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Executives

Kevin Enda – IR

Michael Weaver – Chairman, President and CEO

Curtis Garner – CFO

Otelco, Inc. (OTT) Q3 2011 Earnings Call November 3, 2011 11:00 AM ET

Operator

Good day and welcome to the Otelco Incorporated third quarter 2011 conference call. As a reminder, today’s presentation is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Kevin Enda.

Please go ahead sir.

Kevin Enda

Thank you Doris, and welcome to this Otelco conference call to review the company's results for the third quarter ended September 30, 2011, which were released yesterday afternoon. Conducting the call today will be Michael Weaver, President and Chief Executive Officer; and Curtis Garner, Chief Financial Officer.

Before we start, let me offer the cautionary note that statements made on this conference call that are not statements of historical or current fact constitute forward-looking statements. Such forward looking statements involve known and unknown risks, uncertainties and other unknown factors that could cause the actual results of the company to be materially different from the historical results or from any future results expressed or implied by such forward-looking statements.

In addition to statements, which explicitly describes such risks and uncertainties, listeners are urged to consider statements labeled with the terms believes, expects, intends, anticipates, plans, or similar terms to be uncertain and forward-looking. The forward-looking statements contained herein are also subject generally to other risks and uncertainties that are described from time to time in the company's filings with the SEC.

With that stated, I'll now turn the call over to Mike Weaver.

Michael Weaver

Thanks, Kevin. Good morning, everyone. Obviously I have a few brief comments before I ask Curtis to review the third quarter results.

First, I hope you saw our announcement that we finally closed the acquisition of Shoreham Telephone on October 14. This acquisition has over 5000 access line equivalents that are Otelco family [ph]. The process to integrate their operations into our systems has already started. We expect this process to take approximately 6 months, and at this time we don’t anticipate any significant problems.

Our plans for Shoreham include expanding the existing broadband coverage, adding bundled services to the current offerings, and using the existing network as our anchor to get into the CLEC business in Vermont. Second we began to see positive results from our new triple play bundles in Alabama as we experienced a 2.5% growth in our cable subscribers, growth in our data services and a decrease in the rate of decline of our access lines.

In addition to the improvement in our metrics, we continue to find ways to reduce cost as evidenced by the consolidation of our Alabama RLEC business offices. Looking at the CLEC operations, we experienced changes in our sales and marketing organization as we finally completed our planned addition of nine collocation sites in New England. With these new sites, we now have 47 sites throughout New England.

We continue to be pleased with the growth in our hosted PBX product as we saw a 34% increase in revenue generated from this product in the third quarter. The hosted PBX is a valuable addition to our product mix as it works well with any broadband provider, which gives us the ability to serve customers outside of our existing markets.

Third quarter produced adjusted EBITDA of $11.1 million, which was negatively impacted by almost $400,000 of non-recurring cost. Included in these costs are legal expense for Shoreham and severance expenses associated with office consolidation in Alabama and the changes I have just mentioned in our sales and marketing organization.

Another opportunity for us is the wireless network conversion to the 4G, which gives us the opportunity to provide fiber [ph] facilities to towers located in our existing footprint. We recently received orders to build [inaudible] additional sites in Alabama and Missouri. The construction is currently in progress and we expect to begin to bill for these services in January of next year.

We remain cautiously optimistic that the FCC USF/ICC reform plan revealed last week will have minimal financial impact on our operations. Based on the executive summary of the plan, we do not expect to see any material changes in our USF and access revenue over the next several years. The USF for our RLEC isn’t expected to change at all for the next two years, and we expect a gradual shift for the 3 to 5 years thereafter.

For the FCC wants to eventually move the current access revenue process to bill and keep the plan cost for a multi-year transition for donating [ph] access rights for companies like Otelco. In addition, there are recovery mechanisms that allow RLECs to increase charges to end users by modest amounts.

Currently, Interstate switched access revenue amounts to 9% of our total revenue and the [inaudible] portion of USF represents only 4% of our revenue so far this year. We basically view this reform as good news for our industry, and it finally removes some of the uncertainty and it actually may prove to be a catalyst for additional RLEC acquisition opportunities in the future.

We continue to look for accretive acquisitions. Finally, we paid our 27th consecutive IDS distribution in September and we remain committed to continuing our policy of returning cash to our shareholders.

Curtis, if you would, please discuss financial results.

Curtis Garner

Thank you Mike, and thanks to everyone on the call for joining us today. I'll provide a brief overview of our financial performance for the quarter, and then we can take your questions. We anticipate that our 10-Q should be filed tomorrow with additional detailed information.

Total revenues decreased 3.2% in the third quarter to $25.3 million from $26.1 million a year ago. Declines from the traditional loss of RLEC voice access line related revenues were not offset by growth in the CLEC, particularly in the new markets, and by growth in the Alabama cable television revenues. Mike already mentioned both the completion of the CLEC build out and the new cable bundles that we have been installing.

Breaking the revenue down further, local services revenue decreased 5.7% in the third quarter to $11.7 million from $12.4 million. RLEC revenue decreased $0.4 million, reflecting the decline in RLEC voice access lines. The balance of the decline was due to a one-time gain in CLEC revenues in the year ago period, including a benefit of the refund from a service provider tax audit.

I will give you some detail on the next four items, but just note that all of those changed either up or down by less than $100,000 in each category.

Network access revenue was basically flat in the third quarter declining $29,000 to $8 million. The small decline in interstate and intrastate switched access revenue was generally offset by an increase in the usage related fees.

Cable television revenue increased 7.4% or $53,000 to around $0.8 million in 2011. Growth in IPTV subscribers and the shift to high-definition packages in Alabama was offset by the decline in revenue associated with the conversion of our Missouri cable customers to satellite services, which happened in the first quarter of 2011.

Internet revenue decreased 2.2% to $3.4 million from $3.5 million. Growth in broadband data lines offset the loss of dial-up subscribers primarily in those portions of Maine and Missouri, where we do not have the option to convert them to some form of a high-speed Internet data line. Transport services revenues decreased 5.6% to $1.3 million from $1.4 million. Market price changes for both new and existing customers caused that decline.

If we look at expenses now, operating expenses in the third quarter decreased 1.2% to $19.2 million from $19.4 million. Cost of services and products increased 6.3% to $11 million from $10.3 million in the quarter ended September 30, 2010. Higher costs associated with the hosted PBX product support and expanded sales organization and higher internet and total [ph] rental costs were partially offset by RLEC organizational improvements.

During the third quarter we consolidated business offices in Alabama, and adjusted the CLEC sales and sales support organization in Maine, which will provide improvements in cost beginning next quarter. As Mike mentioned, termination costs associated with those charges will reflect in the current quarter’s results.

Selling, general and administrative expenses decreased 1.8% to $3.2 million from $3.3 million primarily related to a reduction in employee and benefit costs, which were offset by higher legal costs associated with the Shoreham acquisition, and some uncollectible expenses related to one carrier customer.

Depreciation and amortization for the third quarter decreased 14.4% to $4.9 million from $5.8 million. Amortization of intangible assets associated with the Country Road acquisition decreased $0.3 million, including contract and customer base intangible assets. Amortization for the telephone plant adjustment associated with the Maine acquisition was completed at the end of the second quarter of 2011, accounting for a decrease of $0.2 million. The remaining decrease of $0.3 million reflects lower depreciation of plant assets in Otelco's regulated entities as the assets become fully depreciated.

Interest expense decreased 1.6% to $6.2 million from $6.3 million a year ago. The decrease reflects the lower senior long-term notes outstanding resulting from voluntary payments of $6.5 million over the last year.

Adjusted EBITDA was $11.1 million for the third quarter compared to $12.7 million for the same quarter a year ago, and $11.9 million in the second quarter of 2011.when you remove the series of one-time items both what we call good guys and bad guys, the result for the third quarter EBITDA improved slightly over the second quarter.

Cash flow from operating activities was $15.4 million in the first 9 months of the year compared to $19.4 million during the same period last year. Cash used in investing activities amounted to $8.4 million compared to $6.4 million a year ago, reflecting continued investment in both our RLEC and CLEC businesses and the tornado damage repair in the second quarter. Investments in property, plant and equipment in the third quarter decreased to $2.2 million from a run rate of over $3 million as we completed the collocation build outs in New England.

Cash flow used in financing activities for the first 9 months amounted to $7.4 million compared to $7.2 million during the same period last year, reflecting the dividends on the converted Class B shares beginning in the second quarter of 2010. Looking forward, we paid for Shoreham using cash off of our balance sheet.

As of September 30, 2011, the company had cash and cash equivalents of $17.8 million compared to $18.2 million at the end of 2010. The company made a $0.4 million voluntary prepayment on our senior debt in May 2011, reducing the balance to $162 million. This represents a combined reduction of $11.5 million since October of 2008, when the credit agreement was put in place.

The third quarter distribution of $5.6 million in interest and dividends to our shareowners and $0.3 million in interest to our bond holders occurred on September 30. As Mike mentioned, this represents the 27 consecutive quarterly distribution since we went public. We anticipate that the company's 2011 dividends will continue to be treated as return of capital for tax purposes of the holders, as they were in 2008, '09 and '10.

Each quarter, the Board will consider the declaration of dividends during its normal scheduled meeting. For this quarter, the Board meets on November 15. The scheduled interest and any dividends declared will be paid on December 30 to holders of record as of the close of business of December 15. The interest payment will cover the period from September 30 to December 29.

Doris, if you'll provide directions, we can take questions at this time.

Question-and-Answer Session

Operator

(Operator instructions) And Mr. Weaver, there appears to be no callers in the queue at this time. I will turn the call back to you sir.

Michael Weaver

Thanks Doris. As always, I appreciate your participation in the call, and we look forward to speaking to you again in the next quarter. Thanks again.

Operator

And ladies and gentlemen that does conclude today’s presentation. We thank you for your participation.

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