosures should be made and the requirements to disclose information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. Our adoption of the requirements of this guidance on January 1, 2010, except for the requirement to separately disclose information about purchases, sales, issuances, and settlements in the reconciliation of recurring Level 3 measurements on a gross basis which becomes effective for fiscal years (and interim periods within those fiscal years) beginning after December 15, 2010, did not have a material impact on our condensed consolidated financial position or results of operations.

 

Regulatory and Legal Matters

 

Significant portions of our telecommunication rates and charges are subject to regulation by the FCC and state commissions.  Many of these rates and charges are based on various tariffs or service guides filed by SureWest and others, including those filed by the NECA for CL charges.  Pending and future regulatory actions, with respect to these and other matters and the filing of new or amended tariffs, may have a material impact on our consolidated financial position and results of operations.  In addition, the emergence of a range of products and services that operate partially or entirely outside traditional regulatory frameworks but that compete with regulated service offerings has created new challenges for both us and the regulators.

 

Our consolidated financial condition and results of operations have been and will be affected by recent and future proceedings before the state commissions and FCC. Pending before the FCC and state commissions are proceedings that, among other things, are considering:

 

·                              additional rules governing the opening of markets to competition and the regulation of the competing telecommunications providers;

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

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

·                              rules that will provide non-discriminatory access by competing service providers to the network capabilities of local exchange carriers; and

·                              the regulated rates and earnings of SureWest Telephone.

 

There are a number of pending and anticipated other regulatory proceedings occurring at the federal and state levels that may have a material impact on SureWest Telephone and also on subsidiaries in the Broadband segment. These regulatory proceedings also include newer issues, such as consideration of broadband deployment and regulation of IP-enabled services. The outcomes and impact of these proceedings and related court matters on the Telecom segment, the Broadband segment and the Company as a whole cannot be determined at this time.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

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

 

ITEM 4.  CONTROLS AND PROCEDURES.

 

Evaluation of disclosure controls and procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon, and as of the date of this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective, at the reasonable assurance level, to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act is authorized, recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

 

In the second quarter of 2010, we reduced our workforce by approximately 60 positions, including open and unfilled positions.  The affected positions were comprised of a range of levels across the Company, including Bill M. DeMuth, Senior Vice President and Chief Technology Officer, who left the Company on June 30, 2010 pursuant to a Severance Agreement.  The responsibilities of the affected employees were assumed by remaining employees and management, as deemed necessary.  Based on our interim control testing and management’s continual assessment of our internal control environment to date, the changes to our employee base and management team have not adversely impacted our internal controls or control environment, however we will continue to monitor our internal controls for any adverse impacts.

 

There has been no change in our internal control over financial reporting during the quarter and nine-month period ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our control over financial reporting.  However, beginning in the second quarter of 2010, we commenced certain strategic projects to move our cash management services from our existing financial institutions to two new financial institutions. The movement of these services will likely be completed in 2010.  As part of these projects, management will be evaluating our internal controls over financial reporting after the completion of all of the cash management changes.

 

Limitations on the effectiveness of controls

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to our management, Board of Directors and Audit Committee regarding the reliability of financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.

 

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PART II —OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS.

 

Refer to Notes 5 and 9 to our condensed consolidated financial statements of the Quarterly Report on Form 10-Q for a discussion of recent developments related to our regulatory and legal proceedings.

 

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

 

July 1, 2010 - July 31, 2010

 

 

$

 

2,246,863

 

253,137

 

August 1, 2010 - August 31, 2010

 

 

$

 

2,246,863

 

253,137

 

September 1, 2010 - September 30, 2010 (1) (2)

 

54,870

 

$

7.07

 

2,301,733

 

1,198,267

 

 


(1)        As discussed in Part 1, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, in September 2010 the Company’s Board of Directors authorized the repurchase of up to an additional one million shares, supplementing the previously authorized share repurchase program.

(2)        Approximately 42 thousand shares repurchased in September 2010 did not settle until October 2010.

 

ITEM 6EXHIBITS.

 

(a)          Index to Exhibits.

 

Exhibit
No.

 

Description

 

Method
of Filing

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

 

 

SUREWEST COMMUNICATIONS

 

(Registrant)

 

 

 

 

 

By:

/s/ STEVEN C. OLDHAM

 

 

Steven C. Oldham,

 

 

President and Chief

 

 

Executive Officer

 

 

 

 

 

 

 

By:

/s/ DAN T. BESSEY

 

 

Dan T. Bessey,

 

 

Vice President and

 

 

Chief Financial Officer

 

 

 

Date: October 28, 2010

 

 

 

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