10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2005
	or
¨	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 organization)	(I.R.S. Employer Identification No.)
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   ý          No   ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes   o          No   ý

APPLICABLE ONLY TO CORPORATE USERS:

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 9, 2005
Class A Common Stock ($0.01 par value per share)	9,676,733
Class B Common Stock ($0.01 par value per share)	544,671

OTELCO INC.

FORM 10-Q

For the three and six month period ended June 30, 2005

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of December 31, 2004 and June 30, 2005
	Consolidated Statements of Income for the three and six months ended June 30, 2004 and 2005
	Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2005
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II OTHER INFORMATION
Item 4.	Submission of Matters to a vote of Security Holders
Item 6.	Exhibits

2

Unless the context otherwise requires, the words “we”, “us”, “our”, “the company” and “Otelco” refer to Otelco Inc., a Delaware corporation.

FORWARD-LOOKING STATEMENTS

The 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, 2004			June 30 2005
				(unaudited)
Assets
Current assets
Cash and cash equivalents	$	5,406,545		$	5,231,715
Accounts receivable:
Due from subscribers, net of allowance for doubtful accounts of $170,515 and $163,993, respectively.	1,179,074			1,185,584
Unbilled receivables	1,884,405			1,805,661
Other	1,522,945			1,410,512
Materials and supplies	1,039,910			1,006,614
Prepaid expenses	537,784			469,636
Deferred income taxes	652,625			652,625
Total current assets	12,223,288			11,762,347
Property and equipment, net	48,195,568			46,723,783
Goodwill	119,714,094			119,714,094
Intangible assets, net	2,050,943			1,819,511
Investments	1,298,852			1,205,251
Deferred financing costs	8,020,743			7,423,264
Interest rate cap	4,723,135			3,921,098
Total assets	$	196,226,623		$	192,569,348
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$	2,690,351		$	1,433,021
Accrued expenses	1,862,604			2,553,098
Advance billings and payments	1,141,013			1,159,093
Customer deposits	220,209			233,864
Total Current Liabilities	5,914,177			5,379,076
Deferred income taxes	13,053,226			13,053,226
Other liabilities	196,644			185,284
Total deferred tax and other liabilities	13,249,870			13,238,510
Long-term notes payable	161,075,498			161,075,498
Derivative liability	2,788,716			2,173,237
Class B common convertible to senior subordinated notes	3,212,528			3,433,991
Stockholders’ Equity
Class A Common Stock, $.01 par value-authorized 20,000,000 shares; issued and outstanding 9,676,733 shares	96,767			96,767
Class B Common Stock, $.01 par value-authorized 800,000 shares; issued and outstanding 544,671 shares	5,447			5,447
Additional paid in capital	12,435,800			9,024,752
Retained deficit	(2,597,315		)	(1,151,744		)
Accumulated other comprehensive income (loss)	45,135			(706,186		)
Total stockholders’ equity	9,985,834			7,269,036
Total liabilities and stockholders’ equity	$	196,226,623		$	192,569,348

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

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OTELCO INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three months ended June 30,						Six months ended June 30,
	2004			2005			2004			2005
Revenues
Local service	$	3,511,668		$	3,561,731		$	6,929,055		$	7,205,376
Network access	3,888,914			5,235,327			8,001,836			10,964,633
Long distance and other telephone services	673,905			779,294			1,352,574			1,564,274
Cable television	435,483			516,060			873,413			1,012,178
Internet	519,033			1,350,112			999,364			2,723,158
Total revenues	9,029,003			11,442,524			18,156,242			23,469,619
Operating expenses
Cost of services and products	1,992,032			3,020,050			3,961,424			6,073,594
Selling, general and administrative expenses	1,588,107			1,512,050			3,218,619			3,326,999
Depreciation and amortization	1,493,491			2,370,986			3,047,182			4,736,193
Total operating expenses	5,073,630			6,903,086			10,227,225			14,136,786
Income from operations	3,955,373			4,539,438			7,929,017			9,332,833
Other income (expense)
Interest expense	(792,413		)	(4,057,957		)	(1,630,234		)	(8,035,748		)
Change in fair value of derivative	—			337,696			—			615,479
Other income	6,637			47,215			54,276			320,691
Total other expense	(785,776		)	(3,673,046		)	(1,575,958		)	(7,099,578		)
Income before income tax and accretion expense	3,169,597			866,392			6,353,059			2,233,255
Income tax expense	(1,122,038		)	(139,301		)	(2,248,984		)	(566,221		)
Income before accretion expense	2,047,559			727,091			4,104,075			1,667,034
Accretion of Class B common convertible to senior subordinated notes	—			(110,732		)	—			(221,463		)
Net income available to common stockholders	$	2,047,559		$	616,359		$	4,104,075		$	1,445,571
Weighted average shares outstanding:
Basic	8,054,841			9,676,733			8,054,841			9,676,733
Diluted	8,557,304			10,221,404			8,557,304			10,221,404
Net income per share
Basic	$	0.25		$	0.06		$	0.51		$	0.15
Diluted	$	0.24		$	0.04		$	0.48		$	0.10
Dividends declared per share	$	—		$	0.18		$	—		$	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,
	2004			2005
Cash flows from operating activities:
Net income	$	4,104,075		$	1,445,571
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation	2,848,300			3,844,022
Amortization	198,882			892,171
Interest rate caplet	—			50,716
Accretion expense	—			221,463
Change in fair value of derivative liability	—			(615,479		)
Provision for uncollectible revenue	34,014			42,249
Changes in assets and liabilities, net of assets and liabilities acquired:
Accounts receivables	128,321			142,418
Material and supplies	179,330			33,296
Prepaid expenses and other assets	239,955			68,151
Accounts payable and accrued liabilities	2,961,437			(566,838		)
Advance billings and payments	38,701			18,080
Other liabilities	(11,000		)	2,295
Net cash from operating activities	10,722,015			5,578,115
Cash flows from investing activities:
Acquisition and construction of property and equipment	(1,914,215		)	(2,359,481		)
Proceeds from retirement of investment	38,778			80,846
Capitalized transaction costs	(479,314		)	—
Net cash from investing activities	(2,354,751		)	(2,278,635		)
Cash flows from financing activities:
Cash dividends paid	—			(3,411,048		)
Loan origination cost and transaction cost	—			(63,262		)
Repayment of long-term notes payable	(3,811,113		)	—
Net cash from financing activities	(3,811,113		)	(3,474,310		)
Net increase (decrease) in cash and cash equivalents	4,556,151			(174,830		)
Cash and cash equivalents, beginning of period	1,650,307			5,406,545
Cash and cash equivalents, end of period	$	6,206,458		$	5,231,715
Supplemental disclosures of cash flow information:
Interest paid	$	1,393,200		$	8,337,834
Income taxes paid (received)	$	452,000		$	(350,000	)

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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”), its wholly owned subsidiaries Otelco Telecommunications LLC (“OTC”), Otelco Telephone LLC (“OTP”), Hopper Holding Company, Inc. (“HHC”), Brindlee Holdings LLC (“BH”), Page & Kiser Communications, Inc. (“PKC”), and Mid-Missouri Holding Corporation (“MMH”).  HHC’s wholly owned subsidiary is Hopper Telecommunications Company, Inc. (“HTC”).  BH’s owned subsidiary is Brindlee Mountain Telephone Company, Inc. (“BMTC”).  PKC’s wholly owned subsidiary is Blountsville Telephone Company, Inc. (“BTC”).  On December 21, 2004, the Company acquired MMH.  MMH’s wholly owned subsidiary is Mid-Missouri Telephone Company (“MMT”).  MMT is the sole stockholder of Imagination, Inc., which provides internet services in certain locations in Missouri.  The accompanying consolidated financial statements include the accounts of the Company and all of its subsidiaries after elimination of all material intercompany balances and transactions.

The consolidated financial statements and footnotes 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, 2004.  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.

2.Commitment 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 and Missouri Public Service Commission related primarily to rate making.  Currently, none of the legal proceedings are expected to have a material adverse effect on our business.

3.Acquisitions

On December 21, 2004, the Company acquired 100% of the outstanding common stock of MMH.  MMH owns 100% of MMT.  MMT is a local exchange carrier in central Missouri.  The implicit purchase price of the acquisition was $30,540,774 including assumed notes payable.  The excess of the total purchase price over the assigned value of the identifiable net assets is reflected as goodwill and intangible assets in the amount of $17,858,806 and $1,800,000, respectively.  The goodwill related to the acquisition is not deductible for tax purposes.

The allocation of the net purchase price for the MMH acquisition is as follows:

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	2004
Current Assets	$	1,158,957
Property and equipment	12,900,823
Intangible assets	1,800,000
Goodwill	17,858,806
Other assets	422,680
Current liabilities	(1,144,674		)
Notes payable	(16,714,140		)
Other liabilities	(2,455,818		)
Net purchase price	$	13,826,634

The Company issued 856,234 shares of Class A common stock ($8,562 par value) underlying the 856,234 IDSs and 53,413 shares of Class B common stock ($534 par value) in connection with the acquisition of MMHC based on an exchange ratio of 0.14126 IDSs and 0.00881 shares of Class B common stock for each share of MMHC.  The issuance of Class A common stock represented by Income Deposit Securities (“IDSs”), Class B common stock and Class A common stock associated with the conversion of options resulted in an increase in paid-in capital of $7,222,120.  Each IDS represents one share of Class A common stock and a 13.0% senior subordinated note with a $7.50 principal amount.  The number of IDSs and shares of Class B common stock to be received upon exchange of each outstanding option to acquire shares of Mid-Missouri Holding were equal to the number of IDSs and shares of Class B common stock that a holder would have received in the exchange had the holder exercised the option on a “cashless basis.”  The embedded exchange feature of the Class B common stock is accounted for separately as a derivative liability.

The following unaudited pro forma information presents the combined results of operations of the Company as though the acquisition of MMH completed in 2004 occurred at the beginning of the year.   The results include certain adjustments, including increased interest expense on notes payable related to the acquisition.  The pro forma financial information does not necessarily reflect the results of operations had the acquisition been completed at the beginning of 2004 or those which may be obtained in the future. The impacts of accounting for the change in fair value of derivative and accretion expense have not been included in the results.

	Unaudited For the three months ended June 30, 2004		Unaudited For the six months ended June 30, 2004
Revenues	$	11,693,475	$	23,508,187
Income from operations	4,684,876		9,413,142
Net income	2,230,659		4,502,523
Basic net income per share	$	0.28	$	0.56
Diluted net income per share	$	0.26	$	0.53

The acquisition was accounted for using the purchase method of accounting and accordingly, the accompanying financial statements include the financial position and results of operation from the date of acquisition.

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4.Derivative and Hedge Activities

The interest rate cap was purchased on December 21, 2004, coincident with the closing of our initial public offering and the recapitalization of our senior notes payable.  The interest rate cap was purchased to mitigate the risk of rising interest rates to limit or cap the rate at 7%.  It is considered an effective hedge as all critical terms of the interest rate cap are identical to the underlying debt it hedges.  Changes in the fair value of the interest rate cap are not included in earnings but are reported as a component of accumulated other comprehensive income.  For the three months and six months ended June 30, 2005 the change in the fair value of the interest rate cap was $(1,554,453) and $(751,321) respectively.  The cost of the interest rate cap is expensed as interest over the effective life of the hedge in accordance with the quarterly value of the caplets as determined at the date of inception.  For the three months and six months ended June 30, 2005 the cost of the interest rate cap was $29,619 and $50,716, respectively.

5.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 could occur if the Class B common stock were exercised into IDSs.  Class B common stock is convertible on a one-for-one basis into IDSs, each of which includes a Class A common share.  For periods prior to our conversion, membership units were treated on an as if converted basis into Class A and Class B common shares.

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

	For the three months ended June 30,									For the six months ended June 30,
	2004						2005			2004		2005
Weighted average common shares at conversion	8,054,841						8,054,841			8,054,841		8,054,841
Purchase of Mid-Missouri Holding Corp., sale of common shares by Company, and buy-back of common shares by Company (12/21/04)	—						1,621,892			—		1,621,892
Weighted average common shares-basic	8,054,841						9,676,733			8,054,841		9,676,733
Effect of Class B shares at conversion	502,463						502,463			502,463		502,463
Effect on Class B shares from purchse of Mid Missouri-Holding Corp., sale of common shares by Company, and buy-back of common shares by Company (12/21/04)	—						42,208			—		42,208
Effect of dilutive securities	502,463						544,671			502,463		544,671
Weighted-average common shares and potential common shares-diluted	8,557,304						10,221,404			8,557,304		10,221,404
Net income available to common stockholders	$					2,047,559	$	616,359		$	4,104,075	$	1,445,571
Net income per basic share	$				0.25		$	0.06		$	0.51	$	0.15
Net income available to common stockholders	$			2,047,559			$	616,359		$	4,104,075	$	1,445,571
Plus: Accretion expense of Class B common convertible to senior subordinated notes	—						110,732			—		221,463
Less: Change in fair value of derivative	—						(337,696		)	—		(615,479		)
Net income available for diluted shares	$		2,047,559				$	389,395		$	4,104,075	$	1,051,555
Net income per diluted share	$	0.24					$	0.04		$	0.48	$	0.10

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6.Other Comprehensive Income (Loss)

The components of other comprehensive income (loss) consist of:

	For the three months ended June 30,					For the six months ended June 30,
	2004		2005			2004		2005
Net income	$	2,047,559	$	616,359		$	4,104,075	$	1,445,571
Hedge accounting	—		(1,554,453		)	—		(751,321		)
Total comprehensive income (loss)	$	2,047,559	$	(938,094	)	$	4,104,075	$	694,250

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

Overview

General

Since 1999, we have acquired and operate five rural local exchange carriers serving twenty exchanges through four central offices and thirteen remote switches in approximately 1,540 square miles of north central Alabama and central Missouri.  We are the sole wireline telephone services provider in the rural communities we serve.  Our services include local telephone, network access, long distance and other telephone related services, cable television and Internet access.  We view, manage and evaluate the results of operations from the various telephony products and services as one company and therefore have identified one reporting segment as it relates to providing segment information.  As of June 30, 2005, we operated approximately 37,400 access line equivalents.

Our core businesses are local telephone service 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 76.9% of our total revenues in the second quarter of 2005.  We also provide long distance and other telephone related services, cable television and dial-up and high-speed Internet access.

The following discussion and analysis should be read in conjunction with our financial statements and the related notes included in Item 1 of Part 1 and other financial information appearing elsewhere in this report.  The following discussion and analysis discusses our financial condition and results of operations on a consolidated basis, including the acquisition (the “Mid-Missouri Acquisition”) of Mid-Missouri Holding Corp. (“MMH”) as of December 21, 2004.

Revenue Sources

We derive our revenues from five sources:

•Local services.  We receive revenues from providing local exchange telephone services.  These revenues include monthly subscription charges for basic service, calling to adjacent communities on a per minute basis, local private line services and enhanced calling features, such as voicemail, caller identification, call waiting and call forwarding.

•Network access services.  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 and Missouri are based on rates approved by the Alabama Public Service Commission and Missouri Public Service Commission respectively.  Switched and special access charges for interstate and international services are based on rates approved by the Federal Communications Commission.

•Long distance and other telephone services.  We receive revenues for providing long distance services to our customers.  We also provide billing and collections services for other carriers under contract and receive revenues from directory advertising.

•Cable television services.  We offer basic, digital and pay per view cable television services to a portion of our telephone service territory in both Alabama and Missouri.

•Internet services.  We receive revenues from monthly recurring charges for dial-up and high-speed Internet access.

Access Line and Customer 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 rural local exchange carrier industry, the number of access lines we serve has been decreasing gradually when normalized for territory acquisitions.  We expect this trend to continue for the industry and our territory.  In addition to the impact of the

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economy on our customers, the growth of our high-speed Internet access services will continue to have an impact on residential and small business customers’ requirements for second access lines.  Our response to this trend will have an important impact on our future revenues.  Our primary strategy consists of leveraging our strong incumbent market position to increase revenue per access line by selling additional services to our customer base.

	Year Ended December 31,						March 31,		June 30,
	2002		2003		2004		2005		2005
Access line equivalents (1):
Residential access lines	19,343		22,100		25,237		25,314		25,013
Business access lines	6,654		7,355		8,414		8,310		8,006
Total access lines	25,997		29,455		33,651		33,624		33,019
High-speed lines	1,361		2,185		3,488		4,014		4,407
Total access line equivalents	27,358		31,640		37,139		37,638		37,426
Long distance customers	8,183		11,374		13,641		14,039		14,061
Cable television customers	3,442		3,628		3,959		4,023		4,163
Dial-up Internet customers	2,463		2,331		15,348		14,693		13,831
Average monthly revenue per access line (2)	$	94.40	$	101.45	$	105.88	$	112.66	$	108.52

(1)We define access line equivalents as access lines, cable modems and digital subscriber lines.

(2)We calculate average monthly revenue per access line as equal to (A) our average revenues for the period within our telephone territory divided by (B) the average of the number of access lines on the first day and the last day of the period. Year-to-date average revenue per access line is $111.08.

We will continue our strategy of increasing revenues by cross-selling to our existing customer base, in the form of bundled service packages and individual additional services as they become available.  Our high-speed Internet customers continue to grow from 4,014 customers at March 31, 2005, to 4,407 at June 30, 2005. We expect continued revenue growth in this area of our business.  This growth in our high-speed Internet customers is expected to have a negative effect on our dial-up Internet customers as some customers migrate to high-speed Internet access.  In addition, we expect the growth in our high-speed Internet access customers will have a negative effect on our access lines as some customers will no longer have a need for second lines for purposes of dial-up Internet access.  During second quarter 2005, residential and business access lines and business data circuits declined 1.8% while high-speed Internet customers grew 9.8% during the same period.

Our long distance customers increased to 14,061 from March 31, 2005 to June 30, 2005 and now represent 42.6% of our access lines.  Our cable television customers grew 140 to 4,163 from March 31, 2005 to June 30, 2005.  While we have experienced annual increases in our cable television programming costs, and expect this trend to continue in the future, we expect these increases will be offset by a corresponding increase in the price that we charge our cable television customers for cable television service offerings.  Dial-up internet customers declined to 13,831 on June 30, 2005 from 14,693 on March 31, 2005, including the subscribers we service outside of our telephone service area, reflecting the shift to high-speed Internet services.

Our average revenue per access line for the second fiscal quarter decreased 3.7% from the first fiscal quarter of 2005.  The primary contributor was a non-recurring reduction in access revenue associated with the industry process of truing-up prior period rates, offset by increases in high-speed Internet, cable and long distance revenues. With the Mid-Missouri Acquisition on December 21, 2004, there was an increase in average revenue per access line associated with the proportionately larger contribution from High Cost Loop support. On a year-to-date basis, average revenue per access line is $111.08 for an increase of 4.9% over 2004. Coupled with the increase in high-speed access, long distance and cable subscribers, we continue to provide an increasingly valuable basket of services to our subscribers.

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Categories of Operating Expenses

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

Cost of services.  This includes expense for salaries, wages and benefits relating to plant operation, maintenance and customer service; other plant operations, maintenance and administrative costs; network access costs; and costs of sales 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 (e.g., legal fees) relating to engineering, financial, human resources and corporate operations; information management expenses, including billing; allowance for uncollectibles; expenses for travel, lodging and meals; internal and external communications costs; stock option compensation expense; insurance premiums; stock exchange and banking fees; and postage.  Included in selling, general and administrative expenses historically are annual management fees of approximately $1.0 million in 2004 payable to Seaport Capital Partners II, L.P. and its affiliates, or Seaport Capital.  These fees were terminated on December 21, 2004 in conjunction with our initial public offering.  The incremental selling, general and administrative expenses associated with being a public company replace these fees.

Depreciation and amortization.  This includes depreciation of our telecommunications, cable and Internet networks and equipment, and amortization of intangible assets.

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, operating margins decrease reflecting the lower margins associated with these more competitive services.  We expect to control expenses while we continue to grow our business.

Results of Operations

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

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	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2005		2004		2005
Revenues
Local service	38.9	%	31.1	%	38.2	%	30.7	%
Network access	43.1		45.8		44.1		46.7
Long distance and other telephone services	7.5		6.8		7.4		6.7
Cable television	4.8		4.5		4.8		4.3
Internet	5.7		11.8		5.5		11.6
Total revenues	100.0	%	100.0	%	100.0	%	100.0	%
Operating expenses
Cost of services and products	22.1	%	26.4	%	21.8		25.9
Selling, general and administrative expenses	17.6		13.2		17.7		14.1
Depreciation and amortization	16.5		20.7		16.8		20.2
Total operating expenses	56.2		60.3		56.3		60.2
Income from operations	43.8		39.7		43.7		39.8
Other income (expense)
Interest expense	(8.8	)	(35.5	)	(9.0	)	(34.2	)
Change in fair value of derivative	—		3.0		—		2.6
Other income	0.1		0.4		0.3		1.3
Total other expense	(8.7	)	(32.1	)	(8.7	)	(30.3	)
Income before income taxes	35.1		7.6		35.0		9.5
Income tax expense	(12.4	)	(1.2	)	(12.4	)	(2.4	)
Income before accretion expense	22.7		6.4		22.6		7.1
Accretion of Class B common convertible to senior subordinated notes	—		(1.0	)	—		(0.9	)
Net income available to common stockholders	22.7	%	5.4	%	22.6	%	6.2	%

Three months and six months ended June 30, 2005 compared to three months and six months ended June 30, 2004

Total Revenues.  Total revenues grew 26.7% in the three months ended June 30, 2005 to $11.4 million from $9.0 million in the three months ended June 30, 2004.  Total revenues grew 29.3% in the six months ended June 30, 2005 to $23.5 million from $18.2 million in the six months ended June 30, 2004.  The tables below provide the components of our revenues for the three months and six month of 2005 compared to the three months and six months of 2004.

For the three months ended June 30, 2005 and 2004

	Three Months Ended June 30,				Change
	2004		2005		Amount		Percent
	(dollars in thousands)
Local service	$	3,512	$	3,562	$	50	1.4	%
Network access	3,889		5,235		1,346		34.6
Long distance and other telephone services	674		779		105		15.6
Cable television	435		516		81		18.6
Internet	519		1,350		831		160.1
Total	$	9,029	$	11,442	$	2,413	26.7

Local service.  Local service revenue in the three months ended June 30, 2005 grew 1.4% to $3.6 million from $3.5 million in the three months ended June 30, 2004.  This growth was attributable to an increase of $0.2 million from the Mid-Missouri Acquisition offset by $0.1 million from a decrease in minutes of use on our various local calling arrangements and customer attrition.  Access lines

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increased 3,720 primarily from the acquisition of Mid-Missouri, partially offset by continued growth of the Company’s high-speed Internet service which resulted in the loss of some second access lines used by customers for dial-up Internet access and wireline customer attrition.

Network access.  Network access revenue in the three months ended June 30, 2005 grew 34.6% to $5.2 million from $3.9 million in the first three months ended June 30, 2004.  This growth was primarily attributable to the increase of $1.4 million associated with the Mid-Missouri Acquisition offset by a decrease of $0.1 million in interstate access revenue after netting a small increase in federal universal service charges.

Long distance and other telephone services.  Long distance and other telephone services revenue in the three months ended June 30, 2005 increased 15.6% to $0.8 million from $0.7 million in the three months ended June 30, 2004.  The Mid-Missouri Acquisition increased revenue by $0.2 million, offset by a reduction of $0.1 in other carrier billing and collection agreements and property rental income.

Cable television.  Cable television revenue in the three months ended June 30, 2005 increased 18.6% to $0.5 million from $0.4 million in the three months ended June 30, 2004.  The increase was due to the impact of a $2.00 per month increase in basic cable prices, the addition of 370 customers associated with the Mid-Missouri Acquisition and growth of 214 customers in Alabama.

Internet.  Internet revenue in the three months ended June 30, 2005 increased 160.1% to $1.3 million from $0.5 million in the three months ended June 30, 2004.  Of this increase, $0.1 million was attributable to the addition of almost 1,400 new high-speed Internet customers in Alabama and $0.7 million was attributable to the addition of high-speed and dial-up Internet customers associated with the Mid-Missouri Acquisition.

For the six months ended June 30, 2005 and 2004

	Six Months Ended June 30,				Change
	2004		2005		Amount		Percent
	(dollars in thousands)
Local service	$	6,929	$	7,206	$	277	4.0	%
Network access	8,002		10,965		2,963		37.0
Long distance and other telephone services	1,353		1,564		211		15.6
Cable television	873		1,012		139		15.9
Internet	999		2,723		1,724		172.6
Total	$	18,156	$	23,470	$	5,314	29.3

Local service.  Local service revenue in the six months ended June 30, 2005 grew 4.0% to $7.2 million from $6.9 million in the six months ended June 30, 2004.  This growth was attributable to an increase of $0.3 million from the Mid-Missouri Acquisition.

Network access.  Network access revenue in the six months ended June 30, 2005 grew 37.0% to $11.0 million from $8.0 million in the first six months ended June 30, 2004.  This growth was primarily attributable to the Mid-Missouri Acquisition.

Long distance and other telephone services.  Long distance and other telephone services revenue in the six months ended June 30, 2005 increased 15.6% to $1.6 million from $1.4 million in the six months ended June 30, 2004.  The Mid-Missouri Acquisition increased revenue by $0.3 million, offset by a reduction of $0.1 in other carrier billing and collection agreements and property rental income.

Cable television.  Cable television revenue in the six months ended June 30, 2005 increased 15.9% to $1.0 million from $0.9 million in the six months ended June 30, 2004.  The increase was due to the

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impact of a $2.00 per month increase in basic cable prices, the addition of 370 customers associated with the Mid-Missouri Acquisition and growth of 214 customers in Alabama.

Internet.  Internet revenue in the six months ended June 30, 2005 increased 172.6% to $2.7 million from $1.0 million in the six months ended June 30, 2004.  Of this increase, $0.3 million was attributable to the addition of almost 1,300 new high-speed Internet customers in Alabama and $1.4 million was attributable to the addition of high-speed and dial-up Internet customers associated with the Mid-Missouri Acquisition.

Operating expenses.  Operating expenses in the three months ended June 30, 2005 increased 36.0% to $6.9 million from $5.1 million the three months ended June 30, 2004.  Operating expenses in the six months ended June 30, 2005 increased 38.2% to $14.1 million from $10.2 million the six months ended June 30, 2004.  The increase was primarily attributable to the Mid-Missouri Acquisition, amortization of loan costs associated with our initial public offering and public company costs.

For the three months ended June 30, 2005 and 2004

	Three Months Ended June 30,				Change
	2004		2005		Amount			Percent
	(dollars in thousands)
Cost of services	$	1,992	$	3,020	$	1,028		51.6	%
Selling, general and administrative expenses	1,588		1,512		(76		)	(4.8	)
Depreciation and amortization	1,494		2,371		877			58.7
Total	$	5,074	$	6,903	$	1,829		36.0

Cost of services.  The cost of services increased 51.6% to $3.0 million in the three months ended June 30, 2005 from $2.0 million in the three months ended June 30, 2004.  The Mid-Missouri Acquisition accounted for $0.9 million of this increase.  The balance of the increase was attributable to the higher installation and service costs associated with the increase in Internet customers and higher cable programming fees.

Selling, general and administrative expenses.  Selling, general and administrative expenses decreased 4.8% to $1.5 million in the three months ended June 30, 2005 from $1.6 million in the three months ended June 30, 2004.  The costs associated with the Mid-Missouri Acquisition and our public company costs in the period were slightly less than the elimination of management fees paid to a related party and stock option expense in the previous year.

Depreciation and amortization.  Depreciation and amortization increased 58.7% to $2.4 million in the three months ended June 30, 2005 from $1.5 million in three months ended June 30, 2004.  The Mid-Missouri Acquisition accounted for $0.5 million and the amortization of loan costs associated with our initial public offering accounted for $0.3 million. The balance of the increase was associated with increased high-speed Internet equipment and amortization of intangibles.

For the six months ended June 30, 2005 and 2004

	Six Months Ended June 30,				Change
	2004		2005		Amount		Percent
	(dollars in thousands)
Cost of services	$	3,961	$	6,074	$	2,113	53.3	%
Selling, general and administrative expenses	3,219		3,327		108		3.4
Depreciation and amortization	3,047		4,736		1,689		55.4
Total	$	10,227	$	14,137	$	3,910	38.2

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Cost of services.  The cost of services increased 53.3% to $6.1 million in the six months ended June 30, 2005 from $4.0 million in the six months ended June 30, 2004.  The Mid-Missouri Acquisition accounted for $1.8 million of this increase.  The balance of the increase was attributable to the higher installation and service costs associated with the increase in Internet customers and higher cable programming fees.

Selling, general and administrative expenses.  Selling, general and administrative expenses increased 3.4% to $3.3 million in the six months ended June 30, 2005 from $3.2 million in the six months ended June 30, 2004.  The costs associated with the Mid-Missouri Acquisition and our public company costs in the period were slightly higher than the elimination of management fees paid to a related party and stock option expense in the previous year.

Depreciation and amortization.  Depreciation and amortization increased 55.4% to $4.7 million in the six months ended June 30, 2005 from $3.0 million in six months ended June 30, 2004.  The Mid-Missouri Acquisition accounted for $0.9 million and the amortization of loan costs associated with our initial public offering accounted for $0.6 million. The balance of the increase was associated with increased high-speed Internet equipment and amortization of intangibles.

For the three months and six months ended June 30, 2005 and 2004

Interest expense.  Interest expense increased 412.1% to $4.1 million in the three months ended June 30, 2005 from $0.8 million in the three months ended June 30, 2004.  Interest expense increased 392.9% to $8.0 million in the six months ended June 30, 2005 from $1.6 million in the six months ended June 30, 2004.  The new credit facility and the senior subordinated notes associated with our initial public offering in December 2004 replaced existing variable rate term debt. Interest on the new credit facility is capped at 7% for the five year term ending December 20, 2009. Interest on the senior subordinate notes is 13% for the 15 year term ending December 30, 2019.

Change in fair value of derivative associated with Class B common convertible to Class A common.  The derivative value associated with the conversion option for our Class B common stock must be fair valued each quarter until conversion occurs, not later than December 21, 2009. The reduction in maximum time to conversion and the increase in the price of IDSs and the underlying Class A common stock since the initial public offering combined to reduce the fair value of this liability by $0.6 million at the end of the first six months of 2005, including $0.3 million in the three months ended June 30, 2005.

Other income.  Other income was less than $0.1 million in the three months ended June 30, 2005 and 2004. Other income increased 490.9% to $0.3 million in the six months ended June 30, 2005 from $0.1 million in the six months ended June 30, 2004.  The increase was attributable to the increased annual patronage dividend income from CoBank received in first quarter 2005.

Income taxes.  Provision for income taxes in the three months ended June 30, 2005 declined 87.6% to $0.1 million from $1.1 million in the three months ended June 30, 2004.  Provision for income taxes in the six months ended June 30, 2005 declined 74.8% to $0.6 million from $2.2 million in the six months ended June 30, 2004.  This reflects the expected lower income generated from the capital structure associated with our initial public offering in December 2004 and the estimated lower tax rate for the full year. In calculating the effective tax rate, the change in the fair value of the derivative associated with the Class B common convertible to Class A common is excluded as a permanent difference. As a result, the effective rate will vary from period to period.

Accretion of Class B common convertible to senior subordinated notes.  Our Class B common stock was issued to the existing equity holders coincident with our initial public offering on December 21, 2004.  These shares represent their retained interest in the company.  They do not receive any dividends and will convert into IDSs not later than December 21, 2009.  For the first two years after their issuance, the present value discount on the portion of the shares related to the conversion to senior subordinated notes is being accreted as a non-cash expense to the Company. For the three months and six months ended June 30, 2005, this accretion expense was $0.1 million and $0.2 million respectively.

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Net income.  As a result of the foregoing, net income available to common stockholders in the three months ended June 30, 2005 decreased 69.9% to $0.6 million from $2.0 million in the three months ended June 30, 2004 and net income in the six months ended June 30, 2005 decreased 64.8% to $1.4 million from $4.1 million in the six months ended June 30, 2004.

Liquidity and Capital Resources

Having completed the transactions associated with our initial public offering, our liquidity needs will arise primarily from: (i) interest payments related to our credit facility and our senior subordinated notes; (ii) capital expenditures, (iii) working capital requirements; (iv) dividend payments on our Class A common stock; and (v) potential acquisitions.

Cash flows from operating activities for the first six months of 2005 amounted to $5.6 million compared to $10.7 million for the first six months of 2004.  The changes are primarily the result of higher interest associated with the capital structure of the Company since its initial public offering, the payment of accrued expenses associated with the initial public offering, and advance payments for dial-up Internet customers outside of our telephone service territory.

Cash flows from investing activities for the first six months of 2005 amounted to $2.3 million compared to $2.4 million for the first six months of 2004.  The capital expenditures for the acquisition and construction of property and equipment associated with the Mid-Missouri Acquisition accounted for the increase, offset by the absence of any capitalized transaction costs in 2005.

Cash flows from financing activities for the first six months of 2005 reflected the change in equity and debt structure of the company associated with our initial public offering.  The company distributed $3.4 million in cash dividends to stockholders in the first six months of 2005 compared to $3.8 million for repayment of long-term notes payable in the first six months of 2004, accounting for the change between periods.

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

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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 speculative derivative or commodity type instruments.  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 are exposed to interest rate risk, primarily from the change in LIBOR or a base rate.  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 Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2005.

With the completion of our initial public offering on December 21, 2004, we are subject to the reporting requirements under Regulation S-K for the first time and anticipate being classified as an accelerated filer for the year ending December 31, 2005.

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 first and second quarter of fiscal 2005 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 4.  Submission of Matters to a Vote of Security Holders

Otelco Inc. held its Annual Meeting of Stockholders on May 26, 2005. At that meeting, stockholders elected William Bak and Michael D. Weaver as Directors of the Company for a term to expire at the 2008 Annual Meeting of Stockholders. The results of the voting are as follows:

	Votes For	Votes Withheld
William Bak	8,267,653	42,602
Michael D. Weaver	8,198,528	111,727

The following directors also have terms in office that continue after the Annual Meeting of Stockholders: Howard Haug, John P. Kunz, Stephen P. McCall, Andrew Meyers, and William F. Reddersen.

In addition, stockholders ratified the appointment of BDO Seidman, LLP as our Independent Registered Public Accounting Firm for the fiscal year ending December 31, 2005. The result of the voting is as follows:

	Votes For	Votes Against	Abstain	Broker Non-Vote
Ratification of appointment of independent registered public accounting firm	8,278,701	7,468	24,086	0

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 10, 2005	OTELCO INC.
	By:	/s/ Michael D. Weaver
		Michael D. Weaver
		President and Chief Executive Officer
Date: August 10, 2005
	By:	/s/ Curtis L. Garner, Jr.
		Curtis L. Garner, Jr.
		Chief Financial Officer

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EXHIBIT INDEX

Exhibit No.	Description
10.4	Long-term Incentive Compensation Plan approved May 12, 2005
31.1	Certificate pursuant to Rule 13A-14(a) or Rule 15d-14(a) of 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) of 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

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EX-10.4

Exhibit 10.4

OTELCO INC.

LONG-TERM INCENTIVE PLAN

TABLE OF CONTENTS

1.	PURPOSE OF PLAN
2.	PARTICIPATION
3.	CREDITS UNDER THE PLAN
	3.1	Calculation of Incentive Pool
	3.2	Conversion of Incentive Pool Amount
	3.3	Allocation of IDS Units
4.	ACCOUNTS
	4.1	IDS Unit Accounts
	4.2	Dividend and Interest Equivalents Accounts
	4.3	Accounts Not Funded; No Rights as Holders of IDSs
	4.4	Reduction in Accounts
5.	VESTING
	5.1	IDS Unit Account
	5.2	Dividend and Interest Equivalents Account
	5.3	Acceleration of Vesting Upon Retirement
6.	DISTRIBUTIONS
	6.1	Payment of IDS Units
	6.2	Payment of Dividend and Interest Equivalents
	6.3	Payment Election
	6.4	Distribution Upon Termination of Employment
	6.5	Distribution Upon a Change in Control Event
	6.6	Section 162(m) Limitation
7.	ADMINISTRATION
	7.1	Committee
	7.2	Committee Action
	7.3	Powers and Duties of the Committee
	7.4	Construction and Interpretation
	7.5	Information
	7.6	Compensation, Expenses and Indemnity
	7.7	Annual Statements

i

8.	MISCELLANEOUS
	8.1	Unsecured General Creditor
	8.2	Trust Arrangement
	8.3	Restriction Against Assignment
	8.4	Withholding
	8.5	Amendment, Modification, Suspension or Termination
	8.6	Governing Law; Severability
	8.7	Receipt or Release
	8.8	Payments on Behalf of Persons Under Incapacity
	8.9	No Right to Employment
	8.10	Compliance with Laws
	8.11	Plan Construction
	8.12	Headings, etc. Not Part of Agreement
	8.13	Claims Procedure
9.	ADJUSTMENTS IN CASE OF CHANGES IN IDS OR COMMON STOCK
10.	DEFINITIONS

ii

OTELCO INC.

LONG-TERM INCENTIVE PLAN

1.PURPOSE OF PLAN

The purpose of this Plan is to promote the success of the Company by rewarding a select group of management and highly compensated employees for exemplary performance as an additional means to attract, motivate and retain such employees and to further align the interests of participants with those of the holders of the Company’s securities generally.  Only Eligible Employees (as defined herein) may participate in this Plan.

2.PARTICIPATION

The Committee shall select from the class of Eligible Employees those particular Eligible Employees who may be eligible to receive IDS Units in accordance with Section 3.  If the Committee determines in its sole discretion that a Participant no longer qualifies as a member of a select group of management or highly compensated employees, as membership in such group is determined in accordance with Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA, or that the inclusion of any Eligible Employee in this Plan could violate any applicable law or jeopardize the status of this Plan as a plan intended to be “unfunded” and “maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees” within the meaning of ERISA Sections 201(2), 301(a)(3) and 401(a)(1), the Committee shall have the right, in its sole discretion, to (i) immediately distribute the Participant’s then vested IDS Units and Dividend and Interest Equivalents and (other than the payment when vested of any of the Participant’s unvested IDS Units and Dividend and Interest Equivalents) terminate the Participant’s participation in this Plan, and/or (ii) take such further reasonable action that the Committee deems appropriate in the circumstances.

3.CREDITS UNDER THE PLAN

3.1Calculation of Incentive Pool.  Before the start of each Plan Year during the term of this Plan, the Company shall establish a target level of EBITDA (“Target EBITDA”) for such Plan Year.  At the close of a Plan Year, the Company’s audited financial statements shall be used to calculate the Company’s actual level of EBITDA (“Actual EBITDA”) for such Plan Year.  An “Incentive Pool Amount” shall be established for each Plan Year based on the amount, if any, by which Actual EBITDA exceeds Target EBITDA (“Excess EBITDA”) for such Plan Year.  The Incentive Pool Amount shall equal: (i) fifteen percent (15%) of the first $1,000,000, or any portion thereof, of Excess EBIDTA, plus (ii) twenty percent (20%) of the amount, if any, by which Excess EBITDA exceeds $1,000,000.  If Actual EBITDA does not exceed Target EBITDA for a Plan Year, no Incentive Pool Amount shall be established for such Plan Year.

3.2Conversion of Incentive Pool Amount.   The Incentive Pool Amount for a Plan Year, if any, shall be divided by the Fair Market Value of an IDS on December 31of such Plan Year (the “Determination Date”), and the resulting amount shall be the number of IDS Units credited under this Plan for such Plan Year.

1

3.3Allocation of IDS Units.  The number of IDS Units for a Plan Year determined in accordance with Section 3.2 above shall be allocated among Participants, in the sole discretion of the Committee, based on the Participant’s contribution to the overall financial results of the Company or such other factors as the Committee deems relevant, on or as soon as administratively practicable after May 1 following the close of such Plan Year (the “Crediting Date”).

4.ACCOUNTS

4.1IDS Unit Accounts.  The Committee shall establish and maintain an IDS Unit Account for each Participant to whom IDS Units are allocated pursuant to Section 3.3.

4.1.1Crediting of IDS Units.  On the applicable Crediting Date, the Committee shall credit the Participant’s IDS Units Account with the number of IDS Units, if any, allocated to such Participant in accordance with Section 3.3.

4.1.2Subaccounts.  The Committee shall establish separate vested and unvested subaccounts under a Participant’s IDS Unit Account.  25% of the IDS Units credited to a Participant on any Crediting Date shall be initially credited to the Participant’s vested subaccount, and the remainder shall be initially credited to the Participant’s unvested subaccount.

4.2Dividend and Interest Equivalents Accounts.  The Committee shall establish and maintain a Dividend and Interest Equivalents Account for each Participant to whom IDS Units are allocated pursuant to Section 3.3.

4.2.1Crediting of Dividend and Interest Equivalents.  On or as soon as administratively practicable after the date on which the Company pays a dividend or makes a payment of interest on its IDSs (a “Dividend or Interest Payment Date”), the Participant’s Dividend and Interest Equivalents Account shall be credited with an amount equal to the amount of the Dividend and Interest Equivalents representing cash dividends or interest paid with respect to that number of IDSs equal to the aggregate number of IDS Units in the Participant’s IDS Unit Account at the start of business as of the relevant record date for such dividend or interest payment.  A Participant’s Dividend and Equivalents Account shall continue to be credited with Dividend and Interest Equivalents pursuant to this Section 4.2.1, until the number of IDS Units credited to such Participant’s IDS Unit Account (after reduction pursuant to Section 5.4) reaches zero.

4.2.2Subaccounts.  The Committee shall establish separate vested and unvested subaccounts under a Participant’s Dividend and Interest Equivalents Account.  Dividend and Interest Equivalents attributable to vested IDS Units shall initially be credited to the Participant’s vested subaccount, and Dividend and Interest Equivalents attributable to unvested IDS Units shall initially be credited to the Participant’s unvested subaccount.

2

4.3Accounts Not Funded; No Rights as Holders of IDSs.  A Participant’s Accounts shall be memorandum accounts on the books of the Company.  The IDS Units credited to a Participant’s IDS Unit Account, and the Dividend and Interest Equivalents credited to a Participant’s Dividend and Interest Equivalents Account, shall be used solely as a device for the determination of the payment to be eventually distributed to such Participant in accordance with this Plan.  The IDS Units and Dividend and Interest Equivalents shall not be treated as property or (subject to Section 8.2) as a trust fund of any kind.  No Participant shall be entitled to any voting or other rights as a holder of IDSs with respect to IDS Units or Dividend and Interest Equivalents credited under this Plan.  The IDS Units and Dividend and Interest Equivalents credited (and the payment to which the Participant is entitled under this Plan) shall be subject to adjustment in accordance with Section 9of this Plan.

4.4Reduction in Accounts.  A Participant’s Accounts shall be reduced by the number of IDS Units, and the amount of Dividend and Interest Equivalents, as applicable, with respect to which payment is made, in the case of IDS Units, which are extinguished, or in either case are credited to the Deferred Compensation Plan.

5.VESTING

5.1IDS Unit Account.  IDS Units credited to a Participant’s IDS Unit Account on a Crediting Date pursuant to Section 4.1.1 shall initially be entirely unvested, and shall become 100% vested on the third anniversary of such Crediting Date.  On each Crediting Date, the vested subaccount of the Participant’s IDS Unit Account shall be increased by the IDS Units (if any) that became vested as of such Crediting Date, and the unvested subaccount of the Participant’s IDS Unit Account shall be reduced by those IDS Units.

5.2Dividend and Interest Equivalents Account.  Dividend and Interest Equivalents credited to a Participant’s Dividend and Interest Equivalents Account on a Dividend or Interest Payment Date pursuant to Section 4.2.1 with respect to then-vested IDS Units shall be fully vested on such Dividend or Interest Payment Date.  Dividend and Interest Equivalents credited with respect to unvested IDS Units shall initially be credited to the unvested subaccount of a Participant’s Dividend and Interest Equivalents Account, and such amounts shall become vested at the time the corresponding IDS Units become vested as set forth in Section 5.1.  The vested subaccount of the Participant’s Dividend and Interest Equivalents Account shall be increased by any Dividend and Interest Equivalents that become vested as of a Crediting Date, and the unvested subaccount of the Participant’s Dividend and Interest Equivalents Account shall be reduced by those Dividend and Interest Equivalents.

5.3Acceleration of Vesting Upon Retirement.  Notwithstanding the foregoing, a Participant shall become fully vested as to all IDS Units credited to his or her IDS Unit Account, and all Dividend and Interest Equivalents credited to his or her Dividend and Interest Equivalents Account, if while an employee of the Company or a Subsidiary, the Participant (i) dies, (ii) becomes totally and permanently

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disabled or (iii) reaches the Participant’s Retirement Date.  Total and permanent disability shall be determined by the Committee in its discretion, and if the Company maintains a long term disability plan that covers the Participant, the Committee’s discretion shall be guided by the standard set forth in such plan.

6.DISTRIBUTIONS

6.1Payment of IDS Units.  On or as soon as administratively practicable after the first business day in June following the close of a Plan Year (the “IDS Unit Distribution Date”), the Company shall make a cash payment to a Participant (or in the event of his or her death, to his or her Beneficiary) in an amount equal to the (i) number of IDS Units in the vested subaccount of the Participant’s IDS Unit Account that had been credited to the Participant’s IDS Unit Account for at least one (1) year as of the IDS Unit Distribution Date, multiplied by (ii) the Fair Market Value of an IDS as of the first business day immediately preceding the IDS Unit Distribution Date.

6.2Payment of Dividend and Interest Equivalents.  On or as soon as administratively practicable after June 30, or the first business day thereafter, following the close of a Plan Year (the “Dividend and Interest Equivalent Distribution Date”), the Company shall make a cash payment to a Participant (or in the event of his or her death, to his or her Beneficiary) in an amount equal to the aggregate amount of Dividend and Interest Equivalents that are credited to the vested subaccount of the Participant’s Dividend and Interest Equivalents Account as of and on the Dividend and Interest Equivalent Distribution Date.

6.3Payment Election.  No later than June 30 of each Plan Year (or such earlier date established by the Committee consistent with the election requirements imposed under Code Section 409A), the Committee may permit each participant to elect that in lieu of the payments provided in Sections 6.1 and 6.2, the amounts that otherwise would have been paid with respect to the IDS Units and corresponding Dividend and Interest Equivalents with respect to such Plan Year shall be credited to the Deferred Compensation Plan.  Any such election must provide for payment pursuant to the terms of the Deferred Compensation Plan and the requirements of Code Section 409A.

6.4Distribution Upon Termination of Employment.

6.4.1Termination of Unvested IDS Units and Dividend and Interest Equivalents.  Upon a Participant’s Termination Date, IDS Units credited to the unvested subaccount of such Participant’s IDS Unit Account, and Dividend and Interest Equivalents credited to the unvested subaccount of such Participant’s Dividend and Interest Equivalents Account, shall immediately terminate and the Participant shall have no rights with respect thereto.

6.4.2Payment of IDS Units Upon Termination of Employment.  Within thirty (30) days after a Participant’s Termination Date, the Company shall make a cash payment to a Participant (or in the event of his or her death, to his or her Beneficiary) in an amount equal to the (i) number of IDS Units in the vested subaccount of the Participant’s IDS Unit Account as of the

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Termination Date, multiplied by (ii) the Fair Market Value of an IDS as of the first business day immediately preceding the Termination Date.  No such payment shall be credited to the Deferred Compensation Plan.

6.4.3Payment of Dividend and Interest Equivalents Upon Termination of Employment.  Within thirty (30) days after a Participant’s Termination Date, the Company shall make a cash payment to a Participant (or in the event of his or her death, to his or her Beneficiary) in an amount equal to the aggregate amount of Dividend and Interest Equivalents credited to the vested subaccount of the Participant’s Dividend and Interest Equivalents Account as of the Termination Date.  No such payment shall be credited to the Deferred Compensation Plan.

6.4.4Payments to Key Employees.  Notwithstanding anything contained herein to the contrary, the Termination Date of a Participant who is a Key Employee of a Participating Affiliate shall be deemed to be the date that is six (6) months after it would otherwise be without this Section 6.3.4 (or if earlier, the date of the Participant’s death).

6.5Distribution Upon a Change in Control Event.

6.5.1Acceleration Upon a Change in Control Event.  Upon a Change in Control Event, IDS Units credited to a Participant’s IDS Unit Account, and Dividend and Interest Equivalents credited to a Participant’s Dividend and Interest Equivalents Account, that are not then fully vested, shall automatically become fully vested and credited to the applicable vested subaccounts upon the occurrence of such event.

6.5.2Payment of IDS Units Upon Change in Control Event.  Within thirty (30) days after a Change in Control Event, the Company shall make a cash payment to a Participant (or in the event of his or her death, to his or her Beneficiary) in an amount equal to the (i) number of IDS Units in the Participant’s IDS Unit Account that are fully vested as of the effective date of the Change in Control Event (after giving effect to any accelerated vesting pursuant to Section 6.5.1), multiplied by (ii) the Fair Market Value of an IDS as of the first business day immediately preceding the effective date of the Change in Control Event.  No such payment shall be credited to the Deferred Compensation Plan.

6.5.3Payment of Dividend and Interest Equivalents Upon Change in Control Event.  Within thirty (30) days after a Change in Control Event, the Company shall make a cash payment to a Participant (or in the event of his or her death, to his or her Beneficiary) in an amount equal to aggregate amount of Dividend and Interest Equivalents that are fully vested as of the effective date of the Change in Control Event (after giving effect to any accelerated vesting pursuant to Section 6.5.1).  No such payment shall be credited to the Deferred Compensation Plan.

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6.6Section 162(m) Limitation.  Notwithstanding anything herein to the contrary, if the Committee determines in good faith that there is a reasonable likelihood that any benefits paid to a Participant for a taxable year of the respective Participating Affiliate would not be deductible by the Participating Affiliate solely by reason of the limitation under Section 162(m) of the Code, then, to the extent reasonably deemed necessary by the Committee to ensure that the entire amount of any distribution to the Participant pursuant to this Plan is deductible, the Committee shall defer all or any portion of a distribution under this Plan.  The amounts so deferred shall be distributed to the Participant or his or her Beneficiary (in the event of the Participant’s death) at the earliest possible date, as determined by the Committee in good faith, on which the deductibility of compensation paid or payable to the Participant for the taxable year of the Participating Affiliate during which the distribution is made will not be limited by Section 162(m) of the Code.

7.ADMINISTRATION

7.1Committee.  The Committee shall be appointed by, and serve at the pleasure of, the Board of Directors.  The number of members comprising the Committee shall be determined by the Board, which may from time to time vary the number of members.  A member of the Committee may resign by delivering a written notice of resignation to the Board.  The Board may remove any member by delivering a certified copy of its resolution of removal to such member.  Vacancies in the membership of the Committee shall be filled promptly by the Board.

7.2Committee Action.  The Committee shall act at meetings by affirmative vote of a majority of the members of the Committee.  Any action permitted to be taken at a meeting may be taken without a meeting if, prior to such action, a written consent to the action is signed by all members of the Committee and such written consent is filed with the minutes of the proceedings of the Committee.  A member of the Committee shall not vote or act upon any matter which relates solely to himself or herself as a Participant.  The Chairman or any other member or members of the Committee designated by the Chairman may execute any certificate or other written direction on behalf of the Committee.

7.3Powers and Duties of the Committee.  The Committee, on behalf of the Participants and their Beneficiaries, shall enforce this Plan in accordance with its terms, shall be charged with the general administration of this Plan, and shall have all powers necessary to accomplish its purposes, including, but not by way of limitation, the following:

(a)To construe and interpret the terms and provisions of this Plan;

(b)To compute and certify to each Participating Affiliate and to any Trustee the amount and kind of benefits payable to Participants and their Beneficiaries, and to determine the time and manner in which such benefits are paid;

(c)To maintain all records that may be necessary for the administration of this Plan;

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(d)To provide for the disclosure of all information and the filing or provision of all reports and statements to Participants, Beneficiaries or governmental agencies as shall be required by law;

(e)To make and publish such rules for the regulation of this Plan and procedures for the administration of this Plan as are not inconsistent with the terms hereof;

(f)To appoint a plan administrator or any other agent, and to delegate to them such powers and duties in connection with the administration of this Plan as the Committee may from time to time prescribe;

(g)To authorize all disbursements by a Participating Affiliate and any Trustee pursuant to this Plan and any Trust; and

(h)To direct each Trustee concerning the performance of various duties and responsibilities under the related Trust.

7.4Construction and Interpretation.  The Committee shall have full discretion to construe and interpret the terms and provisions of this Plan, which interpretation or construction shall be final and binding on all parties, including but not limited to Participating Affiliates and any Participant or Beneficiary.  The Committee shall administer such terms and provisions in a uniform and nondiscriminatory manner and in full accordance with any and all laws applicable to this Plan.

7.5Information.  To enable the Committee to perform its functions, each Participating Affiliate shall supply full and timely information to the Committee on all matters relating to the compensation of all Participants, their death or other cause of termination, and such other pertinent facts as the Committee may require.

7.6Compensation, Expenses and Indemnity.

7.6.1No Compensation.  The members of the Committee shall serve without compensation for their services hereunder.

7.6.2Legal Counsel; Administrative Expenses.  The Committee is authorized at the expense of the Company to employ such legal counsel as it may deem advisable to assist in the performance of its duties hereunder.  Expenses and fees in connection with the administration of this Plan shall be paid by the Company.

7.6.3Indemnification.  To the extent permitted by applicable state law, the Company and each of the other Participating Affiliates shall indemnify and save harmless the Committee and each member thereof, the Board of Directors and any delegate of the Committee who is an employee of a Participating Affiliate against any and all expenses, liabilities and claims, including legal fees to defend against such liabilities and claims arising out of their discharge in good faith of responsibilities under or incident to this Plan, other than expenses and liabilities arising out of willful misconduct.

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This indemnity shall not preclude such further indemnities as may be available under insurance purchased by a Participating Affiliate or provided by a Participating Affiliate under any bylaw, agreement or otherwise, as such indemnities are permitted under state law.

7.7Annual Statements.  Under procedures established by the Committee, a Participant shall receive a statement with respect to such Participant’s Accounts on no less than an annual basis.

8.MISCELLANEOUS

8.1Unsecured General Creditor.  Participants and their Beneficiaries, heirs, successors, and assigns shall have no legal or equitable rights, claims, or interest in any specific property or assets of any Participating Affiliate.  No assets of any Participating Affiliate shall be held under any trust (except as provided in Section 8.2), or held in any way as collateral security for the fulfilling of the obligations of any Participating Affiliate under this Plan.  Any and all of each Participating Affiliate’s assets shall be, and remain, the general unpledged, unrestricted assets of the Company.  Each Participating Affiliate’s obligations under this Plan shall be merely that of an unfunded and unsecured promise of the Participating Affiliate to pay money in the future to those persons to whom the Participating Affiliate has a benefit obligation under this Plan (as determined in accordance with the terms hereof), and the respective rights of the Participants and Beneficiaries shall be no greater than those of unsecured general creditors.

8.2Trust Arrangement.  Notwithstanding Section 8.1, a Participating Affiliate may at any time transfer assets representing all or any portion of a Participant’s Accounts to a Trust to be held and invested and reinvested by the Trustee pursuant to the terms of the Trust Agreement.  However, to the extent provided in the Trust Agreement only, such transferred amounts shall remain subject to the claims of general creditors of the Participating Affiliate that established the Trust.  To the extent that assets representing a Participant’s Accounts are held in a Trust when his or her benefits under this Plan become payable, the Participating Affiliate that is liable for the payment of such benefits may direct the Trustee to pay such benefits to the Participant from the assets of the Trust.

8.3Restriction Against Assignment.  The respective Participating Affiliate shall pay all amounts payable hereunder only to the person or persons designated by this Plan and not to any other person or corporation.  No part of a Participant’s Accounts shall be liable for the debts, contracts, or engagements of any Participant, his or her Beneficiary, or successors in interest, nor shall a Participant’s Accounts be subject to execution by levy, attachment, or garnishment or by any other legal or equitable proceeding, nor shall any such person have any right to alienate, anticipate, commute, pledge, encumber, or assign any benefits or payments hereunder in any manner whatsoever.  If any Participant, Beneficiary or successor in interest is adjudicated bankrupt or purports to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge any distribution or payment from this Plan, voluntarily or involuntarily, the Committee, in its discretion, may cancel such

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distribution or payment (or any part thereof) to or for the benefit of such Participant, Beneficiary or successor in interest in such manner as the Committee shall direct.

8.4Withholding.

8.4.1Employment Taxes Upon Vesting.  The Company (or any Subsidiary by which the Participant is or was employed) may, in its reasonable discretion, satisfy any state or federal employment tax withholding obligation with respect to the vesting of IDS Units credited to the Participant’s IDS Unit Account and Dividend and Interest Equivalents credited to the Participant’s Dividend and Interest Equivalents Account by either (a) deducting such amounts from any compensation payable by the Company (or a Subsidiary) to the Participant, or (b) reducing the vested portion of the Participant’s IDS Unit Account or Dividend and Interest Equivalents Account, as applicable, by the amount necessary to satisfy such withholding obligation.

8.4.2Distributions.  There shall be deducted from each payment or distribution made under this Plan, or any other compensation payable to the Participant (or Beneficiary), all taxes which are required to be withheld by the Company (or a Subsidiary) in respect to such payment or distribution or this Plan.  The Company (or the Subsidiary by which the Participant is or was employed) shall have the right to reduce any payment or distribution (or other compensation) by the amount of cash sufficient to provide the amount of said taxes.  If the Company (or a Subsidiary), for any reason, elects not to (or cannot) satisfy the withholding obligation from the amounts otherwise payable under this Plan, the Participant shall pay or provide for payment in cash of the amount of any taxes which the Company (or a Subsidiary) may be required to withhold with respect to the benefits hereunder.

8.5Amendment, Modification, Suspension or Termination.  The Board or the Committee may amend, modify, suspend or terminate this Plan in whole or in part, except that no amendment, modification, suspension or termination shall have any retroactive effect to reduce any amounts allocated to a Participant’s Accounts.  Notwithstanding the foregoing, the Committee may terminate prospectively or reduce prospectively the crediting of Dividend and Interest Equivalents and increases in Appreciated Value.

8.6Governing Law; Severability.  This Plan shall be construed, governed and administered in accordance with the laws of the State of Alabama.  If any provisions of this instrument shall be held by a court of competent jurisdiction to be invalid or unenforceable, the remaining provisions hereof shall continue to be fully effective.

8.7Receipt or Release.  Any payment to a Participant or the Participant’s Beneficiary in accordance with the provisions of this Plan shall, to the extent thereof, be in full satisfaction of all claims against the Committee, the Company and its Subsidiaries, and the Trustee.  The Committee may require such Participant or Beneficiary, as a

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condition precedent to such payment, to execute a receipt and release to such effect.

8.8Payments on Behalf of Persons Under Incapacity.  In the event that any amount becomes payable under this Plan to a person who, in the sole judgment of the Committee, is considered by reason of physical or mental condition to be unable to give a valid receipt therefore, the Committee may direct that such payment be made to any person found by the Committee, in its sole judgment, to have assumed the care of such person. Any payment made pursuant to such determination shall constitute a full release and discharge of the Committee, the Company and its Subsidiaries.

8.9No Right to Employment.  Participation in this Plan shall not give any person the right to continued employment or service or any rights or interests other than as herein provided.  No Participant shall have any right to any payment or benefit hereunder except to the extent provided in this Plan.

8.10Compliance with Laws.  This Plan and the payment of money under this Plan are subject to compliance with all applicable federal and state laws, rules and regulations (including but not limited to state and federal securities law) and to such approvals by any listing, agency or any regulatory or governmental authority as may, in the opinion of counsel for the Company or a Subsidiary, be necessary or advisable in connection therewith.  Any securities delivered under this Plan shall be subject to such restrictions, and the person acquiring such securities shall, if requested by the Company or a Subsidiary, provide such assurances and representations to the Company or the Subsidiary as the Company or the Subsidiary may deem necessary or desirable to assure compliance with all applicable legal requirements.

8.11Plan Construction.

8.11.1Rule 16b-3.  It is the intent of the Company that transactions pursuant to this Plan satisfy and be interpreted in a manner that satisfies the applicable requirements of Rule 16b-3 promulgated under the Exchange Act (“Rule 16b-3”) so that, the crediting of IDS Units and Dividend and Interest Equivalents and any other event with respect to IDS Units and Dividend and Interest Equivalents under this Plan will be entitled to the benefits of Rule 16b-3 or other exemptive rules under Section 16 of the Exchange Act and will not be subjected to avoidable liability thereunder.

8.11.2Section 409A.  This Plan shall be construed and interpreted to comply with Section 409A of the Code to the extent required to preserve the intended tax consequences of this Plan.  The Company reserves the right to amend this Plan to the extent it reasonably determines is necessary in order to preserve the intended tax consequences of this Plan in light of Section 409A of the Code and any regulations or other guidance promulgated thereunder.

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8.12Headings, etc. Not Part of Agreement.  Headings and subheadings in this Plan are inserted for convenience of reference only and are not to be considered in the construction of the provisions hereof.

8.13Claims Procedure.

8.13.1Presentation of Claim.  Any Participant or Beneficiary of a deceased Participant (such Participant or Beneficiary being referred to below as a “Claimant”) may deliver to the Committee a written claim for a determination with respect to the benefits payable to such Claimant pursuant to this Plan.  If such a claim relates to the contents of a notice received by the Claimant, the claim must be made within sixty (60) days after such notice was received by the Claimant.  All other claims must be made within one hundred eighty (180) days of the date on which the event that caused the claim to arise occurred.  The claim must state with particularity the determination desired by the Claimant.

8.13.2Notification of Decision.  The Committee shall consider a Claimant’s claim within a reasonable time, but no later than ninety (90) days after receiving the claim.  If the Committee determines that special circumstances require an extension of time for processing the claim, written notice of the extension shall be furnished to the Claimant prior to the termination of the initial ninety (90) day period.  In no event shall such extension exceed a period of ninety (90) days from the end of the initial period.  The extension notice shall indicate the special circumstances requiring an extension of time and the date by which the Committee expects to render the benefit determination.  The Committee shall notify the Claimant in writing:

(a)that the Claimant’s requested determination has been made, and that the claim has been allowed in full; or

(b)that the Committee has reached a conclusion contrary, in whole or in part, to the Claimant’s requested determination, and such notice must set forth in a manner calculated to be understood by the Claimant:

(i)the specific reason(s) for the denial of the claim, or any part of it;

(ii)specific reference(s) to pertinent provisions of this Plan upon which such denial was based;

(iii)a description of any additional material or information necessary for the Claimant to perfect the claim, and an explanation of why such material or information is necessary;

(iv)an explanation of the claim review procedure set forth in Section 8.13.3; and

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(v)a statement of the Claimant’s right to bring an arbitration pursuant to Section 8.13.6 or, to the extent required by law, a civil action under ERISA Section 502(a) following an adverse benefit determination on review.

8.13.3Review of a Denied Claim.  On or before sixty (60) days after receiving a notice from the Committee that a claim has been denied, in whole or in part, a Claimant (or the Claimant’s duly authorized representative) may file with the Committee a written request for a review of the denial of the claim.  The Claimant (or the Claimant’s duly authorized representative):

(a)may, upon request and free of charge, have reasonable access to, and copies of, all documents, records and other information relevant to the claim for benefits;

(b)may submit written comments or other documents; and/or

(c)may request a hearing, which the Committee, in its sole discretion, may grant.

8.13.4Decision on Review.  The Committee shall render its decision on review promptly, and no later than sixty (60) days after the Committee receives the Claimant’s written request for a review of the denial of the claim.  If the Committee determines that special circumstances require an extension of time for processing the claim, written notice of the extension shall be furnished to the Claimant prior to the termination of the initial sixty (60) day period.  In no event shall such extension exceed a period of sixty (60) days from the end of the initial period.  The extension notice shall indicate the special circumstances requiring an extension of time and the date by which the Committee expects to render the benefit determination.  In rendering its decision, the Committee shall take into account all comments, documents, records and other information submitted by the Claimant relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination.  The decision must be written in a manner calculated to be understood by the Claimant, and it must contain:

(a)specific reasons for the decision;

(b)specific reference(s) to the pertinent Plan provisions upon which the decision was based;

(c)a statement that the Claimant is entitled to receive, upon request and free of charge, reasonable access to and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the Claimant’s claim for benefits; and

(d)a statement of the Claimant’s right to bring a civil action under ERISA Section 502(a).

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8.13.5Pre and Post-Change in Control Procedures.  With respect to claims made prior to the occurrence of a Change in Control Event, a Claimant’s compliance with the foregoing provisions of this Section 8.13 is a mandatory prerequisite to a Claimant’s right to commence arbitration pursuant to Section 8.13.6 with respect to any claim for benefits under this Plan.  With respect to claims made upon and after the occurrence of a Change in Control Event, the Claimant may proceed directly to arbitration in accordance with Section 8.13.6 and need not first satisfy the foregoing provisions of this Section 8.13.

8.13.6Arbitration of Claims.  All claims or controversies arising out of or in connection with this Plan, that the Company or any Subsidiary may have against any Claimant, or that any Claimant may have against the Company or any Subsidiary or against any of their respective officers, directors, employees or agents acting in their capacity as such, shall, subject to the initial review provided for in the foregoing provisions of this Section 8.13 that are effective with respect to claims brought prior to the occurrence of a Change in Control Event, be resolved through arbitration as provided in this Section 8.13.6.  The decision of an arbitrator on any issue, dispute, claim or controversy submitted for arbitration, shall be final and binding upon the Company, any Participating Affiliate and the Claimant and that judgment may be entered on the award of the arbitrator in any court having proper jurisdiction.  With respect to claims arising upon or following the occurrence of a Change in Control Event (but not with respect to any determination made by the Committee prior to the Change in Control Event), the arbitrator shall review de novo any claim previously considered by the Committee pursuant to this Section 8.13.

Except as otherwise provided in this procedure or by mutual agreement of the parties, any arbitration shall be conducted in Orange County, California before a sole arbitrator selected from Judicial Arbitration and Mediation Services, Inc., Atlanta, Georgia, or its successor (“JAMS”), or if JAMS is no longer able to supply the arbitrator, such arbitrator shall be selected from the American Arbitration Association, and shall be conducted in accordance with the provisions of Alabama Code of Civil Practice §§ 6 et seq. as the exclusive forum for the resolution of such dispute.  The party desiring to initiate arbitration shall do so by sending written notice of an intention to arbitrate to the other party, which notice shall include a description of the nature of all claims or controversies asserted and a description of the facts upon which such claims are based.  Pursuant to Alabama Code of Civil Practice § 6-6-500, provisional injunctive relief may, but need not, be sought by either party to this Agreement in a court of law while arbitration proceedings are pending, and any provisional injunctive relief granted by such court shall remain effective until the matter is finally determined by the arbitrator.  Final resolution of any dispute through arbitration may include any remedy or relief which the arbitrator deems just and equitable, including any and all remedies provided by applicable state or federal statutes.  At the conclusion of the

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arbitration, the arbitrator shall issue a written decision that sets forth the essential findings and conclusions upon which the arbitrator’s award or decision is based.  Any award or relief granted by the arbitrator hereunder shall be final and binding on the parties hereto and may be enforced by any court of competent jurisdiction.  The parties acknowledge and agree that they are hereby waiving any rights to trial by jury in any action, proceeding or counterclaim brought by either of the parties against the other in connection with any matter whatsoever arising out of or in any way connected with this Plan.

All forum costs of the arbitration (including, but not limited to, the fees and expenses of the arbitrator) shall be advanced and borne by the Company.  Further, the fees and expenses of the counsel for the Claimant as to any claim arising upon or after a Change in Control Event shall be advanced and borne by the Company; provided, however, that if it is determined by the arbitrator that the Claimant did not commence the arbitration in good faith and had no reasonable basis therefore, the Claimant shall repay to the Company all amounts advanced by the Company to cover the Claimant’s fees and expenses of counsel and shall reimburse the Company for its reasonable legal fees and expenses (other than forum costs) in connection with the arbitration.

The arbitrator shall interpret this Plan, any applicable Company policy or rules and regulations, any applicable substantive law (and the law of remedies, if applicable) of the state in which the claim arose or applicable federal law (any such law to be applicable only to the extent consistent with Section 8.6).  In reaching his or her decision, the arbitrator shall have no authority to change or modify any lawful Company policy, rule or regulation, or this Plan.  The arbitrator, and not any federal, state or local court or agency, shall have exclusive and broad authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this Plan, including but not limited to, any claim that all or any part of this Plan is voidable.

The arbitrator shall have authority to entertain a motion to dismiss and/or motion for summary judgment by any party and shall apply the standards governing such motions under the Federal Rules of Civil Procedure.

9.ADJUSTMENTS IN CASE OF CHANGES IN IDS OR COMMON STOCK

Upon the occurrence of an Event (as defined below), the Committee shall make adjustments as it deems appropriate in the number and kind of securities or other consideration that may become payable with respect to the IDS Units or Dividend and Interest Equivalents credited under this Plan.  If an Event shall occur and any IDS Units or Dividend and Interest Equivalents have not been fully vested and paid upon such Event or prior thereto, such IDS Units and Dividend and Interest Equivalents may, in the sole discretion of the Committee, become payable in securities or other consideration (the “Restricted Property”) rather than in the cash otherwise payable in respect of such IDS Units or Dividend and Interest Equivalents.  Such

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Restricted Property shall become payable at such time or times (if any) as the related IDS Units or Dividend and Interest Equivalents become payable in accordance with this Plan and shall be subject to the same vesting conditions as such related IDS Units or Dividend and Interest Equivalents.  Notwithstanding the foregoing, to the extent that the Restricted Property includes any cash, the commitment hereunder shall become an unsecured promise to pay an amount equal to such cash (with earnings attributable thereto as if such amount had been invested, pursuant to policies established by the Committee, in interest bearing, FDIC insured (subject to applicable insurance limits) deposits of a depository institution selected by the Committee) at such times and in such proportions as the related IDS Units or Dividend and Interest Equivalents become payable in accordance with this Plan.  Notwithstanding the foregoing, the IDS Units or Dividend and Interest Equivalents and any cash or other securities or property payable in respect of the IDS Units or Dividend and Interest Equivalents shall continue to be subject to proportionate and equitable adjustments (if any) under this Section 9 consistent with the effect of such events on holders of IDSs or the Common Stock generally (but without duplication of benefits if Dividend and Interest Equivalents are credited), as the Committee determines to be necessary or appropriate, and in the amount of cash or the number, kind and/or character of securities or other property and/or rights payable in respect of IDS Units or Dividend and Interest Equivalents granted under this Plan.  For purposes of this Section 9, “Event” means a liquidation, dissolution, Change in Control Event, merger, consolidation, or other combination or reorganization, or a recapitalization, reclassification, extraordinary dividend or other distribution (including a split up or a spin off of the Company or any significant Subsidiary), or a sale or other distribution of substantially all the assets of the Company as an entirety.

10.DEFINITIONS

Whenever the following words and phrases are used in this Plan, with the first letter capitalized, they shall have the meanings specified below.

“Accounts” shall mean a Participant’s IDS Unit Account and Dividend and Interest Equivalents Account.

“Actual EBITDA” shall have the meaning set forth in Section 3.1.

“Beneficiary” or “Beneficiaries” as to a Participant shall mean the person or persons, including a trustee, personal representative or other fiduciary, last designated in writing by a Participant in accordance with the procedures established by the Committee to receive the benefits specified hereunder in the event of the Participant’s death.  No beneficiary designation shall become effective until it is filed with the Committee, and no beneficiary designation of someone other than the Participant’s spouse shall be effective unless such designation is consented to by the Participant’s spouse on a form provided by and in accordance with the procedures established by the Committee.  If there is no Beneficiary designation in effect, of there is no surviving designated Beneficiary, then the Participant’s surviving spouse shall be the Beneficiary.  If there is no surviving spouse to receive any benefits payable in accordance with the preceding sentence, the duly appointed and currently acting personal representative of the Participant’s estate (which shall include either the Participant’s probate estate or living trust) shall be the Beneficiary.  In any case where there is no such personal representative of the Participant’s estate duly appointed and acting in that capacity within ninety (90) days after the Participant’s death (or such extended period as the Committee determines is reasonably necessary to allow

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such personal representative to be appointed, but not to exceed one hundred eighty (180) days after the Participant’s death), then the Participant’s Beneficiary shall be deemed to be the person or persons who can verify by court order that they are legally entitled to receive the benefits specified hereunder.  If the Committee has any doubt as to the proper Beneficiary to receive payments pursuant to this Plan, the Committee shall have the right, exercisable in its reasonable discretion, to cause the Participating Affiliate that employs the Participant to withhold such payments until this matter is resolved to the Committee’s reasonable satisfaction.  The payment of benefits under this Plan to a Beneficiary shall fully and completely discharge all Participating Affiliates and the Committee from all further obligations under this Plan with respect to the Participant.

“Board of Directors” or “Board” shall mean the Board of Directors of the Company.

“Change in Control Event” shall mean any of the following:

(a)The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act (a “Person”)) of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 30% or more of either (1) the then-outstanding IDSs of the Company (the “Outstanding Company IDSs”), (2) the then-outstanding shares of common stock of the Company (the “Outstanding Company Common Stock”) or (3) the combined voting power of the then-outstanding voting securities of the Company entitled to vote generally in the election of directors of the Company (the “Outstanding Company Voting Securities”); provided, however, that, for purposes of this definition, the following acquisitions shall not constitute a Change in Control Event; (A) any acquisition directly from the Company, (B) any acquisition by the Company, (C) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any affiliate of the Company or a successor, or (D) any acquisition by any entity pursuant to a transaction that complies with clauses (c)(1), (2) and (3) below;

(b)Individuals who, as of the date this Plan is adopted by the Board (the “Adoption Date”), constitute the Board (the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director of the Company subsequent to the Adoption Date whose election, or nomination for election by the Company’s stockholders, was approved by a vote of at least two-thirds (2/3) of the directors of the Company then comprising the Incumbent Board (including for these purposes, the new members whose election or nomination was so approved, without counting the member and his predecessor twice) shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors of the Company or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board;

(c)Consummation of a reorganization, merger, statutory share exchange or consolidation or similar corporate transaction involving the Company or any of its

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Subsidiaries, a sale or other disposition of all or substantially all of the assets of the Company, or the acquisition of assets or stock of another entity by the Company or any of its Subsidiaries (each, a “Business Combination”), in each case unless, following such Business Combination, (1) all or substantially all of the individuals and entities that were the beneficial owners of the Outstanding Company IDSs, the Outstanding Company Common Stock and the Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 50% of the then-outstanding income deposit securities, the then-outstanding shares of common stock and the combined voting power of the then-outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the entity resulting from such Business Combination (including, without limitation, an entity that, as a result of such transaction, owns the Company or all or substantially all of the Company’s assets directly or through one or more subsidiaries (a “Parent”)) in substantially the same proportions as their ownership immediately prior to such Business Combination of the Outstanding Company IDSs, the Outstanding Company Common Stock and the Outstanding Company Voting Securities, as the case may be, (2) no Person (excluding any entity resulting from such Business Combination or a Parent or any employee benefit plan (or related trust) of the Company or such entity resulting from such Business Combination or Parent) beneficially owns, directly or indirectly, 30% or more of, respectively, the then-outstanding income deposit securities, the then-outstanding shares of common stock of the entity resulting from such Business Combination or the combined voting power of the then-outstanding voting securities of such entity, except to the extent that the ownership in excess of 30% existed prior to the Business Combination, and (3) at least a majority of the members of the board of directors or trustees of the entity resulting from such Business Combination or a Parent were members of the Incumbent Board at the time of the execution of the initial agreement or of the action of the Board providing for such Business Combination; or

(d)Approval by the stockholders of the Company of a complete liquidation or dissolution of the Company other than in the context of a transaction that does not constitute a Change in Control Event under clause (c) above.

“Code” shall mean the Internal Revenue Code of 1986, as amended.

“Committee” shall mean the Compensation Committee of the Board, which shall administer this Plan in accordance with Section 7 of this Plan.

“Common Stock” shall mean the Class A common stock of the Company, par value $0.01 per share, subject to adjustment pursuant to Section 9 of this Plan.

“Company” shall mean Otelco Inc., and any successor corporation.

“Crediting Date” shall have the meaning set forth in Section 3.3.

“Deferred Compensation Plan” shall mean the nonqualified deferred compensation plan of the Company or a Subsidiary designated by the Committee.

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“Determination Date” shall have the meaning set forth in Section 3.2.

“Dividend and Interest Equivalent” shall mean the amount of cash dividends, payments of interest or other cash distributions paid by the Company with respect to that number of IDSs equal to the aggregate number of IDS Units credited to a Participant’s IDS Unit Account as of the applicable record date for the dividend, interest payment or other distribution.  Such amount shall be credited to the Participant’s Dividend and Interest Equivalents Account in accordance with Section 4.2 and shall be payable in cash in accordance with Section 6.2.

“Dividend and Interest Equivalent Distribution Date” shall have the meaning set forth in Section 6.2.

“Dividend and Interest Equivalents Account” shall mean the account established for each Participant pursuant to Section 4.2.

“Dividend or Interest Payment Date” shall have the meaning set forth in Section 4.2.1.

“EBITDA” shall mean, with respect to a Plan Year, the Company’s consolidated net income (or loss, as applicable), plus interest expense, depreciation and amortization (including write-down of goodwill), income taxes and certain non-recurring fees, expenses or charges, as set forth in the indenture governing the Company’s Senior Subordinated Notes.

“Eligible Employee” shall mean any officer or salaried key employee of a Participating Affiliate.

“ERISA” shall mean the Employee Retirement Income Security Act of 1974, as amended.

“Excess EBITDA” shall have the meaning set forth in Section 3.1.

“Exchange Act” shall mean the Securities Exchange Act of 1934, as amended from time to time.

“Fair Market Value” on any date means (a) if the IDSs are listed or admitted to trade on a national securities exchange, the closing price of an IDS on the Composite Tape, as published in the Western Edition of The Wall Street Journal, of the principal national securities exchange on which the IDSs are so listed or admitted to trade, on such date, or, if there is no trading of the IDS on such date, then the closing price of an IDS as quoted on such Composite Tape on the next preceding date on which there was trading in such securities; (b) if the IDSs are not listed or admitted to trade on a national securities exchange, the last/closing price for an IDS on such date, as furnished by the National Association of Securities Dealers, Inc. (“NASD”) through the NASDAQ National Market Reporting System or a similar organization if the NASD is no longer reporting such information; (c) if the IDSs are not listed or admitted to trade on a national securities exchange and are not reported on the National Market Reporting System, the mean between the bid and asked price for an IDS on such date, as furnished by the NASD or a similar organization; or (d) if the IDSs are not listed or admitted to trade on a national securities exchange, are not reported on the National Market Reporting System and if bid and asked prices for the IDSs are not furnished by the NASD or a similar organization, the value as reasonably established by the Committee at such time for purposes of this Plan.  Any determination as to fair market value made pursuant to this Plan shall be conclusive and binding on all persons.  The

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Committee may, however, provide that the Fair Market Value shall equal the last closing price of an IDS as reported on the composite tape for securities listed on a national securities exchange or as furnished by the NASD and available on the date in question or the average of the high and low prices of an IDS as reported on the composite tape for securities listed on a national securities exchange or as furnished by the NASD for the date in question or the most recent trading day.

“Incentive Pool Amount” shall have the meaning set forth in Section 3.1.

“IDS” shall mean the Company’s Income Deposit Securities.  Each IDS shall initially represent (a) one (1) share of the Company’s Common Stock, and (b) one (1) thirteen percent (13%) senior subordinated note of the Company with a principal amount of $7.50 (the “Senior Subordinated Notes”).

“IDS Unit” shall mean, solely for purposes of this Plan, a non-voting unit of measurement which is deemed solely for bookkeeping purposes to be equivalent to one outstanding IDS (subject to Section 9).  IDS Units may be credited to a Participant’s IDS Unit Account pursuant to Section 4.1.

“IDS Unit Account” shall mean the account established and maintained for each Participant pursuant to Section 4.1.

“IDS Unit Distribution Date” shall have the meaning set forth in Section 6.1.

“Key Employee” shall mean a “key employee” of the Company within the meaning of Section 416(i) of the Code (without regard to paragraph (5) thereof).

“Participant” shall mean any Eligible Employee who is selected for participation in this Plan and who is allocated IDS Units in accordance with Section 3.3.

“Participating Affiliate” shall mean the Company or a Subsidiary that elects to adopt this Plan for the benefit of its employees.  “Participating Affiliates” means, collectively, the Company and such Subsidiaries that have elected to adopt this Plan.

“Plan” shall mean this Otelco Inc. Long-Term Incentive Plan as set forth herein and as amended from time to time.

“Plan Year” shall mean the twelve (12) consecutive month period beginning January 1 each year.

“Restricted Property” shall have the meaning set forth in Section 9.

“Retirement Date” shall mean the date of a Participant’s voluntary termination of employment from a Participating Affiliate (i) on or after attaining age 65 with ten (10) years of service, or (ii) on or after attaining age 55 with fifteen (15) years of service.

“Separation From Service” shall mean a “separation from service” within the meaning of Section 409A (or other applicable section) of the Code and any applicable guidance promulgated thereunder.

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“Subsidiary” shall mean each corporation, which is a member of a controlled group of corporations (within the meaning of Section 414(b) of the Code) of which the Company is a component member.

“Target EBITDA” shall have the meaning set forth in Section 3.1.

“Termination Date” with respect to a Participant shall mean the first date that, for any reason, the Participant is no longer employed by the Company or one of its Subsidiaries and, if applicable, is no longer a member of the Board of Directors.

“Trust” means a grantor trust maintained under the terms of the related Trust Agreement.

“Trust Agreement” means a trust agreement entered into by and between a Participating Affiliate and the related Trustee with respect to this Plan, as amended from time to time.

“Trustee” means the entity, which has entered into the related Trust Agreement as trustee of the Trust thereunder, and any duly appointed successor.

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IN WITNESS WHEREOF, the Company has caused this Plan to be executed by its duly authorized officer effective as of May 12, 2005.

OTELCO INC.
By:		/s/ Michael D. Weaver
Print Name:			Michael D. Weaver
Its:	President and CEO

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EX-31.1

Exhibit 31.1

CERTIFICATION BY CHIEF EXECUTIVE OFFICER

I, Michael D. Weaver, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Otelco Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a.designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c.disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:   August 10, 2005

/s/ Michael D. Weaver

Michael D. Weaver

President & Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION BY CHIEF FINANCIAL OFFICER

I, Curtis L. Garner, Jr., certify that:

1.I have reviewed this quarterly report on Form 10-Q of Otelco Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a.designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c.disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:   August 10, 2005

/s/ Curtis L. Garner, Jr.

Curtis L. Garner, Jr.

Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Otelco Inc. (the “Company”) on Form 10-Q for the period ended June 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael D. Weaver, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

1.The Report fully complies with the requirements of Section 13(a) or 15 (d) of the Securities Exchange Act of 1934; and

2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Michael D. Weaver

Michael D. Weaver

Chief Executive Officer

August 10, 2005

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Otelco Inc. (the “Company”) on Form 10-Q for the period ended June 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Curtis L. Garner, Jr., Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

1.The Report fully complies with the requirements of Section 13(a) or 15 (d) of the Securities Exchange Act of 1934; and

2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Curtis L. Garner, Jr.

Curtis L. Garner, Jr.

Chief Financial Officer

August 10, 2005