Operating Expenses

Operating expenses in the three months ended June 30, 2011, decreased 6.8% to $18.2 million from $19.5 million in the three months ended June 30, 2010. Cost of services and products increased 3.2% to $10.8 in the quarter ended June 30, 2011, from $10.4 million in the quarter ended June 30, 2010. Higher costs associated with the hosted PBX product support were partially offset by reduced overhead expenses. Selling, general and administrative expenses decreased 10.1% to $2.9 million in the three months ended June 30, 2011, from $3.2 million in the three months ended June 30, 2010, primarily related to a non-recurring reduction in employee and benefit costs and operating taxes plus lower legal expenses, partially offset by higher uncollectible expenses associated with carrier billing and customer credits. Depreciation and amortization for second quarter 2011 decreased 22.7% to $4.5 million from $5.8 million in second quarter 2010. Amortization of intangible assets associated with the Country Road acquisition decreased $0.3 million, including contract and customer base intangible assets. The remaining decrease of $1.0 million reflects lower depreciation of plant assets in Otelco’s regulated entities as assets become fully depreciated.

Interest Expense

Interest expense was constant at $6.2 million in the quarter ended June 30, 2011 compared to a year ago. The increase in interest expense associated with the additional senior subordinated notes issued in the exchange of our Class B shares in June 2010 was offset by lower interest costs on our senior long-term notes resulting from voluntary principal prepayments of $6.5 million since second quarter 2010.

Change in Fair Value of Derivatives

As a requirement of the existing senior debt, the Company has two interest rate swap agreements intended to hedge changes in interest rates on its senior debt. The swap agreements do not qualify for hedge accounting under the technical requirements of Accounting Standards Codification 815. Changes in value for the two swaps are reflected in change in the fair value of derivatives on the income statement and have no impact on cash. Over the life of the swaps, the change in value will be zero, with no impact on Adjusted EBITDA or operations. The liability for the swap decreased $0.5 million in second quarter 2011 compared to an increase in the liability for the swap of $0.2 million in the second quarter of 2010.

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Otelco Inc. Income Deposit Secs Units Cons Stock Downgraded (OTT)