Otelco (OTEL) 10-Q 2011 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2011
	Or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from  to

Commission File Number: 1-32362

OTELCO INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	52-2126395
(State or Other Jurisdiction of Incorporation or	(I.R.S. Employer Identification No.)
Organization)
505 Third Avenue East, Oneonta, Alabama	35121
(Address of Principal Executive Offices)	(Zip Code)

(205) 625-3574

(Registrant’s Telephone Number, Including Area Code)

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No o

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

Large accelerated filer o Accelerated filer x Non-accelerated filer o Smaller reporting company 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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Class	Outstanding at August 5, 2011
Class A Common Stock ($0.01 par value per share)	13,221,404
Class B Common Stock ($0.01 par value per share)	0

OTELCO INC.

FORM 10-Q

For the three month period ended June 30, 2011

TABLE OF CONTENTS

		Page
PART I FINANCIAL INFORMATION		2
Item 1.	Financial Statements	2
	Consolidated Balance Sheets as of December 31, 2010 and June 30, 2011	2
	Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2010 and 2011	3
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2011	4
	Notes to Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	21
Item 4.	Controls and Procedures	21
PART II OTHER INFORMATION		22
Item 6.	Exhibits	22

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Unless the context otherwise requires, the words “we,” “us,” “our,” “the Company” and “Otelco” refer to Otelco Inc., a Delaware corporation, and its consolidated subsidiaries as of June 30, 2011.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations relating to our financial condition, results of operations, plans, objectives, future performance and business. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. These forward-looking statements are based on assumptions that we have made in light of our experience in the industry in which we operate, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial condition or results of operations and cause actual results to differ materially from those in the forward-looking statements.

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PART I  FINANCIAL INFORMATION

Item 1. Financial Statements

OTELCO INC.
CONSOLIDATED BALANCE SHEETS
	December 31,			June 30,
	2010			2011
				(unaudited)
Assets
Current assets
Cash and cash equivalents	$	18,226,374		$	16,433,171
Accounts receivable:
Due from subscribers, net of allowance for doubtful accounts of $230,752 and $280,924, respectively		4,406,257			3,981,258
Unbilled receivables		2,161,277			2,182,458
Other		4,299,088			5,209,607
Materials and supplies		1,817,311			1,905,575
Prepaid expenses		1,305,028			946,894
Deferred income taxes		626,267			626,267
Total current assets		32,841,602			31,285,230
Property and equipment, net		63,887,213			63,644,065
Goodwill		188,190,078			188,190,078
Intangible assets, net		25,934,042			22,312,111
Investments		1,967,095			1,954,340
Deferred financing costs		5,757,825			5,073,776
Deferred income taxes		4,415,097			4,415,097
Other assets		183,946			142,326
Total assets	$	323,176,898		$	317,017,023
Liabilities and Stockholders’ Deficit
Current liabilities
Accounts payable	$	768,055		$	657,999
Accrued expenses		7,926,954			6,769,695
Advance billings and payments		1,595,133			1,525,201
Deferred income taxes		353,285			353,285
Customer deposits		172,479			183,349
Total current liabilities		10,815,906			9,489,529
Deferred income taxes		42,512,576			42,512,576
Interest rate swaps		2,471,331			1,485,090
Advance billings and payments		656,968			636,276
Other liabilities		368,349			350,543
Long-term notes payable		271,595,855			271,159,708
Total liabilities		328,420,985			325,633,722
Stockholders’ Deficit
Class A Common Stock, $.01 par value-authorized 20,000,000 shares; issued and outstanding 13,221,404 shares		132,214			132,214
Additional paid in capital		921,718			-
Retained deficit		(6,298,019	)		(8,748,913	)
Total stockholders’ deficit		(5,244,087	)		(8,616,699	)
Total liabilities and stockholders’ deficit	$	323,176,898		$	317,017,023

The accompanying notes are an integral part of these consolidated financial statements.

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OTELCO INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2011			2010			2011
Revenues	$	26,510,944		$	25,501,062		$	52,305,153		$	50,893,060
Operating expenses
Cost of services and products		10,427,781			10,756,512			21,037,973			21,776,724
Selling, general and administrative expenses		3,236,515			2,909,960			6,467,512			6,237,017
Depreciation and amortization		5,835,311			4,507,979			11,919,602			10,231,997
Total operating expenses		19,499,607			18,174,451			39,425,087			38,245,738
Income from operations		7,011,337			7,326,611			12,880,066			12,647,322
Other income (expense)
Interest expense		(6,179,470	)		(6,199,172	)		(12,168,112	)		(12,369,303	)
Change in fair value of derivatives		(176,279	)		480,086			(1,062,449	)		986,241
Other income		24,027			33,148			382,859			382,497
Total other expenses		(6,331,722	)		(5,685,938	)		(12,847,702	)		(11,000,565	)
Income before income tax		679,615			1,640,673			32,364			1,646,757
Income tax expense		(262,339	)		(357,396	)		(744	)		(358,828	)
Net income available to common stockholders	$	417,276		$	1,283,277		$	31,620		$	1,287,929
Weighted average common shares outstanding:
Basic		12,812,901			13,221,404			12,747,540			13,221,404
Diluted		13,221,404			13,221,404			13,221,404			13,221,404
Basic net income per common share	$	0.03		$	0.10		$	-		$	0.10
Diluted net income per common share	$	0.03		$	0.10		$	-		$	0.10
Dividends declared per common share	$	0.18		$	0.18		$	0.35		$	0.35
The accompanying notes are an integral part of these consolidated financial statements.

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OTELCO INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
	Six Months Ended
	June 30,
	2010			2011
Cash flows from operating activities:
Net income	$	31,620		$	1,287,929
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation		6,900,218			5,829,266
Amortization		5,019,383			4,402,731
Amortization of debt premium		(44,820	)		(50,319	)
Amortization of loan costs		677,302			684,048
Change in fair value of derivatives		1,062,449			(986,241	)
Provision for uncollectible revenue		65,581			322,029
Changes in operating assets and liabilities; net of operating assets and liabilities acquired:
Accounts receivable		(16,151	)		(778,135	)
Material and supplies		(25,002	)		(88,264	)
Prepaid expenses and other assets		373,651			345,828
Income tax receivable		389,486			-
Accounts payable and accrued liabilities		(358,957	)		(1,267,317	)
Advance billings and payments		(58,444	)		(90,624	)
Other liabilities		(2,041	)		(6,935	)
Net cash from operating activities		14,014,275			9,603,996
Cash flows used in investing activities:
Acquisition and construction of property and equipment		(4,087,263	)		(6,350,827	)
Deferred charges		(1,041	)		-
Net cash used in investing activities		(4,088,304	)		(6,350,827	)
Cash flows used in financing activities:
Cash dividends paid		(4,564,546	)		(4,660,544	)
Direct cost of exchange of Class B shares for Class A shares		(194,053	)		-
Principal repayment of long-term debt		-			(385,828	)
Loan origination costs		(155,160	)		-
Net cash used in financing activities		(4,913,759	)		(5,046,372	)
Net increase (decrease) in cash and cash equivalents		5,012,212			(1,793,203	)
Cash and cash equivalents, beginning of period		17,731,044			18,226,374
Cash and cash equivalents, end of period	$	22,743,256		$	16,433,171
Supplemental disclosures of cash flow information:
Interest paid	$	11,535,629		$	11,735,574
Income taxes paid (received)	$	(289,163	)	$	158,003
The accompanying notes are an integral part of these consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(unaudited)

1.   Organization and Basis of Financial Reporting

Basis of Presentation and Principles of Consolidation

The consolidated financial statements include the accounts of Otelco Inc. (the “Company”) and its subsidiaries, all of which are either directly or indirectly wholly owned. These include: Otelco Telecommunications LLC (“OTC”); Otelco Telephone LLC (“OTP”); Hopper Telecommunications Company, Inc. (“HTC”); Brindlee Mountain Telephone Company, Inc. (“BMTC”); Blountsville Telephone Company, Inc. (“BTC”); Mid-Missouri Holding Corporation (“MMH”) and its wholly owned subsidiary Mid-Missouri Telephone Company (“MMT”) and its wholly owned subsidiary Imagination, Inc.; Mid-Maine Telecom, Inc. (“MMTI”); Mid-Maine TelPlus (“MMTP”); The Granby Telephone & Telegraph Co. of Massachusetts (“GTT”); War Acquisition Corporation (“WT”); The Pine Tree Telephone and Telegraph Company (“PTT”); Saco River Telegraph and Telephone Company (“SRT”); CRC Communications of Maine, Inc. (“PTN”); and Communications Design Acquisition Corporation (“CDAC”).

The accompanying consolidated financial statements include the accounts of the Company and all of the aforesaid subsidiaries after elimination of all material intercompany balances and transactions. The unaudited operating results for the three months and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011 or any other period.

The consolidated financial statements and notes included in this Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2010. The interim consolidated financial information herein is unaudited. The information reflects all adjustments (which include only normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods included in the report.

In the quarter ended June 30, 2011, we obtained more detailed information for the application of accumulated depreciation to the fixed assets of our regulated subsidiaries. The application of the additional information reduced accumulated depreciation for the period by approximately $0.7 million. This change in estimate will not affect future reporting periods.

Certain prior year amounts have been reclassified to conform with the current year’s presentation.

Recent Accounting Pronouncements

During 2011, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Updates (“ASUs”) 2011-01 through 2011-07. Except for ASU 2011-04 and ASU 2011-05, which are discussed below, these ASUs provide technical corrections to existing guidance related to specialized industries or entities and therefore, have minimal, if any, impact on the Company.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), an update to Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures (“ASC 820”). ASU 2011-04 provides guidance to change the wording used to describe many of the requirements in U.S. generally accepted accounting principles for measuring fair value and for disclosing information about fair value measurements. For public entities, ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and is to be applied prospectively. Early application by public entities is not permitted. As ASU 2011-04 impacts presentation only, the adoption of this update will not impact our consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), an update to ASC 220, Comprehensive Income. This ASU requires the components of net income and the components of other comprehensive income to be presented either in a single continuous statement of comprehensive income or in two separate but continuous statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. This guidance does not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income or how earnings per share is calculated or presented. ASU 2011-05 is effective for public entities for interim and annual periods beginning after December 15, 2011. Early adoption is permitted. As ASU 2011-05 impacts presentation only, the adoption of this update will not impact our consolidated financial statements.

2.   Commitments and Contingencies

From time to time, we may be involved in various claims, legal actions and regulatory proceedings incidental to and in the ordinary course of business, including administrative hearings of the Alabama, Maine, Massachusetts, Missouri, New Hampshire and West Virginia Public Service Commissions relating primarily to rate making. Currently, none of the legal proceedings are expected to have a material adverse effect on our business.

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3.   Derivative Activities

The Company has two interest rate swaps with approved counterparties. The first swap has a notional amount of $90 million with the Company paying a fixed rate of 1.85% and the counterparty paying a variable rate based upon the three month LIBOR interest rate. It is effective from February 9, 2009 through February 8, 2012. The second swap has a notional amount of $60 million with the Company paying a fixed rate of 2.0475% and the counterparty paying a variable rate based upon the three month LIBOR interest rate. It is effective from February 9, 2010 through February 8, 2012. From an accounting perspective, the documentation for both swaps does not meet the technical requirements of ASC 815, Derivatives and Hedging, to allow the swaps to be considered highly effective hedging instruments and therefore the swaps do not qualify for hedge accounting. The change in fair value of the swaps is charged or credited to income as a change in fair value of derivatives. Over the life of the swaps, the cumulative change in value will be zero.

4.   Income per Common Share and Potential Common Share

Basic income per common share is computed by dividing net income by the weighted average number of shares outstanding for the period. Diluted income per common share reflects the potential dilution that would occur had all of the issued and outstanding shares of Class B common stock been exchanged for Income Deposit Securities (“IDSs”) at the beginning of the period. On June 8, 2010, all of the Company’s issued and outstanding shares of Class B common stock were exchanged for IDSs on a one-for-one basis. Each of the IDSs issued in the exchange includes a common share. Diluted amounts are not included in the computation of diluted loss per common share when the inclusion of such amounts would be anti-dilutive. The Company does not have any outstanding stock arrangements that might be potentially dilutive.

A reconciliation of the common shares for the Company’s basic and diluted income per common share calculation is as follows:

	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
	2010		2011		2010		2011
Weighted average of common shares-basic		12,812,901		13,221,404		12,747,540		13,221,404
Effect of dilutive securities		408,503		-		473,864		-
Weighted average common shares and potential common shares-diluted		13,221,404		13,221,404		13,221,404		13,221,404
Net income available to common stockholders	$	417,276	$	1,283,277	$	31,620	$	1,287,929
Net income per basic share	$	0.03	$	0.10	$	-	$	0.10
Net income available to common stockholders	$	417,276	$	1,283,277	$	31,620	$	1,287,929
Less: Change in fair value of Class B derivative		-		-		-		-
Net income available for diluted shares	$	417,276	$	1,283,277	$	31,620	$	1,287,929
Net income per diluted share	$	0.03	$	0.10	$	-	$	0.10

5.   Fair Value Measurement

The Company adopted ASC 820, which defines fair value, establishes a framework for measuring fair value and requires additional disclosures about fair value measurements. The framework that is set forth in this standard is applicable to the fair value measurements where it is permitted or required under other accounting pronouncements.

ASC 820 defines fair value as the exit price, which is the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date. ASC 820 establishes a three-tier fair value hierarchy that prioritizes inputs to valuation techniques used for fair value measurement.

● Level 1 consists of observable market data in an active market for identical assets or liabilities.

● Level 2 consists of observable market data, other than that included in Level 1, that is either directly or indirectly observable.

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● Level 3 consists of unobservable market data. The input may reflect the assumptions of the Company, not a market participant, if there is little available market data and the Company’s own assumptions are considered by management to be the best available information.

In accordance with ASC 820, the following tables represent the Company’s fair value hierarchy for its financial assets and liabilities as of December 31, 2010 and June 30, 2011:

	December 31, 2010
	Fair Value		Level 1 (1)		Level 2 (2)		Level 3 (3)
Liabilities
Interest rate swaps	$	2,471,331	$	-	$	2,471,331	$	-
Total liabilities	$	2,471,331	$	-	$	2,471,331	$	-
	June 30, 2011
	Fair Value		Level 1 (1)		Level 2 (2)		Level 3 (3)
Liabilities
Interest rate swaps	$	1,485,090	$	-	$	1,485,090	$	-
Total liabilities	$	1,485,090	$	-	$	1,485,090	$	-

(1) Quoted prices in active markets for identical assets.

(2) Significant other observable inputs.

(3) Significant unobservable inputs.

The interest rate swaps are valued at the end of the quarter based on available market information.

6.   Subsidiary Guarantees

The Company has no independent assets or operations separate from its operating subsidiaries. The guarantees of its senior subordinated notes by 12 of its 14 operating subsidiaries are full and unconditional, joint and several. The operating subsidiaries have no independent long-term notes payable. There are no significant restrictions on the ability of the Company to obtain funds from its operating subsidiaries by dividend or loan. The condensed consolidated financial information is provided for the guarantor entities.

The following tables present condensed consolidating balance sheets as of December 31, 2010 and June 30, 2011; condensed consolidating statements of operations for the three months ended June 30, 2010 and 2011; condensed consolidating statements of operations for the six months ended June 30, 2010 and 2011; and condensed consolidating statements of cash flows for the six months ended June 30, 2010 and2011.

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Otelco Inc.

Condensed Consolidating Balance Sheet

December 31, 2010

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
ASSETS
Current assets
Cash and cash equivalents	$	-		$	18,064,970		$	161,404		$	-		$	18,226,374
Accounts receivable, net		-			9,741,477			1,125,145			-			10,866,622
Materials and supplies		-			893,186			924,125			-			1,817,311
Prepaid expenses		184,055			1,022,697			98,276			-			1,305,028
Deferred income taxes		626,267			-			-			-			626,267
Investment in subsidiaries		131,010,180			-			-			(131,010,180	)		-
Intercompany receivable		(129,599,481	)		-			-			129,599,481			-
Total current assets		2,221,021			29,722,330			2,308,950			(1,410,699	)		32,841,602
Property and equipment, net		218,301			54,043,819			9,625,093			-			63,887,213
Goodwill		239,970,317			(49,843,599	)		(1,936,640	)		-			188,190,078
Intangible assets, net		-			23,326,214			2,607,828			-			25,934,042
Investments		1,203,605			433,059			330,431			-			1,967,095
Deferred income taxes		4,415,097			-			-			-			4,415,097
Other long-term assets		5,757,825			183,946			-			-			5,941,771
Total assets	$	253,786,166		$	57,865,769		$	12,935,662		$	(1,410,699	)	$	323,176,898
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities
Accounts payable and accrued expenses	$	2,280,661		$	4,659,879		$	1,754,469		$	-		$	8,695,009
Intercompany payables		-			(131,769,870	)		2,170,389			129,599,481			-
Other current liabilities		353,285			1,678,145			89,467			-			2,120,897
Total current liabilities		2,633,946			(125,431,846	)		4,014,325			129,599,481			10,815,906
Deferred income taxes		22,592,597			16,666,501			3,253,478			-			42,512,576
Other liabilities		2,471,331			1,025,317			-			-			3,496,648
Long-term notes payable		231,332,379			40,263,476			-			-			271,595,855
Stockholders’ equity (deficit)		(5,244,087	)		125,342,321			5,667,859			(131,010,180	)		(5,244,087	)
Total liabilities and stockholders’ equity (deficit)	$	253,786,166		$	57,865,769		$	12,935,662		$	(1,410,699	)	$	323,176,898

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Otelco Inc.

Condensed Consolidating Balance Sheet

June 30, 2011

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
ASSETS
Current assets
Cash and cash equivalents	$	-		$	15,915,478		$	517,693		$	-		$	16,433,171
Accounts receivable, net		-			10,340,393			1,032,930			-			11,373,323
Materials and supplies		-			975,870			929,705			-			1,905,575
Prepaid expenses		198,891			699,086			48,917			-			946,894
Deferred income taxes		626,267			-			-			-			626,267
Investment in subsidiaries		143,509,939			-			-			(143,509,939	)		-
Intercompany receivable		(146,735,044	)		689,458			(689,458	)		146,735,044			-
Total current assets		(2,399,947	)		28,620,285			1,839,787			3,225,105			31,285,230
Property and equipment, net		524,215			54,312,203			8,807,647			-			63,644,065
Goodwill		239,970,317			(49,843,599	)		(1,936,640	)		-			188,190,078
Intangible assets, net		-			19,828,465			2,483,646			-			22,312,111
Investments		1,203,605			420,304			330,431			-			1,954,340
Deferred income taxes		4,415,097			-			-			-			4,415,097
Other long-term assets		5,073,776			142,326			-			-			5,216,102
Total assets	$	248,787,063		$	53,479,984		$	11,524,871		$	3,225,105		$	317,017,023
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities
Accounts payable and accrued expenses	$	2,076,561		$	3,729,835		$	1,621,298		$	-		$	7,427,694
Intercompany payables		-			(146,735,044	)		-			146,735,044			-
Other current liabilities		353,285			1,616,029			92,521			-			2,061,835
Total current liabilities		2,429,846			(141,389,180	)		1,713,819			146,735,044			9,489,529
Deferred income taxes		22,592,594			16,666,504			3,253,478			-			42,512,576
Other liabilities		1,485,090			986,819			-			-			2,471,909
Long-term notes payable		230,896,232			40,263,476			-			-			271,159,708
Stockholders’ equity (deficit)		(8,616,699	)		136,952,365			6,557,574			(143,509,939	)		(8,616,699	)
Total liabilities and stockholders’ equity (deficit)	$	248,787,063		$	53,479,984		$	11,524,871		$	3,225,105		$	317,017,023

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Three Months Ended June 30, 2010

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues	$	801,566		$	25,763,717		$	2,755,166		$	(2,809,505	)	$	26,510,944
Operating expenses		(801,566	)		(19,287,396	)		(2,220,150	)		2,809,505			(19,499,607	)
Income from operations		-			6,476,321			535,016			-			7,011,337
Other expense		(6,244,557	)		(87,131	)		(34	)		-			(6,331,722	)
Earnings from subsidiaries		6,924,172			-			-			(6,924,172	)		-
Income before income tax		679,615			6,389,190			534,982			(6,924,172	)		679,615
Income tax expense		(262,339	)		-			-			-			(262,339	)
Net income to common stockholders	$	417,276		$	6,389,190		$	534,982		$	(6,924,172	)	$	417,276

9

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Three Months Ended June 30, 2011

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues	$	683,089		$	24,865,811		$	2,548,932		$	(2,596,770	)	$	25,501,062
Operating expenses		(683,090	)		(18,233,881	)		(1,854,250	)		2,596,770			(18,174,451	)
Income from operations		(1	)		6,631,930			694,682			-			7,326,611
Other income (expense)		(5,619,690	)		(69,270	)		3,022			-			(5,685,938	)
Earnings from subsidiaries		7,260,364			(389,568	)		-			(6,870,796	)		-
Income before income tax		1,640,673			6,173,092			697,704			(6,870,796	)		1,640,673
Income tax expense		(357,396	)		-			-			-			(357,396	)
Net income to common stockholders	$	1,283,277		$	6,173,092		$	697,704		$	(6,870,796	)	$	1,283,277

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Six Months Ended June 30, 2010

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues	$	1,621,079		$	50,767,112		$	5,551,502		$	(5,634,540	)	$	52,305,153
Operating expenses		(1,621,079	)		(38,923,398	)		(4,515,150	)		5,634,540			(39,425,087	)
Income from operations		-			11,843,714			1,036,352			-			12,880,066
Other expense		(12,681,589	)		(166,063	)		(50	)		-			(12,847,702	)
Earnings from subsidiaries		12,713,953			-			-			(12,713,953	)		-
Income before income tax		32,364			11,677,651			1,036,302			(12,713,953	)		32,364
Income tax expense		(744	)		-			-			-			(744	)
Net income to common stockholders	$	31,620		$	11,677,651		$	1,036,302		$	(12,713,953	)	$	31,620

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Six Months Ended June 30, 2011

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues	$	1,567,352		$	49,653,245		$	5,123,906		$	(5,451,443	)	$	50,893,060
Operating expenses		(1,567,353	)		(37,892,644	)		(4,237,184	)		5,451,443			(38,245,738	)
Income from operations		(1	)		11,760,601			886,722			-			12,647,322
Other income (expense)		(10,853,003	)		(150,555	)		2,993			-			(11,000,565	)
Earnings from subsidiaries		12,499,761			-			-			(12,499,761	)		-
Income before income tax		1,646,757			11,610,046			889,715			(12,499,761	)		1,646,757
Income tax expense		(358,828	)		-			-			-			(358,828	)
Net income to common stockholders	$	1,287,929		$	11,610,046		$	889,715		$	(12,499,761	)	$	1,287,929

10

Otelco Inc.

Condensed Consolidating Statement of Cash Flows

For the Six Months Ended June 30, 2010

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries				Eliminations			Consolidated
Cash flows from operating activities:										��
Net income	$	31,620		$	11,677,651		$	1,036,302			$	(12,713,953	)	$	31,620
Adjustment to reconcile net income to cash flows from operating activities		1,694,931			10,259,423			1,725,759				-			13,680,113
Changes in assets and liabilities, net of assets and liabilities acquired		15,901,162			(13,286,240	)		(2,312,380	)			-			302,542
Net cash provided by operating activities		17,627,713			8,650,834			449,681				(12,713,953	)		14,014,275
Cash flows used in investing activities		-			(3,668,494	)		(419,810	)			-			(4,088,304	)
Cash flows used in financing activities		(17,627,713	)		1			-				12,713,953			(4,913,759	)
Net increase in cash and cash equivalents		-			4,982,341			29,871				-			5,012,212
Cash and cash equivalents, beginning of period		-			17,617,266			113,778				-			17,731,044
Cash and cash equivalents, end of period	$	-		$	22,599,607		$	143,649			$	-		$	22,743,256

Otelco Inc.

Condensed Consolidating Statement of Cash Flows

For the Six Months Ended June 30, 2011

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:
Net income	$	1,287,929		$	11,610,044		$	889,715		$	(12,499,759	)	$	1,287,929
Adjustment to reconcile net income to cash flows from operating activities		(352,512	)		9,096,405			1,457,621			-			10,201,514
Changes in assets and liabilities, net of assets and liabilities acquired		16,916,630			(17,252,428	)		(1,549,649	)		-			(1,885,447	)
Net cash provided by operating activities		17,852,047			3,454,021			797,687			(12,499,759	)		9,603,996
Cash flows used in investing activities		(305,914	)		(5,603,515	)		(441,398	)		-			(6,350,827	)
Cash flows used in financing activities		(17,546,133	)		2			-			12,499,759			(5,046,372	)
Net increase (decrease) in cash and cash equivalents		-			(2,149,492	)		356,289			-			(1,793,203	)
Cash and cash equivalents, beginning of period		-			18,064,970			161,404			-			18,226,374
Cash and cash equivalents, end of period	$	-		$	15,915,478		$	517,693		$	-		$	16,433,171

7.   Revenue Concentrations

Revenues for interstate access services are based on reimbursement of costs and an allowed rate of return. Revenues of this nature are received from the National Exchange Carrier Association in the form of monthly settlements. Such revenues amounted to 9.8% and 9.5% of the Company’s total revenues for the six months ended June 30, 2010 and 2011, respectively.

The Company has a contract through 2012 with Time Warner Cable (“TW”) for the provision of wholesale network connections to TW’s customers in Maine and New Hampshire. TW represented approximately 10.3% and 11.6% of the Company’s consolidated revenue for the six months ended June 30, 2010 and 2011, respectively. Other unrelated telecommunications providers also pay the Company access revenue for terminating calls through us to TW’s customers.

11

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

General

We operate ten rural local exchange carriers (“RLECs”) serving subscribers in north central Alabama, central Maine, western Massachusetts, central Missouri and southern West Virginia. We are the sole wireline telephone services provider for many of the rural communities we serve. We also operate competitive local exchange carriers (“CLECs”) serving subscribers throughout the states of Maine and New Hampshire. Our services include local and long distance telephone services, network access, other telephone related services, cable television (in some markets) and internet access. We view, manage and evaluate the results of operations from the various telecommunications services as one company and therefore have identified one reporting segment as it relates to providing segment information. As of June 30, 2011, we operated approximately 98,304 access line equivalents and supplied an additional 154,785 wholesale network connections.

Our core businesses are local and long distance telecommunications services, wholesale access to the local and long distance network and the provision of network access to other wireline, long distance and wireless carriers for calls originated or terminated on our network. Our core businesses generated approximately 78.3% of our total revenues in the second quarter of 2011. We also provide cable and satellite television service in some markets and digital high-speed data lines and dial-up internet access in all of our markets.

The following discussion and analysis should be read in conjunction with our financial statements and the related notes included in Item 1 of Part I and the other financial information appearing elsewhere in this report. The following discussion and analysis addresses our financial condition and results of operations on a consolidated basis.

Revenue Sources

We offer a wide range of telecommunications and entertainment services to our subscribers. More than half of our residential customers receive packages of services that are delivered and billed together. Our CLEC subscribers contract with us for selected services that meet their specific telecommunications requirements. Our revenues come from five sources:

● Local services. We receive revenues from providing local exchange telecommunications services in our ten rural territories, from the wholesale network services in New England and on a competitive basis throughout Maine and New Hampshire. These revenues include monthly subscription charges for basic service, calling beyond the local territory on a fixed price and on a per minute basis, local private line services and enhanced calling features, such as voicemail, caller identification, call waiting and call forwarding. We also provide billing and collections services for other carriers under contract and receive revenues from directory advertising. A growing portion of our rural subscribers take bundled service plans which include multiple services, including unlimited domestic calling, for a flat monthly fee.

● Network access. We receive revenues from charges established to compensate us for the origination, transport and termination of calls of long distance and other interexchange carriers. These include subscriber line charges imposed on end users and switched and special access charges paid by carriers. Switched access charges for long distance services within Alabama, Maine, Massachusetts, Missouri, New Hampshire and West Virginia are based on rates approved by the Alabama Public Service Commission, the Maine Public Utilities Commission (the “MPUC”), the Massachusetts Department of Telecommunications and Cable, the Missouri Public Service Commission, the New Hampshire Public Utilities Commission (the “NHPUC”) and the West Virginia Public Service Commission, respectively, where appropriate. Switched and special access charges for interstate and international services are based on rates approved by the Federal Communications Commission.

● Cable television. We offer basic, digital, high-definition, digital video recording and pay per view cable television services to a portion of our telephone service territory in Alabama, including Internet Protocol television (“IPTV”) and Video on Demand. We are a reseller of satellite services for DirecTV.

● Internet. We receive revenues from monthly recurring charges for digital high-speed data lines, dial-up internet access and ancillary services such as web hosting and computer virus protection.

● Transport. We receive monthly recurring revenues for the rental of fiber to transport data and other telecommunications services in Maine.

12

Voice and Data Access Line Trends

The number of access lines served is a fundamental factor in determining revenue stability for a telecommunications provider. Reflecting a general trend in the RLEC industry, the number of rural voice access lines we serve has been decreasing gradually when normalized for territory acquisitions. We expect that this trend will continue, and may be potentially impacted by the effect of the economy on our customers. These trends will be partially offset by the growth of data access lines, also called digital high-speed internet access service. Our competitive carrier voice and data access lines have grown as we continue to further penetrate our chosen markets. Our ability to continue this growth and our response to the rural trends will have an important impact on our future revenues. Our primary strategy consists of leveraging our strong incumbent market position, selling additional services to our rural customer base and providing better service and support levels than the incumbent carrier to our competitive customer base.

Key Operating Statistics

									Quarterly
									% Change
	December 31,				March 31,		June 30,		from
	2009		2010		2011		2011		March 31, 2011
Otelco access line equivalents(1)		100,356		99,639		99,271		98,304		(1.0	) %
RLEC and other services:
Voice access lines		48,215		45,461		44,770		44,113		(1.5	) %
Data access lines		20,066		20,852		21,158		21,137		(0.1	) %
Access line equivalents(1)		68,281		66,313		65,928		65,250		(1.0	) %
Cable television customers		4,195		4,227		4,029		4,054		0.6	%
Satellite television customers		100		125		217		222		2.3	%
Additional internet customers		9,116		6,975		6,435		6,046		(6.0	) %
RLEC dial-up		786		393		341		307		(10.0	) %
Other dial-up		6,439		4,300		3,786		3,403		(10.1	) %
Other data lines		1,891		2,282		2,308		2,336		1.2	%
CLEC:
Voice access lines		28,647		29,944		30,084		29,842		(0.8	) %
Data access lines		3,428		3,382		3,259		3,212		(1.4	) %
Access line equivalents(1)		32,075		33,326		33,343		33,054		(0.9	) %
Wholesale network connections		132,324		149,043		152,101		154,785		1.8	%
	For the Year Ended				For the Three Months Ended		For the Three Months Ended
	December 31,				March 31,		June 30,
		2009		2010		2011		2011
Total revenues (in millions):	$	103.8	$	104.4	$	25.4	$	25.5
RLEC	$	60.8	$	58.4	$	14.2	$	14.3
CLEC	$	43.0	$	46.0	$	11.2	$	11.2

(1)We define access line equivalents as voice access lines and data access lines (including cable modems, digital subscriber lines and dedicated data access trunks).

In our RLEC territories, access line equivalents decreased by 678 during second quarter 2011, or 1.0%, compared to March 31, 2011. Voice access lines declined 1.5% while data access lines declined by 0.1% during the period. Second quarter has historically been our weakest quarter for RLEC access line retention, primarily driven by housing movement at the end of the school year. We offer location specific bundled service packages, many including unlimited domestic calling, tailored to the telecommunications requirements of our customers.

In our Maine and New Hampshire CLEC operations, access line equivalents decreased by 289 during second quarter 2011, or 0.9%, compared to March 31, 2011. Voice access lines decreased 0.8% while data access lines decreased 1.4% during the period. Competition, the continued impact of the economy and a more extended schedule for providing service in new territory impacted growth. Virtually all of our competitive customers are businesses, with service bundles tailored to their specific business requirements.

13

Competitive pricing and bundling of services have led Otelco’s long distance service to be the choice of the majority of the customers in the rural markets we serve. In addition, almost all of our Maine and New Hampshire CLEC customers have selected us as their long distance carrier. Our cable television customers increased 0.6% from March 31, 2011 to 4,054 as of June 30, 2011. We upgraded 10 customers to our digital offering and added 53 new IPTV customers during the same period. Other internet customers decreased 6.0% to 6,046 as of June 30, 2011 compared to March 31, 2011. This also includes the subscribers we service outside of our telephone service area throughout Missouri and Maine, reflecting the shift to digital high-speed internet services. In Missouri, we are expanding our data access lines for digital high-speed internet in selected areas outside of our telephone service territory. Approximately 38% of the other internet customers are served by high-speed data capability from Otelco.

Our Rate and Pricing Structure

Our CLEC pricing is based on market requirements. We combine varying services to meet individual customer requirements, including technical support, and provide multi-year contracts which are both market sensitive for the customer and profitable for us. The MPUC and the NHPUC impose certain requirements on all CLECs operating in their markets for reporting and for interactions with the various incumbent local exchange and interexchange carriers. These requirements provide wide latitude in pricing services.

Our RLECs operate in five states and are regulated in varying degrees by the respective state regulatory authorities. The impact on pricing flexibility varies by state. In Maine, two of our wholly owned subsidiaries, Saco River Telegraph and Telephone Company and The Pine Tree Telephone and Telegraph Company, have obtained authority to implement pricing flexibility while remaining under rate-of-return regulation. Our rates for other services we provide, including cable, long distance, data lines and dial-up and high-speed internet access, are not price regulated. The market for competitive services, such as wireless, also impacts our ability to adjust prices. With the increase of bundled services offerings, including unlimited long distance, pricing for individual services takes on reduced importance to revenue stability. We expect this trend to continue into the immediate future.

Categories of Operating Expenses

Our operating expenses are categorized as cost of services and products; selling, general and administrative expenses; and depreciation and amortization.

Cost of services and products. This includes expenses for salaries, wages and benefits relating to plant operation, maintenance, sales and customer service; other plant operations, maintenance and administrative costs; network access costs; and costs of services for long distance, cable television, internet and directory services.

Selling, general and administrative expenses. This includes expenses for salaries, wages and benefits and contract service payments relating to engineering, financial, human resources and corporate operations; information management expenses, including billing; allowance for uncollectible revenue; expenses for travel, lodging and meals; internal and external communications costs; insurance premiums; stock exchange and banking fees; and postage.

Depreciation and amortization. This includes depreciation of our telecommunications, cable and internet networks and equipment, and amortization of intangible assets. Certain of these amortization expenses continue to be deductible for tax purposes.

Our Ability to Control Operating Expenses

We strive to control expenses in order to maintain our strong operating margins. As our revenue shifts to non-regulated services and CLEC customers, operating margins decrease reflecting the lower margins associated with these services. We expect to control expenses while we continue to grow our business.

14

Results of Operations

The following table sets forth our results of operations as a percentage of total revenues for the periods indicated:

	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2011			2010			2011
Revenues
Local services		46.3	%		46.8	%		46.9	%		47.0	%
Network access		32.5			31.7			31.7			31.3
Cable television		2.6			2.8			2.6			2.9
Internet		13.3			13.5			13.5			13.6
Transport services		5.3			5.2			5.3			5.2
Total revenues		100.0	%		100.0	%		100.0	%		100.0	%
Operating expenses
Cost of services and products		39.4	%		42.2	%		40.2	%		42.8	%
Selling, general and administrative expenses		12.2			11.4			12.4			12.3
Depreciation and amortization		22.0			17.7			22.8			20.1
Total operating expenses		73.6			71.3			75.4			75.2
Income from operations		26.4			28.7			24.6			24.8
Other income (expense)
Interest expense		(23.2	)		(24.3	)		(23.3	)		(24.3	)
Change in fair value of derivatives		(0.7	)		1.9			(2.0	)		1.9
Other income		0.1			0.1			0.8			0.8
Total other expenses		(23.8	)		(22.3	)		(24.5	)		(21.6	)
Income before income tax		2.6			6.4			0.1			3.2
Income tax expense		(1.0	)		(1.4	)		(0.0	)		(0.7	)
Net income available to common stockholders		1.6	%		5.0	%		0.1	%		2.5	%

Three Months and Six Months Ended June 30, 2011 Compared to Three Months and Six Months Ended June 30, 2010

Total revenues. Total revenues decreased 3.8% in the three months ended June 30, 2011 to $25.5 million from $26.5 million in the three months ended June 30, 2010. Total revenues decreased 2.7% in the six months ended June 30, 2011 to $50.9 million from $52.3 million in the six months ended June 30, 2010. The tables below provide the components of our revenues for the three months and six months ended June 30, 2011 compared to the same periods of 2010.

For the three months ended June 30, 2011 and 2010

	Three Months Ended June 30,				Change
	2010		2011		Amount			Percent
	(dollars in thousands)
Local services	$	12,286	$	11,940	$	(346	)		(2.8	)%
Network access		8,604		8,076		(528	)		(6.1	)
Cable television		699		707		8			1.1
Internet		3,527		3,458		(69	)		(2.0	)
Transport services		1,395		1,320		(75	)		(5.4	)
Total	$	26,511	$	25,501	$	(1,010	)		(3.8	)

15

Local services. Local services revenue decreased 2.8% to $11.9 million in the three months ended June 30, 2011 from $12.3 million in the three months ended June 30, 2010. The growth in CLEC revenue accounted for an increase of $0.1 million. RLEC revenue, including bundled services such as long distance, decreased $0.4 million reflecting the decline in RLEC voice access lines.

Network access. Network access revenue decreased 6.1% to $8.1 million in the three months ended June 30, 2011 from $8.6 million in the three months ended June 30, 2010. Interstate and intrastate switched access declined $0.1 million. A one-time settlement in 2010 accounted for the balance of the difference.

Cable television. Cable television revenue increased 1.1% to remain at $0.7 million in the three months ended June 30, 2011 and June 30, 2010. Growth in IPTV subscribers and the shift to high-definition packages in Alabama was offset by the decline in revenue associated with the conversion of our Missouri cable customers to satellite services during first quarter 2011.

Internet. Internet revenue decreased 2.0% to remain at $3.5 million in the three months ended June 30, 2011 and June 30, 2010. The growth in new digital data access lines, including related equipment rental, and fiber leases offset the decline of dial-up internet customers associated with the conversion to digital data access lines, including those customers in Maine and Missouri that are outside of our local service areas.

Transport services. Transport services revenue decreased 5.4% to $1.3 million in the three months ended June 30, 2011 from $1.4 million in the three months ended June 30, 2010. Market price changes for new and existing customers caused the decline.

For the six months ended June 30, 2011 and 2010

	Six Months Ended June 30,				Change
	2010		2011		Amount			Percent
	(dollars in thousands)
Local services	$	24,525	$	23,946	$	(579	)		(2.4	)%
Network access		16,589		15,936		(653	)		(3.9	)
Cable television		1,364		1,459		95			7.0
Internet		7,038		6,914		(124	)		(1.8	)
Transport services		2,789		2,638		(151	)		(5.4	)
Total	$	52,305	$	50,893	$	(1,412	)		(2.7	)

Local services. Local services revenue decreased 2.4% to $23.9 million in the six months ended June 30, 2011 from $24.5 million in the six months ended June 30, 2010. The growth in CLEC revenue accounted for an increase of $0.2 million. RLEC revenue, including bundled services such as long distance, decreased $0.7 million reflecting the decline in RLEC access lines.

Network access. Network access revenue decreased 3.9% to $15.9 million in the six months ended June 30, 2011 from $16.6 million in the six months ended June 30, 2010. Interstate and intrastate switched access declined $0.2 million. A one-time settlement in 2010 accounted for the balance of the difference.

Cable television. Cable television revenue increased 7.0% to $1.5 million in the six months ended June 30, 2011 from $1.4 million in the six months ended June 30, 2010. Growth in IPTV subscribers and the shift to high-definition packages increased revenue $0.3 million, which was partially offset by a $0.2 million decline associated with the conversion of our Missouri cable customers to satellite services during first quarter 2011 and fewer basic cable customers.

Internet. Internet revenue decreased 1.8% to $6.9 million in the six months ended June 30, 2011 from $7.0 million in the six months ended June 30, 2010. The growth in new digital data access lines, including related equipment rental, and Missouri fiber leases accounted for an increase of $0.2 million. The decline of dial-up internet customers associated with the conversion to digital data access lines, including those customers in Maine and Missouri that are outside of our local service areas, accounted for a decrease of $0.3 million.

Transport services. Transport services revenue decreased 5.4% to $2.7 million in the six months ended June 30, 2011 from $2.8 million in the six months ended June 30, 2010. Market price changes for new and existing customers caused the decline.

Operating expenses. Operating expenses in the three months ended June 30, 2011 decreased 6.8% to $18.2 million from $19.5 million in the three months ended June 30, 2010. Operating expenses in the six months ended June 30, 2011 decreased 3.0% to $38.2 million from $39.4 million in the six months ended June 30, 2010. The tables below provide the components of our operating expenses for the three months and six months ended June 30, 2011 compared to the same periods of 2010.

16

For the three months ended June 30, 2011 and 2010

	Three Months Ended June 30,				Change
	2010		2011		Amount			Percent
	(dollars in thousands)
Cost of services and products	$	10,428	$	10,757	$	329			3.2	%
Selling, general and administrative expenses		3,237		2,910		(327	)		(10.1	)
Depreciation and amortization		5,835		4,508		(1,327	)		(22.7	)
Total	$	19,500	$	18,175	$	(1,325	)		(6.8	)

Cost of services and products. Cost of services and products increased 3.2% to $10.8 million in the three months ended June 30, 2011 from $10.4 million in the three months ended June 30, 2010. The increase is primarily associated with higher sales and services expenses of $0.5 million for the new hosted private branch exchange (“PBX”) product, partially offset by lower network and maintenance costs of $0.2 million.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased 10.1% to $2.9 million in the three months ended June 30, 2011 from $3.2 million in the three months ended June 30, 2010. Lower employee costs of $0.2 million, legal costs of $0.1 million and administrative costs of $0.1 million, plus operating tax credits of $0.2 million, were partially offset by an increase of $0.3 million in uncollectible revenue reserves.

Depreciation and amortization. Depreciation and amortization decreased 22.7% to $4.5 million in the three months ended June 30, 2011 from $5.8 million in the three months ended June 30, 2010. Amortization of intangible assets associated with the acquisition of three entities from Country Road Communications LLC (the “CR Companies”) decreased $0.3 million, including contract and customer base intangible assets. The remaining decrease of $1.0 million reflects lower depreciation of plant assets in our regulated entities as assets become fully depreciated, as well as the application of additional information to more accurately reflect the remaining useful lives of these regulated assets. This change in estimate will not affect future reporting periods.

For the six months ended June 30, 2011 and 2010

	Six Months Ended June 30,				Change
	2010		2011		Amount			Percent
	(dollars in thousands)
Cost of services and products	$	21,038	$	21,777	$	739			3.5	%
Selling, general and administrative expenses		6,467		6,237		(230	)		(3.6	)
Depreciation and amortization		11,920		10,232		(1,688	)		(14.2	)
Total	$	39,425	$	38,246	$	(1,179	)		(3.0	)

Cost of services and products. Cost of services and products increased 3.5% to $21.8 million in the six months ended June 30, 2011 from $21.0 million in the six months ended June 30, 2010. The increase is primarily associated with higher sales and services expenses of $0.9 million for the new hosted PBX product, partially offset by lower RLEC network, customer service and maintenance costs of $0.2 million.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased 3.6% to $6.2 million in the six months ended June 30, 2011 from $6.5 million in the six months ended June 30, 2010. Operational synergies and lower operational taxes, legal and insurance costs of $0.6 million were partially offset by higher external relations costs and reserves for uncollectible accounts of $0.3 million.

Depreciation and amortization. Depreciation and amortization decreased 14.2% to $10.2 million in the six months ended June 30, 2011 from $11.9 million in the six months ended June 30, 2010. Amortization of intangible assets associated with the acquisition of the CR Companies decreased $0.4 million, including a covenant not to compete and contract customer base assets. The remaining decrease of $1.3 million reflected lower depreciation of plant assets in our regulated entities as assets become fully depreciated, as well as the application of additional information to more accurately reflect the remaining useful lives of these regulated assets. This change in estimate will not affect future reporting periods.

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For the three months ended June 30, 2011 and 2010

	Three Months Ended June 30,						Change
	2010			2011			Amount			Percent
	(dollars in thousands)
Interest expense	$	(6,179	)	$	(6,199	)	$	20			0.3	%
Change in fair value of derivatives		(176	)		480			656		NM
Other income		24			33			9			37.5
Income tax expense		(262	)		(357	)		(95	)		36.3

Interest expense. Interest expense was $6.2 million in the three months ended June 30, 2011 and June 30, 2010. Increased interest associated with the exchange of our Class B shares for Income Deposit Securities (“IDSs”) in June 2010 was offset by lower interest on our senior credit facility related to voluntary prepayments of principal.

Change in fair value of derivatives. We have two interest rate swap agreements to hedge our exposure to changes in interest rate costs associated with our senior credit facility. From an accounting perspective, the swaps do not meet the technical requirements to allow the swaps to be considered highly effective hedging instruments and therefore the swaps do not qualify for hedge accounting. These swap agreements must be considered investments and the change in value is reflected as a change in fair value of derivatives. The liability associated with the swaps declined $0.5 million in the three months ended June 30, 2011 reflecting the changes in the anticipated interest rate market and the shorter time to maturity, compared to an increase in liability of $0.2 million in the three months ended June 30, 2010. Over the life of the swaps, the cumulative change in value will be zero. See —Liquidity and Capital Resources below for additional explanation.

Other income. Other income was less than $0.1 million in the three months ended June 30, 2011 and June 30, 2010.

Income tax expense. Provision for income taxes was an expense of $0.4 million in the three months ended June 30, 2011 and an expense of $0.3 million in the three months ended June 30, 2010. 

For the six months ended June 30, 2011 and 2010

	Six Months Ended June 30,						Change
	2010			2011			Amount			Percent
	(dollars in thousands)
Interest expense	$	(12,168	)	$	(12,369	)	$	201			1.7	%
Change in fair value of derivatives		(1,062	)		986			2,048		NM
Other income		383			382			(1	)		(0.3	)
Income tax expense		-			(359	)		(359	)	NM

Interest expense. Interest expense increased 1.7% to $12.4 million in the six months ended June 30, 2011 from $12.2 million in the six months ended June 30, 2010. Interest associated with the exchange of our Class B shares for IDSs in June 2010 accounted for the increase.

Change in fair value of derivatives. We have two interest rate swap agreements to hedge our exposure to changes in interest rate costs associated with our senior credit facility. From an accounting perspective, the swaps do not meet the technical requirements to allow the swaps to be considered highly effective hedging instruments and therefore the swaps do not qualify for hedge accounting. These swap agreements must be considered investments and the change in value is reflected as a change in fair value of derivatives. The liability associated with the swaps declined $1.0 million in the six months ended June 30, 2011 reflecting the changes in the anticipated interest rate market and the shorter time to maturity, compared to an increase in liability of $1.0 million in the six months ended June 30, 2010. Over the life of the swaps, the cumulative change in value will be zero. See — Liquidity and Capital Resources below for additional explanation.

Other income. Other income was $0.4 million in the six months ended June 30, 2011 and June 30, 2010, reflecting the annual CoBank dividends that we receive in the first quarter of each year.

Income tax expense. Provision for income taxes was an expense of $0.4 million in the six months ended June 30, 2011 and an expense of less than $0.1 million in the six months ended June 30, 2010.

Net income. As a result of the foregoing, there was net income of $1.3 million in the three months ended June 30, 2011 and $0.4 million in the three months ended June 30, 2010. There was net income of $1.3 million in the six months ended June 30, 2011 and less than $0.1 million in the six months ended June 30, 2010.

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Liquidity and Capital Resources

Our liquidity needs arise primarily from: (i) interest payments related to our senior credit facility and our senior subordinated notes; (ii) capital expenditures; (iii) working capital requirements; (iv) dividend payments on our Class A common stock (“common stock”); and (v) potential acquisitions.

Historically, we satisfy our operating cash requirements from the cash generated by our business and utilize borrowings under our senior credit facility to facilitate acquisitions; however, we expect to finance our previously announced anticipated acquisition of Shoreham Telephone Company, Inc. using cash on hand. For the six months ended June 30, 2011, we generated cash from our business to invest in additional property and equipment, pay interest on our senior debt, pay interest associated with the senior subordinated debt inherent in our IDSs and fund dividends (as declared by our board of directors) on the shares of common stock that are inherent in our IDSs. After meeting all of these needs of our business and making a voluntary prepayment on our senior credit facility, cash decreased from $18.2 million at December 31, 2010 to $16.4 million at June 30, 2011. The Company has as its current policy to return a high percentage of its available cash to its IDS holders.

Cash flows from operating activities for the first six months of 2011 amounted to $9.6 million compared to $14.0 million for the first six months of 2010. Net income, when adjusted for its non-cash components, declined by $2.3 million reflecting lower revenues and somewhat higher costs and expenses. The changes in operating assets and liabilities of $2.1 million reflect a $0.4 million income tax receivable only in 2010, an increase in the change in accounts receivable of $0.8 million reflecting a non-recurring improvement in payments from carriers in Maine during 2010 and a change of $0.9 million in payables and other liabilities.

Cash flows used in investing activities for the first six months of 2011 were $6.4 million compared to $4.1 million in the first six months of 2010. The higher rate of capital expenditures for property and equipment in the first six months of 2011, including storm damage repair, accounted for the difference.

Cash flows used in financing activities for the first six months of 2011 were $5.0 million compared to $4.9 million for the first six months of 2010, reflecting payments of dividends to stockholders in both periods. The dividend was $0.17625 per share per quarter in both periods. The number of shares of common stock outstanding increased in June 2010 in connection with the exchange of our Class B shares for IDSs. We have paid twenty-six consecutive dividends at this rate since the Company went public in December 2004.

We do not invest in financial instruments as part of our business strategy. The Company has a $90 million notional amount interest rate swap with the Company paying 1.85% and the counterparty paying a variable rate based upon the three month LIBOR for three years beginning February 9, 2009 and a $60 million notional amount interest rate swap with the Company paying 2.0475% and the counterparty paying a variable rate based upon the three month LIBOR for two years beginning February 9, 2010. From an accounting perspective, the documentation for both swaps does not meet the technical requirements of Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging, to allow the swaps to be considered highly effective as hedging instruments and therefore the swaps do not qualify for hedge accounting.

We also have received patronage shares, primarily from one of our lenders, over a period of years for which there is a limited market to determine value until the shares are redeemed by the issuing institution. Historically, these shares have been redeemed at a value similar to their issued value. Due to the uncertainty of this future value, these shares are carried at approximately 55% of their issued value.

We anticipate that operating cash flow, together with borrowings under our senior credit facility, will be adequate to meet our currently anticipated operating and capital expenditure requirements for at least the next 12 months.

The following table provides a summary of the extent to which cash generated from operations is reinvested in our operations, used to pay interest on our senior debt and senior subordinated notes or distributed as dividends to our stockholders for the periods indicated. The table reflects the increased investment in our business during 2011, including the replacement of storm damaged poles, lines and equipment.

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	Six Months Ended June 30,
	2010			2011
	(dollars in thousands)
Cash generation
Revenues	$	52,305		$	50,893
Other income		383			382
Cash received from operations		52,688			51,275
Cost of services and products		21,038			21,777
Selling, general and administrative expenses		6,468			6,237
Cash consumed by operations		27,506			28,014
Cash generated from operations	$	25,182		$	23,261
Cash utilization
Capital investment in operations	$	4,087		$	6,351
Senior debt interest and fees		4,803			4,767
Interest on senior subordinated notes		6,765			6,998
Dividends		4,565			4,661
Cash utilized by the Company	$	20,220		$	22,777
Percentage of cash utilized of cash generated		80.3	%		97.9	%

We use adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) as an operational performance measurement. Adjusted EBITDA, as presented in this Form 10-Q, corresponds to the definition of Adjusted EBITDA in the indenture governing our senior subordinated notes and our senior credit facility. Adjusted EBITDA, as presented in this Form 10-Q, is a supplemental measure of our performance that is not required by, or presented in accordance with, accounting principles generally accepted in the United States (“U.S. GAAP”). Our senior credit facility requires that we report performance in this format each quarter and involved lending institutions utilize this measure to determine compliance with credit facility requirements. We report Adjusted EBITDA in our quarterly earnings press release to allow current and potential investors to understand this performance metric and because we believe that it provides current and potential investors with helpful information with respect to our operating performance and cash flows. However, Adjusted EBITDA should not be considered as an alternative to net income or any other performance measures derived in accordance with U.S. GAAP or as an alternative to net cash provided by operating activities as a measure of our liquidity. Our presentation of Adjusted EBITDA may not be comparable to similarly titled measures used by other companies. Adjusted EBITDA for the three months and six months ended June 30, 2010 and 2011, and its reconciliation to net income, is reflected in the table below:

	Three Months Ended June 30,					Six Months Ended June 30,
	2010		2011			2010		2011
	(dollars in thousands)
Net income	$	417	$	1,283		$	32	$	1,288
Add:  Depreciation		3,327		2,307			6,900		5,829
Interest expense - net of premium		5,840		5,857			11,491		11,685
Interest expense - amortize loan cost		339		342			677		684
Income tax expense		262		357			1		359
Change in fair value of derivatives		176		(480	)		1,062		(986	)
Loan fees		19		19			38		38
Amortization - intangibles		2,510		2,202			5,019		4,403
Adjusted EBITDA	$	12,890	$	11,887		$	25,220	$	23,300

Recent Accounting Pronouncements

During 2011, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Updates (“ASUs”) 2011-01 through 2011-07. Except for ASU 2011-04 and ASU 2011-05, which are discussed below, these ASUs provide technical corrections to existing guidance related to specialized industries or entities and therefore, have minimal, if any, impact on the Company.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), an update to ASC 820, Fair Value Measurements and Disclosures. ASU 2011-04 provides guidance to change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For public entities, ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and is to be applied prospectively. Early application by public entities is not permitted. As ASU 2011-04 impacts presentation only, the adoption of this update will not impact our consolidated financial statements.

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In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), an update to ASC 220, Comprehensive Income. This ASU requires the components of net income and the components of other comprehensive income to be presented either in a single continuous statement of comprehensive income or in two separate but continuous statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. This guidance does not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income or how earnings per share is calculated or presented. ASU 2011-05 is effective for public entities for interim and annual periods beginning after December 15, 2011. Early adoption is permitted. As ASU 2011-05 impacts presentation only, the adoption of this update will not impact our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our short-term excess cash balance is invested in short-term commercial paper. We do not invest in any derivative or commodity type instruments. Our two interest rate swap agreements are technically not effective hedges and therefore do not qualify for hedge accounting. The change in the fair value of the swaps is charged or credited to income as a change in fair value of derivatives. Over the life of the swaps, the cumulative change in value will be zero. Accordingly, we are subject to minimal market risk on our investments.

We have the ability to borrow up to $15.0 million under a revolving loan facility. The interest rate is variable and, accordingly, we would be exposed to interest rate risk, primarily from a change in LIBOR or a base rate, should the facility be used. Currently, we have no loans drawn under this facility.

Item 4. Controls and Procedures

With the participation of the Chief Executive Officer and the Chief Financial Officer, management has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2011.

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the three months ended June 30, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 

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PART II  OTHER INFORMATION

Item 6. Exhibits

Exhibits

See Exhibit Index.

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SIGNATURES

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

Date: August 5, 2011	OTELCO INC.
	By:	/s/ Curtis L. Garner, Jr.
		Curtis L. Garner, Jr.
		Chief Financial Officer

EXHIBIT INDEX

Exhibit No.	Description
31.1	Certificate pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934 of the Chief Executive Officer
31.2	Certificate pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934 of the Chief Financial Officer
32.1	Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive Officer
32.2	Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Financial Officer
101	The following information from the Company’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2011 formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Cash Flows; and (iv) Notes to Consolidated Financial Statements, tagged as blocks of text