UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

(Mark One)

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

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For the Fiscal Year Ended December 31, 2017

OR

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

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For the Transition Period from            to            

Commission File Number: 1-32362

OTELCO INC.

(Exact Name of Registrant as Specified in Its Charter)

205-625-3580
(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

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

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

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 ☒ No ☐

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

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

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

As of June 30, 2017, the aggregate market value of the registrant’s Class A Common Stock held by non-affiliates of the registrant was $21.1 million based on the closing sale price of the registrant’s Class A Common Stock as reported on the Nasdaq Stock Market LLC. In determining the market value of the registrant’s Class A Common Stock held by non-affiliates, shares of Class A Common Stock beneficially owned by the registrant’s directors and officers and holders of more than 10% of the registrant’s Class A Common Stock have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☒ No ☐

As of March 13, 2018, the registrant had 3,388,621 shares of Class A Common Stock, par value $0.01 per share, and 0 shares of Class B Common Stock, par value $0.01 per share, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required in Part III of this report is incorporated by reference from the registrant’s proxy statement to be filed pursuant to Regulation 14A with respect to the registrant’s 2018 annual meeting of stockholders.

OTELCO INC.

TABLE OF CONTENTS

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Unless the context otherwise requires, the words “we,” “us,” “our,” the “Company” and “Otelco” refer to Otelco Inc., a Delaware corporation, and its consolidated subsidiaries as of December 31, 2017.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations relating to our financial condition, results of operations, plans, objectives, future performance and business. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. These forward-looking statements are based on assumptions that we have made in light of our experience in the industry in which we operate, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial condition or results of operations, or cause our actual results to differ materially from those in the forward-looking statements. These factors include, among other things, those discussed in Item 1A, Risk Factors. We assume no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

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PART I

Item 1.   Business

History

We were formed as a Delaware limited liability company in 1998 for the purpose of operating and acquiring rural local exchange carriers, which we refer to as RLECs. Since 1999, we have acquired eleven RLEC businesses, four of which serve contiguous territories in north central Alabama; three of which serve territories adjacent to either Portland or Bangor, Maine; and one each serving a portion of western Massachusetts, central Missouri, western Vermont and southern West Virginia. In addition to traditional telephone services, we provide a variety of unregulated services in all of our RLEC territories, including internet data lines and long distance services. We have also acquired three facilities based competitive local exchange carriers, which we refer to as CLECs, which offer services primarily to business or enterprise customers in Maine, New Hampshire, and Massachusetts and have historically operated under the trade name OTT Communications. The Company completed an initial public offering in December 2004 at which time it converted from a Delaware limited liability company into a Delaware corporation and changed its name to Otelco Inc. In 2018, we will transition to using the brand name Otelco in all locations where we provide service.

The following table shows the aggregate number of our voice and data access lines and other services we offer, such as cable and Internet Protocol television, which we refer to as IPTV, and security systems (which together are access line equivalents), as of December 31, 2017:

Our RLEC companies trace their history to the introduction of telecommunication services in the areas they served over 100 years ago. We are able to leverage our long-standing relationship with our local service customers by offering them a broad suite of telecommunications and information services, such as long distance, internet/broadband data access and, in some areas, video and security, thereby increasing customer loyalty and revenue per access line equivalent. Each RLEC qualifies as a rural telephone company under the Federal Communications Act of 1934, which we refer to as the Communications Act. We are currently exempt from certain costly interconnection requirements imposed on larger incumbent local telephone companies by the Communications Act. Although this exemption helps us maintain our strong competitive position, we have direct competition in portions of our RLEC markets, primarily where a cable provider also serves the same market. In addition, the larger wireless carriers have deployed their 4G/LTE networks in most of our markets.

In Maine, Massachusetts, and New Hampshire, our facilities-based CLEC serves primarily business customers, utilizing both owned and leased fiber as its backbone network. In nearly two decades of operations, the CLEC has grown to provide nearly 35,000 access line equivalents.

Acquisitions have represented a significant part of our growth. From 1999 to 2003, we acquired four contiguous RLECs in north central Alabama. In 2004, we acquired an RLEC in central Missouri. In 2006, we acquired an RLEC adjacent to Bangor, Maine and a CLEC serving the state of Maine. In 2008, we acquired RLECs adjacent to Portland, Maine, in western Massachusetts and southern West Virginia, as well as two CLECs serving customers in Maine and New Hampshire. In 2011, we acquired an RLEC in

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western Vermont. In 2014, we acquired the assets of Reliable Networks of Maine, LLC, which we refer to as Reliable Networks, a Portland, Maine-based provider of cloud hosting and managed services for companies who rely on mission-critical software applications. The acquisition expanded our service offerings to include multi-tenancy hosting of vendor-agnostic email, database, web and industry vertical software applications, as well as related professional engineering services, which we refer to, collectively, as managed services.

The following table reflects the percentage of total revenues derived from each of our service offerings for the year ended December 31, 2017:

Revenue Mix

Local Services

We are the sole provider of wireline voice telephone services in three of the eleven RLEC territories we serve. In seven territories, the incumbent cable provider also offers local services in portions of our territory. In Missouri, a local electric co-operative also offers local services in a portion of our territory. Local services enable customers to originate and receive telephone calls. The amount that we can charge a customer for certain basic services in Alabama, Maine, Massachusetts, Missouri, Vermont and West Virginia is regulated by the Alabama Public Service Commission, which we refer to as the APSC, the Maine Public Utilities Commission, which we refer to as the MPUC, the Massachusetts Department of Telecommunications and Cable, which we refer to as the MDTC, the Missouri Public Service Commission, which we refer to as the MPSC, the Vermont Public Utilities Commission, which we refer to as the VPUC, and the West Virginia Public Service Commission, which we refer to as the WVPSC. We also have authority to provide service in New Hampshire from the New Hampshire Public Utilities Commission, which we refer to as the NHPUC. The regulatory involvement in pricing varies by state and by type of service. In recent years, state commissions have relaxed regulation of most of our services.

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

We offer long distance telephone services to our RLEC local telephone customers. We provide long distance services on our own facilities or through services purchased from various long distance providers. At December 31, 2017, customers representing approximately 74% of our regulated voice access lines subscribed to our long distance services. We intend to continue to make our long distance business an integral part of the services we provide to our RLEC customers principally through bundling of services.

In Maine, Massachusetts and New Hampshire, our CLEC provides communications services tailored to business and enterprise customers, including specialized data and voice network configurations, to support their unique business requirements. Our fiber network allows us to offer our customers affordable and reliable voice and data solutions to support their business requirements and applications.

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Network Access

Network access revenue relates primarily to services provided by us to long distance carriers in connection with their use of our facilities to originate and terminate interstate and intrastate long distance, or toll, telephone calls. As toll calls are generally billed to the customer originating the call, network access charges are applied in order to compensate each telecommunications company providing services relating to the call. Network access charges apply to both interstate and intrastate calls. As of December 31, 2016, all eleven of our RLECs received Interstate Common Line Support, which we refer to as ICLS, revenue from the Universal Service Fund, which we refer to as the USF, and three of our RLECs also received Universal Service Fund High Cost Loop, which we refer to as USF HCL, revenue. This revenue is included in our reported network access revenue. Beginning January 1, 2017, ICLS and USF HCL funding was replaced by Alternative Connect America Model, which we refer to as ACAM, funding for ten of our RLECs. One of our RLECs continues to receive USF HCL, and a revised form of ICLS called Connect America Fund Broadband Loop Support, which we refer to as CAF BLS.

Intrastate Access Charges.   We generate intrastate access revenue when a long distance call, involving a long distance carrier, is originated and terminated within the same state. The interexchange carrier pays us an intrastate access payment for either terminating or originating the call. We record the details of the call through our carrier access billing system. Our access charges for our intrastate access services were historically set by state regulatory commissions. The Federal Communications Commission, which we refer to as the FCC, intercarrier compensation order released in October 2011, which we refer to as the FCC ICC Order, preempted the state commissions’ authority to set terminating intrastate access service rates, and required companies with terminating access rates higher than interstate rates to reduce their terminating intrastate access rates to a rate equal to interstate access service rates by July 1, 2013, and to move to a “bill and keep” arrangement by July 1, 2020, which will eliminate access charges between carriers. The FCC ICC Order created the Connect America Fund, which we refer to as the CAF, to offset the RLECs’ resulting loss in intrastate terminating access revenues but limited the yearly amount recovered to 95% of the previous year’s revenue requirement. There is no recovery mechanism for the lost revenue in our CLEC.

Interstate Access Charges.   We generate interstate access revenue when a long distance call originates from an area served by one of our local exchange carriers and terminates outside of that state, or vice versa. We bill interstate access charges in a manner similar to intrastate access charges. Our RLEC interstate access charges are regulated by the FCC through our participation in tariffs filed by John Staurulakis Inc. The FCC regulates the prices local exchange carriers charge for access services in two ways: price caps and rate-of-return. All of our RLECs are rate-of-return carriers for purposes of interstate network access regulation. Interstate access revenue for rate-of-return carriers for non-FCC ICC Order elements is based on an FCC regulated rate-of-return on investment and recovery of operating expenses and taxes, in each case solely to the extent related to interstate access. From 1990 through June 2016, the rate-of-return had been authorized up to 11.25%. In March 2016, the FCC reduced the authorized rate-of-return to 9.75% effective July 1, 2021, using a transitional approach to reduce the impact of an immediate reduction. Rate-of-return transition began on July 1, 2016, with the authorized rate reduced to 11.0%, with further 25 basis points reductions each July 1 thereafter until the authorized rate reaches 9.75% on July 1, 2021. The FCC requires terminating interstate access rates to move to a “bill and keep” arrangement by July 1, 2020, which will eliminate access charges between carriers. Initial reductions in interstate access rates began July 1, 2012, with additional reductions on July 1 of each year through July 1, 2020. The CAF provides recovery of terminating interstate access revenues. This recovery is limited to 95% of the previous year’s revenue requirement and excludes CLECs.

Federal Universal Service Fund High Cost Loop Revenue.   One of our eleven operating subsidiaries recovers a portion of its operating costs through the USF HCL, which is regulated by the FCC and administered by the Universal Service Administrative Company, which we refer to as USAC, a non-profit organization. Based on historic and other information, a nationwide average cost per loop is determined by USAC. Any incumbent local exchange carrier whose individual cost per loop exceeds the nationwide average by more than 15% qualifies for USF HCL support. All of our RLECs have been designated as eligible telecommunication carriers, which we refer to as ETCs. The USF HCL, which is funded by assessments on all United States telecommunication carriers as a percentage of their revenue from end-users of interstate and international service, distributes funds to our participating RLECs based upon their respective costs for providing local services. USF HCL payments are received monthly.

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Interstate Common Line Support.   An FCC order on October 23, 2016, revised ICLS with new provisions to provide support for broadband capable loops, as well as traditional voice loops, known as Connect America Fund Broadband Loop Support, which we refer to as CAF BLS, for rate-of-return carriers. CAF BLS replaces ICLS. CAF BLS requirements include specific broadband deployment obligations, including the number of locations to be capable of broadband speeds of 10/1 within certain eligible Census Blocks in our service areas. On January 1, 2017, one of our RLECs began receiving CAF BLS.

Alternative Connect America Model.   Through December 31, 2016, our RLECs received USF HCL and ICLS revenue, which is included in our network access revenue. On March 23, 2016, the FCC released an order, which adopted changes to the Universal Service programs, directed to preserve and advance voice and broadband service in areas served by rate-of-return carriers. The order provided qualifying rate-of-return carriers the option of receiving model-based support through ACAM in lieu of legacy rate-of-return support through CAF BLS, formerly ICLS, and USF HCL. ACAM includes support for broadband service as well as voice service. Ten of our RLECs qualify for ACAM, and have elected to accept ACAM support. These elections were effective on January 1, 2017, and will provide ACAM support through 2026. The ACAM election includes specific broadband deployment obligations, including the number of locations to be capable of specific broadband speeds within certain eligible Census Blocks in our service areas.

Transition Service Fund Revenue.   Our four Alabama RLECs recover a portion of their costs through the Transition Service Fund, which we refer to as the TSF, which is administered by the APSC. All interexchange carriers originating calls in Alabama contribute to the TSF on a monthly basis, with the amount of each carrier’s contribution calculated based upon its relative originating minutes of use compared to the aggregate originating minutes of use for all telecommunication carriers participating in the TSF. The TSF reduces the vulnerability of our Alabama RLECs to a loss of access and interconnection revenue. TSF payments are received monthly. Negotiations to eliminate TSF payments in Alabama were completed in August 2015. TSF payments will be phased out over a five-year period that began in June 2016 and will end in June 2021. The reduction in TSF was 5% in each of 2016 and 2017 and will be 10% in 2018 and 15% in each of 2019 and 2020.

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

Internet

We provide a variety of internet access data lines to our customers, including bulk broadband data access to support large corporate enterprise users and digital high-speed data lines in varying capacity speeds for business and residential use. Digital high-speed data lines are provided via digital subscriber line, which we refer to as DSL; cable modems; and wireless broadband, depending upon the location in which the service is offered, and via dedicated fiber connectivity to larger business customers. We charge our internet customers a flat rate for unlimited usage and a premium for higher speed internet services. We are able to provide digital high-speed internet data lines to over 95% of our RLEC access lines and all of our CLEC access lines. Under ACAM, we have specific requirements to expand the availability of higher broadband speeds to our customers and expect to invest in our network to meet or exceed those requirements.

Transport Services

Our CLEC receives monthly recurring revenues for the rental of fiber to transport data and other telecommunication services in Maine and New Hampshire from businesses and telecommunication carriers over our fiber network.

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Video and Security

We provide cable television services, including high definition, digital video recording capability and video on demand, which we refer to as VOD, over networks with 750 MHz of transmission capacity or by IPTV in our Alabama service area. We offer digital signals, high-definition program content, digital video recording capability and VOD through both our traditional cable plant and IPTV. Our cable television packages offer from 20 to 200 channels. We are a licensed installer of security equipment in Alabama. We offer wireless security systems in Alabama and Missouri and monthly monitoring of security systems through a third-party monitoring company.

Managed Services

We provide private/hybrid cloud hosting services, as well as consulting and professional engineering services, for mission-critical software applications used by small and mid-sized North American companies. Revenues are generated from monthly recurring hosting fees, commonly referred to as Infrastructure as a Service, which we refer to as IaaS, monthly maintenance fees, à la carte professional engineering services, and pay-as-you-use Software as a Service, which we refer to as SaaS. Services are domiciled in two diverse owned data centers.

Network Assets

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

Sales, Marketing and Customer Service

In Maine, Massachusetts, New Hampshire, Vermont and West Virginia, our RLECs and CLEC have historically provided services under the brand names “OTT Communications” and “Reliable Networks.” However, beginning in 2018, all services will be rebranded under the brand name “Otelco”. Our CLEC competes with the incumbent carriers throughout each state, as well as with other competitive communications providers, utilizing both an employee and agent sales force. Service configurations are tailored to meet specific customer requirements, utilizing customer designed voice and data telecommunications configurations. Increased service monitoring for business customers is provided through a state of the art network operations center and serves as a differentiator for our offers. We offer an IP-based Hosted Private Branch Exchange service, which we refer to as HPBX, that provides industry-leading capability for our customers, as well as cloud hosting and professional engineering services.

Our RLEC marketing approach emphasizes locally managed, customer-oriented sales, marketing and service. We believe that we are able to differentiate ourselves from any competition by providing a superior level of service in our territories. Each of our RLECs has a long history in the communities it serves, which has helped to enhance our reputation among local residents by fostering familiarity with our products and level of service. Our customer service representatives are local residents and often have a direct connection to their communities, which we believe improves customer satisfaction and enhances our reputation with local residents. We also build upon our strong reputation by participating in local activities, such as local fund raising and charitable events for schools and community organizations and, in Alabama, by airing local interest programs on our local access community cable channels.

Part of our strategy is to increase customer loyalty and strengthen our brand name by deploying new technologies and by offering comprehensive bundling of services, including digital high-speed internet access, cable television, unlimited long distance and a full array of calling features. In addition, our ability to provide our customers with a single, unified bill for all of our RLEC and traditional CLEC services is a competitive advantage and helps to enhance customer loyalty.

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Competition

Local Services

We believe that many of the competitive threats to wireline telephone companies are not as significant in portions of our RLEC service areas as in more urban areas. The demographic characteristics of rural telecommunications markets generally require significant capital investment to offer competitive wireline telephone services with low potential revenues. However, our RLECs face wireline telephone competition in the majority of our markets from a cable company or electric co-operative offering telephone and data services. New market entrants, such as providers of satellite broadband, and indirect competition such as voice over IP, which we refer to as VoIP, have also gained greater acceptance over time.

We currently qualify for the federal rural exemption from certain interconnection obligations that support industry competition, including obligations to provide services for resale at discounted wholesale prices and to offer unbundled network elements. If the exemption were terminated by a state commission, our RLECs could face additional competition.

In all of our markets, we face competition from wireless carriers. We have experienced a decrease in access lines as a result of customers switching their residential wireline telephone service to a wireless service. However, the introduction of residential bundled offerings, including unlimited long distance calling, appears to have recaptured minutes back from wireless carriers. In addition, a portion of the wireless technology threat to our business is reduced, due in part to the topography of some of our telephone territories, which can result in inconsistent wireless coverage in some areas. Nevertheless, as wireless carriers continue the deployment of newer technologies in our territories, we expect to experience increased competition from these carriers.

The long distance market remains competitive in all of our RLEC territories. We compete with major national and regional interexchange carriers as well as wireless carriers and other service providers. However, we believe that our service bundling that includes long distance, our long-standing local presence in our territories and our ability to provide a single, unified bill for all of our services, are major competitive advantages. At December 31, 2017, approximately 74% of our regulated voice access lines subscribed to our long distance services. The majority of our CLEC customers have also selected us for their long distance services as part of their overall package of services.

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

Internet

Competition in the provision of RLEC data lines and internet services currently comes from alternative digital high-speed internet service providers. Competitors vary on a market-to-market basis and include cable providers Charter Communications, Inc., under the Spectrum brand name, which we refer to as Spectrum, Comcast Corporation, which we refer to as Comcast, and Co-Mo Electric Cooperative, Inc. In Missouri, we provide high-speed data lines to approximately 1,900 subscribers outside of our rural telephone services territory. Our CLEC customers are provided a variety of data access service options based on their individual requirements.

Transport Services

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

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Video and Security

We offer cable television services, including VOD, in our Alabama territory. Cable services are delivered through traditional cable technology and IPTV. Spectrum provides cable service, passing about 30% of our RLEC Alabama telephone subscribers and approximately 60% of our RLEC Maine telephone subscribers. In Massachusetts, Comcast provides cable service, passing more than 90% of our telephone subscribers. In West Virginia, Shentel provides cable service, passing more than 98% of our telephone subscribers. In addition, we compete against digital broadcast satellite providers including DISH Network and DirecTV in our Alabama territory. Our broadband subscribers also have access to “Over The Top” entertainment services offered by numerous providers, such as Netflix and Hulu, including local broadcast channels in Vermont.

Managed Services

The managed services and cloud hosting market has numerous competitors from very large multi-dimensional companies such as Amazon, Microsoft, Google and IBM, to divisions of large telecommunications firms, to small operations serving specific local markets or industries. Our managed services offerings are focused on small and mid-sized companies who have mission-critical software applications that also need operational and design support for their applications.

Information Technology and Support Systems

We have integrated software systems that function as operational support and customer care/billing systems. One system serves our Alabama and Missouri subscribers, and one serves our Maine, Massachusetts, New Hampshire, Vermont and West Virginia subscribers. Reliable Networks’ clients are currently invoiced directly by an additional billing system. The systems include automated provisioning and service activation, mechanized line records and trouble reporting. These services are provided through the use of licensed third-party software. We have selected a vendor to combine all of our billing and operating systems onto a single platform for additional marketing and operational synergies, and are expecting to move to the new platform during second quarter 2018.

We have implemented all currently established safeguards to Customer Proprietary Network Information as established by the FCC for telecommunications providers and we are compliant with the “red flag” provisions of the Fair and Accurate Credit Transactions Act.

Environment

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

Employees

As of December 31, 2017, we employed 222 employees, 4 of which were part time employees. None of our employees are members of, or are represented by, any labor union or other collective bargaining unit. We consider our relations with our employees to be good.

Item 1A.   Risk Factors

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

The Telecommunications Industry Has Experienced Increased Competition.

The market for telecommunication services is highly competitive. Currently, we have competition in eight of our markets from cable providers and an electric co-operative. Certain competitors benefit from brand recognition, financial, personnel and marketing resources and access to capital that are significantly greater than ours, which may also be impacted by further industry consolidation. In addition, our relative

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size and the distance between our regional businesses makes it more difficult for us to achieve scale economies and efficiencies than certain of our competitors, which puts us at a competitive disadvantage and may lead to customer attrition. We cannot predict the number of new competitors that will emerge, especially as a result of existing or new federal and state regulatory or legislative actions. Increased competition from existing and new entities could have an adverse effect on our business, revenue and cash flow.

In all of our markets, we face competition from wireless carriers. As wireless carriers continue to build-out their voice and data networks and add products and services targeted to the fixed wireless market, we may experience increased competition, which could have an adverse effect on our business, revenue and cash flow.

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

In Maine, New Hampshire and Massachusetts, our CLEC operations may encounter a change in the competitive landscape that would impact its continued ability to grow and/or retain customers, sustain current pricing plans and control the cost of access to incumbent carrier customers. Our CLEC leases a portion of its facilities, reducing its ability to adjust to price competition.

We provide our long distance services within our territories, primarily through bundling long distance with other local services and providing a single bill for these services. Our long distance competitors, including those with significantly greater resources than us and carriers offering VoIP services, continue to develop attractive new offerings. There can be no assurance that our local services revenue, including long distance services, will not decrease in the future due to competition and/or the introduction of new services.

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

We operate in an industry that is regulated at the federal, state and local level. The majority of our revenue has historically been supported by and subject to regulation. Certain federal and state regulations and local franchise requirements have been, are currently, and may in the future be, the subject of judicial proceedings, legislative hearings and administrative proposals. Such proceedings may relate to, among other things, federal and state universal service funds, the rates we may charge for our local, network access and other services, the manner in which we offer and bundle our services, the terms and conditions of interconnection, unbundled network elements and resale rates, and could change the manner in which telecommunications companies operate. The FCC ICC Order began significantly reducing access revenue received by us in July 2012. Subsequently, we accepted the FCC’s ACAM offer for ten of our eleven RLECs, which replaced USF HCL revenue for those RLECs effective as of January 1, 2017, and will require additional network capital expenditures. ACAM support will decline over a ten year period. In addition, there can be no assurances that recent FCC actions will not be changed in the future. Any such changes could adversely affect our business, revenue and cash flow.

If We Fail to Meet Our Broadband Deployment Obligations Under ACAM, We May Lose All or Part of Our ACAM Support.

On March 23, 2016, the FCC released an order, which adopted changes to the Universal Service programs, directed to preserve and advance voice and broadband service in areas served by rate-of-return carriers. The order provided qualifying rate-of-return carriers the option of receiving model-based support through ACAM in lieu of legacy rate-of-return support through CAF BLS, formerly ICLS, and USF HCL. Ten of our RLECs qualify for ACAM, and have elected to accept ACAM support. These elections were effective on January 1, 2017, and are expected to provide ACAM support through 2026. However, the ACAM election includes specific broadband deployment obligations, including the number of locations to be capable of specific broadband speeds within certain eligible Census Blocks in our service areas. If we fail to meet these broadband deployment obligations, we may lose all or part of our ACAM support, which would adversely affect our business, revenue and cash flow.

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

Our credit facility contains certain covenants that, among other things, restrict our ability to take specific actions, which may limit our ability to invest in new services or respond to competitive forces, including, without limitation, restrictions on our ability to:

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incur certain liens;

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incur additional indebtedness;

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wind up, liquidate, merge, or consolidate with any other person or transfer or dispose of certain properties or assets;

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change the nature of our business;

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•

make certain types of restricted payments, including dividends on our common stock, investments and acquisitions;

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•

enter into specified transactions with affiliates; and

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•

enter into sale and leaseback transactions.

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Any of our future indebtedness may impose similar or other restrictive covenants.

Our credit facility also requires quarterly fixed principal payments and annual variable excess cash flow payments, which may limit cash available for our operations. In addition, our financial covenants may require the use of operating cash to pay outstanding debt and limit our ability to invest in our operations.

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

The telecommunications industry is subject to rapid and significant changes in technology, frequent new service introductions and evolving industry standards. Technological developments may reduce the competitiveness of our networks and require additional capital expenditures or the procurement of additional products that could be expensive and time consuming to install and integrate into our network. Our financial condition or the terms and conditions included in our credit facilities may limit our ability to make additional capital expenditures or procure additional products. In addition, a substantive investment by a competitor in a new technology could challenge our position in the marketplace, as the services offered by our competitor arising out of new technology may reduce the attractiveness of our services. If we fail to adapt successfully to technological advances or fail to obtain access to new technologies, we could lose customers and be limited in our ability to attract new customers and/or sell new services to our existing customers. In addition, delivery of new services in a cost-efficient manner depends upon many factors, and we may not generate the revenue anticipated from such services.

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

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

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our territories could have significant weather events which physically damage access lines and network infrastructure, potentially disrupting our ability to provide service and potentially encouraging our customers to find alternative service providers;

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

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much of our equipment has long service lives, which could increase the frequency of malfunction and outage;

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our equipment, access and network interface suppliers could experience outages, delivery limitations or labor issues which could impact our ability to provide services to our customers;

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

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•

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

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

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

We operate critical infrastructure and our operating activities are subject to risks caused by misappropriation, misuse, leakage, falsification and accidental release or loss of information maintained in our information technology systems, including customer, personnel and vendor data. These risks could result from cyber-attacks, which may be committed by our employees or external actors operating in any geography, including jurisdictions where law enforcement measures to address such attacks are unavailable or ineffective, or by other means. Cyber-attacks against companies have increased in frequency, sophistication, scope and potential harm in recent years. Any preventive actions we have taken or may take to reduce the risks of cyber-attacks may be insufficient to repel or mitigate the effects of a cyber-attack in the future, and our resources available to take preventive actions in the future may be limited. We could be exposed to significant costs if any of the above risks were to materialize, and any of the events described above could impair our operations, damage the reputation and credibility of us and our business and have a negative impact on our revenues. Costs related to these risks could include incentives offered to existing customers to retain their business, increased expenditures on cyber security measures and the use of alternate resources, lost revenues from business interruption and litigation, which may be protracted in nature. We could also be required to expend significant capital and other resources to remedy any such security breach.

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

Our business is conducted primarily in north central Alabama, Maine, New Hampshire, western Massachusetts, central Missouri, western Vermont and southern West Virginia and, accordingly, our business is dependent upon the general economic conditions of these regions. There can be no assurance that future economic conditions in these regions, including the slow recovery from the global economic downturn that began in 2008, will not impact demand for our services or cause residents or businesses to relocate to other regions, which may adversely impact our business, revenue and cash flow. There can also be no assurance that these regions will respond to market and economic changes in a similar nature to urban markets or other regional areas.

Our Success Depends on a Small Number of Key Personnel.

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

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

Our business generates revenue by delivering voice and data services over access lines. We have experienced net voice access line loss in our RLEC territories due to increased competition, wireless substitution, challenging economic conditions and loss of second lines. RLEC residential voice access lines declined by approximately 8.7% during 2017. We expect to continue to experience net residential voice access line loss in our rural markets. It is unlikely that we will be able to offset the loss of residential voice lines by data access line growth, and if we are unable to do so, our business and results of operations would be adversely affected.

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

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

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

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

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

Approximately 21.9% of our revenue for the year ended December 31, 2017, was derived from interstate network access charges paid by long distance carriers for use of our facilities to originate and terminate interstate and intrastate telephone calls. The interstate network access rates that we can charge are regulated by the FCC. Terminating intrastate network access rates, which formerly were regulated by the regulatory commissions in each state in which we operate, have been capped and reduced by the FCC. The FCC continues to reform the federal network access charge system with the stated intent to promote deployment of broadband data services. In October 2011, the FCC released the FCC ICC Order, which has and will continue to significantly change the way telecommunication carriers receive compensation for exchanging traffic. On July 1, 2013, all terminating intrastate rates that exceeded the interstate rate were reduced to the interstate rate. In 2014, the interstate rate began a six year reduction to “bill and keep” in which carriers bill their customers for services and keep those charges, but neither pay for nor receive compensation from traffic sent to or received from other carriers. It is unknown at this time what additional changes, if any, the FCC or state regulatory commissions may adopt. Such regulatory developments could adversely affect our business, revenue and cash flow.

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

Certain of our RLECs charge rates for local services and originating intrastate access service based in part upon a rate-of-return authorized by the state regulatory commissions. These authorized rates are subject to audit at any time and may be reduced if the state regulatory commission finds them excessive. If any of our RLECs is ordered to reduce its rates or if its applications to increase rates are denied or delayed, our business, revenue and cash flow may be negatively impacted.

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Failure to Receive Approved Levels of FCC Support Funding Would Adversely Affect Our Business, Revenue and Cash Flow.

Beginning January 1, 2017, ACAM replaced USF HCL for two of our three RLECS that had previously received USF HCL support payments, and the third RLEC continues to receive USF HCL and CAF BLS support payments. All of those support payments will require us to make additional capital investments to build out our network to support the delivery of higher broadband speeds. If our participating RLECs do not receive the approved level of ACAM, USF HCL, and CAF BLS support from the FCC for any reason, our business, revenue and cash flow would be negatively affected.

The outcome of any future FCC proceedings and other regulatory or legislative changes could affect the amount of support that we receive, and could have an adverse effect on our business, revenue and cash flow. If a wireless or other telecommunication carrier receives ETC status in our service areas or even outside of our service areas, the amount of support we receive from the USF HCL could decline under current rules, and under some proposed USF HCL rule changes, could be significantly reduced.

USAC serves as the administrative agent to collect data and distribute funds for USF and in 2006, it began conducting High Cost Beneficiary audits, designed to ensure compliance with FCC rules and program requirements and to assist in program compliance. USAC randomly selects RLECs to be audited each year and several of our RLECs have been selected for one of these audits each year. In December 2016, four of our RLECs were selected for a payment quality assurance audit, which has since been completed with no material findings. USAC has issued a no further action determination letter for three of these audits and the fourth audit revealed an overpayment of  $102 to us, which we refunded to USAC in July 2017. If USAC determines in any future audit that any of our data submissions were incorrect, we could be required to return funds to USAC for the period under review, which would negatively affect our business revenue and cash flow.

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

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

If we fail to maintain proper and effective internal control over financial reporting, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, investors’ views of us and, as a result, the value of our common stock.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, our management is required to report upon the effectiveness of our internal control over financial reporting. However, for so long as we remain a “smaller reporting company” for Securities and Exchange Commission reporting purposes, we intend to take advantage of certain exemptions from various Securities and Exchange Commission reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which section would otherwise require us to annually obtain an audited opinion from our independent registered public accounting firm regarding the effectiveness of our internal control over financial reporting. If material weaknesses or deficiencies in our internal controls exist and go undetected or unremediated, our financial statements could contain material misstatements that, when discovered in the future, could harm our operating results, investors’ views of us and, as a result, the value of our common stock.

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The ongoing implementation of a new billing and operations system could interfere with our operations, which could adversely impact our business and reputation.

We are in the process of implementing a new billing and operations system, which we currently expect to fully implement during the second quarter of 2018. The new billing and operations system has and will continue to require significant capital and human resources to deploy. There can be no assurance that the actual costs for the new billing and operations system will not exceed our current estimates or that the new billing and operations system will not take longer to implement than we currently expect. In addition, potential flaws in implementing the new billing and operations system may pose risks to our ability to operate successfully and efficiently. These risks could result in disruption in operations, loss of valuable data and damage to our reputation, all of which could adversely affect our business.

Item 1B.   Unresolved Staff Comments

None.

Item 2.   Properties

Our property consists primarily of land and buildings; central office, internet and cable equipment; computer software; telephone lines; and related equipment. Our telephone lines include aerial and underground cable, conduit, poles and wires. Our central office equipment includes digital and software defined switches, internet and other servers and related peripheral equipment. We own substantially all our real property in Alabama, Missouri, Vermont and West Virginia, including our corporate office. We primarily lease real property in Maine, Massachusetts and New Hampshire, including our primary office locations in Bangor, New Gloucester and Portland, Maine. As of December 31, 2017, our property and equipment consisted of the following (in thousands):

Item 3.   Legal Proceedings

From time to time, we may be involved in various claims, legal actions and regulatory proceedings incidental to and in the ordinary course of business, including administrative hearings of the APSC, MPUC, MDTC, MPSC, NHPUC, VPUC and WVPSC relating primarily to rate making and customer service requirements. In addition, we may be involved in similar proceedings with interconnection carriers and the FCC. Currently, except as set forth below, none of our legal proceedings are expected to have a material adverse effect on our business.

Sprint Communications L.P., which we refer to as Sprint, MCI Communications Services, Inc., which we refer to as MCI, and Verizon Select Services, Inc., which we refer to as Verizon, have filed more than 60 lawsuits in federal courts across the United States alleging that over 400 local exchange carriers overcharged Sprint, MCI and Verizon for so-called intraMTA traffic (wireless phone calls that originate and terminate in the same metropolitan transit area). The lawsuits seek a refund of previously-paid access charges for intraMTA traffic, as well as a discount related to intraMTA traffic on a going-forward basis. One of our subsidiaries, Otelco Mid-Missouri LLC, was named as a defendant in two of the lawsuits that are being

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brought before the District Court for the Western District of Missouri (one filed on May 2, 2014, by Sprint and the other filed on September 5, 2014, by MCI and Verizon). In addition, one of our other subsidiaries, Otelco Telephone LLC, was named as a defendant in a lawsuit relating to these issues filed by MCI and Verizon in the District Court for the District of Delaware on September 5, 2014. As all of the lawsuits relating to these issues raise the same fundamental questions of law, the United States Judicial Panel on Multidistrict Litigation has consolidated the lawsuits in the District Court for the Northern District of Texas for all pre-trial proceedings. On November 17, 2015, that court issued a memorandum opinion and order dismissing the plaintiffs’ federal-law claims with prejudice, dismissing the state-law claims but granting leave to replead said claims, and denying the local exchange carrier defendants’ request to refer the matter to the FCC. On May 5, 2016, Sprint filed amended complaints alleging additional state law claims. Level 3 Communications LLC, which we refer to as Level 3, has filed similar lawsuits against many of the same local exchange carrier defendants, but not against us or any of our subsidiaries. Those proceedings have also been consolidated with the Verizon, MCI and Sprint claims and the relevant parties have been filing motions related to the Level 3 claims and conducting preliminary discovery. Level 3 moved to dismiss the local exchange carrier defendants’ claims and the local exchange carrier defendants opposed the motion. On March 22, 2017, the District Court for the Northern District of Texas issued a memorandum and order denying Level 3’s motion to dismiss, putting the Level 3 claims in a similar procedural posture as the Verizon, MCI and Sprint claims. On May 3, 2017, the District Court for the Northern District of Texas dismissed Sprint’s amended complaints against the local exchange carrier defendants. On June 1, 2017, the District Court for the Northern District of Texas issued an updated scheduling order calling for the parties to submit all materials necessary for that court to rule on pending summary judgement motions by September 1, 2017. Currently, the parties continue to litigate pretrial motions. Motions for summary judgment were due on February 23, 2018. The District Court for the Northern District of Texas has not yet ruled on any pending summary judgment motions.

On November 10, 2014, a large coalition of the local exchange carrier defendants, including Otelco Mid-Missouri LLC and Otelco Telephone LLC, filed a petition for declaratory ruling with the FCC seeking a ruling by it that: (1) any traffic intentionally routed over Interexchange carrier, which we refer to as an IXC, trunks by IXCs should be subject to access charges; (2) only carriers with specific agreements with a local exchange carrier may use alternative billing arrangements; (3) federal tariffing rules require the local exchange carriers to assess access charges for switched access traffic routed through Feature Group D trunks; and (4) the IXCs may not engage in self-help by refusing to pay the local exchange carriers’ properly assessed access charges. On March 11, 2015, the local exchange carrier defendants filed their reply brief with the FCC. No timeline has been established for a decision by the FCC. At this time, it is not possible to determine whether this action will have a material adverse effect on our business.

Item 4.   Mine Safety Disclosures

Not applicable.

Item X.   Executive Officers of the Registrant

The following table sets forth the names and positions of our executive officers, and their ages, in each case, as of December 31, 2017.

Robert J. Souza became our President in May 2014 and was appointed Chief Executive Officer and elected as a Director in January 2015. Prior to becoming our President, he served as our Senior Vice President and General Manager for our New England division from July 2010 to May 2014. He joined Otelco in October 2008 as the Vice President of Operations for New England. He served as President of

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Pine Tree Holdings, Inc., Granby Holdings, Inc. and War Holdings, Inc., which we refer to, collectively, as the Country Road Companies, from 2001 until they were acquired by Otelco in October 2008. Prior to that role, he served as Operations Manager for Saco River Telephone and Telegraph, having joined that company in 1983. His 40 years of experience in the industry includes three years with Ooltewah-Collegedale Telephone Company in Tennessee and five years with New England Telephone in Maine.

Curtis L. Garner, Jr. has served as our Chief Financial Officer since February 2004 and was elected as a Director in May 2015. Prior to becoming our Chief Financial Officer, he provided consulting services to a number of businesses and not-for-profit organizations from October 2002. He served PTEK Holdings, Inc. from November 1997 through September 2002 (including one year as a consultant), first as President of one of its divisions, and later as Chief Administrative Officer for another division. Prior thereto, he spent 26 years at AT&T Corp., retiring in 1997 as the Chief Financial Officer of the Southern and Southwestern Regions of AT&T Corp.’s consumer long distance business.

Edwin D. Tisdale has served as our Senior Vice President for Operations since May 2017. Prior to that, he served as our Senior Vice President for New England from May 2014 to May 2017. He served as our Senior Vice President for New England regulated operations from July of 2010 to May 2014 and as Vice President for New England Support Services from November 2008 to 2010. From 1996 until October 2008, he served as General Manager of Pine Tree Telephone and Telegraph Company and Chief Financial Officer of the Country Road Companies until they were acquired by Otelco. Prior to that time, he worked in banking and real estate.

Dennis K. Andrews has served as Senior Vice President for Regulatory Affairs and Human Resources in May 2017. Prior to that he served as Senior Vice President and General Manager of our Alabama division from August 2006 and of our Missouri division from July 2012. He served as our Vice President and General Manager of two Alabama operating subsidiaries since November 2005 and Vice President — Regulatory Affairs since July 2000. Prior to that position, he spent 21 years at Brindlee Mountain Telephone Company, which we acquired in 2001, where he held several positions, including Vice President — Finance, General Manager, Operations Manager and Accounting Department Manager.

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

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

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PART II

Item 5.

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

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Market Information

Our certificate of incorporation currently authorizes two separate classes of common stock, our Class A common stock, par value $0.01 per share, and our Class B common stock, par value $0.01 per share. Our Class A common stock began trading on the Nasdaq Global Market, under the symbol “OTEL,” on May 28, 2013, following our emergence from bankruptcy. On May 16, 2014, the listing of our Class A common stock was transferred to the Nasdaq Capital Market.

The high and low closing sales prices for our Class A common stock during the quarters indicated are as follows:

On February 17, 2016, in connection with the termination of one of our prior credit facilities, all 232,780 then outstanding shares of our Class B common stock were automatically converted into an equal number of shares of our Class A common stock. Accordingly, no shares of our Class B common stock are currently outstanding and no established trading market exists for our Class B common stock.

Holders

As of March 13, 2018, there were approximately 2,700 record holders of our Class A common stock and no holders of our Class B common stock.

Dividends

We did not declare or pay cash dividends on any shares of our common stock during 2016 or 2017.

Restrictions on Payment of Dividends

Our credit facility provides that, in both 2018 and 2019, we are permitted to declare and pay cash dividends and redeem our common stock in an aggregate amount not to exceed $1,250,000 per year, so long as we are in compliance with all covenants contained in, and are not in default under, the credit facility, and we have at least $4,500,000 of cash and cash equivalents after giving effect to the applicable dividend or redemption. In addition, our credit facility further provides that, in 2020 and each calendar year thereafter, we will be permitted to declare and pay cash dividends and redeem our common stock in an aggregate amount up to 50% of our Consolidated EBITDA (as defined in the credit facility), minus the sum of debt service, taxes paid in cash, capital expenditures and other non-recurring or unusual cash charges, expenses or losses, so long as we are in compliance with all covenants contained in, and are not in default under, the credit facility, the ratio of our total debt to Consolidated EBITDA for the four most recent fiscal quarters is less than 2.50:1.00 and we have at least $4,500,000 of cash and cash equivalents after giving effect to the applicable dividend or redemption.

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Item 6.

Selected Financial Data

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The following table sets forth our selected consolidated financial information. The consolidated financial information as of December 31, 2016, and 2017, and for each of the three years in the period ended December 31, 2017, has been derived from, and should be read together with, our audited consolidated financial statements and the accompanying notes included in Item 8, Financial Statements and Supplementary Data. The consolidated financial information as of December 31, 2013, 2014, and 2015, and for each of the two years in the period ended December 31, 2014, has been derived from our audited consolidated financial statements not included in this report. The consolidated financial information set forth below should be read in conjunction with, and is qualified in its entirety by reference to, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and our audited consolidated financial statements and related notes in Item 8, Financial Statements and Supplementary Data.

(1)

During the year ended December 31, 2014, we acquired substantially all of the assets of Reliable Networks.

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(2)

Excludes loan costs.

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Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Overview

General

Since 1999, we have acquired and operate eleven RLECs serving subscribers in north central Alabama, central Maine, western Massachusetts, central Missouri, western Vermont and southern West Virginia. We also operate a CLEC serving subscribers in Maine, Massachusetts, and New Hampshire. Our services include a broad suite of communications and information services including local and long distance telephone services; internet and broadband data services; network access to other wireline, long distance and wireless carriers for calls originated or terminated on our network; other telephone related services;

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cloud hosting and professional engineering services for small and mid-sized companies who rely on mission-critical software applications; digital high-speed transport services (in our New England market); and video and security (in some markets). As of December 31, 2017, we operated 95,277 voice, data and other access lines, which we refer to as access line equivalents. We view, manage and evaluate the results of operations from the various telecommunications products and services as one company and therefore have identified one reporting segment as it relates to providing segment information.

The FCC released the FCC ICC Order in November 2011. This order has made and continues to make substantial changes in the way telecommunication carriers are compensated for serving high cost areas and for completing traffic with other carriers. We began seeing the significant impact of the FCC ICC Order to our business in July 2012, with additional impacts beginning in July 2013 and July 2014. The initial consequence to our business was to reduce access revenue from intrastate calling in Maine and other states where intrastate rates were higher than interstate rates. A portion of this revenue loss for our RLEC properties is returned to us through the CAF. There is no recovery mechanism for the lost revenue in our CLEC. The impact of the FCC ICC Order is expected to continue reducing our revenue and net income through 2020.

Support under the new ACAM model-based approach increased 2017 support by approximately $1.5 million compared to 2016 support received under legacy rate-of-return regulation. Without the new ACAM model-based support, in 2017 our RLECs would have seen a normal year-over-year funding decrease under USF HCL and the FCC’s newly-adopted Budget Control mechanism. ACAM support requires additional investment in plant and equipment to reach target broadband speeds and covered locations. ACAM support will decline through 2026 as the additional investment is completed.

The Tax Cuts and Jobs Act, which we refer to as the Tax Act, passed in December 2017 is expected to reduce our cash tax liability. Specifically, both the lower income tax rate and the extension of bonus depreciation under the Tax Act are expected to positively impact our federal tax requirements. The limitation on interest deductibility under the Tax Act is not expected to impact our tax liabilities.

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes, included in Item 8, Financial Statements and Supplementary Data, and the other financial information appearing elsewhere in this report. The following discussion and analysis relates to our financial condition and results of operations on a consolidated basis.

Revenue Sources

We derive our revenues from six sources:

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Local services.   We receive revenues from providing local exchange telecommunication services in our eleven rural territories. In addition, we receive revenues on a competitive basis through both wholesale and retail channels throughout Maine, New Hampshire and western Massachusetts. These revenues include monthly subscription charges for basic service, calling beyond the local territory on a fixed price and on a per minute basis, local private line services and enhanced calling features, such as voicemail, caller identification, call waiting and call forwarding. We also provide billing and collections services for other carriers under contract and receive revenues from directory advertising. A significant portion of our rural subscribers take bundled service plans which include multiple services, including unlimited domestic calling, for a flat monthly fee.

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•

Network access.   We receive revenues from charges established to compensate us for the origination, transport and termination of calls of long distance, wireless and other interexchange carriers. These include subscriber line charges imposed on customers and switched and special access charges paid by carriers. Switched access charges for long distance services within Alabama, Maine, Massachusetts, Missouri, New Hampshire, Vermont and West Virginia have historically been based on rates approved by the APSC, MPUC, MDTC, MPSC, NHPUC, VPUC and WVPSC, respectively, where appropriate. The FCC ICC Order preempted the state commissions’ authority to set terminating intrastate access service rates, and required companies with terminating access rates higher than interstate rates to reduce their terminating intrastate access rates to a rate equal to interstate access service rates by July 1, 2013, and to move to a “bill and keep” arrangement by July 1, 2020, which will eliminate access charges between carriers. The FCC

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ICC Order prescribes a recovery mechanism for the recovery of any decrease in intrastate terminating access revenues through the CAF for RLEC companies. This recovery is limited to 95% of the previous year’s revenue requirement. Interstate access revenue is based on an FCC-regulated rate-of-return on investment and recovery of expenses and taxes. From 1990 through June 2016, the rate-of-return had been authorized up to 11.25%. In March 2016, the FCC reduced the authorized rate-of-return to 9.75% effective July 1, 2021, using a transitional approach to reduce the impact of an immediate reduction. Rate-of-return transition began on July 1, 2016, with the authorized rate reduced to 11.0%, with further 25 basis points reductions each July 1 thereafter until the authorized rate reaches 9.75% on July 1, 2021. Switched and special access charges for interstate and international services are based on rates approved by the FCC. We also receive revenue from the USF for the deployment of voice and broadband services to end-user customers. Since January 1, 2017, ten of our RLECs receive support payments through ACAM and one of our RLECs receives support payments through modified legacy rate-of-return support mechanisms for USF HCL and ICLS.

•

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

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•

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

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•

Video and security.   We offer basic, digital, high-definition, digital video recording, VOD and pay per view cable television services to a portion of our telephone service territory in Alabama, including IPTV. We offer wireless security systems and system monitoring in Alabama and Missouri. Until October 2016, we were a reseller of satellite services for DirecTV in Missouri.

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•

Managed services.   We provide private/hybrid cloud hosting services, as well as consulting and professional engineering services, for mission-critical software applications for small and mid-sized North American companies. Revenues are generated from monthly recurring hosting IaaS fees, monthly maintenance fees, à la carte professional engineering services, and pay-as-you-use SaaS fees. Services are domiciled in two diverse owned data centers.

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Access Line and Customer Trends

The number of voice, data and other access lines served is a fundamental factor in determining revenue stability for a telecommunications provider. Reflecting a general trend in the RLEC industry, the number of rural residential voice access lines we serve has been decreasing each year, while business access lines have been more stable. We expect that this trend will continue, and may be further influenced by competition from cable and co-operative electric providers in our RLEC properties and the availability of alternative telecommunications products, such as cellular and IP-based services. In the past, the growth of data access lines has partially offset the loss of residential voice access lines. However, the current high level of data access line penetration in our RLEC territories and broadband data competition presently constrain this impact. Our ability to grow CLEC and RLEC business voice and data lines will have an important impact on our future revenues. Approximately 53% of our access line equivalents at December 31, 2017, and December 31, 2016, served business and enterprise customers. Our primary strategy consists of leveraging our strong incumbent market position, selling additional services to our rural customer base and providing a broader suite of new IP technology and managed services to our competitive customer base.

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Key Operating Statistics
(unaudited)

(1)

We define access line equivalents as retail and wholesale voice lines, data lines (including cable modems, digital subscriber lines, other broadband connections and dedicated data access trunks) and other services (including entertainment and security services).

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For 2017, business and enterprise access line equivalents decreased 5.0%. The primary factors in the decline were the decrease in traditional voice CLEC lines and business multi-use lines in Alabama. Residential access line equivalents decreased 4.0%, with the decrease attributable to the loss of RLEC customers to competitive alternatives, which is consistent with existing trends. Initiation of service to the Leverett, Massachusetts community in April 2017 increased CLEC residential customers. We are the primary long distance provider for our customers, serving approximately 74% of our RLEC customer base and virtually all of our CLEC customers. Other RLEC services decreased by 3.3%, primarily in Alabama cable television.

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

Competition.   We face competition from cable providers or electric co-operatives in the majority of our RLEC territories, which primarily impacts our residential voice and data access lines. We also experience residential voice access line losses to wireless carrier substitution. We have responded to competition by offering bundled service packages which include unlimited domestic calling; features like voice mail and caller identification; data access lines; and, where possible, television services. These service bundles are designed to meet the broader communications needs of our customers at industry competitive prices. There are a number of established competitive providers in our Maine, Massachusetts and New Hampshire CLEC markets. The effectiveness of our sales force, the pricing of our products and the market perception of the quality of our service are critical to our success in these markets.

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Cyclical Economic and Industry Factors.   We believe that changes in global economic conditions have and will continue to have an impact on our voice access line count. The rural nature of much of the territory we serve delays both the negative and positive response to the economy’s impact on our customer base.

Our Rate and Pricing Structure

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

Our RLECs operate in six states and have limited regulation by the respective state regulatory authorities. The impact on pricing flexibility varies by state. In Maine and Vermont, our wholly-owned subsidiaries have obtained authority to implement pricing flexibility while remaining under rate-of-return regulation. Our rates for other services we provide, including cable, long-distance, data lines and legacy dial-up and high-speed internet access, are not price regulated. The market for competitive services, such as wireless, also affects the ability to adjust prices. With the increase of bundled services offerings, including unlimited long distance, pricing for individual services takes on reduced importance to revenue stability. We expect this trend to continue into the immediate future.

Alabama RLECs have state service funds, which were implemented more than a decade ago as part of balancing local service pricing and long distance access rates. These funds were intended to neutralize the revenue impact on state RLECs from pricing shifts implemented to reduce access rates over time. The Alabama Transition Service Fund provided total compensation of  $0.3 million, representing 0.5% of our total revenue for the years ended December 31, 2016, and 2017. The revenue we receive from these funds is in the process of being phased out over a five-year period that began in June 2016. Reduction in fund revenue was 5% in each of 2016 and 2017 and will be 10% in 2018 and 15% in each of 2019 and 2020.

Categories of Operating Expenses

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

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

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

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

Our Ability to Control Operating Expenses

We strive to control expenses in order to maintain our operating margins. As our revenue continues to shift to non-regulated services and CLEC customers, and our residential RLEC revenue continues to decline, operating margins decrease due to the lower margins associated with non-regulated services. Reductions in USF and intercarrier compensation payments based on FCC action in 2011 may be difficult to fully offset through expense control and pricing action. However, in 2017, ACAM began providing support funding to increase capital investment in broadband services in our RLECs.

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Results of Operations

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

Year Ended December 31, 2017, Compared to Year Ended December 31, 2016

Total Revenues.   Total revenues decreased 0.6% in 2017 to $68.5 million from $68.9 million in 2016. The table below provides the components of our revenues for 2017 compared to 2016.

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Local services.   Local services revenue in 2017 decreased 5.1% to $22.4 million from $23.6 million in 2016. Local and related service revenue decreased $0.5 million and long distance revenue and reciprocal compensation decreased $0.3 million in 2017 compared to 2016, reflecting the decline in residential voice access lines and the impact of the FCC ICC Order. In addition, HPBX equipment sales declined $0.3 million and directory revenue declined $0.1 million in 2017 compared to 2016.

Network access.   Network access revenue in 2017 increased 4.5% to $22.0 million from $21.0 million in 2016. ACAM and CAF revenue increased $8.9 million, partially offset by a decrease in switch and special access revenue of  $7.3 million. End-user based charges and USF fees decreased $0.6 million.

Internet.   Internet revenue in 2017 increased 0.9% to $15.8 million from $15.6 million in 2016. Higher broadband speeds and new data customers in a municipality in Massachusetts increased revenue by $0.3 million, which was partially offset by a decrease of  $0.1 million in fiber rental.

Transport services.   Transport services revenue in 2017 decreased 5.6% to $4.6 million from $4.9 million in 2016. Changes in industry pricing of wide area network services accounted for the decrease, which was partially offset by increases in wholesale transport services.

Video and security.   Video and security revenue in 2017 increased 3.4% to $3.0 million from $2.9 million in 2016. An increase in IPTV subscribers and price adjustments were partially offset by a decrease in basic cable subscribers.

Managed services.   Managed services revenue in 2017 decreased 14.5% to $0.8 million from $0.9 million in 2016. Lower professional services revenue accounted for the decrease.

Operating expenses.   Operating expenses decreased 2.4% in 2017 to $48.9 million from $50.1 million in 2016. The table below provides the components of our operating expenses for 2017 compared to 2016.

Cost of services.   Cost of services decreased 1.5% to $31.4 million in 2017 from $31.9 million in 2016. Decreases in cost of toll and access expense of  $0.6 million, marketing, sales and customer service expense of  $0.5 million, HPBX equipment expense of  $0.3 million, and last mile loop cost of  $0.3 million in 2017 compared to 2016 were partially offset by increases in network operations expense of  $0.6 million, pole rental expense of  $0.3 million, cable programming and internet expense of  $0.2 million, and $0.1 million in computer expenses.

Selling, general and administrative expenses.   Selling, general and administrative expenses decreased 0.9% to $10.1 million in 2017 from $10.2 million in 2016. Our senior management bonus plan changed to a cash-based plan in 2017 versus a stock-based plan in 2016, generating an expense increase of  $0.5 million. Decreases of  $0.3 million in legal expense associated with a 2016 Board of Directors project for which there was not a comparable project in 2017 and a $0.1 million decrease in each of cloud hosting, human resources and external relations, property taxes and other administrative expenses were partially offset by increases in accounting and finance expense of  $0.1 million and expenses associated with the planning and implementation of a new company-wide billing and operations support system of  $0.1 million.

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Depreciation and amortization.   Depreciation and amortization decreased 8.0% to $7.4 million in 2017 from $8.0 million in 2016. Amortization of the telephone plant adjustment decreased $0.4 million and amortization of intangible assets decreased $0.1 million. RLEC depreciation decreased by $0.1 million in 2017 compared to 2016.

*

Not a meaningful calculation.

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Interest expense.   Interest expense increased 24.6% in 2017 to $13.2 million from $10.6 million in 2016. Amortization of loan cost accounted for an increase of  $3.4 million in 2017 when compared to 2016, including extinguishment of loan costs associated with our former credit facilities of  $3.7 million. Lower interest rates on our new credit facility and lower outstanding principal balance accounted for a decrease of $0.8 million.

Loss on debt prepayment penalty.   Loss on debt prepayment penalty is associated with terminating our previous credit facilities in November 2017. There was no comparable expense in 2016.

Other income.   Other income decreased 67.3% in 2017 to $0.2 million from $0.6 million in 2016. Lower dividends and patronage share redemption from CoBank accounted for the decrease.

Income tax benefit (expense).   The provision for income tax decreased 314.8% as a benefit in 2017 of $7.9 million compared to an expense of  $3.7 million in 2016, primarily due to the impact of the remeasurement of deferred tax liabilities for the lower income tax rate associated with the Tax Act. The Tax Act reduces the U.S. federal corporate tax rate from 35% to a flat rate of 21%. As a result, we have recognized an income tax benefit of  $9.3 million, which increased diluted earnings per share by $2.71 for the year ended December 31, 2017. The effective income tax rate was (184.5)%, 41.5% and 39.8% for 2017, 2016 and 2015, respectively. Beginning in 2018, we believe our effective tax rate will be approximately 26% to 27%.

Net income.   As a result of the foregoing, there was net income of  $12.1 million in 2017 compared to $5.1 million in 2016.

Year Ended December 31, 2016, Compared to Year Ended December 31, 2015

Total Revenues. Total revenues decreased 3.0% in 2016 to $68.9 million from $71.1 million in 2015. The table below provides the components of our revenues for 2016 compared to 2015.

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Local services.   Local services revenue in 2016 decreased 5.8% to $23.6 million from $25.1 million in 2015. Local service revenue decreased $0.9 million and long distance revenue decreased $0.6 million in 2016 compared to 2015, reflecting the decline in residential voice access lines and the impact of the FCC ICC Order. In addition, special line revenue and reciprocal compensation each declined $0.1 million in 2016 compared to 2015. The decreases were partially offset by increased fiber, Ethernet and least cost routing revenue of  $0.2 million in 2016 compared to 2015.

Network access.   Network access revenue in 2016 decreased 5.0% to $21.0 million from $22.2 million in 2015. End-user based charges decreased $0.2 million, switched access revenue decreased $0.7 million, and special access decreased $0.7 million in 2016 compared to 2015. The decreases were partially offset by an increase in the CAF of  $0.5 million in 2016 compared to 2015.

Internet.   Internet revenue in 2016 increased 5.0% to $15.6 million from $14.9 million in 2015. Installation and equipment rental fees increased $0.1 million and increased broadband speeds increased $0.6 million in 2016 compared to 2015.

Transport services.   Transport services revenue in 2016 decreased 8.9% to $4.9 million from $5.4 million in 2015. Changes in industry pricing accounted for the decrease.

Video and security.   Video and security revenue in 2016 increased 5.2% to $2.9 million from $2.8 million in 2015. An increase in security and IPTV subscribers and price adjustments accounted for the increase.

Managed services.   Managed services revenue in 2016 increased 1.5% from 2015 to remain at $0.9 million. A small increase in professional services revenue was partially offset by a small decrease in cloud hosting revenue.

Operating expenses.   Operating expenses decreased 3.3% in 2016 to $50.1 million from $51.8 million in 2015. The table below provides the components of our operating expenses for 2016 compared to 2015.

Cost of services.   Cost of services decreased 3.8% to $31.9 million in 2016 from $33.1 million in 2015. Decreases in operations expense of  $0.4 million, access circuit expense of  $0.3 million, HPBX equipment expense of  $0.3 million, marketing, customer service and directory expense of  $0.2 million, cost of toll of $0.2 million and internet cost of  $0.1 million in 2016 compared to 2015 were partially offset by a reduction in performance assurance plan credits, which is an offset to expense of  $0.2 million, and an increase in cable programming expense of  $0.1 million compared to 2015.

Selling, general and administrative expenses.   Selling, general and administrative expenses increased 3.9% to $10.2 million in 2016 from $9.8 million in 2015. Increases in legal expense of  $0.3 million for a Board of Directors project, loan fees of  $0.1 million and non-cash incentive and earn-out stock compensation of  $0.1 million compared to 2015 were partially offset by decreases of  $0.1 million in uncollectible revenue and $0.1 million in insurance and operating taxes in 2016 compared to 2015. In 2015, there was $0.1 million in reduced liabilities for a former employee for which there was no comparable expense reduction in 2016.

Depreciation and amortization.   Depreciation and amortization decreased 9.6% to $8.0 million in 2016 from $8.9 million in 2015. Amortization of intangible assets and the telephone plant adjustment decreased $0.3 million, CLEC property, plant and equipment depreciation decreased by $0.3 million, cable depreciation decreased by $0.2 million and New England RLEC depreciation decreased by $0.1 million compared to 2015. An increase in Alabama RLEC depreciation of  $0.1 million compared to 2015 partially offset the decreases.

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Interest expense.   Interest expense increased 34.7% in 2016 to $10.6 million from $7.9 million in 2015. Higher interest rates on the credit facilities we entered into in 2016 accounted for an increase of  $2.2 million and the increase in loan cost amortization accounted for an increase of  $0.5 million compared to 2015.

Other income.   Other income decreased 41.5% in 2016 to $0.6 million from $1.1 million in 2015. Lower dividends and patronage share redemption from CoBank accounted for the decrease.

Income tax expense.   The provision for income tax expense decreased 26.0% in 2016 to $3.7 million compared to $4.9 million in 2015, primarily due to lower net income. The effective income tax rate was 41.5% and 39.8% for 2016 and 2015, respectively.

Net income.   As a result of the foregoing, there was net income of  $5.1 million in 2016 compared to $7.5 million in 2015.

Liquidity and Capital Resources

Our liquidity needs arise primarily from: (i) principal and interest payments related to our credit facility; (ii) capital expenditures for investment in our business, including ACAM requirements; and (iii) working capital requirements. Historically, we have satisfied our operating cash requirements from the cash generated by our business and utilized borrowings under our credit facilities to support larger acquisitions. For the year ended December 31, 2017, we generated cash from our business to invest in additional property and equipment; pay scheduled and voluntary principal on our prior senior credit facility; pay interest on our senior and subordinated debt; and pay fees and prepayment penalties associated with implementing our new credit facility. Cash decreased from $10.5 million at December 31, 2016, to $3.6 million at December 31, 2017. During 2017, we reduced the balance of our notes payable by $11.7 million from $97.6 million as of December 31, 2016, to $85.9 million as of December 31, 2017. Our new credit facility requires annual principal reduction of  $4.3 million paid equally on a quarterly basis and, beginning in 2019, an annual principal payment equal to 50% of our excess cash flow for the year.

Cash flows from operating activities for 2017 were $18.0 million compared to $18.6 million for 2016, primarily reflecting the remeasurement of deferred tax liabilities for the lower income tax rate associated with the Tax Act.

Cash flows used in investing activities for 2017 were $8.5 million compared to $6.9 million for 2016, reflecting the acquisition and construction of property and equipment in 2017, including investments to support the ACAM requirements.

Cash flows used in financing activities for 2017 were $16.4 million compared to $8.1 million for 2016, primarily reflecting costs associated with the replacement of our prior credit facilities in November 2017.

We do not use financial instruments as part of our business strategy. However, our new credit facility requires that we acquire an interest rate hedge on at least 50% of our outstanding notes payable balance for a period of at least two years. Accordingly, we purchased a two-year 3.0% interest rate cap on one-month LIBOR covering $45.0 million on February 26, 2018.

We also have received patronage shares, primarily from one of our bank lenders, over a period of years for which there is a limited market to determine value until the shares are redeemed by the issuing institution. Historically, these shares have been redeemed at a value similar to their issued value. In 2017, we received $0.3 million for equity retirement of patronage shares, the fourth such retirement since we became a publicly traded company. During the period from February 2016 through October 2017, under our prior credit facilities, the issuing institution no longer provided patronage shares to us, as it was not a lender under either facility, and was expected to repatriate the remaining shares over the next nine years. Due to

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the uncertainty of the shares’ future value, these shares are carried at $1.5 million, or approximately 34% of their issued value. Our new credit facility is with the same issuing institution. Accordingly, we expect to once again receive dividends in cash and patronage shares beginning in 2018. Re-establishing the relationship with the institution in 2017 may affect the schedule of receiving redemption of current patronage shares beginning in 2019.

In 2016, we entered into a senior credit facility, providing for a five-year term loan facility in the aggregate principal amount of  $85.0 million and a five-year $5.0 million revolving credit facility, and a new subordinated credit facility, providing for a five and a half-year term loan facility in the aggregate principal amount of  $15.3 million, which facilities replaced a prior credit facility that was scheduled to mature on April 30, 2016. On November 2, 2017, we replaced both of the credit facilities that we entered into in 2016 with a new five-year credit facility, providing for a term loan facility in the aggregate principal amount of $87.0 million, a $5.0 million revolving credit facility and an incremental term loan facility in an aggregate principal amount of up to $20,000,000, subject to the satisfaction of certain conditions and lender participation.

We anticipate that operating cash flow, together with borrowings under our revolving credit facility, will be adequate to meet our currently anticipated operating and capital expenditure requirements for at least the next 12 months. Our indebtedness levels have been reduced each year and the related debt service requirements have been reduced with the new credit facility. The Tax Act reduces our cash income taxes beginning with the 2017 tax year. These factors assist us in meeting our capital expenditure requirements under ACAM. However, as a result of our capital expenditure requirements under ACAM, we may not retain a sufficient amount of cash to finance growth opportunities or unanticipated capital expenditure needs or to fund our operations in the event of a significant business downturn. We may have to forego growth opportunities or capital expenditures that would otherwise be necessary or desirable if we do not find alternative sources of financing. If we do not have sufficient cash for these purposes, our financial condition and our business will suffer.

We use consolidated earnings before interest, taxes, depreciation and amortization, which we refer to as Consolidated EBITDA, and the ratio of our debt, net of cash, to Consolidated EBITDA for the last twelve months, which we refer to as the Leverage Ratio, as operational performance measurements. Consolidated EBITDA, as presented in this report, corresponds to the definition of Consolidated EBITDA in our credit facility. Consolidated EBITDA and the Leverage Ratio, as presented in this report, are supplemental measures of our performance that are not required by, or presented in accordance with, accounting principles generally accepted in the United States, which we refer to as U.S. GAAP. The lender under our credit facility uses Consolidated EBITDA to determine compliance with credit facility requirements. We report Consolidated EBITDA and the Leverage Ratio in our quarterly earnings press release to allow current and potential investors to understand these performance metrics and because we believe that they provide current and potential investors with helpful information with respect to our operating performance, including our ability to generate earnings sufficient to service our debt, and enhance understanding of our financial performance and highlight operational trends. However, Consolidated EBITDA and the Leverage Ratio should not be considered as an alternative to net income or any other performance measures derived in accordance with U.S. GAAP. Our presentation of Consolidated EBITDA and the Leverage Ratio may not be comparable to similarly titled measures used by other companies. Consolidated EBITDA for the years ended December 31, 2017, and 2016, and its reconciliation to net income, is reflected in the table below:

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The table below provides the calculation of the Leverage Ratio, as of December 31, 2017 (dollar amounts in thousands).

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Critical Accounting Policies and Accounting Estimates

The process of preparing financial statements requires the use of estimates on the part of management. These estimates are based on our historical experience combined with management’s understanding of current facts and circumstances. Certain of our accounting policies are considered critical as they are both important to the portrayal of our financial statements and require significant or complex judgment on the part of management. See Item 8, Financial Statements and Supplementary Data — Note 2, Summary of Significant Accounting Policies, for a description of our critical accounting policies and estimates.

Recently Adopted Accounting Pronouncements

See Item 8, Financial Statements and Supplementary Data — Note 2, Summary of Significant Accounting Policies — Recently Adopted Accounting Pronouncements, for a description of the recently adopted accounting pronouncements that are applicable to us.

Recent Accounting Pronouncements

See Item 8, Financial Statements and Supplementary Data — Note 2, Summary of Significant Accounting Policies — Recent Accounting Pronouncements, for a description of the recent accounting pronouncements that are applicable to us.

Item 7A.   Quantitative and Qualitative Disclosures about Market Risk

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

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Interest rates applicable to the term loans, incremental term loans and the revolving loans (other than the swing line loans) under our credit facility are set at a margin over an adjusted LIBOR rate (which is defined as LIBOR multiplied by the statutory reserve rate) or a base rate (which is defined as the highest of (a) the prime rate, (b) the federal funds effective rate plus 0.50% per annum and (c) the adjusted LIBOR rate for an interest period of one month plus 1.00% per annum), at our option. Interest rates applicable to the swing line loans under our credit facility are set at a margin over the above-mentioned base rate. Accordingly, we are exposed to interest rate risk. Based on the daily average amount of our outstanding variable rate debt during 2017, a one percentage point change in one-month LIBOR interest rates would have resulted in an increase of  $0.7 million in our interest expense for the year ended December 31, 2017.

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Item 8.   Financial Statements and Supplementary Data

OTELCO INC.

CONSOLIDATED FINANCIAL STATEMENTS

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Report of Independent Registered Public Accounting Firm

Shareholders and Board of Directors
Otelco Inc.
Oneonta, Alabama

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Otelco Inc. (the “Company”) and subsidiaries as of December 31, 2017 and 2016, the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ BDO USA, LLP

We have served as the Company’s auditor since 2004.

Atlanta, GA
March 13, 2018

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OTELCO INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(in thousands, except share par values and share amounts)

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

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OTELCO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)

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

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OTELCO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(in thousands, except share amounts)

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

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OTELCO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

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

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OTELCO INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017

1.

Nature of Business

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Otelco Inc. (together with its consolidated subsidiaries, the “Company”) provides a broad range of telecommunication services on a retail and wholesale basis. These services include local and long distance calling; network access to and from the Company’s customers; data transport; digital high-speed and legacy dial-up internet access; cable and Internet Protocol television; other telephone related services; and cloud hosting and managed services. The principal markets for these services are business and residential customers residing in and adjacent to the exchanges the Company serves in Alabama, Maine, Massachusetts, Missouri, Vermont, and West Virginia. In addition, the Company serves business customers throughout Maine and New Hampshire and provides legacy dial-up internet service throughout the states of Maine and Missouri. The Company offers various communications services that are sold to economically similar customers in a comparable manner of distribution. The Company also offers cloud hosting and managed services for small and mid-sized companies who rely on mission-critical software applications. The majority of customers buy multiple services, often bundled together at a single price. The Company views, manages and evaluates the results of its operations from the various communications services as one company and therefore has identified one reporting segment as it relates to providing segment information.

Refinancings

On January 25, 2016, the Company entered into a senior loan agreement (the “Senior Loan Agreement”), providing for a five year term loan facility in the aggregate principal amount of  $85.0 million and a five year $5.0 million revolving credit facility, and a subordinated loan agreement (the “Subordinated Loan Agreement”), providing for a five and a half year term loan facility in the aggregate principal amount of  $15.0 million. On February 17, 2016, the Subordinated Loan Agreement was amended to increase the aggregate principal amount available for borrowing thereunder to $15.3 million, and the Company borrowed $85.0 million under the term loan facility of the Senior Loan Agreement and $15.3 million under the Subordinated Loan Agreement. The Company used the borrowings under the Senior Loan Agreement and the Subordinated Loan Agreement to, among other things, pay all amounts due, including principal, interest and fees, and satisfy in full all of its obligations under its previous credit facility (the “Previous Credit Facility”), which was scheduled to mature on April 30, 2016. As a result of the repayment of the Previous Credit Facility, all of the shares of the Company’s Class B common stock were automatically converted into an equal number of shares of the Company’s Class A common stock. The term loan facility under the Senior Loan Agreement required principal payments of  $1.0 million quarterly, which payments began on April 1, 2016. Principal amounts outstanding under the Subordinated Loan Agreement were generally not due until maturity. The Company recorded costs of  $15 thousand and write-off of loan costs of  $140 thousand in connection with this refinancing. During second quarter 2017, the Company paid an amendment fee of  $77.9 thousand to its senior lender under the Senior Loan Agreement to raise the capital expenditure limits under the Senior Loan Agreement to $8.5 million and $7.5 million for 2017 and 2018, respectively. The increased capital expenditures were necessary to fulfill build out requirements associated with the Federal Communications Commission’s (the “FCC’s”) Alternative Connect America Model (“ACAM”) program.

On November 2, 2017, the Company refinanced the Senior Loan Agreement and the Subordinated Loan Agreement with a new $92 million, five-year credit facility from a consortium of banks led by CoBank, ACB (the “New Credit Facility”). The New Credit Facility includes an $87.0 million term loan and a $5.0 million revolving loan, which is undrawn. The New Credit Facility also includes a $20.0 million accordion feature that could be used to increase the term-loan portion of the New Credit Facility. Proceeds from the New Credit Facility and cash on hand were used to pay all amounts due in respect of principal, interest, prepayment premiums and fees under the Senior Loan Agreement and the Subordinated Loan Agreement, as well as fees associated with the transaction. The Company recorded costs of  $28 thousand and write-off of loan costs of  $3.7 million in connection with this refinancing.

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2.

Summary of Significant Accounting Policies

​

Basis of Presentation and Principles of Consolidation

The consolidated financial statements include the accounts of Otelco Inc. and its subsidiaries, all of which are either directly or indirectly wholly owned. These include: Blountsville Telephone LLC (“BTC”); Brindlee Mountain Telephone LLC; CRC Communications LLC (“CRC”); Granby Telephone LLC; Hopper Telecommunications LLC; Mid-Maine Telecom LLC; Mid-Maine TelPlus LLC; Otelco Mid-Missouri LLC (“MMT”) and its wholly-owned subsidiary I-Land Internet Services LLC; Otelco Telecommunications LLC; Otelco Telephone LLC (“OTP”); Pine Tree Telephone LLC; Saco River Telephone LLC; Shoreham Telephone LLC; and War Telephone LLC.

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

Use of Estimates

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

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

Regulatory Accounting

The Company follows the accounting for regulated enterprises, which is now part of Accounting Standards Codification (“ASC”) 980, Regulated Operations (“ASC 980”), as issued by the Financial Accounting Standards Board (the “FASB”). This accounting practice recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, ASC 980 requires the Company to depreciate telecommunications property and equipment over the estimated useful lives approved by regulators, which could be different than the estimated useful lives that would otherwise be determined by management. ASC 980 also requires deferral of certain costs and obligations based upon approvals received from regulators to permit recovery of such amounts in future years. Criteria that would give rise to the discontinuance of accounting in accordance with ASC 980 include (1) increasing competition restricting the ability of the Company to establish prices that allow it to recover specific costs and (2) significant changes in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. The Company periodically reviews the criteria to determine whether the continuing application of ASC 980 is appropriate for its rural local exchange carriers (“RLECs”). As of December 31, 2017, and 2016, 80.5% and 77.0%, respectively, of the Company’s net property, plant and equipment was accounted for under ASC 980.

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

Intangible Assets and Goodwill

Intangible assets consist primarily of the fair values of customer related intangibles, non-compete agreements and long-term customer contracts acquired in connection with business combinations. Goodwill represents the excess of total acquisition cost over the assigned value of net identifiable tangible and intangible assets acquired through various business combinations, less any impairment. Due to the regulatory accounting required by ASC 980, the Company did not record acquired regulated telecommunications property and equipment at fair value as required by ASC 805, Business Combinations,

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