Note 1 - Nature of Business

12 Months Ended

Dec. 31, 2012

1. Nature of Business

Otelco Inc. (the “Company”) provides a broad range of telecommunications services on a retail and wholesale basis. These services include local and long distance calling; network access to and from our customers; data transport; digital high-speed and legacy dial-up internet access; cable, satellite and internet protocol television; wireless; and other telephone related services. The principal markets for these services are residential and business customers residing in and adjacent to the exchanges the Company serves in Alabama, Massachusetts, Maine, 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 majority of our 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.

Recent Developments

In June 2012, Time Warner Cable Information Systems (“TW”) officially notified the Company that it would not renew its contract with the Company for wholesale network connections. This contract and related carrier access revenue, representing approximately 15% of the Company’s 2012 revenue, expired on December 31, 2012. Additionally, in November 2011, the Federal Communications Commission (“FCC”) released an order which made substantial changes to the way telecommunications carriers are compensated for serving high cost areas and for completing traffic with other carriers, requiring a lowering of intrastate rates where they exceed interstate rates. The FCC order has and will continue to negatively impact the operations of the Company over the coming years.

Management has taken measures to reduce costs and align margins in response to the anticipated decline in revenues. During second quarter 2012, the Company ceased paying dividend payments indefinitely, reduced senior management and board of director compensation and reduced employees. These measures alone were not sufficient to allow the Company to continue to service its approximately $270 million of debt. The Company’s current senior secured term loan had a maturity date of October 31, 2013 and the Company and its management team diligently explored a variety of potential transactions in an effort to refinance the existing debt or acquire additional capital resources.

In May 2012, the Company retained Evercore Group, L.L.C. as its financial advisor to assist the Company to engage in negotiations with the lenders under its senior secured credit facility with respect to a potential balance sheet restructuring. The Company provided the lenders under its senior secured credit facility with information regarding its operations, projections, and business plan to facilitate their ability to negotiate and assess a potential restructuring plan with the Company. After good-faith, arms-length negotiations, on January 31, 2013, the Company reached an agreement with the lenders under its senior secured credit facility on a prepackaged chapter 11 plan of reorganization (the “Plan”). Terms of the agreement were released in a Form 8-K filed by the Company on February 1, 2013.

Bankruptcy Filing of the Company and its Direct and Indirect Subsidiaries

On March 24, 2013 the Company and each of its direct and indirect subsidiaries filed voluntary petitions for reorganization (the “Reorganization Cases”) under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) in order to effectuate the Plan. Chapter 11 of the Bankruptcy Code is the principal business reorganization chapter of the Bankruptcy Code. Chapter 11 allows the Company to remain in possession of its assets, and to continue to manage and operate its business while restructuring its debt, without the need to liquidate and go out of business. If the Plan is approved by the Bankruptcy Court and consummated, the following transactions will occur.

the $162 million of outstanding principal term loan obligations under the Company’s senior credit facility will be reduced to a maximum of $142 million (or such higher amount that is agreed to in writing by the agent under the Company’s senior credit facility and the holders of more than 50% in number and 66 2/3% in amount of the outstanding principal term loan obligations under the Company’s senior credit facility) through a cash payment;

the maturity of the outstanding principal term loan obligations under the Company’s senior credit facility will be extended to April 30,2016;

the holders of the outstanding principal term loan obligations under the Company’s senior credit facility will receive their pro rata share of the Company’s new Class B common stock, which new Class B common stock will represent 7.5% of the total economic and voting interests in the Company immediately following the effectiveness of the Plan, subject to dilution of up to 10% on account of the issuance of equity interests in the Company pursuant to a management equity plan which is expected to be adopted by the Company following its emergence from bankruptcy (the “Management Equity Plan”);

certain revolving loan commitments under the Company’s senior credit facility will be reinstated, with availability of up to $5 million;

the Company’s outstanding senior subordinated notes, including the outstanding senior subordinated notes constituting part of the Company’s Income Deposit Securities (“IDSs”), will be cancelled and the holders of outstanding senior subordinated notes, including senior subordinated notes held through IDSs, will receive their pro rata share of the Company’s new Class A common stock, which new Class A common stock will represent 92.5% of the total economic and voting interests in the Company immediately following the effectiveness of the Plan, subject to dilution of up to 10% on account of the issuance of equity interests in the Company pursuant to the Management Equity Plan; and

the outstanding shares of the Company’s existing Class A common stock (“common stock”), all of which currently constitute par of the IDSs, will be cancelled.

There can be no assurance as to the timing for approval of the Plan or that the Plan will be confirmed.

Going Concern

As shown in the accompanying consolidated financial statements, the Company has incurred substantial losses from operations, and as of December 31, 2012, the Company’s current liabilities exceeded its current assets by $240.2 million, and the Company had a retained deficit of $141.7 million. The filing of the Reorganization Cases on March 24, 2013 constituted an event of default and triggered the automatic and immediate acceleration of debt outstanding under the terms of the Company’s senior credit facility and the indenture governing our senior subordinated notes. In addition, the filing of the Reorganization Cases terminated the revolving loan commitments under our senior credit facility. We believe that any efforts to enforce our payment obligations under our senior credit facility and the indenture governing our senior subordinated notes are stayed while the Company remains in the bankruptcy process. There has been no decision on whether fresh start accounting is applicable upon confirmation of the Plan by the Bankruptcy Court. The Company’s indentures governing its subordinated notes, as well as the credit agreement with its senior lenders, contain acceleration clauses in which debts become immediately due subject to a triggering event. The bankruptcy filing on March 24, 2013 triggered the Company’s notes and credit facility to become immediately due. The accompanying consolidated financial statements have been classified to reflect this triggering event as of the year ended December 31, 2012.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern; however, failure to receive approval of the Plan may raise substantial doubt about the Company’s ability to do so. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result should the Company be unable to continue as a going concern.