-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ISmvrXsmzSltN14VLjbZv3cnXJccmI1VukVcFtqCHwn19XsOT5eKQlhaUTiHNO7J 4tu9LU3Kq/joev5S88ElIw== 0001104659-07-059650.txt : 20070807 0001104659-07-059650.hdr.sgml : 20070807 20070807152535 ACCESSION NUMBER: 0001104659-07-059650 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20070630 FILED AS OF DATE: 20070807 DATE AS OF CHANGE: 20070807 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUREWEST COMMUNICATIONS CENTRAL INDEX KEY: 0000943117 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 680365195 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-29660 FILM NUMBER: 071031412 BUSINESS ADDRESS: STREET 1: 211 LINCOLN ST CITY: ROSEVILLE STATE: CA ZIP: 95678-0969 BUSINESS PHONE: 9167861407 MAIL ADDRESS: STREET 1: 211 LINCOLN ST CITY: ROSEVILLE STATE: CA ZIP: 95678-0969 FORMER COMPANY: FORMER CONFORMED NAME: ROSEVILLE COMMUNICATIONS CO DATE OF NAME CHANGE: 19960827 FORMER COMPANY: FORMER CONFORMED NAME: ROSEVILLE COMTECH DATE OF NAME CHANGE: 19950328 10-Q 1 a07-19126_110q.htm 10-Q

 

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 June 30, 2007

 

or

 

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

 

Commission File Number 0-556

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.)

 

200 Vernon Street, Roseville, California

 

95678

(Address of principal executive offices)

 

(Zip Code)

 

(916) 786-6141

(Registrant’s telephone number, including area code)

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

Large accelerated filer  o

Accelerated filer  x

Non-accelerated filer  o

 

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

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

As of July 30, 2007, 14,465,709 shares of the registrant’s Common Stock were outstanding.

 







PART 1 – FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS.

SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

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

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Operating revenues:

 

 

 

 

 

 

 

 

 

Telecom

 

$

27,249

 

$

28,196

 

$

53,610

 

$

55,296

 

Broadband

 

17,069

 

15,024

 

33,491

 

28,906

 

Wireless

 

8,115

 

8,144

 

16,316

 

16,538

 

Total operating revenues

 

52,433

 

51,364

 

103,417

 

100,740

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

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

 

17,685

 

17,301

 

36,435

 

34,974

 

Customer operations and selling

 

8,355

 

8,276

 

17,230

 

16,847

 

General and administrative

 

9,696

 

8,816

 

18,277

 

16,835

 

Depreciation and amortization

 

14,275

 

15,007

 

28,063

 

29,470

 

Total operating expenses

 

50,011

 

49,400

 

100,005

 

98,126

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

2,422

 

1,964

 

3,412

 

2,614

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

1,157

 

109

 

1,662

 

179

 

Interest expense

 

(1,699

)

(1,715

)

(3,099

)

(3,308

)

Other, net

 

(69

)

(271

)

(273

)

(379

)

Total other income (expense), net

 

(611

)

(1,877

)

(1,710

)

(3,508

)

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

1,811

 

87

 

1,702

 

(894

)

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit)

 

26

 

(4

)

(136

)

(425

)

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

1,785

 

91

 

1,838

 

(469

)

 

 

 

 

 

 

 

 

 

 

Discontinued operations, net of tax:

 

 

 

 

 

 

 

 

 

Income from discontinued operations

 

 

1,313

 

999

 

3,072

 

Gain (loss) on sale of discontinued operations

 

(279

)

 

59,902

 

 

Total discontinued operations

 

(279

)

1,313

 

60,901

 

3,072

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

1,506

 

$

1,404

 

$

62,739

 

$

2,603

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per common share:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

0.12

 

$

0.01

 

$

0.13

 

$

(0.03

)

Discontinued operations, net of tax

 

(0.02

)

0.09

 

4.22

 

0.21

 

Net income per basic common share

 

$

0.10

 

$

0.10

 

$

4.35

 

$

0.18

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings (loss) per common share:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

0.12

 

$

0.01

 

$

0.13

 

$

(0.03

)

Discontinued operations, net of tax

 

(0.02

)

0.09

 

4.20

 

0.21

 

Net income per diluted common share

 

$

0.10

 

$

0.10

 

$

4.33

 

$

0.18

 

 

 

 

 

 

 

 

 

 

 

Dividends per share

 

$

0.25

 

$

0.25

 

$

0.50

 

$

0.50

 

 

 

 

 

 

 

 

 

 

 

Shares of common stock used to calculate earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

14,440

 

14,578

 

14,432

 

14,578

 

Diluted

 

14,490

 

14,609

 

14,484

 

14,578

 

 

See accompanying notes.

1




SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; Amounts in thousands)

 

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

36,913

 

$

6,371

 

Short-term investments

 

30,522

 

695

 

Accounts receivable, net

 

22,858

 

22,014

 

Inventories

 

5,358

 

5,348

 

Prepaid expenses

 

4,689

 

4,275

 

Deferred income taxes

 

5,335

 

7,285

 

Assets of discontinued operations

 

 

6,132

 

Total current assets

 

105,675

 

52,120

 

 

 

 

 

 

 

Property, plant and equipment, net

 

370,794

 

376,364

 

 

 

 

 

 

 

Intangible and other assets:

 

 

 

 

 

Wireless licenses, net

 

13,566

 

13,566

 

Goodwill

 

2,171

 

2,171

 

Deferred charges and other assets

 

1,466

 

1,529

 

 

 

17,203

 

17,266

 

 

 

$

493,672

 

$

445,750

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt and capital lease obligations

 

$

3,642

 

$

3,642

 

Accounts payable

 

2,920

 

3,069

 

Other accrued liabilities

 

18,966

 

21,736

 

Current portion of contractual shareable earnings obligations

 

1,734

 

1,707

 

Advance billings and deferred revenues

 

9,459

 

9,374

 

Accrued income taxes

 

 

345

 

Accrued compensation and pension benefits

 

6,780

 

5,382

 

Liabilities of discontinued operations

 

 

298

 

Total current liabilities

 

43,501

 

45,553

 

 

 

 

 

 

 

Long-term debt and capital lease obligations

 

121,828

 

121,831

 

Long-term contractual shareable earnings obligations

 

742

 

1,891

 

Deferred income taxes

 

31,880

 

36,777

 

Other liabilities and deferred revenues

 

13,745

 

13,922

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, without par value; 100,000 shares authorized, 14,466 and 14,465 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively

 

158,618

 

157,926

 

Accumulated other comprehensive income

 

611

 

565

 

Retained earnings

 

122,747

 

67,285

 

Total shareholders’ equity

 

281,976

 

225,776

 

 

 

$

493,672

 

$

445,750

 

 

See accompanying notes.

2




SUREWEST COMMUNICATIONS

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; Amounts in thousands)

 

 

Six Months Ended June 30,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Net cash provided by continuing operations

 

$

22,394

 

$

26,475

 

Net cash (used in) provided by discontinued operations

 

(42,486

)

4,944

 

Net cash (used in) provided by operating activities

 

(20,092

)

31,419

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from sale of discontinued operations

 

110,123

 

 

Capital expenditures for property, plant and equipment

 

(22,503

)

(24,647

)

Purchases of held-to-maturity investments

 

(121,275

)

 

Maturities of held-to-maturity investments

 

91,525

 

 

Net cash provided by (used in) investing activities

 

57,870

 

(24,647

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

 

40,000

 

Increase in short-term borrowings

 

 

(30,000

)

Principal payments of long-term debt and capital lease obligations

 

(3

)

(24

)

Dividends paid

 

(7,233

)

(7,315

)

Other, net

 

 

1

 

Net cash (used in) provided by financing activities

 

(7,236

)

2,662

 

 

 

 

 

 

 

Increase in cash and cash equivalents

 

30,542

 

9,434

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

6,371

 

7,633

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

36,913

 

$

17,067

 

 

See accompanying notes.

3




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”) is a holding company with wholly-owned subsidiaries that provide communications services in Northern California. The Company’s operating subsidiaries are SureWest Telephone, SureWest Long Distance, SureWest Broadband, SureWest TeleVideo, SureWest TeleVideo of Roseville, SureWest Internet, SureWest Custom Data Services and SureWest Wireless. As discussed in Note 2 below, in February 2007 the Company sold its wholly-owned subsidiary SureWest Directories. Accordingly, the financial results of SureWest Directories have been reported as discontinued operations for all periods presented in accordance with 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 reflect historical amounts exclusive of discontinued operations, unless otherwise noted. The Company expects that the sources of its revenues and its cost structure may be different in future periods, both as a result of its entry into new communications markets and competitive forces in each of the markets in which the Company has operations.

In the opinion of management, the accompanying condensed consolidated balance sheets and related interim statements of income 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”) 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. 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 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 the Company’s 2006 Annual Report on Form 10-K filed with the SEC.

Statements of Cash Flows Information

During the six months ended June 30, 2007, the Company made income tax payments of $44,970. No income tax payments were made during the six months ended June 30, 2006. The increase in income taxes paid (and corresponding decrease in net cash provided by operating activities) was due to an increase in estimated income tax payments primarily as a result of the gain on the sale of SureWest Directories, as discussed in Note 2 below.

Stock-based Compensation

Stock Plans

The Company has two Equity Incentive Plans (the “Stock Plans”) for certain employees, outside directors and consultants of the Company, which were approved by shareholders. The Company authorized for future issuance under the Stock Plans approximately 1.7 million shares (subject to upward adjustment based upon the Company’s issued and outstanding shares) of authorized, but unissued, common stock. The Stock Plans permit issuance by the Company of awards in the form of restricted common stock (“RSAs”), restricted common stock units (“RSUs”), performance shares, stock options and stock appreciation rights. 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 of the grant. The term of any stock option shall not exceed 10 years.

Adoption of Statement of Financial Accounting Standards No. 123(R)

Effective January 2006, the Company adopted SFAS No. 123(R), Share-Based Payment, using the modified-prospective-transition method. Since the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation and SFAS No. 123(R) were materially consistent under the Company’s Stock Plans, the adoption of SFAS No. 123(R) did not have a significant impact on the Company’s financial position or results of operations.

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

4




Restricted Common Stock Awards and Units

The following table summarizes the RSAs and RSUs granted to certain eligible participants during the quarters and six-month periods ended June 30, 2007 and 2006:

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

Grant Date

 

 

 

2007

 

Fair Value

 

2006

 

Fair Value

 

2007

 

Fair Value

 

2006

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RSAs Granted

 

 

$

 

 

$

 

1,338

 

$

23.97

 

3,000

 

$

27.63

 

RSUs Granted

 

5,000

 

$

26.21

 

5,000

 

$

22.54

 

5,000

 

$

26.21

 

6,500

 

$

22.54 - 27.63

 

RSU Dividends

 

 

$

 

101

 

$

18.75 - 19.62

 

 

$

 

101

 

$

18.75 - 19.62

 

Total

 

5,000

 

 

 

5,101

 

 

 

6,338

 

 

 

9,601

 

 

 

 

Stock-based compensation expense for both RSAs and RSUs of $477 and $654 was recorded during the quarter and six-month period ended June 30, 2007, respectively. During the same prior year periods, the Company recorded stock-based compensation expense of $259 and $548, respectively.  RSAs and RSUs are amortized over their respective vesting periods, which range from immediate vesting to a five-year vesting period. In connection with the adoption of SFAS No. 123(R), the Company records stock-based compensation for RSAs and RSUs on a straight-line basis. The Company will continue to recognize stock-based compensation on RSAs and RSUs granted prior to 2006 using the graded vesting method. In accordance with the provisions of SFAS No. 123(R), the Company has estimated expected forfeitures based on historical experience and is recognizing compensation expense only for those RSAs and RSUs expected to vest.

The following table summarizes the RSAs activity during the six-month period ended June 30, 2007:

 

 

 

 

Weighted Average

 

Nonvested Shares

 

Shares

 

Grant Date Fair Value

 

 

 

 

 

 

 

Nonvested-January 1, 2007

 

125,467

 

$

27.00

 

Granted

 

6,338

 

$

25.74

 

Vested

 

(33,245

)

$

25.36

 

Forfeited

 

(224

)

$

30.55

 

Nonvested-June 30, 2007

 

98,336

 

$

26.79

 

 

As of June 30, 2007, total unrecognized compensation cost related to nonvested restricted stock was $1,373 and will be recognized over a weighted-average period of approximately three years. The total fair value of RSAs and RSUs vested during the six-month period ended June 30, 2007 was $843.

Stock Options Expense

The Company issues new shares of common stock upon exercise of stock options.  The following table summarizes stock option activity for the Company’s stock option plans for the six-month period ended June 30, 2007:

 

 

 

 

Weighted

 

Weighted

 

 

 

 

 

Average

 

Average

 

 

 

 

 

Exercise

 

Remaining

 

Options

 

Shares

 

Price

 

Contractual Life

 

 

 

 

 

 

 

 

 

Outstanding-January 1, 2007

 

383,714

 

$

40.28

 

 

 

Forfeited

 

(11,975

)

 

 

 

Outstanding-June 30, 2007

 

371,739

 

$

40.29

 

4

 

Vested or Expected to Vest at June 30, 2007

 

371,739

 

$

40.29

 

4

 

Exercisable at June 30, 2007

 

371,665

 

$

40.29

 

4

 

 

5




There were no stock options granted, exercised or expired during the six-month period ended June 30, 2007. In addition, there were no stock options with an exercise price below the market price of the Company’s stock at that date.

Per Share Amounts

Shares used in the computation of basic earnings per share are based on the weighted average number of unrestricted common stock shares, RSAs 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 unrestricted common stock shares, RSAs and RSUs outstanding, plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method, which includes outstanding unvested RSAs and RSUs, unless their inclusion would be anti-dilutive.

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

Change in Estimate

During the first quarter of 2007, the Company completed its triennial review of asset lives that evaluated the appropriateness of the estimated useful lives of its property, plant and equipment for all segments.  The evaluation considered the Company’s 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, 2007, the Company increased the estimated useful lives of certain of its customer premise equipment, circuit equipment, cable plant and towers primarily in the Broadband segment. The increase in asset lives primarily ranged between 1 to 4 years, although the change in estimated useful lives for towers was 8 years.  The Company’s revisions to its estimated useful lives have been supported by an assessment and report from an independent party with expertise in this area that found the revisions to be reasonable in light of the Company’s plan and useful life estimates in comparable businesses. During the quarter and six-month period ended June 30, 2007, this change in estimate decreased consolidated depreciation expense by $933 and $1,881 and increased consolidated net income by $640 ($0.04 per share) and $1,295 (0.09 per share), respectively.

Reclassifications

Certain amounts in the Company’s 2006 condensed consolidated financial statements have been reclassified to conform to the presentation of the Company’s 2007 condensed consolidated financial statements.

2.     DISCONTINUED OPERATIONS

In January 2007, the Company entered into a definitive agreement with GateHouse Media to sell SureWest Directories, its directory publishing business.  As part of the transaction, GateHouse Media became the publisher of the official directory of SureWest Telephone. The transaction was consummated on February 28, 2007.  Under the agreement, GateHouse Media acquired 100% of the stock of SureWest Directories for an aggregate cash purchase price of $110,123, resulting in a gain of $101,286, less estimated income taxes of $41,384.

The following table summarizes the financial information for SureWest Directories’ operations for the quarters and six-month periods ended June 30, 2007 and 2006:

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Directory advertising revenues

 

$

 

$

3,993

 

$

2,939

 

$

8,781

 

Income before income taxes

 

 

2,211

 

1,682

 

5,173

 

Income tax expense

 

 

898

 

683

 

2,101

 

Income from discontinued operations

 

$

 

$

1,313

 

$

999

 

$

3,072

 

 

6




3.     BUSINESS SEGMENTS

The Company has three reportable business segments: Telecommunications (“Telecom”), Broadband and Wireless. The Telecom segment includes SureWest Telephone and SureWest Long Distance, which provide landline telecommunications services, Digital Subscriber Line (“DSL”) service, long distance services and certain non-regulated services. SureWest Telephone, which is the principal operating subsidiary of the Telecom segment, provides local services, toll telephone services, network access services and certain non-regulated services.  SureWest Long Distance provides long distance services.

The Broadband segment provides various services, including: high-speed and dial-up Internet, digital video, voice, network access, toll telephone and managed services in the greater Sacramento area, principally to customers residing outside of SureWest Telephone’s service area. The Company offers high-speed Internet, digital video, voice and long distance phone service as a bundled package sometimes referred to as fiber-to-the-premise (“FTTP”). The Broadband segment includes the Company’s subsidiaries SureWest Broadband, SureWest TeleVideo, SureWest TeleVideo of Roseville, SureWest Internet, SureWest Custom Data Services; and a division of SureWest Telephone operating as a Competitive Local Exchange Carrier.

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

In accordance with the provisions of SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information, the Company has aggregated certain of its operating segments within the Telecom and Broadband segments because it believes that such operating segments share similar economic characteristics.

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 investment income associated with cash and investments held by Corporate Operations is included in the results of the operations of the Company’s segments. The Company evaluates the performance of its segments based on income (loss) from operations.

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

7




 

 

 

 

 

 

 

 

 

Corporate

 

Intercompany

 

 

 

 

 

Telecom

 

Broadband

 

Wireless

 

Operations

 

Eliminations

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of and for the three months ended June 30, 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

27,249

 

$

17,069

 

$

8,115

 

$

 

$

 

$

52,433

 

Intersegment revenues

 

5,918

 

475

 

781

 

 

(7,174

)

 

Operating expenses*

 

16,008

 

16,661

 

10,241

 

 

(7,174

)

35,736

 

Depreciation and amortization

 

5,678

 

5,431

 

3,166

 

 

 

14,275

 

Income (loss) from operations

 

11,481

 

(4,548

)

(4,511

)

 

 

2,422

 

Income (loss) from continuing operations

 

$

8,047

 

$

(3,435

)

$

(2,827

)

$

 

$

 

$

1,785

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of and for the three months ended June 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

28,196

 

$

15,024

 

$

8,144

 

$

 

$

 

$

51,364

 

Intersegment revenues

 

7,450

 

312

 

695

 

 

(8,457

)

 

Operating expenses*

 

16,950

 

16,327

 

9,573

 

 

(8,457

)

34,393

 

Depreciation and amortization

 

6,309

 

5,721

 

2,977

 

 

 

15,007

 

Income (loss) from operations

 

12,387

 

(6,712

)

(3,711

)

 

 

1,964

 

Income (loss) from continuing operations

 

$

7,286

 

$

(4,777

)

$

(2,418

)

$

 

$

 

$

91

 

 


*Exclusive of depreciation and amortization

 

 

 

 

 

 

 

 

Corporate

 

Intercompany

 

 

 

 

 

Telecom

 

Broadband

 

Wireless

 

Operations

 

Eliminations

 

Consolidated

 

As of and for the six months ended June 30, 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

53,610

 

$

33,491

 

$

16,316

 

$

 

$

 

$

103,417

 

Intersegment revenues

 

12,890

 

995

 

1,566

 

 

(15,451

)

 

Operating expenses*

 

32,439

 

34,439

 

20,515

 

 

(15,451

)

71,942

 

Depreciation and amortization

 

11,243

 

10,618

 

6,202

 

 

 

28,063

 

Income (loss) from operations

 

22,818

 

(10,571

)

(8,835

)

 

 

3,412

 

Income (loss) from continuing operations

 

$

15,025

 

$

(7,530

)

$

(5,657

)

$

 

$

 

$

1,838

 

Total assets

 

$

802,382

 

$

447,576

 

$

156,329

 

$

679,528

 

$

(1,592,143

)

$

493,672

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of and for the six months ended June 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues from external customers

 

$

55,296

 

$

28,906

 

$

16,538

 

$

 

$

 

$

100,740

 

Intersegment revenues

 

14,778

 

736

 

1,375

 

 

(16,889

)

 

Operating expenses*

 

33,968

 

32,998

 

18,579

 

 

(16,889

)

68,656

 

Depreciation and amortization

 

12,612

 

10,918

 

5,940

 

 

 

29,470

 

Income (loss) from operations

 

23,494

 

(14,274

)

(6,606

)

 

 

2,614

 

Income (loss) from continuing operations

 

$

13,747

 

$

(9,866

)

$

(4,350

)

$

 

$

 

$

(469

)

Total assets

 

$

695,859

 

$

352,920

 

$

149,953

 

$

412,969

 

$

(1,152,458

)

$

459,243

 

 


*Exclusive of depreciation and amortization

8




4.     ESTIMATED SHAREABLE EARNINGS OBLIGATIONS

Significant portions of the SureWest Telephone’s rates and charges are subject to regulation by the Federal Communications Commission (“FCC”) and the California Public Utilities Commission (“CPUC”).  Rates and charges are based on various tariffs filed by SureWest and others, including those filed by the National Exchange Carrier Association (“NECA”) for interstate common line (“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 the Company’s consolidated financial position and results of operations.

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 current and prior year monitoring periods.  For the quarter and six-month period ended June 30, 2007, these changes in estimates increased the Company’s consolidated revenues by $688 and $806 and net income by $473 ($0.03 per share) and $555 ($0.04 per share), respectively.  The Company did not record any significant changes in estimates during the quarter and six-month period ended June 30, 2006.

In 2004, the Company 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 is returning approximately $6,500 (“Dividend A”), plus interest at the 90-day commercial paper rate for non-financial institutions, which was 5.23% as of June 30, 2007, and an imputed rate of 3.15%, to its end users through a consumer dividend over a period of approximately four years, which began January 1, 2005.  In addition, SureWest Telephone paid a one-time consumer dividend of $2,600 (“Dividend B”), to consumers to settle the monitoring periods 2000 to 2004 payable over approximately two years, which began January 1, 2005 and was completed in March 2007.  The consumer dividend included an annual imputed interest rate of 3.15% (no stated contractual interest rate).  The consumer dividends were recorded as a reduction of the Company’s contractual shareable earnings obligations.  At June 30, 2007, the aggregate contractual shareable earnings obligation for these surcredits was $2,476 (which is net of an unamortized discount pertaining to imputed interest of $66 at that date).

The following table summarizes the amounts returned to end users through consumer dividends for the quarters and six-month periods ended June 30, 2007 and 2006.

 

 

Quarter Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Dividend A

 

$

475

 

$

505

 

$

961

 

$

1,020

 

Dividend B

 

 

295

 

210

 

596

 

Total

 

$

475

 

$

800

 

$

1,171

 

$

1,616

 

 

As part of the settlement agreement, SureWest Telephone was 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.  However, this consumer dividend was subject to reduction based upon the results of other pending regulatory proceedings.  Pursuant to a CPUC order in December 2006, beginning in 2007 this dividend was offset by a reduction in the Company’s interim draw from the California High Cost Fund (“CHCF”), which was previously authorized by a CPUC decision in August 2005 which allowed SureWest Telephone to continue receiving $11,500 annually from the CHCF to offset its intrastate regulated operating expenses on an interim basis. In August 2006, the Company requested permission from the CPUC to implement a graduated phase down of its $11,500 draw and in December 2006, the CPUC authorized the Company to offset its interim draw from the CHCF with the aforementioned $1,300 consumer dividend.  The Division of Ratepayer Advocates (“DRA”) filed comments on the Company’s request and recommended that SureWest Telephone immediately discontinue receipt of its entire annual $11,500 interim CHCF fund draw.  In July 2007, the CPUC released a Proposed Decision which if adopted would deny the DRA request, grant SureWest Telephone’s Petition and commence the phase down of SureWest Telephone’s interim CHCF draw over a five-year period, a phase down that would end on January 1, 2012. The phase down of the interim draw is proposed to begin in 2007, initially reducing the annual $11,500 interim draw by the aforementioned $1,300 consumer dividend to $10,200. In each subsequent year the interim CHCF draw would be incrementally reduced by approximately $2,000 annually.  The final results of this proceeding,

9




a pending rulemaking proceeding reviewing the entire CHCF and the resultant potential effects on SureWest Telephone could impact future support through the CHCF.

In an ongoing proceeding relating to the New Regulatory Framework (under which SureWest Telephone has been regulated under 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 lifeline and basic residential services, (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.

In January 2007, The Utility Reform Network filed a petition for writ of review in the Court of Appeal of the State of California seeking an order that the CPUC’s decision be set aside.  In May 2007, the Court of Appeal denied The Utility Reform Network’s Petition for Writ of review and the CPUC’s decision has become final.

As of June 30, 2007, the Company’s consolidated balance sheet reflected aggregate liabilities of $73 relating to SureWest Telephone’s estimated interstate shareable earnings obligations. The calculations supporting these liabilities are very complex and involve a variety of estimates prior to the ultimate settlement of such obligations. In addition, SureWest Telephone’s interstate shareable earnings obligations lapse over time if SureWest Telephone’s interexchange carriers and other customers do not claim the amounts ascribed to them. Accordingly, it is reasonably possible that management’s estimates of the Company’s liabilities for interstate shareable earnings obligations could change in the near term, and the amounts involved could be material.

5.     INCOME TAXES

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

The adoption of FIN No. 48 did not have a material impact on the Company’s financial position or results of operations.  The Company had a liability for unrecognized tax benefits of approximately $1,511 and $1,003 at the date of adoption and June 30, 2007, respectively.  Unrecognized tax benefits were reduced by $374 and $523 during the quarter and six month period ended June 30, 2007, respectively, due to lapses in the statute of limitations.  There were no changes due to tax positions taken or settlements with taxing authorities.

The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate were $1,008 and $500 at January 1, 2007 and June 30, 2007, respectively and include approximately $284 of income tax benefits relating to research and development credits and accrued interest that are affected by statute of limitations expiring within the next 12 months.

The Company’s policy is to recognize interest and penalties related to uncertain tax positions in income tax expense.  As of June 30, 2007, the Company had approximately $167 of accrued interest and penalties in the unrecongnized tax benefits above.

As of June 30, 2007, the following tax years and related taxing jurisdictions were open:

 

Tax Year

 

Taxing Jurisdiction

 

2000

 

California

 

2002 - 2006

 

Federal and California

 

 

10




6.     PENSION AND OTHER POST-RETIREMENT BENEFITS

The Company sponsors a noncontributory defined benefit pension plan (the “Pension Plan”) covering substantially all of its 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. The Company’s 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, United States government and agency securities and international equity securities.

The Company also has an unfunded Supplemental Executive Retirement Plan (“SERP”), which provides supplemental retirement benefits to certain former executives of the Company. 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.

In addition, the Company provides certain post-retirement benefits other than pensions (“Other Benefits”) to substantially all employees, including medical expense reimbursement, continuation of active medical plan, life insurance benefits and a stated reimbursement for Medicare supplemental insurance.

In January 2007, the Company amended the Pension Plan, SERP and Other Benefits (collectively the “Plans”).  As a result, effective April 1, 2007, the Company froze the Pension Plan so that no person is eligible to become a new participant in the Plans on or following that date and all future benefit accruals for existing employees under the Plans cease.  The amendments to the Plans were accounted for as plan curtailments, resulting in the recognition of a $574 non-cash pretax curtailment loss ($0.04 per share) reflected in operating expenses in the Company’s consolidated statement of operations during the quarter ended December 31, 2006.

In March 2007, the Company amended the Other Benefits Plan effectively reinstating nearly all post-retirement benefits previously offered, as described above, for all employee’s hired on or before March 1, 2007.  Life insurance benefits and a stated reimbursement for Medicare supplemental insurance were available to employee’s who retired prior to June 1, 2007 and April 1, 2007, respectively.

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements No’s 87, 88, 106 and 132(R).  SFAS No. 158 requires an employer to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income.  SFAS No. 158 requires an employer with publicly traded equity securities to initially recognize the funded status of a defined benefit postretirement plan and the required disclosures as of the end of the fiscal year ending after December 15, 2006.  The Company adopted SFAS No. 158 on December 31, 2006.

Components of Net Periodic Benefit Cost

Net periodic pension costs recognized in the condensed consolidated statements of income for the quarters and six-month periods ended June 30, 2007 and 2006 under the Plans included the following components:

 

 

Pension Plan and SERP

 

Other Benefits

 

 

 

2007

 

2006

 

2007

 

2006

 

Quarter ended June 30,

 

 

 

 

 

 

 

 

 

Service cost-benefits earned during the period

 

$

(107

)

$

690

 

$

64

 

$

167

 

Interest cost on projected benefit obligation

 

1,829

 

1,753

 

238

 

185

 

Expected return on plan assets

 

(2,330

)

(2,150

)

(192

)

(80

)

Amortization of prior service cost

 

1

 

21

 

(46

)

12

 

Recognized net actuarial (gain)/loss

 

10

 

166

 

(31

)

12

 

Net pension and other benefits (income)/cost

 

$

(597

)

$

480

 

$

33

 

$

296

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30,

 

 

 

 

 

 

 

 

 

Service cost-benefits earned during the period

 

$

1,093

 

$

2,236

 

$

64

 

$

333

 

Interest cost on projected benefit obligation

 

3,629

 

3,793

 

238

 

370

 

Expected return on plan assets

 

(4,630

)

(4,315

)

(192

)

(160

)

Amortization of prior service cost

 

1

 

47

 

(46

)

25

 

Recognized net actuarial (gain)/loss

 

10

 

464

 

(31

)

25

 

Net pension and other benefits cost

 

$

103

 

$

2,225

 

$

33

 

$

593

 

11




7.     COMMITMENTS AND CONTINGENCIES

Credit Arrangements

In May 2006, the Company completed an unsecured Credit Agreement for a Term Loan facility and a Revolving Loan facility (collectively “Loan Facilities”) in principal amounts up to $75,000 and $25,000, respectively.  Interest on the Loan Facilities is payable quarterly and based on a LIBOR, variable interest rate, or a fixed interest rate pricing formula, or a combination, as defined in the Credit Agreement. Principal payments on the outstanding amounts borrowed under the Term Loan facility as of December 31, 2007 were due in equal quarterly installments commencing March 31, 2008 through June 30, 2016.  The Revolving Loan facility had an expiration date of June 30, 2013.  In May 2007, the Company amended and restated its Credit Agreement for both the Term Loan facility and the Revolving Loan facility to principal amounts of $40,000 and up to $60,000, respectively.  Principal payments on the outstanding amounts borrowed under the Loan Facilities are now due and payable on May 1, 2012.  There were no material changes to interest calculations, interest payments, or financial covenants.  As of June 30, 2007 and December 31, 2006, $40,000 was outstanding under the Term Loan Facility and no amounts were outstanding under the Revolving Loan facility.

Certain of the Company’s credit arrangements contain financial and operating covenants that restrict, among other things, the payment of cash dividends, repurchase of the Company’s capital stock, the making of certain other restricted payments and the incurrence of additional indebtedness. The covenants also require the Company to maintain certain financial ratios and minimum levels of tangible net worth. At June 30, 2007 and December 31, 2006, retained earnings of approximately $121,976 and $65,776, respectively, were available for the payment of cash dividends or other restricted payments under the terms of the Company’s credit arrangements.

Litigation, Regulatory Proceedings and Other Contingencies

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

8.     RECENT ACCOUNTING PRONOUNCEMENTS

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115. This standard permits an entity to elect to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007.  Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of FASB Statement No. 157, Fair Value Measurements. The Company is currently evaluating the impact, if any, the adoption of SFAS No. 159 will have on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The Company is currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on its consolidated financial statements.

12




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

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

Certain information included in this quarterly report on Form 10-Q of SureWest Communications (the “Company”), 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 the Company’s revenue and its cost structure resulting from its 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. Such forward looking statements are subject to a number of risks, assumptions and uncertainties that could cause the Company’s actual results to differ from those projected in such forward looking statements.

Important factors that could cause actual results to differ from those set forth in the forward looking statements include, but are not limited to: advances in telecommunications technology, changes in the telecommunications regulatory environment, changes in the financial stability of other telecommunications providers that are customers of the Company, changes in competition in markets or businesses in which the Company operates, adverse circumstances affecting the economy in California in general, and in the Sacramento, California Metropolitan area in particular, the availability of future financing, changes in the demand for services and products, new product and service development and introductions, pending and future litigation, and unanticipated changes in the growth of the Company’s emerging businesses, including the wireless and broadband business segments.

Corporate Structure

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

The Telecom segment includes SureWest Telephone and SureWest Long Distance, which provide landline telecommunications services, Digital Subscriber Line (“DSL”) service, long distance services and certain non-regulated services. SureWest Telephone, which is the principal operating subsidiary of the Telecom segment, provides local services, toll telephone services, network access services and certain non-regulated services.  SureWest Long Distance is a reseller of long distance services.

Effective February 28, 2007, GateHouse Media acquired 100% of the stock of SureWest Directories (previously included in the Telecom segment), its directory publishing business for an aggregate cash purchase price of $110,123, resulting in a gain of $101,286, less estimated income taxes of $41,384.  As part of the transaction, GateHouse Media became the publisher of the official directory of SureWest Telephone. The Company continues to evaluate its businesses and product lines and believes this transaction will permit the Company to focus more on the strategic growth of its core business of being a full-service integrated communications provider.

The Broadband segment includes the Company’s subsidiaries SureWest Broadband, SureWest TeleVideo, SureWest TeleVideo of Roseville, SureWest Internet, SureWest Custom Data Services; and a division of SureWest Telephone operating as a Competitive Local Exchange Carrier (“CLEC”). The Broadband segment provides various services, including high-speed and dial-up Internet, digital video, voice, network access, long distance and managed services in the greater Sacramento area, principally to customers residing outside of SureWest Telephone’s service area.

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

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

13




Consolidated Net Income

Net income for the six-month period ended June 30, 2007 was $62,739, or $4.35 per share, substantially all of which ($60,901, or $4.22 per share, net of tax) resulted from the sale of SureWest Directories on February 28, 2007.  In the same prior year period, the Company’s net income was $2,603 ($0.18 per share), of which $3,072 ($0.21 per share) was attributable to the operations of SureWest Directories (now reported as a discontinued operation).  In the first quarter of 2007, income from operations of SureWest Directories (for the two-months ended February 28, 2007) was $999.

Income from continuing operations in the six-month period ended June 30, 2007 was $1,838 ($0.13 per share), compared to a loss of $469 ($0.03 per share) in the same period of 2006.

Results of Operations

Consolidated Overview

The tables below reflect certain financial data (on a consolidated and segment basis) and selected operating metrics for each reportable segment as of and for the quarters and six-month periods ended June 30, 2007 and 2006.

Financial Data

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

2007

 

2006

 

$
Change

 

%
Change

 

2007

 

2006

 

$
Change

 

%
Change

 

Operating revenues (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Telecom

 

$

27,249

 

$

28,196

 

$

(947

)

(3

)%

 

$

53,610

 

$

55,296

 

$

(1,686

)

(3

)%

 

Broadband

 

17,069

 

15,024

 

2,045

 

14

 

 

33,491

 

28,906

 

4,585

 

16

 

 

Wireless

 

8,115

 

8,144

 

(29

)

 

 

16,316

 

16,538

 

(222

)

(1

)

 

Operating revenues

 

52,433

 

51,364

 

1,069

 

2

 

 

103,417

 

100,740

 

2,677

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Telecom

 

11,481

 

12,387

 

(906

)

(7

)

 

22,818

 

23,494

 

(676

)

(3

)

 

Broadband

 

(4,548

)

(6,712

)

2,164

 

32

 

 

(10,571

)

(14,274

)

3,703

 

26

 

 

Wireless

 

(4,511

)

(3,711

)

(800

)

(22

)

 

(8,835

)

(6,606

)

(2,229

)

(34

)

 

Income from operations

 

2,422

 

1,964

 

458

 

23

 

 

3,412

 

2,614

 

798

 

31

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Telecom

 

8,047

 

7,286

 

761

 

10

 

 

15,025

 

13,747

 

1,278

 

9

 

 

Broadband

 

(3,435

)

(4,777

)

1,342

 

28

 

 

(7,530

)

(9,866

)

2,336

 

24

 

 

Wireless

 

(2,827

)

(2,418

)

(409

)

(17

)%

 

(5,657

)

(4,350

)

(1,307

)

(30

)%

 

Income (loss) from continuing operations

 

$

1,785

 

$

91

 

$

1,694

 

NA

 

 

$

1,838

 

$

(469

)

$

2,307

 

NA

 

 

 


(1) External customers only

14




Selected Operating Metrics

 

 

As of June 30,

 

 

 

2007

 

2006

 

Change

 

% Change

 

Telecom

 

 

 

 

 

 

 

 

 

Incumbent Local Exchange Carrier access lines

 

120,969

 

127,278

 

(6,309

)

(5

)%

Long distance lines

 

58,175

 

55,637

 

2,538

 

5

 

 

 

 

 

 

 

 

 

 

 

Broadband

 

 

 

 

 

 

 

 

 

Total subscribers (1)

 

62,130

 

53,505

 

8,625

 

16

 

Broadband Revenue-generating units (2)

 

100,657

 

85,907

 

14,750

 

17

 

Data

 

59,792

 

51,038

 

8,754

 

17

 

Video

 

19,747

 

17,110

 

2,637

 

15

 

Voice

 

21,118

 

17,759

 

3,359

 

19

 

Business Voice-grade equivalents (3)

 

946,900

 

696,500

 

250,400

 

36

 

 

 

 

 

 

 

 

 

 

 

Wireless

 

 

 

 

 

 

 

 

 

Subscribers

 

51,568

 

52,993

 

(1,425

)

(3

)%

 


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

(2)          The Broadband segment can deliver multiple services to a customer. Accordingly, the Company maintains statistical data regarding Revenue-generating units for digital video, voice and data, in addition to the number of subscribers. For example, a single subscriber who purchases digital video, voice and data services would be reflected as three Revenue-generating units.

(3)          Business Voice-grade equivalents (“VGEs”) are calculated by dividing the capacity of all circuits in use by 64 kilobits (bandwidth representing a voice access line).  DSL VGEs are counted as two 64 kbps channels.

Operating revenues from external customers in the Telecom segment decreased $947 and $1,686 during the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006. SureWest Telephone continues to experience decreases in local and network access revenues due to competition from wireless (including SureWest Wireless) and wireline competitors, contributing to an approximate 5% decline in access lines.  In addition, network access revenues decreased due to a decline in the rate base, which affects the interstate pool settlements from the National Exchange Carrier Association (“NECA”) (see Regulatory Matters within the Telecom Segment Results of Operations and Critical Accounting Estimates sections below).  SureWest Telephone’s revenues are also impacted by shareable earnings obligations and changes in funding levels authorized by the California Public Utilities Commission (“CPUC”), which are also discussed below in the Telecom Segment Results of Operations.

While the Telecom segment steadily continues to generate a majority of the Company’s revenues, cash flows and net income, the Company believes that the results of the Telecom segment in recent years (reflected in declining revenues and access lines) support, in part, the Company’s efforts to continue to develop its other business segments.

Broadband operating revenues from external customers increased $2,045 and $4,585 during the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006 primarily as a result of the continued expansion of the broadband network and growth in the demand for data and video services.  During the six-month period ended June 30, 2007, the Broadband segment experienced a 16% increase in the number of subscribers compared to the same prior year period.  In addition, broadband business services realized a 36% increase in VGEs compared to the prior year. While continuing to produce significant revenue increases, the expansion of the broadband residential services has and will continue to require significant capital and expense commitments.

Operating revenues from external customers in the Wireless segment for the quarter and six-month period ended June 30, 2007 decreased $29 and $222, respectively, compared to the same periods in 2006.  The decrease in operating revenues was attributable to a decline in equipment revenue as a result of a reduction in the average selling price per handset offset in part by an increase in the quantity of handsets sold.  As the Company deemphasizes the prepaid market and migrates toward contract subscribers, the number of wireless subscribers decreased to 51,568 at June 30, 2007, a 3% decline compared to the same prior year period.  Despite the subscriber decline, access and feature revenues increased from the prior year as a result of an increase in the average revenue per subscriber and the introduction of new features during 2006.

15




The Company’s consolidated operating expenses, excluding depreciation and amortization, increased $1,343 and $3,286 during the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006.  Cost of services and products expense increased $384 and $1,461, respectively, in the current year periods as a result of (i) the continued growth in subscribers and services within the Broadband segment and (ii) an increase in the cost of equipment sales due to an increase in the quantity of wireless handsets sold.  Customer operations and selling expense increased $79 and $383 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006 due primarily to an increase in sales and advertising costs to promote subscriber growth and new product offerings within the Broadband and Wireless segments.  General and administrative expenses increased $880 and $1,442 for the quarter and six-month period ended June 30, 2007 compared to the same periods in 2006 primarily as a result of an increase in consulting and advisory fees related to strategic initiatives and the commencement in 2007 of a project to evaluate the feasibility to outsource certain non-core processes.

The increase in operating expenses was offset in part by a decline in costs associated with the Company’s defined benefit pension plan (the “Pension Plan”), Supplemental Executive Retirement Plan (“SERP”) and certain post-retirement benefits other than pensions (“Other Benefits”) (collectively the “Plans”) as a result of amendments to the Plans.  The Plan amendments, effective April 1, 2007, froze the Pension Plan so that no person is eligible to become a new participant in the Plans on or following that date and all future benefit accruals for existing participants under the Plans cease.  The amendments to the Plans were accounted for as plan curtailments, resulting in the recognition of a $574 non-cash pretax curtailment loss ($0.04 per share) reflected in operating expenses in the Company’s consolidated statement of operations during the quarter ended December 31, 2006.  As a result of the Pension Plan freeze and final actuarial calculations, the Company recorded income of $686 and expense of $13 related to the Pension and Other Benefits Plans during the quarter and six months ended June 30, 2007, respectively, representing a $1,249 and $2,114 decrease in costs associated with the Pension and Other Benefits Plans compared to the same prior year periods.

The Company’s consolidated depreciation and amortization expense decreased $732 and $1,407 during the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006, despite the continued network build-out and success-based capital projects undertaken within the residential broadband service territories, due to a change in accounting estimate recorded during 2007, as described below.

During the first quarter of 2007, the Company completed its triennial review of asset lives that evaluated the appropriateness of the estimated useful lives of its property, plant and equipment for all segments.  The evaluation considered the Company’s 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, 2007, the Company increased the estimated useful lives of certain of its customer premise equipment, circuit equipment, cable plant and towers primarily in the Broadband segment. The increase in asset lives primarily ranged between 1 to 4 years, although the change in estimated useful lives for towers was 8 years.  The Company’s revisions to its estimated useful lives have been supported by an assessment and report from an independent party with expertise in this area that found the revisions to be reasonable in light of the Company’s plan and useful life estimates in comparable businesses. During the quarter and six-month period ended June 30, 2007, this change in estimate decreased consolidated depreciation expense by $933 and $1,881 and increased consolidated net income by $640 ($0.04 per share) and $1,295 ($0.09 per share), respectively.

16




Segment Results of Operations

Telecom

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

2007

 

2006

 

$
Change

 

%
Change

 

2007

 

2006

 

$
Change

 

%
Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Local service

 

$

14,653

 

$

15,581

 

$

(928

)

(6

)%

 

$

29,432

 

$

31,162

 

$

(1,730

)

(6

)%

 

Network access service

 

10,062

 

9,966

 

96

 

1

 

 

19,254

 

19,883

 

(629

)

(3

)

 

Long distance service

 

1,457

 

1,334

 

123

 

9

 

 

2,883

 

2,718

 

165

 

6

 

 

Other

 

1,077

 

1,315

 

(238

)

(18

)

 

2,041

 

1,533

 

508

 

33

 

 

Total operating revenues from external customers

 

27,249

 

28,196

 

(947

)

(3

)

 

53,610

 

55,296

 

(1,686

)

(3

)

 

Intersegment revenues

 

5,918

 

7,450

 

(1,532

)

(21

)

 

12,890

 

14,778

 

(1,888

)

(13

)

 

Operating expenses*

 

16,008

 

16,950

 

(942

)

(6

)

 

32,439

 

33,968

 

(1,529

)

(5

)

 

Depreciation and amortization

 

5,678

 

6,309

 

(631

)

(10

)

 

11,243

 

12,612

 

(1,369

)

(11

)

 

Income from operations

 

11,481

 

12,387

 

(906

)

(7

)

 

22,818

 

23,494

 

(676

)

(3

)

 

Income from continuing operations

 

$

8,047

 

$

7,286

 

$

761

 

10

%

 

$

15,025

 

$

13,747

 

$

1,278

 

9

%

 

 


*Exclusive of depreciation and amortization

Operating Revenues

Operating revenues from external customers in the Telecom segment decreased $947 and $1,686 in the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006.  SureWest Telephone continues to experience decreases in local and network access revenues due to competition from wireless (including SureWest Wireless) and wireline competitors, contributing to an approximate 5% decline in access lines.  In addition, network access revenues decreased due to a decline in the rate base, which affects the interstate pool settlements from the NECA (see Regulatory Matters and Critical Accounting Estimates sections below).  SureWest Telephone’s revenues can also be impacted by shareable earnings obligations and changes in funding levels authorized by the CPUC, which are discussed below in the Regulatory Matters section.

Operating Expenses

Operating expenses for the Telecom segment decreased $942 and $1,529 for the quarter and six-month period ended June 30, 2007, compared to the same periods in 2006.  This decrease in operating expenses was primarily due to a $630 and $1,163 decline in the costs related to the Pension Plan and Other Benefits (collectively “post-retirement benefits”), for the quarter and six month periods ended June 30, 2007, respectively, as described in the Consolidated Overview section above.  In addition, the number of full time equivalent employees in the Telecom segment decreased approximately 15% from June 2006 to June 2007.

Cost of services and products (exclusive of depreciation and amortization) decreased $2,135 and $2,776 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006.  The decrease was mostly attributable to the decrease in post-retirement benefits costs as described above and decreases in network operations and support expenses as a result of reductions in the number of employees.  The decreases were partially offset by increases in long distance access expense as a result of the InfinitAccessTM bundle program and an increase in minutes of use.

Customer operations and selling expense increased $152 and $246 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006, due primarily to an increase in billing and collection costs, which were impacted by the increase in long distance access expense previously discussed. The increase was partially offset by a decrease in labor costs as a result of a reduction in the number of employees and internal efficiencies resulting from integrated customer support systems and productivity gains.

17




General and administrative expense increased $1,041 and $1,001 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006.  The increase was due in large part to an increase in consulting and advisory fees related to strategic initiatives and the commencement in 2007 of a project to evaluate the feasibility to outsource certain non-core processes.

Depreciation and amortization decreased $631 and $1,369 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006 due primarily to a significant portion of computer software becoming fully depreciated during 2006.

Regulatory Matters

Revenues from services subject to regulation constituted approximately 47% of the Company’s total operating revenues from continuing operations for the quarter and six-month period ended June 30, 2007, respectively. For the same prior year periods, revenues from services subject to regulation constituted approximately 50% and 51%, respectively, of the Company’s total operating revenues from continuing operations.  Local service, network access service and toll service are included in revenues from services subject to regulation, and are derived from various sources including:

·                  business and residential subscribers, for basic exchange services;

·                  surcharges, mandated by the CPUC;

·                  long distance carriers, for network access service;

·                  competitive access providers and subscribers, for network access service;

·                  interstate pool settlements from NECA;

·                  support payments from federal or state programs; and

·                  support payments from the California High Cost Fund (“CHCF”), recovering costs of services including extended area service (“EAS”).

Significant portions of the SureWest Telephone’s rates and charges are subject to regulation by the Federal Communications Commission (“FCC”) and the CPUC.  Rates and charges are based on various tariffs filed by SureWest and others, including those filed by the NECA for interstate common line (“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 the Company’s consolidated financial position and results of operations.

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 current and prior year monitoring periods.  For the quarter and six-month period ended June 30, 2007, these changes in estimates increased the Company’s consolidated revenues by $688 and $806 and net income by $473 ($0.03 per share) and $555 ($0.04 per share), respectively.  The Company did not record any significant changes in estimates during the quarter and six-month period ended June 30, 2006.

In 2004, the Company 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 is returning approximately $6,500 (“Dividend A”), plus interest at the 90-day commercial paper rate for non-financial institutions to its end users through a consumer dividend over a period of approximately four years, which began January 1, 2005.  In addition, SureWest Telephone paid a one-time consumer dividend of $2,600 (“Dividend B”), to consumers to settle the monitoring periods 2000 to 2004 payable over approximately two years, which began January 1, 2005 and was completed in March 2007.

As part of the settlement agreement SureWest Telephone was 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.  However, this consumer dividend was subject to reduction based upon the results of other pending regulatory proceedings.  Pursuant to a CPUC order in December 2006, beginning in 2007 this dividend was offset by a reduction in the Company’s interim draw from the CHCF, which was previously authorized by a CPUC decision in August 2005 which allowed SureWest Telephone to continue receiving $11,500 annually from the CHCF to offset its intrastate regulated operating expenses on an interim basis. In August 2006, the Company requested permission from the CPUC to implement a graduated phase down of its annual $11,500 interim draw and in December 2006, the CPUC authorized the Company to offset its interim draw from the CHCF with the aforementioned $1,300 consumer dividend.  The Division of Ratepayer Advocates (“DRA”) filed comments on the Company’s request and recommended that SureWest Telephone immediately discontinue receipt of its entire annual $11,500 interim CHCF fund draw.  In July 2007, the CPUC released

18




a Proposed Decision which if adopted would deny the DRA request, grant SureWest Telephone’s Petition and commence the phase down of SureWest Telephone’s interim CHCF draw over a five-year period, a phase down that would end on January 1, 2012. The phase down of the interim draw is proposed to begin in 2007, initially reducing the annual $11,500 interim draw by the aforementioned $1,300 consumer dividend to $10,200. In each subsequent year the interim CHCF draw would be incrementally reduced by approximately $2,000 annually.  The final results of this proceeding, a pending rulemaking proceeding reviewing the entire CHCF and the resultant potential effects on SureWest Telephone could impact future support through the CHCF.

In an ongoing proceeding relating to the New Regulatory Framework (under which SureWest Telephone has been regulated under 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 lifeline and basic residential services, (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.

In January 2007, The Utility Reform Network filed a petition for writ of review in the Court of Appeal of the State of California seeking an order that the CPUC’s decision be set aside.  In May 2007, the Court of Appeal denied The Utility Reform Network’s Petition for Writ of review and the CPUC’s decision has become final.

As of June 30, 2007, the Company’s consolidated balance sheet reflected aggregate liabilities of $73 relating to SureWest Telephone’s estimated interstate shareable earnings obligations. The calculations supporting these liabilities are very complex and involve a variety of estimates prior to the ultimate settlement of such obligations. In addition, SureWest Telephone’s interstate shareable earnings obligations lapse over time if SureWest Telephone’s interexchange carriers and other customers do not claim the amounts ascribed to them. Accordingly, it is reasonably possible that management’s estimates of the Company’s liabilities for interstate shareable earnings obligations could change in the near term, and the amounts involved could be material.

Broadband

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

$

 

%

 

 

 

2007

 

2006

 

Change

 

Change

 

2007

 

2006

 

Change

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Data

 

$

8,219

 

$

7,240

 

$

979

 

14

%

 

$

16,101

 

$

14,145

 

$

1,956

 

14

%

 

Video

 

3,777

 

3,093

 

684

 

22

 

 

7,404

 

5,849

 

1,555

 

27

 

 

Voice

 

2,191

 

1,856

 

335

 

18

 

 

4,340

 

3,585

 

755

 

21

 

 

Network access

 

2,346

 

2,360

 

(14

)

(1

)

 

4,589

 

4,374

 

215

 

5

 

 

Other

 

536

 

475

 

61

 

13

 

 

1,057

 

953

 

104

 

11

 

 

Total operating revenues from external customers

 

17,069

 

15,024

 

2,045

 

14

 

 

33,491

 

28,906

 

4,585

 

16

 

 

Intersegment revenues

 

475

 

312

 

163

 

52

 

 

995

 

736

 

259

 

35

 

 

Operating expenses*

 

16,661

 

16,327

 

334

 

2

 

 

34,439

 

32,998

 

1,441

 

4

 

 

Depreciation and amortization

 

5,431

 

5,721

 

(290

)

(5

)

 

10,618

 

10,918

 

(300

)

(3

)

 

Loss from operations

 

(4,548

)

(6,712

)

2,164

 

32

 

 

(10,571

)

(14,274

)

3,703

 

26

 

 

Loss from continuing operations

 

$

(3,435

)

$

(4,777

)

$

1,342

 

28

%

 

$

(7,530

)

$

(9,866

)

$

2,336

 

24

%

 

 


*Exclusive of depreciation and amortization

Operating Revenues

Operating revenues from external customers in the Broadband segment increased $2,045 and $4,585 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006. The increase in Broadband revenues was due to the combined effects of (i) a 17% increase in Revenue-generating units of broadband services and (ii) the continued expansion of business broadband services as evidenced by a 36% increase in VGEs.

19




Operating Expenses

Total operating expenses in the Broadband segment increased $334 and $1,441 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006. The increase in operating expenses was offset in part by a decline in the costs related to the Pension Plan and Other Benefits of $452 and $637 for the quarter and six month periods ended June 30, 2007, respectively, as described in the Consolidated Overview section above.

Cost of services and products (exclusive of depreciation and amortization) increased $958 and $1,592 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006, due primarily to (i) an increase in programming and transport costs related to the growth in Broadband subscribers and residential broadband Revenue-generating units and (ii) an increase in access expense and maintenance costs corresponding to the increased subscriber count, as well as the expanded network footprint.

Customer operations expense increased $89 and $193 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006.  The increase was attributable to an increase in sales and advertising costs to promote new and existing product offerings within the Broadband segment.

General and administrative expense decreased $713 and $344 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006. The decrease was primarily due to a reduction in information technology expenses which was offset in part by an increase in consulting and advisory fees related to strategic initiatives and the commencement in 2007 of a project to evaluate the feasibility to outsource certain non-core processes.

Depreciation and amortization decreased $290 and $300 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006.  Depreciation expense in the Broadband segment increased due to the continued network build-out and success-based capital projects undertaken within the residential broadband service territories however was offset by a change in accounting estimate recorded during 2007, as discussed below.

During the first quarter of 2007, the Company completed its triennial review of asset lives that evaluated the appropriateness of the estimated useful lives of its property, plant and equipment for all segments.  The evaluation considered the Company’s 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, 2007, the Company increased the estimated useful lives of certain of its customer premise equipment, circuit equipment, cable plant and towers primarily in the Broadband segment. The increase in asset lives primarily ranged between 1 to 4 years, although the change in estimated useful lives for the towers was 8 years.  The Company’s revisions to its estimated useful lives have been supported by an assessment and report from an independent party with expertise in this area that found the revisions to be reasonable in light of the Company’s plan and useful life estimates in comparable businesses. During the quarter and six-month period ended June 30, 2007, this change in estimate decreased the Broadband segment depreciation expense by $933 and $1,881 and increased consolidated net income by $640 ($0.04 per share) and $1,295 ($0.09 per share), respectively.

Wireless

 

 

 

Quarter Ended June 30,

 

Six Months Ended June 30,

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

$

 

%

 

 

 

2007

 

2006

 

Change

 

Change

 

2007

 

2006

 

Change

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wireless revenues from external customers

 

$

8,115

 

$

8,144

 

$

(29

)

%

 

$

16,316

 

$

16,538

 

$

(222

)

(1

)%

 

Intersegment revenues

 

781

 

695

 

86

 

12

 

 

1,566

 

1,375

 

191

 

14

 

 

Operating expenses*

 

10,241

 

9,573

 

668

 

7

 

 

20,515

 

18,579

 

1,936

 

10

 

 

Depreciation and amortization

 

3,166

 

2,977

 

189

 

6

 

 

6,202

 

5,940

 

262

 

4

 

 

Loss from operations

 

(4,511

)

(3,711

)

(800

)

(22

)

 

(8,835

)

(6,606

)

(2,229

)

(34

)

 

Loss from continuing operations

 

$

(2,827

)

$

(2,418

)

$

(409

)

(17

)%

 

$

(5,657

)

$

(4,350

)

$

(1,307

)

(30

)%

 

                       


*Exclusive of depreciation and amortization

20




Operating Revenues

Operating revenues from external customers in the Wireless segment decreased $29 and $222 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006.  The decrease in revenue was due primarily to (i) a decline in equipment revenue resulting from a decrease in the average selling price of handsets offset in part by an increase in the quantity of handsets sold and (ii) an increase in bad debt expense.  The decrease in revenue was partially offset by an increase in (i) access and roaming revenues as a result of the introduction of higher priced plans in 2006 and (ii) feature revenue as a result of new features introduced in 2006.

Operating Expenses

Operating expenses for the Wireless segment increased $668 and $1,936 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006. The increase in operating expenses was offset in part by a decline in the costs related to the Pension Plan and Other Benefits of $167 and $314 for the quarter and six month periods ended June 30, 2007, respectively, as described in the Consolidated Overview section above.

Cost of services and products (exclusive of depreciation and amortization) increased $128 and $950 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006, primarily due to increases in (i) the quantity of handsets sold, (ii) costs associated with additional features introduced in 2006, (iii) interconnect expense due to an increase in lines used and (iv) long distance expense due to an increase in the minutes of use.

Customer operations expense increased $206 for the six-month period ended June 30, 2007 compared to the same periods in 2006, due primarily to an increase in sales and advertising expense as a result of increased promotional campaigns.

General and administrative expense increased $561 and $780 for the quarter and six-month period ended June 30, 2007, respectively, as compared to the same periods in 2006.  The increase was primarily due to an increase in consulting and advisory fees related to strategic initiatives and the commencement in 2007 of a project to evaluate the feasibility to outsource certain non-core processes.

Non-operating Items

Other Income and Expense, Net

Consolidated interest income increased $1,048 and $1,483 during the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006, due to the increase in cash, cash equivalents and short-term investments resulting primarily from the proceeds received from the sale of the directory publishing business, as described above.

Income Taxes

Income tax benefits decreased $30 and $289 for the quarter and six-month period ended June 30, 2007, respectively, compared to the same periods in 2006, due primarily to a reduction of the income tax liability for unrecognized income tax benefits related to fiscal year 2000 federal research and development credits. The effective federal and state income tax rates for continuing operations were approximately 8.0% and 47.5% for the six-month periods ended June 30, 2007 and 2006, respectively.

Liquidity and Capital Resources

As reflected in the Condensed Consolidated Statements of Cash Flows, net cash used in operating activities was $20,092 for the six-month period ended June 30, 2007 due primarily to (i) net cash used in discontinued operations of $42,486, which consisted primarily of income tax payments of $44,970 related to the gain on the sale of SureWest Directories, (ii) a decrease in accounts payable and accrued liabilities of approximately $2,500 due primarily to a decrease in outstanding obligations related to professional fees and capital project expenditures and (iii) a decrease in deferred income taxes of $2,947.  Cash used in operating activities was offset in part by (i) net income from continuing operations of $1,838 and (ii) non-cash charges of $28,063 consisting primarily of depreciation and amortization due to capital investments principally in the Broadband segment.

Net cash provided by investing activities for the six-month period ended June 30, 2007 was $57,870 due primarily to the proceeds from the sale of SureWest Directories of $110,123, offset by capital expenditures pertaining to ongoing plant construction projects of $22,503 and a net increase in held-to-maturity investments of $29,750.

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Net cash used in financing activities was $7,236 for the six-month period ended June 30, 2007 due primarily to the payment of dividends.

The Company’s working capital was $62,174 at June 30, 2007.  The increase in working capital during the six months ended June 30, 2007 was substantially attributable to the sale of the directory publishing business to Gatehouse Media on February 28, 2007 for an aggregate cash purchase price of $110,123.  The sale of the directory publishing business resulted in an increase in cash, cash equivalents and short-term investments.  The increase in working capital was also partially attributable to a decrease in contractual shareable earnings obligations, deferred income taxes and accrued liabilities.  As discussed below, the Company believes that its working capital position, the proceeds from the sale of SureWest Directories, operating cash flows and borrowing capacity are sufficient to satisfy its liquidity requirements in the next twelve months.

The Company’s most significant use of funds in the remainder of 2007 is expected to be for (i) budgeted capital expenditures of approximately $32,500, (ii) scheduled payments of long-term debt of $3,636 and (iii) support of the operations of SureWest Wireless up to an anticipated $2,100. In addition, during 2007 the payment of dividends, which is at the discretion of the Company’s Board of Directors, could be as much as $7,200 based on the Company’s most recent dividend payments. A substantial portion of the 2007 budgeted capital expenditures is at the discretion of the Company, and dependent upon the Company’s working capital position, operating cash flows and ability to borrow, as described below. The Company is required to comply with its cable franchise agreements to continue its build-out in the franchise areas.

The Company contributes to the Pension Plan and Other Benefits Plans, which provide retirement benefits to all employees. Contributions are intended to provide for benefits attributed to service to date. The Company’s funding policy is to contribute annually an actuarially determined amount consistent with applicable federal income tax regulations. As discussed in the Consolidated Overview section above, the Company stopped accruing benefits for active participants effective April 1, 2007.  The Company believes that future funding requirements will decrease significantly as a result of the freeze of the Plans.  The Company will continue to evaluate the future funding requirements of the Plans and fund them as deemed necessary.  As of June 30, 2007, the Company had not made any contributions to the Plans and does not expect to make any contributions during the remainder of 2007.

As discussed more fully in the Regulatory Matters section above, the CPUC has been reviewing whether SureWest Telephone should continue receiving the annual $11,500 interim draw from the CHCF and the advisability and impacts of phasing out the payments gradually over a period of years.  The Company has proposed to phase down its $11,500 annual interim CHCF draw over a five-to-ten year period.  In December 2006, the CPUC issued an interim decision providing for the Company to reduce its interim annual draw from the CHCF by $1,300 on a monthly prorated basis, to $10,200 in the aggregate from $11,500, to reflect a “consumer dividend” required in another regulatory proceeding which was to be effective January 1, 2007. In July 2007, the CPUC released a Proposed Decision which if adopted would grant SureWest Telephone’s Petition and phase down its interim CHCF draw over a five-year period to end on January 1, 2012.  The phase down of the interim draw is proposed to begin in 2007, initially reducing the annual $11,500 interim draw by the aforementioned $1,300 consumer dividend to $10,200.  In each subsequent year, the interim CHCF draw would be reduced by approximately $2,000 annually.  The Company will seek to recover the eliminated revenues through operating efficiencies and/or rate increases. For a more detailed discussion, see Regulatory Matters within the Telecom Segment Results of Operations.

In May 2006, the Company completed an unsecured Credit Agreement for a Term Loan facility and a Revolving Loan facility (collectively “Loan Facilities”) in principal amounts up to $75,000 and $25,000, respectively.  Interest on the Loan Facilities is payable quarterly and based on a LIBOR, variable interest rate, or a fixed interest rate pricing formula, or a combination, as defined in the Credit Agreement. Principal payments on the outstanding amounts borrowed under the Term Loan facility as of December 31, 2007 were due in equal quarterly installments commencing March 31, 2008 through June 30, 2016.  The Revolving Loan facility had an expiration date of June 30, 2013.  In May 2007, the Company amended and restated its Credit Agreement for both the Term Loan facility and the Revolving Loan facility to principal amounts of $40,000 and up to $60,000, respectively.  Principal payments on the outstanding amounts borrowed under the Loan Facilities are now due and payable on May 1, 2012.  There were no material changes to interest calculations, interest payments, or financial covenants.  As of June 30, 2007, $40,000 was outstanding under the Term Loan Facility and no amounts were outstanding under the Revolving Loan facility.

The Company had a liability of $1,003 for unrecognized tax benefits as of June 30, 2007 for which it cannot at this time make a reasonably reliable estimate of the period of related future payments, if any.

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The Company’s Board of Directors has authorized the repurchase of up to 2.5 million shares of the Company’s common stock.  Shares are purchased from time to time in the open market or through privately negotiated transactions, subject to overall financial and market conditions. Through June 30, 2007, approximately 1.2 million shares of common stock had been repurchased.

The Company had cash, cash equivalents and short-term investments at June 30, 2007, of $67,435. On February 28, 2007, the Company received the pre-tax proceeds from the sale of its directory publishing business of approximately $110,123, as described above.  Accordingly, the Company believes that its working capital position, the proceeds from the sale of the directory publishing business, operating cash flows and borrowing capacity are sufficient to satisfy its liquidity requirements for the next twelve months. This includes capital expenditures as required by the Company’s cable franchise agreements, while maintaining adequate cash and cash equivalents. The Company believes, given its financial position and debt-to-equity position, it has substantial additional short-and long-term borrowing capacity. As indicated above, a substantial portion of the Company’s 2007 budgeted capital expenditures and cash dividend payments is at the discretion of the Company. Accordingly, the Company believes that it can modify its planned construction and commitments and cash dividend payments if the results of operations or available capital so require.

Dividends are declared at the discretion of the Company’s Board of Directors. However, the Note Purchase Agreement under which the Company issued its Series A and Series B Senior Notes, and the Credit Agreement contain financial and operating covenants that restrict, among other things, the payment of cash dividends, the repurchase of the Company’s capital stock, the making of certain other restricted payments and the incurrence of additional indebtedness. In addition, the Company is required to maintain certain financial ratios and minimum levels of tangible net worth. At June 30, 2007, retained earnings of approximately $121,976 would have been available for the payments described immediately above, under the Company’s Note Purchase Agreement and the Credit Agreement.

Critical Accounting Estimates

Below is a summary of the Company’s critical accounting policies and estimates, which are more fully described in the referenced Notes to the Company’s Consolidated Financial Statements. Management has discussed development and selection of critical accounting policies and estimates with the Company’s Audit Committee.

·                                          In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, goodwill and wireless licenses are 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 the Company to estimate the fair value at the reporting unit level. To determine the fair value in 2006, the Company obtained an independent valuation of the Company’s goodwill using a discounted cash flow 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 15% weighted average cost of capital based on industry weighted averaged cost of capital; and

·      no terminal growth rate.

The carrying value of the Company’s goodwill was $2,171 as of December 31, 2006. The fair value of the Company’s goodwill is based on the value associated with the telephone reporting unit, which benefits from the goodwill. The telephone reporting unit includes SureWest Telephone and certain related non-regulated services. When determining the fair value, the use of different estimates or assumptions within the discounted cash flow model could result in a different fair value. For example, the Company used a discount rate of 15.0% and no terminal growth rate in its assessment of fair value in 2006. At November 30, 2006 the fair value of the telephone reporting unit was $199,900 and the associated carrying value was $22,800. If the discount rate were to increase 2%, the fair value of the telephone reporting unit would decrease by approximately $24,000, but would not result in an impairment of goodwill.

The Company’s wireless licenses include Personal Communications Services (“PCS”) and Local Multipoint Distribution System (“LMDS”) licenses. The carrying values at December 31, 2006 of the PCS and LMDS licenses were $8,925 and $4,641, respectively. In assessing the recoverability of the Company’s PCS licenses, the Company obtained an independent valuation in 2006, which reviewed transactions involving sales of comparable wireless licenses in the aftermarket, using characteristics of the license and the related market, including geographic location, market size and megahertz frequency.

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In assessing the recoverability of the Company’s LMDS licenses, the Company obtained an independent valuation, as comparable license sales data was not available. The independent valuation estimates fair value of the Company’s LMDS licenses using a discounted cash flow 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 20% weighted average cost of capital based on industry weighted averaged cost of capital adjusted to reflect the inherent risks associated with the introduction of a new service offering; and

·      a 5% terminal value growth rate.

The use of different estimates or assumptions within the discounted cash flow model when determining fair value of the Company’s LMDS licenses could result in different values for these licenses. For example, the Company used a discount rate of 20% and a terminal growth rate of 5% in its assessment of fair value in 2006. If the discount rate were to increase 1%, the fair value of the LMDS licenses would decrease by $1,000, which would result in an impairment charge of approximately $242 based on the carrying value of the LMDS licenses as of December 31, 2006. In addition, the Company’s LMDS licenses may be impaired in the future if the estimates and assumptions used in the 2006 LMDS license discounted cash flow model are not met.

If the estimated fair value is less than the carrying value, then the carrying value is written down to the fair value. As a result of the Company’s annual test for 2006, no impairment of either goodwill or PCS or LMDS licenses was indicated. During the six-month period ended June 30, 2007, the Company was unaware of any events or changes in circumstance that would require a test of impairment that may potentially reduce the fair value below the carrying value.

·                                          Total revenues from telephone services are affected by rates authorized by various regulatory agencies. The FCC monitors SureWest Telephone’s interstate earnings through its tariff review procedures and the use of annual cost separation studies prepared by SureWest Telephone. The FCC establishes rules that carriers must follow in the filing of tariffs and the preparation of the annual studies. Based on these rules, the Company is required to prospectively set its annual interstate rates based on the aforementioned cost separation studies. These cost studies include estimates and assumptions regarding various financial data including operating expenses, taxes and investment in property, plant and equipment. Non-financial data estimates are also utilized in the preparation of these cost studies, including projected demand usage and detailed network information. The Company must also make estimates of the jurisdictional separation of this data to assign current financial and operating data to the interstate or intrastate jurisdiction. These estimates are finalized in future periods as actual data becomes available to complete the separation studies. The Company also participates in the NECA pool for certain interstate services and derives revenues from that pool. In addition to the estimates noted above, the Company’s earned rate-of-return from its participation in the NECA pool can also be impacted by the earnings and data of other carriers who participate in the pool.

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

·                                          The Company recognizes revenue when (i) persuasive evidence of an arrangement between the Company and the customer exists, (ii) delivery of the product to the customer has occurred or service has been provided to the customer, (iii) the price to the customer is fixed or determinable and (iv) collectibility of the sales price is reasonably assured. Revenues based on a flat fee, derived principally from local telephone, dedicated network access, data communications, Internet access service, residential/business broadband service and non-contract wireless services, are billed in advance and recognized in subsequent periods when the services are provided. Contract wireless services are billed in arrears. Revenues based on usage, derived primarily from network access, roaming and long distance services, are recognized monthly as services are provided. Incremental direct costs of telecommunications service activation are charged to expense in the period in which they are incurred.

The Company applies the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, to all wireless handset sales below cost, which approximates fair value in the absence of an activation “subsidy”, when receiving an up-front

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fee of any kind (e.g., a service activation fee). The application of EITF Issue No. 00-21 results in the immediate recognition of all or a portion of such up-front fees as equipment sales revenue. Additionally, when the Company activates wireless service for a customer, but does not concurrently provide the customer with a handset, any up-front fees received continue to be deferred and amortized over the expected term of the customer relationship. The Company provides a general right of return within the first 30 days of service for a full refund of the handset price. The estimated equipment return allowance associated with this right of return is estimated based on historical experience.

·                                          The Company maintains allowances for doubtful accounts for estimated losses resulting from the potential inability of its customers to make required payments. In evaluating the collectibility of its accounts receivable, the Company assesses a number of factors including a specific customer’s or carrier’s ability to meet its financial obligations to the Company, the length of time the receivable has been past due and historical and future expectations of conditions that may impact the Company’s ability to collect its accounts receivable. If circumstances change or economic conditions worsen such that the Company’s past collection experience is no longer relevant, the Company’s estimate of the recoverability of its accounts receivable could be further reduced from the levels reflected in the Company’s consolidated balance sheet. If uncollectibility of the Company’s billed revenue changes by 1%, the Company would expect an increase in uncollectible expense of approximately $2,200. As of June 30, 2007, the Company had three customers that accounted for approximately 5% of consolidated accounts receivable, net of allowances. Although management believes that these customers are creditworthy, a severe adverse impact on their business operations could have a corresponding material effect on their ability to pay timely and, therefore, on the Company’s results of operations, cash flows and financial condition. In addition, certain revenues are subject to refund if the customer terminates services or returns equipment within a stipulated time period, or if certain performance criteria are not met. Accordingly, the Company maintains accounts receivable allowances and recognizes certain customer refund liabilities, through charges to revenues, based on the Company’s best estimates of the resolution of these contingencies, which are based on historical experience.

·                                          The Company states its inventories held for sale, primarily wireless handsets, at lower of cost or market. In assessing the ultimate recoverability of inventories, the Company is required to make estimates regarding future customer demand and technological advances of equipment.

·                                          Property, plant and equipment are recorded at cost. Retirements and other reductions of regulated telephone plant and equipment are charged against accumulated depreciation with no gain or loss recognized in accordance with the composite group remaining life methodology utilized for telephone plant assets. When property applicable to non-telephone operations is sold or retired, the asset and related accumulated depreciation are removed from the accounts and the associated gain or loss is recognized. Property, plant and equipment is depreciated or amortized using the straight-line method over their estimated economic lives. The economic lives are estimated at the time the assets are acquired and are based on historical experience with similar assets, as well as anticipated technological or other changes. If technological changes were to occur more rapidly than anticipated or differently than anticipated, the economic lives assigned to these assets may need to be shortened, resulting in the recognition of increased depreciation and amortization expense in future periods. Likewise, if the anticipated technological or other changes occur more slowly than anticipated, the life of the asset group could be extended based on the life assigned to new assets added to the group. This could result in a reduction of depreciation and amortization expense in future periods. As discussed above in the Broadband segment results of operations, in January 2007 the Company revised the estimated useful lives of certain of its central office and cable and wire facilities assets. During the quarter and six-month period ended June 30, 2007, this change in estimate decreased the Broadband segment depreciation expense by $933 and $1,881 and increased consolidated net income by $640 ($0.04 per share) and $1,295 ($0.09 per share), respectively. The Company reviews the estimated useful lives of its property, plant and equipment once every three years, or when events or circumstances indicate that the carrying amount may not be recoverable over the remaining lives of the assets. In assessing the recoverability of the Company’s property, plant and equipment, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets.

·                                          The Company accounts for asset retirement obligations in accordance with SFAS No. 143, Accounting for Asset Retirement Obligations and FASB Interpretation (“FIN”) No. 47, Accounting for Conditional Retirement Obligations, which requires the Company to recognize a retirement obligation when a legal obligation exists to remove an asset at some point in the future or if legislation exists that requires special disposal procedures of

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the asset. The Company believes it may have potential retirement obligations relating to its wireless cell sites and disposal obligations relating to the removal of tenant improvements at certain of its leased facilities and certain building materials containing asbestos.