10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

x         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2011

OR

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

For the Transition Period from            to

Commission File Number: 1-32362

OTELCO INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	52-2126395
(State or Other Jurisdiction of Incorporation or 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)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class	Name of Each Exchange on Which Registered
Income Deposit Securities, each representing shares of Common Stock and Senior Subordinated Notes due 2019	The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

Large accelerated filer o Accelerated filer x Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of June 30, 2011, the aggregate market value of the registrant’s Income Deposit Securities (IDSs) held by non-affiliates of the registrant was $247.1 million based on the closing sale price as reported on NASDAQ. Each IDS represents one share of Common Stock, par value $0.01 per share, and $7.50 principal amount of senior subordinated notes due 2019. In determining the market value of the registrant’s IDSs held by non-affiliates, IDSs beneficially owned by directors, officers and holders of more than 10% of the registrant’s IDSs have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 5, 2012, the registrant had 13,221,404 shares of Common Stock, par value $0.01 per share, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required in Part III of this report is incorporated by reference from the registrant’s proxy statement to be filed pursuant to Regulation 14A with respect to the registrant’s 2012 annual meeting of stockholders.

OTELCO INC.

TABLE OF CONTENTS

			Page
PART I			2
	Item 1.	Business	2
	Item 1A.	Risk Factors	8
	Item 1B.	Unresolved Staff Comments	13
	Item 2.	Properties	13
	Item 3.	Legal Proceedings	13
	Item 4.	Mine Safety Disclosures	13
	Item X.	Executive Officers of the Registrant	13
PART II			15
	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	15
	Item 6.	Selected Financial Data	18
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	32
	Item 8.	Financial Statements and Supplementary Data	33
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	61
	Item 9A.	Controls and Procedures	61
	Item 9B.	Other Information	62
PART III			63
	Item 10.	Directors, Executive Officers and Corporate Governance	63
	Item 11.	Executive Compensation	63
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	63
	Item 13.	Certain Relationships and Related Transactions, and Director Independence	63
	Item 14.	Principal Accountant Fees and Services	63
PART IV			64
	Item 15.	Exhibits and Financial Statement Schedules	64

i

Unless the context otherwise requires, the words “we,” “us,” “our,” the “Company” and “Otelco” refer to Otelco Inc., a Delaware corporation, and its consolidated subsidiaries as of December 31, 2011.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations relating to our financial condition, results of operations, plans, objectives, future performance and business. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. These forward-looking statements are based on assumptions that we have made in light of our experience in the industry in which we operate, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial condition or results of operations and cause actual results to differ materially from those in the forward-looking statements. These factors include, among other things, those discussed under the caption “Risk Factors” in Item 1A.

PART I

Item 1. Business

History

We were formed in Delaware in 1998 for the purpose of operating and acquiring rural local exchange carriers, or RLECs. Since 1999, we have acquired eleven RLEC businesses, four of which serve contiguous territories in north central Alabama; three of which serve territories adjacent to either Portland or Bangor, Maine; and one each serving a portion of western Massachusetts, central Missouri, western Vermont and southern West Virginia. We provide competitive services through several subsidiaries in certain of these territories. In addition, we acquired three facilities based competitive local exchange carriers, or CLECs, which are collectively offering services under the trade name OTT Communications in Maine, New Hampshire, and Massachusetts. The Company completed an initial public offering of income deposit securities, or IDSs, in December 2004 at which time it converted from a Delaware limited liability company into a Delaware corporation and changed its name to Otelco Inc. In July 2007, the Company completed an additional offering of 3,000,000 IDS units. On June 8, 2010, we exchanged all of our issued and outstanding shares of Class B common stock, which were issued in connection with our initial public offering, for an equal number of IDSs registered under the Securities Act of 1933.

The following table shows the aggregate number of our voice and data access lines (which together are access line equivalents) and other services we offer such as wholesale network connections, television, and other internet customers as of December 31, 2011:

Voice and data access lines, or access line equivalents	102,378
Wholesale network connections	157,144
Cable television customers	4,201
Additional internet customers	5,414

The RLEC companies we acquired can trace their history as local communications providers to the introduction of telecommunications services in the areas they serve. We are able to leverage our long-standing relationship with our local service customers by offering them a broad suite of telecommunications and information services, such as long distance, internet/broadband data access and, in some areas, cable or satellite television, thereby increasing customer loyalty and revenue per access line.

Our RLECs have historically experienced relatively stable operating results and strong cash flows and operate in supportive regulatory environments. Each RLEC qualifies as a rural telephone company under the Federal Communications Act of 1934, or the Communications Act, so we are currently exempt from certain costly interconnection requirements imposed on incumbent or historical local telephone companies, or incumbent local exchange carriers, by the Communications Act. While this exemption helps us maintain our strong competitive position, we do have direct competition in portions of our RLEC market, primarily where a cable provider also serves the same market. The cost of operations and capital investment requirements for new entrants is high, discouraging such investments.

In Maine and New Hampshire, our facilities based CLEC serves primarily business customers, utilizing our 423 miles of owned and leased fiber as a backbone network. In thirteen years of operations, the CLEC has grown to provide more than 33,000 voice and data access lines and 157,000 wholesale network connections. Facilities were installed in 2011 to expand services into western Massachusetts in the coming year.

Acquisitions have represented a significant part of our growth. A summary of each acquisition follows:

Otelco Telephone. On January 5, 1999, through Otelco Telephone LLC, or Otelco Telephone, we acquired certain telecommunications businesses from Oneonta Telephone Company, Inc., a rural local exchange carrier that serves a portion of Blount county in Alabama. In connection with the transaction, we acquired 8,127 voice and data access lines.

Hopper. On September 30, 1999, we acquired Hopper Telecommunications Company, Inc., or Hopper, a rural local exchange carrier that serves portions of Blount and Etowah counties in Alabama. In connection with the transaction, we acquired 3,827 voice and data access lines.

2

Brindlee. On July 19, 2000, we acquired Brindlee Mountain Telephone Company, or Brindlee, a rural local exchange carrier that serves portions of Marshall, Morgan, Blount and Cullman counties in Alabama. In connection with the transaction, we acquired 14,013 voice and data access lines.

Blountsville. On June 30, 2003, we acquired Blountsville Telephone Company, Inc., or Blountsville, a rural local exchange carrier that serves a portion of Blount county in Alabama. In connection with the transaction, we acquired 4,080 voice and data access lines.

Mid-Missouri. On December 21, 2004, we acquired Mid-Missouri Telephone Company, or Mid-Missouri, a rural local exchange carrier that serves portions of Cooper, Moniteau, Morgan, Pettis and Saline counties in central Missouri. In connection with the transaction, we acquired approximately 4,585 voice and data access lines. In addition, we provide internet services in areas surrounding our territory.

Mid-Maine. On July 3, 2006, we acquired Mid-Maine Communications, Inc., or Mid-Maine, a rural local exchange carrier that serves portions of Penobscot, Somerset and Piscataquis counties adjacent to Bangor, Maine and a competitive local exchange carrier, serving customers adjacent to its fiber network along the I-95 corridor in Maine. In connection with the transaction, we acquired approximately 22,413 voice and data access lines. In addition, we provide dial-up internet services throughout Maine.

Country Road. On October 31, 2008, we acquired Pine Tree Holdings, Inc., Granby Holdings, Inc. and War Holdings, Inc., which we collectively refer to as the CR Companies, from Country Road Communications LLC. The three holding companies had four RLEC operating subsidiaries: War Acquisition Corp., or War, serves areas in and around War, West Virginia; The Granby Telephone and Telegraph Co. of Mass., or Granby, serves areas in and around Granby, Massachusetts; and Saco River Telegraph and Telephone Company, or Saco River, and The Pine Tree Telephone and Telegraph Company, or Pine Tree, which collectively serve areas in and around Buxton, Hollis, Waterboro, Gray and New Gloucester, Maine (adjacent to Portland). There are also two CLEC subsidiaries providing services primarily to business customers in Maine and New Hampshire – CRC Communications of Maine, Inc. and Communications Design Acquisition Corporation. In connection with the transaction, we acquired approximately 29,112 voice and data access lines and 93,994 wholesale network connections.

Shoreham. On October 14, 2011, we acquired Shoreham Telephone Company, Inc. or Shoreham, a rural local exchange carrier that serves portions of Addison county in western Vermont. In connection with the transaction, we acquired approximately 4,990 voice and data access lines.

The following table reflects the percentage of total revenues derived from each of our service offerings for the year ended December 31, 2011:

Revenue Mix

Source of Revenue
Local services	46.6	%
Network access	31.6
Cable television	2.9
Internet	13.7
Transport services	5.2
Total	100.0	%

Local Services

We are the sole provider of wireline telephone services in seven of the eleven RLEC territories we serve. In the remaining four territories, the incumbent cable provider also offers local services in portions of our territory. Local services enable customers to originate and receive telephone calls. The amount that we can charge a customer for certain basic services in Alabama, Maine, Massachusetts, Missouri, Vermont and West Virginia is regulated by the Alabama Public Service Commission, or APSC; the Maine Public Utilities Commission, or MPUC; the Massachusetts Department of Telecommunications and Cable, or MDTC; the Missouri Public Service Commission, or MPSC; the Vermont Public Service Board, or VPSB; and the West Virginia Public Service Commission, or WVPSC. We also have authority to provide service in New Hampshire from the New Hampshire Public Utilities Commission, or NHPUC. The regulatory involvement in pricing varies by state and by type of service. Increasingly, bundled services generally involve less regulation.

3

Revenue derived from local services includes monthly recurring charges for voice access lines providing local dial tone and calling features, including caller identification, call waiting, call forwarding and voicemail. We also receive revenue for providing long distance services to our customers, billing and collection services for other carriers under contract, and directory advertising. We provide local services on a retail basis to residential and business customers. With the high level of acceptance of local service bundles, a growing percentage of our customers receive a broad range of services, including long distance, for a single, fixed monthly price.

We also offer long distance telephone services to our local telephone customers who do not purchase a local service bundle. We resell long distance services purchased from various long distance providers. At December 31, 2011, customers representing more than 62% of our regulated access lines subscribed to our long distance services. We intend to continue to make our long distance business an integral part of the services we provide to our RLEC customers principally through bundling of services.

In Maine and New Hampshire, our CLEC provides communications services tailored to business customers, including specialized data and voice network configurations, to support their unique business requirements. Our fiber network allows us to offer our customers affordable and reliable voice and data solutions to support their business requirements and applications, which is a significant differentiator for our Company in the competitive local exchange carrier environment in which we operate. In connection with the acquisition of the CR Companies, the Company acquired a multi-year contract with Time Warner Cable, or TW, a large multiple system operator, for the provision of wholesale network connections to TW’s customers in Maine and New Hampshire. The contract extends through December 31, 2012 and represented approximately 11.7% of our consolidated revenue for 2011. In addition, we receive access revenue from carriers for completing calls to TW’s customers.

We derive revenue from other telephone related services, including leasing, selling, installing, and maintaining customer premise telecommunications equipment and the publication of local telephone directories in certain of our RLEC territories. We also provide billing and collection services for long distance carriers (also referred to as interexchange carriers) through negotiated billing and collection agreements for certain types of toll calls placed by our local customers.

Network Access

Network access revenue relates primarily to services provided by us to long distance carriers in connection with their use of our facilities to originate and terminate interstate and intrastate long distance, or toll, telephone calls. As toll calls are generally billed to the customer originating the call, network access charges are applied in order to compensate each telecommunications company providing services relating to the call. Network access charges apply to both interstate and intrastate calls. Our network access revenues also include revenues we receive from wireless carriers for terminating their calls on our networks pursuant to our interconnection agreements with those wireless carriers. Blountsville, Hopper, Mid-Missouri, Shoreham and War also receive Universal Service Fund High Cost Loop, or USF HCL, revenue which is included in our reported network access revenue.

Intrastate Access Charges. We generate intrastate access revenue when a long distance call involving a long distance carrier is originated and terminated within the same state. The interexchange carrier pays us an intrastate access payment for either terminating or originating the call. We record the details of the call through our carrier access billing system. Our access charges for our intrastate access services are set by the APSC, the MPUC, the MDTC, the MPSC, the NHPUC, the VPSB, and the WVPSC for Alabama, Maine, Massachusetts, Missouri, New Hampshire, Vermont and West Virginia, respectively. A Federal Communications Commission, or FCC, Order of October 27, 2011 (the “FCC Order”) preempted the state commissions’ authority to set intrastate access service rates, and requires states with terminating access rates higher than interstate rates to reduce their terminating intrastate access rates to a rate equal to interstate access service rates by July 1, 2013, and to move to a “bill and keep” arrangement by July 1, 2020. The FCC Order prescribes a recovery mechanism for the recovery of any decrease in intrastate terminating access revenues through the Connect America Fund. This recovery is limited to 95% of the previous year’s revenue requirement. The FCC Order is being contested by a number of states.

Interstate Access Charges. We generate interstate access revenue when a long distance call originates from an area served by one of our local exchange carriers and terminates outside of that state, or vice versa. We bill interstate access charges in a manner similar to intrastate access charges. Our RLEC interstate access charges are regulated by the FCC through our participation in tariffs filed by the National Exchange Carriers Association, or NECA. The FCC regulates the prices local exchange carriers charge for access services in two ways: price caps and rate-of-return. All of our rural local exchange carriers are rate-of-return carriers for purposes of interstate network access regulation. Interstate access revenue for rate-of-return carriers is based on an FCC regulated rate-of-return currently authorized up to 11.25% on investment and recovery of operating expenses and taxes, in each case solely to the extent related to interstate access. The FCC Order requires terminating interstate access rates to move to a “bill and keep” arrangement by July 1, 2020. Initial reductions in interstate access rates occur July 1, 2014, with additional reductions through July 1, 2019. The FCC Order prescribes a recovery mechanism for the recovery of any decrease in terminating interstate access revenues through the Connect America Fund. This recovery is limited to 95% of the previous year’s revenue requirement.

4

Federal Universal Service Fund High Cost Loop Revenue. Blountsville, Hopper, Mid-Missouri, Shoreham and War recover a portion of their costs through the USF HCL, which is regulated by the FCC and administered by the Universal Service Administrative Company, or USAC, a non-profit organization. Based on historic and other information, a nationwide average cost per loop is determined by USAC. Any incumbent local exchange carrier whose individual cost per loop exceeds the nationwide average by more than 15% qualifies for USF HCL support. Although all of our rural local exchange carriers have been designated as eligible telecommunications carriers, or ETCs, Otelco Telephone, Brindlee, Granby, Mid-Maine, Pine Tree and Saco River do not receive USF HCL support because their cost per loop does not exceed the national average by more than fifteen percent. The USF HCL, which is funded by assessments on all United States telecommunications carriers as a percentage of their revenue from end-users of interstate and international service, distributes funds to our participating RLECs based upon their respective costs for providing local services. USF HCL payments are received monthly. The FCC Order introduced new requirements for carriers to become certified as ETCs. ETCs must now, upon their customers’ reasonable request, provide broadband service at minimum speeds of 4 Mbps download and 1 Mbps upload, at prices reasonably comparable to those provided in urban areas. In addition, the FCC Order placed limits on the recovery of certain operating expenses, implemented a benchmark floor for local service rates, and placed limits on the overall support an ETC can receive. Not all of our RLECs provide services to all of their customers at these minimum speeds. The FCC has not provided guidance as to what constitutes a reasonable request. Depending on how a reasonable request ultimately gets defined, some of our RLECs may not qualify as ETCs, which could have a material adverse effect on our financial position and results of operations.

Transition Service Fund Revenue. Otelco Telephone, Hopper, Brindlee, and Blountsville recover a portion of their costs through the Transition Service Fund, or TSF, which is administered by the APSC. All interexchange carriers originating or completing calls in Alabama contribute to the TSF on a monthly basis, with the amount of each carrier’s contribution calculated based upon its relative originating and terminating minutes of use compared to the aggregate originating and terminating minutes of use for all telecommunications carriers participating in the TSF. The TSF reduces the vulnerability of our Alabama rural local exchange carriers to a loss of access and interconnection revenue. TSF payments are received monthly.

Maine Universal Service Fund. Mid-Maine recovers a portion of its costs through the Maine Universal Service Fund, or MUSF, which is administered by the MPUC. All local and interexchange carriers in Maine contribute to the MUSF on a monthly basis, with the amount of each carrier’s contribution calculated based upon a percentage of retail intrastate revenues. The MUSF was created to support RLEC universal service goals in response to legislative mandates to reduce intrastate access rates.

Cable Television

We provide cable television services, including high definition, digital video recording capability and video on demand, or VOD, over networks with 750 MHz of transmission capacity or by Internet Protocol TV, or IPTV, in our Alabama service area. Our cable television packages offer from 20 to 200 channels. We are a licensed installer of satellite television and have deployed these services to customers in our Missouri territory. In 2011, we converted our Missouri cable customers to satellite television.

Internet

We provide a variety of internet access data lines to our customers, including bulk broadband data access to support large corporate users; digital high-speed data lines in varying capacity speeds for business and residential use; and residential dial-up connectivity. Digital high-speed data lines are provided via digital subscriber line, or DSL; cable modems; and wireless broadband, depending upon the location in which the service is offered and via dedicated fiber connectivity to larger business customers. We charge our internet customers a flat rate for unlimited internet usage and a premium for higher speed internet services. We are able to provide digital high-speed internet data lines to over 90% of our RLEC access lines and all of our CLEC lines. We intend to expand the availability of our high-speed internet services as warranted by customer demand by installing additional equipment at certain switching locations. In Maine and Missouri, we provide legacy dial-up internet services throughout the state.

Transport Services

Our CLEC receives monthly recurring revenues for the rental of fiber to transport data and other telecommunications services in Maine and New Hampshire from businesses and telecommunications carriers along our 423 mile owned and leased fiber route.

Network Assets

Our telephone networks include carrier grade advanced switching capabilities provided by traditional digital as well as software based switches; fiber rings and routes; and network software supporting specialized business applications, all of which meet industry standards for service integrity, redundancy, reliability and flexibility. Our networks enable us to provide traditional and Internet Protocol, or IP, wireline telephone services and other calling features; long distance services; digital internet access services through DSL and cable modems and dedicated circuits; and specialized customer specific applications.

5

Our cable television network in Alabama has been upgraded to a transmission capacity of 750 MHz or utilizes IPTV delivery. We offer digital signals, high-definition program content, digital video recording capability and VOD through both our traditional cable plant and IPTV.

Sales, Marketing & Customer Service

In Maine and New Hampshire, our CLEC provides services under the brand name OTT Communications. We compete with the incumbent carriers throughout each state, utilizing both an employee and agent sales force. Service configurations are tailored to meet specific customer requirements, utilizing customer designed voice and data telecommunications configurations. Increased service monitoring for business customers is provided through a state of the art network operations center and serves as a differentiator for our offers. We offer an IP based Hosted Private Branch Exchange, or PBX, service that provides industry leading capability for our customers that is not generally available from our current competitors.

Our RLEC marketing approach emphasizes locally managed, customer-oriented sales, marketing and service. We believe that we are able to differentiate ourselves from any competition by providing a superior level of service in our territories. Each of our RLECs has a long history in the communities it serves, which has helped to enhance our reputation among local residents by fostering familiarity with our products and level of service. To demonstrate our commitment to the markets we serve, we maintain local offices in most of the population centers within our service territories. While customers have the option of paying their bills on-line or by mail, credit card or automatic withdrawal from their bank account, many elect to pay their monthly bill in person at the local office. This provides us with an opportunity to directly market our services to our existing customers. These offices typically are staffed by local residents and provide sales and customer support services in the community. Local offices facilitate a direct connection to the community, which we believe improves customer satisfaction and enhances our reputation with local residents. We also build upon our strong reputation by participating in local activities, such as local fund raising and charitable events for schools and community organizations and, in Alabama, by airing local interest programs on our local access community cable channels.

In order to capitalize on the strong branding of each of our rural local exchange carriers, while simultaneously establishing and reinforcing the “Otelco” and “OTT Communications” brand names across our service territories, we often identify both the historical name of the RLEC and Otelco or OTT Communications on our marketing materials and other customer communications. Part of our strategy is to increase customer loyalty and strengthen our brand name by deploying new technologies and by offering comprehensive bundling of services, including digital high-speed internet access, cable and satellite television, long distance and a full array of calling features. In addition, our ability to provide our customers with a single, unified bill for all of our services is a major competitive advantage and helps to enhance customer loyalty.

Competition

Local Services

We believe that many of the competitive threats to wireline telephone companies are not as significant in portions of our RLEC service areas as in more urban areas. The demographic characteristics of rural telecommunications markets generally require significant capital investment to offer competitive wireline telephone services with low potential revenues. As a result, rural local exchange carriers generally do not face the threat of significant wireline telephone competition except in markets where a cable company provides existing services. We face current or future direct competition from cable providers in portions of six of our eleven RLEC territories. New market entrants, such as providers of satellite broadband or voice over electric lines and indirect competition such as voice over internet protocol, or VoIP, may gain traction in the future.

We currently qualify for the rural exemption from certain interconnection obligations which support industry competition, including obligations to provide services for resale at discounted wholesale prices and to offer unbundled network elements. If the APSC, MPUC, MDTC, MPSC, VPSB or WVPSC terminates this exemption for our rural local exchange carriers, we may face competition from resellers and other wireline carriers.

In our markets, we face competition from wireless carriers. We have experienced a decrease in access lines as a result of customers switching their residential wireline telephone service to a wireless service. We have also experienced an increase in network access revenue associated with terminating wireless calls on our telephone network. The introduction of residential bundled offerings including unlimited calling appears to have recaptured minutes back from wireless carriers. A portion of the wireless technology threat to our business is reduced due in part to the topography of some of our telephone territories and current inconsistent wireless coverage in some areas. However, as wireless carriers continue to employ new technologies in our territories, we expect to experience increased competition from these carriers.

6

The long distance market remains competitive in all of our rural local exchange carrier territories. We compete with major national and regional interexchange carriers, including AT&T and Verizon, as well as wireless carriers, and other service providers. However, we believe that our service bundling that includes long distance, our long-standing local presence in our territories and our ability to provide a single, unified bill for all of our services, are major competitive advantages. At December 31, 2011, more than 62% of our regulated access lines subscribed to our long distance services. The majority of our CLEC customers have also selected us for their long distance services as part of their overall package of services.

In addition, under the Communications Act, a competitor can obtain USF HCL support if a state public service commission (or the FCC in certain instances) determines that it would be in the public interest and designates such competitor as an ETC. While access to USF HCL support by our competitors currently would not reduce our current USF HCL revenue, such economic support could facilitate competition in our RLEC territories, particularly from wireless carriers. The FCC Order will impact amounts paid to and received from, as well as eligibility for payments from, USF HCL. As discussed above, the FCC Order also introduces new requirements for carriers to become certified as ETCs. ETCs must now, upon their customers’ reasonable request, provide broadband service at minimum speeds of 4 Mbps download and 1 Mbps upload, at prices reasonably comparable to those provided in urban areas. In addition, the FCC’s Order placed limits on the recovery of certain operating expenses, implemented a benchmark floor for local service rates, and places limits on the overall support an ETC can receive. Not all of our RLECs provide services to all of their customers at these minimum speeds. The FCC has not provided guidance as to what constitutes a reasonable request. Depending on how a reasonable request ultimately gets defined, some of our RLECs may not qualify as ETCs, which could have a material adverse effect on our financial position and results of operations.

In Maine and New Hampshire, we operate as a facilities based competitive local exchange carrier in areas primarily served by FairPoint Communications as the incumbent local exchange carrier. There are other competitors who serve these markets today as both facilities based and resale carriers. Our focus has been on the small to medium size business customer with multiple locations and enterprise telecommunications requirements, where we offer a combination of knowledge, experience, competitive pricing and new IP based products to meet their specialized needs.

Cable Television

We offer cable television services, including VOD, in our Alabama territory and are a licensed agent for a satellite provider. Services are delivered through traditional cable technology and IPTV. Charter Communications, Inc., or Charter, provides cable service, passing about 30% of our telephone subscribers. In Maine, TW provides cable service, passing approximately 60% of our RLEC telephone subscribers. In Massachusetts, Comcast Corporation, or Comcast, provides cable service, passing more than 90% of our telephone subscribers. In addition, we compete against digital broadcast satellite providers including Dish Network and DirecTV. Our broadband subscribers also have access to “Over The Top” entertainment services offered by numerous providers.

Internet

Competition in the provision of RLEC data lines and internet services currently comes from alternative digital high-speed internet service providers. Competitors vary on a market-to-market basis and include Charter, TW and Comcast. At December 31, 2011, we provided data access lines to approximately 49% of our rural voice access lines. In Maine and Missouri, we also provide high-speed data lines and dial-up internet services to approximately 5,100 subscribers outside of our rural telephone services territory, where approximately 45% of those customers receive high-speed data services. Our CLEC customers are provided a variety of data access service options, based on their individual requirements.

Transport Services

Other local telephone companies, long distance carriers, cable providers, utilities, governments, and industry associations deploy and sell fiber capacity to users. Existing and newly deployed capacity could impact market pricing. Multi-year contracts generally protect existing relationships and provide revenue stability. The cost of and time required for deploying new fiber can be a deterrent to adding capacity. We have expanded our fiber network in Maine to reach additional locations and serve incremental customers.

Information Technology and Support Systems

We have integrated software systems that function as operational support and customer care/billing systems. One system serves our Alabama and Missouri local exchange subscribers, one serves our additional internet subscribers in Missouri, and one serves our Maine, Massachusetts, New Hampshire, Vermont and West Virginia subscribers. The systems include automated provisioning and service activation, mechanized line records and trouble reporting. These services are provided through the use of

7

licensed third-party software. By utilizing integrated software systems, we are able to reduce individual company costs and standardize functions resulting in greater efficiencies and profitability.

     Each system allows us to provide a single, unified bill for all our services which we believe is a significant competitive advantage. Additionally, the systems provide us an extensive database that enables us to gather detailed marketing information in our service territories. This capability allows us to market new services as they become available to particular customers. The Company has implemented all currently established safeguards to Customer Proprietary Network Information as established by the FCC for telecommunications providers and is compliant with the “red flag” provisions of the Fair and Accurate Credit Transactions Act.

Environment

We are subject to various federal, state and local laws relating to the protection of the environment. We believe that we are in compliance in all material respects with all such laws. The environmental compliance costs incurred by us to date have not been material, and we currently have no reason to believe that such costs will become material in the foreseeable future.

Employees

As of December 31, 2011, we employed 325 full-time and 5 part-time employees. None of our employees are members of, or are represented by, any labor union or other collective bargaining unit. We consider our relations with our employees to be good.

Available Information

Under the Securities Exchange Act of 1934, we are required to file with or furnish to the Securities and Exchange Commission, or the SEC, annual, quarterly and current reports, proxy and information statements and other information. You may read and copy any document we file with or furnish to the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information about the Public Reference Room. The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. We file electronically with the SEC.

We make available, free of charge, through the investor relations section of our website, our reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, as soon as reasonably practicable after they are filed with or furnished to the SEC. The address for our website is http://www.OtelcoInc.com.

Our Code of Ethics applies to all of our employees, officers and directors, including our chief executive officer and our chief financial officer and principal accounting officer. The full text of the Code of Ethics is available at the investor relations section of our website, http://www.OtelcoInc.com. We intend to disclose any amendment to, or waiver from, a provision of the Code of Ethics that applies to our chief executive officer or chief financial officer and principal accounting officer in the investor relations section of our website. The investor relations section of our website also includes charters for the audit committee, compensation committee and nominating and corporate governance committee of our board of directors.

The information contained on our website is not part of, and is not incorporated in, this or any other report we file with or furnish to the SEC.

Item 1A. Risk Factors

In evaluating our business, every investor should carefully consider the following risks. Our business, financial condition or results of operation could be materially adversely affected by any of the following risks.

The Telecommunications Industry Has Experienced Increased Competition.

Although we have historically experienced limited wireline telephone competition in many of our RLEC territories, the market for telecommunications services is highly competitive. Certain competitors benefit from brand recognition and financial, personnel, marketing and other resources that are significantly greater than ours. We cannot predict the number of competitors that will emerge, especially as a result of existing or new federal and state regulatory or legislative actions. Increased competition from existing and new entities could have an adverse effect on our business, revenue and cash flow.

In all of our markets, we face competition from wireless carriers, including the potential for customers to export existing wireline telephone numbers to wireless services. As wireless carriers continue to build-out their networks and add products and

8

services aimed at the fixed wireless market, we may experience increased competition, which could have an adverse effect on our business, revenue and cash flow.

The current and potential competitors in our RLEC territories include cable television companies; competitive local exchange carriers and other providers of telecommunications and data services, including internet and VoIP service providers; wireless carriers; satellite television companies; alternate access providers; neighboring incumbent local exchange carriers; long distance companies and electric utilities that may provide services competitive with those products and services that we provide or intend to provide.

In Maine and New Hampshire, our competitive local exchange carrier operations may encounter a change in the competitive landscape that would impact its continued ability to grow and/or retain customers, sustain current pricing plans, and control the cost of access to incumbent carrier customers.

Although our long distance operations have historically been modest in relation to our competitors, we have expanded our long distance business within our territories, primarily through bundling long distance with other local services and providing a single bill for these services. Our existing long distance competitors, including those with significantly greater resources than us, could respond to such initiatives and new competitors may enter the market with attractive offerings. There can be no assurance that our local services revenue, including long distance services, will not decrease in the future as competition and/or the cost of providing services increase.

We Have a Significant Amount of Debt Maturing in October 2013.

We currently have outstanding $162.0 million of debt under our senior credit facility that matures in October 2013. We will be in default under the senior credit facility if we are unable to refinance this debt at or prior to its maturity. There can be no assurance that market conditions will allow us to refinance this debt at or prior to its maturity on terms that are acceptable to us, or at all. Any such refinancing may contain covenants that could limit in a significant manner our ability to pay interest on our senior subordinated notes and dividends on our common stock.

Changes in the Regulation of the Telecommunications Industry Could Adversely Affect Our Business, Revenue or Cash Flow.

We operate in an industry that is regulated at the federal, state and local level. The majority of our revenue has historically been supported by and subject to regulation. Certain federal and state regulations and local franchise requirements have been, are currently, and may in the future be, the subject of judicial proceedings, legislative hearings and administrative proposals. Such proceedings may relate to, among other things, federal and state universal service funds (including USF HCL), the rates we may charge for our local, network access and other services, the manner in which we offer and bundle our services, the terms and conditions of interconnection, unbundled network elements and resale rates, and could change the manner in which telecommunications companies operate. The FCC Order will significantly reduce access revenue received by us beginning as soon as this year and USF HCL revenue over a five to ten year period. In addition, the FCC Order imposes certain costs and rate increases on carriers that we may not be able to pass on to our customers without experiencing further access line loss.

We Are Dependent on One Large Services Contract for More than Ten Percent of Our Revenue.

We provide more than 150,000 wholesale network connections for TW in Maine and New Hampshire. The current five year contract with TW expires at the end of 2012 and represented approximately 11.7% of our consolidated revenue for 2011. There can be no assurance that TW will renew the contract or that any extension of the contract will cover the same services currently provided or the same level of pricing contained in the existing contract. Termination of our relationship with TW could have a material adverse effect on our financial performance and cause us to reduce or eliminate dividends or, pursuant to the terms of our senior credit facility, defer interest on our senior subordinated notes, including the senior subordinated notes that are part of the IDSs.

We Are Subject to Restrictive Debt Covenants That Limit Our Business Flexibility By Imposing Operating and Financial Restrictions on Our Operations.

The agreements governing our indebtedness impose significant operating and financial restrictions on us. These restrictions prohibit or limit, among other things:

● the incurrence of additional indebtedness and the issuance of preferred stock and certain redeemable capital stock;

● the making of certain types of restricted payments, including investments and acquisitions;

● the payment of dividends on our common stock;

9

● specified sales of assets;

● specified transactions with affiliates;

● the creation of a number of liens;

● consolidations, mergers and transfers of all or substantially all of our assets; and

● our ability to change the nature of our business.

We May Not Be Able to Integrate New Technologies and Provide New Services in a Cost-Efficient Manner.

The telecommunications industry is subject to rapid and significant changes in technology, frequent new service introductions and evolving industry standards. We cannot predict the effect of these changes on our competitive position, our capital expenditure requirements, our profitability or the industry generally. Technological developments may reduce the competitiveness of our networks and require additional capital expenditures or the procurement of additional products that could be expensive and time consuming to install and integrate into our network. In addition, new products and services arising out of technological developments may reduce the attractiveness of our services. If we fail to adapt successfully to technological advances or fail to obtain access to new technologies, we could lose customers and be limited in our ability to attract new customers and/or sell new services to our existing customers. In addition, delivery of new services in a cost-efficient manner depends upon many factors, and we may not generate the revenue anticipated from such services.

Disruptions in Our Networks and Infrastructure May Cause Us to Lose Customers and Incur Additional Expenses.

To be successful, we will need to continue to provide our customers with reliable and timely service over our networks. We face the following risks to our networks and infrastructure:

● our territories could have significant weather events which physically damage access lines and network infrastructure;

● our rural geography creates the risk of security breaches, break-ins and sabotage;

● power surges and outages, computer viruses or hacking, and software or hardware defects which are beyond our control; and

● unusual spikes in demand or capacity limitations in our or our suppliers’ networks.

Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and/or incur expenses, and thereby adversely affect our business, revenue and cash flow. In addition, the APSC, MPUC, MDTC, MPSC, NHPUC, VPSB and/or WVPSC could require us to issue credits on customer bills for such service interruptions, further impacting revenue and cash flow. Wholesale network contracts could impose service level penalties for service disruptions.

Our Operating Activities Are Subject to Risks Caused by Misappropriation, Misuse, Leakage, Falsification and Accidental Release or Loss of Information Maintained in Our Information Technology Systems.

Our operating activities are subject to risks caused by misappropriation, misuse, leakage, falsification and accidental release or loss of information maintained in our information technology systems, including customer, personnel and vendor data. We could be exposed to significant costs if such risks were to materialize, and such events could damage the reputation and credibility of us and our business and have a negative impact on our revenues. We could also be required to expend significant capital and other resources to remedy any such security breach.

Our Business is Geographically Concentrated and Dependent on Regional Economic Conditions.

Our business is conducted primarily in north central Alabama, Maine, New Hampshire, western Massachusetts, central Missouri, western Vermont and southern West Virginia and, accordingly, our business is dependent upon the general economic conditions of these regions. There can be no assurance that future economic conditions in these regions, including as a result of the recent global economic downturn, will not impact demand for our services or cause residents to relocate to other regions, which may adversely impact our business, revenue and cash flow.

10

Our Success Depends on a Small Number of Key Personnel.

Our success depends on the personal efforts of a small group of skilled employees and senior management. The rural nature of much of our service area provides for a smaller pool of skilled telephone employees and increases the challenge of hiring employees. The loss of key personnel could have a material adverse effect on our financial performance.

We Provide Services to Our Customers Over Access Lines, and if We Lose Access Lines, Our Business and Results of Operations May Be Adversely Affected.

Our business generates revenue by delivering voice and data services over access lines. We have experienced net voice access line loss in our RLEC territories due to challenging economic conditions, wireless substitution, loss of second lines and increased competition. RLEC voice access lines, adjusted for the acquisition of Shoreham, declined by approximately 5.4% during 2011. We expect to continue to experience net voice access line loss in our rural markets. If voice access line losses are not substantially offset by data access line gains, it could adversely affect our business and results of operations.

Our Performance Is Subject to a Number of Other Economic and Non-Economic Factors, Which We May Not Be Able to Predict Accurately.

There are factors that may be beyond our control that could affect our operations and business. Such factors include adverse changes in the conditions in the specific markets for our products and services, the conditions in the broader market for telecommunications services and the conditions in the domestic and global economies, generally.

Although our performance is affected by the general condition of the economy, not all of our services are affected equally. Voice access revenue is generally linked to relatively consistent variables such as population changes, housing starts and general economic activity levels in the areas served. Data access and cable television revenue is generally related to more variable factors such as changing levels of discretionary spending on entertainment and the adoption of e-commerce and other on-line activities by our current or prospective customers. It is not possible for management to accurately predict all of these factors and the impact of such factors on our performance.

Changes in the competitive, technological and regulatory environments may also impact our ability to increase revenue and/or earnings from the provision of local wireline services. We may therefore have to place increased emphasis on developing and realizing revenue through the provision of new and enhanced services with higher growth potential. In such a case, there is a risk that these revenue sources as well as our cost savings efforts through further efficiency gains will not grow or develop at a fast enough pace to offset slowing growth in local services. It is also possible that as we invest in new technologies and services, demand for those new services may not develop. There can be no assurance that we will be able to successfully expand our service offerings through the development of new services, and our efforts to do so may have a material adverse effect on our financial performance.

Governmental Authorities Could Decrease Network Access Charges or Rates for Local Services, Which Would Adversely Affect Our Revenue.

Approximately 10.1% of our revenue for the year ended December 31, 2011 was derived from interstate network access charges paid by long distance carriers for use of our facilities to originate and terminate interstate and intrastate telephone calls. The interstate network access rates that we can charge are regulated by the FCC, and the intrastate network access rates that we can charge are regulated by the regulatory commissions in each state in which we operate. Those rates may change from time to time. The FCC has reformed and continues to reform the federal network access charge system, including proposed changes intended to promote deployment of broadband data services. In October 2011, the FCC released the FCC Order, which will reduce access revenue received by us beginning as soon as 2012. The FCC Order requires the phase down of our intrastate access rates to interstate levels by July 1, 2013 with rates transitioning to zero by July 1, 2020. It is unknown at this time what additional changes, if any, the FCC or state regulatory commissions may adopt. Such regulatory developments could adversely affect our business, revenue and cash flow.

The local services rates and intrastate access fees charged by our rural local exchange carriers are regulated by state regulatory commissions which have the power to grant and revoke authorization to companies to provide telecommunications services and to impose other conditions and penalties. If we fail to comply with regulations set forth by the state regulatory commissions, we may face revocation of our authorizations in a state or other conditions and penalties. It is possible that new plans would require us to reduce our rates, forego future rate increases, provide greater features as part of our basic service plan or limit our rates for certain offerings. We cannot predict the ultimate impact, if any, of such changes on our business, revenue and cash flow.

Our RLECs operating in Maine, Massachusetts, Missouri, Vermont and West Virginia charge rates for local services and intrastate access service based in part upon a rate-of-return authorized by the state regulatory commissions. These authorized rates are

11

subject to audit at any time and may be reduced if the regulatory commission finds them excessive. If any company is ordered to reduce its rates or if its applications to increase rates are denied or delayed, our business, revenue and cash flow may be negatively impacted.

The NECA may file revisions to its average schedule formula each year which are subject to FCC approval. Six of our subsidiaries participate in average schedule rates. The FCC Order contains provisions which extend limits on corporate operations expense to the Interstate Common Line Support portions of the USF HCL, which will reduce the level of funding some of our operating subsidiaries receive by approximately $0.1 million.

A Reduction in Universal Service Fund High Cost Loop Support Would Adversely Affect Our Business, Revenue and Cash Flow.

Six of our RLECs receive federal USF HCL revenue to support their high cost of operations. Such support payments represented approximately 4.0% of our revenue for the year ended December 31, 2011, and were based upon each participating rural local exchange carrier’s average cost per loop as compared to the national average cost per loop. These support payments fluctuate based upon the historical costs of our participating rural local exchange carriers as compared to the national average cost per loop. Each year, the average cost per loop has increased, putting pressure on the USF HCL funds received by our companies to the extent that our costs do not increase at the same rate. If our participating rural local exchange carriers are unable to receive support from the USF HCL, or if such support is reduced, our business, revenue and cash flow would be negatively affected.

On October 27, 2011, the FCC adopted the FCC Order reforming the current high-cost universal support rules. The FCC Order places limits on certain operating expenses that can be recovered from the Universal Service Fund, or USF, and places additional service requirements to be eligible to receive USF HCL support. The FCC has yet to issue orders addressing all aspects of the high-cost universal support which could affect the amount of USF HCL support we receive. We cannot predict the total impact these orders could have on USF HCL support. The outcome of any future FCC proceedings and other regulatory or legislative changes could affect the amount of USF HCL support that we receive, and could have an adverse effect on our business, revenue and cash flow. If a wireless or other telecommunications carrier receives ETC status in our service areas or even outside of our service areas, the amount of support we receive from the USF HCL could decline under current rules, and under some proposed USF HCL rule changes, could be significantly reduced.

USAC serves as the administrative agent to collect data and distribute funds for USF. In 2006, it began conducting High Cost Beneficiary audits, designed to ensure compliance with FCC rules and program requirements and to assist in program compliance. Carriers are chosen from a random sample of each type of ETC, including average schedule and cost companies, incumbents and competitors, and rural and non-rural, from various states. Audits are designed to ensure proper designation of a carrier as ETC, accuracy of data submissions, documentation of accounting procedures, physical inventory of assets, true-up of projected data, and samples of detailed documentation (for example, invoices, continuing property records). Audits of Blountsville, Hopper, Granby, Otelco Telephone and Brindlee Mountain Telephone, initiated during 2007 and 2008, have been completed and no material action is pending. These audits were conducted widely across our industry as directed by the FCC. There is no guidance on the likelihood of the continuation of the audit process currently available.

If We Were to Lose Our Protected Status Under Interconnection Rules, We Would Incur Additional Administrative and Regulatory Expenses and Face More Competition.

As a “rural telephone company” under the Communications Act, each of our RLECs is exempt from the obligation to lease its unbundled facilities to competitive local exchange carriers, to offer retail services at wholesale prices for resale, to permit competitive co-location at its facilities and to comply with certain other requirements applicable to larger incumbent local exchange carriers. However, we eventually may be required to comply with these requirements in some or all of our service areas if: (i) we receive a bona fide request from a telecommunications carrier; and (ii) the state regulatory commissions, as applicable, determine that it is in the public interest to impose such requirements. In addition, we may be required to comply with some or all of these requirements in order to achieve greater pricing flexibility from state regulators. If we are required to comply with these requirements, we could incur additional administrative and regulatory expenses and face more competition which could adversely affect our business, revenue and cash flow.

Our Current Dividend Policy May Negatively Impact Our Ability to Maintain or Expand Our Network Infrastructure and Finance Capital Expenditures or Operations.

Our board of directors has adopted a dividend policy pursuant to which a significant portion of the cash generated by our business in excess of operating needs, interest and principal payments on indebtedness, and capital expenditures sufficient to maintain our network infrastructure, would in general be distributed as regular quarterly cash dividends to the holders of our common stock and not retained by us. As a result, we may not have sufficient cash to fund our operations in the event of a significant business downturn,

12

finance growth of our network or unanticipated capital expenditure needs. We may have to forego growth opportunities or capital expenditures that would otherwise be necessary or desirable if we do not find alternative sources of financing or if we do not modify our dividend policy. If we do not have sufficient cash for these purposes, our financial condition and our business will suffer or our board of directors may change our dividend policy.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Our property consists primarily of land and buildings; central office, internet and cable equipment; computer software; telephone lines; and related equipment. Our telephone lines include aerial and underground cable, conduit, poles and wires. Our central office equipment includes digital and software defined switches, internet and other servers and related peripheral equipment. We own substantially all our real property in Alabama, Missouri and Vermont, including our corporate office. We primarily lease real property in Maine, Massachusetts, New Hampshire and West Virginia, including our primary office locations in Bangor, New Gloucester and Portland, Maine; Granby, Massachusetts; Bedford, New Hampshire; and War, West Virginia. We also lease certain other real property, including land in Oneonta, Alabama, pursuant to a long-term, renewable lease. A small portion of our Alabama cable television service equipment is located on this leased property. As of December 31, 2011, our property and equipment consisted of the following:

	(In Thousands)
Land	$	1,157
Buildings and improvements		12,247
Telephone equipment		227,826
Cable television equipment		10,918
Furniture and equipment		2,967
Vehicles		6,090
Computer software and equipment		15,591
Internet equipment		3,923
Total property and equipment		280,719
Accumulated depreciation		(214,837	)
Net property and equipment	$	65,882

Our senior credit facility is secured by substantially all of the assets of our subsidiaries that are guarantors of the senior credit facility. As of December 31, 2011, the subsidiary guarantors represented $64.5 million of the $65.9 million in net property and equipment.

Item 3. Legal Proceedings

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 APSC, MPUC, MDTC, MPSC, NHPUC, VPSB and WVPSC relating primarily to rate making and customer service requirements. Currently, none of the legal proceedings are expected to have a material adverse effect on our business.

Item 4. Mine Safety Disclosures

Not applicable.

Item X. Executive Officers of the Registrant

The following table sets forth the names and positions of our executive officers and certain other officers, and their ages as of December 31, 2011.

13

Name	Age	Position
Michael D. Weaver	59	President, Chief Executive Officer and Director
Curtis L. Garner, Jr.	64	Chief Financial Officer
Dennis Andrews	55	Senior Vice President and General Manager, Alabama
Jerry C. Boles	59	Senior Vice President and Controller
E. Todd Wessing	46	Vice President and General Manager, Missouri
Jon C. P. Henderson	39	Senior Vice President, New England CLEC Sales
Robert J. Souza	58	Senior Vice President, New England Operations
Edwin D. Tisdale	52	Senior Vice President, New England RLEC

Michael D. Weaver has served as our President, Chief Executive Officer and a Director since January 1999. Prior to this time, he spent 10 years with Oneonta Telephone Co., Inc., the predecessor to Otelco Telephone, serving as Chief Financial Officer from 1990 to 1998 and General Manager from January 1998 to January 1999.

Curtis L. Garner, Jr. has served as our Chief Financial Officer since February 2004. Prior to this position, he provided consulting services to a number of businesses and not-for-profit organizations from October 2002. He served PTEK Holdings, Inc. from November 1997 through September 2002 (including one year as a consultant), first as President of one of its divisions, and later as Chief Administrative Officer for another division. Prior thereto, he spent 26 years at AT&T Corp., retiring in 1997 as the Chief Financial Officer of the Southern and Southwestern Regions of AT&T Corp.’s consumer long distance business.

Dennis Andrews was appointed Senior Vice President and General Manager of our Alabama division in August 2006. He served as our Vice President and General Manager, Brindlee and Blountsville since November 2005 and Vice President — Regulatory Affairs since July 2000. Prior to this position, he spent 21 years at Brindlee where he held several positions, including Vice President — Finance, General Manager, Operations Manager and Accounting Department Manager.

Jerry C. Boles became our Senior Vice President and Controller in July 2010. He joined Otelco in January 1999 as Vice President and Controller. Prior to joining Otelco, he was controller for McPherson Oil Company for 14 years. He also worked in public accounting for 10 years, is licensed as a CPA by the state of Alabama, and is a member in good standing of the American Institute of Certified Public Accountants.

E. Todd Wessing was appointed as our Vice President and General Manager for Missouri in December 2010. He has worked for the Company (or its predecessor prior to being acquired by Otelco in 2004) since 1988 with experience in outside plant maintenance and installation; construction; and central office switching.

Jon C. P. Henderson became our Senior Vice President for New England CLEC Sales in July 2011. He joined Otelco in July 2006 as the Director of Sales and Marketing of our New England division (previously known as our Maine division). From 1999 until its acquisition by Otelco in 2006, he served in various leadership positions in the sales organization of Mid-Maine, building its successful competitive sales team.

Robert J. Souza became our Senior Vice President for New England Operations in July 2010. He joined Otelco in October 2008 as the Vice President of Operations for New England. He served as President for the CR Companies from 2001 until they were acquired by Otelco in October 2008. Prior to that role, he served as Operations Manager for Saco River, having joined that company in 1983. His 35 years experience in the industry includes three years with Ooltewah-Collegedale Telephone Company in Tennessee and five years with New England Telephone in Maine.

Edwin D. Tisdale has served as our Senior Vice President for New England RLECs since July of 2010 and as Vice President for New England Support Services from November 2008 to 2010. From 1996 until October 2008, he served as General Manager of Pine Tree and Chief Financial Officer of the CR Companies until they were acquired by Otelco. Prior to that time, he worked in banking and real estate.

Officers are not elected for a fixed term of office but hold their position until a successor is named.

14

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our IDSs, each representing one share of common stock and $7.50 principal amount of senior subordinated notes due 2019, trade on the NASDAQ Global Market, or NASDAQ, under the symbol “OTT” and on the Toronto Stock Exchange under the symbol “OTT.un.” The high and low closing sales prices for the IDSs on NASDAQ during the quarters indicated are as follows:

	High ($US)		Low ($US)
2011
Fourth Quarter	$	16.72	$	13.50
Third Quarter	$	18.47	$	14.40
Second Quarter	$	19.65	$	17.27
First Quarter	$	20.30	$	18.18
2010
Fourth Quarter	$	18.80	$	15.33
Third Quarter	$	16.10	$	13.80
Second Quarter	$	16.98	$	14.41
First Quarter	$	16.87	$	13.82

Holders

As of March 5, 2012, there were approximately 16,250 record holders of our IDSs. Holders of our IDSs have the right to separate the IDSs into the shares of common stock and senior subordinated notes represented thereby. As of the date of this report, no holder has elected to separate the IDSs.

Dividends

The board of directors declared and the Company paid dividends of $0.17625 per common share each quarter in 2009, 2010 and 2011 for a total of $0.705 per share for each year. For 2009, 2010 and 2011, all of the dividends were considered a non-taxable return of capital. The Company has paid dividends each quarter since the completion of its initial public offering in December 2004.

Our board of directors has adopted a dividend policy for our common stock pursuant to which, in the event and to the extent we have any available cash for distribution to the holders of shares of our common stock and subject to applicable law and the terms of our credit facility, the indenture governing our senior subordinated notes and any other then outstanding indebtedness of ours, our board of directors will declare cash dividends on our common stock. Our dividend policy reflects a basic judgment that our stockholders would be well served by distributing cash available after business requirements in the form of dividends rather than retaining it. Under this dividend policy, cash generated by our business in excess of operating needs, principal and interest payments on indebtedness, capital expenditures and income taxes would in general be distributed as regular quarterly dividends to the holders of our common stock rather than retained by us as cash on our consolidated balance sheet. In determining our expected dividend levels, we review and analyze, among other things, our operating and financial performance; the anticipated cash requirements associated with our capital structure; our anticipated capital expenditure requirements; our expected other cash needs; the terms of our debt instruments, including our credit facility; changes in the financial market requirements associated with our industry; other potential sources of liquidity; and various other aspects of our business. As these factors change, the board will regularly reassess our dividend policy.

As described more fully below, holders of our common stock may not receive any dividends as a result of the following factors:

● nothing requires us to pay dividends;

● while our current dividend policy contemplates the distribution of our available cash, this policy could be modified or revoked at any time;

15

● even if our dividend policy were not modified or revoked, the actual amount of dividends distributed under the policy and the decision to make any distribution is entirely at the discretion of our board of directors;

● the amount of dividends distributed is subject to covenant restrictions in our indenture and our credit facility, and may also be impacted by our decision to repay indebtedness;

● the amount of dividends distributed is subject to state law restrictions;

● our stockholders have no contractual or other legal right to dividends; and

● we may not have enough cash to pay dividends due to changes to our operating earnings, working capital requirements, debt leverage and amortization requirements and anticipated cash needs.

Dividends on our common stock will not be cumulative. Consequently, if dividends on our common stock are not declared and/or paid at the current level, our stockholders will not be entitled to receive such payments in the future.

Our board of directors will, in its sole discretion, decide to use cash generated to fund capital expenditures or acquisitions, repay indebtedness, pay dividends or for general corporate purposes.

Restrictions on Payment of Dividends

The indenture governing our senior subordinated notes restricts our ability to declare and pay dividends on our common stock as follows:

● we may only pay dividends in any given fiscal quarter that are less than 100% of our excess cash for the period from and including the first fiscal quarter beginning after the date of the indenture to the end of our most recently ended fiscal quarter for which internal financial statements are available at the time of such payment. “Excess Cash” means with respect to any period, Adjusted EBITDA, as defined in the indenture, minus the sum of (i) cash interest expense, (ii) capital expenditures and (iii) cash income tax expense, in each case, for such period;

● we may not pay dividends if our interest coverage ratio, which is defined as Adjusted EBITDA divided by consolidated interest expense, is below 1.4 times;

● we may not pay any dividends if not permitted under any of our senior indebtedness;

● we may not pay any dividends while interest on the senior subordinated notes is being deferred or, after the end of any interest deferral, so long as any deferred interest has not been paid in full; and

● we may not pay any dividends if a default or event of default under the indenture governing the senior subordinated notes has occurred and is continuing.

Our credit facility does not allow us to pay dividends on our common stock unless we maintain:

● a “fixed charge coverage ratio” (defined as our Consolidated EBITDA, as defined in the credit facility, for any period of four consecutive fiscal quarters divided by the sum of certain capital expenditures, cash income taxes, the aggregate amount of cash interest expense and scheduled principal payments for such period) of not less than 1.14 times; and

● a “senior leverage ratio” (defined as senior secured debt as of the last day of any period divided by our Consolidated EBITDA, as defined in the credit facility, for any period of four consecutive fiscal quarters) of not more than 3.85 times.

In addition, our credit facility does not allow us to pay dividends on our common stock if and for as long as (a) interest payments on our senior subordinated notes are required to be deferred pursuant to the terms of the credit facility, (b) any default or event of default exists under the credit facility, (c) deferred interest or interest on deferred interest is outstanding under our senior subordinated notes, (d) a compliance certificate for the prior fiscal quarter has not been timely delivered or (e) there is insufficient excess cash, as defined in the credit facility.

16

Securities Authorized for Issuance under Equity Compensation Plans

No securities have been issued under any equity compensation plan and no such plan is currently in place.

Recent Sales of Unregistered Securities

During the fiscal year ended December 31, 2011, we did not issue any unregistered securities.

Performance Graph

The following graph compares the cumulative total stockholder return (stock price appreciation plus reinvested dividends) for our shares of common stock (represented by IDSs) with the cumulative total return (including reinvested dividends) of the Russell 2000 Index, or Russell 2000, and the Standard & Poor’s — Telecommunications Services Index, or S&P Telecommunications Services, assuming a $100 investment on December 31, 2006 through December 31, 2011:

 

17

Cumulative Stockholder Returns on $100 Invested:

		12/06		12/07		12/08		12/09		12/10		12/11
Otelco Inc.	$	100.00	$	68.56	$	42.52	$	96.71	$	130.00	$	109.11
Russell 2000	$	100.00	$	98.43	$	65.18	$	82.89	$	105.14	$	100.75
S&P Telecommunication Services	$	100.00	$	111.94	$	77.81	$	84.76	$	100.83	$	107.15

Item 6. Selected Financial Data

The following table sets forth our selected consolidated financial and other information. The consolidated financial information as of December 31, 2010 and 2011 and for each of the three years in the period ended December 31, 2011 has been derived from, and should be read together with, our audited consolidated financial statements and the accompanying notes included in Item 8 of this report. The consolidated financial information as of December 31, 2007, 2008 and 2009 and for each of the two years in the period ended December 31, 2008 has been derived from our audited consolidated financial statements not included in this report. The consolidated financial information set forth should be read in conjunction with, and is qualified in its entirety by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and our audited consolidated financial statements and related notes in Item 8 of this report.

	At and For The Year Ended December 31,
	2007			2008(1)			2009			2010		2011(1)
	(In Thousands Except Per Share Amounts)
Income Statement Data
Revenues:
Local services	$	26,102		$	30,014		$	48,441		$	49,014	$	47,463
Network access		25,671			27,281			33,297			32,982		32,128
Cable television		2,184			2,389			2,489			2,799		2,981
Internet		11,517			12,449			14,027			14,015		13,946
Transport services		4,275			4,982			5,501			5,590		5,326
Total	$	69,749		$	77,115		$	103,755		$	104,400	$	101,844
Income from operations	$	19,265		$	21,087		$	21,927		$	26,369	$	24,630
Income (loss) before income tax	$	(195	)	$	243		$	(4,484	)	$	1,301	$	2,447
Net income (loss) available to common stockholders	$	179		$	214		$	(3,118	)	$	691	$	2,197
Net income (loss) per common share
Basic	$	0.02		$	0.02		$	(0.25	)	$	0.05	$	0.17
Diluted	$	(0.10	)	$	(0.03	)	$	(0.25	)	$	0.05	$	0.17
Dividends declared per share	$	0.71		$	0.71		$	0.71		$	0.71	$	0.71
Balance Sheet Data
Cash and cash equivalents	$	12,810		$	13,542		$	17,731		$	18,226	$	12,394
Property and equipment, net		54,610			75,407			69,029			63,887		65,882
Total assets		232,486			355,541			337,528			322,136		317,724
Long-term notes payable (including current portion)		170,020			278,800			273,717			271,596		271,106

(1) During fiscal 2008 and 2011, we acquired the CR Companies and Shoreham, respectively. More information about each acquisition can be found in Item 1 of this report.

18

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

General

Since 1999, we have acquired and operate eleven RLECs serving subscribers in north central Alabama, central Maine, western Massachusetts, central Missouri, western Vermont and southern West Virginia. We are the sole wireline telephone services provider for seven of the rural communities we serve. We also operate a CLEC serving subscribers in Maine and New Hampshire. Our services include local and long distance telephone services, network access, other telephone related services, cable and satellite television (in some markets) and internet access. We view, manage and evaluate the results of operations from the various telecommunications products and services as one company and therefore have identified one reporting segment as it relates to providing segment information. As of December 31, 2011, we operated 102,378 voice and data access lines, or access line equivalents, and supplied an additional 157,144 wholesale network connections.

Our core business is providing local and long distance telecommunications services, wholesale access to the local and long distance network, and network access to other wireline, long distance and wireless carriers for calls originated or terminated on our network. Our core business generated approximately 78.2% of our total revenues in 2011. We also provide cable and satellite television service in some markets and digital high-speed data lines and dial-up internet access in all of our markets.

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes, included in Item 8, and the other financial information appearing elsewhere in this report. The following discussion and analysis relates to our financial condition and results of operations on a consolidated basis, including the acquisition of Shoreham as of October 14, 2011 and through December 31, 2011.

Impact of Indebtedness Levels on our Results of Operations and Liquidity

As a result of the significant amount of debt we have outstanding through our senior credit facility, the senior subordinated note portion of the outstanding IDSs, and the senior subordinated notes held separately (not in the form of IDSs), our interest expense remains at a significantly high level. We entered into interest rate swap agreements to cover the majority of borrowings under the senior credit facility to protect against interest rate swings through February 8, 2012. The senior credit facility does not require scheduled principal payments. In August 2009, November 2010 and May 2011, we made voluntary prepayments totaling $11.5 million to reduce our senior credit facility. Our senior credit facility matures on October 31, 2013.

Our board of directors has adopted a dividend policy for our common stock pursuant to which, in the event and to the extent we have any available cash for distribution to the holders of shares of our common stock and subject to applicable law and terms of our then existing indebtedness, our board of directors will declare cash dividends on our common stock. The cash available for dividend payments may be impacted by our high levels of indebtedness and related debt service requirements discussed above. The cash requirements of our business are funded through cash flow generated from the operations of our business. We also have access to a $15.0 million revolving credit facility to supplement our liquidity position as needed.

There can be no assurance that we will have sufficient cash in the future to pay dividends on our common stock at the historical rate or at all. If we do not generate sufficient cash from our operating activities in the future to pay dividends, we may have to reduce or eliminate dividends. However, if we use working capital to fund dividends, we would have less cash available to pursue growth opportunities such as the introduction of new services and the acquisition of other telecommunications companies, or to respond to unanticipated events such as the failure of a portion of our switching or network facilities. If we do not have sufficient cash to finance growth opportunities or capital expenditures that would otherwise be necessary or desirable, and cannot find alternative sources of financing, our financial condition and our business will suffer.

Our high indebtedness levels and related debt service requirements, our current dividend policy and our capital expenditure requirements will significantly limit any cash available from operations for other uses for the foreseeable future.

Revenue Sources

We derive our revenues from five sources:

● Local services. We receive revenues from providing local exchange telecommunications services in our eleven rural territories, from the wholesale network services in New England, and on a competitive basis throughout Maine and New Hampshire. These revenues include monthly subscription charges for basic service, calling beyond the local territory on a

19

fixed price and on a per minute basis, local private line services and enhanced calling features, such as voicemail, caller identification, call waiting and call forwarding. We also provide billing and collections services for other carriers under contract and receive revenues from directory advertising. A growing portion of our rural subscribers take bundled service plans which include multiple services, including unlimited domestic calling, for a flat monthly fee.

● Network access. We receive revenues from charges established to compensate us for the origination, transport and termination of calls of long distance, wireless 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, Massachusetts, Maine, Missouri, New Hampshire, Vermont and West Virginia are based on rates approved by the APSC, MDTC, MPUC, MPSC, NHPUC, VPSB and WVPSC, respectively, where appropriate. Switched and special access charges for interstate and international services are based on rates approved by the FCC.

● Cable television. We offer basic, digital, high-definition, digital video recording, VOD and pay per view cable television services to a portion of our telephone service territory in Alabama, including IPTV. We are a reseller of satellite services for DirecTV.

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

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

Access Line and Customer Trends

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

Key Operating Statistics

									Quarterly
									% Change
					September		December		September 30-			Annual
	December 31,				30,		31,		December 31,			% Change
	2009		2010		2011		2011(2)		2011			2010-2011
Otelco access line equivalents(1)		100,356		99,639		97,958		102,378		4.5	%		2.7	%
RLEC and other services:
Voice access lines		48,215		45,461		43,444		46,202		6.3	%		1.6	%
Data access lines		20,066		20,852		21,162		22,904		8.2	%		9.8	%
Access line equivalents(1)		68,281		66,313		64,606		69,106		7.0	%		4.2	%
Cable television customers		4,195		4,227		4,156		4,201		1.1	%		(0.6	)%
Satellite television customers		100		125		224		226		0.9	%		1.5	%
Additional internet customers		9,116		6,975		5,654		5,414		(4.2	)%		(22.4	)%
RLEC dial-up		786		393		274		301		9.9	%		(23.4	)%
Other dial-up		6,439		4,300		3,085		2,797		(9.3	)%		(35.0	)%
Other data lines		1,891		2,282		2,295		2,316		0.9	%		1.5	%
CLEC:
Voice access lines		28,647		29,944		30,145		30,189		0.1	%		0.8	%
Data access lines		3,428		3,382		3,207		3,083		(3.9	)%		(8.8	)%
Access line equivalents(1)		32,075		33,326		33,352		33,272		(0.2	)%		(0.2	)%
Wholesale network connections		132,324		149,043		155,691		157,144		0.9	%		5.5	%

20

	For the Years Ended December 31,						Annual Change  2010-2011
		2009		2010		2011	Amount			Percent
Total revenues (in millions):	$	103.8	$	104.4	$	101.8	$	2.6			(2.5	)%
RLEC	$	60.8	$	58.1	$	57.4	$	(0.7	)		(1.2	)%
CLEC	$	43.0	$	46.3	$	44.4	$	(1.9	)		(4.1	)%

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

(2) We acquired Shoreham on October 14, 2011. At December 31, 2011, Shoreham had 3,309 voice access lines and 1,672 data access lines, or 4,981 access line equivalents, and 55 dial-up internet customers which are included in the Key Operating Statistics as of December 31, 2011.

For 2011, RLEC access line equivalents grew 4.2%, reflecting the acquisition of Shoreham. CLEC access line equivalents declined 0.2%, although we installed more than 2,100 seats of our new IP based Hosted PBX offering. We are the primary long distance provider for our customers, serving approximately 63% of our RLEC customer base and virtually all of our CLEC customers. The expansion of IPTV in our Alabama markets and the addition of VOD services contributed to an increase of 243 television customers in Alabama. We converted our cable customers in Missouri to DirecTV, more than offsetting this subscriber growth in Alabama.

We continued our strategy of growing our penetration of the competitive markets in Maine and New Hampshire, adding eight new collocation sites during 2011. At the same time, we expect to maintain RLEC revenues by cross-selling to our existing customer base, using bundled service packages including unlimited long distance and adding new services as they become available. Our growth in data access lines to provide digital high-speed internet access will continue as customers increase the use of available content and new services.

We provide dial-up internet on a statewide basis in Maine and Missouri. We expect that our dial-up internet customers will continue to migrate to data access lines as growth in broadband services continues. In Missouri, we provide data access lines for digital high-speed internet in selected areas outside of our telephone service territory. This data service offering had 1,891, 2,282 and 2,295 customers in 2009, 2010 and 2011, respectively, of the additional internet customers noted in the table above.

The following is a discussion of the major factors affecting our access line count:

Cyclical Economic and Industry Factors. We believe that changes in global economic conditions have and will continue to have an impact on voice access line count. The rural nature of much of the territory we serve delayed the economy’s impact on our customer base and we expect any national recovery to also lag in its impact on our business.

Competition. There are currently no wireline telephone competitors operating within the majority of our RLEC territories. Where wireline competition exists, it comes from the incumbent cable company and has a negative impact on voice access lines. We have also experienced access line losses to wireless carrier substitution, though the impact is reduced due in part to the topography of a portion of our telephone territories and inconsistent wireless coverage. We have responded to competition by offering bundled service packages which include unlimited domestic calling; features like voice mail and caller identification; data access lines; and, where possible, television services. These service bundles are designed to meet the broader communications needs of our customers at industry competitive prices. There are a number of established competitive providers in our Maine and New Hampshire CLEC markets. The effectiveness of our sales force and the pricing of our products are critical to our success in these markets.

Acquisition. In 2011, we purchased Shoreham, an RLEC that serves portions of Addison county in western Vermont.

Our Rate and Pricing Structure

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

Our RLECs operate in six states and are regulated in varying degrees by the respective state regulatory authorities. The impact on pricing flexibility varies by state. In Maine and Vermont, three of our wholly owned subsidiaries, Saco River, Shoreham and Pine Tree, have obtained authority to implement pricing flexibility while remaining under rate-of-return regulation. Our rates for other services we provide, including cable, long-distance, data lines and dial-up and high-speed internet access, are not price regulated. The market for competitive services, such as wireless, also impacts the ability to adjust prices. With the increase of bundled

21

services offerings, including unlimited long distance, pricing for individual services takes on reduced importance to revenue stability. We expect this trend to continue into the immediate future.

Alabama and Maine have state service funds which were implemented over the last 15 years as part of balancing local service pricing and long distance access rates. These funds were intended to neutralize the revenue impact on state RLECs from pricing shifts implemented to reduce access rates over time. The Alabama Transition Service Fund and the MUSF provided total compensation of $3.1 million, representing 3.1% of our total revenue for the year ended December 31, 2011. The revenue we receive from these funds could be affected by the FCC’s efforts to make changes in their Intercarrier Compensation regulations or by the states’ regulatory authorities in response to federal changes.

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

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

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

Our Ability to Control Operating Expenses

We strive to control expenses in order to maintain our strong operating margins. As our revenue shifts to non-regulated services and CLEC customers, operating margins decrease reflecting the lower margins associated with these services. Reductions over time in Universal Service Fund and Intercarrier Compensation payments based on FCC action in 2011 may not be fully offset by expense control.

Results of Operations

The following table sets forth our results of operations as a percentage of total revenues for the periods indicated. All results include acquisitions as of the date acquired.

22

	Year Ended December 31,
	2009			2010			2011
Revenues
Local services		46.7	%		46.9	%		46.6	%
Network access		32.1			31.6			31.6
Cable television		2.4			2.7			2.9
Internet		13.5			13.4			13.7
Transport services		5.3			5.4			5.2
Total revenues		100.0	%		100.0	%		100.0	%
Operating expenses
Cost of services		39.7	%		39.5	%		43.2	%
Selling, general and administrative expenses		13.7			12.5			12.7
Depreciation and amortization		25.5			22.7			19.9
Total operating expenses		78.9			74.7			75.8
Income from operations		21.1			25.3			24.2
Other income (expense)
Interest expense		(24.5	)		(23.7	)		(24.3	)
Change in fair value of derivatives		(1.3	)		(0.8	)		2.2
Other income		0.4			0.5			0.3
Total other expenses		(25.4	)		(24.0	)		(21.8	)
Income (loss) before income taxes		(4.3	)		1.3			2.4
Income tax (expense) benefit		1.3			(0.6	)		(0.2	)
Net income (loss) available to common stockholders		(3.0	)%		0.7	%		2.2	%

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

Total Revenues. Total revenues decreased 2.4% in 2011 to $101.8 million from $104.4 million in 2010. The table below provides the components of our revenues for 2011 compared to 2010.

	Year Ended December 31,				Change
	2010		2011		Amount			Percent
	(Dollars in Thousands)
Local services	$	49,014	$	47,463	$	(1,551	)		(3.2	)%
Network access		32,982		32,128		(854	)		(2.6	)
Cable television		2,799		2,981		182			6.5
Internet		14,015		13,946		(69	)		(0.5	)
Transport services		5,590		5,326		(264	)		(4.7	)
Total	$	104,400	$	101,844	$	(2,556	)		(2.4	)

Local services. Local services revenue in 2011 decreased 3.2% to $47.5 million from $49.0 million in 2010. Shoreham accounted for an increase of $0.2 million. One-time recoveries during 2010 associated with the settlement of bankruptcy and intrastate traffic claims accounted for an increase of $0.5 million when compared with 2011. RLEC revenue, including bundled services such as long distance, decreased $1.0 million, reflecting the decline in voice access lines. Billing and collecting and directory advertising revenue declined $0.2 million.

Network access. Network access revenue in 2011 decreased 2.6% to $32.1 million from $33.0 million in 2010. Shoreham accounted for an increase of $0.3 million. One-time recoveries during 2010 associated with the settlement of bankruptcy and toll claims accounted for an increase of $0.4 million when compared with 2011. Interchange carrier compensation declined $0.7 million.

23

Cable television. Cable television revenue in 2011 increased 6.5% to $3.0 million from $2.8 million in 2010. The growth in IPTV and the conversion of basic services to high definition television, including digital video recording and VOD services in Alabama, accounted for an increase of $0.3 million. The conversion of our Missouri cable subscribers to satellite television reduced revenue by $0.1 million.

Internet. Internet revenue in 2011 decreased 0.5% to $13.9 million from $14.0 million in 2010. Shoreham accounted for an increase of $0.2 million. Fiber rental accounted for an increase of $0.1 million. These increases were more than offset by a decrease of $0.4 million associated with the loss of dial-up internet customers we serve outside of our territory, primarily in Maine where we are not able to offer them a high-speed data line alternative.

Transport services. Transport services revenue in 2011 decreased 2.4% to $5.3 million from $5.6 million in 2010. Changes in industry pricing for services over our fiber backbone network in Maine and New Hampshire accounted for the decline.

Operating expenses. Operating expenses for 2011 decreased 1.0% to $77.2 million from $78.0 million in 2010. This decrease was primarily attributable to the decrease in depreciation and amortization partially offset by higher service costs.

	Year Ended December 31,				Change
	2010		2011		Amount			Percent
	(Dollars in Thousands)
Cost of services	$	41,286	$	43,996	$	2,710			6.6	%
Selling, general and administrative expenses		13,075		12,985		(90	)		(0.7	)
Depreciation and amortization		23,670		20,232		(3,438	)		(14.5	)
Total	$	78,031	$	77,213	$	(818	)		(1.0	)

Cost of services. Cost of services increased 6.6% to $44.0 million in 2011 from $41.3 million in 2010. Shoreham accounted for an increase of $0.3 million. Expense reductions during 2010 associated with the settlement of bankruptcy and toll claims accounted for an increase of $1.7 million as they did not recur in 2011. Other increases included higher employee salaries of $0.9 million, including augmentation of the CLEC sales and services functions; increased cable expense for programming and growth of $0.2 million; and higher pole attachment costs of $0.2 million. The increase was partially offset by reductions in toll costs of $0.6 million.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased 0.7% to $13.0 million in 2011 from $13.1 million in 2010. Shoreham accounted for an increase of $0.1 million. Recoveries during 2010 associated with the settlement of bankruptcy and toll claims accounted for an increase of $0.8 million as they did not recur in 2011. These increases were more than offset by lower employee costs of $0.5 million; property taxes of $0.2 million; sales commissions of $0.2 million; and insurance costs of $0.1 million.

Depreciation and amortization. Depreciation and amortization decreased 14.5% to $20.2 million in 2011 from $23.7 million in 2010. Shoreham accounted for an increase of $0.2 million. Amortization of the intangible assets associated with the acquisition of the CR Companies, including a covenant not to compete and the value of a large multi-year contract, accounted for a decrease of $1.2 million. The plant and equipment adjustment associated with the Mid-Maine acquisition was fully amortized in June 2011, reflecting a decrease of $0.4 million. The balance consisted of decreased depreciation of $2.0 million associated with the investment in our RLECs.

	Year Ended December 31,						Change
	2010			2011			Amount			Percent
	(Dollars in Thousands)
Interest expense	$	(24,747	)	$	(24,776	)	$	29			0.1	%
Change in fair value of derivatives		(878	)		2,230			3,108			NM
Other income		557			363			(194	)		(34.8	)
Income tax expense		(610	)		(250	)		360			NM

Interest expense. Interest expense in 2011 and 2010 was $24.7 million. Interest on senior debt for 2011 decreased $0.2 million on lower outstanding senior debt associated with the voluntary principal prepayments in 2010 and 2011. The interest on the

24

senior subordinated notes associated with the IDSs increased $0.2 million in 2011, reflecting the conversion of the outstanding Class B common stock to IDSs on June 8, 2010.

Change in fair value of derivatives. We had two interest rate swap agreements to hedge our exposure to changes in interest rate costs associated with our senior credit facility. From an accounting perspective, the documentation for both swaps did not meet the technical requirements to allow the swaps to be considered highly effective as hedging instruments and therefore the swaps did not qualify for hedge accounting. These swap agreements were required to be considered as investments and the change in value was reflected as a change in fair value of derivatives. During 2011, these swaps increased in value $2.2 million compared to a decrease in value of $0.9 million during 2010. Over the life of the swaps, the cumulative change in value was zero. Both swaps expired on February 8, 2012. See —Liquidity and Capital Resources below for additional explanation.

Other income. Other income in 2011 decreased 34.8% to $0.4 million from $0.6 million in 2010. This decrease was primarily attributable to a one-time heating system settlement in 2010 in Missouri of $0.1 million and lower interest income on our invested cash and lower dividends from CoBank of $0.1 million.

Income taxes. Provision for income tax expense in 2011 was $0.3 million compared to $0.6 million for 2010. In calculating the effective tax rate, the change in fair value of the derivatives associated with our two interest rate swaps is excluded as a permanent difference. This can cause the effective rate to vary between periods. The effective income tax rate was 46.9% and 10.2% for 2010 and 2011, respectively.

Net income. As a result of the foregoing, there was net income in 2011 of $2.2 million compared to net income in 2010 of $0.7 million.

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

Total Revenues. Total revenues grew 0.6% in 2010 to $104.4 million from $103.8 million in 2009. The table below provides the components of our revenues for 2010 compared to 2009.

	Year Ended December 31,				Change
	2009		2010		Amount		Percent
	(Dollars in Thousands)
Local services	$	48,441	$	49,014	$	573		1.2%
Network access		33,297		32,982		(315)		(0.9)
Cable television		2,489		2,799		310		12.5
Internet		14,027		14,015		(12)		(0.1)
Transport services		5,501		5,590		89		1.6
Total	$	103,755	$	104,400	$	645		0.6

Local services. Local services revenue in 2010 grew 1.2% to $49.0 million from $48.4 million in 2009. This increase was attributable to an increase of $2.1 million from growth in our CLEC business in New England. RLEC revenue, including bundled services such as long distance, decreased $1.5 million, reflecting the decline in RLEC voice access lines and related services.

Network access. Network access revenue in 2010 decreased 0.9% to $33.0 million from $33.3 million in 2009. Increases in CLEC switched access of $1.3 million were more than offset by decreases of $1.4 million in RLEC access and $0.2 million in RLEC end user associated fees.

Cable television. Cable television revenue in 2010 increased 12.5% to $2.8 million from $2.5 million in 2009. The growth in high definition television, VOD and digital video recording services; IPTV subscribers; and basic service price increases in Alabama accounted for the increase.

Internet. Internet revenue was $14.0 million in both 2010 and 2009, although such revenue decreased by 0.1% in 2010. Increases of $0.6 million attributable to the addition of new high-speed internet data lines were offset by comparable decreases associated with the loss of dial-up internet customers, including those we serve outside of our territory, primarily in Maine where we are not able to offer a high-speed data line alternative.

25

Transport services. Transport services revenue in 2010 increased 1.6% to $5.6 million from $5.5 million in 2009. The continued growth in wholesale transport revenue from CLEC customers in Maine and New Hampshire drove this increase.

Operating expenses. Operating expenses for 2010 decreased 4.6% to $78.0 million from $81.8 million in 2009. This decrease was primarily attributable to a reduction in amortization expense for intangibles and lower uncollectible revenue.

	Year Ended December 31,				Change
	2009		2010		Amount		Percent
	(Dollars in Thousands)
Cost of services	$	41,179	$	41,286	$	107		0.3%
Selling, general and administrative expenses		14,164		13,075		(1,089)		(7.7)
Depreciation and amortization		26,486		23,670		(2,816)		(10.6)
Total	$	81,829	$	78,031	$	(3,798)		(4.6)

Cost of services. Cost of services increased 0.3% to $41.3 million in 2010 from $41.2 million in 2009. CLEC cost increases of $0.6 million in long distance and $0.2 million in customer service reflect the growth in CLEC revenue for the period. RLEC costs increased by $0.1 million for cable services but declined by an aggregate of $0.8 million in other expense categories, including pole rental, access costs and other operational synergies.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased 7.7% to $13.1 million in 2010 from $14.2 million in 2009. Decreases in uncollectible billing of $0.6 million and provision for bad debt of $0.2 million; general and administrative expenses of $0.7 million; insurance premiums of $0.2 million; legal expenses of $0.2 million; and postage of $0.1 million were partially offset by increases in CLEC sales positions and commissions of $0.9 million.

Depreciation and amortization. Depreciation and amortization decreased 10.6% to $23.7 million in 2010 from $26.5 million in 2009. Amortization of the intangible assets associated with the acquisition of the CR Companies, including a covenant not to compete and the value of a large multi-year contract, accounted for a decrease of $2.2 million. The balance consisted of decreased depreciation of $0.8 million associated with the investment in our RLECs and an increase of $0.2 million associated with increased investment in our CLEC.

	Year Ended December 31,				Change
	2009		2010		Amount		Percent
	(Dollars in Thousands)
Interest expense	$	(25,416)	$	(24,747)	$	(669)		(2.6)%
Change in fair value of derivatives		(1,354)		(878)		476		NM
Other income		359		557		198		55.2
Income tax (expense) benefit		1,367		(610)		(1,977)		NM

Interest expense. Interest expense in 2010 decreased 2.6% to $24.7 million from $25.4 million in 2009. Non-cash interest caplet expense associated with the recognition of the cost of the five year interest rate cap purchased at the time of the initial public offering was $1.2 million in 2009. The interest rate cap expired at the end of 2009, resulting in no comparable expense in 2010, or a decrease of $1.2 million. Interest on senior debt increased by $0.2 million as interest rate swap costs increased, partially offset by the lower outstanding principal balance under our senior credit facility resulting from the two voluntary prepayments made in 2009 and 2010. The interest on the senior subordinated notes associated with the IDSs increased $0.3 million, reflecting the conversion of the outstanding Class B common stock to IDSs on June 8, 2010.

Change in fair value of derivatives. We had two interest rate swap agreements to hedge our exposure to changes in interest rate costs associated with our senior credit facility. From an accounting perspective, the documentation for both swaps did not meet the technical requirements to allow the swaps to be considered highly effective as hedging instruments and therefore the swaps did not qualify for hedge accounting. The value of the swap liability increased in 2010, as interest rates remained at historic lows, but the increase in liability was $0.5 million lower than was experienced in 2009. Over the life of the swaps, the cumulative change in value was zero. Both swaps expired on February 8, 2012. See —Liquidity and Capital Resources below for additional explanation

26

Other income. Other income in 2010 increased 55.2% to $0.6 million from $0.4 million in 2009. An increase in dividends from CoBank accounted for $0.1 million and an increase in interest income on our invested cash accounted for the balance.

Income taxes. Provision for income taxes in 2010 was an expense of $0.6 million compared to a benefit of $1.4 million for 2009. In calculating the effective tax rate, the change in fair value of the derivatives associated with our two interest rate swaps are excluded as permanent differences. This can cause the effective rate to vary between periods. The effective income tax rate was 30.5% and 46.9% for 2009 and 2010, respectively.

Net income (loss). As a result of the foregoing, there was net income in 2010 of $0.7 million compared to a net loss in 2009 of $3.1 million.

Liquidity and Capital Resources

Our liquidity needs arise primarily from: (i) interest payments related to our credit facility and our senior subordinated notes; (ii) capital expenditures for investment in our business; (iii) working capital requirements; (iv) dividend payments on our common stock, when declared by our board of directors; and (v) potential acquisitions.

Cash flows from operating activities for 2011 were $19.5 million compared to $26.4 million for 2010. See the table below regarding cash generation and cash utilization.

Cash flows used in investing activities for 2011 were $15.6 million compared to $10.2 million for 2010. The acquisition and construction of property and equipment reflected cash used in investing activities of $10.5 million in 2011 compared to $10.2 million in 2010. The Company also used $5.1 million to acquire Shoreham in October 2011.

Cash flows used in financing activities for 2011 were $9.8 million compared to $15.7 million for 2010. In 2010 and 2011, the Company declared and paid dividends amounting to $9.2 million and $9.3 million, respectively, to the holders of its common stock. The increase reflects the conversion of Class B common stock to IDS units. In addition, the Company made voluntary prepayments of $6.1 million in 2010 and $0.4 million in 2011 on its senior debt due in October 2013.

Total capital expenditures in 2011 were $10.6 million, up $0.4 million from $10.2 million in 2010, reflecting the expansion of the Maine and New Hampshire CLEC footprint; continued upgrade to our RLEC data network; and the IPTV system in Alabama. Our business continues to invest approximately 9% to 10% of revenue each year in business infrastructure.

We currently have outstanding $162.0 million under the term loan portion of our second amended and restated credit facility that matures in October 2013, reflecting a $0.4 million voluntary prepayment made by the Company in May 2011. Borrowings under the term loan bear interest at LIBOR plus a margin that can range from 3.5% to 4.25% (at December 31, 2011, the rate was 0.2763% LIBOR plus 4.0% margin). In February 2009, the Company executed two interest rate swap agreements as the fixed rate counterparty to hedge its exposure to changes in interest rate costs associated with its senior credit facility. Both swap agreements hedged the 3 month LIBOR rate. The first agreement was effective February 9, 2009 for three years with a notional amount of $90 million and a fixed interest rate of 1.85%. The second agreement was effective February 9, 2010 for two years with a notional amount of $60 million and a fixed interest rate of 2.0475%. From an accounting perspective, the documentation for both swaps did not meet the technical requirements of Accounting Standards Codification, or ASC, 815, Derivatives and Hedging, or ASC 815, to allow the swaps to be considered highly effective as hedging instruments. Both swaps expired on February 8, 2012.

We also have outstanding an aggregate of $107.7 million senior subordinated notes due in 2019 which bear interest at a rate of 13%, payable quarterly. On June 8, 2010, our outstanding shares of Class B common stock were exchanged for IDSs on a one-for-one basis.

In addition, we currently have a $15.0 million revolving credit facility, which bears interest at a variable rate. No borrowings were outstanding under this facility at December 31, 2011 or at any time since its inception. We are charged a 0.5% fee on the unused balance, payable quarterly.

Our credit facility has material covenants based upon Consolidated EBITDA, as defined in the credit facility, and our senior subordinated notes have material covenants based upon Adjusted EBITDA, as defined in the indenture for the senior subordinated notes. In our credit facility, covenants relating to our senior leverage and fixed charge ratios are calculated based upon Consolidated EBITDA. In the indenture for the senior subordinated notes, our ability to pay dividends on our common stock is dependent in large part on our Adjusted EBITDA. In addition, our ability to incur debt under the indenture for the senior subordinated notes and the credit facility is based on our ability to meet a specified leverage ratio. If we are unable to meet the leverage ratio, our liquidity would be adversely affected to the extent that we intend to rely on additional debt to enhance our liquidity.

27

The following table provides a summary of the extent to which cash generated from operations is reinvested in our operations, used to pay interest on our senior debt and senior subordinated notes or distributed as dividends to our stockholders for 2009, 2010 and 2011. The voluntary prepayments of our senior debt of $0.4 million in 2011, $6.1 million in 2010 and $5.0 million in 2009 are not included.

	Year Ended December 31,
	2009			2010			2011
	(Dollars in Thousands)
Cash generation
Revenue	$	103,755		$	104,400		$	101,844
Other income		359			557			363
Cash received from operations		104,114			104,957			102,207
Cost of services		41,179			41,286			43,996
Selling, general and administrative expenses		14,164			13,075			12,985
Cash consumed by operations		55,343			54,361			56,981
Cash generated from operations	$	48,771		$	50,596		$	45,226
Cash utilization
Capital investment in operations	$	9,596		$	10,225		$	10,548
Senior debt interest and fees		9,589			9,791			9,577
Interest on senior subordinated notes		13,465			13,763			13,996
Dividends		8,937			9,225			9,321
Cash utilized by the Company	$	41,587		$	43,004		$	43,442
Percentage of cash utilized of cash generated		85.3	%		85.0	%		96.1	%

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. However, our current dividend policy, our indebtedness levels and related debt service requirements and our capital expenditure requirements will significantly limit any cash available from operations for other uses for the foreseeable future. We may not retain a sufficient amount of cash to finance growth opportunities or unanticipated capital expenditure needs or to fund our operations in the event of a significant business downturn. We may have to forego growth opportunities or capital expenditures that would otherwise be necessary or desirable or adjust our current dividend policy if we do not find alternative sources of financing. If we do not have sufficient cash for these purposes, our financial condition and our business will suffer.

Obligations and Commitments

The following table discloses aggregate information about our contractual obligations as of December 31, 2011, including scheduled interest and principal for the periods in which payments are due:

28

	Total		Less Than 1 Year		1-3 Years		3-5 Years		More Than 5 Years
Second amended and restated credit facility
Term	$	162,000,000	$	–	$	162,000,000	$	–	$	–
Revolver(1)		–		–		–		–		–
Senior subordinated notes		107,660,531		–		–		–		107,660,531
Expected interest expense (2)		125,983,187		21,661,849		34,341,994		27,991,738		41,987,607
Total contractual cash obligations	$	395,643,718	$	21,661,849	$	196,341,994	$	27,991,738	$	149,648,138

(1)

We have a $15.0 million revolving credit facility with an October 2013 maturity available. No amounts were drawn on this facility on December 31, 2011 or during 2011. The Company pays a commitment fee of 0.50% per annum, payable quarterly in arrears, on the unused portion of the revolver loan.

(2)

Expected interest payments to be made in future periods reflect anticipated interest payments related to our $162.0 million senior credit facility and our $107.7 million senior subordinated notes at 13.0%, including those associated with our IDSs and those held separately. Interest on the senior credit facility reflects a LIBOR rate of from 0.5% to 1.0% plus a margin of 4.0%. Interest rate hedging ran through February 8, 2012 and is not currently expected to be replaced. We have assumed in the presentation above that we will hold the senior credit facility until maturity in 2013 and the senior subordinated notes until maturity in 2019. No interest payment is included for the revolving credit facility because of the variability and timing of advances and repayments thereunder.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements.

Critical Accounting Policies and Accounting Estimates

The process of preparing financial statements requires the use of estimates on the part of management. These estimates are based on our historical experience combined with management’s understanding of current facts and circumstances. Certain of our accounting policies are considered critical as they are both important to the portrayal of our financial statements and require significant or complex judgment on the part of management. The following is a summary of certain policies considered critical by management.

Regulatory Accounting. The Company follows the accounting for regulated enterprises, which is now part of Accounting Standards Codification 980, Regulated Operations, or ASC 980. This accounting practice recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, ASC 980 requires the Company to depreciate telecommunications property and equipment over the useful lives approved by regulators, which could be different than the useful lives that would otherwise be determined by management. ASC 980 also requires deferral of certain costs and obligations based upon approvals received from regulators to permit recovery of such amounts in future years. Criteria that would give rise to the discontinuance of accounting in accordance with ASC 980 include (1) increasing competition restricting the ability of the Company to establish prices that allow it to recover specific costs and (2) significant changes in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. The Company periodically reviews the criteria to determine whether the continuing application of ASC 980 is appropriate for its rural local exchange carriers. As of December 31, 2010 and 2011, 65.7% and 68.3%, respectively, of the Company’s net property, plant and equipment was accounted for under ASC 980.

The Company is subject to reviews and audits by regulatory agencies. The effect of these reviews and audits, if any, will be recorded in the period in which they become known and determinable.

Intangible Assets and Goodwill. Intangible assets consist primarily of the fair value of customer related intangibles, non-compete agreements and long-term customer contracts. Goodwill represents the excess of total acquisition cost over the assigned value of net identifiable tangible and intangible assets acquired through various business combinations. Due to the regulatory accounting required by ASC 980, the Company did not record acquired regulated telecommunications property and equipment at fair value as required by ASC 805, Business Combinations, or ASC 805, through 2004. In accordance with 47 CFR 32.2000, the federal regulation governing acquired telecommunications property and equipment, such property and equipment is accounted for at original cost, and depreciation and amortization of property and equipment acquired is credited to accumulated depreciation.

For the acquisition of Shoreham, property has been recorded at fair value in accordance with ASC 805, resulting in a plant acquisition adjustment in 2011. The Company has acquired identifiable intangible assets associated with the territories it serves, including a non-compete agreement with one of the former owners of Shoreham, and the customer lists of Shoreham. Any excess of the total purchase price over the amounts assigned to tangible and identifiable assets is recorded as goodwill.

29

The Company performs a quarterly review of its identified intangible assets to determine if facts and circumstances exist which indicate that the useful life is shorter than originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances do exist, the Company assesses the recoverability of identified intangible assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets.

Revenue Recognition. Local services revenue for monthly recurring local services is billed in advance to a portion of the Company’s customers and in arrears to the balance of the customers. The Company records revenue for charges that have not yet been invoiced to its customers as unbilled revenue when services are rendered. The Company records revenue billed in advance as advance billings and defers recognition until such revenue is earned. Long distance service is billed to customers in arrears based on actual usage except when it is included in service bundles. The Company records unbilled long distance revenue as unbilled revenue when services are rendered. In bundles, unlimited usage is billed in arrears at a flat rate.

Network access revenue is derived from several sources. Revenue for interstate access services is received through tariffed access charges filed by the NECA with the FCC on behalf of the NECA member companies for our regulated subsidiaries. These access charges are billed by the Company to interstate interexchange carriers and pooled with like-revenues from all NECA member companies. A portion of the pooled access charge revenue received by the Company is based upon its actual cost of providing interstate access service, plus a return on the investment dedicated to providing that service. The balance of the pooled access charge revenue received by the Company is based upon the nationwide average schedule costs of providing interstate access services. Rates for our competitive subsidiaries are set by FCC rule to be no more than the interconnecting interstate rate of the predominant local carrier. Revenue for intrastate access service is received through tariffed access charges billed by the Company to the originating intrastate carrier using access rates filed with the appropriate state regulatory commissions and are retained by the Company. Revenue for the intrastate/interLATA access service is received through tariffed access charges as filed with the APSC, MDTC, MPSC, MPUC, NHPUC, VPSB and WVPSC. These access charges are billed to the intrastate carriers and are retained by the Company. Revenue for terminating and originating long distance service is received through charges for providing usage of the local exchange network. Toll revenues are recognized when services are rendered.

Cable television, internet and transport service revenues are recognized when services are rendered. Operating revenues from the lease of dark fiber covered by indefeasible rights-of-use (IRU) agreements are recorded as earned. In some cases, the entire lease payment is received at inception of the lease and recognized ratably over the lease term after recognition of expenses associated with lease inception. The Company has deferred revenue in the consolidated balance sheet as of December 31, 2010 and 2011 of $656,968 and $615,584, respectively, related to transport services.

Long-Lived Assets. The Company reviews its long-lived assets for impairment at each balance sheet date and whenever events or changes in circumstances indicate that the carrying amount of an asset should be assessed. To determine if an impairment exists, the Company estimates the future undiscounted cash flows expected to result from the use of the asset being reviewed for impairment. If the sum of these expected future cash flows is less than the carrying amount of the asset, the Company recognizes an impairment loss in accordance with guidance included in ASC 360, Property, Plant, and Equipment. The amount of the impairment recognized is determined by estimating the fair value of the assets and recording a loss for the excess of the carrying value over the fair value.

Income Taxes. The Company accounts for income taxes using the asset and liability approach in accordance with guidance included in ASC 740, Income Taxes. The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The provision for income taxes consists of an amount for the taxes currently payable and a provision for the tax consequences deferred to future periods.

Recently Adopted Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board, or the FASB, issued Accounting Standards Update, or ASU, 2009-13, Multiple-Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task Force, or ASU 2009-13, an update to ASC 605, Revenue Recognition. ASU 2009-13 provides application guidance on whether multiple deliverables exist, how the deliverables should be separated, and how the consideration should be allocated to one or more units of accounting. ASU 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific evidence is not available, or estimated selling price if neither vendor-specific nor third-party evidence is available. The Company was required to apply this

30

guidance prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010; however, earlier application was permitted and the Company began applying the guidance in July 2010. The early adoption of this update did not have a material impact on our consolidated financial statements.

In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements, or ASU 2010-06, an update to ASC 820, Fair Value Measurements and Disclosures, or ASC 820. ASU 2010-06 provides more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. The new disclosures and clarifications of existing disclosures were effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures were effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this update did not have a material impact on our consolidated financial statements.

In February 2010, the FASB issued ASU 2010-09, Amendments to Certain Recognition and Disclosure Requirements, orASU 2010-09, an update to ASC 855, Subsequent Events. ASU 2010-09 eliminates the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of accounting principles generally accepted in the United States. The FASB believes these amendments remove potential conflicts with the SEC’s literature. ASU 2010-09 was effective upon issuance except for the use of the issued date for conduit debt obligors, which was effective for interim or annual periods ending after June 15, 2010. The adoption of this update did not have a material impact on our consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, orASU 2010-20, an update to ASC 310, Receivables. ASU 2010-20 provides additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. ASU 2010-20 applies to all entities with financing receivables, excluding short-term trade accounts receivable or receivables measured at fair value or the lower of cost or fair value. For public entities, this update was effective for interim and annual reporting periods ending on or after December 15, 2010. The adoption of this update did not have a material impact on our consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations, or ASU 2010-29, an update to ASC 805. ASU 2010-29 applies to any public entity that enters into business combinations that are material on an individual or aggregate basis. If comparative financial statements are presented, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. This update also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 was effective prospectively for business combinations for which the acquisition date was on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption was permitted and the Company began applying the guidance in December 2010. The adoption of this update did not have a material impact on our consolidated financial statements.

Recent Accounting Pronouncements

During 2011, the FASB issued ASU 2011-01 through ASU 2011-12. Except for ASU 2011-04, ASU 2011-05, ASU 2011-08, and ASU 2011-09, which are discussed below, these ASUs provide technical corrections to existing guidance related to specialized industries or entities and therefore, have minimal, if any, impact on the Company.

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

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, or ASU 2011-05, an update to ASC 220, Comprehensive Income. This ASU requires the components of net income and the components of other comprehensive income to be presented either in a single continuous statement of comprehensive income or in two separate but continuous statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. This guidance does not change the items that must be reported in other comprehensive income, when an item of

31

other comprehensive income must be reclassified to net income or how earnings per share is calculated or presented. ASU 2011-05 is effective for public entities for interim and annual periods beginning after December 15, 2011. As ASU 2011-05 impacts presentation only, the adoption of this update will not impact our consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment, or ASU 2011-08, an update to ASC 350, Intangibles – Goodwill and Other, or ASC 350. This ASU will provide an entity with the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test in accordance with ASC 350. ASU 2011-08 is effective for annual and interim goodwill impairment tests for fiscal years beginning after December 15, 2011. As ASU 2011-08 impacts testing procedures only, the adoption of this update will not impact our consolidated financial statements.

In September 2011, the FASB issued ASU 2011-09, Disclosures about an Employer’s Participation in a Multiemployer Plan, or ASU 2011-09, an update to ASC 715, Compensation – Retirement Benefits, subtopic 80, Multiemployer Plans. ASU 2011-09 requires additional disclosures for multiemployer pension plans and multiemployer other postretirement benefit plans. ASU 2011-09 is intended to create greater transparency in financial reporting by disclosing the commitments an employer has made to a multiemployer pension plan and the potential future cash flow implications of an employer’s participation in the plan. ASU 2011-09 is effective for public entities for annual periods with fiscal years ending after December 15, 2011. ASU 2011-09 impacts disclosure only, the adoption of this update did not impact our consolidated financial statements.

Subsequent Events

Effective as of January 1, 2012, each of the Company’s subsidiaries that was a corporation converted into a limited liability company pursuant to applicable state law, except that one of the Company’s corporate subsidiaries was merged with and into the Company effective as of January 1, 2012. As a result of the conversions and the merger, the Company currently expects to lower its income tax obligation in Missouri, as well as lower its cash income tax obligation in Alabama by utilizing net operating loss carryforwards and deferred tax assets.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Our short-term excess cash balance is invested in short-term commercial paper. We do not invest in any derivative or commodity type instruments, although our two interest rate swap agreements were technically not effective hedges and therefore did not qualify for hedge accounting. The change in fair value of the swaps was charged or credited to income as a change in fair value of derivatives. Over the life of the swaps, the cumulative change in value was zero. Both swaps expired on February 8, 2012. 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 that expires on October 31, 2013. The interest rate is variable and, accordingly, we are exposed to interest rate risk, primarily from a change in LIBOR or a base rate. Currently, we have no loans drawn under this facility.

32

Item 8. Financial Statements and Supplementary Data

OTELCO INC.

CONSOLIDATED FINANCIAL STATEMENTS

	Page
Reports of Independent Registered Public Accounting Firm	34
Consolidated Balance Sheets	36
Consolidated Statements of Operations	37
Consolidated Statements of Stockholders’ Equity (Deficit)	38
Consolidated Statements of Cash Flows	39
Notes to Consolidated Financial Statements	40

33

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Otelco Inc.

Oneonta, Alabama

We have audited the accompanying consolidated balance sheets of Otelco Inc. as of December 31, 2011 and 2010 and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Otelco Inc. at December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Otelco Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 5, 2012 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP

Atlanta, Georgia

March 5, 2012

34

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

Otelco Inc.

Oneonta, Alabama

We have audited Otelco Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Otelco Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Item 9A, Management’s Report on Internal Control Over Financial Reporting”. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As indicated in the accompanying “Item 9A, Management’s Report on Internal Control over Financial Reporting”, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Shoreham Telephone LLC, which was acquired on October 14, 2011, and which is included in the consolidated balance sheets of Otelco Inc. as of December 31, 2011, and the related consolidated statements of operations, stockholders’ deficit and cash flows for the year then ended. Shoreham Telephone LLC constituted 2.4% of total assets as of December 31, 2011, and 0.7% and 4.7% of revenues and net income, respectively, for the year then ended. Management did not assess the effectiveness of internal control over financial reporting of Shoreham Telephone LLC because of the timing of the acquisition which was completed on October 14, 2011. Our audit of internal control over financial reporting of Otelco Inc. also did not include an evaluation of the internal control over financial reporting of Shoreham Telephone LLC.

In our opinion, Otelco Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Otelco Inc. as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2011 and our report dated March 5, 2012 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP

Atlanta, Georgia

March 5, 2012

35

OTELCO INC.

CONSOLIDATED BALANCE SHEETS

	As of December 31,
	2010			2011
Assets
Current assets
Cash and cash equivalents	$	18,226,374		$	12,393,792
Accounts receivable:
Due from subscribers, net of allowance for doubtful accounts of $230,752 and $260,568, respectively		4,406,257			4,355,632
Unbilled receivables		2,161,277			2,183,465
Other		4,299,088			5,449,074
Materials and supplies		1,817,311			1,780,820
Prepaid expenses		1,305,028			1,328,475
Deferred income taxes		626,267			726,310
Total current assets		32,841,602			28,217,568
Property and equipment, net		63,887,213			65,881,975
Goodwill		188,190,078			188,954,840
Intangible assets, net		25,934,042			20,545,691
Investments		1,967,095			1,943,805
Deferred financing costs		5,757,825			4,485,324
Deferred income taxes		4,415,097			7,454,443
Prepaid expenses		106,685			238,386
Other assets		77,261			2,281
Total assets	$	323,176,898		$	317,724,313
Liabilities and Stockholders’ Deficit
Current liabilities
Accounts payable	$	768,055		$	1,490,717
Accrued expenses		7,926,954			6,034,104
Advance billings and payments		1,595,133			1,590,689
Deferred income taxes		353,285			353,285
Customer deposits		172,479			143,657
Total current liabilities		10,815,906			9,612,452
Deferred income taxes		42,512,576			48,112,384
Interest rate swaps		2,471,331			241,438
Advance billings and payments		656,968			615,584
Other liabilities		368,349			403,823
Long-term notes payable		271,595,855			271,106,387
Total liabilities		328,420,985			330,092,068
Stockholders’ deficit
Class A Common Stock, $.01 par value-authorized 20,000,000 shares; issued and outstanding 13,221,404 shares		132,214			132,214
Additional paid in capital		921,718			–
Retained deficit		(6,298,019	)		(12,499,969	)
Total stockholders’ deficit		(5,244,087	)		(12,367,755	)
Total liabilities and stockholders’ deficit	$	323,176,898		$	317,724,313

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

36

OTELCO INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

	Years Ended December 31,
	2009			2010			2011
Revenues	$	103,755,454		$	104,400,219		$	101,843,567
Operating expenses
Cost of services		41,178,502			41,286,418			43,995,953
Selling, general and administrative expenses		14,164,465			13,074,794			12,984,686
Depreciation and amortization		26,485,628			23,670,243			20,232,833
Total operating expenses		81,828,595			78,031,455			77,213,472
Income from operations		21,926,859			26,368,764			24,630,095
Other income (expense)
Interest expense		(25,416,024			(24,746,542	)		(24,776,123	)
Change in fair value of derivatives		(1,354,759	)		(878,518	)		2,229,893
Other income		359,484			556,820			363,482
Total other expenses		(26,411,299	)		(25,068,240	)		(22,182,748	)
Income (loss) before income tax		(4,484,440	)		1,300,524			2,447,347
Income tax (expense) benefit		1,366,629			(609,809	)		(249,929	)
Net income (loss) available to common stockholders	$	(3,117,811	)	$	690,715		$	2,197,418
Weighted average common shares outstanding:
Basic		12,676,733			12,985,629			13,221,404
Diluted		13,221,404			13,221,404			13,221,404
Basic net income (loss) per common share	$	(0.25	)	$	0.05		$	0.17
Diluted net income (loss) per common share	$	(0.25	)	$	0.05		$	0.17
Dividends declared per common share	$	0.71		$	0.71		$	0.71

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

37

OTELCO INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

	Class A Common Stock				Class B Common Stock						Additional Paid- In			Retained			Accumulated Other Comprehensive			Total Stockholders’
	Shares		Amount		Shares			Amount			Capital			Deficit			Income (Loss)			Equity (Deficit)
Balance, December 31, 2008		12,676,733	$	126,767		544,671		$	5,447		$	19,277,959		$	(3,870,923	)	$	(1,160,759	)	$	14,378,491
Comprehensive Loss
Net loss															(3,117,811	)					(3,117,811	)
Change in fair value of interest rate cap																		1,160,759			1,160,759
Total comprehensive loss																					(1,957,052	)
Dividends declared												(8,937,097	)								(8,937,097	)
Balance, December 31, 2009		12,676,733	$	126,767		544,671		$	5,447		$	10,340,862		$	(6,988,734	)	$	–		$	3,484,342
Comprehensive Income
Net income															690,715						690,715
Total comprehensive income																					690,715
Class B conversion to Class A		544,671		5,447		(544,671	)		(5,447	)											0
Direct cost of Class B conversion												(194,053	)								(194,053	)
Dividends declared												(9,225,091	)								(9,225,091	)
Balance, December 31, 2010		13,221,404	$	132,214		–		$	–		$	921,718		$	(6,298,019	)	$	–		$	(5,244,087	)
Comprehensive Income
Net income															2,197,418						2,197,418
Total comprehensive income																					2,197,418
Dividends declared												(921,718	)		(8,399,368	)					(9,321,086	)
Balance, December 31, 2011		13,221,404	$	132,214		–		$	–		$	–		$	(12,499,969	)	$	–		$	(12,367,755	)

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

38

OTELCO INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Years Ended December 31,
	2009			2010			2011
Cash flows from operating activities:
Net income (loss)	$	(3,117,811	)	$	690,715		$	2,197,418
Adjustments to reconcile net income (loss) to cash flows from operating activities:
Depreciation		14,444,714			13,837,560			11,891,474
Amortization		12,040,914			9,832,683			8,341,359
Interest rate caplet		1,168,522			–			–
Amortization of debt premium		(82,212	)		(92,307	)		(103,640	)
Amortization of loan costs		1,351,906			1,361,351			1,368,095
Change in fair value of derivatives		1,354,759			878,518			(2,229,893	)
Provision (benefit) for deferred income taxes		(1,507,798	)		428,098			226,962
Provision for uncollectible revenue		920,945			141,474			914,555
Changes in operating assets and liabilities; net of operating assets and liabilities acquired:
Accounts receivables		739,921			427,432			(1,590,110	)
Material and supplies		339,909			152,655			173,350
Prepaid expenses and other assets		(200,341	)		(69,464	)		(117,356	)
Income tax receivable		(207,842	)		389,486			-
Accounts payable and accrued liabilities		1,094,474			(1,657,758	)		(1,423,589	)
Advance billings and payments		(400,085	)		(111,673	)		(116,732	)
Other liabilities		(30,850	)		202,751			(1,756	)
Net cash from operating activities		27,909,125			26,411,521			19,530,137
Cash flows from investing activities:
Acquisition and construction of property and equipment		(9,596,049	)		(10,225,229	)		(10,547,705	)
Purchase of investment		–			(1,708	)		(2,220	)
Proceeds (loss) from retirement of investment		(1,085	)		1,067			–
Wholesale customer acquisition		(179,554	)		–			–
Payments for the purchase of Shoreham Telephone, net of cash acquired		–			–			(5,010,284	)
Deferred charges/acquisition		(6,551	)		(1,845	)		–
Net cash used in investing activities		(9,783,239	)		(10,227,715	)		(15,560,209	)
Cash flows used in financing activities:
Cash dividends paid		(8,937,097	)		(9,225,091	)		(9,321,086	)
Direct cost of exchange of Class B shares for Class A shares		–			(194,053	)		–
Loan origination costs		–			(155,160	)		(95,596	)
Repayment of long-term notes payable		(5,000,000	)		(6,114,172	)		(385,828	)
Net cash used in financing activities		(13,937,097	)		(15,688,476	)		(9,802,510	)
Net increase (decrease) in cash and cash equivalents		4,188,789			495,330			(5,832,582	)
Cash and cash equivalents, beginning of period		13,542,255			17,731,044			18,226,374
Cash and cash equivalents, end of period	$	17,731,044		$	18,226,374		$	12,393,792
Supplemental disclosures of cash flow information:
Interest paid	$	23,378,798		$	23,484,474		$	24,130,675
Income taxes paid (received)	$	67,658		$	(265,275	)	$	90,517

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

39

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

1.  Summary of Significant Accounting Policies

Nature of Business

Otelco Inc. (the “Company”) provides a broad range of telecommunications services on a retail and wholesale basis. These services include local and long distance calling; network access to and from our customers; data transport; digital high-speed and dial-up internet access; cable, satellite and internet protocol television; wireless; and other telephone related services. The principal markets for these services are residential and business customers residing in and adjacent to the exchanges the Company serves in Alabama, Massachusetts, Maine, Missouri, Vermont, and West Virginia. In addition, the Company serves business customers throughout Maine and New Hampshire and provides dial-up internet service throughout the states of Maine and Missouri. The Company offers various communications services that are sold to economically similar customers in a comparable manner of distribution. The majority of our customers buy multiple services, often bundled together at a single price. The Company views, manages and evaluates the results of its operations from the various communications services as one company and therefore has identified one reporting segment as it relates to providing segment information.

Basis of Presentation and Principles of Consolidation

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

The accompanying consolidated financial statements include the accounts of the Company and all of the aforesaid subsidiaries after elimination of all material intercompany balances and transactions.

Use of Estimates

The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. The estimates and assumptions used in the accompanying consolidated financial statements are based upon management’s evaluation of the relevant facts and circumstances as of the date of the financial statements. Actual results may differ from the estimates and assumptions used in preparing the accompanying consolidated financial statements.

Significant accounting estimates include the recoverability of goodwill, identified intangibles, long-term assets, deferred tax valuation allowances and provision for bad debt.

Regulatory Accounting

The Company follows the accounting for regulated enterprises, which is now part of Accounting Standards Codification (“ASC”) 980, Regulated Operations (“ASC 980”), as issued by the Financial Accounting Standards Board (the “FASB”). This accounting practice recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, ASC 980 requires the Company to depreciate telecommunications property and equipment over the estimated useful lives approved by regulators, which could be different than the estimated useful lives that would otherwise be determined by management. ASC 980 also requires deferral of certain costs and obligations based upon approvals received from regulators to permit recovery of such amounts in future years. Criteria that would give rise to the discontinuance of accounting in accordance with ASC 980 include (1) increasing competition restricting the ability of the Company to establish prices that allow it to recover specific costs and (2) significant changes in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. The Company periodically reviews the criteria to determine whether the continuing application of ASC 980 is appropriate for its rural local exchange carriers.

40

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

The Company is subject to reviews and audits by regulatory agencies. The effect of these reviews and audits, if any, will be recorded in the period in which they first become known and determinable.

Intangible Assets and Goodwill

Intangible assets consist primarily of the fair value of customer related intangibles, non-compete agreements and long-term customer contracts. Goodwill represents the excess of total acquisition cost over the assigned value of net identifiable tangible and intangible assets acquired through various business combinations. Due to the regulatory accounting required by ASC 980, the Company did not record acquired regulated telecommunications property and equipment at fair value as required by ASC 805, Business Combinations (“ASC 805”), through 2004. In accordance with 47 CFR 32.2000, the federal regulation governing acquired telecommunications property and equipment, such property and equipment is accounted for at original cost, and depreciation and amortization of property and equipment acquired is credited to accumulated depreciation.

The Company’s annual budgeting, forecasting and tax planning cycle begins in September. The Company’s strategy for growth includes acquisitions, a process that actively involves its board of directors in financial and strategy decisions, utilizing the budgeting, forecasting and tax planning information and changes in the telecommunications marketplace. Based on these factors and to allow the audit committee of the Company’s board of directors sufficient time to review management’s assessment of goodwill for impairment, management changed its annual goodwill impairment testing date from December 31 to October 1. The Company believes this change in testing date is preferable under the circumstances as the change more closely aligns the analysis with the Company’s budgeting and forecasting process. The Company does not believe that this change in annual goodwill impairment testing date will accelerate, delay or avoid any impairment charge.

For the acquisition of ST, property has been recorded at fair value in accordance with ASC 805, resulting in a plant acquisition adjustment in 2011. The Company has acquired identifiable intangible assets associated with the territories it serves, including a non-compete agreement with one of the former owners of ST, and the customer lists of ST. Any excess of the total purchase price over the amounts assigned to tangible and identifiable assets is recorded as goodwill.

The Company performs a quarterly review of its identified intangible assets to determine if facts and circumstances exist which indicate that the useful life is shorter than originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances do exist, the Company assesses the recoverability of identified intangible assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets.

Revenue Recognition

Local services revenues. Local services revenue for monthly recurring local services is billed in advance to a portion of the Company’s customers and in arrears to the balance of the customers. The Company records revenue for charges that have not yet been invoiced to its customers as unbilled revenue when services are rendered. The Company records revenue billed in advance as advance billings and defers recognition until such revenue is earned. Long distance service is billed to customers in arrears based on actual usage except when it is included in service bundles. The Company records unbilled long distance revenue as unbilled revenue when services are rendered. In bundles, unlimited usage is billed in arrears at a flat rate.

Network access. Network access revenue is derived from several sources. Revenue for interstate access services is received through tariffed access charges filed by the National Exchange Carrier Association (“NECA”) with the Federal Communications Commission (“FCC”) on behalf of the NECA member companies for our regulated subsidiaries. These access charges are billed by the Company to interstate interexchange carriers and pooled with like-revenues from all NECA member companies. A portion of the pooled access charge revenue received by the Company is based upon its actual cost of providing interstate access service, plus a return on the investment dedicated to providing that service. The balance of the pooled access charge revenue received by the Company is based upon the nationwide average schedule costs of providing interstate access services. Rates for our competitive subsidiaries are set by FCC rule to be no more than the interconnecting interstate rate of the predominant local carrier. Revenue for intrastate access service is received through tariffed access charges billed by the Company to the originating intrastate carrier using access rates filed with the Alabama Public Service Commission (“APSC”), the Maine Public Utilities Commission (“MPUC”), the Massachusetts Department of Telecommunications and Cable (“MDTC”), the Missouri Public Service Commission (“MPSC”), the New Hampshire Public Utilities Commission (“NHPUC”), the Vermont Public Service Board (“VPSB”) and the West Virginia Public

41

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Service Commission (“WVPSC”) and are retained by the Company. Revenue for the intrastate/interLATA access service is received through tariffed access charges as filed with the APSC, MDTC, MPSC, MPUC, NHPUC, VPSB and WVPSC. These access charges are billed to the intrastate carriers and are retained by the Company. Revenue for terminating and originating long distance service is received through charges for providing usage of the local exchange network. Toll revenues are recognized when services are rendered.

Cable television, internet and transport services. Cable television, internet and transport service revenues are recognized when services are rendered. Operating revenues from the lease of dark fiber covered by indefeasible rights-of-use agreements are recorded as earned. In some cases, the entire lease payment is received at inception of the lease and recognized ratably over the lease term after recognition of expenses associated with lease inception. The Company has deferred revenue in the consolidated balance sheet as of December 31, 2010 and 2011 of $656,968 and $615,584, respectively, related to transport services.

Cash and Cash Equivalents

Cash equivalents are stated at cost plus accrued interest, which approximates fair value. Cash equivalents are high-quality, short-term money market instruments and highly liquid debt instruments with an original maturity of three months or less when purchased. The cash equivalents are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of changes in interest rates.

Accounts Receivable

The Company extends credit to its commercial and residential customers based upon a written credit policy. Service interruption is the primary vehicle for controlling losses. Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate for the amount of probable credit losses in the Company’s existing accounts receivable. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends, and other information. Receivable balances are reviewed on an aged basis and account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Materials and Supplies

Materials and supplies are stated at the lower of cost or market value. Cost is determined using an average cost basis.

Property and Equipment

Regulated property and equipment is stated at original cost. Unregulated property and equipment purchased through acquisitions is stated at its fair value at the date of acquisition. Expenditures for improvements that significantly add to productive capacity or extend the useful life of an asset are capitalized. Expenditures for maintenance and repairs are expensed when incurred. Depreciation of regulated property and equipment is computed principally using the straight-line method over useful lives determined by the APSC, MDTC, MPSC, MPUC, NHPUC, VPSB and WVPSC as discussed above. Depreciation of unregulated property and equipment primarily employs the straight-line method over industry standard estimated useful lives.

Long-Lived Assets

The Company reviews its long-lived assets for impairment at each balance sheet date and whenever events or changes in circumstances indicate that the carrying amount of an asset should be assessed. To determine if an impairment exists, the Company estimates the future undiscounted cash flows expected to result from the use of the asset being reviewed for impairment. If the sum of these expected future cash flows is less than the carrying amount of the asset, the Company recognizes an impairment loss in accordance with guidance included in ASC 360, Property, Plant, and Equipment. The amount of the impairment recognized is determined by estimating the fair value of the assets and recording a loss for the excess of the carrying value over the fair value.

Deferred Financing Costs

Deferred financing and loan costs consist of debt issuance costs incurred in obtaining long-term financing, which are amortized over the life of the related debt. Amortization of deferred financing and loan costs is classified as “Interest expense”. When

42

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

amendments to debt agreements are considered to extinguish existing debt per guidance included in ASC 470, Debt, the remaining deferred financing costs are amortized at the time of amendment.

Derivative Financial Instruments

Derivative financial instruments are accounted for under guidance included in ASC 815, Derivatives and Hedging (“ASC 815”). Under ASC 815, all derivatives are recorded on the balance sheet as assets or liabilities and measured at fair value. The embedded exchange feature of the Class B common stock was accounted for as a derivative liability. This liability was adjusted to estimated fair value on each balance sheet date with the offset to other non-operating income or expense. No liability existed and the Class B shares were exchanged for Income Deposit Securities (“IDS”) units on a one-for-one basis on June 8, 2010. Each of the IDSs issued in the exchange includes a share of Class A common stock (“common stock”).

The Company is exposed to the market risk of adverse changes in interest rates. An 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 3% for the three month LIBOR index plus the applicable margin on $80 million in senior debt for five years. On July 5, 2007, the Company repaid $55,353,032 in debt, reducing its senior debt below the level of the rate cap. The cap was considered an effective hedge for the remaining senior debt as all critical terms of the interest rate cap were identical to the underlying debt it hedged. The balance of the cap at that time was considered as an investment and adjustments were made to accumulated other comprehensive income to reflect this change. On October 31, 2008, the Company implemented its second amended and restated credit agreement, increasing senior debt to $173.5 million in conjunction with the acquisition of three entities from Country Road Communications LLC. The full $80 million rate cap was accounted for as an effective hedge from that date through the end of the rate cap on December 20, 2009. The cost of the effective portion of the interest rate cap was 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.

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

Income Taxes

The Company accounts for income taxes using the asset and liability approach in accordance with guidance included in ASC 740, Income Taxes (“ASC 740”). The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The provision for income taxes consists of an amount for the taxes currently payable and a provision for the tax consequences deferred to future periods.

Interest and penalties related to income tax matters would be recognized in income tax expense. As of December 31, 2011, we did not have an amount recorded for interest and penalties.

The Company conducts business in multiple jurisdictions and, as a result, one or more subsidiaries file income tax returns in the U.S. federal, various state and local jurisdictions. All tax years since 2004 are open for examination by various tax authorities.

43

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Fair Value of Financial Instruments

The carrying value of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, derivative liabilities and long-term notes payable approximate their fair value as of December 31, 2010 and 2011.

Comprehensive Income (Loss)

Comprehensive income (loss) equals net income (loss) plus other comprehensive income. Other comprehensive income refers to revenue, expenses, gains and losses, which are reflected in retained earnings but excluded from net income.

Income (Loss) per Common Share

The Company computes net income (loss) per common share in accordance with the provision included in ASC 260, Earnings per Share (“ASC 260”). Under ASC 260, basic and diluted income per share is computed by dividing net income (loss) available to stockholders by the weighted average number of common shares and common share equivalents outstanding during the period. Basic income (loss) per common share excludes the effect of potentially dilutive securities, while diluted income (loss) per common share reflects the potential dilution that would occur if securities or other contracts to issue common shares were exercised for, converted into or otherwise resulted in the issuance of common shares. Net income (loss) is adjusted for the Class B derivative liability in calculating diluted earnings. On June 8, 2010, all of the Company’s Class B shares were exchanged for IDSs, which include a common share, on a one-for-one basis.

Recently Adopted Accounting Pronouncements

In October 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-13, Multiple-Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”), an update to ASC 605, Revenue Recognition. ASU 2009-13 provides application guidance on whether multiple deliverables exist, how the deliverables should be separated, and how the consideration should be allocated to one or more units of accounting. ASU 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific evidence is not available, or estimated selling price if neither vendor-specific nor third-party evidence is available. The Company was required to apply this guidance prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010; however, earlier application was permitted and the Company began applying the guidance in July 2010. The early adoption of this update did not have a material impact on our consolidated financial statements.

In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”), an update to ASC 820, Fair Value Measurements and Disclosures (“ASC 820”). ASU 2010-06 provides more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. The new disclosures and clarifications of existing disclosures were effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures were effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this update did not have a material impact on our consolidated financial statements.

In February 2010, the FASB issued ASU 2010-09, Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”), an update to ASC 855, Subsequent Events. ASU 2010-09 eliminates the requirement for a Securities and Exchange Commission (“SEC”) filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of accounting principles generally accepted in the United States. The FASB believes these amendments remove potential conflicts with the SEC’s literature. ASU 2010-09 was effective upon issuance except for the use of the issued date for conduit debt obligors, which was effective for interim or annual periods ending after June 15, 2010. The adoption of this update did not have a material impact on our consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”), an update to ASC 310, Receivables. ASU 2010-20 provides additional information to

44

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. ASU 2010-20 applies to all entities with financing receivables, excluding short-term trade accounts receivable or receivables measured at fair value or the lower of cost or fair value. For public entities, this update was effective for interim and annual reporting periods ending on or after December 15, 2010. The adoption of this update did not have a material impact on our consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations (“ASU 2010-29”), an update to ASC 805. ASU 2010-29 applies to any public entity that enters into business combinations that are material on an individual or aggregate basis. If comparative financial statements are presented, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. This update also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 was effective prospectively for business combinations for which the acquisition date was on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption was permitted and the Company began applying the guidance in December 2010. The adoption of this update did not have a material impact on our consolidated financial statements.

Recent Accounting Pronouncements

During 2011, the FASB issued ASU 2011-01 through ASU 2011-12. Except for ASU 2011-04, ASU 2011-05, ASU 2011-08, and ASU 2011-09, which are discussed below, these ASUs provide technical corrections to existing guidance related to specialized industries or entities and therefore, have minimal, if any, impact on the Company.

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

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

In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment (“ASU 2011-08”), an update to ASC 350, Intangibles – Goodwill and Other (“ASC 350”). This ASU will provide an entity with the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test in accordance with ASC 350. ASU 2011-08 is effective for annual and interim goodwill impairment tests for fiscal years beginning after December 15, 2011. As ASU 2011-08 impacts testing procedures only, the adoption of this update will not impact our consolidated financial statements.

In September 2011, the FASB issued ASU 2011-09, Disclosures about an Employer’s Participation in a Multiemployer Plan (“ASU 2011-09”), an update to ASC 715, Compensation – Retirement Benefits, subtopic 80, Multiemployer Plans. ASU 2011-09 requires additional disclosures for multiemployer pension plans and multiemployer other postretirement benefit plans. ASU 2011-09 is intended to create greater transparency in financial reporting by disclosing the commitments an employer has made to a multiemployer pension plan and the potential future cash flow implications of an employer’s participation in the plan. ASU 2011-09 is effective for

45

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

public entities for annual periods with fiscal years ending after December 15, 2011. ASU 2011-09 impacts disclosure only, the adoption of this update did not impact our consolidated financial statements.

2. Income Deposit Securities Issued

On June 8, 2010, the Company issued 544,671 IDSs, representing an aggregate of 544,671 shares of common stock and $4,085,033 aggregate principal amount of our 13% senior subordinated notes due 2019, in exchange for all 544,671 shares of our issued and outstanding Class B common stock. There were no proceeds to the Company from this exchange. The $4.1 million of senior subordinated notes was reclassified from the mezzanine section of the balance sheet to long-term notes payable. Interest on the $4.1 million of senior subordinated notes was reflected in interest expense beginning June 8, 2010.

3. Acquisitions

On October 14, 2011, ST acquired 100% of the issued and outstanding common stock of Shoreham Telephone Company, Inc. (“STC”) and, immediately thereafter, STC merged with and into ST. ST provides telecommunications solutions, including voice, data and internet services, to residential and business customers in western Vermont.

The stock purchase agreement relating to the acquisition of STC provided for cash consideration of $5,248,134, including the extinguishment of notes payable of $410,904 and accrued interest of $3,081, which were paid at closing. The excess of the purchase price over the fair value of identifiable assets and liabilities is reflected as goodwill of $764,761. The goodwill related to the acquisition is not deductible for tax purposes.

The allocation of the net purchase price for the STC acquisition was as follows:

	October 14, 2011
Cash	$	237,850
Other current assets		552,331
Property and equipment		4,529,760
Intangible assets		1,729,600
Goodwill		764,761
Current liabilities		(332,710	)
Deferred income tax liabilities		(2,233,458	)
Purchase price	$	5,248,134

The acquisition has been recorded at fair value in accordance with ASC 805 resulting in a plant acquisition adjustment in 2011. Property and equipment have depreciation lives consistent with those shown in the Property and Equipment Note. The intangible assets at time of acquisition included regulated customer based assets at fair value of $1,672,200 which had remaining lives of 10 years; trade name fair valued at $16,200 which had a remaining life of 5 years; and a non-competition agreement fair valued at $41,200 which had a remaining life of 2 years. The acquisition was accounted for using the acquisition method of accounting and, accordingly, the accompanying consolidated financial statements include the financial position and results of operations from the date of acquisition.

The following unaudited pro forma information presents the combined results of operations of the Company as though the acquisition of STC had occurred at the beginning of 2010. The results include certain adjustments, including increased amortization expense related to intangible assets. The pro forma financial information does not necessarily reflect the results of operations had the acquisition been completed at the beginning of 2010 or those which may be obtained in the future.

46

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

	Unaudited		Unaudited
	2010		2011
Revenues	$	106,812,024	$	103,707,313
Income from operations	$	26,422,934	$	24,705,377
Net income	$	722,165	$	1,935,327
Basic net income per common share	$	0.05	$	0.15
Diluted net income per common share	$	0.05	$	0.15

4. Goodwill and Intangible Assets

ASC 350 requires that goodwill be tested for impairment. The Company performs an annual impairment test to determine whether the carrying value of goodwill exceeds its fair market value. We conducted our annual impairment test of goodwill as of October 1, 2011 and determined that no adjustment to the carrying value of goodwill for any reportable units was necessary. Although the Company has only one reporting segment, it considers its three territories (Alabama, Missouri and New England) to be reporting units for purposes of testing for impairment of goodwill. The fair value exceeds the carrying value of the net assets for Alabama, Missouri and New England by 8.7%, 11.0% and 41.3%, respectively. Goodwill for Alabama, Missouri and New England represents 53.8%, 9.4% and 36.8%, respectively, of total goodwill for the Company. As of December 31, 2011, we determined that no events or circumstances from October 1, 2011 through December 31, 2011 indicated that a further assessment was necessary. Based on the results of its impairment test, the Company does not believe that there is an impairment of the goodwill balance at December 31, 2010 or 2011, respectively.

Intangible assets are summarized as follows:

	December 31, 2010							December 31, 2011
	Carrying Value		Accumulated Amortization			Net Value		Carrying Value		Accumulated Amortization			Net Value
Goodwill						$	188,190,078						$	188,954,840
Other intangible assets
Customer relationships	$	27,757,682	$	(11,773,248	)	$	15,984,434	$	29,429,882	$	(15,483,937	)	$	13,945,945
Contract relationships		19,600,000		(9,683,333	)		9,916,667		19,600,000		(13,066,667	)		6,533,333
Non-competition		53,903		(20,962	)		32,941		95,103		(44,080	)		51,023
Trade name		-		-			-		16,200		(810	)		15,390
Total	$	47,411,585	$	(21,477,543	)	$	25,934,042	$	49,141,185	$	(28,595,494	)	$	20,545,691

These intangible assets have a range of 1 to 15 years of useful lives and utilize both the sum-of-the-years’ digits and straight-line methods of amortization, as appropriate. The following table presents current and expected amortization expense of the existing intangible assets as of December 31, 2011 for each of the following periods:

47

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Aggregate amortization expense:
For the year ended December 31, 2009	$	10,443,409
For the year ended December 31, 2010	$	8,271,338
For the year ended December 31, 2011	$	7,117,951
Expected amortization expense for the years ending December 31,
2012	$	6,038,437
2013		4,756,206
2014		3,475,031
2015		2,106,063
2016		1,054,458
Thereafter		3,115,496
Total	$	20,545,691

5. Property and Equipment

A summary of property and equipment is shown as follows:

	Estimated		December 31,
	Life		2010		2011
Land			$	1,113,797	$	1,156,843
Building and improvements		20-40		11,530,062		12,246,942
Telephone equipment		6-20		211,279,443		227,825,838
Cable television equipment		7		10,368,161		10,918,212
Furniture and equipment		8-14		2,766,793		2,967,337
Vehicles		7-9		5,768,620		6,089,630
Computer software equipment		5-7		13,986,754		15,590,697
Internet equipment		5		3,707,226		3,923,314
Total property, plant and equipment				260,520,856		280,718,813
Accumulated depreciation and amortization				(196,633,643)		(214,836,838)
Net property, plant and equipment			$	63,887,213	$	65,881,975

The Company’s composite depreciation rate for property and equipment was 20.9%, 21.7% and 19.2% in 2009, 2010 and 2011, respectively. Depreciation expense for the years ended December 31, 2009, 2010 and 2011 was $14,444,714, $13,837,560 and $11,891,474, respectively. Amortization expense for telephone plant adjustment was $1,554,932, $1,554,932 and $1,216,739 for the years ended December 31, 2009, 2010 and 2011, respectfully.

6. Other Accounts Receivable

Other accounts receivable consist of the following:

48

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

	December 31,
	2010		2011
Carrier access bills receivable	$	1,815,060	$	1,561,174
NECA receivable		1,041,206		682,016
Receivables from Alabama Service Fund		443,169		423,356
Wholesale contracts receivable		809,035		1,880,608
Other miscellaneous		190,618		901,920
	$	4,299,088	$	5,449,074

7. Investments

Investments consist of the following:

	December 31,
	2010		2011
Investment in CoBank stock	$	1,474,920	$	1,474,920
Rental property		423,154		397,644
Other miscellaneous		69,021		71,241
	$	1,967,095	$	1,943,805

The investment in CoBank stock is carried at historical cost due to no readily determinable fair value for those instruments being available. Management believes there has been no other than temporary impairment in such investment. This investment consists of patronage certificates that represent ownership in the financial institution where the Company has, and in the past, had, debt. These certificates yield dividends on an annual basis, and the investment is redeemed ratably subsequent to the repayment of the debt.

8. Leases

Minimum future rental commitments under non-cancellable operating leases, primarily for real property and office facilities at December 31, 2011, consist of the following:

2012	$	594,758
2013		561,866
2014		242,734
2015		114,486
2016		93,093
Thereafter		388,470
Total	$	1,995,407

Rent expense for the years ended December 31, 2009, 2010 and 2011 was $481,099, $499,928 and $599,569, respectively.

9. Long-Term Debt

The Company’s credit agreement with General Electric Capital Corporation, originally dated December 21, 2004, has been amended and restated on several occasions to reflect requirements for funds to complete two acquisitions and the use of proceeds from the Company’s successful offering of 3,000,000 IDS units on July 5, 2007. On October 20, 2008, the Company completed its second amendment and restatement of its credit agreement, increasing the principal balance from $64.6 million to $173.5 million on October 31, 2008 for the acquisition of Pine Tree Holdings, Inc., Granby Holdings, Inc. and War Holdings, Inc. (collectively, the “CR Companies”) from Country Road Communications LLC, changing the variable margin, and extending the maturity from July 3, 2011 to October 31, 2013. The variable margin based on leverage is 4% over LIBOR. On May 9, 2011, November 9, 2010, and August 8, 2009, the Company made voluntary prepayments of $385,828, $6.1 million, and $5.0 million, respectively, reducing the credit facility notes payable balance to $162.0 million at December 31, 2011.

49

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Long-term notes payable consists of the following:

	December 31,
	2010		2011
Term credit facility, General Electric Capital Corporation; variable interest rate of 4.29% at December 31, 2011. There are no scheduled principal payments. Interest payments are due on the last day of each LIBOR period or at one month intervals, whichever date comes first. Interest rate is the index rate plus the applicable term loan index margin or the applicable LIBOR rate plus the applicable term loan LIBOR margin. The Company made voluntary prepayments of $5.0 million, $6.1 million, and $385,828 on August 8, 2009, November 9, 2010, and May 9, 2011, respectively. The unpaid balance will be due October 31, 2013.	$	162,385,828	$	162,000,000
13% Senior subordinated notes, due 2019; interest payments are due quarterly. On June 8, 2010, IDS units that included $4,085,033 in senior subordinated debt were issued in the conversion of Class B shares. Premium amortization for the years ended December 31, 2010 and 2011 was $92,307 and $103,640, respectively.		100,710,027		100,606,387
13% Senior subordinated notes, held separately, due 2019; interest payments are due quarterly.		8,500,000		8,500,000
Total long-term notes payable		271,595,855		271,106,387
Less: current portion		–		–
Long-term notes payable	$	271,595,855	$	271,106,387

Associated with these long-term notes payable, the Company capitalized $8.1 million in deferred financing costs associated with the credit facility and the 13% senior subordinated notes put in place on December 21, 2004. On July 3, 2006, an additional $1,545,743 in deferred financing costs was capitalized. On July 5, 2007, $1,064,526 in deferred financing costs were written-off associated with the reduction in long-term notes payable from the proceeds of the Company’s offering of 3,000,000 IDS units. On October 31, 2008, an additional $5,311,138 in deferred financing costs was capitalized associated with the acquisition of the CR Companies. $1,406,088 in deferred financing costs were written-off associated with the effective extinguishment of the existing indebtedness at time of closing. The credit facility is secured by the total assets of the subsidiary guarantors.

The Company has a revolving credit facility of $15,000,000. There was no balance as of December 31, 2010 and 2011. The interest rate is the index rate plus a variable margin or LIBOR rate plus a variable margin, whichever is applicable. The margin at December 31, 2010 and 2011 was 4.0%. The range of margins can vary from 3.5% to 4.25%, depending on our total debt leverage. The Company pays a commitment fee of 0.50% per annum, payable quarterly in arrears, on the unused portion of the revolver loan. The commitment fee expense was $76,042 for both years ended December 31, 2010 and 2011.

The deferred financing costs related to the issuance of debt is capitalized and amortized over the life of the debt obligation. Amortization of deferred financing costs is reflected in interest expense. The amortization of deferred financing costs also includes unamortized loan cost that is expensed due to the related debt being extinguished. The unamortized loan cost that was expensed and included in amortization expense for the years ended December 31, 2009, 2010 and 2011 was $1,351,906, $1,361,351 and $1,368,095, respectively.

50

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Maturities of long-term debt for the next five years are as follows:

2012	$	–
2013		–
2014		162,000,000
2015		–
2016		–
Thereafter		107,660,531
Total principal		269,660,531
Unamortized premium		1,445,856
Total	$	271,106,387

The above schedule of maturities of long-term debt includes the premium paid for the debt associated with the 3,000,000 IDS units issued July 5, 2007.

The Company’s long-term notes payable agreement is subject to certain financial covenants and restrictions on indebtedness, financial guarantees, business combinations and other related items. As of December 31, 2011, the Company is in compliance with all covenants.

10. Derivative and Hedge Activities

An interest rate cap was purchased on December 21, 2004, coincident with the closing of our initial public offering. The interest rate cap was purchased to mitigate the risk of rising interest rates by capping the rate at 3% for the three month LIBOR index plus the applicable margin on $80 million in senior debt for five years. On July 5, 2007, the Company repaid $55,353,032 in debt, reducing its senior debt below the level of the rate cap. The balance of the cap at that time was considered as an investment and adjustments were made to accumulated other comprehensive income to reflect this change. On October 31, 2008, the Company implemented its second amended and restated credit agreement, increasing senior debt to $173.5 million in conjunction with the acquisition of the CR Companies. The full $80 million rate cap again became effective as a hedge from that date forward through the end of the rate cap on December 20, 2009.

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

Changes in the fair value of the effective portion of the interest rate hedges are not included in earnings but are reported as a component of accumulated other comprehensive income. Changes in the fair value of interest rate hedges which do not technically qualify for hedge accounting are reported in the change in fair value of derivatives on the statement of operations and reflected in earnings.

The cost of the effective portion of the interest rate cap was 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 year ended December 31, 2009, the cost of the effective portion of the interest rate cap was $1,168,522. The rate cap ended December 20, 2009.

11. Income Taxes

Income tax expense (benefit) for the years ended December 31, 2009, 2010 and 2011 is summarized below:

51

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

	For the Years Ended December 31,
	2009		2010		2011
Federal income taxes
Current	$	114,947	$	(3,015)	$	(2,033)
Deferred		(1,474,119)		278,383		(75,765)
Total federal tax expense (benefit)		(1,359,172)		275,368		(77,798)
State income taxes
Current		26,222		184,726		25,000
Deferred		(33,679)		149,715		302,727
Total state tax expense (benefit)		(7,457)		334,441		327,727
Total income tax expense (benefit)	$	(1,366,629)	$	609,809	$	249,929

Total income tax expense (benefit) was different than that computed by applying U.S. federal income tax rates to income from continuing operations before income taxes for the years ended December 31, 2009, 2010 and 2011. The reasons for the differences are presented below:

	For the Years Ended December 31,
	2009			2010			2011
Federal income tax at statutory rate		35	%		35	%		35	%
Federal income tax provision (benefit)
at statutory rate	$	(1,569,554	)	$	455,183		$	856,571
Change in fair value of derivatives		474,166			307,482			(781,466	)
State income tax (provision), net of federal
income tax effects		(4,847	)		217,387			213,022
Other		(266,394	)		(370,243	)		(38,198	)
Provision (benefit) for income taxes	$	(1,366,629	)	$	609,809		$	249,929
Effective income tax rate		30.5	%		46.9	%		10.2	%

As of December 31, 2011 the Company has U.S. federal and state net operating loss carryforwards of $17.3 million and $22.8 million, respectively. These net operating loss carryforwards expire at various times beginning in 2021 through 2031. These acquired losses are subject to annual limitations imposed by rules under the Internal Revenue Code. These net operating loss carryforwards are more likely than not to be used prior to their expiration.

During 2009, the Company took advantage of the 5-year net operating loss carryback provisions of the Worker, Homeownership, and Business Act of 2009. Approximately, $1.7 million of the 2008 net operating loss was carried back to 2004 for a refund of $0.4 million.

52

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2010 and 2011 are presented below:

December 31,
2010	2011(1)

Deferred tax liabilities:
Amortization	$	(25,604,600)	$	(28,374,977)
Depreciation		(9,448,329)		(13,924,912)
Amortized intangibles		(7,443,579)		(5,796,972)
Prepaid expense		(353,285)		(353,285)
Other		(16,068)		(15,523)
Total deferred tax liabilities	$	(42,865,861)	$	(48,465,669)
Deferred tax assets:
Deferred compensation	$	308,479	$	297,468
Federal net operating loss carryforwards		3,163,018		6,058,180
Alternative minimum credits carryforwards		504,130		504,130
State net operating loss carryforwards		278,462		438,786
Advance payments		272,357		256,218
Bad debt		226,305		298,683
Other		288,613		327,288
Total deferred tax assets	$	5,041,364	$	8,180,753

(1)  The 2011 balances include net deferred tax liabilities in the amount of $2,233,458 related to the STC stock acquisition that occurred on October 14, 2011.

Effective January 1, 2007, the Company adopted the provision included in ASC 740. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This pronouncement also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of ASC 740 did not result in the identification of material uncertain tax positions through December 31, 2011. Tax years from 2007 forward remain open for audit.

12. Employee Benefit Program

Employees of all subsidiaries except BTC participate in a defined contribution savings plan under Section 401(k) of the Internal Revenue Code, which is sponsored by the Company. The terms of the plan provide for an elective contribution from employees not to exceed $16,500 for each of 2009, 2010 and 2011. The Company matches the employee’s contribution up to 6% of the employee’s annual compensation. For the years ended December 31, 2009, 2010 and 2011, the total expense associated with this plan was $713,364, $742,288 and $733,161, respectively.

The employees of BTC participate in a multiemployer Retirement and Security Program (“RSP”) as a defined benefit plan and a Savings Plan (“SP”) provided through the National Telecommunications Cooperative Association (“NTCA”). Participation in the RSP requires a minimum employee contribution of 1% of their annual compensation. The Company contributes 9.4%, 6.0%, and 6.0% for 2009, 2010 and 2011, respectively, of their annual compensation for every participating employee. On October 1, 2009, the Company reduced its contribution from 10.5% to 6%. SP is a defined contribution savings plan under Section 401(k) of the Internal Revenue Code to which the Company made no contribution for 2009, 2010 or 2011. The employee can make voluntary contributions to the SP as desired. For the years ended December 31, 2009, 2010 and 2011, the total expense associated with these plans was $70,271, $60,030, and $50,220, respectively

13. Income (Loss) per Common Share and Potential Common Share

Basic income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding for the period. Diluted income (loss) per common share reflects the potential dilution that would occur had all of the issued and outstanding shares of Class B common stock been exchanged for IDSs at the beginning of the period. On

53

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

June 8, 2010, all of the Company’s issued and outstanding shares of Class B common stock were exchanged for IDSs on a one-for-one basis. Each of the IDSs issued in the exchange includes a common share. Diluted amounts are not included in the computation of diluted loss per common share when the inclusion of such amounts would be anti-dilutive.

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

	For the Years Ended December 31,
	2009			2010		2011
Weighted average of common shares-basic		12,676,733			12,985,629		13,221,404
Effect of dilutive securities		544,671			235,775		–
Weighted average common shares and potential common shares-diluted		13,221,404			13,221,404		13,221,404
Net income (loss) available to common shareholders	$	(3,117,811	)	$	690,715	$	2,197,418
Net income (loss) per basic common share	$	(0.25	)	$	0.05	$	0.17
Net income (loss) available to common stockholders	$	(3,117,811	)	$	690,715	$	2,197,418
Change in fair value of Class B derivative		(238,054	)		–		–
Net income (loss) available for diluted common shares	$	(3,355,865	)	$	690,715	$	2,197,418
Net income (loss) per diluted common share	$	(0.25	)	$	0.05	$	0.17

14. Selected Quarterly Financial Data (unaudited)

	First Quarter			Second Quarter		Third Quarter		Fourth Quarter
Fiscal 2010:
Revenue	$	25,794,209		$	26,510,944	$	26,145,227	$	25,949,839
Operating income		5,868,729			7,011,337		6,727,966		6,760,732
Net income (loss)		(385,656	)		417,276		63,075		596,020
Net income (loss) per common share, basic	$	(0.03	)	$	0.03	$	–	$	0.04
Net income (loss) per common share, diluted	$	(0.03	)	$	0.03	$	–	$	0.04
Fiscal 2011:
Revenue	$	25,392,000		$	25,501,062	$	25,302,747	$	25,647,758
Operating income		5,320,713			7,326,611		6,124,154		5,858,617
Net income		4,654			1,283,277		885,462		24,025
Net income per common share, basic	$	–		$	0.10	$	0.07	$	–
Net income per common share, diluted	$	–		$	0.10	$	0.07	$	–

15. Fair Value Measurement

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

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

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

54

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

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

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

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

	December 31, 2010
	Fair Value		Level 1 (1)		Level 2 (2)		Level 3 (3)
Liabilities
Interest rate swaps	$	2,471,331	$	–	$	2,471,331	$	–
Total liabilities	$	2,471,331	$	–	$	2,471,331	$	–

	December 31, 2011
	Fair Value		Level 1 (1)		Level 2 (2)		Level 3 (3)
Liabilities
Interest rate swaps	$	241,438	$	–	$	241,438	$	–
Total liabilities	$	241,438	$	–	$	241,438	$	–
(1) Quoted prices in active markets for identical assets. (2) Significant other observable inputs. (3) Significant unobservable inputs.

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

16. Subsidiary Guarantees

On October 1, 2011, MMT became a guarantor of the Company’s senior subordinated notes and on October 14, 2011, ST become a guarantor of the Company’s senior subordinated notes.

The Company has no independent assets or operations separate from its operating subsidiaries. The guarantees of its senior subordinated notes by 14 of its 15 operating subsidiaries are full and unconditional, joint and several. The operating subsidiaries have no independent long-term notes payable. There are no significant restrictions on the ability of the Company to obtain funds from its operating subsidiaries by dividend or loan. The condensed consolidated financial information is provided for the guarantor entities.

The following tables present condensed consolidating balance sheets as of December 31, 2010 and 2011; condensed consolidating statements of operations for the years ended December 31, 2009, 2010 and 2011; and condensed consolidating statements of cash flows for the years ended December 31, 2009, 2010 and 2011.

55

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Otelco Inc.

Condensed Consolidating Balance Sheet

December 31, 2010

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
ASSETS
Current assets
Cash and cash equivalents	$	–		$	18,064,970		$	161,404		$	–		$	18,226,374
Accounts receivable, net		–			10,072,847			793,775			–			10,866,622
Materials and supplies		–			893,186			924,125			–			1,817,311
Prepaid expenses		184,055			1,022,697			98,276			–			1,305,028
Deferred income taxes		626,267			–			–			–			626,267
Investment in subsidiaries		131,010,180			–			–			(131,010,180	)		–
Intercompany receivable		(129,599,481	)		–			–			129,599,481			–
Total current assets		2,221,021			30,053,700			1,977,580			(1,410,699	)		32,841,602
Property and equipment, net		218,301			54,043,819			9,625,093			–			63,887,213
Goodwill		239,970,317			(49,843,599	)		(1,936,640	)		–			188,190,078
Intangibles assets, net		–			23,326,214			2,607,828			–			25,934,042
Investments		1,203,605			433,059			330,431			–			1,967,095
Deferred income taxes		4,415,097			–			–			–			4,415,097
Other long-term assets		5,757,825			183,946			–			–			5,941,771
Total assets	$	253,786,166		$	58,197,139		$	12,604,292		$	(1,410,699	)	$	323,176,898
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities
Accounts payable and accrued expenses	$	2,280,661		$	4,991,249		$	1,423,099		$	–		$	8,695,009
Intercompany payables		–			(131,769,870	)		2,170,389			129,599,481			–
Other current liabilities		353,285			1,678,145			89,467			–			2,120,897
Total current liabilities		2,633,946			(125,100,476	)		3,682,955			129,599,481			10,815,906
Deferred income taxes		22,592,597			16,666,501			3,253,478			–			42,512,576
Other liabilities		2,471,331			1,025,317			–			–			3,496,648
Long-term notes payable		231,332,379			40,263,476			–			–			271,595,855
Stockholders’ equity (deficit)		(5,244,087	)		125,342,321			5,667,859			(131,010,180	)		(5,244,087	)
Total liabilities and stockholders’ equity (deficit)	$	253,786,166		$	58,197,139		$	12,604,292		$	(1,410,699	)	$	323,176,898

56

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Otelco Inc.

Condensed Consolidating Balance Sheet

December 31, 2011

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
ASSETS
Current assets
Cash and cash equivalents	$	–		$	12,393,441		$	351		$	–		$	12,393,792
Accounts receivable, net		–			11,445,049			543,122			–			11,988,171
Materials and supplies		–			827,194			953,626			–			1,780,820
Prepaid expenses		194,244			1,115,339			18,892			–			1,328,475
Deferred income taxes		726,310			–			–			–			726,310
Investment in subsidiaries		147,614,140			–			–			(147,614,140	)		–
Intercompany receivable		(154,849,721	)		(688,391	)		688,391			154,849,721			–
Total current assets		(6,315,027	)		25,092,632			2,204,382			7,235,581			28,217,568
Property and equipment, net		–			64,524,981			1,356,994			–			65,881,975
Goodwill		239,970,317			(47,435,761	)		(3,579,716	)		–			188,954,840
Intangibles assets, net		–			18,186,227			2,359,464			–			20,545,691
Investments		1,203,605			432,186			308,014			–			1,943,805
Deferred income taxes		7,454,443			–			–			–			7,454,443
Other long-term assets		4,485,324			240,667			–			–			4,725,991
Total assets	$	246,798,662		$	61,040,932		$	2,649,138		$	7,235,581		$	317,724,313
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities
Accounts payable and accrued expenses	$	1,306,872		$	4,793,854		$	1,424,095		$	–		$	7,524,821
Intercompany payables		–			(154,849,721	)		–			154,849,721			–
Other current liabilities		353,285			1,668,933			65,413			–			2,087,631
Total current liabilities		1,660,157			(148,386,934	)		1,489,508			154,849,721			9,612,452
Deferred income taxes		26,421,911			20,354,646			1,335,827			–			48,112,384
Other liabilities		241,438			1,019,407			–			–			1,260,845
Long-term notes payable		230,842,911			40,263,476			–			–			271,106,387
Stockholders’ equity (deficit)		(12,367,755	)		147,790,337			(176,197	)		(147,614,140	)		(12,367,755	)
Total liabilities and stockholders’ equity (deficit)	$	246,798,662		$	61,040,932		$	2,649,138		$	7,235,581		$	317,724,313

57

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Twelve Months Ended December 31, 2009

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenue	$	3,318,678		$	100,173,351		$	11,701,213		$	(11,437,788	)	$	103,755,454
Operating expenses		(3,318,678	)		(80,815,648	)		(9,132,057	)		11,437,788			(81,828,595	)
Income from operations		–			19,357,703			2,569,156			–			21,926,859
Other income (expense)		(26,098,959	)		(390,828	)		78,488			–			(26,411,299	)
Earnings from subsidiaries		14,247,278			–			–			(14,247,278	)		–
Income (loss) before income tax		(11,851,681	)		18,966,875			2,647,644			(14,247,278	)		(4,484,440	)
Income tax (expense) benefit		8,733,870			(6,330,343	)		(1,036,898	)		–			1,366,629
Net income (loss) to common stockholders	$	(3,117,811	)	$	12,636,532		$	1,610,746		$	(14,247,278	)	$	(3,117,811	)

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Twelve Months Ended December 31, 2010

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues	$	3,493,053		$	101,600,140		$	10,855,909		$	(11,548,883	)	$	104,400,219
Operating expenses		(3,493,053	)		(77,083,003	)		(9,004,282	)		11,548,883			(78,031,455	)
Income from operations		–			24,517,137			1,851,627			–			26,368,764
Other income (expense)		(24,856,925	)		(311,219	)		99,904			–			(25,068,240	)
Earnings from subsidiaries		26,157,449			–			–			(26,157,449	)		–
Income before income tax		1,300,524			24,205,918			1,951,531			(26,157,449	)		1,300,524
Income tax expense		(609,809	)		(7,944,116	)		(761,943	)		8,706,059			(609,809	)
Net income to common stockholders	$	690,715		$	16,261,802		$	1,189,588		$	(17,451,390	)	$	690,715

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Twelve Months Ended December 31, 2011

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues	$	3,289,457		$	99,770,739		$	4,234,814		$	(5,451,443	)	$	101,843,567
Operating expenses		(3,289,457	)		(75,146,885	)		(4,228,573	)		5,451,443			(77,213,472	)
Income from operations		–			24,623,854			6,241			–			24,630,095
Other income (expense)		(21,825,630	)		(356,881	)		(237	)		–			(22,182,748	)
Earnings from subsidiaries		24,272,977			–			–			(24,272,977	)		–
Income before income tax		2,447,347			24,266,973			6,004			(24,272,977	)		2,447,347
Income tax expense		(249,929	)		(7,666,626	)		(2,395	)		7,669,021			(249,929	)
Net income to common stockholders	$	2,197,418		$	16,600,347		$	3,609		$	(16,603,956	)	$	2,197,418

58

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Otelco Inc.

Condensed Consolidating Statement of Cash Flows

For the Twelve Months Ended December 31, 2009

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities: Net income (loss)	$	(3,117,811	)	$	12,636,532		$	1,610,746		$	(14,247,278	)	$	(3,117,811	)
Adjustment to reconcile net income (loss) to cash flows from operating activities		5,379,288			21,551,341			2,761,121			–			29,691,750
Changes in operating assets and liabilities, net of operating assets and liabilities acquired		25,922,898			(21,716,059	)		(2,871,653	)		–			1,335,186
Net cash provided by operating activities		28,184,375			12,471,814			1,500,214			(14,247,278	)		27,909,125
Cash flows used in investing activities		–			(8,375,686	)		(1,407,553	)		–			(9,783,239	)
Cash flows used in financing activities		(28,184,375	)		–			–			14,247,278			(13,937,097	)
Net increase in cash and cash equivalents		–			4,096,128			92,661			–			4,188,789
Cash and cash equivalents, beginning of period		–			13,521,138			21,117			–			13,542,255
Cash and cash equivalents, end of period	$	–		$	17,617,266		$	113,778		$	–		$	17,731,044

Otelco Inc.

Condensed Consolidating Statement of Cash Flows

For the Twelve Months Ended December 31, 2010

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:  Net income	$	690,715		$	16,261,802		$	1,189,588		$	(17,451,390	)	$	690,715
Adjustment to reconcile net income to cash flows from operating activities		5,075,290			18,105,293			3,206,795			–			26,387,378
Changes in operating assets and liabilities, net of operating assets and liabilities acquired		27,592,163			(25,289,272	)		(2,969,463	)		–			(666,572	)
Net cash provided by operating activities		33,358,168			9,077,823			1,426,920			(17,451,390	)		26,411,521
Cash flows used in investing activities		(218,301	)		(8,630,120	)		(1,379,294	)		–			(10,227,715	)
Cash flows used in financing activities		(33,139,867	)		1			–			17,451,390			(15,688,476	)
Net increase in cash and cash equivalents		–			447,704			47,626			–			495,330
Cash and cash equivalents, beginning of period		–			17,617,266			113,778			–			17,731,044
Cash and cash equivalents, end of period	$	–		$	18,064,970		$	161,404		$	–		$	18,226,374

59

OTELCO INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011

Otelco Inc.

Condensed Consolidating Statement of Cash Flows

For the Twelve Months Ended December 31, 2011

	Parent		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations		Consolidated
Cash flows from operating activities: Net income	$	2,197,418	$	33,204,304	$	3,608	$	(33,207,912)	$	2,197,418
Adjustment to reconcile net income to cash flows from operating activities		(275,513)		19,762,543		921,882		–		20,408,912
Changes in operating assets and liabilities, net of operating assets and liabilities acquired		24,266,264		(27,119,787)		(222,670)		–		(3,076,193)
Net cash provided by operating activities		26,188,169		25,847,060		702,820		(33,207,912)		19,530,137
Cash flows used in investing activities		218,301		(15,075,741)		(702,769)		–		(15,560,209)
Cash flows used in financing activities		(26,406,470)		(16,603,952)		–		33,207,912		(9,802,510)
Net increase (decrease) in cash and cash equivalents		–		(5,832,633)		51		–		(5,832,582)
Cash and cash equivalents, beginning of period		–		18,226,074		300		–		18,226,374
Cash and cash equivalents, end of period	$	–	$	12,393,441	$	351	$	–	$	12,393,792

17. Revenue Concentrations

Revenues for interstate access services are based on reimbursement of costs and an allowed rate of return. Revenues of this nature are received from the NECA in the form of monthly settlements. Such revenues amounted to 10.8%, 9.9%, and 10.1% of the Company’s total revenues for the years ended December 31, 2009, 2010 and 2011, respectively.

In connection with the acquisition of the CR Companies, the Company has a contract through 2012 with Time Warner Cable (“TW”) for the provision of wholesale network connections to TW’s customers in Maine and New Hampshire. TW represented approximately 10.7% and 11.7% of the consolidated revenue for the years ended December 31, 2010 and 2011, respectively. Other unrelated telecommunications providers also pay the Company access revenue for terminating calls through us to TW’s customers.

18. Commitments and Contingencies

From time to time, we may be involved in various claims, legal actions and regulatory proceedings incidental to and in the ordinary course of business, including administrative hearings of the APSC, MDTC, MPSC, MPUC, NHPUC, VPSB and WVPSC relating primarily to rate making. Currently, none of the legal proceedings are expected to have a material adverse effect on our business.

19. Subsequent Events

Effective as of January 1, 2012, each of the Company’s subsidiaries that was a corporation converted into a limited liability company pursuant to applicable state law, except that MMH was merged with and into the Company effective as of January 1, 2012. As a result of the conversions and the merger, the Company currently expects to lower its income tax obligation in Missouri, as well as lower its cash income tax obligation in Alabama by utilizing net operating loss carryforwards and deferred tax assets.

60

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A.     Controls and Procedures

Disclosure 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 December 31, 2011.

Management’s Annual Report on Internal Control over Financial Reporting

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Securities Exchange Act of 1934 defines internal control over financial reporting in Rule 13a-15(f) and 15d-15(f) as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

● Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

● Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

● Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

Management’s assessment did not include the internal controls of Shoreham which was acquired on October 14, 2011, and which is included in the consolidated balance sheet of Otelco Inc. as of December 31, 2011, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for the year then ended because of the timing of the acquisition. Shoreham constituted 2.4% of the Company’s consolidated total assets as of December 31, 2011, and 0.7% and 4.7% of the Company’s consolidated revenues and net income, respectively, for the year then ended.

Based upon its assessment, management concluded that, as of December 31, 2011, the Company’s internal control over financial reporting is effective based upon those criteria.

The effectiveness of our internal control over financial reporting as at December 31, 2011 has been independently audited by BDO USA, LLP, an independent registered public accounting firm, as stated in their attestation report included in Item 8 of this report.

61

Changes in Internal Control over Financial Reporting

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 fourth quarter of fiscal 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B.     Other Information

None.

62

PART III

Item 10. Directors, Executive Officers and Corporate Governance

We have a code of ethics that applies to each director and employee of the Company, including the principal executive, financial, and accounting officers. Our code of ethics is available on our website at http://www.OtelcoInc.com under the Investor Relations section titled Corporate Governance. We intend to disclose any amendment to, or waiver from, a provision of the code of ethics that applies to our chief executive officer or chief financial officer and principal accounting officer in the investor relations section of our website.

The other information required by this Item is incorporated herein by reference to the applicable information in the proxy statement for our 2012 annual meeting of stockholders, including the information set forth under the captions “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Governance of the Company — Audit Committee.” See Item X in Part I of this report regarding our executive officers.

Item 11. Executive Compensation

The information required by this Item is incorporated herein by reference to the applicable information in the proxy statement for our 2012 annual meeting of stockholders, including the information set forth under the captions “Executive Compensation,” “Compensation of Directors,” “Compensation Committee Report” and “Compensation Committee Interlocks and Insider Participation.”

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The Company currently has no securities authorized for issuance under an equity compensation plan. The other information required by this Item is incorporated herein by reference to the applicable information in the proxy statement for our 2012 annual meeting of stockholders, including the information set forth under the caption “Beneficial Ownership of Common Stock.”

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this Item is incorporated herein by reference to the applicable information in the proxy statement for our 2012 annual meeting of stockholders, including the information set forth under the caption “Election of Directors” and “Other Relationships and Transactions with Executives.”

Item 14. Principal Accountant Fees and Services

The information required by this Item is incorporated herein by reference to the applicable information in the proxy statement for our 2012 annual meeting of stockholders, including the information set forth under the caption “Our Relationship with Our Independent Registered Public Accounting Firm.”

63

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a)(1) Financial Statements

	Page
Reports of Independent Registered Public Accounting Firm	34
Consolidated Balance Sheets	36
Consolidated Statements of Operations	37
Consolidated Statements of Stockholders’ Equity (Deficit)	38
Consolidated Statements of Cash Flows	39
Notes to Consolidated Financial Statements	40

(a)(2) Financial Statement Schedules

None

(a)(3) Exhibits

Exhibit No.	Description
3.1	Certificate of Incorporation of Otelco Inc. (filed as Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference)
3.2	Third Amended and Restated By-laws of Otelco Inc. (filed as Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference)
4.1	Indenture, dated as of December 21, 2004, among Otelco Inc., each subsidiary listed on the signature pages thereto and Wells Fargo Bank, National Association, as trustee, relating to the 13% Senior Subordinated Notes dues 2019 (filed as Exhibit 4.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference)
4.2	Supplemental Indenture, dated as of July 3, 2006, by and among Mid-Maine Communications, Inc., Mid-Maine TelPlus, the Existing Guarantors listed on the signature pages thereto, and Wells Fargo Bank, NA, as trustee (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on July 5, 2006 and incorporated herein by reference)
4.3	Second Supplemental Indenture, dated as of July 5, 2007, by and among Otelco Inc., certain of its subsidiaries and Wells Fargo Bank, National Association, as trustee (filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on July 5, 2007 and incorporated herein by reference)
4.4	Third Supplemental Indenture, dated as of October 31, 2008, by and among War Holdings, Inc., Pine Tree Holdings, Inc., The Pine Tree Telegraph and Telephone Company, CRC Communications of Maine, Inc., Saco River Telegraph and Telephone Company, Communications Design Acquisition Corporation, Granby Holdings, Inc., The Granby Telegraph and Telephone Co. of Mass., Inc., the Existing Guarantors listed on the signature pages thereto, Otelco Inc. and Wells Fargo Bank, National Association, as trustee (filed as Exhibit 4.4 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 and incorporated herein by reference)
4.5	Fourth Supplemental Indenture, dated as of June 8, 2010, among Otelco Inc., certain of its subsidiaries and Wells Fargo Bank, National Association, as trustee (filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on June 8, 2010 and incorporated herein by reference)

64

Exhibit No.	Description
4.6	Fifth Supplemental Indenture, dated as of October 1, 2011, among Otelco Inc., Mid-Missouri Telephone Company, the Existing Guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as trustee (filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 3, 2011 and incorporated herein by reference)
4.7	Sixth Supplemental Indenture, dated as of October 14, 2011, among Otelco Inc., Shoreham Telephone LLC, the Existing Guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as trustee (filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 14, 2011 and incorporated herein by reference)
4.8	Form of 13% Senior Subordinated Note due 2019 (included in Exhibit 4.1)
4.9	Form of stock certificate for common stock (filed as Exhibit 4.4 to Amendment No. 4 to Registration Statement on Form S-1 (file no. 333-115341) and incorporated herein by reference)
4.10	Form of global Income Deposit Security (filed as Exhibit 4.5 to Amendment No. 4 to Registration Statement on Form S-1 (file no. 333-115341) and incorporated herein by reference)
10.1	Amended and Restated Employment Agreement, dated as of March 11, 2009, between Otelco Inc. and Michael D. Weaver (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 12, 2009 and incorporated herein by reference)*
10.2	Amended and Restated Employment Agreement, dated as of March 11, 2009, between Otelco Inc. and Curtis L. Garner, Jr. (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on March 11, 2009 and incorporated herein by reference)*
10.4	Employment Agreement, dated as of August 24, 2006, between Otelco Inc. and Dennis Andrews (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 29, 2006 and incorporated herein by reference)*
10.5	Employment Agreement, dated as of November 15, 2006, between Otelco Inc. and Jerry C. Boles (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on November 15, 2006 and incorporated herein by reference)*
10.6	Second Amended and Restated Credit Agreement, dated as of October 20, 2008, by and among Otelco Inc. and the other credit party signatories thereto and General Electric Capital Corporation, as a lender and as an agent for the lenders, and the other lenders from time to time party thereto (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 21, 2008 and incorporated herein by reference)
10.7	Amendment, dated as of December 17, 2008, to the Employment Agreement, dated as of August 24, 2006, between Otelco Inc. and Dennis Andrews (filed as Exhibit 10.10 to the Company’s Annual Report on Form 10-K filed on March 11, 2009 and incorporated herein by reference)*
10.8	Amendment, dated as of December 17, 2008, to the Employment Agreement, dated as of November 15, 2006, between Otelco Inc. and Jerry C. Boles (filed as Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 and incorporated herein by reference)*
10.9	Amended and Restated Employment Agreement, dated as of April 27, 2009, between Otelco Inc. and Robert Souza (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 28, 2009 and incorporated herein by reference)*
10.10	Executive Long Term Incentive Plan approved May 12, 2009, effective January 1, 2009 (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 14, 2009 and incorporated herein by reference)*
10.11	Amendment, dated as of March 5, 2010, to the Amended and Restated Employment Agreement, dated as of March 11, 2009, between Otelco Inc. and Michael D. Weaver (filed as Exhibit 10.13 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and incorporated herein by reference)*

10.12 Amendment, dated as of March 5, 2010, to the Amended and Restated Employment Agreement, dated as of March 11, 2009, between Otelco Inc. and Curtis L. Garner, Jr. (filed as Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and incorporated herein by reference)*

65

Exhibit No.	Description
10.13	Second Amendment, dated as of March 4, 2011, to the Employment Agreement, dated as of August 24, 2006, between Otelco Inc. and Dennis Andrews, as previously amended on December 17, 2008 (filed as Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 and incorporated herein by reference)*
10.14	Second Amendment, dated as of March 4, 2011, to the Employment Agreement, dated as of November 15, 2006, between Otelco Inc. and Jerry C. Boles, as previously amended on December 17, 2008 (filed as Exhibit 10.15 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 and incorporated herein by reference)*
10.15	Amendment, dated as of March 4, 2011, to the Amended and Restated Employment Agreement, dated as of April 27, 2009, between Otelco Inc. and Robert Souza (filed as Exhibit 10.16 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 and incorporated herein by reference)*
10.16	Amended and Restated Employment Agreement, dated as of April 10, 2009, between Otelco Inc and Edwin D. Tisdale (filed as Exhibit 10.18 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 and incorporated herein by reference)*
10.17	Amendment, dated as of March 4, 2011, to the Amended and Restated Employment Agreement, dated as of April 10, 2009, between Otelco Inc and Edwin D. Tisdale (filed as Exhibit 10.19 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 and incorporated herein by reference)*
10.18	Employment Agreement, dated as of August 14, 2011, between Otelco Inc. and Jon C. P. Henderson*
12.1	Computation of Ratio of Earnings to Fixed Charges
18.1	BDO USA, LLP Preferability Letter
21.1	List of subsidiaries of Otelco Inc.
23.1	Consent of BDO USA, LLP, Independent Registered Public Accounting Firm
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
101	The following information from the Company’s annual report on Form 10-K for the year ended December 31, 2011 formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Stockholders’ Equity (Deficit); (iv) Consolidated Statements of Cash Flows; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text

*           Management contract or compensatory plan or arrangement

66

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

OTELCO INC.
By:	/s/ Michael D. Weaver
	Michael D. Weaver
	President and Chief Executive Officer

Date: March 5, 2012

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

Signature	Title	Date
/s/ Michael D. Weaver	President, Chief Executive Officer and Director	March 5, 2012
Michael D. Weaver	(Principal Executive Officer)
/s/ Curtis L. Garner, Jr.	Chief Financial Officer	March 5, 2012
Curtis L. Garner, Jr.	(Principal Financial and Accounting Officer)
/s/ William Bak	Director	March 5, 2012
William Bak
/s/ Robert E. Guth	Director	March 5, 2012
Robert E. Guth
/s/ Howard J. Haug	Director	March 5, 2012
Howard J. Haug
/s/ Stephen P. McCall	Director	March 5, 2012
Stephen P. McCall
/s/ Andrew Meyers	Director	March 5, 2012
Andrew Meyers
/s/ William F. Reddersen	Director	March 5, 2012
William F. Reddersen

EX-10.18

EXHIBIT 10.18

EMPLOYMENT AGREEMENT

Employment Agreement dated as of August 14, 2011 (this “Agreement”), by and between OTELCO INC., a Delaware corporation (“Otelco” or the “Company”) and Jon C. P. Henderson (the “Employee”).

WHEREAS, the Company and the Employee desire to enter into this Agreement.

NOW THEREFORE, in consideration of the mutual covenants contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:

SECTION 1.     Effective Date; Termination.

This Agreement shall become effective on the date first written above (the “Effective Date”).

SECTION 2.     Employment Period.

Subject to Section 4, the Company hereby agrees to employ the Employee, and the Employee hereby agrees to be employed by the Company, in accordance with the terms and provisions of this Agreement, for the period from the Effective Date through the Termination Date (the “Employment Period”).

SECTION 3.     Terms of Employment.

(a) Duties and Position. During the Employment Period, the Employee shall serve as Senior Vice President of CLEC Sales, Customer Service and Marketing, New England Division. As such, the Employee shall have duties and responsibilities commensurate with such position and such other duties and responsibilities as may from time to time be assigned to or vested in the Employee by the Company’s board of directors (the “Board”) or the Company’s Chief Executive Officer.

(b) Full Time. During the Employment Period, and excluding any periods of vacation and sick leave to which the Employee is entitled, the Employee agrees to devote his full business time and efforts, to the best of his ability, experience and talent, to the business and affairs of the Company. During the Employment Period, it shall not be a violation of this Agreement for the Employee to serve on corporate, civic or charitable boards or committees or manage personal investments (including serving as a member of boards of directors or similar bodies of entities not engaged in competition with Otelco or its subsidiaries, (collectively, the “Company Entities”) (as determined by the Board in its reasonable discretion)), in each case, so long as such activities do not interfere with the performance of the Employee’s responsibilities as an employee of the Company in accordance with this Agreement.

(c) Compensation.

(i) Base Salary. During the Employment Period, the Employee shall receive an annual base salary of $200,000 subject to increase by the Board of Directors of the Company (the “Board”), which Annual Base Salary shall be further subject to annual increase by an amount equal to reflect the increase in the cost of living, if any, between the date of the immediately preceding increase and the date of each such adjustment, based upon the Consumer Price Index for Urban Consumers, or if that index is discontinued, a similar index prepared by a department or agency of the United States government (as so adjusted, the “Annual Base Salary”). The Annual Base Salary shall be paid in accordance with the customary payroll practices of the Company, subject to withholding and other payroll taxes.

(ii) Bonus. For each fiscal year during the Employment Period, the Employee shall be entitled to receive a bonus (the “Bonus”) of up to 50% of the Annual Base Salary.  25% of the Bonus shall be based upon achieving the Company’s New England CLEC revenue goals and 75% of the Bonus will be based upon achieving the Company’s New England CLEC EBITDA goals to be established by the Board or any duly appointed committee thereof in good faith, in its sole discretion.

(iii) Benefits. During the Employment Period, the Employee shall be entitled to participate in all incentive (including any long term incentive plan), savings and retirement plans, practices, policies and programs applicable generally to other employees of the Company and shall be eligible for participation in and shall receive all benefits under welfare benefit plans, practices, policies and programs provided by the Company to the extent applicable generally to other employees of the Company.

(iv) Automobile.  During the Employment Period, the Company shall provide the Employee with the use of a Company automobile (or, at the Company’s option, shall lease an automobile for the Employee’s use) and shall reimburse Employee for all reasonable expenses incurred by the Employee in connection with the use and maintenance of such automobile.

(v) Expenses. The Employee shall be entitled to receive reimbursement for all reasonable expenses incurred by the Employee during the Employment Period in connection with the performance of his duties hereunder, in accordance with the policies, practices and procedures of the Company as in effect from time to time.

(vi) Vacation and Holidays. During the Employment Period, the Employee shall be entitled to paid holidays and vacation in accordance with the policies of the Company generally applicable to other employees of the Company generally.

SECTION 4.     Termination of Employment.

(a) Death or Disability. The Employee’s employment shall terminate automatically upon the Employee’s death or Disability. For purposes of this Agreement, “Disability” shall mean the Employee’s inability to perform his duties and obligations hereunder for any 90 days during a period of 180 consecutive days due to mental or physical incapacity as determined by a physician selected by the Company or its insurers.

2

(b) Termination by the Employee. The Employee may terminate his employment with the Company at any time, without prior notice.

(c) Termination by the Company. The Company may terminate the Employee’s employment with the Company at any time, with or without Cause and without prior notice. “Cause” will mean that any of the following will have occurred (i) the Employee has been convicted of a felony, stolen funds or otherwise engaged in fraudulent conduct, (ii) the Employee has engaged in willful misconduct or has been grossly negligent, in each case, which has been materially injurious to the Company, (iii) the Employee has failed or refused to comply with directions of the Board that are reasonably consistent with the Employee’s current position or (iv) the Employee has breached the terms of this Agreement. “Without Cause” shall mean a termination by the Company of the Employee’s employment during the Employment Period for any reason other than a termination based upon Cause, death or Disability.

SECTION 5.     Obligations of the Company upon Termination.

(a) Without Cause. If, during the Employment Period, the Company shall terminate the Employee’s employment Without Cause, then the Company will provide the Employee with the following severance payments and/or benefits:

(i) The Company shall pay to the Employee a lump sum in the amount of the Employee’s accrued but unpaid Annual Base Salary through the Termination Date (“Accrued Obligations”);

(ii) The Employee, if applicable, and members of his family shall be entitled to continue their participation in the Company’s welfare and benefit plans (the “Benefits”) until the Termination Date;

(iii) The Company shall pay to the Employee a lump sum in the amount of one-half (1/2) of his Annual Base Salary within six (6) months following termination but not later than March 14 of the calendar year following termination; and

(iv) The Company shall pay to the Employee a lump sum amount equal to the Bonus the Employee would have received had he remained employed by the Company through the end of the fiscal year in which the termination accrued, pro rated for the number of days Employee was employed by the Company during such fiscal year, to be paid at the same time that similar bonuses are paid to the Company’s other employees.

(b) Cause; by the Employee; Death or Disability. If the Employee’s employment shall be terminated by the Company for Cause, by the Employee for any reason, or due to death or Disability, then the Company shall have no further payment obligations to the Employee (or his heirs or legal representatives) other than for (i) payment of Accrued Obligations and (ii) the continuance of Benefits through the Termination Date.

(c) Condition; Release. The Employee acknowledges and agrees that the Company’s obligations to make payments under Section 5(a) will be conditioned on the Employee executing and delivering a customary general release in form and substance reasonably satisfactory to the Company.

3

SECTION 6.     Nondisclosure and Nonuse of Confidential Information.

(a) The Employee shall not disclose or use at any time, either during the Employment Period or thereafter, any Confidential Information (as hereinafter defined) of which the Employee is or becomes aware as a consequence of or in connection with his employment with the Company, whether or not such information is developed by him, except (i) to the extent that such disclosure or use is in furtherance of the Employee’s performance in good faith of his duties as Senior Vice President of CLEC Sales, Customer Service and Marketing, New England Division or (ii) to the extent required by law or legal process; provided that (A) the Employee agrees to provide the Company with prompt written notice of any such law or legal process and to assist the Company, at the Company’s expense, in asserting any legal challenges to or appeals of such law or legal process that the Company in its sole discretion pursues, and (B) in complying with any such law or legal process, the Employee shall limit his disclosure only to the Confidential Information that is expressly required to be disclosed by such law or legal process. The Employee will take all commercially reasonable steps to safeguard Confidential Information and to protect it against disclosure, misuse, espionage, loss and theft. The Employee shall deliver to the Company on the Termination Date, or at any time the Company may request, all memoranda, notes, plans, records, reports, computer tapes and software and other documents and data (and copies thereof) relating to the Confidential Information or the Work Product (as hereinafter defined) of the Company Entities which the Employee may then possess or have under his control.

(b) The Employee agrees that all Work Product belongs in all instances to the Company Entities. The Employee will promptly disclose such Work Product to the Board and perform all actions reasonably requested by the Board (whether during or after the Employment Period) to establish and confirm the Company Entities’ ownership of the Work Product (including, without limitation, the execution and delivery of assignments, consents, powers of attorney and other instruments) and to provide reasonable assistance to the Company (whether during or after the Employment Period), at the Company’s sole expense, in connection with the prosecution of any applications for patents, trademarks, trade names, service marks or reissues thereof or in the prosecution or defense of interferences relating to any Work Product. The Employee recognizes and agrees that the Work Product, to the extent copyrightable, constitutes works for hire under the copyright laws of the United States.

(c) “Confidential Information” means information that is not generally known to the public and that is used, developed or obtained by the Company Entities in connection with their business, including, but not limited to, information, observations and data obtained by the Employee while employed by the Company or any predecessors thereof (including those obtained prior to the date of this Agreement) concerning (i) the business or affairs of Otelco and its Affiliates (including the Company Entities) and (ii) products, services, fees, costs, pricing structures, analyses, drawings, photographs and reports, computer software (including operating systems, applications and program listings), data bases, accounting and business methods, inventions, devices, new developments, methods and processes (whether patentable or unpatentable and whether or not reduced to practice), customers and clients and customer and client lists, all technology and trade secrets, and all similar and related information in whatever form. Confidential Information will not include any information that (A) is or becomes generally available to the public other than through disclosure by the Employee in violation of this Section 6, (B) was provided to the Employee prior to the date hereof on a non-confidential basis from a Person who was not otherwise bound by a confidentiality agreement or duty to Otelco or an Affiliate thereof (including the Company Entities) or (C) becomes available to the Employee on a non-confidential basis from a Person who is not otherwise bound by a confidentiality agreement or duty to Otelco or its Affiliates (including the Company Entities) or is not otherwise prohibited from transmitting the information to the Employee.

4

(d) “Work Product” means all inventions, innovations, improvements, technical information, systems, software developments, methods, designs, analyses, drawings, reports, service, marks, trademarks, trade names, trade dress, logos and all similar or related information (whether patentable or unpatentable) which relates to the Company’s actual or anticipated business, research and development or existing or future products or services and which are conceived, developed or made by the Employee (whether or not during usual business hours and whether or not alone or in conjunction with any other person) during the Employment Period together with all patent applications, letters patent, trademark, trade name and service mark applications or registrations, copyrights and reissues thereof that may be granted for or upon any of the foregoing.

SECTION 7.     Non-Compete and Non-Solicit.

(a) The Employee acknowledges that, in the course of the Employee’s employment with the Company, the Employee has become familiar, or will become familiar, with Otelco and its Affiliates (including the Company Entities) trade secrets and with other confidential information concerning Otelco and its Affiliates (including the Company Entities) and that his services have been and will be of special, unique and extraordinary value to Otelco and its Affiliates (including the Company Entities). Therefore, the Employee agrees that, during the Employment Period and for six (6) months thereafter (the “Restricted Period”), the Employee shall not directly or indirectly (i) engage, within the Restricted Territory, in any telephone or communications business, including, but not limited to, incumbent local exchange carrier, long distance telephone business, cable television, Internet access, or other business that Otelco or any of its Affiliates (including the Company Entities) is engaged in during the Employee’s employment by the Company (the “Company Business”), (ii) compete or participate as agent, employee, consultant, advisor, representative or otherwise in any enterprise engaged in a business which has any operations engaged in the Company Business within the Restricted Territory or (iii) compete or participate as a stockholder, partner, member or joint venturer, or have any direct or indirect financial interest, in any enterprise which has any material operations engaged in the Company Business within the Restricted Territory; provided, however, that nothing contained herein will prohibit the Employee from (A) owning, operating or managing any business, or acting upon any business opportunity, after obtaining approval of a majority of the Board or (B) owning no more than five percent (5%) of the equity of any publicly traded entity with respect to which the Employee does not serve as an officer, director, employee, consultant or in any other capacity other than as an investor. The term “Restricted Territory” means all states within the United States in which Otelco or any of its Affiliates (including the Company Entities) conducts or is pursuing or analyzing plans to conduct Company Business as of the Termination Date.

5

(b) As a means reasonably designed to protect Confidential Information, the Employee agrees that, during the period commencing on the Effective Date and ending on the expiration of the Restricted Period, the Employee will not (i) solicit or make any other contact with, directly or indirectly, any customer of Otelco or any of its Affiliates (including the Company Entities) as of the date that the Employee ceases to be employed by the Company with respect to the provision of any service to any such customer that is the same or substantially similar to any service provided to such customer by Otelco or any of its Affiliates (including the Company Entities) or (ii) solicit or make any other contact with, directly or indirectly, any employee of Otelco or any of its Affiliates (including the Company Entities) on the date that the Employee ceases to be employed by the Company (or any person who was employed by Otelco or any of its Affiliates (including the Company Entities) at any time during the three-month period prior to the Termination Date) with respect to any employment, services or other business relationship.

SECTION 8.     Remedies.

The Employee acknowledges that irreparable damage would occur in the event of a breach of the provisions of Section 6 or Section 7 by the Employee. It is accordingly agreed that, in addition to any other remedy to which its is entitled at law or in equity, the Company will be entitled to an injunction or injunctions to prevent breaches of such sections of this Agreement and to enforce specifically the terms and provisions of such sections.

SECTION 9.     Definitions.

“Accrued Obligations” has the meaning set forth in Section 5(a)(i).

“Affiliate” means, with respect to any Person, any other Person that is controlled by, controlling or under common control with, such Person. Notwithstanding anything to the contrary contained herein, with respect to Otelco, the term “Affiliate” will include, without limitation, each Person with an ownership interest in Otelco (and each member, stockholder or partner of each such Person), each Person in which any stockholder of Otelco (and each member, stockholder or partner of each such Person) holds or has the right to acquire, collectively, more than 10% of the voting equity interests.

“Agreement” has the meaning set forth in the Caption.

“Annual Base Salary” has the meaning set forth in Section 3(c)(i).

“Benefits” has the meaning set forth in Section 5(a)(ii).

“Board” has the meaning set forth in Section 3(a).

“Bonus” has the meaning set forth in Section 3(c)(ii).

“Business Day” means any day that is not a Saturday, Sunday, legal holiday or other day on which banks are required to be closed in New York, New York.

“Cause” has the meaning set forth in Section 4(c).

“Company” has the meaning set forth in the Caption.

6

“Company Business” has the meaning set forth in Section 7(a).

“Company Entities” has the meaning set forth in Section 3(b).

“Confidential Information” has the meaning set forth in Section 6(c).

“Disability” has the meaning set forth in Section 4(a).

“Effective Date” has the meaning set forth in Section 1.

“Employee” has the meaning set forth in the Caption.

“Employment Period” has the meaning set forth in Section 2.

“Person” means an individual, partnership, corporation, limited liability company, trust or unincorporated organization, or a government or agency or political subdivision thereof.

“Restricted Period” has the meaning set forth in Section 7(a).

“Restricted Territory” has the meaning set forth in Section 7(a).

“Termination Date” means the effective date of the termination of the Employee’s employment with the Company, for any reason, by any party, or by death or Disability.

“Without Cause” has the meaning set forth in Section 4(c).

“Work Product” has the meaning set forth in Section 6(d).

SECTION 10.     General Provisions.

(a) Severability. It is the desire and intent of the parties hereto that the provisions of this Agreement be enforced to the fullest extent permissible under the laws and public policies applied in each jurisdiction in which enforcement is sought. Accordingly, if any particular provision of this Agreement shall be adjudicated by a court of competent jurisdiction to be invalid, prohibited or unenforceable for any reason, such provision, as to such jurisdiction, shall be ineffective, without invalidating the remaining provisions of this Agreement or affecting the validity or enforceability of such provision in any other jurisdiction. Notwithstanding the foregoing, if such provision could be more narrowly drawn so as not to be invalid, prohibited or unenforceable in such jurisdiction, it shall, as to such jurisdiction, be so narrowly drawn, without invalidating the remaining provisions of this Agreement or affecting the validity or enforceability of such provision in any other jurisdiction.

(b) Entire Agreement. This Agreement embodies the complete agreement and understanding among the parties hereto with respect to the subject matter hereof. This Agreement supersedes and preempts any prior understandings, agreements or representations by or among the parties, written or oral, which may have related to the subject matter hereof in any way.

7

(c) Survival. Notwithstanding anything to the contrary contained herein, the provisions of Section 6, Section 7 and Section 8 shall survive the termination of this Agreement.

(d) Counterparts. This Agreement may be executed in separate counterparts, each of which is deemed to be an original and all of which taken together constitute one and the same agreement.

(e) Successors and Assigns; Beneficiaries. This Agreement is personal to the Employee and without the prior written consent of the Company shall not be assignable by the Employee other than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Employee’s heirs and legal representatives and the successors and assigns of the Company. The Company reserves the right to assign this Agreement in whole or in part to any of its Affiliates and upon any such assignment, the term “Company” will be deemed to be such Affiliate

(f) Governing Law. THIS AGREEMENT WILL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK, WITHOUT GIVING EFFECT TO ANY CHOICE OF LAW OR CONFLICTING PROVISION OR RULE (WHETHER OF THE STATE OF NEW YORK OR ANY OTHER JURISDICTION) THAT WOULD CAUSE THE LAWS OF ANY JURISDICTION OTHER THAN THE STATE OF NEW YORK TO BE APPLIED. IN FURTHERANCE OF THE FOREGOING, THE INTERNAL LAW OF THE STATE OF NEW YORK WILL CONTROL THE INTERPRETATION AND CONSTRUCTION OF THIS AGREEMENT, EVEN IF UNDER SUCH JURISDICTION’S CHOICE OF LAW OR CONFLICT OF LAW ANALYSIS, THE SUBSTANTIVE LAW OF SOME OTHER JURISDICTION WOULD ORDINARILY APPLY.

(g) Waiver of Jury Trial. EACH PARTY HERETO HEREBY IRREVOCABLY WAIVES ITS RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT OR ANY DEALINGS BETWEEN THE PARTIES HERETO RELATING TO THE SUBJECT MATTER HEREOF.

(h) Amendment and Waiver. The provisions of this Agreement may be amended and waived only with the prior written consent of the Employee and the Company and no course of conduct or failure or delay in enforcing the provisions of this Agreement shall be construed as a waiver of such provisions or affect the validity, binding effect or enforceability of this Agreement or any provision hereof.

(i) Notices. All notices, requests, demands, claims, consents and other communications which are required or otherwise delivered hereunder shall be in writing and shall be deemed to have been duly given if (i) personally delivered or transmitted by electronic mail, (ii) sent by nationally recognized overnight courier, (iii) mailed by registered or certified mail with postage prepaid, return receipt requested or (iv) transmitted by facsimile (with a copy of such transmission concurrently transmitted by registered or certified mail with postage prepaid, return receipt requested), to the parties hereto at the following addresses (or at such other address for a party as shall be specified by like notice):

8

(j) If to the Board or the Company, to:

Otelco Inc.

505 Third Avenue East

Oneonta, Alabama 35121

Attention: Curtis L. Garner, Jr.

Telephone No: (205) 625-3571

Facsimile No: (205) 625-3528

with a copy to:

Dorsey & Whitney LLP

250 Park Avenue

New York, New York 10177

Attention: Steven Khadavi, Esq.

Telephone No: (212) 415-9376

Facsimile No: (212) 953-7201

(k) if to the Employee to:

Jon Henderson

166 Main Street Orono, ME 04473

Telephone No: 207 866-2472

Facsimile No: 866-394-9809

or to such other address as the party to whom such notice or other communication is to be given may have furnished to each other party in writing in accordance herewith. Any such notice or communication shall be deemed to have been received (i) when delivered, if personally delivered or transmitted by electronic mail, with receipt acknowledgment by the recipient by return electronic mail, (ii) when sent, if sent by facsimile on a Business Day during normal business hours (or, if not sent on a Business Day during normal business hours, on the next Business Day after the date sent by facsimile), (iii) on the next Business Day after dispatch, if sent by nationally recognized, overnight courier guaranteeing next Business Day delivery and (iv) on the fifth (5th) Business Day following the date on which the piece of mail containing such communication is posted, if sent by mail.

(l) Descriptive Headings. The descriptive headings of this Agreement are inserted for convenience only and do not constitute a part of this Agreement.

(m) Construction. Where specific language is used to clarify by example a general statement contained herein, such specific language shall not be deemed to modify, limit or restrict in any manner the construction of the general statement to which it relates. The language used in this Agreement shall be deemed to be the language chosen by the parties to express their mutual intent, and no rule of strict construction shall be applied against any party.

(n) Nouns and Pronouns. Whenever the context may require, any pronouns used herein shall include the corresponding masculine, feminine or neuter forms, and the singular form of nouns and pronouns shall include the plural and vice-versa.

[Signature page follows]

9

IN WITNESS WHEREOF, the parties hereto have executed this Employment Agreement as of the date first written above.

OTELCO INC.
By:	/s/ Curtis L. Garner, Jr.
	Name:           Curtis L. Garner, Jr. Title:             Chief Financial Officer
EMPLOYEE
	/s/ Jon C. P. Henderson
	Jon C. P. Henderson

EX-12.1

Exhibit 12.1

Statement Setting Forth Detail for Computation of Ratio of Earnings to Fixed Charges

(dollars in thousands)

	Year Ended December 31,
	2007			2008		2009			2010		2011
Fixed Charges
Interest expense	$	21,378		$	21,808	$	25,416		$	24,747	$	24,776
Earnings
Income (loss) before income taxes	$	(195	)	$	243	$	(4,484	)	$	1,301	$	2,447
Add: Interest expense		21,378			21,808		25,416			24,747		24,776
Total earnings	$	21,183		$	22,051	$	20,932		$	26,048	$	27,223
Ratio of earnings to fixed charges		1.0			1.0		0.8			1.1		1.1

EX-18.1

Exhibit 18.1

[Letterhead of BDO USA, LLP]

March 5, 2012

Board of Directors

Otelco Inc.

505 Third Avenue East

Oneonta, AL  35121

Dear Directors:

As stated in Note 1 to the consolidated financial statements of Otelco Inc. for the year ended December 31, 2011, the Company changed the date of its annual goodwill impairment test from the last day of the year to the first day following the end of its third quarter and states that the newly adopted accounting principle is preferable in the circumstances because it better aligns the timing of the Company’s budgeting process with this test, as the impairment test is dependent on the results of the Company’s budgeting process, and allows the Company more time to accurately complete its impairment testing process in order to timely file those statements with the Securities and Exchange Commission in accordance with its accelerated filing requirements. In connection with our audit of the above mentioned consolidated financial statements, we have evaluated the circumstances and the business judgment and planning which formulated your basis to make the change in accounting principle.

It should be understood that criteria have not been established by the Financial Accounting Standards Board for selecting from among the alternative accounting principles that exist in this area. However, for purposes of the Company’s compliance with the requirements of the Securities and Exchange Commission, we are furnishing this letter.

Based on our audit, we concur with management’s judgment that the newly adopted accounting principle described in Note 1 is preferable in the circumstances. In formulating this position, we are relying on management’s business planning and judgment, which we do not find to be unreasonable.

Very truly yours,

/s/ BDO USA, LLP

EX-21.1

Exhibit 21.1

LIST OF SUBSIDIARIES OF OTELCO INC.

EXACT NAME OF SUBSIDIARY	STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION
Brindlee Mountain Telephone LLC	Alabama
Blountsville Telephone LLC	Alabama
Communications Design Acquisition LLC	Delaware
CRC Communications LLC	Delaware
Granby Telephone LLC	Massachusetts
Hopper Telecommunications LLC	Alabama
I-Land Internet Services LLC	Missouri
Mid-Maine Telecom LLC	Maine
Mid-Maine TelPlus LLC	Maine
Otelco Mid-Missouri LLC	Missouri
Otelco Telecommunications LLC	Delaware
Otelco Telephone LLC	Delaware
Pine Tree Telephone LLC	Maine
Saco River Telephone LLC	Delaware
Shoreham Telephone LLC	Delaware
War Telephone LLC	Delaware

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

Otelco Inc.

Oneonta, Alabama

We hereby consent to the incorporation by reference in the Registration Statement on Form S-­3 (No. 333-169738) of Otelco Inc. of our reports dated March 5, 2012, relating to the consolidated financial statements, and the effectiveness of Otelco Inc.’s internal control over financial reporting, which appear in this Form 10­-K.

/s/ BDO USA, LLP

Atlanta, Georgia

March 5, 2012

EX-31.1

Exhibit 31.1

CERTIFICATION BY CHIEF EXECUTIVE OFFICER

I, Michael D. Weaver, certify that:

1. I have reviewed this annual report on Form 10-K 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(s) 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. 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

d. 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 (the registrant’s fourth fiscal quarter in the case of an annual report) 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: March 5, 2012

/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 annual report on Form 10-K 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(s) 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. 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

d. 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 (the registrant’s fourth fiscal quarter in the case of an annual report) 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: March 5, 2012

/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 Annual Report of Otelco Inc. (the “Company”) on Form 10-K for the period ended December 31, 2011, 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

President & Chief Executive Officer

March 5, 2012

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

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 Annual Report of Otelco Inc. (the “Company”) on Form 10-K for the period ended December 31, 2011, 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

March 5, 2012

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

XML

Note 19 - Subsequent Events

12 Months Ended

Dec. 31, 2011

Note 19 - Subsequent Events Disclosure

Note 19 - Subsequent Events

19.     Subsequent Events

     Effective as of January 1, 2012 each of the Company’s subsidiaries that was a corporation converted into a limited liability company pursuant to applicable state law, except that MMH was merged with and into the Company effective as of January 1, 2012.  As a result of the conversions and the merger, the Company currently expects to lower its income tax obligation in Missouri, as well as lower its cash income tax obligation in Alabama by utilizing net operating loss carryforwards and deferred tax assets.

XML

Note 3 - Acquisitions

12 Months Ended

Dec. 31, 2011

Note 3 - Acquisitions Disclosure

Note 3 - Acquisitions

3.     Acquisitions

     On October 14, 2011, ST acquired 100% of the issued and outstanding common stock of Shoreham Telephone Company Inc. (“STC”) and merged STC with and into ST.  ST provides telecommunications solutions, including voice, data and internet services, to residential and business customers in Western Vermont.

     The stock purchase agreement related to the acquisition of STC provided for cash consideration of $5,248,134, including the extinguishment of notes payable of $410,904 and accrued interest of $3,081, which were paid off at closing.  The excess of the purchase price over the fair value of identifiable assets and liabilities is reflected as goodwill of $764,761.  The goodwill related to the acquisition is not deductible for tax purposes.

     The allocation of the net purchase price for the STC acquisition was as follows:

	October 14, 2011
Cash	$	237,850
Other current assets		552,331
Property and equipment		4,529,760
Intangible assets		1,729,600
Goodwill		764,761
Current liabilities		(332,710	)
Deferred income tax liabilities		(2,233,458	)
Purchase price	$	5,248,134

The acquisition has been recorded at fair value in accordance with Accounting Standards Codification (“ASC”) 805, Business Combination (“ASC 805”) resulting in a plant acquisition adjustment for Shoreham.  Property and equipment have depreciation lives consistent with those shown in the Property and Equipment Note.  The intangible assets at time of acquisition included regulated customer based assets at fair value of $1,672,200 which had remaining lives of 10 years; trade name fair valued at $16,200 with had a remaining life of 5 years; and a non-competition agreement fair valued at $41,200 which had a remaining life of 2 years.  The acquisition was accounted for using the acquisition method of accounting and accordingly, the accompanying consolidated financial statements include the financial position and results of operations from the date of acquisition.

     The following unaudited pro forma information presents the combined results of operations of the Company as though the acquisition of the STC had occurred at the beginning of the preceding year.  The results include certain adjustments, including increased amortization expense related to intangible assets.  The pro forma financial information does not necessarily reflect the results of operations had the acquisition been completed at the beginning of the period or those which may be obtained in the future.

	Unaudited		Unaudited
	2010		2011
Revenues	$	106,812,024	$	103,707,313
Income from operations		26,422,934		24,705,377
Net income		722,165		1,935,327
Basic net income per share	$	0.05	$	0.15
Diluted net income per share	$	0.05	$	0.15

XML

Note 2 - Income Deposit Securities Issued

12 Months Ended

Dec. 31, 2011

Note 2 - Income Deposit Securities Issued Disclosure

Note 2 - Income Deposit Securities Issued

2.     Income Deposit Securities Issued

     On June 8, 2010, the Company issued 544,671 IDSs, representing an aggregate of 544,671 shares of our Class A common stock and $4,085,033 aggregate principal amount of our 13% senior subordinated notes due 2019, in exchange for all 544,671 shares of our issued and outstanding Class B common stock.  There were no proceeds to the Company from this exchange.  The $4.1 million of senior subordinated notes was reclassified from the mezzanine section of the balance sheet to long-term notes payable.  Interest on the $4.1 million of senior subordinated notes was reflected in interest expense beginning June 8, 2010.

XML

Consolidated Balance Sheets (USD $)	Dec. 31, 2011	Dec. 31, 2010
Assets
Cash and cash equivalents	$ 12,393,792	$ 18,226,374
Accounts receivable:
Due from subscribers, net of allowance for doubtful accounts of $230,752 and $260,568, respectively	4,355,632	4,406,257
Unbilled receivables	2,183,465	2,161,277
Other	5,449,074	4,299,088
Materials and supplies	1,780,820	1,817,311
Prepaid expenses	1,328,475	1,305,028
Deferred income taxes	726,310	626,267
Total current assets	28,217,568	32,841,602
Property and equipment, net	65,881,975	63,887,213
Goodwill	188,954,840	188,190,078
Intangible assets, net	20,545,691	25,934,042
Investments	1,943,805	1,967,095
Deferred financing costs	4,485,324	5,757,825
Deferred income taxes	7,454,443	4,415,097
Prepaid expenses	238,386	106,685
Other assets	2,281	77,261
Total assets	317,724,313	323,176,898
Liabilities and Stockholders' Deficit
Accounts payable	1,490,717	768,055
Accrued expenses	6,034,104	7,926,954
Advance billings and payments	1,590,689	1,595,133
Deferred income taxes	353,285	353,285
Customer deposits	143,657	172,479
Total current liabilities	9,612,452	10,815,906
Deferred income taxes	48,112,384	42,512,576
Interest rate swaps	241,438	2,471,331
Advance billings and payments	615,584	656,968
Other liabilities	403,823	368,349
Long-term notes payable	271,106,387	271,595,855
Total liabilities	330,092,068	328,420,985
Stockholders' Deficit
Class A Common Stock, $.01 par value-authorized 20,000,000 shares; issued and outstanding 13,221,404 shares	132,214	132,214
Additional paid in capital		921,718
Retained deficit	(12,499,969)	(6,298,019)
Total stockholders' deficit	(12,367,755)	(5,244,087)
Total liabilities and stockholders' deficit	$ 317,724,313	$ 323,176,898

XML

Consolidated Statements Of Cash Flows (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Cash flows from operating activities:
Net income (loss)	$ 2,197,418	$ 690,715	$ (3,117,811)
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation	11,891,474	13,837,560	14,444,714
Amortization	8,341,359	9,832,683	12,040,914
Interest rate caplet			1,168,522
Amortization of debt premium	(103,640)	(92,307)	(82,212)
Amortization of loan costs	1,368,095	1,361,351	1,351,906
Change in fair value of derivatives	(2,229,893)	878,518	1,354,759
Provision for deferred income taxes	226,962	428,098	(1,507,798)
Provision for uncollectible revenue	914,555	141,474	920,945
Changes in assets and liabilities; net of assets and liabilities acquired:
Accounts receivables	(1,590,110)	427,432	739,921
Material and supplies	173,350	152,655	339,909
Prepaid expenses and other assets	(117,356)	(69,464)	(200,341)
Income tax receivable		389,486	(207,842)
Accounts payable and accrued liabilities	(1,423,589)	(1,657,758)	1,094,474
Advance billings and payments	(116,732)	(111,673)	(400,085)
Other liabilities	(1,756)	202,751	(30,850)
Net cash from operating activities	19,530,137	26,411,521	27,909,125
Cash flows from investing activities:
Acquisition and construction of property and equipment	(10,547,705)	(10,225,229)	(9,596,049)
Purchase of investment	(2,220)	(1,708)
Proceeds from retirement of investment		1,067	(1,085)
Wholesale customer acquisition			(179,554)
Payments for the purchase of Shoreham Telephone, net of cash acquired	(5,010,284)
Deferred charges/acquisition		(1,845)	(6,551)
Net cash used in investing activities	(15,560,209)	(10,227,715)	(9,783,239)
Cash flows used in financing activities:
Cash dividends paid	(9,321,088)	(9,225,091)	(8,937,097)
Direct cost of exchange of Class B shares for Class A shares		(194,053)
Loan origination costs	(95,594)	(155,160)
Repayment of long-term notes payable	(385,828)	(6,114,172)	(5,000,000)
Net cash used in financing activities	(9,802,510)	(15,688,476)	(13,937,097)
Net increase (decrease) in cash and cash equivalents	(5,832,582)	495,330	4,188,789
Cash and cash equivalents, beginning of period	18,226,374	17,731,044	13,542,255
Cash and cash equivalents, end of period	12,393,792	18,226,374	17,731,044
Supplemental disclosures of cash flow information:
Interest paid	24,130,675	23,484,474	23,378,798
Income taxes paid (received)	$ 90,517	$ (265,275)	$ 67,658

XML

Note 16 - Subsidiary Guarantees

12 Months Ended

Dec. 31, 2011

Note 16 - Subsidiary Guarantees Disclosure

Note 16 - Subsidiary Guarantees

16.     Subsidiary Guarantees

    The Company has no independent assets or operations separate from its operating subsidiaries.  The guarantees of its senior subordinated notes by 14 of its 15 operating subsidiaries are full and unconditional, joint and several.  The operating subsidiaries have no independent long-term notes payable.  There are no significant restrictions on the ability of the Company to obtain funds from its operating subsidiaries by dividend or loan.  The condensed consolidated financial information is provided for the guarantor entities.  In 2011, MMT became a guarantor of the senior subordinated notes.

     The following tables present condensed consolidating balance sheets as of December 31, 2010 and 2011, condensed consolidating statements of operations for the years ended December 31, 2009, 2010 and 2011; and condensed consolidating statements of cash flows for the years ended December 31, 2009, 2010 and 2011.

Otelco Inc.

Condensed Consolidating Balance Sheet

December 31, 2010

	Parent			Guarantor			Non-Guarantor			Eliminations			Consolidated
				Subsidiaries			Subsidiaries
ASSETS
Current assets
Cash and cash equivalents	$	-		$	18,064,970		$	161,404		$	-		$	18,226,374
Accounts receivable, net		-			10,072,847			793,775			-			10,866,622
Materials and supplies		-			893,186			924,125			-			1,817,311
Prepaid expenses		184,055			1,022,697			98,276			-			1,305,028
Deferred income taxes		626,267			-			-			-			626,267
Investment in subsidiaries		131,010,180			-			-			(131,010,180	)		-
Intercompany receivable		(129,599,481	)		-			-			129,599,481			-
Total current assets		2,221,021			30,053,700			1,977,580			(1,410,699	)		32,841,602
Property and equipment, net		218,301			54,043,819			9,625,093			-			63,887,213
Goodwill		239,970,317			(49,843,599	)		(1,936,640	)		-			188,190,078
Intangible assets, net		-			23,326,214			2,607,828			-			25,934,042
Investments		1,203,605			433,059			330,431			-			1,967,095
Deferred income taxes		4,415,097			-			-			-			4,415,097
Other long-term assets		5,757,825			183,946			-			-			5,941,771
Total assets	$	253,786,166		$	58,197,139		$	12,604,292		$	(1,410,699	)	$	323,176,898
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses	$	2,280,661		$	4,991,249		$	1,423,099		$	-		$	8,695,009
Intercompany payables		-			(131,769,870	)		2,170,389			129,599,481			-
Other current liabilities		353,285			1,678,145			89,467			-			2,120,897
Total current liabilities		2,633,946			(125,100,476	)		3,682,955			129,599,481			10,815,906
Deferred income taxes		22,592,597			16,666,501			3,253,478			-			42,512,576
Other liabilities		2,471,331			1,025,317			-			-			3,496,648
Long-term notes payable		231,332,379			40,263,476			-			-			271,595,855
Stockholders' equity  (deficit)		(5,244,087	)		125,342,321			5,667,859			(131,010,180	)		(5,244,087	)
Total liabilities and stockholders' equity  (deficit)	$	253,786,166		$	58,197,139		$	12,604,292		$	(1,410,699	)	$	323,176,898

	Parent			Guarantor			Non-Guarantor			Eliminations			Consolidated
				Subsidiaries			Subsidiaries
ASSETS
Current assets
Cash and cash equivalents	$	-		$	12,393,441		$	351		$	-		$	12,393,792
Accounts receivable, net		-			11,445,049			543,122			-			11,988,171
Materials and supplies		-			827,194			953,626			-			1,780,820
Prepaid expenses		194,244			1,115,339			18,892			-			1,328,475
Deferred income taxes		726,310			-			-			-			726,310
Investment in subsidiaries		147,614,140			-			-			(147,614,140	)		-
Intercompany receivable		(154,849,721	)		(688,391	)		688,391			154,849,721			-
Total current assets		(6,315,027	)		25,092,632			2,204,382			7,235,581			28,217,568
Property and equipment, net		-			64,524,981			1,356,994			-			65,881,975
Goodwill		239,970,317			(47,435,761	)		(3,579,716	)		-			188,954,840
Intangible assets, net		-			18,186,227			2,359,464			-			20,545,691
Investments		1,203,605			432,186			308,014			-			1,943,805
Deferred income taxes		7,454,443			-			-			-			7,454,443
Other long-term assets		4,485,324			240,667			-			-			4,725,991
Total assets	$	246,798,662		$	61,040,932		$	2,649,138		$	7,235,581		$	317,724,313
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses	$	1,306,872		$	4,793,854		$	1,424,095		$	-		$	7,524,821
Intercompany payables		-			(154,849,721	)		-			154,849,721			-
Other current liabilities		353,285			1,668,933			65,413			-			2,087,631
Total current liabilities		1,660,157			(148,386,934	)		1,489,508			154,849,721			9,612,452
Deferred income taxes		26,421,911			20,354,646			1,335,827			-			48,112,384
Other liabilities		241,438			1,019,407			-			-			1,260,845
Long-term notes payable		230,842,911			40,263,476			-			-			271,106,387
Stockholders' equity (deficit)		(12,367,755	)		147,790,337			(176,197	)		(147,614,140	)		(12,367,755	)
Total liabilities and stockholders' equity (deficit)	$	246,798,662		$	61,040,932		$	2,649,138		$	7,235,581		$	317,724,313

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Twelve Months Ended December 31, 2009

				Guarantor			Non-Guarantor
	Parent			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenue	$	3,318,678		$	100,173,351		$	11,701,213		$	(11,437,788	)	$	103,755,454
Operating expenses		(3,318,678	)		(80,815,648	)		(9,132,057	)		11,437,788			(81,828,595	)
Income from operations		-			19,357,703			2,569,156			-			21,926,859
Other income (expense)		(26,098,959	)		(390,828	)		78,488			-			(26,411,299	)
Earnings from subsidiaries		14,247,278			-			-			(14,247,278	)		-
Income (loss) before income tax		(11,851,681	)		18,966,875			2,647,644			(14,247,278	)		(4,484,440	)
Income tax (expense) benefit		8,733,870			(6,330,343	)		(1,036,898	)		-			1,366,629
Net income (loss) to common stockholders	$	(3,117,811	)	$	12,636,532		$	1,610,746		$	(14,247,278	)	$	(3,117,811	)

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Twelve Months Ended December 31, 2010

				Guarantor			Non-Guarantor
	Parent			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues	$	3,493,053		$	101,600,140		$	10,855,909		$	(11,548,883	)	$	104,400,219
Operating expenses		(3,493,053	)		(77,083,003	)		(9,004,282	)		11,548,883			(78,031,455	)
Income from operations		-			24,517,137			1,851,627			-			26,368,764
Other income (expense)		(24,856,925	)		(311,219	)		99,904			-			(25,068,240	)
Earnings from subsidiaries		26,157,449			-			-			(26,157,449	)		-
Income before income tax		1,300,524			24,205,918			1,951,531			(26,157,449	)		1,300,524
Income tax expense		(609,809	)		(7,944,116	)		(761,943	)		8,706,059			(609,809	)
Net income to common stockholders	$	690,715		$	16,261,802		$	1,189,588		$	(17,451,390	)	$	690,715

Otelco Inc.

Condensed Consolidating Statement of Operations

For the Twelve Months Ended December 31, 2011

				Guarantor			Non-Guarantor
	Parent			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues	$	3,289,457		$	99,770,739		$	4,234,814		$	(5,451,443	)	$	101,843,567
Operating expenses		(3,289,457	)		(75,146,885	)		(4,228,573	)		5,451,443			(77,213,472	)
Income from operations		-			24,623,854			6,241			-			24,630,095
Other income (expense)		(21,825,630	)		(356,881	)		(237	)		-			(22,182,748	)
Earnings from subsidiaries		24,272,977			-			-			(24,272,977	)		-
Income before income tax		2,447,347			24,266,973			6,004			(24,272,977	)		2,447,347
Income tax expense		(249,929	)		(7,666,626	)		(2,395	)		7,669,021			(249,929	)
Net income to common stockholders	$	2,197,418		$	16,600,347		$	3,609		$	(16,603,956	)	$	2,197,418

Otelco Inc.

Condensed Consolidating Statement of Cash Flows

For the Twelve Months Ended December 31, 2009

				Guarantor			Non-Guarantor
	Parent			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	(3,117,811	)	$	12,636,532		$	1,610,746		$	(14,247,278	)	$	(3,117,811	)
Adjustment to reconcile net income (loss) to cash flows from operating activities		5,379,288			21,551,341			2,761,121			-			29,691,750
Changes in assets and liabilities, net of assets and liabilities acquired		25,922,898			(21,716,059	)		(2,871,653	)		-			1,335,186
Net cash provided by operating activities		28,184,375			12,471,814			1,500,214			(14,247,278	)		27,909,125
Cash flows used in investing activities		-			(8,375,686	)		(1,407,553	)		-			(9,783,239	)
Cash flows used in financing activities		(28,184,375	)		-			-			14,247,278			(13,937,097	)
Net increase in cash and cash equivalents		-			4,096,128			92,661			-			4,188,789
Cash and cash equivalents, beginning of period		-			13,521,138			21,117			-			13,542,255
Cash and cash equivalents, end of period	$	-		$	17,617,266		$	113,778		$	-		$	17,731,044

Otelco Inc.

Condensed Consolidating Statement of Cash Flows

For the Twelve Months Ended December 31, 2010

				Guarantor			Non-Guarantor
	Parent			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	690,715		$	16,261,802		$	1,189,588		$	(17,451,390	)	$	690,715
Adjustment to reconcile net income (loss) to cash flows from operating activities		5,075,290			18,105,293			3,206,795			-			26,387,378
Changes in assets and liabilities, net of assets and liabilities acquired		27,592,163			(25,289,272	)		(2,969,463	)		-			(666,572	)
Net cash provided by operating activities		33,358,168			9,077,823			1,426,920			(17,451,390	)		26,411,521
Cash flows used in investing activities		(218,301	)		(8,630,120	)		(1,379,294	)		-			(10,227,715	)
Cash flows used in financing activities		(33,139,867	)		1			-			17,451,390			(15,688,476	)
Net increase (decrease) in cash and cash equivalents		-			447,704			47,626			-			495,330
Cash and cash equivalents, beginning of period		-			17,617,266			113,778			-			17,731,044
Cash and cash equivalents, end of period	$	-		$	18,064,970		$	161,404		$	-		$	18,226,374

Otelco Inc.

Condensed Consolidating Statement of Cash Flows

For the Twelve Months Ended December 31, 2011

				Guarantor			Non-Guarantor
	Parent			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	2,197,418		$	33,204,304		$	3,608		$	(33,207,912	)	$	2,197,418
Adjustment to reconcile net income (loss) to cash flows from operating activities		(275,513	)		19,762,543			921,882			-			20,408,912
Changes in assets and liabilities, net of assets and liabilities acquired		24,266,264			(27,119,787	)		(222,670	)		-			(3,076,193	)
Net cash provided by operating activities		26,188,169			25,847,060			702,820			(33,207,912	)		19,530,137
Cash flows used in investing activities		218,301			(15,075,741	)		(702,769	)		-			(15,560,209	)
Cash flows used in financing activities		(26,406,470	)		(16,603,952	)		-			33,207,912			(9,802,510	)
Net increase (decrease) in cash and cash equivalents		-			(5,832,633	)		51			-			(5,832,582	)
Cash and cash equivalents, beginning of period		-			18,226,074			300			-			18,226,374
Cash and cash equivalents, end of period	$	-		$	12,393,441		$	351		$	-		$	12,393,792

XML

Note 18 - Commitments And Contingencies

12 Months Ended

Dec. 31, 2011

Note 18 - Commitments And Contingencies Disclosure

Note 18 - Commitments And Contingencies

18.     Commitments and Contingencies

     From time to time, we may be involved in various claims, legal actions and regulatory proceedings incidental to and in the ordinary course of business, including administrative hearings of the APSC, MDTC, MPSC, MPUC, NHPUC, VPSB and WVPSC relating primarily to rate making.  Currently, none of the legal proceedings are expected to have a material adverse effect on our business.

XML

Note 1 - Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2011

Note 1 - Summary of Significant Accounting Policies Disclosure

Note 1 - Summary of Significant Accounting Policies

1.      Summary of Significant Accounting Policies

  Nature of Business

     Otelco Inc. (the “Company”) provides a broad range of telecommunications services on a retail and wholesale basis.  These services include local and long distance calling; network access to and from our customers; data transport; digital high-speed and dial-up internet access; cable, satellite and internet protocol television; wireless; and other telephone related services.  The principal markets for these services are residential and business customers residing in and adjacent to the exchanges the Company serves in Alabama, Massachusetts, Maine, Missouri, Vermont, and West Virginia.  In addition, the Company serves business customers throughout Maine and New Hampshire and provides dial-up internet service throughout the states of Maine and Missouri.  The Company offers various communications services that are sold to economically similar customers in a comparable manner of distribution.  The majority of our customers buy multiple services, often bundled together at a single price.  The Company views, manages and evaluates the results of its operations from the various communications services as one company and therefore has identified one reporting segment as it relates to providing segment information.

Basis of Presentation and Principles of Consolidation

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

     The accompanying consolidated financial statements include the accounts of the Company and all of the aforesaid subsidiaries after elimination of all material intercompany balances and transactions.

Use of Estimates

     The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities.  The estimates and assumptions used in the accompanying consolidated financial statements are based upon management’s evaluation of the relevant facts and circumstances as of the date of the financial statements.  Actual results may differ from the estimates and assumptions used in preparing the accompanying consolidated financial statements.

     Significant accounting estimates include the recoverability of goodwill, identified intangibles, long-term assets, deferred tax valuation allowances,and allowance for bad debt.

Regulatory Accounting

     The Company follows the accounting for regulated enterprises, which is now part of Accounting Standards Codification (“ASC”) 980, Regulated Operations as issued by the Financial Accounting Standards Board (“FASB”).  This accounting practice recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities.  Accordingly, ASC 980 requires the Company to depreciate telecommunications property and equipment over the estimated useful lives approved by regulators, which could be different than the estimated useful lives that would otherwise be determined by management.  ASC 980 also requires deferral of certain costs and obligations based upon approvals received from regulators to permit recovery of such amounts in future years.  Criteria that would give rise to the discontinuance of accounting in accordance with ASC 980 include (1) increasing competition restricting the ability of the Company to establish prices that allow it to recover specific costs and (2) significant changes in the manner in which rates are set by regulators from cost-based regulation to another form of regulation.  The Company periodically reviews the criteria to determine whether the continuing application of ASC 980 is appropriate for our rural local exchange carriers.

     The Company is subject to reviews and audits by regulatory agencies.  The effect of these reviews and audits, if any, will be recorded in the period in which they first become known and determinable.

Intangible Assets and Goodwill

     Intangible assets consist primarily of the fair value of customer related intangibles, non-compete agreements and long-term customer contracts.  Goodwill represents the excess of total acquisition cost over the assigned value of net identifiable tangible and intangible assets acquired through various business combinations.  Due to the regulatory accounting required by ASC 980, the Company did not record acquired regulated telecommunications property and equipment at fair value as required by ASC 805, Business Combinations, through 2004.  In accordance with 47 CFR 32.2000, the federal regulation governing acquired telecommunications property and equipment, such property and equipment is accounted for at original cost, and depreciation and amortization of property and equipment acquired is credited to accumulated depreciation.

     The Company’s annual budgeting, forecasting and tax planning cycle begins in September.  The Company’s strategy for growth includes acquisitions, a process that actively involves its board of directors in financial and strategy decisions, utilizing the budgeting, forecasting and tax planning information and changes in the telecommunications marketplace.  Based on these factors and to allow the audit committee of the Company’s board of directors sufficient time to review management’s assessment of goodwill for impairment, management changed its annual goodwill impairment testing date from December 31 to October 1.  The company believes this change in testing date is preferable under the circumstances as the change more closely alignes the analysis with the Company’s budgeting and forecasting process.  The Company does not believe that this change in annual goodwill impairment testing date will accelerate, delay or avoid any impairment change.

     For the acquisition of ST, property has been recorded at fair value in accordance with ASC 805, resulting in a plant acquisition adjustment in 2011.  The Company has acquired identifiable intangible assets associated with the territories it serves including a non-compete agreement with one of the former owners, and the customer lists.  Any excess of the total purchase price over the amounts assigned to tangible and identifiable assets is recorded as goodwill.

     The Company performs a quarterly review of its identified intangible assets to determine if facts and circumstances exist which indicate that the useful life is shorter than originally estimated or that the carrying amount of assets may not be recoverable.  If such facts and circumstances do exist, the Company assesses the recoverability of identified intangible assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts.  Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets.

Revenue Recognition

      Local service revenues.  Local service revenue for monthly recurring local services is billed in advance to a portion of the Company’s customers and in arrears to the balance of the customers.  The Company records revenue for charges that have not yet been invoiced to its customers as unbilled revenue when services are rendered.  The Company records revenue billed in advance as advance billings and defers recognition until such revenue is earned.  Long distance service is billed to customers in arrears based on actual usage except when it is included in service bundles.  The Company records unbilled long distance revenue as unbilled revenue when services are rendered.  In bundles, unlimited usage is billed in arrears at a flat rate.

      Network access.  Network access revenue is derived from several sources.  Revenue for interstate access services is received through tariffed access charges filed by the National Exchange Carrier Association (“NECA”) with the Federal Communications Commission (“FCC”) on behalf of the NECA member companies for our regulated subsidiaries.  These access charges are billed by the Company to interstate interexchange carriers and pooled with like-revenues from all NECA member companies.  A portion of the pooled access charge revenue received by the Company is based upon its actual cost of providing interstate access service, plus a return on the investment dedicated to providing that service.  The balance of the pooled access charge revenue received by the Company is based upon the nationwide average schedule costs of providing interstate access services.  Rates for our competitive subsidiaries are set by FCC rule to be no more than the interconnecting interstate rate of the predominant local carrier.  Revenue for intrastate access service is received through tariffed access charges billed by the Company to the originating intrastate carrier using access rates filed with the Alabama Public Service Commission (“APSC”), the Maine Public Utilities Commission (“MPUC”), The Massachusetts Department of Telecommunications and Cable (“MDTC”), the Missouri Public Service Commission (“MPSC”), the New Hampshire Public Utilities Commission (“NHPUC”), the Vermont Public Service Board (“VPSB”) and the West Virginia Public Service Commission (“WVPSC”) and are retained by the Company.  Revenue for the intrastate/interLATA access service is received through tariffed access charges as filed with the APSC, MDTC, MPSC, MPUC, NHPUC, VPSB and WVPSC. These access charges are billed to the intrastate carriers and are retained by the Company.  Revenue for terminating and originating long distance service is received through charges for providing usage of the local exchange network.  Toll revenues are recognized when services are rendered.

      Cable television, internet and transport services.  Cable television, internet and transport service revenues are recognized when services are rendered.  Operating revenues from the lease of dark fiber covered by indefeasible rights-of-use (IRU) agreements are recorded as earned.  In some cases, the entire lease payment is received at inception of the lease and recognized ratably over the lease term after recognition of expenses associated with lease inception.  The Company has deferred revenue in the consolidated balance sheet as of December 31, 2010 and 2011 of $656,968 and $615,584, respectively, related to transport services.

Cash and Cash Equivalents

     Cash equivalents are stated at cost plus accrued interest, which approximates fair value.  Cash equivalents are high-quality, short-term money market instruments and highly liquid debt instruments with an original maturity of three months or less when purchased.  The cash equivalents are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of changes in interest rates.

Accounts Receivable

     The Company extends credit to its commercial and residential customers based upon a written credit policy.  Service interruption is the primary vehicle for controlling losses.  Accounts receivable are recorded at the invoiced amount and do not bear interest.  The allowance for doubtful accounts is the Company’s best estimate for the amount of probable credit losses in the Company’s existing accounts receivable.  The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends, and other information.  Receivable balances are reviewed on an aged basis and account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Materials and Supplies

     Materials and supplies are stated at the lower of cost or market value.  Cost is determined using an average cost basis.

Property and Equipment

     Regulated property and equipment is stated at original cost.  Unregulated property and equipment purchased through acquisitions is stated at its fair value at the date of acquisition.  Expenditures for improvements that significantly add to productive capacity or extend the useful life of an asset are capitalized.  Expenditures for maintenance and repairs are expensed when incurred.  Depreciation of regulated property and equipment is computed principally using the straight-line method over useful lives determined by the APSC, MDTC, MPSC, MPUC, NHPUC, VPSB and WVPSC as discussed above.  Depreciation of unregulated property and equipment primarily employs the straight-line method over industry standard estimated useful lives.

Long-Lived Assets

     The Company reviews its long-lived assets for impairment at each balance sheet date and whenever events or changes in circumstances indicate that the carrying amount of an asset should be assessed.  To determine if an impairment exists, the Company estimates the future undiscounted cash flows expected to result from the use of the asset being reviewed for impairment.  If the sum of these expected future cash flows is less than the carrying amount of the asset, the Company recognizes an impairment loss in accordance with guidance included in ASC 360, Property, Plant, and Equipment.  The amount of the impairment recognized is determined by estimating the fair value of the assets and recording a loss for the excess of the carrying value over the fair value.

Deferred Financing Costs

     Deferred financing and loan costs consist of debt issuance costs incurred in obtaining long-term financing, which are amortized over the life of the related debt.  Amortization of deferred financing and loan costs is classified as “Interest expense”.  When amendments to debt agreements are considered to extinguish existing debt per guidance included in ASC 470, Debt, the remaining deferred financing costs are amortized at the time of amendment.

Derivative Financial Instruments

     Derivative financial instruments are accounted for under guidance included in ASC 815, Derivatives and Hedging. Under ASC 815, all derivatives are recorded on the balance sheet as assets or liabilities and measured at fair value.  The embedded exchange feature of the Class B common stock was accounted for as a derivative liability.  This liability was adjusted to estimated fair value on each balance sheet date with the offset to other non-operating income or expense.  No liability existed and the Class B shares were exchanged for Income Deposit Securities (“IDS”) units on a one-for-one basis on June 8, 2010.  Each of the IDSs issued in the exchange includes a Class A common share.

     The Company is exposed to the market risk of adverse changes in interest rates.  An 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 3% for the three month LIBOR index plus the applicable margin on $80 million in senior debt for five years.  On July 5, 2007, the Company repaid $55,353,032 in debt, reducing its senior debt below the level of the rate cap.  The cap was considered an effective hedge for the remaining senior debt as all critical terms of the interest rate cap were identical to the underlying debt it hedged.  The balance of the cap at that time was considered as an investment and adjustments were made to accumulated other comprehensive income to reflect this change.  On October 31, 2008, the Company implemented its second amended and restated credit agreement, increasing senior debt to $173.5 million in conjunction with the acquisition of three entities from Country Road Communications LLC.  The full $80 million rate cap was accounted for as an effective hedge from that date through the end of the rate cap on December 20, 2009.  The cost of the effective portion of the interest rate cap was 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.

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

Income Taxes

     The Company accounts for income taxes using the asset and liability approach in accordance with guidance included in ASC 740, Income Taxes.  The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities.  A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized.

     The provision for income taxes consists of an amount for the taxes currently payable and a provision for the tax consequences deferred to future periods.

     Interest and penalties related to income tax matters would be recognized in income tax expense.  As of December 31, 2011, we did not have an amount recorded for interest and penalties.

     The Company conducts business in multiple jurisdictions and, as a result, one or more subsidiaries file income tax returns in the U.S. federal, various state and local jurisdictions.  All tax years since 2004 are open for examination by various tax authorities.

Fair Value of Financial Instruments

     The carrying value of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, derivative liabilities and long-term notes payable approximate their value as of December 31, 2010 and 2011.

Comprehensive Income (Loss)

     Comprehensive income (loss) equals net income (loss) plus other comprehensive income.  Other comprehensive income refers to revenue, expenses, gains and losses, which are reflected in retained earnings but excluded from net income.

Income (Loss) per Common Share

     The Company computes net income (loss) per Class A common share in accordance with the provision included in ASC 260, Earnings per Share.  Under ASC 260, basic and diluted income per share is computed by dividing net income (loss) available to stockholders by the weighted average number of common shares and common share equivalents outstanding during the period.  Basic income (loss) per common share excludes the effect of potentially dilutive securities, while diluted income (loss) per common share reflects the potential dilution that would occur if securities or other contracts to issue common shares were exercised for, converted into or otherwise resulted in the issuance of common shares.  Net income (loss) is adjusted for the Class B derivative liability in calculating diluted earnings.  On June 8, 2010, all of the Company’s Class B shares were exchanged for IDSs, including a Class A common share, on a one-for-one basis.

Recently Adopted Accounting Pronouncements

     In October 2009, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2009-13, Multiple-Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task Force (“ASU 2009-13”), an update to ASC 605, Revenue Recognition (“ASU 2009-13”).  ASU 2009-13 provides application guidance on whether multiple deliverables exist, how the deliverables should be separated, and how the consideration should be allocated to one or more units of accounting.  ASU 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable.  The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific evidence is not available, or estimated selling price if neither vendor-specific nor third-party evidence is available.  The Company is required to apply this guidance prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010; however, earlier application was permitted and the Company began applying the guidance in July 2010.  The early adoption of this update did not have a material impact on our consolidated financial statements.

     In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”), an update to ASC 820, Fair Value Measurements and Disclosures (“ASC 820”).  ASU 2010-06 provides more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  The adoption of this update did not have a material impact on our consolidated financial statements.

     In February 2010, the FASB issued ASU 2010-09, Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”), an update to ASC 855, Subsequent Events (“ASC 855”).  ASU 2010-09 eliminates the requirement for a Securities and Exchange Commission (“SEC”) filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements.  Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of accounting principles generally accepted in the United States.  The FASB believes these amendments remove potential conflicts with the SEC’s literature.  ASU 2010-09 is effective upon issuance except for the use of the issued date for conduit debt obligors, which is effective for interim or annual periods ending after June 15, 2010.  The adoption of this update did not have a material impact on our consolidated financial statements.

     In July 2010, the FASB issued ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”), an update to ASC 310, Receivables (“ASC 310”).  ASU 2010-20 provides additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses.  ASU 2010-20 applies to all entities with financing receivables, excluding short-term trade accounts receivable or receivables measured at fair value or the lower of cost or fair value.  For public entities, this update is effective for interim and annual reporting periods ending on or after December 15, 2010.  The adoption of this update did not have a material impact on our consolidated financial statements.

     In December 2010, the FASB issued ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations (“ASU 2010-29”), an update to ASC 805, Business Combinations (“ASC 805”).  ASU 2010-29 applies to any public entity that enters into business combinations that are material on an individual or aggregate basis.  If comparative financial statements are presented, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.  This update also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.  ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  Early adoption is permitted and the Company began applying the guidance in December 2010.  The adoption of this update did not have a material impact on our consolidated financial statements.

Recent Accounting Pronouncements

     During 2011, the FASB issued ASU 2011-01 through 2011-12. Except for ASU 2011-04, ASU 2011-05, ASU 2011-08, and ASU 2011-09, which are discussed below, these ASUs provide technical corrections to existing guidance related to specialized industries or entities and therefore, have minimal, if any, impact on the Company.

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

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

     In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment (“ASU 2011-08”), an update to ASC 350, Intangibles – Goodwill and Other (“ASC 350”).  This ASU will provide an entity with the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.  However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test in accordance with ASC 350.  ASU 2011-08 is effective for annual and interim goodwill impairment tests for fiscal years beginning after December 15, 2011.  Early adoption is permitted.  As ASU 2011-08 impacts testing procedures only, the adoption of this update will not impact our consolidated financial statements.

     In September 2011, the FASB issued ASU 2011-09, Disclosures about an Employer’s Participation in a Multiemployer Plan (“ASU 2011-09”), an update to ASC 715, Compensation – Retirement Benefits, subtopic 80, Multiemployer Plans.  ASU 2011-09 requires additional disclosures for multiemployer pension plans and multiemployer other postretirement benefit plans.  ASU 2011-09 is intended to create greater transparency in financial reporting by disclosing the commitments an employer has made to a multiemployer pension plan and the potential future cash flow implications of an employer’s participation in the plan.  ASU 2011-09 impacts disclosure only, the adoption of this update did not impact our consolidated financial statements.

XML

Consolidated Balance Sheets (Parentheticals) (USD $)	Dec. 31, 2011	Dec. 31, 2010
Accounts receivable:
Allowance for doubtful accounts	$ 260,568	$ 230,752
Stockholders' Deficit
Common stock par value	$ 0.01	$ 0.01
Common stock, shares authorized	20,000,000	20,000,000
Common stock, shares issued	13,221,404	13,221,404
Common stock, shares outstanding	13,221,404	13,221,404

XML

Note 11 - Income Taxes

12 Months Ended

Dec. 31, 2011

Note 11 - Income Taxes Disclosure

Note 11 - Income Taxes

11.     Income Taxes

     Income tax expense for the years ended December 31, 2009, 2010 and 2011 is summarized below:

	For the Years Ended December 31,
	2009			2010			2011
Federal income taxes
Current	$	114,947		$	(3,015	)	$	(2,033	)
Deferred		(1,474,119	)		278,383			(75,765	)
Total federal tax expense (benefit)		(1,359,172	)		275,368			(77,798	)
State income taxes
Current		26,222			184,726			25,000
Deferred		(33,679	)		149,715			302,727
Total state tax expense (benefit)		(7,457	)		334,441			327,727
Total tax expense (benefit)	$	(1,366,629	)	$	609,809		$	249,929

     Total income tax expense (benefit) was different than that computed by applying U.S. federal income tax rates to income from continuing operations before income taxes for the years ended December 31, 2009, 2010 and 2011.  The reasons for the differences are presented below:

	For the Years Ended December 31,
	2009			2010			2011
Federal income tax at statutory rate		35	%		35	%		35	%
Federal income tax provision (benefit) at statutory rate	$	(1,569,554	)	$	455,183		$	856,571
Change in fair value of derivative		474,166			307,482			(781,466	)
State income tax (provision), net of federal income tax effects		(4,847	)		217,387			213,022
Other		(266,394	)		(370,243	)		(38,198	)
Provision (benefit) on income taxes	$	(1,366,629	)	$	609,809		$	249,929
Effective income tax rate		30.5	%		46.9	%		10.2	%

      As of December 31, 2011 the Company has U.S. federal and state net operating loss carryforwards of $17.3 million and $22.8 million, respectively.  These net operating loss carryforwards expire at various times beginning in 2021 through 2031 and will more likely, than not, be used prior to their expiration  These acquired losses are subject to annual limitations imposed by rules under the Internal Revenue Code.

     During 2009, the Company took advantage of the 5-year net operating loss carryback provisions of the Worker, Homeownership, and Business Act of 2009.  Approximately, $1.7 million of the 2008 net operating loss was carried back to 2004 for a refund of $0.4 million.

     The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2010 and 2011 are presented below:

	December 31,
	2010			2011
Deferred tax liabilities:
Amortization	$	(25,604,600	)	$	(28,374,977	)
Depreciation		(9,448,329	)		(13,924,912	)
Amortized intangibles		(7,443,579	)		(5,796,972	)
Prepaid expense		(353,285	)		(353,285	)
Other		(16,068	)		(15,523	)
Total deferred tax liabilities	$	(42,865,861	)	$	(48,465,669	)
Deferred tax assets:
Deferred Compensation	$	308,479		$	297,468
Federal net operating loss carryforwards		3,163,018			6,058,180
Alternative minimum credits carryforwards		504,130			504,130
State net operating loss carryforwards		278,462			438,786
Advance payments		272,357			256,218
Bad debt		226,305			298,683
Other		288,613			327,288
Total deferred tax assets	$	5,041,364		$	8,180,753

     The 2011 balances include net deferred tax liabilities in the amount of ($2,233,458) related to the STC stock acquisition that occurred on October 14, 2011.

     Effective January 1, 2007, the Company adopted the provision included in ASC 740, Income Taxes.  ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements.   ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  This pronouncement also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  The adoption of ASC 740 did not result in the identification of material uncertain tax positions through December 31, 2011.  Tax years from 2007 forward remain open for audit.

XML

Document And Entity Information (USD $)	12 Months Ended
	Dec. 31, 2011	Mar. 05, 2012	Jun. 30, 2011
Entity Information
Entity Registrant Name	OTELCO INC.
Entity Central Index Key	0001288359
Current Fiscal Year End Date	--12-31
Entity Filer Category	Accelerated Filer
Entity Current Reporting Status	Yes
Entity Voluntary Filers	No
Entity Well-known Seasoned Issuer	No
Entity Common Stock, Shares Outstanding		13,221,404
Entity Public Float			$ 247,100,000
Document Information
Document Type	10-K
Amendment Flag	false
Document Period End Date	Dec. 31, 2011
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	FY

XML

Note 12 - Employee Benefit Program

12 Months Ended

Dec. 31, 2011

Note 12 - Employee Benefit Program Disclosure

Note 12 - Employee Benefit Program

12.     Employee Benefit Program

     Employees of all subsidiaries except BTC participate in a defined contribution savings plan under Section 401(k) of the Internal Revenue Code, which is sponsored by the Company.  The terms of the plan provide for an elective contribution from employees not to exceed $16,500, $16,500, and $16,500 for 2009, 2010 and 2011, respectively.  The Company matches the employee’s contribution up to 6% of the employee’s annual compensation.  For the years ended December 31, 2009, 2010 and 2011, the total expense associated with this plan was $713,364, $742,288 and $733,161, respectively.

     The employees of BTC participate in a multiemployer Retirement and Security Program (“RSP”) as a defined benefit plan and a Savings Plan (“SP”) provided through the National Telecommunications Cooperative Association (“NTCA”).  Participation in the RSP requires a minimum employee contribution of 1% of their annual compensation.  The Company contributes 9.4%, 6.0%, and 6.0% for 2009, 2010 and 2011, respectively of their annual compensation for every participating employee.  On October 1, 2009, the Company reduced its contribution from 10.5% to 6%.  SP is a defined contribution savings plan under Section 401(k) of the Internal Revenue Code to which the Company made no contribution for 2009, 2010 and 2011.  The employee can make voluntary contributions to the SP as desired.  For the years ended December 31, 2009, 2010 and 2011 the total expense associated with these plans was $70,271, $60,030, $50,220, respectively.

XML

Consolidated Statements Of Operations (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Revenues	$ 101,843,567	$ 104,400,219	$ 103,755,454
Operating expenses
Cost of services and products	43,995,953	41,286,418	41,178,502
Selling, general and administrative expenses	12,984,686	13,074,794	14,164,465
Depreciation and amortization	20,232,833	23,670,243	26,485,628
Total operating expenses	77,213,472	78,031,455	81,828,595
Income from operations	24,630,095	26,368,764	21,926,859
Other income (expense)
Interest expense	(24,776,123)	(24,746,542)	(25,416,024)
Change in fair value of derivatives	2,229,893	(878,518)	(1,354,759)
Other income	363,482	556,820	359,484
Total other expense	(22,182,748)	(25,068,240)	(26,411,299)
Income (loss) before income tax	2,447,347	1,300,524	(4,484,440)
Income tax (expense) benefit	(249,929)	(609,809)	1,366,629
Net income (loss) available to common stockholders	$ 2,197,418	$ 690,715	$ (3,117,811)
Weighted average shares outstanding:
Basic	13,221,404	12,985,629	12,676,733
Diluted	13,221,404	13,221,404	13,221,404
Basic net income (loss) per share	$ 0.17	$ 0.05	$ (0.25)
Diluted net income (loss) per share	$ 0.17	$ 0.05	$ (0.25)
Dividends declared per share	$ 0.71	$ 0.71	$ 0.71

XML

Note 6 - Other Accounts Receivable

12 Months Ended

Dec. 31, 2011

Note 6 - Other Accounts Receivable Disclosure

Note 6 - Other Accounts Receivable

6.     Other Accounts Receivable

     Other accounts receivable consist of the following:

	December 31,
	2010		2011
Carrier access bills receivable	$	1,815,060	$	1,561,174
NECA receivable		1,041,206		682,016
Receivables from Alabama Service Fund		443,169		423,356
Wholesale contracts receivable		809,035		1,880,608
Other miscellaneous		190,618		901,920
	$	4,299,088	$	5,449,074

XML

Note 5 - Property And Equipment

12 Months Ended

Dec. 31, 2011

Note 5 - Property And Equipment Disclosure

Note 5 - Property And Equipment

5.     Property and Equipment

     A summary of property and equipment from continuing operations is shown as follows:

	Estimated		December 31,
	Life		2010			2011
Land			$	1,113,797		$	1,156,843
Building and improvements		20-40		11,530,062			12,246,942
Telephone equipment		6-20		211,279,443			227,825,838
Cable television equipment		7		10,368,161			10,918,212
Furniture and equipment		8-14		2,766,793			2,967,337
Vehicles		7-9		5,768,620			6,089,630
Computer software equipment		5-7		13,986,754			15,590,697
Internet equipment		5		3,707,226			3,923,314
Total property, plant and equipment				260,520,856			280,718,813
Accumulated depreciation and amortization				(196,633,643	)		(214,836,838	)
Net property, plant and equipment			$	63,887,213		$	65,881,975

The Company’s composite depreciation rate for property and equipment was 20.9%, 21.7% and 19.2% in 2009, 2010 and 2011, respectively.  Depreciation expense for the years ended December 31, 2009, 2010 and 2011 was $14,444,714, $13,837,560 and $11,891,474, respectively.  Amortization expense for telephone plant adjustment was $1,554,932, $1,554,932 and $1,216,739 for the years ended December 31, 2009, 2010 and 2011, respectfully.

XML

Note 17 - Revenue Concentrations

12 Months Ended

Dec. 31, 2011

Note 17 - Revenue Concentrations Disclosure

Note 17 - Revenue Concentrations

17.     Revenue Concentrations

     Revenues for interstate access services are based on reimbursement of costs and an allowed rate of return.  Revenues of this nature are received from the National Exchange Carrier Association in the form of monthly settlements.  Such revenues amounted to 10.8%, 9.9%, and 10.1% of the Company’s total revenues for the years ended December 31, 2009, 2010 and 2011, respectively.

     In connection with the acquisition of the CR Companies, the Company has a contract through 2012 with Time Warner Cable (“TW”) for the provision of wholesale network connections to TW’s customers in Maine and New Hampshire. TW represented approximately 10.7% and 11.7% of the consolidated revenue for the years ended December 31, 2010 and 2011, respectively.  Other unrelated telecommunications providers also pay the Company access revenue for terminating calls through us to TW’s customers.

XML

Note 13 - Income (loss ) Per Common Share And Potential Common Share

12 Months Ended

Dec. 31, 2011

Note 13 - Income (loss ) Per Common Share And Potential Common Share Disclosure

Note 13 - Income (loss ) Per Common Share And Potential Common Share

13.     Income (Loss) per Common Share and Potential Common Share

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

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

	For the Years Ended December 31,
	2009			2010		2011
Weighted average of common shares-basic		12,676,733			12,985,629		13,221,404
Effect of dilutive securities		544,671			235,775		-
Weighted average common shares and potential
common shares-diluted		13,221,404			13,221,404		13,221,404
Net icome (loss) available to common shareholders	$	(3,117,811	)	$	690,715	$	2,197,418
Net income (loss) per basic share	$	(0.25	)	$	0.05	$	0.17
Net income (loss) available to common stockholders	$	(3,117,811	)	$	690,715	$	2,197,418
Change in fair value of Class B derivative		(238,054	)		-		-
Net income (loss) available for diluted shares	$	(3,355,865	)	$	690,715	$	2,197,418
Net income (loss) per diluted share	$	(0.25	)	$	0.05	$	0.17

XML

Note 9 - Long-Term Debt

12 Months Ended

Dec. 31, 2011

Note 9 - Long-Term Debt Disclosure

Note 9 - Long-Term Debt

9.     Long-Term Debt

    The Company’s credit agreement with General Electric Capital Corporation, originally dated December 21, 2004, has been amended and restated on several occasions to reflect requirements for funds to complete two acquisitions and the use of proceeds from the Company’s successful offering of 3,000,000 IDS units on July 5, 2007.  On October 20, 2008, the Company completed its second amendment and restatement, increasing the principal balance from $64.6 million to $173.5 million on October 31, 2008 for the acquisition of the CR Companies, changing the variable margin, and extending the maturity from July 3, 2011 to October 31, 2013.  The variable margin based on leverage is 4% over LIBOR.  On November 9, 2010, August 8, 2009, and May 9, 2011, the Company made voluntary prepayments of $6.1 million, $5.0 million and $385,828, respectively, reducing the credit facility notes payable balance to $162.0 million at December 31, 2011.

     Long-term notes payable consists of the following:

	December 31,
	2010		2011
Term credit facility, General Electric Captial Corporation; variable interest rate of 4.29% and 4.29% at December 31, 2011. There are no scheduled principal payments. Interest payments are due on the last day of each LIBOR period or at one month intervals, whichever date comes first. Interest rate is the index rate plus the applicable term loan index margin or the applicable LIBOR rate plus the applicable term loan LIBOR margin. The Company also made voluntary prepayments of $5.0 million, $6.1 million, and $385,828 on August 8, 2009, November 9, 2010, and May 9, 2011, respectively. The unpaid balance will be due October 31, 2013	$	162,385,828	$	162,000,000
13% Senior subordinated notes, due 2019; interest payments are due quarterly. On July 5, 2007, the Company sold 3,000,000 IDS units that included $22,500,000 in senior subordinated debt and, $1,830,791 in premium paid for debt. On June 8, 2010, IDS units were issued in the conversion of Class B shares. Premium amortization for the years ended December 31, 2010 and 2011 was $92,307 and $103,640, respectively.		100,710,027		100,606,387
13% Senior subordinated notes, held separately, due 2019; interest payments are due quarterly.		8,500,000		8,500,000
Total long-term notes payable	$	271,595,855	$	271,106,387
Less: current portion		-		-
Long-term notes payable	$	271,595,855	$	271,106,387

     Associated with these long-term notes payable, the Company capitalized $8.1 million in deferred financing costs associated with the credit facility and the 13% senior subordinated notes put in place on December 21, 2004.  On July 3, 2006, an additional $1,545,743 in deferred financing costs was capitalized.  On July 5, 2007, $1,064,526 in deferred finance costs were written off associated with the reduction in long-term notes payable from the proceeds of the Company’s offering of 3,000,000 IDS units. On October 31, 2008, an additional $5,311,138 in deferred financing costs was capitalized associated with the acquisition of the CR Companies. $1,406,088 in deferred financing costs were written-off associated with the effective extinguishment of the existing indebtedness at time of closing.  The credit facility is secured by the total assets of the subsidiary guarantors.

     The Company has a revolving credit facility of $15,000,000.  There was no balance as of December 31, 2010 and 2011.  The interest rate is the index rate plus a variable margin or LIBOR rate plus a variable margin, whichever is applicable.  The margin at December 31, 2010 and 2011 was 4.0%.  The range of margins can vary from 3.5% to 4.25%, depending on our total debt leverage.  The Company pays a commitment fee of 0.50% per annum, payable quarterly in arrears, on the unused portion of the revolver loan.  The commitment fee expense was $76,042 for both years ended December 31, 2010 and 2011.

     The deferred financing costs related to the issuance of debt is capitalized and amortized over the life of the debt obligation.  Amortization of deferred financing costs is reflected in interest expense.  The amortization of deferred financing costs also includes unamortized loan cost that is expensed due to the related debt being extinguished.  The unamortized loan cost that was expensed and included in amortization expense for the years ended December 31, 2009, 2010 and 2011 was $1,351,906, $1,361,351 and $1,368,095, respectively.

Maturities of long-term debt for the next five years are as follows:

2012	$	-
2013		162,000,000
2014		-
2015		-
2016		-
Thereafter		107,660,531
Total principal	$	269,660,531
Unamortized premium		1,445,856
Total	$	271,106,387

The above schedule of maturities of long-term debt includes the premium paid for the debt associated with the 3,000,000 IDS units issued July 5, 2007.

The Company’s long-term notes payable agreement is subject to certain financial covenants and restrictions on indebtedness, financial guarantees, business combinations and other related items.  As of December 31, 2011, the Company is in compliance with all covenants.

XML

Note 7 - Investments

12 Months Ended

Dec. 31, 2011

Note 7 - Investments Disclosure

Note 7 - Investments

7.     Investments

     Investments consist of the following:

	December 31,
	2010		2011
Investment in CoBank stock	$	1,474,920	$	1,474,920
Rental property		423,154		397,644
Other miscellaneous		69,021		71,241
	$	1,967,095	$	1,943,805

     The investment in CoBank stock is carried at historical cost due to no readily determinable fair value for those instruments being available.  Management believes there has been no other than temporary impairment in such investment.  This investment consists of patronage certificates that represent ownership in the financial institution where the Company has, and in the past, had, debt.  These certificates yield dividends on an annual basis, and the investment is redeemed ratably subsequent to the repayment of the debt.

XML

Note 8 - Leases

12 Months Ended

Dec. 31, 2011

Note 8 - Leases Disclosure

Note 8 - Leases

8.     Leases

     Minimum future rental commitments under non-cancellable operating leases, primarily for real property and office facilities at December 31, 2011, consist of the following:

2012	$	594,758
2013		561,866
2014		242,734
2015		114,486
2016		93,093
Thereafter		388,470
	$	1,995,407

     Rent expense for the years ended December 31, 2009, 2010, and 2011 was $481,099, $499,928 and $599,569, respectively.

XML

Note 10 - Derivative And Hedge Activities

12 Months Ended

Dec. 31, 2011

Note 10 - Derivative And Hedge Activities Disclosure

Note 10 - Derivative And Hedge Activities

10.      Derivative and Hedge Activities

     An interest rate cap was purchased on December 21, 2004, coincident with the closing of our initial public offering. The interest rate cap was purchased to mitigate the risk of rising interest rates by capping the rate at 3% for the three month LIBOR index plus the applicable margin on $80 million in senior debt for five years. On July 5, 2007, the Company repaid $55,353,032 in debt, reducing its senior debt below the level of the rate cap. The balance of the cap at that time was considered as an investment and adjustments were made to accumulated other comprehensive income to reflect this change. On October 31, 2008, the Company implemented its second amended and restated credit agreement, increasing senior debt to $173.5 million in conjunction with the acquisition of the CR Companies. The full $80 million rate cap again became effective as a hedge from that date forward through the end of the rate cap on December 20, 2009.

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

     Changes in the fair value of the effective portion of the interest rate hedges are not included in earnings but are reported as a component of accumulated other comprehensive income.  Changes in the fair value of interest rate hedges which do not technically qualify for hedge accounting are reported in the change in fair value of derivatives on the statement of operations and reflected in earnings.

     The cost of the effective portion of the interest rate cap was 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.  The expense related to the ineffective portion of the interest rate cap in 2008 is reflected in the change in fair value of derivatives.  For the year ended December 31, 2009, the cost of the effective portion of the interest rate cap was $1,168,522.  The rate cap ended December 20, 2009.

XML

Note 15 - Fair Value Measurement

12 Months Ended

Dec. 31, 2011

Note 15 - Fair Value Measurement Disclosure

Note 15 - Fair Value Measurement

15.     Fair Value Measurement

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

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

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

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

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

In accordance with ASC 820, Fair Value Measurements and Disclosures, the following table represents the Company’s fair value hierarchy for its financial assets and liabilities as of December 31, 2010 and 2011:

	December 31, 2010
	Fair Value		Level 1 (1)		Level 2 (2)		Level 3 (3)
Liabilities
Interest rate swaps	$	2,471,331	$	-	$	2,471,331	$	-
Total liabilities	$	2,471,331	$	-	$	2,471,331	$	-
	Dectember 31, 2011
	Fair Value		Level 1 (1)		Level 2 (2)		Level 3 (3)
Liabilities
Interest rate swaps	$	241,438	$	-	$	241,438	$	-
Total liabilities	$	241,438	$	-	$	241,438	$	-

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

(2)  Significant other observable inputs.

(3)  Significant unobservable inputs.

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

XML

Consolidated Statements Of Changes In Stockholders' Equity (USD $)	Class A Common Stock	Class B Common Stock	Additional Paid-In Capital	Retained (Deficit)	Accumulated Other Comprehensive Income (Loss)	Total Stockholders' Equity (Deficit)
Balance at Dec. 31, 2008	$ 126,767	$ 5,447	$ 19,277,959	$ (3,870,923)	$ (1,160,759)	$ 14,378,491
Balance (in shares) at Dec. 31, 2008	12,676,733	544,671
Comprehensive Income
Net income (loss)				(3,117,811)		(3,117,811)
Change in value of interest rate cap					1,160,759	1,160,759
Total comprehensive income						(1,957,052)
Dividends declared			(8,937,097)			(8,937,097)
Balance at Dec. 31, 2009	126,767	5,447	10,340,862	(6,988,734)		3,484,342
Balance (in shares) at Dec. 31, 2009	12,676,733	544,671
Comprehensive Income
Net income (loss)				690,715		690,715
Total comprehensive income						690,715
Dividends declared			(9,225,091)			(9,225,091)
Class B conversion to Class A	5,447	(5,447)				0
Class B conversion to Class A (in shares)	544,671	(544,671)
Direct cost of Class B conversion			(194,053)			(194,053)
Balance at Dec. 31, 2010	132,214		921,718	(6,298,019)		(5,244,087)
Balance (in shares) at Dec. 31, 2010	13,221,404
Comprehensive Income
Net income (loss)				2,197,418		2,197,418
Total comprehensive income						2,197,418
Dividends declared			(921,718)	(8,399,368)		(9,321,086)
Balance at Dec. 31, 2011	$ 132,214			$ (12,499,969)		$ (12,367,755)
Balance (in shares) at Dec. 31, 2011	13,221,404

XML

Note 4 - Goodwill And Intangible Assets

12 Months Ended

Dec. 31, 2011

Note 4 - Goodwill And Intangible Assets Disclosure

Note 4 - Goodwill And Intangible Assets

4.     Goodwill and Intangible Assets

     In June 2001, FASB issued guidance included in ASC 350, Intangibles-Goodwill and Other.    ASC 350 requires that goodwill shall be tested for impairment.  The Company performs an annual impairment test to determine whether the carrying value of goodwill exceeds its fair market value.  We conducted our annual impairment test of goodwill as of October 1, 2011 and determined that no adjustment to the carrying value of goodwill for any reportable units was necessary.  Although the Company has only one reporting segment, it considers its three territories – Alabama, Missouri, and New England – to be reporting units for purposes of testing for impairment of goodwill.  The fair value exceeds the carrying value of the net assets for Alabama, Missouri, and New England by 8.7%, 11.0%, and 41.3%, respectively.  Goodwill for Alabama, Missouri, and New England represents 53.8%, 9.4%, and 36.8%, respectively, of the total goodwill for the Company.  As of December 31, 2011, we determined that no events or circumstances from October 1, 2011 through December 31, 2011 indicated that a further assessment was necessary.  Based on the results of its impairment test, the Company does not believe that there is an impairment of the goodwill balance at December 31, 2010 or 2011, respectively.

      Intangible assets are summarized as follows:

	December 31, 2010							December 31, 2011
	Carrying		Accumulated			Net		Carrying		Accumulated			Net
	Value		Amortization			Value		Value		Amortization			Value
Goodwill						$	188,190,078						$	188,954,840
Other intangible assets
Customer relationships	$	27,757,682	$	(11,773,248	)	$	15,984,434	$	29,429,882	$	(15,483,937	)	$	13,945,945
Contract relationships		19,600,000		(9,683,333	)		9,916,667		19,600,000		(13,066,667	)		6,533,333
Non competition		53,903		(20,962	)		32,941		95,103		(44,080	)		51,023
Trade Name		-		-			-		16,200		(810	)		15,390
Total	$	47,411,585	$	(21,477,543	)	$	25,934,042	$	49,141,185	$	(28,595,494	)	$	20,545,691

     These intangible assets have a range of 1 to 15 years of useful lives and utilize both the sum-of-the-years’ digits and straight-line methods of amortization, as appropriate.  The following table presents current and expected amortization expense of the existing intangible assets as of December 31, 2011 for each of the following periods:

Aggregate amortization expense:
For the year ended December 31, 2009	$	10,443,409
For the year ended December 31, 2010	$	8,271,338
For the year ended December 31, 2011	$	7,117,951
Expected amortization expense for the years ending December 31,
2012		6,038,437
2013		4,756,206
2014		3,475,031
2015		2,106,063
2016		1,054,458
Thereafter		3,115,496
Total	$	20,545,691

XML

Note 14 - Selected Quarterly Financial Data (unaudited )

12 Months Ended

Dec. 31, 2011

Note 14 - Selected Quarterly Financial Data (unaudited ) Disclosure

Note 14 - Selected Quarterly Financial Data (unaudited )

14.     Selected Quarterly Financial Data (unaudited)

	First Quarter			Second Quarter		Third Quarter		Fourth Quarter
Fiscal 2010:
Revenue	$	25,794,209		$	26,510,944	$	26,145,227	$	25,949,839
Operating income		5,868,729			7,011,337		6,727,966		6,760,732
Net income (loss)		(385,656	)		417,276		63,075		596,020
Net income (loss) per share, basic	$	(0.03	)	$	0.03	$	-	$	0.04
Net income (loss) per share, diluted	$	(0.03	)	$	0.03	$	-	$	0.04
Fiscal 2011:
Revenue	$	25,392,000		$	25,501,062	$	25,302,747	$	25,647,758
Operating income		5,320,713			7,326,611		6,124,154		5,858,617
Net income		4,654			1,283,277		885,462		24,025
Net income per share, basic	$	-		$	0.10	$	0.07	$	-
Net income per share, diluted	$	-		$	0.10	$	0.07	$	-