**Table          of Contents**

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**UNITED      STATES**

**SECURITIES      AND EXCHANGE COMMISSION**

**Washington,      D.C. 20549**

**FORM      10-Q**

| (Mark                One) |                                                                                                                                  |
|---------------------------|---------------------------------------------------------------------------------------------------------------------------------------|
|                      |                                                                                                                                  |
| ý                    | QUARTERLY                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE                ACT OF                1934  |
|                      |                                                                                                                                  |
|                      | For                the quarterly period ended September 30, 2006or                                                                    |
|                      |                                                                                                                                  |
|  ̈                    | TRANSITION                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE                ACT OF                1934 |
|                      | For                the transition period from __________ to                __________                                                 |

**OTELCO      INC.**

| 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)                           |
|                                                            |   |                                                |

**APPLICABLE      ONLY TO CORPORATE USERS:**

| **Class**                                                       |   | **Outstanding                at November 6, 2006** |
|-----------------------------------------------------------------|--------|----------------------------------------------------|
| Class                A Common Stock ($0.01 par value per share) |   | 9,676,733                                          |
|                                                            |   |                                               |
| Class                B Common Stock ($0.01 par value per share) |   | 544,671                                            |

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**Table        of Contents**

**OTELCO      INC.**

**FORM      10-Q**

**For      the three month period ended September 30, 2006**

**TABLE      OF CONTENTS**

**PART      I   FINANCIAL INFORMATION**

|   | Consolidated                Balance Sheets as of December 31, 2005 and                September 30, 2006 |
|--------|----------------------------------------------------------------------------------------------------------|

|   | Consolidated                Statements of Income for the three months and                nine months ended September 30, 2005 and                2006 |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | Consolidated                Statements of Cash Flows for the nine months ended                September 30, 2005 and 2006 |
|--------|---------------------------------------------------------------------------------------------------------------------------|

|   | Notes                to Consolidated Financial                Statements |
|--------|--------------------------------------------------------------------------|

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

| Item                3. | Quantitative                and Qualitative Disclosures about Market                Risk |
|------------------------|------------------------------------------------------------------------------------------|

| Item                4. | Controls                and                Procedures |
|------------------------|-------------------------------------------------------|

**PART      II   OTHER INFORMATION**

| Item                6. | Exhibits |
|------------------------|----------|

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

**FORWARD-LOOKING      STATEMENTS**

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**Table          of Contents**

| **OTELCO                  INC.**                                  |
|-------------------------------------------------------------------|
| **CONSOLIDATED                  BALANCE                  SHEETS** |

|                                                                                                     |   | **December                  31,** |        | **September                  30,** |   |
|----------------------------------------------------------------------------------------------------------|--------|-----------------------------------|-------------|------------------------------------|--------|
|                                                                                                     |   | **2005**                          |        | **2006**                           |   |
| **Assets**                                                                                               |   |                              |        | **(unaudited)**                    |   |
| Current                    assets                                                                        |   |                              |        |                               |   |
| Cash                  and cash equivalents                                                               |   | $                                 | 5,569,233   |                               | $      | 14,691,890 |   |
| Accounts                  receivable:                                                                    |   |                              |        |                               |   |   |   |
| Due                  from subscribers, net of allowance for doubtful                                     |   |                              |        |                               |   |   |   |
| accounts                  of $163,028 and $198,088 respectively                                          |   |                              | 1,212,909   |                               |   | 2,931,832 |   |
| Unbilled                  receivables                                                                    |   |                              | 1,828,104   |                               |   | 2,302,904 |   |
| Other                                                                                                    |   |                              | 1,482,171   |                               |   | 1,773,234 |   |
| Materials                  and supplies                                                                  |   |                              | 932,861     |                               |   | 1,986,975 |   |
| Prepaid                  expenses                                                                        |   |                              | 504,256     |                               |   | 595,477 |   |
| Income                  tax receivables                                                                  |   |                              | 749,591     |                               |   | 749,591 |   |
| Deferred                  income taxes                                                                   |   |                              | 872,675     |                               |   | 872,675 |   |
| Total                  current assets                                                                    |   |                              | 13,151,800  |                               |   | 25,904,578 |   |
|                                                                                                     |   |                              |        |                               |   |   |   |
| Property                  and equipment, net                                                             |   |                              | 44,555,611  |                               |   | 62,026,887 |   |
| Goodwill                                                                                                 |   |                              | 119,431,993 |                               |   | 134,226,762 |   |
| Intangible                  assets, net                                                                  |   |                              | 1,588,079   |                               |   | 11,709,781 |   |
| Investments                                                                                              |   |                              | 1,108,249   |                               |   | 1,244,888 |   |
| Deferred                  financing costs                                                                |   |                              | 6,971,610   |                               |   | 7,205,426 |   |
| Interest                  rate cap                                                                       |   |                              | 5,318,728   |                               |   | 4,807,755 |   |
| Deferred                  costs                                                                          |   |                              | —     |                               |   | 67,921 |   |
| Total                  assets                                                                            |   | $                                 | 192,126,070 |                               | $      | 247,193,998 |   |
|                                                                                                     |   |                              |        |                               |   |   |   |
| **Liabilities                  and Stockholders' Equity**                                                |   |                              |        |                               |   |   |   |
| Current                  liabilities                                                                     |   |                              |        |                               |   |   |   |
| Accounts                  payable                                                                        |   | $                                 | 1,106,114   |                               | $      | 2,105,577 |   |
| Accrued                  expenses                                                                        |   |                              | 1,692,841   |                               |   | 9,517,809 |   |
| Advance                  billings and payments                                                           |   |                              | 1,204,680   |                               |   | 2,231,842 |   |
| Customer                  deposits                                                                       |   |                              | 213,524     |                               |   | 217,605 |   |
| Total                  current liabilities                                                               |   |                              | 4,217,159   |                               |   | 14,072,833 |   |
|                                                                                                          |   |                              |        |                               |   |   |   |
| Deferred                  income taxes                                                                   |   |                              | 15,345,890  |                               |   | 23,722,135 |   |
| Other                  liabilities                                                                       |   |                              | 192,769     |                               |   | 185,098 |   |
| Total                  deferred tax and other liabilities                                                |   |                              | 15,538,659  |                               |   | 23,907,233 |   |
|                                                                                                     |   |                              |        |                               |   |   |   |
| Long-term                  notes payable                                                                 |   |                              | 161,075,498 |                               |   | 201,075,498 |   |
| Derivative                  liability                                                                    |   |                              | 1,830,095   |                               |   | 1,492,399 |   |
| Class                  B common convertible to senior subordinated notes                                 |   |                              | 3,655,454   |                               |   | 3,987,649 |   |
|                                                                                                     |   |                              |        |                               |   |   |   |
| Stockholders'                  Equity                                                                    |   |                              |        |                               |   |   |   |
| Class                  A Common Stock, $.01 par value-authorized 20,000,000                  shares;     |   |                              |        |                               |   |   |   |
| issued                  and outstanding 9,676,733 shares                                                 |   |                              | 96,767      |                               |   | 96,767 |   |
| Class                  B Common Stock, $.01 par value-authorized 800,000 shares;                  issued |   |                              |        |                               |   |  |   |
| and                  outstanding 544,671 shares                                                          |   |                              | 5,447       |                               |   | 5,447 |   |
| Additional                  paid in capital                                                              |   |                              | 5,613,703   |                               |   | 1,989,566 |   |
| Retained                  deficit                                                                        |   |                              | (805,731    | )                                  |   | (364,761 | ) |
| Accumulated                  other comprehensive income                                                  |   |                              | 899,019     |                               |   | 931,367 |   |
| Total                  stockholders' equity                                                              |   |                              | 5,809,205   |                               |   | 2,658,386 |   |
| Total                  liabilities and stockholders' equity                                              |   | $                                 | 192,126,070 |                               | $      | 247,193,998 |   |
|                                                                                                     |   |                              |        |                               |   |   |   |
|                                                                                                          |   |                              |        |                               |   |   |   |

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**Table          of Contents**

| **OTELCO                INC.****CONSOLIDATED                STATEMENTS OF INCOME**(unaudited) |
|-----------------------------------------------------------------------------------------------|

|                                                                 |   | **Three                months ended****September                30,** |                           | **Nine                months ended****September                30,** |   |
|----------------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------------------------------|----------------------------------------------------------------------|--------|
|                                                                 |   | **2005**                                                              |                           | **2006**                                                             |   | **2005** |   | **2006** |   |
| Revenues                                                             |   |                                                                  |                           |                                                                 |   |   |   |   |   |
| Local                services                                        |   | $                                                                     | 4,383,431                      |                                                                 | $      | 6,387,561 |   | $ | 13,153,081 |   | $ | 15,043,360 |   |
| Network                access                                        |   |                                                                  | 5,324,589                      |                                                                 |   | 6,533,743 |   |   | 16,289,223 |   |   | 16,849,379 |   |
| Cable                television                                      |   |                                                                  | 533,812                        |                                                                 |   | 550,914 |   |   | 1,545,990 |   |   | 1,631,985 |   |
| Internet                                                             |   |                                                                  | 1,417,485                      |                                                                 |   | 2,725,156 |   |   | 4,140,643 |   |   | 5,743,860 |   |
| Transport                services                                    |   |                                                                  |       |                                                                 |   | 939,598 |   |   |          |   |   | 939,598 |   |
| Total                revenues                                        |   |                                                                  | 11,659,317                     |                                                                 |   | 17,136,972 |   |   | 35,128,937 |   |   | 40,208,182 |   |
| Operating                expenses                                    |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Cost                of services and products                         |   |                                                                  | 3,282,787                      |                                                                 |   | 6,139,234 |   |   | 9,356,381 |   |   | 12,501,035 |   |
| Selling,                general and administrative expenses          |   |                                                                  | 1,585,280                      |                                                                 |   | 2,451,391 |   |   | 4,912,279 |   |   | 5,604,055 |   |
| Depreciation                and amortization                         |   |                                                                  | 2,375,266                      |                                                                 |   | 4,031,841 |   |   | 7,111,459 |   |   | 8,696,215 |   |
| Total                operating expenses                              |   |                                                                  | 7,243,333                      |                                                                 |   | 12,622,466 |   |   | 21,380,119 |   |   | 26,801,305 |   |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Income                from operations                                |   |                                                                  | 4,415,984                      |                                                                 |   | 4,514,506 |   |   | 13,748,818 |   |   | 13,406,877 |   |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Other                income (expense)                                |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Interest                expense                                      |   |                                                                  | (4,131,073                     | )                                                                    |   | (4,998,563 | ) |   | (12,166,821 | ) |   | (13,445,668 | ) |
| Change                in fair value of derivative                    |   |                                                                  | 305,016                        |                                                                 |   | 27,234 |   |   | 920,494 |   |   | 337,696 |   |
| Other                income                                          |   |                                                                  | 58,662                         |                                                                 |   | 201,419 |   |   | 379,353 |   |   | 3,197,927 |   |
| Total                other expense                                   |   |                                                                  | (3,767,395                     | )                                                                    |   | (4,769,910 | ) |   | (10,866,974 | ) |   | (9,910,045 | ) |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Income                (loss) before income tax and accretion expense |   |                                                                  | 648,589                        |                                                                 |   | (255,404 | ) |   | 2,881,844 |   |   | 3,496,832 |   |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Income                tax expense                                    |   |                                                                  | (41,601                        | )                                                                    |   | 1,375 |   |   | (607,822 | ) |   | (1,231,235 | ) |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Income                (loss) before accretion expense                |   |                                                                  | 606,988                        |                                                                 |   | (254,029 | ) |   | 2,274,022 |   |   | 2,265,597 |   |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Accretion                of Class B common convertible to senior     |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| subordinated                notes                                    |   |                                                                  | (110,732                       | )                                                                    |   | (110,732 | ) |   | (332,194 | ) |   | (332,195 | ) |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Net                income (loss) available to common stockholders    |   | $                                                                     | 496,256                        |                                                                 | $      | (364,761 | ) | $ | 1,941,828 |   | $ | 1,933,402 |   |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Weighted                average shares outstanding:                  |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Basic                                                                |   |                                                                  | 9,676,733                      |                                                                 |   | 9,676,733 |   |   | 9,676,733 |   |   | 9,676,733 |   |
| Diluted                                                              |   |                                                                  | 10,221,404                     |                                                                 |   | 10,221,404 |   |   | 10,221,404 |   |   | 10,221,404 |   |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Net                income (loss) per share                           |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Basic                                                                |   | $                                                                     | 0.05                           |                                                                 | $      | (0.04 | ) | $ | 0.20 |   | $ | 0.20 |   |
| Diluted                                                              |   | $                                                                     | 0.03                           |                                                                 | $      | (0.03 | ) | $ | 0.13 |   | $ | 0.19 |   |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
| Dividends                declared per share                          |   | $                                                                     | 0.18                           |                                                                 | $      | 0.18 |   | $ | 0.53 |   | $ | 0.53 |   |
|                                                                 |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |
|                                                                      |   |                                                                  |                           |                                                                 |   |   |   |   |   |   |   |   |   |

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**Table          of Contents**

| **OTELCO                INC.**                                      |
|---------------------------------------------------------------------|
| **CONSOLIDATED                STATEMENTS OF CASH FLOWS**(unaudited) |

|                                                                                                           |   | **Nine                months ended****September                30,** |       |
|----------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|------------|
|                                                                                                           |   | **2005**                                                             |       | **2006** |   |
| Cash                flows from operating activities:                                                           |   |                                                                 |       |   |   |
| Net                income                                                                                      |   | $                                                                    | 1,941,828  |   | $ | 1,933,402 |   |
| Adjustments                to reconcile net income to cash flows from operating                activities:     |   |                                                                 |       |   |   |  |   |
| Depreciation                                                                                                   |   |                                                                 | 5,772,431  |   |   | 6,390,925 |   |
| Amortization                                                                                                   |   |                                                                 | 1,339,027  |   |   | 1,890,831 |   |
| Interest                rate caplet                                                                            |   |                                                                 | 130,739    |   |   | 543,321 |   |
| Accretion                expense                                                                               |   |                                                                 | 332,194    |   |   | 332,195 |   |
| Change                in fair value of derivative liability                                                    |   |                                                                 | (920,494   | ) |   | (337,695 | ) |
| Provision                for uncollectible revenue                                                             |   |                                                                 | —    |   |   | 123,979 |   |
| Gain                on disposition of other assets                                                             |   |                                                                 | 84,197     |   |   | (2,686,745 | ) |
| Changes                in assets and liabilities; net of assets and liabilities                acquired:       |   |                                                                 |       |   |   |  |   |
| Accounts                receivables                                                                            |   |                                                                 | 18,393     |   |   | (155,522 | ) |
| Material                and supplies                                                                           |   |                                                                 | 71,282     |   |   | (20,652 | ) |
| Income                tax receivable                                                                           |   |                                                                 | —    |   |   | 287,804 |   |
| Prepaid                expenses and other assets                                                               |   |                                                                 | 60,367     |   |   | 101,675 |   |
| Accounts                payable and accrued liabilities                                                        |   |                                                                 | (427,017   | ) |   | 4,888,886 |   |
| Advance                billings and payments                                                                   |   |                                                                 | (71,831    | ) |   | 1,888 |   |
| Other                liabilities                                                                               |   |                                                                 | 11,105     |   |   | (3,860 | ) |
|  Net                cash from operating activities                                                        |   |                                                                 | 8,342,221  |   |   | 13,290,432 |   |
|                                                                                                           |   |                                                                 |       |   |   |   |   |
| Cash                flows from investing activities:                                                           |   |                                                                 |       |   |   |   |   |
| Acquisition                and construction of property and equipment                                          |   |                                                                 | (3,339,695 | ) |   | (3,662,910 | ) |
| Proceeds                from retirement of investment                                                          |   |                                                                 | 122,914    |   |   | 3,226,651 |   |
| Payment                for the purchase of Mid-Missouri Holding Corp, net of cash                acquired      |   |                                                                 | 29,683     |   |   | — |   |
| Payment                for the purchase of Mid-Maine Communications, Inc., net of cash                acquired |   |                                                                 | —    |   |   | (15,905,248 | ) |
| Deferred                costs                                                                                  |   |                                                                 | —    |   |   | (67,921 | ) |
|  Net                cash from investing activities                                                        |   |                                                                 | (3,187,098 | ) |   | (16,409,428 | ) |
|                                                                                                           |   |                                                                 |       |   |   |   |   |
| Cash                flows from financing activities:                                                           |   |                                                                 |       |   |   |   |   |
| Cash                dividends paid                                                                             |   |                                                                 | (5,116,572 | ) |   | (3,411,048 | ) |
| Proceeds                from long-term notes payable                                                           |   |                                                                 | —    |   |   | 40,000,000 |   |
| Repayment                of long-term notes payable                                                            |   |                                                                 | —    |   |   | (24,347,299 | ) |
| Loan                origination costs and transaction cost                                                     |   |                                                                 | (68,406    | ) |   | — |   |
|  Net                cash from financing activities                                                        |   |                                                                 | (5,184,978 | ) |   | 12,241,653 |   |
|                                                                                                           |   |                                                                 |       |   |   |   |   |
| Net                increase (decrease) in cash and cash equivalents                                            |   |                                                                 | (29,855    | ) |   | 9,122,657 |   |
| Cash                and cash equivalents, beginning of period                                                  |   |                                                                 | 5,406,545  |   |   | 5,569,233 |   |
|                                                                                                           |   |                                                                 |       |   |   |   |   |
| Cash                and cash equivalents, end of period                                                        |   | $                                                                    | 5,376,690  |   | $ | 14,691,890 |   |
|                                                                                                           |   |                                                                 |       |   |   |   |   |
| Supplemental                disclosures of cash flow information:                                              |   |                                                                 |       |   |   |   |   |
| Interest                paid                                                                                   |   | $                                                                    | 12,317,453 |   | $ | 12,130,902 |   |
| Income                taxes received                                                                           |   | $                                                                    | (357,226   | ) | $ | (262,632 | ) |
| Dividends                declared but not paid                                                                 |   | $                                                                    | —    |   | $ | 1,705,524 |   |
|                                                                                                           |   |                                                                 |       |   |   |   |   |
|                                                                                                                |   |                                                                 |       |   |   |   |   |

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**Table          of Contents**

**NOTES      TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

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

***Basis      of Presentation and Principles of Consolidation***

| **2.** | **Commitment                and Contingencies** |
|--------|-------------------------------------------------|

| **3.** | **Derivative                and Hedge Activities** |
|--------|----------------------------------------------------|

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**Table          of Contents**

| **4.** | **Income                per Common Share and Potential Common                Share** |
|--------|--------------------------------------------------------------------------------------|

|                                                                |   | For                  the three months |       | For                  the nine months |   |
|---------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|--------|
|                                                                |   | ended                  September 30,  |       | ended                  September 30, |   |
|                                                                |   | 2005                                  |       | 2006                                 |   | 2005 |   | 2006 |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |
| Weighted                  average common shares-basic               |   |                                  | 9,676,733  |                                 |   | 9,676,733 |   |   | 9,676,733 |   |   | 9,676,733 |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| Effect                  of dilutive securities                      |   |                                  | 544,671    |                                 |   | 544,671 |   |   | 544,671 |   |   | 544,671 |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| Weighted-average                  common shares and potential       |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| common                  shares-diluted                              |   |                                  | 10,221,404 |                                 |   | 10,221,404 |   |   | 10,221,404 |   |   | 10,221,404 |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| Net                  income (loss) available to common stockholders |   | $                                     | 496,256    |                                 | $      | (364,761 | ) | $ | 1,941,828 |   | $ | 1,933,402 |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| Net                  income (loss) per basic share                  |   | $                                     | 0.05       |                                 | $      | (0.04 | ) | $ | 0.20 |   | $ | 0.20 |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| Net                  income (loss) available to common stockholders |   | $                                     | 496,256    |                                 | $      | (364,761 | ) | $ | 1,941,828 |   | $ | 1,933,402 |   |
| Plus:                  Accretion expense of Class B common          |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| convertible                  to senior subordinated notes           |   |                                  | 110,732    |                                 |   | 110,732 |   |   | 332,194 |   |   | 332,195 |   |
| Less:                  Change in fair value of derivative           |   |                                  | (305,016   | )                                    |   | (27,234 | ) |   | (920,494 | ) |   | (337,696 | ) |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| Net                  income (loss) available for diluted shares     |   | $                                     | 301,972    |                                 | $      | (281,263 | ) | $ | 1,353,528 |   | $ | 1,927,901 |   |
|                                                                |   |                                  |       |                                 |   |   |   |   |   |   |   |   |   |
| Net                  income (loss) per diluted share                |   | $                                     | 0.03       |                                 | $      | (0.03 | ) | $ | 0.13 |   | $ | 0.19 |   |

| **5.** | **Other                Comprehensive Income** |
|--------|-----------------------------------------------|

|                                               |   | For                  the three months |      | For                  the nine months |   |
|----------------------------------------------------|--------|---------------------------------------|-----------|--------------------------------------|--------|
|                                               |   | ended                  September 30,  |      | ended                  September 30, |   |
|                                               |   | 2005                                  |      | 2006                                 |   | 2005 |   | 2006 |   |
|                                               |   |                                  |      |                                 |   |   |   |   |   |
| Net                  income (loss)                 |   | $                                     | 496,256   |                                 | $      | (364,761 | ) | $ | 1,941,828 |   | $ | 1,933,402 |   |
|                                               |   |                                  |           |                                 |   |   |   |   |  |   |   |   |   |
| Hedge                  accounting                  |   |                                  | 1,207,369 |                                 |   | (1,454,243 | ) |   | 456,048 |   |   | 32,349 |   |
|                                               |   |                                  |      |                                 |   |   |   |   |   |   |   |   |   |
| Total                  comprehensive income (loss) |   | $                                     | 1,703,625 |                                 | $      | (1,819,004 | ) | $ | 2,397,876 |   | $ | 1,965,751 |   |

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**Table          of Contents**

| **6.** | **Other                Income** |
|--------|---------------------------------|

| **7.** | **Acquisition** |
|--------|-----------------|

| Cash                  paid             |   | $      | 16,113,647 |   |
|----------------------------------------|--------|--------|------------|--------|
| Notes                  payable assumed |   |   | 24,347,299 |   |
|  Purchase                  price  |   | $      | 40,460,946 |   |

|                                    |   | **July                  2, 2006** |       |
|-----------------------------------------|--------|-----------------------------------|------------|
| Cash                                    |   | $                                 | 208,399    |   |
| Current                  Assets         |   |                              | 3,867,982  |   |
| Property                  and equipment |   |                              | 20,180,158 |   |
| Intangible                  assets      |   |                              | 10,700,606 |   |
| Goodwill                                |   |                              | 14,794,767 |   |
| Other                  assets           |   |                              | 2,367,842  |   |
| Current                  liabilities    |   |                              | (3,282,563 | ) |
| Other                  liabilities      |   |                              | (8,376,245 | ) |
| Purchase                  price         |   | $                                 | 40,460,946 |   |

|   | · | 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. |
|--------|--------|---------------------------------------------------------------------------------|

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**Table          of Contents**

|                                                 |   | **Three                  Months Ended September 30,** |       | **Nine                  Months Ended September 30,** |   |
|------------------------------------------------------|--------|-------------------------------------------------------|------------|------------------------------------------------------|--------|
|                                                 |   | **2005**                                              |       | **2006**                                             |   | **2005** |   | **2006** |   |
|                                                 |   |                                                  |       |                                                 |   |   |   |   |   |
| Revenue                                              |   | $                                                     | 17,037,023 |                                                 | $      | 17,309,107 |   | $ | 51,585,731 |   | $ | 51,737,344 |   |
| Income                  from operations              |   |                                                  | 4,674,859  |                                                 |   | 4,498,433 |   |   | 14,780,507 |   |   | 12,694,334 |   |
| Net                  income (loss)                   |   |                                                  | 269,963    |                                                 |   | (392,426 | ) |   | 1,179,254 |   |   | 1,063,343 |   |
|                                                 |   |                                                  |       |                                                 |   |   |   |   |   |   |   |   |   |
| Basic                  net income (loss) per share   |   | $                                                     | 0.03       |                                                 | $      | (0.05 | ) | $ | 0.15 |   | $ | 0.13 |   |
| Diluted                  net income (loss) per share |   | $                                                     | 0.03       |                                                 | $      | (0.05 | ) | $ | 0.14 |   | $ | 0.12 |   |

| **8.** | **Recent                Accounting Pronouncements** |
|--------|-----------------------------------------------------|

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**Table          of Contents**

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

**Overview**

***General***

***Revenue      Sources***

|  | · | *Local                services.*                We                receive revenues from providing local exchange telephone services.                These                revenues include monthly subscription charges for basic service,                calling                to adjacent communities on a per minute basis, local private line                services                and enhanced calling features, such as voicemail, caller identification,                call waiting and call forwarding. We also receive revenues for providing                long distance services to our customers. With the high level of acceptance                of local service bundles including unlimited calling, these telephone                services are viewed by our customers as part of their local telephone                service. We also provide billing and collections services for other                carriers under contract and receive revenues from directory advertising                in                our local communities. |
|--|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|  | · | *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. |
|--|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|  | · | *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. |
|--|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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**Table          of Contents**

|  | · | *Transport.*                We                receive monthly recurring revenues for the rental of fiber to transport                data and other telecommunications services in Maine from business                and                telecommunications carriers along a 188 mile fiber                route. |
|--|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

***Access      Line and Customer Trends***

|                                           |   |  Year                  Ended December 31, |   | June                  30, |   | September                  30, |   |
|------------------------------------------------|--------|------------------------------------------------|--------|---------------------------|--------|--------------------------------|--------|
|                                           |   | 2003                                           |   | 2004                      |   | 2005                           |   | 2006 |   | 2006 |   |
| Access                  line equivalents (1):  |   |                                      |   |                      |   |                           |   |   |   |   |   |
| Residential                  access lines      |   |                                           | 22,100 |                      |   | 25,237                         |   |   | 24,541 |   |   | 24,273 |   |   | 29,963 |   |
| Business                  access lines         |   |                                           | 7,355  |                      |   | 8,414                          |   |   | 8,036 |   |   | 7,961 |   |   | 21,682 |   |
| Access                  lines                  |   |                                           | 29,455 |                      |   | 33,651                         |   |   | 32,577 |   |   | 32,234 |   |   | 51,645 |   |
| Digital                  high-speed lines      |   |                                           | 2,185  |                      |   | 3,488                          |   |   | 5,962 |   |   | 7,323 |   |   | 10,902 |   |
| Total                  access line equivalents |   |                                           | 31,640 |                      |   | 37,139                         |   |   | 38,539 |   |   | 39,557 |   |   | 62,547 |   |
|                                           |   |                                           |   |                      |   |                           |   |   |   |   |   |   |   |   |   |   |
| Long                  distance customers       |   |                                           | 11,374 |                      |   | 13,641                         |   |   | 14,438 |   |   | 16,566 |   |   | 21,088 |   |
| Cable                  television customers    |   |                                           | 3,628  |                      |   | 3,959                          |   |   | 4,220 |   |   | 4,196 |   |   | 4,187 |   |
| Dial-up                  Internet customers    |   |                                           | 2,331  |                      |   | 15,348                         |   |   | 12,149 |   |   | 10,614 |   |   | 20,999 |   |
|                                                |   |                                           |   |                      |   |                           |   |   |   |   |   |   |   |   |   |   |

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**Table          of Contents**

***Our      Rate and Pricing Structure***

**Categories      of Operating Expenses**

*Cost      of services and products. *

*Selling,      general and administrative expenses. *

*Depreciation      and amortization. *

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

***Results      of Operations***

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**Table          of Contents**

|                                                               |   | **Three                  Months Ended September 30,** |   | **Nine                  Months Ended September 30,** |   |
|--------------------------------------------------------------------|--------|-------------------------------------------------------|--------|------------------------------------------------------|--------|
|                                                               |   |  **2005**                                        |   | **2006**                                             |   | **2005** |   | **2006** |   |
| Revenues                                                           |   |                                             |   |                                            |   |    |   |    |   |
| Local                  service                                     |   |                                                  | 37.6   | %                                                    |   | 37.3 | % |   | 37.4 | % |   | 37.4 | % |
| Network                  access                                    |   |                                                  | 45.7   |                                                 |   | 38.1 |   |   | 46.4 |   |   | 41.9 |   |
| Cable                  television                                  |   |                                                  | 4.6    |                                                 |   | 3.2 |   |   | 4.4 |   |   | 4.1 |   |
| Internet                                                           |   |                                                  | 12.1   |                                                 |   | 15.9 |   |   | 11.8 |   |   | 14.3 |   |
| Transport                                                          |   |                                                  | 0.0    |                                                 |   | 5.5 |   |   | - |   |   | 2.3 |   |
|  Total                  revenues                              |   |                                                  | 100.0  | %                                                    |   | 100.0 | % |   | 100.0 | % |   | 100.0 | % |
| Operating                  expenses                                |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Cost                  of services and products                     |   |                                                  | 28.1   | %                                                    |   | 35.8 | % |   | 26.6 |   |   | 31.1 |   |
| Selling,                  general and administrative expenses      |   |                                                  | 13.6   |                                                 |   | 14.3 |   |   | 14.0 |   |   | 14.0 |   |
| Depreciation                  and amortization                     |   |                                                  | 20.4   |                                                 |   | 23.6 |   |   | 20.3 |   |   | 21.6 |   |
|  Total                  operating expenses                    |   |                                                  | 62.1   |                                                 |   | 73.7 |   |   | 60.9 |   |   | 66.7 |   |
|                                                               |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Income                  from operations                            |   |                                                  | 37.9   |                                                 |   | 26.3 |   |   | 39.1 |   |   | 33.3 |   |
|                                                               |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Other                  income (expense)                            |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Interest                  expense                                  |   |                                                  | (35.4  | )                                                    |   | (29.2 | ) |   | (34.6 | ) |   | (33.4 | ) |
| Change                  in fair value of derivative                |   |                                                  | 2.6    |                                                 |   | 0.2 |   |   | 2.6 |   |   | 0.8 |   |
| Other                  income                                      |   |                                                  | 0.5    |                                                 |   | 1.2 |   |   | 1.1 |   |   | 8.0 |   |
|  Total                  other expense                         |   |                                                  | (32.3  | )                                                    |   | (27.8 | ) |   | (30.9 | ) |   | (24.6 | ) |
|                                                               |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Income                  before income taxes                        |   |                                                  | 5.6    |                                                 |   | (1.5 | ) |   | 8.2 |   |   | 8.7 |   |
|                                                               |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Income                  tax expense                                |   |                                                  | (0.4   | )                                                    |   | 0.0 |   |   | (1.7 | ) |   | (3.1 | ) |
|                                                               |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Income                  before accretion expense                   |   |                                                  | 5.2    |                                                 |   | (1.5 | ) |   | 6.5 |   |   | 5.6 |   |
|                                                               |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Accretion                  of Class B common convertible to senior |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| subordinated                  notes                                |   |                                                  | (0.9   | )                                                    |   | (0.6 | ) |   | (1.0 | ) |   | (0.8 | ) |
|                                                               |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |
| Net                  income available to common stockholders       |   |                                                  | 4.3    | %                                                    |   | (2.1 | )% |   | 5.5 | % |   | 4.8 | % |
|                                                               |   |                                                  |   |                                                 |   |   |   |   |   |   |   |   |   |

***Three      months and nine months ended September 30, 2006 compared to three months and      nine months ended September 30, 2005***

*Total      Revenues. *

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**Table          of Contents**

*For      the three months ended September 30, 2006 and 2005*

|                                |   | **Three                  Months Ended September 30,** |    | **Change** |   |
|-------------------------------------|--------|-------------------------------------------------------|---------|------------|--------|
|                                |   | **2005**                                              |    | **2006**   |   | **Amount** |   | **Percent** |   |
|                                     |   |  (dollars                  in thousands)         |    |
| Local                  services     |   | $                                                     | 4,383   |       | $      | 6,387 |   | $ | 2,004 |   |   | 45.7 | % |
| Network                  access     |   |                                                  | 5,325   |       |   | 6,534 |   |   | 1,209 |   |   | 22.7 |   |
| Cable                  television   |   |                                                  | 534     |       |   | 551 |   |   | 17 |   |   | 3.2 |   |
| Internet                            |   |                                                  | 1,417   |       |   | 2,725 |   |   | 1,308 |   |   | 92.3 |   |
| Transport                  services |   |                                                  | — |       |   | 940 |   |   | 940 |   |   | — |   |
| Total                               |   | $                                                     | 11,659  |       | $      | 17,137 |   | $ | 5,478 |   |   | 47.0 |   |

*For      the nine months ended September 30, 2006 and 2005*

|                                |   | **Nine                  Months Ended September 30,** |    | **Change** |   |
|-------------------------------------|--------|------------------------------------------------------|---------|------------|--------|
|                                |   | **2005**                                             |    | **2006**   |   | **Amount** |   | **Percent** |   |
|                                |   |  (dollars                  in thousands)        |    |
| Local                  services     |   | $                                                    | 13,153  |       | $      | 15,043 |   | $ | 1,890 |   |   | 14.4 | % |
| Network                  access     |   |                                                 | 16,289  |       |   | 16,849 |   |   | 560 |   |   | 3.4 |   |
| Cable                  television   |   |                                                 | 1,546   |       |   | 1,632 |   |   | 86 |   |   | 5.6 |   |
| Internet                            |   |                                                 | 4,141   |       |   | 5,744 |   |   | 1,603 |   |   | 38.7 |   |
| Transport                  services |   |                                                 | — |       |   | 940 |   |   | 940 |   |   | — |   |
| Total                               |   | $                                                    | 35,129  |       | $      | 40,208 |   | $ | 5,079 |   |   | 14.5 |   |

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**Table          of Contents**

*Operating      expenses. *

*For      the three months ended September 30, 2006 and 2005*

|                                                          |   | **Three                  Months Ended September 30,** |   | **Change** |   |
|---------------------------------------------------------------|--------|-------------------------------------------------------|--------|------------|--------|
|                                                          |   | **2005**                                              |   | **2006**   |   | **Amount** |   | **Percent** |   |
|                                                          |   |  (dollars                  in thousands)         |   |
| Cost                  of services                             |   | $                                                     | 3,283  |       | $      | 6,139 |   |   | 2,856 |   |   | 87.0 | % |
| Selling,                  general and administrative expenses |   |                                                  | 1,585  |       |   | 2,451 |   |   | 866 |   |   | 54.6 |   |
| Depreciation                  and amortization                |   |                                                  | 2,375  |       |   | 4,032 |   |   | 1,657 |   |   | 69.7 |   |
| Total                                                         |   | $                                                     | 7,243  |       | $      | 12,622 |   | $ | 5,379 |   |   | 74.3 |   |

*For      the nine months ended September 30, 2006 and 2005*

|                                                          |   | **Nine                  Months Ended September 30,** |   | **Change** |   |
|---------------------------------------------------------------|--------|------------------------------------------------------|--------|------------|--------|
|                                                          |   | **2005**                                             |   | **2006**   |   | **Amount** |   | **Percent** |   |
|                                                          |   |  (dollars                  in thousands)        |   |
| Cost                  of services                             |   | $                                                    | 9,356  |       | $      | 12,501 |   | $ | 3,145 |   |   | 33.6 | % |
| Selling,                  general and administrative expenses |   |                                                 | 4,912  |       |   | 5,604 |   |   | 692 |   |   | 14.1 |   |
| Depreciation                  and amortization                |   |                                                 | 7,112  |       |   | 8,696 |   |   | 1,584 |   |   | 22.3 |   |
| Total                                                         |   | $                                                    | 21,380 |       | $      | 26,801 |   | $ | 5,421 |   |   | 25.4 |   |
|                                                          |   |                                                 |   |       |   |   |   |   |   |   |   |   |   |

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**Table          of Contents**

*For      the three months and nine months ended September 30, 2006 and      2005*

*Interest      expense. *

*Change      in fair value of derivative associated with Class B common convertible to Class      A common. *

*Other      income. *

*Income      taxes. *

*Accretion      of Class B common convertible to senior subordinated notes. *

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**Table          of Contents**

*Net      income. *

**Liquidity      and Capital Resources**

**Recent      Accounting Pronouncements**

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**Table          of Contents**

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

**Item      4. Controls and Procedures**

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**Table          of Contents**

**PART      II OTHER INFORMATION**

**Item.      6. Exhibits**

See      Exhibit Index.

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**Table          of Contents**

**Signatures**

**OTELCO      INC.**

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**Table          of Contents**

**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 Officer                                                     |
| 31.2                           |   | Certificate                pursuant to Rule 13A-14(a) or Rule 15d-14(a) of the Securities Exchange                Act of 1934 of the Chief Financial Officer                                                     |
| 32.1                           |   | Certificate                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section                906 of                the Sarbanes-Oxley Act of 2002, of the Chief Executive                Officer |
| 32.2                           |   | Certificate                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section                906 of                the Sarbanes-Oxley Act of 2002, of the Chief Financial                Officer |

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