**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





(Mark
                One)ý
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934For
                the quarterly period ended March 31, 2007
              or ̈
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934For
                the transition period from to




Commission
      File Number: 1-32362




**OTELCO
      INC.**


(Exact
      name of registrant as specified in its charter)





Delaware
            
            52-2126395(State
                or other jurisdiction of incorporation or
            
            (I.R.S.
                Employer Identification No.)organization)505
                Third Avenue East, Oneonta, Alabama
            
            35121(Address
                of Principal Executive Offices)
            
            (Zip
                Code)


(205)
      625-3574





(Registrant’s
      telephone number, including area code)




N/A


(Former
      name, former address and former fiscal year, if changed since last
      report)




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




Yes ý No ̈




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




Large
      accelerated filer o  Accelerated
      filer ý Non-accelerated
      filer
o




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).




Yes  ̈  No ý




**APPLICABLE
      ONLY TO CORPORATE USERS:**




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




**Class**
            
            **Outstanding
                at May 9, 2007**Class
                A Common Stock ($0.01 par value per share)
            
            9,676,733Class
                B Common Stock ($0.01 par value per share)
            
            544,671










**OTELCO
      INC.**


**FORM
      10-Q**


**For
      the three month period ended March 31, 2007**


**TABLE
      OF CONTENTS**









**PART
      I FINANCIAL INFORMATION**


Item
                1.
            Financial
                Statements


Consolidated
                Balance Sheets as of December 31, 2006 and March 31,
                2007


Consolidated
                Statements of Income for the three months ended March 31, 2006 and
                2007


Consolidated
                Statements of Cash Flows for the three months ended March 31, 2006
                and
                2007


Notes
                to Consolidated Financial
                Statements


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


Item
                3.
            Quantitative
                and Qualitative Disclosures about Market
                Risk


Item
                4.
            Controls
                and Procedures





**PART
      II OTHER INFORMATION**


Item
                6.
            Exhibits







i


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




**FORWARD-LOOKING
      STATEMENTS**




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




1


**PART
      1. FINANCIAL INFORMATION**




**Item
      1. Financial Statements**




**OTELCO
                INC.**
              **CONSOLIDATED
                BALANCE SHEETS****December
                31,**
              **2006**
            
            **March
                31,**
              **2007****Assets**
            
            
            
            **(unaudited)**Current
                assetsCash
                and cash equivalents
            
            $
            14,401,849
            
            $
            10,641,424Accounts
                receivable:Due
                from subscribers, net of allowance for doubtful accounts of
              $207,359
                and $184,552 respectively
            
            
            3,105,636
            
            
            2,740,587Unbilled
                receivables
            
            
            2,324,213
            
            
            2,410,991Other
            
            
            1,680,144
            
            
            1,878,545Materials
                and supplies
            
            
            1,962,938
            
            
            2,020,599Prepaid
                expenses
            
            
            1,062,947
            
            
            804,447Deferred
                income taxes
            
            
            766,225
            
            
            832,946Total
                current assets
            
            
            25,303,952
            
            
            21,329,539Property
                and equipment, net
            
            
            60,493,789
            
            
            58,715,659Goodwill
            
            
            134,182,309
            
            
            134,403,170Intangible
                assets, net
            
            
            11,340,806
            
            
            10,884,297Investments
            
            
            1,240,250
            
            
            1,226,001Deferred
                financing costs
            
            
            6,652,393
            
            
            6,254,272Interest
                rate cap
            
            
            4,542,160
            
            
            3,922,585Deferred
                charges
            
            
            96,628
            
            
            89,896Total
                assets
            
            $
            243,852,287
            
            $
            236,825,419**Liabilities
                and Stockholders’ Equity (Deficit)**Current
                liabilitiesAccounts
                payable
            
            $
            1,658,911
            
            $
            1,035,816Dividends
                payable
            
            
            1,705,524
            
            
            -Accrued
                expenses
            
            
            5,875,863
            
            
            3,511,889Advance
                billings and payments
            
            
            2,119,701
            
            
            2,143,593Customer
                deposits
            
            
            197,496
            
            
            213,261Total
                Current Liabilities
            
            
            11,557,495
            
            
            6,904,559Deferred
                income taxes
            
            
            24,712,213
            
            
            24,778,934Other
                liabilities
            
            
            187,037
            
            
            180,082Total
                deferred tax and other liabilities
            
            
            24,899,250
            
            
            24,959,016Long-term
                notes payable
            
            
            201,075,498
            
            
            201,075,498Derivative
                liability
            
            
            2,107,877
            
            
            1,890,008Class
                B common convertible to senior subordinated notes
            
            
            4,085,033
            
            
            4,085,033Stockholders’
                Equity (Deficit)Class
                A Common Stock, $.01 par value-authorized 20,000,000 shares; issued
                and
                outstanding 9,676,733 shares
            
            
            96,767
            
            
            96,767Class
                B Common Stock, $.01 par value-authorized 800,000 shares; issued
                and
                outstanding 544,671 shares
            
            
            5,447
            
            
            5,447Additional
                paid in capital
            
            
            284,041
            
            
            -Retained
                deficit
            
            
            (1,137,166
            )
            
            (2,676,857
            )Accumulated
                other comprehensive income
            
            
            878,045
            
            
            485,948Total
                stockholders’ equity (deficit)
            
            
            127,134
            
            
            (2,088,695
            )Total
                liabilities and stockholders’ equity (deficit)
            
            $
            243,852,287
            
            $
            236,825,419


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




2





**OTELCO**
              **CONSOLIDATED
                STATEMENTS OF OPERATIONS****(unaudited)****Three
                months ended**
              **March
                31,****2006**
            
            **2007**RevenuesLocal
                services
            
            $
            4,303,399
            
            $
            6,348,496Network
                access
            
            
            5,145,055
            
            
            6,437,589Cable
                television
            
            
            542,506
            
            
            547,527Internet
            
            
            1,522,437
            
            
            2,820,298Transport
                services
            
            
            -
            
            
            1,018,483Total
                revenues
            
            
            11,513,397
            
            
            17,172,393Operating
                expensesCost
                of services and products
            
            
            3,174,687
            
            
            6,271,057Selling,
                general and administrative expenses
            
            
            1,671,341
            
            
            2,501,800Depreciation
                and amortization
            
            
            1,968,341
            
            
            3,629,091Total
                operatingexpenses
            
            
            6,814,369
            
            
            12,401,948Income
                from operations
            
            
            4,699,028
            
            
            4,770,445Other
                income (expense)Interest
                expense
            
            
            (4,549,475
            )
            
            (5,376,264
            )Change
                in fair value of derivative
            
            
            179,741
            
            
            217,868Other
                income
            
            
            187,239
            
            
            281,449Total
                otherexpense
            
            
            (4,182,495
            )
            
            (4,876,947
            )Income
                (loss) before income tax and accretion expense
            
            
            516,533
            
            
            (106,502
            )Income
                tax expense
            
            
            (161,210
            )
            
            (11,705
            )Income
                (loss) before accretion expense
            
            
            355,323
            
            
            (118,207
            )Accretion
                of Class B common convertible to senior subordinated notes
            
            
            (110,732
            )
            
            0Net
                income (loss) available to common stockholders
            
            $
            244,591
            
            $
            (118,207
            )Weighted
                average shares outstanding:Basic
            
            
            9,676,733
            
            
            9,676,733Diluted
            
            
            10,221,404
            
            
            10,221,404Net
                income (loss) per shareBasic
            
            $
            0.03
            
            $
            (0.01
            )Diluted
            
            $
            0.02
            
            $
            (0.03
            )Dividends
                declared per share
            
            $
            0.18
            
            $
            0.18






The
        accompanying notes are an integral part of these consolidated financial
        statements.
  3


**OTELCO**
              **CONSOLIDATED
                STATEMENTS OF CASH FLOWS****(unaudited)****Three
                months ended**
              **March
                31,****2006**
            
            **2007**Cash
                flows from operating activities:Net
                income (loss)
            
            $
            244,591
            
            $
            (118,207
            )Adjustments
                to reconcile net income to cash flows from operating
                activities:Depreciation
            
            
            1,916,918
            
            
            2,980,190Amortization
            
            
            51,424
            
            
            648,901Interest
                rate caplet
            
            
            162,962
            
            
            227,478Amortization
                of loan cost
            
            
            343,437
            
            
            398,121Accretion
                expense
            
            
            110,732
            
            
            -Change
                in fair value of derivative liability
            
            
            (179,741
            )
            
            (217,868
            )Provision
                for uncollectible revenue
            
            
            38,947
            
            
            17,242Changes
                in assets and liabilities, net of assets and liabilities
                acquired:Accounts
                receivables
            
            
            (31,976
            )
            
            (113,935
            )Material
                and supplies
            
            
            3,305
            
            
            (57,661
            )Prepaid
                expenses and other assets
            
            
            (9,089
            )
            
            258,500Accounts
                payable and accrued liabilities
            
            
            66,293
            
            
            (4,736,893
            )Advance
                billings and payments
            
            
            49,130
            
            
            23,892Other
                liabilities
            
            
            784
            
            
            8,810Net
                cash from operatingactivities
            
            
            2,767,717
            
            
            (681,430
            )Cash
                flows from investing activities:Acquisition
                and construction of property and equipment
            
            
            (1,158,880
            )
            
            (1,374,914
            )Proceeds
                from retirement of investment
            
            
            128,558
            
            
            7,871Deferred
                charges
            
            
            (14,890
            )
            
            (6,428
            )Net
                cash from investing activities
            
            
            (1,045,212
            )
            
            (1,373,471
            )Cash
                flows from financing activities:Cash
                dividends paid
            
            
            (1,705,524
            )
            
            (1,705,524
            )Net
                cash from financing activities
            
            
            (1,705,524
            )
            
            (1,705,524
            )Net
                increase (decrease) in cash and cash equivalents
            
            
            16,981
            
            
            (3,760,425
            )Cash
                and cash equivalents, beginning of period
            
            
            5,569,233
            
            
            14,401,849Cash
                and cash equivalents, end of period
            
            $
            5,586,214
            
            $
            10,641,424Supplemental
                disclosures of cash flow information:Interest
                paid
            
            $
            4,046,312
            
            $
            7,401,647Income
                taxes paid (received)
            
            $
            -
            
            $
            (173,718
            )






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


4




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(unaudited)**





**1.** **Organization
      and Basis of Financial Reporting**





**Basis
      of Presentation and Principles of Consolidation**


The
      consolidated financial statements include the accounts of Otelco Inc. (the
      “Company”), its wholly owned subsidiaries Otelco Telecommunications LLC, Otelco
      Telephone LLC, Hopper Holding Company, Inc. (“HHC”), Brindlee Holdings LLC
      (“BH”), Page & Kiser Communications, Inc. (“PKC”), Mid-Missouri Holding
      Corporation (“MMH”), and Mid-Maine Communications, Inc. (“Mid-Maine”). HHC’s
      wholly owned subsidiary is Hopper Telecommunications Company, Inc. BH’s owned
      subsidiary is Brindlee Mountain Telephone Company, Inc. PKC’s wholly owned
      subsidiary is Blountsville Telephone Company, Inc. MMH’s wholly owned subsidiary
      is Mid-Missouri Telephone Company (“MMT”). MMT is the sole stockholder of
      Imagination, Inc. Mid-Maine’s wholly owned subsidiaries are Mid-Maine Telecom,
      Inc. (“MMTI”) and Mid-Maine TelPlus (“MMTP”). The accompanying consolidated
      financial statements include the accounts of the Company and all of the
      aforesaid subsidiaries after elimination of all material intercompany balances
      and transactions.




The
      consolidated financial statements and footnotes included in this Form 10-Q
      should be read in conjunction with the consolidated financial statements and
      notes thereto included in the Company’s annual report on Form 10-K for the year
      ended December 31, 2006. The interim consolidated financial information herein
      is unaudited. The information reflects all adjustments (which include only
      normal recurring adjustments), which are, in the opinion of management,
      necessary for a fair presentation of the financial position and results of
      operations for the periods included in the report.





**2.** **Commitment
      and Contingencies**





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





**3.** **Derivative
      and Hedge Activities**





The
      interest rate cap was purchased on December 21, 2004, coincident with the
      closing of our initial public offering and the recapitalization of our senior
      notes payable. The interest rate cap was purchased to mitigate the risk of
      rising interest rates to limit or cap the rate at 7%. It is considered an
      effective hedge as all critical terms of the interest rate cap are identical
      to
      the underlying debt it hedges. Changes in the fair value of the interest rate
      cap are not included in earnings but are reported as a component of accumulated
      other comprehensive income. For the three months ended March 31, 2006 and 2007
      the change in the fair value of the interest rate cap was $876,453 and $392,097,
      respectively. The cost of the interest rate cap is expensed as interest over
      the
      effective life of the hedge in accordance with the quarterly value of the
      caplets as determined at the date of inception. For the three months ended
      March
      31, 2006 and 2007 the cost of the interest rate cap was $162,962 and $227,478,
      respectively.




5





**4.** **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 shares outstanding for the period. Diluted income
      (loss) per common share reflects the potential dilution that could occur if
      the
      Class B common stock were exercised into IDSs. Class B common stock is
      convertible on a one-for-one basis into IDSs, each of which includes a Class
      A
      common share. For periods prior to our conversion, membership units were treated
      on an as if converted basis into Class A and Class B common shares.




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




**Three
                months ended**
              **March
                31,****2006**
            
            **2007**Weighted
                average common shares-basic
            
            
            9,676,733
            
            
            9,676,733Effect
                of dilutive securities
            
            
            544,671
            
            
            544,671Weighted-average
                common shares and potential common shares-diluted
            
            
            10,221,404
            
            
            10,221,404Net
                income (loss) available to common stockholders
            
            
            244,591
            
            
            (118,207
            )$
            0.03
            
            $
            (0.01
            )Net
                Income (loss) per basic shareNet
                income (loss) available to common stockholders
            
            $
            244,591
            
            $
            (118,207
            )Plus:
                Accretion expense of Class B common convertible to senior subordinated
                notes
            
            
            110,732
            
            
            0Less:
                Change in fair value of derivative
            
            
            (179,741
            )
            
            (217,868
            )Net
                income (loss) available for diluted shares
            
            $
            175,582
            
            $
            (336,075
            )Net
                income (loss) per diluted share
            
            $
            0.02
            
            $
            (0.03
            )





**5.** **Acquisition**




On
      July
      3, 2006, the Company acquired 100% of the outstanding common stock of MMeT
      through a merger of MMeT with MM Merger Corp, with MMeT as the surviving
      wholly-owned subsidiary. MMeT owns 100% of two subsidiaries, MMTI and MMTP.
      MMeT
      provides telecommunications solutions, including voice, data and Internet
      services, to residential and business customers in portions of Maine and extends
      Otelco into the New England market.





The
      stated purchase price in the acquisition agreement was $37,750,000. The purchase
      price was $40,555,738, including transaction costs and the assumed notes payable
      of $24,347,299 which were paid off at closing. The excess of the purchase price
      over the market value of assets and liabilities is reflected as goodwill of
      $14,971,176. The goodwill related to the acquisition is not deductible for
      tax
      purposes. The aggregate consideration paid for the acquisition was as
      follows:





6




Cash
                paid
            
            $
            16,208,439Notes
                payable assumed
            
            
            24,347,299Purchase
                price
            
            $
            40,555,738





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





**July
                3, 2006**Cash
            
            $
            208,399Other
                current assets
            
            
            3,691,420Property
                and equipment
            
            
            20,180,158Intangible
                assets
            
            
            10,700,606Goodwill
            
            
            14,971,176Other
                assets
            
            
            2,367,842Current
                liabilities
            
            
            (3,074,876
            )Other
                liabilities
            
            
            (8,488,987
            )Purchase
                price
            
            $
            40,555,738





The
      intangible assets at time of acquisition included regulated and unregulated
      customer based assets fair valued at $8.8 million which have remaining lives
      of
      25 years. The customer base assets are being amortized over a 15 year life.
      Also, intangible assets included a non-competition agreement fair valued at
      $1.8
      million which had a remaining life of 2 years.





Concurrent
      with the closing of the acquisition, the Company entered into an amended and
      restated credit agreement, dated as of July 3, 2006, to amend and restate the
      credit agreement, dated as of December 21, 2004, by and among Otelco and the
      other credit parties to the agreement and General Electric Capital Corporation
      as a lender and agent for the lenders. The credit facilities under the amended
      and restated credit agreement are comprised of:





·
            Term
                loans of $120 million due July 3, 2011, consisting of an original
                term
                loan of $80 million, and an additional term loan of $40 million,
                used to
                finance the acquisition and related transaction costs and to provide
                working capital for the Company and its subsidiaries and for other
                corporate purposes; and





·
            A
                revolving loan commitment of up to $15
                million.





The
      term
      loan facility was fully drawn concurrent with closing. Interest rates applicable
      to the term loan and any revolving loans are an index rate plus 2.25% or LIBOR
      plus 3.25%. In addition, there are fees associated with undrawn revolver
      balances and certain annual fees. The Company has an $80 million interest rate
      cap through December 16, 2009 which caps LIBOR plus 3.25% margin at
      6.25%.





The
      acquisition was accounted for using the purchase method of accounting and
      accordingly, the accompanying 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 MMeT had occurred at
      the
      beginning of the preceding year. The results include certain adjustments,
      including increased interest expense on notes payable and 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.




7





**Unaudited**
              **Three
                months****ended**
              **March
                31, 2006**Revenues
            
            $
            17,365,460Income
                from operations
            
            
            4,920,517Net
                income
            
            
            67,036Basic
                net income per share
            
            $
            0.01Diluted
                net income per share
            
            $
            0.01




**6.** **Adoption
      of FIN 48**




In
      June
      2006, the Financial Accounting Standards Board issued FIN 48, *Accounting for
      Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,
      Accounting for Income Taxes*. The interpretation addresses the determination
      of whether tax benefits claimed or expected to be claimed on a tax return should
      be recorded in the financial statements. Under FIN 48, the Company may recognize
      the tax benefit from an uncertain tax position only if it is more likely than
      not that the tax position will be sustained on examination by the taxing
      authorities, based on the technical merits of the position. The tax benefits
      recognized in the financial statements from such a position should be measured
      based on the largest benefit that has a greater than fifty percent likelihood
      of
      being realized upon ultimate settlement. FIN 48 also provides guidance on
      derecognition, classification, interest and penalties on income taxes,
      accounting in interim periods and requires increased disclosures.




The
      Company adopted the provisions of FIN 48 on January 1, 2007. After application
      of the provisions of FIN 48, it was not necessary for the Company to recognize
      any liability for unrecognized tax benefits or adjustment to the balance of
      retained earnings as of January 1, 2007. The Company’s policy is to classify
      interest and penalties related to unrecognized tax benefits in income tax
      expense. As of January 1, 2007, the Company had no accrued interest and
      penalties related to unrecognized tax benefits.




As
      of
      January 1, 2007, after the implementation of FIN 48, the Company’s has no
      unrecognized tax benefits.




The
      Company and its subsidiaries file income tax returns in the U.S. federal
      jurisdiction and three state jurisdictions. For federal tax purposes, the
      Company’s 2003 through 2006 tax years remain open for examination by the tax
      authorities under the normal three year statute of limitations. Generally,
      for
      state tax purposes, the Company’s 2002 through 2006 tax years remain open for
      examination by the tax authorities under a four year statute of limitations
      The
      adoption of FIN No. 48 on January 1, 2007, did not have a material
      effect on the Company’s consolidated results of operations or financial
      condition.




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




**Overview**




***General***




Since
      1999, we have acquired and operate six rural local exchange carriers operating
      in portions of eleven counties in approximately 2,390 square miles of north
      central Alabama, central Maine and central Missouri. We are the sole wireline
      telephone services provider in the rural communities we serve. We also provide
      competitive telecommunications services through several subsidiaries. Our
      services include local and long distance telephone, network access, transport,
      digital high-speed and dial-up Internet access, cable television and other
      telephone related services. We view, manage and evaluate the results of
      operations from the various telephony products and services as one company
      and
      therefore have identified one reporting segment as it relates to providing
      segment information. As of March 31, 2007, we operated approximately 65,326
      total access line equivalents.




8


Our
      core
      businesses are local and long distance telephone services and the provision
      of
      network access to other wireline and wireless carriers for calls originated
      or
      terminated on our network. Our core businesses generated approximately 74.5%
      of
      our total revenues in the first quarter of 2007. We also provide cable
      television service in some markets, and dial-up and digital high-speed Internet
      access in all of our markets.




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




***Revenue
      Sources***




We
      derive
      our revenues from five sources:




·
            *Local
                services.*We
                receive revenues from providing local exchange telephone services.
                These
                revenues include monthly subscription charges for basic service,
                calling
                to adjacent communities on a per minute basis, long distance services,
                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 in our local
                communities. A growing portion of our subscribers take bundled service
                plans which include multiple services including domestic long distance
                services.




·
            *Network
                access services.*We
                receive revenues from charges established to compensate us for the
                origination, transport and termination of calls of long distance
                and other
                interexchange carriers. These include subscriber line charges imposed
                on
                end users and switched and special access charges paid by carriers.
                Switched access charges for long distance services within Alabama,
                Maine
                and Missouri are based on rates approved by the Alabama Public Service
                Commission (“APSC”), Maine Public Utilities Commission and Missouri Public
                Service Commission respectively. Switched and special access charges
                for
                interstate and international services are based on rates approved
                by the
                Federal Communications Commission.




·
            *Cable
                television services.*We
                offer basic, digital and pay per view cable television services to
                a
                portion of our telephone service territory in Alabama and Missouri.
                We
                expect to add high definition and DVR services in Alabama later in
                2007.




·
            *Internet
                services.*We
                receive revenues from monthly recurring charges for dial-up and digital
                high-speed Internet access, including dial-up customers throughout
                the
                State of Maine and in areas surrounding our Missouri service
                area.




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




***Access
      Line and Customer Trends***




The
      number of traditional access lines served is one
      of the fundamental factors in determining revenue stability for a
      telecommunications provider. Reflecting a general trend in the rural local
      exchange carrier industry, the number of access lines we serve has been
      decreasing gradually when normalized for territory acquisitions. We expect
      this
      trend to continue for the industry and our territory. Our competitive carrier
      access lines continue to grow as we further penetrate our chosen markets. The
      introduction of unlimited calling bundles may positively impact customer churn
      over time. The growth of our digital high-speed Internet access services will
      continue to reduce demand for second access lines for residential and small
      business customers. Our response to this trend will have an important impact
      on
      our future revenues. Our primary strategy consists of leveraging our strong
      incumbent market position and bundling services to meet customer communications
      needs, increasing revenue per access line.




9




**Year
                Ended December 31,**
            
            **March
                31,****2005**
            
            **2006**
            
            **2007**Access
                line equivalents (1):Residential
                access lines
            
            
            24,541
            
            
            29,832
            
            
            29,789Business
                access lines
            
            
            8,036
            
            
            22,171
            
            
            22,577Access
                lines
            
            
            32,577
            
            
            52,003
            
            
            52,366Digital
                high-speed lines
            
            
            6,314
            
            
            11,951
            
            
            12,960Total
                access lines equivalents
            
            
            38,891
            
            
            63,594
            
            
            65,326Long
                distance customers
            
            
            14,438
            
            
            21,370
            
            
            22,066Cable
                television customers
            
            
            4,220
            
            
            4,188
            
            
            4,211Dial-up
                Internet customers
            
            
            12,149
            
            
            19,587
            
            
            18,313





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




On
      July
      3, 2006, we completed the acquisition of Mid-Maine. Subscriber results for
      December 31, 2006 and March 31, 2007 include this acquisition.




In 2006, we
      introduced bundled service packages including unlimited domestic calling to
      our
      Alabama residential and all Missouri customers. As of March 31, 2007, over
      7,000
      customers signed up for one of these packages. Our digital high-speed Internet
      customers continue to grow from 11,951 customers at December 31, 2006, to 12,963
      at March 31, 2007. We expect continued revenue growth in this area of our
      business.




Our
      long
      distance customers increased 3.3% to 22,066 on March 31, 2007 from 21,370 on
      December 31, 2006. Our cable television customers increased slightly to 4,211
      as
      of March 31, 2007. We anticipate introducing high definition and digital video
      services in Alabama during the third quarter 2007. Dial-up Internet customers decreased 6.5% to 18,313 on March 31, 2007. This also includes the
      subscribers we service outside of our telephone service area in Missouri and
      throughout Maine and will continue to reflect the expected impact of the shift
      to digital high-speed Internet services.




***Our
      Rate and Pricing Structure***




Our
      Alabama companies are now regulated under the Alabama Communications Reform
      Act
      of 2005 (“ACRA”). State regulation under the provisions of ACRA began October
      31, 2006 for new services and on February 1, 2007 for existing services.
      Regulation under ACRA eliminates the APSC’s jurisdiction over retail telephone
      rates and service terms, with the exception of limited authority to enforce
      a
      statutory cap on certain non-bundled basic residential and business service
      and
      optional calling features. APSC retains jurisdiction over interconnection
      agreements, access charges and other wholesale arrangements. The APSC retains
      exclusive jurisdiction over residential service complaints but its authority
      is
      limited to enforcing the terms of service agreements and federal truth in
      billing requirements.




**Categories
      of Operating Expenses**




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




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




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




10


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




***Our
      Ability to Control Operating Expenses***




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




***Results
      of Operations***




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




**Three
                months ended**
              **March
                31,****2006**
            
            **2007**RevenuesLocal
                service
            
            
            37.4
            %
            
            37.0
            %Network
                access
            
            
            44.7
            
            
            37.5Cable
                television
            
            
            4.7
            
            
            3.2Internet
            
            
            13.2
            
            
            16.4Transport
            
            
            0.0
            
            
            5.9Total
                revenues
            
            
            100.00
            
            
            100.00Operating
                expensesCost
                of services and products
            
            
            27.6
            %
            
            36.5
            %Selling,
                general and administrative expenses
            
            
            14.5
            
            
            14.6Depreciation
                and amortization
            
            
            17.1
            
            
            21.1Total
                operating expenses
            
            
            59.2
            
            
            72.2Income
                from operations
            
            
            40.8
            
            
            27.8Other
                income (expense)Interest
                expense
            
            
            (39.5
            )
            
            (31.3
            )Change
                in fair value of derivative
            
            
            1.6
            
            
            1.3Other
                income
            
            
            1.6
            
            
            1.6Total
                other expense
            
            
            (36.3
            )
            
            (28.4
            )Income
                before income taxes
            
            
            4.5
            
            
            (0.6
            )Income
                tax expense
            
            
            (1.4
            )
            
            (0.1
            )Income
                before accretion expense
            
            
            3.1
            
            
            (0.7
            )Accretion
                of Class B common convertible to senior subordinated notes
            
            
            (1.0
            )
            
            0.0Net
                income available to common stockholders
            
            
            2.1
            %
            
            (0.7
            )%





***Three
      months ended March 31, 2007 compared to three months ended March 31,
      2006***




*Total
      Revenues.* Total
      revenues increased 49.2% in the three months ended March 31, 2007 to $17.2
      million from $11.5 million in the three months ended March 31, 2006. The primary
      reason for the increase is the acquisition of Mid-Maine on July 3, 2006. The
      tables below provide the components of our revenues for the three months ended
      March 31, 2007 compared to the same period of 2006.




11





*For
      the three months ended March 31, 2007 and 2006*




**Three
                Months Ended**
              **March
                31,**
            
            **Change****2006**
            
            **2007**
            
            **Amount**
            
            **Percent**(dollars
                in thousands)Local
                services
            
            $
            4,303
            
            $
            6,348
            
            $
            2,045
            
            
            47.5
            %Network
                access
            
            
            5,145
            
            
            6,438
            
            
            1,293
            
            
            25.1Cable
                television
            
            
            543
            
            
            548
            
            
            5
            
            
            0.9Internet
            
            
            1,522
            
            
            2,820
            
            
            1,298
            
            
            85.2Transport
                services
            
            
            -
            
            
            1,018
            
            
            1,018
            
            
            -Total
            
            $
            11,513
            
            $
            17,172
            
            $
            5,659
            
            
            49.2




Local
      services .
      Local
      services revenue increased 47.5% to $6.3 million in the three months ended March
      31,
      2007 from
      $4.3
      million in the three months ended March
      31,
      2006 .
      The
      addition of Mid-Maine accounted for an increase of $2.1 million. Our Alabama
      and
      Missouri local services revenue decreased $0.1 million, reflecting a decrease
      in
      access lines and directory revenue, partially offset by the increased feature
      and long distance revenue associated with bundled service offerings. Unlimited
      calling bundles in Alabama and Missouri represent 32% and 22% respectively
      of
      the relevant customer base.




Network
      access .
      Network
      access revenue increased 25.1% to $6.4 million in the three months ended March
      31,
      2007 from
      $5.1
      million in the three months ended March
      31,
      2006 .
      The
      addition of Mid-Maine accounted for an increase of $1.4 million. This increase
      was partially offset by a decline in universal service fund
      payments.




Cable
      television .
      Cable
      television revenue in the three months ended March
      31,
      2007 increased
      0.9% to $0.5 million which was slightly higher than in the three months ended March
      31,
      2006 .
      The
      increase was due to the impact of higher local advertising revenue.




Internet .
      Internet revenue increased 85.2% to $2.8 million in the three months ended March
      31,
      2007 from
      $1.5
      million in the three months ended March
      31,
      2006 .
      The
      addition of Mid-Maine accounted for an increase of $1.1 million. The balance
      of
      the increase reflects growth of more than 2,000 new digital high-speed Internet
      customers in the balance of the Company which more than offset the decline
      in
      dial-up Internet customers associated with the conversion to digital high-speed
      Internet.




Transport
      Services .
      The
      addition of $1.0 million in transport services revenue is attributable to the
      acquisition of Mid-Maine on July 3, 2006.




*Operating
      expenses.* Operating
      expenses in the three months ended March 31, 2007 increased 82.0% to $12.4
      million from $6.8 million in the three months ended March 31, 2006. The primary
      reason for the increase is the acquisition of Mid-Maine on July 3,
      2006.




*For
      the three months ended March 31, 2007 and 2006*




**Three
                Months Ended**
              **March
                31,**
            
            **Change****2006**
            
            **2007**
            
            **Amount**
            
            **Percent**(dollars
                in thousands)Cost
                of services
            
            $
            3,175
            
            $
            6,271
            
            $
            3,096
            
            
            97.5
            %Selling,
                general and administrative expenses
            
            
            1,671
            
            
            2,502
            
            
            831
            
            
            49.7Depreciation
                and amortization
            
            
            1,968
            
            
            3,629
            
            
            1,661
            
            
            84.4Total
            
            $
            6,814
            
            $
            12,402
            
            $
            5,588
            
            
            82.0





12




Cost
      of services and products .
      Cost of
      service and products increased 97.5% to $6.3 million in the three months ended
      March 31, 2007 from $3.2 million in the three months ended March 31, 2006.
      The
      addition of Mid-Maine accounted for the increase, including providing
      competitive local exchange services in Maine. The increased cost associated
      with
      higher digital high-speed Internet customers and bundled services usage in
      Alabama and Missouri was offset by savings from handling our Internet help
      desk
      internally and by network and organizational efficiencies.




Selling,
      general and administrative expenses .
      Selling, general and administrative expenses increased 49.7% to $2.5 million
      in
      the three months ended March 31, 2007 from $1.7 million in the three months
      ended March 31, 2006. The addition of Mid-Maine accounted for the increase
      of
      $0.8 million.




Depreciation
      and amortization .
      Depreciation and amortization increased 84.4% to $3.6 million in the three
      months ended March 31, 2007 from $2.0 million in the three months ended March
      31, 2006. An increase of $1.5 million is associated with the acquisition of
      Mid-Maine, including the amortization of intangibles of $8.8 million for
      customer based assets with an effective life of 15 years and $1.8 million for
      a
      non-competition agreement with a remaining life of two years; and a telephone
      plant adjustment associated with the purchase price allocation. The balance
      of
      $0.1 million is associated with higher depreciation in Alabama and
      Missouri.




*Interest
      expense.* Interest
      expense increased 18.2% to $5.4 million in the three months ended March 31,
      2007
      from $4.5 million in the three months ended March 31, 2006. The senior credit
      facility was amended to add $40 million for the purchase of Mid-Maine. Interest
      on this additional debt was the primary reason for the increase, which was
      partially offset by a reduction from 4.0% to 3.25% in the margin charged on
      LIBOR rates for the full $120 million facility. Increased amortization of costs
      associated with the five year, $80 million, 7% interest rate cap and
      amortization of costs associated with the amended credit facility accounted
      for
      the balance of the increase.




*Change
      in fair value of derivative associated with Class B common convertible to Class
      A common.* The
      derivative value associated with the conversion option for our Class B common
      stock must be fair valued each quarter until conversion occurs, not later than
      December 21, 2009. The reduction in maximum time to conversion, the change
      in
      price of IDSs and the underlying Class A common stock and the expected time
      for
      conversion impact the fair value of the derivative. The combination of these
      factors changed the value of the derivative by less than $0.1 million in the
      three months ended March 31, 2007 compared to the three months ended March
      31,
      2006.




*Other
      income.* Other
      income was $0.3 million in the three months ended March 31, 2007, up from $0.2
      million in the three months ended March 31, 2006, primarily related to higher
      interest income on higher cash balances.




*Income
      taxes.* Provision
      for income taxes was less than $0.1 million in the three months ended March
      31,
      2007 compared to $0.2 million in the three months ended March 31, 2006.




*Accretion
      of Class B common convertible to senior subordinated notes.* Our
      Class
      B common stock was issued to the existing equity holders coincident with our
      initial public offering on December 21, 2004. These shares represent their
      retained interest in the Company. They do not receive any dividends and will
      convert into IDSs not later than December 21, 2009. For the first two years
      after their issuance, the present value discount on the portion of the shares
      related to the conversion to senior subordinated notes was accreted as a
      non-cash expense to the Company. The process was completed in 2006.




*Net
      income (loss).* As
      a
      result of the foregoing, there was a net loss of $0.1 million available to
      common stockholders in the three months ended March 31, 2007 compared to net
      income of $0.2 million in the three months ended March 31, 2006.




**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,
      (iii) working capital requirements; (iv) dividend payments on our Class A common
      stock; and (v) potential acquisitions.




13


Cash
      flows from operating activities for the first three months of 2007 amounted
      to
      ($0.7) million compared to $2.8 million for the first three months of 2006.
      The
      primary difference relates to the impact of acquiring Mid-Maine, the payment
      of
      the $4.3 million for the fourth quarter of 2006 distribution to IDS holders
      occurring on January 2, 2007 rather than December 30, 2006 (which is a
      Saturday), the $1.6 million in depreciation and amortization of loan cost and
      fair valued intangible assets of Mid-Maine, and receipt of $0.2 million in
      income tax refunds.




Cash
      flows from investing activities in the first three months of 2007 were $1.4
      million compared to $1.0 million in the first three months of 2006. The
      acquisition and construction of property and equipment utilized $0.2 million
      more in the first three months of 2007 than in the same period of 2006,
      reflecting higher expenditures associated with the Mid-Maine acquisition. The
      balance reflected the sale of an asset in 2006.




Cash
      flows from financing activities for the first three months of 2007 and 2006
      used
      $1.7 million, reflecting payment of dividends to shareowners in both periods.




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




**Subsequent
      Events**




On
      May 3,
      2007, we filed a registration statement on Form S-3 to offer up to 3,450,000
      Income Deposit Securities (IDSs) in the United States and Canada representing
      an
      aggregate of 3,450,000 shares of our Class A common stock and $25,875,000
      aggregate principal amount of our 13% senior subordinated notes due 2019. Our
      IDSs are listed on the American Stock Exchange under the symbol “OTT” and on the
      Toronto Stock Exchange under the symbol “OTT.UN”.




**Item
      3. Quantitative and Qualitative Disclosures About Market
      Risk**




Our
      short-term excess cash balance is invested in short-term commercial paper.
      We do
      not invest in any speculative derivative or commodity type instruments.
      Accordingly, we are subject to minimal market risk on our
      investments.




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




**Item
      4. Controls and Procedures**




With
      the
      participation of the Chief Executive Officer and the Chief Financial Officer,
      management has evaluated the effectiveness of our disclosure controls and
      procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
      of
      1934). Based on that evaluation, the Chief Executive Officer and Chief Financial
      Officer concluded that our disclosure controls and procedures were effective
      as
      of March 31, 2007.




There
      were no changes in our internal control over financial reporting (as defined
      in
      Rule 13a-15(f) under the Securities Exchange Act of 1934) during the three
      months ended March 31, 2007 that materially affected, or are reasonably likely
      to materially affect, our internal control over financial reporting.





**PART
      II OTHER INFORMATION**





**Item.
      6. Exhibits**




Exhibits




See
      Exhibit Index.


14


**Signatures**




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




Date:
                  May 9, 2007
              **OTELCO
                  INC.**By:
                  /s/ Curtis L. Garner, Jr.Curtis
                  L. Garner, Jr.Chief
                  Financial Officer









**EXHIBIT
      INDEX**





**Exhibit
                No.**
            
            **Description**31.1
            
            Certificate
                pursuant to Rule 13A-14(a) or Rule 15d-14(a) of the Securities Exchange
                Act of 1934 of the Chief Executive Officer31.2
            
            Certificate
                pursuant to Rule 13A-14(a) or Rule 15d-14(a) of the Securities Exchange
                Act of 1934 of the Chief Financial Officer32.1
            
            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
                Officer32.2
            
            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