10-Q 1 a05-13086_110q.htm 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

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.

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.

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.

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.

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:

	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.

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

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

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

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.

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.

	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

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

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

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.

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.

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.

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.

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

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