**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 September 30, 2005
                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 organization)
              
              (I.R.S.
                  Employer Identification No.)505
                  Third Avenue East, Oneonta, Alabama
              
              35121(Address
                  of Principal Executive Offices)
              
              (Zip
                  Code)
 (205)
        625-3574
 (Registrant’s
        telephone number, including area code)
 N/A
 (Former
        name, former address and former fiscal year, if changed since last
        report)
 
 Indicate
        by check mark whether the registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days.
 
 Yes ý  No  ̈
 
 Indicate
        by check mark whether the registrant is an accelerated filer (as defined
        in Rule
        12b-2 of the Exchange Act).
 
 Yes  ̈  No ý
 
 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 November 7, 2005**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 and nine month periods ended September 30, 2005**
 **TABLE
        OF CONTENTS**
 
 **PART
                    I**
                **FINANCIAL
                    INFORMATION**Item
                    1.
                Financial
                    StatementsConsolidated
                    Balance Sheets as of December 31, 2004 and September 30, 2005Consolidated
                    Statements of Income for the three and nine months
                    endedSeptember
                    30, 2004 and 2005Consolidated
                    Statements of Cash Flows for the nine months endedSeptember
                    30, 2004 and 2005Notes
                    to Consolidated Financial StatementsItem
                    2.
                Management’s
                    Discussion and Analysis of Financial Condition and Results of
                    OperationsItem
                    3.
                Quantitative
                    and Qualitative Disclosures About Market RiskItem
                    4.
                Controls
                    and Procedures**PART
                    II**
                **OTHER
                    INFORMATION**Item
                    6.
                Exhibits
  
 *Unless
        the context otherwise requires, the words “we”, “us”, “our”, “the company” and
“Otelco” refer to Otelco Inc., a Delaware corporation.*
  **FORWARD-LOOKING
        STATEMENTS**
  The
        report contains forward-looking statements that are subject to risks and
        uncertainties. Forward-looking statements give our current expectations relating
        to our financial condition, results of operations, plans, objectives, future
        performance and business. These statements may include words such as
“anticipate,”“estimate,”“expect,”“project,”“plan,”“intend,”“believe” and other
        words and terms of similar meaning in connection with any discussion of the
        timing or nature of future operating or financial performance or other events.
        These forward-looking statements are based on assumptions that we have made
        in
        light of our experience in the industry in which we operate, as well as our
        perceptions of historical trends, current conditions, expected future
        developments and other factors we believe are appropriate under the
        circumstances. Although we believe that these forward-looking statements
        are
        based on reasonable assumptions, you should be aware that many factors could
        affect our actual financial condition or results of operations and cause
        actual
        results to differ materially from those in the forward-looking statements.
  
 **OTELCO
                      INC.****CONSOLIDATED
                      BALANCE SHEETS****December
                      31,**
                    **2004**
                  
                  **September
                      30,**
                    **2005****Assets**
                  
                  
                  
                  **(unaudited)**Current
                      assetsCash
                      and cash equivalents
                  
                  $
                  5,406,545
                  
                  $
                  5,376,690Accounts
                      receivable:Due
                      from subscribers, net of allowance for doubtfulaccounts
                      of $170,515 and $161,887, respectively.
                  
                  
                  1,179,074
                  
                  
                  1,216,816Unbilled
                      receivables
                  
                  
                  1,884,405
                  
                  
                  1,847,399Other
                  
                  
                  1,522,945
                  
                  
                  1,419,619Materials
                      and supplies
                  
                  
                  1,039,910
                  
                  
                  968,628Prepaid
                      expenses
                  
                  
                  537,784
                  
                  
                  477,420Deferred
                      income taxes
                  
                  
                  652,625
                  
                  
                  652,625Total
                      current assets
                  
                  
                  12,223,288
                  
                  
                  11,959,197Property
                      and equipment, net
                  
                  
                  48,195,568
                  
                  
                  45,781,964Goodwill
                  
                  
                  119,714,094
                  
                  
                  119,684,411Intangible
                      assets, net
                  
                  
                  2,050,943
                  
                  
                  1,703,795Investments
                  
                  
                  1,298,852
                  
                  
                  1,156,806Deferred
                      financing costs
                  
                  
                  8,020,743
                  
                  
                  7,097,270Interest
                      rate cap
                  
                  
                  4,723,135
                  
                  
                  5,048,443Total
                      assets
                  
                  $
                  196,226,623
                  
                  $
                  192,431,886**Liabilities
                      and Stockholders' Equity**Current
                      liabilitiesAccounts
                      payable
                  
                  $
                  2,690,351
                  
                  $
                  1,313,447Accrued
                      expenses
                  
                  
                  1,862,604
                  
                  
                  2,812,494Advance
                      billings and payments
                  
                  
                  1,141,013
                  
                  
                  1,069,182Customer
                      deposits
                  
                  
                  220,209
                  
                  
                  233,884Total
                      current liabilities
                  
                  
                  5,914,177
                  
                  
                  5,429,007Deferred
                      income taxes
                  
                  
                  13,053,226
                  
                  
                  13,053,226Other
                      liabilities
                  
                  
                  196,644
                  
                  
                  194,074Total
                      deferred tax and other liabilities
                  
                  
                  13,249,870
                  
                  
                  13,247,300Long-term
                      notes payable
                  
                  
                  161,075,498
                  
                  
                  161,075,498Derivative
                      liability
                  
                  
                  2,788,716
                  
                  
                  1,868,222Class
                      B common convertible to senior subordinated notes
                  
                  
                  3,212,528
                  
                  
                  3,544,722Stockholders'
                      EquityClass
                      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;
                      issuedand
                      outstanding 544,671 shares
                  
                  
                  5,447
                  
                  
                  5,447Additional
                      paid in capital
                  
                  
                  12,435,800
                  
                  
                  7,319,227Retained
                      deficit
                  
                  
                  (2,597,315
                  )
                  
                  (655,487
                  )Accumulated
                      other comprehensive income
                  
                  
                  45,135
                  
                  
                  501,183Total
                      stockholders' equity
                  
                  
                  9,985,834
                  
                  
                  7,267,137Total
                      liabilities and stockholders' equity
                  
                  $
                  196,226,623
                  
                  $
                  192,431,886
 The
              accompanying notes are an integral part of these consolidated financial
              statements.
 
 **OTELCO
                    INC.**
                  **CONSOLIDATED
                      STATEMENTS OF INCOME**
                    (Unaudited)Three
                    months ended
                
                Nine
                    months endedSeptember
                    30,
                
                September
                    30,**2004**
                
                **2005**
                
                **2004**
                
                **2005**RevenuesLocal
                    service
                
                $
                3,562,745
                
                $
                3,567,959
                
                $
                10,491,800
                
                $
                10,773,335Network
                    access
                
                
                4,110,843
                
                
                5,324,589
                
                
                12,112,679
                
                
                16,289,223Long
                    distance and other telephone services
                
                
                639,823
                
                
                815,472
                
                
                1,992,397
                
                
                2,379,746Cable
                    television
                
                
                463,570
                
                
                533,812
                
                
                1,336,982
                
                
                1,545,990Internet
                
                
                542,826
                
                
                1,417,485
                
                
                1,542,191
                
                
                4,140,643Total
                    revenues
                
                
                9,319,807
                
                
                11,659,317
                
                
                27,476,049
                
                
                35,128,937Operating
                    expensesCost
                    of services and products
                
                
                2,093,681
                
                
                3,282,787
                
                
                6,056,543
                
                
                9,356,381Selling,
                    general and administrative expenses
                
                
                1,592,986
                
                
                1,585,280
                
                
                4,810,167
                
                
                4,912,279Depreciation
                    and amortization
                
                
                1,547,966
                
                
                2,375,266
                
                
                4,595,148
                
                
                7,111,459Total
                    operating expenses
                
                
                5,234,633
                
                
                7,243,333
                
                
                15,461,858
                
                
                21,380,119Income
                    from operations
                
                
                4,085,174
                
                
                4,415,984
                
                
                12,014,191
                
                
                13,748,818Other
                    income (expense)Interest
                    expense
                
                
                (784,390
                )
                
                (4,131,073
                )
                
                (2,414,624
                )
                
                (12,166,821
                )Change
                    in fair value of derivative
                
                
                —
                
                
                305,016
                
                
                —
                
                
                920,494Other
                    income
                
                
                15,781
                
                
                58,662
                
                
                70,057
                
                
                379,353Total
                    other expense
                
                
                (768,609
                )
                
                (3,767,395
                )
                
                (2,344,567
                )
                
                (10,866,974
                )Income
                    before income tax and accretion expense
                
                
                3,316,565
                
                
                648,589
                
                
                9,669,624
                
                
                2,881,844Income
                    tax expense
                
                
                (1,174,062
                )
                
                (41,601
                )
                
                (3,423,046
                )
                
                (607,822
                )Income
                    before accretion expense
                
                
                2,142,503
                
                
                606,988
                
                
                6,246,578
                
                
                2,274,022Accretion
                      of Class B common convertible to seniorsubordinated
                      notes
                
                
                —
                
                
                (110,732
                )
                
                —
                
                
                (332,194
                )Net
                    income available to common stockholders
                
                $
                2,142,503
                
                $
                496,256
                
                $
                6,246,578
                
                $
                1,941,828Weighted
                    average shares outstanding:Basic
                
                
                8,054,841
                
                
                9,676,733
                
                
                8,054,841
                
                
                9,676,733Diluted
                
                
                8,557,304
                
                
                10,221,404
                
                
                8,557,304
                
                
                10,221,404Net
                    income per shareBasic
                
                $
                0.27
                
                $
                0.05
                
                $
                0.78
                
                $
                0.20Diluted
                
                $
                0.25
                
                $
                0.03
                
                $
                0.73
                
                $
                0.13Dividends
                    declared per share
                
                $
                —
                
                $
                0.18
                
                $
                —
                
                $
                0.53
 The
          accompanying notes are an integral part of these consolidated financial
          statements.
  **OTELCO
                    INC.****CONSOLIDATED
                    STATEMENTS OF CASH FLOWS**(Unaudited)Nine
                    months endedSeptember
                    30,**2004**
                
                **2005**Cash
                    flows from operating activities:Net
                    income
                
                $
                6,246,578
                
                $
                1,941,828Adjustments
                    to reconcile net income to cash flows from operating
                    activities:Depreciation
                
                
                4,296,825
                
                
                5,772,431Amortization
                
                
                298,323
                
                
                1,339,027Interest
                    rate caplet
                
                
                —
                
                
                130,739Accretion
                    expense
                
                
                —
                
                
                332,194Change
                    in fair value of derivative liability
                
                
                —
                
                
                (920,494
                )Provision
                    for deferred taxes
                
                
                (487,812
                )
                
                —Provision
                    for uncollectible revenue
                
                
                79,417
                
                
                84,197Changes
                    in assets and liabilities, net of assets and liabilities
                    acquired:Accounts
                    receivables
                
                
                (174,621
                )
                
                18,393Material
                    and supplies
                
                
                176,136
                
                
                71,282Prepaid
                    expenses and other assets
                
                
                189,360
                
                
                60,367Accounts
                    payable and accrued liabilities
                
                
                4,078,455
                
                
                (427,017
                )Advance
                    billings and payments
                
                
                33,841
                
                
                (71,831
                )Other
                    liabilities
                
                
                14,400
                
                
                11,105Net
                    cash from operating activities
                
                
                14,750,902
                
                
                8,342,221Cash
                    flows from investing activities:Acquisition
                    and construction of property and equipment
                
                
                (2,650,522
                )
                
                (3,339,695
                )Proceeds
                    from retirement of investment
                
                
                77,556
                
                
                122,914Capitalized
                    transaction costs
                
                
                (832,308
                )
                
                —Payment
                    for the purchase of Mid-Missouri Holding Corp, net of cash
                    acquired
                
                
                —
                
                
                29,683Net
                    cash from investing activities
                
                
                (3,405,274
                )
                
                (3,187,098
                )Cash
                    flows from financing activities:Cash
                    dividends paid
                
                
                —
                
                
                (5,116,572
                )Loan
                    origination cost and transaction cost
                
                
                —
                
                
                (68,406
                )Repayment
                    of long-term notes payable
                
                
                (5,755,909
                )
                
                —Net
                    cash from financing activities
                
                
                (5,755,909
                )
                
                (5,184,978
                )Net
                    increase (decrease) in cash and cash equivalents
                
                
                5,589,719
                
                
                (29,855
                )Cash
                    and cash equivalents, beginning of period
                
                
                1,650,307
                
                
                5,406,545Cash
                    and cash equivalents, end of period
                
                $
                7,240,026
                
                $
                5,376,690Supplemental
                    disclosures of cash flow information:Interest
                    paid
                
                $
                2,166,935
                
                $
                12,317,453Income
                    taxes paid (received)
                
                $
                1,581,026
                
                $
                (357,226
                )
 The
            accompanying notes are an integral part of these consolidated financial
            statements.
 
 **NOTES
          TO CONSOLIDATED FINANCIAL STATEMENTS**
 (Unaudited)
 
 **1.**
              **Organization
                  and Basis of Financial
                  Reporting**
 
 ***Basis
        of Presentation and Principles of Consolidation***
 The
        consolidated financial statements include the accounts of Otelco Inc. (the
        “Company”), its wholly owned subsidiaries Otelco Telecommunications LLC (“OTC”),
        Otelco Telephone LLC (“OTP”), Hopper Holding Company, Inc. (“HHC”), Brindlee
        Holdings LLC (“BH”), Page & Kiser Communications, Inc. (“PKC”), and
        Mid-Missouri Holding Corporation (“MMH”). HHC’s wholly owned subsidiary is
        Hopper Telecommunications Company, Inc. (“HTC”). BH’s owned subsidiary is
        Brindlee Mountain Telephone Company, Inc. (“BMTC”). PKC’s wholly owned
        subsidiary is Blountsville Telephone Company, Inc. (“BTC”). On December 21,
        2004, the Company acquired MMH. MMH’s wholly owned subsidiary is Mid-Missouri
        Telephone Company (“MMT”). MMT is the sole stockholder of Imagination, Inc.,
        which provides internet services in certain locations in Missouri. The
        accompanying consolidated financial statements include the accounts of the
        Company and all of its subsidiaries after elimination of all material
        intercompany balances and transactions.
  The
        consolidated financial statements and footnotes included in this Form 10-Q
        should be read in conjunction with the consolidated financial statements
        and
        notes thereto included in the Company’s annual report on Form 10-K for the year
        ended December 31, 2004. The interim Consolidated Financial information herein
        is unaudited. The information reflects all adjustments (which include only
        normal recurring adjustments), which are, in the opinion of management,
        necessary for a fair presentation of the financial position and results of
        operations for the periods included in the report.
 
 **2.**
              **Commitment
                  and Contingencies**
 
 From
        time
        to time, we may be involved in various claims, legal actions and regulatory
        proceedings incidental to and in the ordinary course of business, including
        administrative hearings of the Alabama and Missouri Public Service Commission
        related primarily to rate making. Currently, none of the legal proceedings
        are
        expected to have a material adverse effect on our business.
 
 **3.**
              **Acquisitions**
 
 On
        December 21, 2004, the Company acquired 100% of the outstanding common stock
        of
        MMH. MMH owns 100% of MMT. MMT is a local exchange carrier in central Missouri.
        The implicit purchase price of the acquisition was $30,540,774 including
        assumed
        notes payable. The excess of the total purchase price over the assigned value
        of
        the identifiable net assets is reflected as goodwill and intangible assets
        in
        the amount of $17,858,806 and $1,800,000, respectively. The goodwill related
        to
        the acquisition is not deductible for tax purposes.
  
 The
        allocation of the net purchase price for the MMH acquisition is as
        follows:
  2004Current
                    Assets
                
                $
                1,158,957Property
                    and equipment
                
                
                12,900,823Intangible
                    assets
                
                
                1,800,000Goodwill
                
                
                17,858,806Other
                    assets
                
                
                422,680Current
                    liabilities
                
                
                (1,144,674
                )Notes
                    payable
                
                
                (16,714,140
                )Other
                    liabilities
                
                
                (2,455,818
                )Net
                    purchase price
                
                $
                13,826,634
 
 The
        Company issued 856,234 shares of Class A common stock ($8,562 par value)
        underlying the 856,234 IDSs and 53,413 shares of Class B common stock ($534
        par
        value) in connection with the acquisition of MMHC based on an exchange ratio
        of
        0.14126 IDSs and 0.00881 shares of Class B common stock for each share of
        MMHC.
        The issuance of Class A common stock represented by Income Deposit Securities
        (“IDSs”), Class B common stock and Class A common stock associated with the
        conversion of options resulted in an increase in paid-in capital of $7,222,120.
        Each IDS represents one share of Class A common stock and a 13.0% senior
        subordinated note with a $7.50 principal amount. The number of IDSs and shares
        of Class B common stock to be received upon exchange of each outstanding
        option
        to acquire shares of Mid-Missouri Holding were equal to the number of IDSs
        and
        shares of Class B common stock that a holder would have received in the exchange
        had the holder exercised the option on a “cashless basis.” The embedded exchange
        feature of the Class B common stock is accounted for separately as a derivative
        liability.
  The
        following unaudited pro forma information presents the combined results of
        operations of the Company as though the acquisition of MMH completed in 2004
        occurred at the beginning of the year. The results include certain adjustments,
        including increased interest expense on notes payable related to the
        acquisition. The pro forma financial information does not necessarily reflect
        the results of operations had the acquisition been completed at the beginning
        of
        2004 or those which may be obtained in the future. The impacts of accounting
        for
        the change in fair value of derivative and accretion expense have not been
        included in the results.
  Unaudited
                
                UnauditedFor
                    the three months ended
                
                For
                    the nine months endedSeptember
                    30, 2004
                
                September
                    30, 2004Revenues
                
                $
                12,263,416
                
                $
                35,771,603Income
                    from operations
                
                
                5,057,204
                
                
                14,470,346Net
                    income
                
                
                2,444,845
                
                
                6,947,368Basic
                    net income per share
                
                $
                0.30
                
                $
                0.86Diluted
                    net income per share
                
                $
                0.29
                
                $
                0.81
 
 
  The
        acquisition was accounted for using the purchase method of accounting and
        accordingly, the accompanying financial statements include the financial
        position and results of operation from the date of acquisition.
  **4.**
              **Derivative
                  and Hedge Activities**
 
 The
        interest rate cap was purchased on December 21, 2004, coincident with the
        closing of our initial public offering and the recapitalization of our senior
        notes payable. The interest rate cap was purchased to mitigate the risk of
        rising interest rates to limit or cap the rate at 7%. It is considered an
        effective hedge as all critical terms of the interest rate cap are identical
        to
        the underlying debt it hedges. Changes in the fair value of the interest
        rate
        cap are not included in earnings but are reported as a component of accumulated
        other comprehensive income. For the three months and nine months ended September
        30, 2005 the change in the fair value of the interest rate cap was $1,207,369
        and $456,048, respectively. The cost of the interest rate cap is expensed
        as
        interest over the effective life of the hedge in accordance with the quarterly
        value of the caplets as determined at the date of inception. For the three
        months and nine months ended September 30, 2005 the cost of the interest
        rate
        cap was $80,024 and $130,740, respectively.
  **5.**
              **Income
                  per Common Share and Potential Common
                  Share**
  Basic
        income per common share is computed by dividing net income by the
        weighted-average number of shares outstanding for the period. Diluted income
        per
        common share reflects the potential dilution that could occur if the Class
        B
        common stock were exercised into IDSs. Class B common stock is convertible
        on a
        one-for-one basis into IDSs, each of which includes a Class A common share.
        For
        periods prior to our conversion, membership units were treated on an as if
        converted basis into Class A and Class B common shares.
  
  A
        reconciliation of the common shares and net income for the Company’s basic and
        diluted income per common share calculation is as follows:
  For
                    the three months
                
                For
                    the nine monthsended
                    September 30,
                
                ended
                    September 30,2004
                
                2005
                
                2004
                
                2005Weighted
                    average common shares at conversion
                
                
                8,054,841
                
                
                8,054,841
                
                
                8,054,841
                
                
                8,054,841Purchase
                    of Mid-Missouri Holding Corp., sale ofcommon
                    shares by Company, and buy-back ofcommon
                    shares by Company (12/21/04)
                
                
                —
                
                
                1,621,892
                
                
                —
                
                
                1,621,892Weighted
                    average common shares-basic
                
                
                8,054,841
                
                
                9,676,733
                
                
                8,054,841
                
                
                9,676,733Effect
                    of Class B shares at conversion
                
                
                502,463
                
                
                502,463
                
                
                502,463
                
                
                502,463Effect
                    on Class B shares from purchase of MidMissouri-Holding
                    Corp., sale of common sharesby
                    Company, and buy-back of common shares byCompany
                    (12/21/04)
                
                
                —
                
                
                42,208
                
                
                —
                
                
                42,208Effect
                    of dilutive securities
                
                
                502,463
                
                
                544,671
                
                
                502,463
                
                
                544,671Weighted-average
                    common shares and potentialcommon
                    shares-diluted
                
                
                8,557,304
                
                
                10,221,404
                
                
                8,557,304
                
                
                10,221,404Net
                    income available to common stockholders
                
                $
                2,142,503
                
                $
                496,256
                
                $
                6,246,578
                
                $
                1,941,828Net
                    income per basic share
                
                $
                0.27
                
                $
                0.05
                
                $
                0.78
                
                $
                0.20Net
                    income available to common stockholders
                
                $
                2,142,503
                
                $
                496,256
                
                $
                6,246,578
                
                $
                1,941,828Plus:
                    Accretion expense of Class B commonconvertible
                    to senior subordinated notes
                
                
                —
                
                
                110,732
                
                
                —
                
                
                332,194Less:
                    Change in fair value of derivative
                
                
                —
                
                
                (305,016
                )
                
                —
                
                
                (920,494
                )Net
                    income available for diluted shares
                
                $
                2,142,503
                
                $
                301,972
                
                $
                6,246,578
                
                $
                1,353,528Net
                    income per diluted share
                
                $
                0.25
                
                $
                0.03
                
                $
                0.73
                
                $
                0.13
  **6.**
                **Other
                    Comprehensive Income**
 The
        components of other comprehensive income consist of:
  For
                    the three months
                
                For
                    the nine monthsended
                    September 30,
                
                ended
                    September 30,2004
                
                2005
                
                2004
                
                2005Net
                    income
                
                $
                2,142,503
                
                $
                496,256
                
                $
                6,246,578
                
                $
                1,941,828Hedge
                    accounting
                
                
                —
                
                
                1,207,369
                
                
                —
                
                
                456,048Total
                    comprehensive income
                
                $
                2,142,503
                
                $
                1,703,625
                
                $
                6,246,578
                
                $
                2,397,876
  
 **Item
        2.** ***Management’s
        Discussion and Analysis of Financial Condition and Results of
        Operations***
 
 **Overview**
 
 ***General***
 
 Since
        1999, we have acquired and operate five rural local exchange carriers serving
        twenty exchanges through four central offices and thirteen remote switches
        in
        approximately 1,540 square miles of north central Alabama and central Missouri.
        We are the sole wireline telephone services provider in the rural communities
        we
        serve. Our services include local telephone, network access, long distance
        and
        other telephone related services, cable television and Internet access. We
        view,
        manage and evaluate the results of operations from the various telephony
        products and services as one company and therefore have identified one reporting
        segment as it relates to providing segment information. As of September 30,
        2005, we operated approximately 38,100 total access line
        equivalents.
 
 Our
        core
        businesses are local telephone service and the provision of network access
        to
        other wireline, long distance and wireless carriers for calls originated
        or
        terminated on our network. Our core businesses generated approximately 77.0%
        of
        our total revenues in the third quarter of 2005. We also provide long distance
        and other telephone related services, cable television and dial-up and digital
        high-speed Internet access.
 
 The
        following discussion and analysis should be read in conjunction with our
        financial statements and the related notes included in Item 1of Part 1 and
        other
        financial information appearing elsewhere in this report. The following
        discussion and analysis discusses our financial condition and results of
        operations on a consolidated basis, including the acquisition (the “Mid-Missouri
        Acquisition”) of Mid-Missouri Holding Corp. (“MMH”) as of December 21,
        2004.
 
 ***Revenue
        Sources***
 
 We
        derive
        our revenues from five sources:
  §
              *Local
                  services.*We
                  receive revenues from providing local exchange telephone services.
                  These
                  revenues include monthly subscription charges for basic service,
                  calling
                  to adjacent communities on a per minute basis, local private line
                  services
                  and enhanced calling features, such as voicemail, caller identification,
                  call waiting and call forwarding.
 §
              *Network
                  access services.*We
                  receive revenues from charges established to compensate us for
                  the
                  origination, transport and termination of calls of long distance
                  and other
                  interexchange carriers. These include subscriber line charges imposed
                  on
                  end users and switched and special access charges paid by carriers.
                  Switched access charges for long distance services within Alabama
                  and
                  Missouri are based on rates approved by the Alabama Public Service
                  Commission and Missouri Public Service Commission respectively.
                  Switched
                  and special access charges for interstate and international services
                  are
                  based on rates approved by the Federal Communications
                  Commission.
 §
              *Long
                  distance and other telephone services*.
                  We receive revenues for providing long distance services to our
                  customers.
                  We also provide billing and collections services for other carriers
                  under
                  contract and receive revenues from directory
                  advertising.
 §
              *Cable
                  television services.*We
                  offer basic, digital and pay per view cable television services
                  to a
                  portion of our telephone service territory in both Alabama and
                  Missouri.
 §
              *Internet
                  services.*We
                  receive revenues from monthly recurring charges for dial-up and
                  digital
                  high-speed Internet access.
 
 ***Access
        Line and Customer Trends***
 
 The
        number of traditional access lines served is a fundamental factor in determining
        revenue stability for a telecommunications provider. Reflecting a general
        trend
        in the rural local exchange carrier industry, the number of access lines
        we
        serve has been decreasing gradually when normalized for territory acquisitions.
        We expect this trend to continue for the industry and our territory. In addition
        to the impact of the economy on our customers, the growth of our digital
        high-speed Internet access services will continue to have an impact on
        residential and small business customers’ requirements for second access lines.
        Our response to this trend will have an important impact on our future revenues.
        Our primary strategy consists of leveraging our strong incumbent market position
        to increase revenue per access line by selling additional services to our
        customer base.
  
 Year
                    Ended December 31,
                
                June
                    30,
                
                September
                    30,2002
                
                2003
                
                2004
                
                2005
                
                2005Access
                    line equivalents (1):Residential
                    access lines
                
                
                19,343
                
                
                22,100
                
                
                25,237
                
                
                25,013
                
                
                24,705Business
                    access lines
                
                
                6,654
                
                
                7,355
                
                
                8,414
                
                
                8,006
                
                
                8,060Access
                    lines
                
                
                25,997
                
                
                29,455
                
                
                33,651
                
                
                33,019
                
                
                32,765Digital
                    high-speed lines
                
                
                1,361
                
                
                2,185
                
                
                3,488
                
                
                4,407
                
                
                5,354Total
                    access line equivalents
                
                
                27,358
                
                
                31,640
                
                
                37,139
                
                
                37,426
                
                
                38,119Long
                    distance customers
                
                
                8,183
                
                
                11,374
                
                
                13,641
                
                
                14,061
                
                
                14,323Cable
                    television customers
                
                
                3,442
                
                
                3,628
                
                
                3,959
                
                
                4,163
                
                
                4,201Dial-up
                    Internet customers
                
                
                2,463
                
                
                2,331
                
                
                15,348
                
                
                13,831
                
                
                12,989Average
                    monthly revenue per access line
                    (2)
                
                $
                94.40
                
                $
                101.45
                
                $
                105.88
                
                $
                108.52
                
                $
                111.64
  (1)
              We
                  define total access line equivalents as access lines, cable modems
                  and
                  digital subscriber lines.(2)
              We
                  calculate average monthly revenue per access line as equal to (A)
                  our
                  average revenues for the period within our telephone territory
                  divided by
                  (B) the average of the number of access lines on the first day
                  and the
                  last day of the period. Average revenue per access line in 2005
                  through
                  September 30 is $111.19.
 
 We
        will
        continue our strategy of increasing revenues by cross-selling to our existing
        customer base, in the form of bundled service packages and individual additional
        services as they become available. Our digital high-speed Internet customers
        continue to grow from 4,407 customers at June 30, 2005, to 5,354 at September
        30, 2005. We expect continued revenue growth in this area of our business.
        This
        growth in our digital high-speed Internet customers is expected to have a
        negative effect on our dial-up Internet customers as some customers migrate
        to
        digital high-speed Internet access. In addition, we expect the growth in
        our
        digital high-speed Internet access customers will have a negative effect
        on our
        access lines as some customers will no longer have a need for second lines
        for
        purposes of dial-up Internet access. During third quarter 2005, residential
        and
        business access lines and business data circuits declined 0.8% while digital
        high-speed Internet customers grew 21.5% during the same period.
 
 Our
        long
        distance customers increased to 14,323 on September 30, 2005 and now represent
        43.7% of our access lines. Our cable television customers grew by 38 in the
        quarter to 4,201 as of September 30, 2005. While we have experienced periodic
        increases in our cable television programming costs, and expect this trend
        to
        continue in the future, we expect these increases will be offset by a
        corresponding increase in the price that we charge our cable television
        customers for cable television service offerings. Dial-up internet customers
        declined to 12,989 on September 30, 2005 from 13,831 on June 30, 2005, including
        the subscribers we service outside of our telephone service area, reflecting
        the
        shift to digital high-speed Internet services.
 
 Our
        average revenue per access line for the third quarter increased 2.9% from
        the
        second quarter of 2005. The primary contributor was the increase in digital
        high-speed Internet, cable, and long distance customers offset by the decline
        in
        dial-up Internet customers in our service territories. With the Mid-Missouri
        Acquisition on December 21, 2004, there was an increase in average revenue
        per
        access line associated with the proportionately larger contribution from
        High
        Cost Loop support. On a year-to-date basis, average revenue per access line
        is
        $111.64 for an increase of 5.4% over 2004. The increase in digital high-speed
        access, long distance and cable subscribers demonstrates our increasingly
        valuable basket of services to our subscribers.
 
 
 ***Categories
        of Operating Expenses***
 
 Our
        operating expenses are categorized as cost of services; selling, general
        and
        administrative expenses; and depreciation and amortization.
 
 *Cost
        of services.* This
        includes expense for salaries, wages and benefits relating to plant operation,
        maintenance and customer service; other plant operations, maintenance and
        administrative costs; network access costs; and costs of sales for long
        distance, cable television, Internet and directory services.
 
 *Selling,
        general and administrative expenses.* This
        includes expenses for salaries, wages and benefits and contract service payments
        (e.g., legal fees) relating to engineering, financial, human resources and
        corporate operations; information management expenses, including billing;
        allowance for uncollectibles; expenses for travel, lodging and meals; internal
        and external communications costs; stock option compensation expense; insurance
        premiums; stock exchange and banking fees; and postage. Included in selling,
        general and administrative expenses historically have been annual management
        fees of approximately $1.0 million payable to Seaport Capital Partners II,
        L.P.
        and its affiliates. These fees were terminated on December 21, 2004 in
        conjunction with our initial public offering. The incremental selling, general
        and administrative expenses associated with being a public company replace
        these
        fees.
 
 *Depreciation
        and amortization.* This
        includes depreciation of our telecommunications, cable and Internet networks
        and
        equipment, and amortization of intangible assets.
 
 ***Our
        Ability to Control Operating Expenses***
 
 We
        strive
        to control expenses in order to maintain our strong operating margins. As
        our
        revenue shifts to non-regulated services, operating margins decrease reflecting
        the lower margins associated with these more competitive services. We expect
        to
        control expenses while we continue to grow our business.
 
 ***Results
        of Operations***
 
 The
        following table sets forth our results of operations as a percentage of total
        revenues for the periods indicated.
 
 
 **Three
                    Months Ended September 30,**
                
                **Nine
                    Months Ended September 30,****2004**
                
                **2005**
                
                **2004**
                
                **2005**RevenuesLocal
                    service
                
                
                38.2
                %
                
                30.6
                %
                
                38.2
                %
                
                30.7
                %Network
                    access
                
                
                44.1
                
                
                45.7
                
                
                44.1
                
                
                46.3Long
                    distance and other telephone services
                
                
                6.9
                
                
                7.0
                
                
                7.2
                
                
                6.8Cable
                    television
                
                
                5.0
                
                
                4.6
                
                
                4.9
                
                
                4.4Internet
                
                
                5.8
                
                
                12.1
                
                
                5.6
                
                
                11.8Total
                    revenues
                
                
                100.0
                %
                
                100.0
                %
                
                100.0
                %
                
                100.0
                %Operating
                    expensesCost
                    of services and products
                
                
                22.5
                %
                
                28.1
                %
                
                22.1
                
                
                26.6Selling,
                    general and administrative expenses
                
                
                17.1
                
                
                13.6
                
                
                17.5
                
                
                14.0Depreciation
                    and amortization
                
                
                16.6
                
                
                20.4
                
                
                16.7
                
                
                20.3Total
                    operating expenses
                
                
                56.2
                
                
                62.1
                
                
                56.3
                
                
                60.9Income
                    from operations
                
                
                43.8
                
                
                37.9
                
                
                43.7
                
                
                39.1Other
                    income (expense)Interest
                    expense
                
                
                (8.4
                )
                
                (35.4
                )
                
                (8.8
                )
                
                (34.6
                )Change
                    in fair value of derivative
                
                
                —
                
                
                2.6
                
                
                —
                
                
                2.6Other
                    income
                
                
                0.2
                
                
                0.5
                
                
                0.3
                
                
                1.1Total
                    other expense
                
                
                (8.2
                )
                
                (32.3
                )
                
                (8.5
                )
                
                (30.9
                )Income
                    before income taxes
                
                
                35.6
                
                
                5.6
                
                
                35.2
                
                
                8.2Income
                    tax expense
                
                
                (12.6
                )
                
                (0.4
                )
                
                (12.5
                )
                
                (1.7
                )Income
                    before accretion expense
                
                
                23.0
                
                
                5.2
                
                
                22.7
                
                
                6.5Accretion
                      of Class B common convertible to seniorsubordinated
                      notes
                
                
                —
                
                
                (0.9
                )
                
                —
                
                
                (1.0
                )Net
                    income available to common stockholders
                
                
                23.0
                %
                
                4.3
                %
                
                22.7
                %
                
                5.5
                %
 
 ***Three
        months and nine months ended September 30, 2005 compared to three months
        and
        nine months ended September 30, 2004***
 
 *Total
        Revenues.* Total
        revenues grew 25.1% in the three months ended September 30, 2005 to $11.7
        million from $9.3 million in the three months ended September 30, 2004. Total
        revenues grew 27.9% in the nine months ended September 30, 2005 to $35.1
        million
        from $27.5 million in the nine months ended September 30, 2004. The tables
        below
        provide the components of our revenues for the three months and nine months
        of
        2005 compared to the three months and nine months of 2004.
 
 *For
        the three months ended September 30, 2005 and 2004*
 **Three
                            Months Ended September 30,**
                        
                        **Change****2004**
                        
                        **2005**
                        
                        **Amount**
                        
                        **Percent**(dollars
                            in thousands)Local
                            service
                        
                        $
                        3,563
                        
                        $
                        3,568
                        
                        $
                        5
                        
                        
                        0.1
                        %Network
                            access
                        
                        
                        4,111
                        
                        
                        5,325
                        
                        
                        1,214
                        
                        
                        29.5Long
                            distance and other telephone services
                        
                        
                        640
                        
                        
                        815
                        
                        
                        175
                        
                        
                        27.3Cable
                            television
                        
                        
                        463
                        
                        
                        534
                        
                        
                        71
                        
                        
                        15.3Internet
                        
                        
                        543
                        
                        
                        1,417
                        
                        
                        874
                        
                        
                        161.0Total
                        
                        $
                        9,320
                        
                        $
                        11,659
                        
                        $
                        2,339
                        
                        
                        25.1
 Local
        service .
        Local
        service revenue in the three months ended September 30, 2005 was $3.6 million,
        the same as in the three months ended September 30, 2004. The increase from
        the
        Mid-Missouri Acquisition was offset by a decrease in minutes of use on our
        various local calling arrangements and customer attrition. Access lines
        increased 3,920 primarily from the acquisition of Mid-Missouri, partially
        offset
        by continued growth of the Company’s digital high-speed Internet service which
        resulted in the loss of some second access lines used by customers for dial-up
        Internet access and wireline customer attrition.
 
 
 Network
        access .
        Network
        access revenue in the three months ended September 30, 2005 grew 29.5% to
        $5.3
        million from $4.1 million in the three months ended September 30, 2004. This
        growth was primarily attributable to the increase of $1.6 million associated
        with the Mid-Missouri Acquisition offset by a decrease of $0.4 million in
        interstate access revenue after netting a small increase in federal universal
        service charges.
 
 Long
        distance and other telephone services .
        Long
        distance and other telephone services revenue in the three months ended
        September 30, 2005 increased 27.3% to $0.8 million from $0.6 million in the
        three months ended September 30, 2004. The Mid-Missouri Acquisition increased
        revenue by $0.2 million.
 
 Cable
        television .
        Cable
        television revenue in the three months ended September 30, 2005 increased
        15.3%
        to $0.5 million from $0.4 million in the three months ended September 30,
        2004.
        The increase was due to the impact of an increase in basic cable prices,
        the
        addition of 360 customers associated with the Mid-Missouri Acquisition and
        growth of 201 customers in Alabama.
 
 Internet .
        Internet revenue in the three months ended September 30, 2005 increased 161.0%
        to $1.4 million from $0.5 million in the three months ended September 30,
        2004.
        Of this increase, $0.2 million was attributable to the addition of over 1,900
        new digital high-speed Internet customers in Alabama and $0.7 million was
        attributable to the addition of digital high-speed and dial-up Internet
        customers associated with the Mid-Missouri Acquisition.
 
 *For
        the nine months ended September 30, 2005 and 2004*
  **Nine
                      Months Ended September 30,**
                  
                  **Change****2004**
                  
                  **2005**
                  
                  **Amount**
                  
                  **Percent**(dollars
                      in thousands)Local
                      service
                  
                  $
                  10,492
                  
                  $
                  10,773
                  
                  $
                  281
                  
                  
                  2.7
                  %Network
                      access
                  
                  
                  12,113
                  
                  
                  16,289
                  
                  
                  4,176
                  
                  
                  34.5Long
                      distance and other telephone services
                  
                  
                  1,992
                  
                  
                  2,380
                  
                  
                  388
                  
                  
                  19.5Cable
                      television
                  
                  
                  1,337
                  
                  
                  1,546
                  
                  
                  209
                  
                  
                  15.6Internet
                  
                  
                  1,542
                  
                  
                  4,141
                  
                  
                  2,599
                  
                  
                  168.5Total
                  
                  $
                  27,476
                  
                  $
                  35,129
                  
                  $
                  7,653
                  
                  
                  27.9
 Local
        service .
        Local
        service revenue in the nine months ended September 30, 2005 grew 2.7% to
        $10.8
        million from $10.5 million in the nine months ended September 30, 2004. This
        growth was attributable to an increase of $0.5 million from the Mid-Missouri
        Acquisition partially offset by a $0.1 million decrease in basic service
        charges
        and a $0.1 million decrease in area calling charges in the Alabama companies.
  Network
        access .
        Network
        access revenue in the nine months ended September 30, 2005 grew 34.5% to
        $16.3
        million from $12.1 million in the nine months ended September 30, 2004. This
        growth was attributable to an increase of $4.6 million associated with the
        Mid-Missouri Acquisition and a $0.2 million increase in federal universal
        service charges in the Alabama companies, offset by a decrease of $0.6 million
        in interstate access revenue in the Alabama companies.
 
 Long
        distance and other telephone services .
        Long
        distance and other telephone services revenue in the nine months ended September
        30, 2005 increased 19.5% to $2.4 million from $2.0 million in the nine months
        ended September 30, 2004. The Mid-Missouri Acquisition increased revenue
        by $0.5
        million, offset by a reduction of $0.1 in other carrier billing and collection
        agreements and property rental income.
 
 Cable
        television .
        Cable
        television revenue in the nine months ended September 30, 2005 increased
        15.6%
        to $1.5 million from $1.3 million in the nine months ended September 30,
        2004.
        The increase was due to an increase in basic cable prices, the addition of
        360
        customers associated with the Mid-Missouri Acquisition and growth of 201
        customers in Alabama.
 
 
 Internet .
        Internet revenue in the nine months ended September 30, 2005 increased 168.5%
        to
        $4.1 million from $1.5 million in the nine months ended September 30, 2004.
        Of
        this increase, $0.4 million was attributable to the addition of over 1,900
        new
        digital high-speed Internet customers in Alabama and $2.2 million was
        attributable to the addition of digital high-speed and dial-up Internet
        customers associated with the Mid-Missouri Acquisition.
  *Operating
        expenses.* Operating
        expenses in the three months ended September 30, 2005 increased 38.4% to
        $7.2
        million from $5.2 million the three months ended September 30, 2004. Operating
        expenses in the nine months ended September 30, 2005 increased 38.3% to $21.4
        million from $15.5 million the nine months ended September 30, 2004. The
        increase was primarily attributable to the Mid-Missouri Acquisition,
        amortization of loan costs associated with our initial public offering and
        public company costs.
 
 *For
        the three months ended September 30, 2005 and 2004*
  **Three
                    Months Ended September 30,**
                
                **Change****2004**
                
                **2005**
                
                **Amount**
                
                **Percent**(dollars
                    in thousands)Cost
                    of services
                
                $
                2,094
                
                $
                3,283
                
                $
                1,189
                
                
                56.8
                %Selling,
                    general and administrative expenses
                
                
                1,593
                
                
                1,585
                
                
                (8
                )
                
                (0.5
                )Depreciation
                    and amortization
                
                
                1,548
                
                
                2,375
                
                
                827
                
                
                53.4Total
                
                $
                5,235
                
                $
                7,243
                
                $
                2,008
                
                
                38.4
 
 Cost
        of services .
        Cost of
        services increased 56.8% to $3.3 million in the three months ended September
        30,
        2005 from $2.1 million in the three months ended September 30, 2004. The
        Mid-Missouri Acquisition accounted for $1.0 million of this increase. The
        balance of the increase was attributable to the higher installation and service
        costs associated with the increase in digital high-speed Internet customers,
        an
        increase in pole rental expense and higher cable programming fees.
 
 Selling,
        general and administrative expenses .
        Selling, general and administrative expenses remained constant at $1.6 million
        in the three months ended September 30, 2005 and the three months ended
        September 30, 2004. The costs associated with the Mid-Missouri Acquisition
        and
        our public company costs in the period were slightly less than the elimination
        of management fees paid to a related party and stock option expense in the
        previous year.
 
 Depreciation
        and amortization .
        Depreciation and amortization increased 53.4% to $2.4 million in the three
        months ended September 30, 2005 from $1.5 million in three months ended
        September 30, 2004. The Mid-Missouri Acquisition accounted for $0.5 million
        and
        the amortization of loan costs associated with our initial public offering
        accounted for $0.3 million. The balance of the increase was associated with
        increased digital high-speed Internet equipment and amortization of
        intangibles.
 
 *For
        the nine months ended September 30, 2005 and 2004*
  **Nine
                    Months Ended September 30,**
                
                **Change****2004**
                
                **2005**
                
                **Amount**
                
                **Percent**(dollars
                    in thousands)Cost
                    of services
                
                $
                6,057
                
                $
                9,356
                
                $
                3,299
                
                
                54.5
                %Selling,
                    general and administrative expenses
                
                
                4,810
                
                
                4,912
                
                
                102
                
                
                2.1Depreciation
                    and amortization
                
                
                4,595
                
                
                7,112
                
                
                2,517
                
                
                54.8Total
                
                $
                15,462
                
                $
                21,380
                
                $
                5,918
                
                
                38.3
  
 Cost
        of services .
        The
        cost of services increased 54.5% to $9.4 million in the nine months ended
        September 30, 2005 from $6.1 million in the nine months ended September 30,
        2004. The Mid-Missouri Acquisition accounted for $2.8 million of this increase.
        The balance of the increase was attributable to the higher installation and
        service costs associated with the increase in digital high-speed Internet
        customers, an increase in pole rental expense and higher cable programming
        fees.
 
 Selling,
        general and administrative expenses .
        Selling, general and administrative expenses increased 2.1% to $4.9 million
        in
        the nine months ended September 30, 2005 from $4.8 million in the nine months
        ended September 30, 2004. The costs associated with the Mid-Missouri Acquisition
        and our public company costs in the period were slightly higher than the
        elimination of management fees paid to a related party and stock option expense
        in the previous year.
 
 Depreciation
        and amortization .
        Depreciation and amortization increased 54.8% to $7.1 million in the nine
        months
        ended September 30, 2005 from $4.6 million in nine months ended September
        30,
        2004. The Mid-Missouri Acquisition accounted for $1.4 million and the
        amortization of loan costs associated with our initial public offering accounted
        for $0.9 million. The balance of the increase was associated with increased
        digital high-speed Internet equipment and amortization of
        intangibles.
 
 *For
        the three months and nine months ended September 30, 2005 and
        2004*
 
 *Interest
        expense.* Interest
        expense increased 426.7% to $4.1 million in the three months ended September
        30,
        2005 from $0.8 million in the three months ended September 30, 2004. Interest
        expense increased 403.9% to $12.2 million in the nine months ended September
        30,
        2005 from $2.4 million in the nine months ended September 30, 2004. The new
        credit facility and the senior subordinated notes associated with our initial
        public offering in December 2004 replaced existing variable rate term debt.
        Interest on the new credit facility is capped at 7% for the five year term
        ending December 20, 2009. Interest on the senior subordinated notes is 13%
        through their maturity in 2019.
 
 *Change
        in fair value of derivative associated with Class B common convertible to
        Class
        A common.* The
        derivative value associated with the conversion option for our Class B common
        stock must be fair valued each quarter until conversion occurs, not later
        than
        December 21, 2009. The reduction in maximum time to conversion and the increase
        in the price of IDSs and the underlying Class A common stock since the initial
        public offering combined to reduce the fair value of this liability by $0.9
        million at the end of the first nine months of 2005, including $0.3 million
        in
        the three months ended September 30, 2005.
 
 *Other
        income.* Other
        income was less than $0.1 million in the three months ended September 30,
        2005
        and 2004. Other income increased 441.5% to $0.4 million in the nine months
        ended
        September 30, 2005 from less than $0.1 million in the nine months ended
        September 30, 2004. The increase was attributable to the increased annual
        patronage dividend income from CoBank received in first quarter
        2005.
 
 *Income
        taxes.* Provision
        for income taxes in the three months ended September 30, 2005 declined 95.5%
        to
        less than $0.1 million from $1.2 million in the three months ended September
        30,
        2004. Provision for income taxes in the nine months ended September 30, 2005
        declined 82.2% to $0.6 million from $3.4 million in the nine months ended
        September 30, 2004. This reflects the expected lower income generated from
        the
        capital structure associated with our initial public offering in December
        2004
        and the estimated lower tax rate for the full year. In calculating the effective
        tax rate, the change in the fair value of the derivative associated with
        the
        Class B common convertible to Class A common is excluded as a permanent
        difference. As a result, the effective rate will vary from period to
        period.
 
 *Accretion
        of Class B common convertible to senior subordinated notes.* Our
        Class
        B common stock was issued to the existing equity holders coincident with
        our
        initial public offering on December 21, 2004. These shares represent their
        retained interest in the company. They do not receive any dividends and will
        convert into IDSs not later than December 21, 2009. For the first two years
        after their issuance, the present value discount on the portion of the shares
        related to the conversion to senior subordinated notes is being accreted
        as a
        non-cash expense to the Company. For the three months and nine months ended
        September 30, 2005, this accretion expense was $0.1 million and $0.3 million
        respectively.
 
 
 *Net
        income.* As
        a
        result of the foregoing, net income available to common stockholders in the
        three months ended September 30, 2005 decreased 76.8% to $0.5 million from
        $2.1
        million in the three months ended September 30, 2004 and net income in the
        nine
        months ended September 30, 2005 decreased 68.9% to $1.9 million from $6.2
        million in the nine months ended September 30, 2004.
  **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.
 
 Cash
        flows from operating activities for the first nine months of 2005 amounted
        to
        $8.3 million compared to $14.8 million for the first nine months of 2004.
        The
        changes are primarily the result of higher interest associated with the capital
        structure of the company since its initial public offering, the payment of
        accrued expenses associated with the initial public offering, and advance
        payments for dial-up Internet customers outside of our telephone service
        territory.
 
 Cash
        flows from investing activities for the first nine months of 2005 amounted
        to
        $3.2 million compared to $3.4 million for the first nine months of 2004.
        The
        capital expenditures for the acquisition and construction of property and
        equipment associated with the Mid-Missouri Acquisition accounted for the
        increase.
 
 Cash
        flows from financing activities for the first nine months of 2005 reflected
        the
        change in equity and debt structure of the company associated with our initial
        public offering. The company distributed $5.1 million in cash dividends to
        stockholders in the first nine months of 2005 compared to $5.8 million for
        repayment of long-term notes payable in the first nine months of 2004,
        accounting for the change between periods.
 
 We
        anticipate that operating cash flow, together with borrowings under our credit
        facility, will be adequate to meet our currently anticipated operating and
        capital expenditure requirements for at least the next 12 months.
  
 **Item
        3.** ***Quantitative
        and Qualitative Disclosures About Market Risk***
 
 Our
        short-term excess cash balance is invested in short-term commercial paper.
        We do
        not invest in any speculative derivative or commodity type instruments.
        Accordingly, we are subject to minimal market risk on our
        investments.
  We
        have
        the ability to borrow up to $15.0 million under a revolving loan facility.
        The
        interest rate is variable and, accordingly, we are exposed to interest rate
        risk, primarily from the change in LIBOR or a base rate. Currently, we have
        no
        loans drawn under this facility.
  **Item
        4.** ***Controls and Procedures***
 
 With
        the
        participation of the Chief Executive Officer and the Chief Financial Officer,
        management has evaluated the effectiveness of our disclosure controls and
        procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
        of
        1934). Based on that evaluation, the Chief Executive Officer and Chief Financial
        Officer concluded that our disclosure controls and procedures were effective
        as
        of September 30, 2005.
  There
        were no changes in our internal control over financial reporting (as defined
        in
        Rule 13a-15(f) under the Securities Exchange Act of 1934) during the first
        nine
        months of fiscal 2005 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.
  
 **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:
                November 10, 2005**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