**As filed with the Securities and Exchange Commission on November 13, 2006**

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-K/A**

AMENDMENTNO. 1

**FOR ANNUAL AND TRANSITION REPORTSPURSUANT TO SECTIONS 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**(MARK ONE)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934 

**FOR THE FISCAL YEAR ENDEDDECEMBER 31, 2005**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934 

**FOR THE TRANSITION PERIODFROM                    TO                    **

**Commission File Number:000-50706**

**ESCHELON TELECOM, INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**                              |   | **41-1843131**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer     |
| incorporation or  organization)           |   | Identification  No.) |
| **730 Second Avenue Minneapolis, MN**     |   | **55402**            |
| (Address of  principal executive offices) |   | (Zip Code)           |

 

Registrant’s telephone number, including area code: **(612) 376-4400**

Securities Registered Pursuant toSection 12(b) of the Act:**None**

Securities Registered Pursuant toSection 12(g) of the Act:**Common Stock, par value $0.01 per share**

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. Yes o     No x

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Act. Yes o     No x

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x     No o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendments to the Form 10-K. x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

| Large accelerated  filer o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Act). Yes o     No x

Asof September 30, 2006, the number ofoutstanding shares of the registrant’s Common Stock, par value $0.01 per share,was 17,946,744 shares.

**DOCUMENTS INCORPORATED BYREFERENCE**

Aportion of the information required by Part III of the Form 10-Kis incorporated by reference from portions of our definitive proxy statementfor our 2006 Annual Meeting of Stockholders to be filed with the Securities andExchange Commission.

 

 

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**EXPLANATORY NOTE**

**This Amendment No. 1 (the “Amendment”) on Form 10-K/A for the fiscal year endedDecember 31, 2005 is being filed to include Condensed ConsolidatingStatements of Cash Flows forthe twelve months ended December 31, 2003, 2004 and 2005 in the Notes toConsolidated Financial Statements in our Form 10-K for the fiscal year ended December 31, 2005 (the “Form 10-K”), to amend thepresentation of the Consolidated Statements of Operations and to amend certaintypographical errors in the Form 10-K. The presentation of the Consolidated Statements ofOperations was amended to exclude the caption Gross Profit. This Amendment amends and supersedes Part IV, Item 15 of the Form10-K.**

**TABLE OF CONTENTS**
| ** ** |   | **Part IV**                         |   |   |
|------------|--------|------------------------------------------|--------|--------|
| Item 15.   |   | Exhibits,  Financial Statement Schedules |   | 3      |
|            |        |                                          |        |        |  |  |  |  |  |

 

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**PART IV**

**Item 15.  Exhibits, Financial Statement Schedules.**

**(a) Documents filedas part of the report:**

(1)                                  Reportof Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of December 31,2004 and 2005

Consolidated Statements of Operations for the yearsended December 31, 2003, 2004 and 2005

Consolidated Statements of Stockholders’ Equity(Deficit) for the years ended December 31, 2003, 2004 and 2005

Consolidated Statements of Cash Flows for the yearsended December 31, 2003, 2004 and 2005

Notes to Consolidated Financial Statements

(2)                                  ScheduleII—Valuation of Qualifying Accounts and Reserves

Report of Independent Registered Public AccountingFirm

(3)                                  Exhibits

**(b) Exhibits:**

The following exhibits are filed or incorporated byreference as stated below:
| Exhibit  Number | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | ** ** | **Description** |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 3.1(2)          |       | Seventh Amended and  Restated Certificate of Incorporation of Eschelon Telecom, Inc. filed on  July 8, 2005.                                                                                                                                                                                                                                                                                                                                                                                  |
| 3.2(2)          |       | Form of Amended  and Restated Bylaws of Eschelon Telecom, Inc. filed on July 8,  2005.                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.1*            |       | Fourth Amended and  Restated Stockholders Agreement dated June 27, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 4.1.2(1)        |       | Amendment No. 1 to  Fourth Amended and Restated Stockholders Agreement dated December 23,  2004 (relating to Exhibit 4.1)                                                                                                                                                                                                                                                                                                                                                                |
| 4.2*            |       | Eschelon  Telecom, Inc. 2002 Stock Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 4.3*            |       | Form of Incentive  Stock Option Grant Agreement Under the Eschelon Telecom, Inc. 2002 Stock  Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.4*            |       | Form of  Nonstatutory Stock Option Grant Agreement Under the Eschelon Telecom, Inc.  2002 Stock Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                               |
| 4.5*            |       | Form of Restricted  Stock Grant Agreement Under the Eschelon Telecom, Inc. 2002 Stock  Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.6**           |       | Indenture dated  March 17, 2004 by and among Eschelon Operating Company; Eschelon  Telecom, Inc.; Eschelon Telecom of Minnesota, Inc.; Eschelon  Telecom of Washington, Inc.; Eschelon Telecom of Colorado, Inc.;  Eschelon Telecom of Nevada, Inc.; Eschelon Telecom of Utah, Inc.;  Eschelon Telecom of Oregon, Inc.; Eschelon Telecom of Arizona, Inc.;  and The Bank of New York Trust Company, N.A.                                                   |
| 4.7**           |       | Registration Rights  Agreement dated March 17, 2004 by and among Jefferies &  Company, Inc.; Wachovia Capital Markets LLC; Eschelon Operating Company;  Eschelon Telecom, Inc.; Eschelon Telecom of Minnesota, Inc.;  Eschelon Telecom of Washington, Inc.; Eschelon Telecom of  Colorado, Inc.; Eschelon Telecom of Nevada, Inc.; Eschelon Telecom  of Utah, Inc.; Eschelon Telecom of Oregon, Inc.; and Eschelon  Telecom of Arizona, Inc. |

 

3

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| Exhibit  Number | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** | **Description** |
|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 4.8**           |       | Security Agreement  dated March 17, 2004 by and among Eschelon Operating Company; Eschelon  Telecom, Inc.; Eschelon Telecom of Minnesota, Inc.; Eschelon  Telecom of Washington, Inc.; Eschelon Telecom of Colorado, Inc.;  Eschelon Telecom of Nevada, Inc.; Eschelon Telecom of Utah, Inc.;  Eschelon Telecom of Oregon, Inc.; Eschelon Telecom of  Arizona, Inc.; and The Bank of New York Trust Company, N.A. (as  Collateral Agent.) |
| 4.9**           |       | Trademark Security  Agreement dated March 17, 2004 by and among Eschelon Operating Company;  Eschelon Telecom, Inc.; and The Bank of New York Trust Company, N.A. (as  Collateral Agent.)                                                                                                                                                                                                                                                                                    |
| 4.10**          |       | Form of Initial 8  3/8% Senior Second Secured Notes due 2010.                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 4.11**          |       | Form of Guarantee  of Initial 8 3/8% Senior Second Secured Notes due 2010.                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.12**          |       | Form of Exchange 8  3/8% Senior Second Secured Notes due 2010.                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 4.13**          |       | Form of Guarantee  of Exchange 8 3/8% Senior Second Secured Notes due 2010.                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.14+           |       | Registration Rights  Agreement dated November 29, 2004 by and among Jefferies &  Company, Inc.; Eschelon Operating Company; Eschelon Telecom, Inc.;  Eschelon Telecom of Minnesota, Inc.; Eschelon Telecom of  Washington, Inc.; Eschelon Telecom of Colorado, Inc.; Eschelon  Telecom of Nevada, Inc.; Eschelon Telecom of Utah, Inc.; Eschelon  Telecom of Oregon, Inc.; and Eschelon Telecom of Arizona, Inc.            |
| 4.15+           |       | Supplemental Indenture  dated November 29, 2004 by and among Eschelon Operating Company, the  guarantors party thereto and The Bank of New York Trust Company, N.A.,  as Trustee.                                                                                                                                                                                                                                                                                            |
| 4.16+           |       | Supplemental Indenture  dated December 31, 2004 by and among Eschelon Operating Company, the  guarantors party thereto and The Bank of New York Trust Company, N.A.,  as Trustee.                                                                                                                                                                                                                                                                                            |
| 4.17+           |       | Supplemental Indenture  dated January 20, 2005 by and among Eschelon Operating Company, the  guarantors party thereto and The Bank of New York Trust Company, N.A., as  trustee.                                                                                                                                                                                                                                                                                                  |
| 4.18(1)         |       | Redemption Agreement as  of October 13, 2004, by and between NTFC Capital Corporation and  Eschelon Telecom, Inc.                                                                                                                                                                                                                                                                                                                                                            |
| 10.1(4)         |       | Employment Agreement  dated May 23, 2005 by and between Eschelon Telecom, Inc. and  Richard A. Smith.                                                                                                                                                                                                                                                                                                                                                                        |
| 10.2*           |       | Employment Offer Letter  dated March 7, 2000 from Eschelon Telecom, Inc. to Geoffrey M.  Boyd.                                                                                                                                                                                                                                                                                                                                                                               |
| 10.2.1*         |       | Severance Pay Letter  Agreement dated November 14, 2002 by and between Eschelon  Telecom, Inc. and Geoffrey M. Boyd.                                                                                                                                                                                                                                                                                                                                                         |
| 10.2.2(3)       |       | Amendment dated  April 11, 2005 to Employement Offer Letter dated March 7, 2000 from  Eschelon Telecom, Inc. to Geoffrey M. Boyd.                                                                                                                                                                                                                                                                                                                                       |
| 10.3*           |       | Change-in-Control  Severance Pay Agreement dated April 21, 1999 by and between Advanced  Telecommunications, Inc. and David A. Kunde.                                                                                                                                                                                                                                                                                                                                        |
| 10.4*           |       | Employment Offer Letter  dated July 19, 1999 from Advanced Telecommunications, Inc. to  Steven K. Wachter.                                                                                                                                                                                                                                                                                                                                                                   |
| 10.5*           |       | Stock Restriction  Agreement dated February 7, 2003 between Eschelon Telecom, Inc. and  Marvin C. Moses.                                                                                                                                                                                                                                                                                                                                                                     |
| 10.6*^          |       | Carrier Global Services  Agreement dated July 28, 2000 by and between MCI WorldCom  Communications, Inc. and Eschelon Telecom, Inc.                                                                                                                                                                                                                                                                                                                                     |
| 10.6.1*^        |       | First Amendment dated  June 20, 2001 to Carrier Global Services Agreement dated July 28,  2000 by and between MCI WorldCom Communications, Inc. and Eschelon  Telecom, Inc.                                                                                                                                                                                                                                                                                        |

 

4

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| Exhibit  Number | ** ** | ** **                                                                                                                                                                                       | ** ** | **Description** |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 10.6.2*^        |       | Second Amendment dated  April 8, 2002 to Carrier Global Services Agreement dated July 28,  2000 by and between MCI WorldCom Communications, Inc. and Eschelon  Telecom, Inc. |
| 10.6.3*^        |       | Third Amendment dated  April 1, 2003 to Carrier Global Services Agreement dated July 28,  2000 by and between MCI WorldCom Communications, Inc. and Eschelon  Telecom, Inc.  |
| 10.6.4*^        |       | WorldCom Internet  Dedicated Service Agreement and Service Order Form dated June 12,  2003.                                                                                            |
| 10.6.5*^        |       | WorldCom Internet  Dedicated Service Agreement and Service Order Form dated  January 23, 2004.                                                                                         |
| 10.6.6*^        |       | WorldCom Internet  Dedicated T3 Price-Protected Agreement dated July 26, 2001.                                                                                                              |
| 10.6.7*^        |       | WorldCom Wholesale  Dedicated Internet Pricing Sheet                                                                                                                                             |
| 10.7*^          |       | Carrier Service  Agreement dated August 25, 2000 between Global Crossing  Bandwidth, Inc. and Eschelon Telecom, Inc.                                                              |
| 10.7.1*^        |       | Amendment #1 dated  November 10, 2000 to Carrier Service Agreement dated August 25,  2000 between Global Crossing Bandwidth, Inc. and Eschelon  Telecom, Inc.                |
| 10.7.2*^        |       | Amendment #2 dated  January 2, 2001 to Carrier Service Agreement dated August 25, 2000  between Global Crossing Bandwidth, Inc. and Eschelon Telecom, Inc.                   |
| 10.7.3*^        |       | Amendment #3 dated  June 25, 2001 to Carrier Service Agreement dated August 25, 2000  between Global Crossing Bandwidth, Inc. and Eschelon Telecom, Inc.                     |
| 10.7.4*^        |       | Amendment #4 dated  July 17, 2001 to Carrier Service Agreement dated August 25, 2000  between Global Crossing Bandwidth, Inc. and Eschelon Telecom, Inc.                     |
| 10.7.5*         |       | Amendment #5 dated  April 25, 2002 to Carrier Service Agreement dated August 25, 2000  between Global Crossing Bandwidth, Inc. and Eschelon Telecom, Inc.                    |
| 10.7.6*^        |       | Amendment #6 dated  July 12, 2002 to Carrier Service Agreement dated August 25, 2000  between Global Crossing Bandwidth, Inc. and Eschelon Telecom, Inc.                     |
| 10.7.7*^        |       | Amendment #7 dated March 26,  2004 to Carrier Service Agreement dated August 25, 2000 between Global  Crossing Bandwidth, Inc. and Eschelon Telecom, Inc.                    |
| 10.7.8(5)^      |       | Amendment #8 dated  September 14, 2004 to Carrier Service Agreement dated August 25,  2000 between Global Crossing Bandwidth, Inc. and Eschelon  Telecom, Inc.               |
| 10.7.9(2)^^     |       | Amendment #9 dated  July 1, 2005 to Carrier Service Agreement dated August 25, 2000  between Global Crossing Bandwidth, Inc. and Eschelon Telecom, Inc.                      |
| 10.11*          |       | Lease of Office Space  by and between St. Paul Properties, Inc. and Eschelon Telecom, Inc.  dated as of November 18, 2003.                                                        |
| 10.11.1(6)      |       | Amendment of Lease  dated December 29, 2005 of Lease of Office Space by and between St. Paul  Properties, Inc. and Eschelon Telecom, Inc. dated as of  November 18, 2003.    |
| 10.12*          |       | Lease Agreement by and  between Timeshare Systems, Inc. and Advanced  Telecommunications, Inc. dated March 3, 1999.                                                               |
| 10.13*          |       | Lease For Storage dated  July 30, 1996 by and between T.H.S. Northstar Associates Limited  Partnership and Fishnet.com, Inc.                                                           |
| 10.13.1*        |       | First Amendment dated  March 10, 1998 of Lease for Storage dated July 30, 1996 by and  between T.H.S. Northstar Associates Limited Partnership and  Fishnet.com, Inc.             |
| 10.13.2*        |       | Second Amendment dated  March 27, 1998 of Lease for Storage dated July 30, 1996 by and  between T.H.S. Northstar Associates Limited Partnership and  Fishnet.com, Inc.            |
| 10.13.3*        |       | Third Amendment dated  April 30, 1999 of Lease for Storage dated July 30, 1996 by and  between T.H.S. Northstar Associates Limited Partnership and Fishnet.com, Inc.              |
| 10.13.4*        |       | Fourth Amendment dated  October 3, 2000 of Lease for Storage dated July 30, 1996 by and  between T.H.S. Northstar Associates Limited Partnership and  Fishnet.com, Inc.           |

 

5

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| Exhibit  Number | ** ** | ** **                                                                                                                                                                              | ** ** | **Description** |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 10.13.5*        |       | Lease For Storage dated  March 6, 2000 by and between T.H.S. Northstar Associates Limited  Partnership and Fishnet.com, Inc.                                                  |
| 10.13.6*        |       | Lease For Storage dated  July 11, 1999 by and between T.H.S. Northstar Associates Limited Partnership  and Fishnet.com, Inc.                                                  |
| 10.13.7(6)      |       | Fifth Amendment dated  January 9, 2006 of Lease For Storage dated July 30, 1996 by and  between T.H.S. Northstar Associates Limited Partnership and  Fishnet.com, Inc.   |
| 10.14*          |       | Lease Agreement by and  between Duke Realty Limited Partnership and Cady Communications, Inc.  dated May 21, 1999.                                                            |
| 10.14.1(6)      |       | Amendment dated  February 15, 2006 of Lease Agreement by and between Duke Realty Limited  Partnership and Cady Communications, Inc. dated May 21, 1999.                  |
| 10.15*          |       | Lease Agreement between  Seattle Telecom LLC and Advanced Telecommunications, Inc. dated  December 20, 1999.                                                                  |
| 10.16*          |       | Office Lease by and  between Parkside Salt Lake Corporation and Advanced  Telecommunications, Inc. dated December 28, 1999.                                                   |
| 10.16.1(6)      |       | Amendment dated  April 28, 2005 to Office Lease by and between Parkside Salt Lake  Corporation and Advanced Telecommunications, Inc. dated  December 28, 1999.           |
| 10.17*          |       | Lease by and between  Denver Place Associates Limited Partnership and Eschelon Telecom of  Colorado, Inc. dated October 24, 2000.                                             |
| 10.18*          |       | Office Lease by and  between SOFI-IV SIM Office Investors II, Limited Partnership and Advanced  Telecommunications, Inc. dated December 19, 1999.                             |
| 10.18.1*        |       | First Amendment dated  March 17, 2003 to Lease by and between SOFI-IV SIM Office Investors II,  Limited Partnership and Eschelon Telecom, Inc. dated December 19,  1999. |
| 10.18.2(6)      |       | Second Amendment dated  July 18, 2005 to Lease by and between SOFI-IV SIM Office Investors II,  Limited Partnership and Eschelon Telecom, Inc. dated December 19,  1999. |
| 10.19*          |       | Lease by and between  Alco Investment Company and Advanced Telecommunications, Inc. dated  November 19, 1999.                                                                 |
| 10.20+          |       | Stock Purchase  Agreement dated October 13, 2004, by and between Eschelon  Telecom, Inc. and Advanced TelCom Group, Inc.                                                 |
| 10.20.1         |       | Amendment to Stock  Purchase Agreement dated as of December 30, 2004 (related to  Exhibit 10.20)                                                                              |
| 10.21+          |       | Asset Purchase  Agreement dated October 13, 2004 by and between GE Business Productivity  Solutions, Inc. and Eschelon Telecom, Inc.                                     |
| 10.22(5)        |       | Lease Agreement by and  between Hartmann Limited Partnership & William Ludwig Hartmann  Marital Trust and Advanced TelCom, Inc. dated August 18, 2000.               |
| 10.23(5)        |       | Lease Agreement by and  between Advanced TelCom, Inc. and 200 South Virginia Investments, LLC  dated July 16, 1999.                                                           |
| 10.23.1(5)      |       | First Amendment to  Lease Agreement by and between Advanced TelCom, Inc. and 200 South  Virginia Investments, LLC dated January 6, 1999.                                      |
| 10.23.2(5)      |       | Second Amendment to  Lease Agreement by and between Advanced TelCom, Inc. and 200 South  Virginia Investments, LLC dated August 1, 2001.                                      |
| 10.23.3(5)      |       | Third Amendment to  Lease Agreement by and between Advanced TelCom, Inc. and 200 South  Virginia Investments, LLC dated April 1, 2004.                                        |
| 10.23.4(5)      |       | Fourth Amendment to  Lease Agreement by and between Advanced TelCom, Inc. and 200 South  Virginia Investments, LLC dated September 2004.                                      |
| 10.24(5)        |       | Triple-Net Lease  Agreement by and between Sunwest Properties II, LLC and Eschelon  Telecom, Inc. dated March 11, 2005.                                                       |
| 10.25(5)        |       | Standard Industrial/Commercial  Single-Tenant Lease—Net by and between Courthouse Square, LLC and Advanced  TelCom Group, Inc. dated January 29, 1999.                   |

 

6

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| Exhibit  Number | ** ** | ** **                                                                                                                                                                   | ** ** | **Description** |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 10.25.1(5)      |       | First Amendment to Lease  by and between Courthouse Square, LLC and Advanced TelCom Group, Inc.  dated August 12, 1999.                                            |
| 10.25.2(5)      |       | Second Amendment to  Lease by and between Kayares International, LLC and Advanced TelCom  Group, Inc. dated November 1, 2002.                                      |
| 10.26(5)        |       | Lease by and between  WVB Holdings, LLC and Advanced TelCom, Inc. dated June 10, 2004.                                                                             |
| 10.27(5)        |       | Office Building Lease  by and between Shaub Properties, Inc. and Advanced TelCom  Group, Inc. dated March 7, 2000.                                            |
| 10.28(5)        |       | Office Lease by and  between Retro, LLC and Advanced TelCom Group, Inc. dated  January 19, 1999.                                                                   |
| 10.28.1(5)      |       | Lease Modification  Agreement by and between Retro, LLC and Advanced TelCom Group, Inc.  dated April 23, 1999.                                                     |
| 10.29(2)        |       | Form of  Indemnification Agreement entered into between Eschelon Telecom, Inc.  and its directors and officers.                                                    |
| 10.30(5)        |       | Lease  Agreement-Commercial Premises by and between Avista Communications of  Washington and Yesterday’s Village, Inc. dated September 30, 1999.              |
| 10.30.1(5)      |       | Amended Lease Agreement  by and between Advanced TelCom, Inc. and Yesterday’s Village, Inc.  dated March 27, 2003.                                       |
| 10.30.2(5)      |       | Amendment to Lease  Agreement by and between Advanced TelCom, Inc. and Yesterday’s  Village, Inc. dated 2004.                                                 |
| 10.31(5)        |       | Lease by and between  U.S. National Bank of Oregon and Shared Communications Services, Inc.  dated March 1, 1996.                                                  |
| 10.31.1(5)      |       | Lease Extension and  Assignment Agreement by and between U.S. Bank, N.A., Shared Communications  Services, Inc. and Advanced TelCom, Inc. dated June 6, 2001. |
| 14.1(1)         |       | Eschelon  Telecom, Inc. Code of Ethics and Business Conduct                                                                                                             |
| 21.1+           |       | Subsidiaries of  Eschelon Telecom, Inc.                                                                                                                                 |
| 23.1            |       | Consent of  Ernst & Young LLP                                                                                                                                       |
| 31.1            |       | Certification by  Richard A. Smith, Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                 |
| 31.2            |       | Certification by  Geoffrey M. Boyd, Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                 |
| 32.1            |       | Certification by  Richard A. Smith, Chief Executive Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                 |
| 32.2            |       | Certification by Geoffrey  M. Boyd, Chief Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                 |

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*                                              Incorporatedherein by reference to Eschelon Telecom, Inc. Registration Statement onForm 10, No. 000-50706 as filed with the Commission onApril 26, 2004.

**                                       Incorporatedherein by reference to Eschelon Operating Company Registration Statement onForm S-4, No. 333-114437 as filed with the Commission onApril 13, 2004.

+                                              Incorporatedherein by reference to Eschelon Operating Company Registration Statement onForm S-4, No. 333-122292 as filed with the Commission onJanuary 25, 2005.

^                                               Portionsof this Exhibit were omitted and have been filed separately with theSecretary of the Commission pursuant to the Company’s Application RequestingConfidential Treatment under Rule 24b-2 of the Exchange Act, filedon April 26, 2004, as amended on July 7, 2005.

7

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^^                                         Portionsof this Exhibit were omitted and have been filed separately with theSecretary of the Commission pursuant to the Company’s Application RequestingConfidential Treatment under Rule 406 of the Securities Act, filed onJuly 7, 2005.

(1)                                       Incorporatedherein by reference to Eschelon Telecom, Inc. Annual Report onForm 10-K as filed with the Commission on March 31, 2005.

(2)                                       Incorporatedherein by reference to Eschelon Telecom, Inc. Registration Statement onForm S-1/A, No. 333-124703 as filed with the Commissionon July 8, 2005.

(3)                                       Incorporatedherein by reference to Eschelon Telecom, Inc. Current Report onForm 8-K as filed with the Commission on April 18, 2005.

(4)                                       Incorporatedherein by reference to Eschelon Telecom, Inc. Current Report onForm 8-K as filed with the Commission on May 27, 2005.

(5)                                       Incorporatedherein by reference to Eschelon Telecom, Inc. Registration Statement onForm S-1, No. 333-124703 as filed with the Commission onMay 6, 2005.

(6)                                       Previously filed on Eschelon Telecom, Inc. Annual Report on Form 10-K as filed with theCommission on March 17, 2006.

8

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**SIGNATURES**

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized, on November 13, 2006.
|   | ESCHELON TELECOM, INC. |
|--------|------------------------|
|   | By                     | /s/ RICHARD A. SMITH |
|   | Name:                  | Richard A. Smith |
|   | Title:                 | *President, Chief Executive  Officer and Director* |

 

Each person whose signature appears below constitutesand appoints Richard A. Smith, Geoffrey M. Boyd and J. Jeffery Oxley and eachof them, his true and lawful attorney-in-fact and agent, with full power andsubstitution and resubstitution, for him and in his name, place and stead, inany and all capacities, to sign any and all amendments to this annual report onForm 10-K and to file the same, with all exhibits thereto, and otherdocuments in connection therewith, with the Securities and Exchange Commission,granting unto said attorney-in-fact and agent full power and authority to doand perform each and every act and thing requisite and necessary to be done inand about the premises, as fully to all intents and purposes as he might orcould do in person, hereby ratifying and confirming all that saidattorney-in-fact, agent, or his substitute may lawfully do or cause to be doneby virtue hereof. Pursuant to the requirements of the Securities Exchange Actof 1934, this report has been signed by the following persons in the capacitiesand on the dates indicated.
|                          | **Signature** | ** **                                      | ** ** | ** **              | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------|---------------|-------------------------------------------------|------------|-------------------------|-----------|------------|------------|------------|----------|------------|
| /s/ RICHARD A. SMITH     |          | President, Chief Executive Officer and Director |       |                    |
| Richard A. Smith         |          | (Principal  Executive Officer)                  |       | November 13,  2006 |
| /s/ GEOFFREY M. BOYD     |          | Chief Financial Officer                         |       |                    |
| Geoffrey M. Boyd         |          | (Principal  Financial and Accounting Officer)   |       | November 13,  2006 |
| /s/ CLIFFORD D. WILLIAMS |          | Chairman of the Board                           |       |                    |
| Clifford D. Williams     |          |                                            |       | November 13,  2006 |
| /s/ MARVIN C. MOSES      |          | Director                                        |       |                    |
| Marvin C. Moses          |          |                                            |       | November 13,  2006 |
| /s/ LOUIS L. MASSARO     |          | Director                                        |       |                    |
| Louis L. Massaro         |          |                                            |       | November 13,  2006 |
| /s/ MARK E. NUNNELLY     |          | Director                                        |       |                    |
| Mark E. Nunnelly         |          |                                            |       | November 13,  2006 |
| /s/ JAMES P. TENBROEK    |          | Director                                        |       |                    |
| James P. TenBroek        |          |                                            |       | November 13,  2006 |
| /s/ IAN K. LORING        |          | Director                                        |       |                    |
| Ian  K. Loring           |          |                                            |       | November 13,  2006 |

 

9

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**EschelonTelecom, Inc.**

**Schedule II—Valuation andQualifying Accounts**

**Years EndedDecember 31, 2003, 2004 and 2005**

**(Dollars in thousands)**
|                                              | ** ** | **Balance at  Beginning  of Year** | ** ** | **Additions  Charged to  Costs and  Expenses** | ** ** | **Less  Deductions** | ** ** | **Balance Acquired  Through  Acquisition on  December 31, 2004** | ** ** | **Balance at  End  of Year** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------|------------|----------------------|------------|--------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| Allowance for Doubtful  Accounts Receivable: |       |                                         |       |                                                     |       |                 |       |                                                                                 |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| 2003                                         |       |                                         | $          | 2,018                                                    |       |                 |       | $                                                                                    | 1,033      |                                   |       |   | $ | (2,312 | ) |   |   | $ | — |   |   |   | $ | 739 |   |   |
| 2004                                         |       |                                         | 739        |                                                     |       |                 | 1,567      |                                                                                 |       |                                   | (1,894     | ) |   |   | 405 |   |   |   | 817 |   |   |
| 2005                                         |       |                                         | 817        |                                                     |       |                 | 2,338      |                                                                                 |       |                                   | (2,663     | ) |   |   | — |   |   |   | 492 |   |   |
|                                              |            |                                              |            |                                                          |            |                      |            |                                                                                      |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                                      | ** ** | **Balance at  Beginning  of Year** | ** ** | **Additions  Charged to  Costs and  Expenses** | ** ** | **Less  Deductions** | ** ** | **Balance Acquired  Through  Acquisition on  December 31, 2004** | ** ** | **Balance at  End  of Year** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------|------------|----------------------|------------|--------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| Valuation Allowance for  Deferred Income Tax Assets: |       |                                         |       |                                                     |       |                 |       |                                                                                 |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| 2003                                                 |       |                                         | $          | 38,482                                                   |       |                 |       | $                                                                                    | 6,279      |                                   |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | 44,761 |   |   |
| 2004                                                 |       |                                         | 44,761     |                                                     |       |                 | 1,378      |                                                                                 |       |                                   | —     |   |   |   | — |   |   |   | 46,139 |   |   |
| 2005                                                 |       |                                         | 46,139     |                                                     |       |                 | 11,661     |                                                                                 |       |                                   | —     |   |   |   | — |   |   |   | 57,800 |   |   |
|                                                      |            |                                              |            |                                                          |            |                      |            |                                                                                      |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

10

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CONSOLIDATED FINANCIALSTATEMENTS

EschelonTelecom, Inc.

Years Ended December 31, 2003, 2004 and 2005

----

**EschelonTelecom, Inc.**

**ConsolidatedFinancial Statements**

**YearsEnded December 31, 2003, 2004 and 2005**

**Index**
| Report of Independent  Registered Public Accounting Firm        |   |   |
|-----------------------------------------------------------------|--------|--------|
| Audited  Consolidated Financial Statements                      |   |   |
| Consolidated  Balance Sheets                                    |   |   |
| Consolidated  Statements of Operations                          |   |   |
| Consolidated  Statements of Stockholders’ Equity (Deficit) |   |   |
| Consolidated  Statements of Cash Flows                          |   |   |
| Notes to Consolidated  Financial Statements                     |   |   |

 

F-1

----

**Reportof Independent Registered Public Accounting Firm**

The Board of DirectorsEschelon Telecom, Inc.

We have audited the accompanying consolidated balancesheets of Eschelon Telecom, Inc. as of December 31, 2004 and 2005,and the related consolidated statements of operations, stockholders’ equity(deficit), and cash flows for each of the three years in the period endedDecember 31, 2005. Our audits also included the financial statement schedulelisted in the Index at Item 15(a). These financial statements and schedule arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements and schedule based on ouraudits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of material misstatement.We were not engaged to perform an audit of the Company’s internal control overfinancial reporting. Our audits included consideration of internal control overfinancial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basis forour opinion.

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of EschelonTelecom, Inc. at December 31, 2004 and 2005, and the consolidatedresults of its operations and its cash flows for each of the three years in theperiod ended December 31, 2005, in conformity with United States generallyaccepted accounting principles. Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, presents fairly in all material respectsthe information set forth therein.
|                        |        |
|------------------------|--------|
| February 17, 2006 |   |
| Minneapolis, Minnesota |   |

 

F-2

----

**EschelonTelecom, Inc.**

**Consolidated Balance Sheets**

**(Dollarsin Thousands, Except per Share Amounts)**
| ** **                                                                                                                                                                                            | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                            | ** ** | **2004**              | ** ** | **2005** | ** ** |
| **Assets**                                                                                                                                                                                            |       |                  |       |   |   |
| Current assets:                                                                                                                                                                                       |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                                             |       | $                     | 26,435     | ** ** | **$** | **26,062** | ** ** |
| Restricted cash                                                                                                                                                                                       |       | 722                   | ** ** | **996** | ** ** |
| Available-for-sale securities                                                                                                                                                                         |       | 6,194                 | ** ** | **4,760** | ** ** |
| Accounts receivable, net of allowance for doubtful  accounts of $817 and $492, respectively                                                                                                           |       | 18,941                | ** ** | **22,996** | ** ** |
| Other receivables                                                                                                                                                                                     |       | 2,976                 | ** ** | **3,052** | ** ** |
| Inventories                                                                                                                                                                                           |       | 2,873                 | ** ** | **2,927** | ** ** |
| Prepaid expenses                                                                                                                                                                                      |       | 2,410                 | ** ** | **2,294** | ** ** |
| Total current assets                                                                                                                                                                                  |       | 60,551                | ** ** | **63,087** | ** ** |
| Property and equipment, net                                                                                                                                                                           |       | 102,849               | ** ** | **126,452** | ** ** |
| Other assets                                                                                                                                                                                          |       | 1,985                 | ** ** | **1,506** | ** ** |
| Goodwill                                                                                                                                                                                              |       | 38,776                | ** ** | **7,168** | ** ** |
| Intangible assets, net                                                                                                                                                                                |       | 32,958                | ** ** | **33,333** | ** ** |
| Total assets                                                                                                                                                                                          |       | $                     | 237,119    | ** ** | **$** | **231,546** | ** ** |
| **Liabilities and stockholders’ equity (deficit)**                                                                                                                                               |       |                  | ** ** | ** ** | ** ** |
| Current  liabilities:                                                                                                                                                                                 |       |                  | ** ** | ** ** | ** ** |
| Accounts payable                                                                                                                                                                                      |       | $                     | 13,801     | ** ** | **$** | **16,400** | ** ** |
| Accrued telecommunication costs                                                                                                                                                                       |       | 2,190                 | ** ** | **4,227** | ** ** |
| Accrued office rent                                                                                                                                                                                   |       | 2,336                 | ** ** | **2,035** | ** ** |
| Accrued interest expense                                                                                                                                                                              |       | 4,070                 | ** ** | **2,646** | ** ** |
| Other accrued expenses                                                                                                                                                                                |       | 5,998                 | ** ** | **5,485** | ** ** |
| Deferred revenue                                                                                                                                                                                      |       | 7,300                 | ** ** | **7,921** | ** ** |
| Accrued compensation expenses                                                                                                                                                                         |       | 3,588                 | ** ** | **2,809** | ** ** |
| Capital lease obligations, current maturities                                                                                                                                                         |       | 1,629                 | ** ** | **2,430** | ** ** |
| Total current liabilities                                                                                                                                                                             |       | 40,912                | ** ** | **43,953** | ** ** |
| Long-term liabilities:                                                                                                                                                                                |       |                  | ** ** | ** ** | ** ** |
| Other long-term liabilities                                                                                                                                                                           |       | 630                   | ** ** | **251** | ** ** |
| Capital lease obligations, less current maturities                                                                                                                                                    |       | 2,824                 | ** ** | **2,964** | ** ** |
| Notes payable                                                                                                                                                                                         |       | 137,778               | ** ** | **92,125** | ** ** |
| Total liabilities                                                                                                                                                                                     |       | 182,144               | ** ** | **139,293** | ** ** |
| Series A convertible preferred stock, $0.01 par  value per share; 100,000,000 shares authorized and 77,526,136 shares issued  and outstanding on December 31, 2004                          |       | 48,155                | ** ** | **—** | ** ** |
| Series B convertible preferred stock, $0.01 par  value per share; 25,000,000 shares authorized and 20,000,000 shares  issued and outstanding on December 31, 2004                      |       | 15,000                | ** ** | **—** | ** ** |
| Stockholders’ equity (deficit):                                                                                                                                                                  |       |                  | ** ** | ** ** | ** ** |
| Common stock, $0.01 par value per share; 200,000,000  shares authorized; issued and outstanding shares—351,134 shares on  December 31, 2004 and 14,634,279 shares on December 31, 2005 |       | 4                     | ** ** | **146** | ** ** |
| Additional paid-in capital                                                                                                                                                                            |       | 115,876               | ** ** | **248,199** | ** ** |
| Accumulated other comprehensive income                                                                                                                                                                |       | 30                    | ** ** | **56** | ** ** |
| Accumulated deficit                                                                                                                                                                                   |       | (124,056              | )          | **(155,047** | **)** |
| Deferred compensation                                                                                                                                                                                 |       | (34                   | )          | **(1,101** | **)** |
| Total stockholders’ equity (deficit)                                                                                                                                                             |       | (8,180                | )          | **92,253** | ** ** |
| Total  liabilities and stockholders’ equity (deficit)                                                                                                                                            |       | $                     | 237,119    | ** ** | **$** | **231,546** | ** ** |

 

F-3

----

**EschelonTelecom, Inc.**

**Consolidated Statements of Operations**

**(Dollarsin Thousands, Except per Share Amounts)**
| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenue:                                                                          | ** ** | ** **                                 |       |   | ** ** | ** ** | ** ** |
| Network services                                                                  |       | $                                          | 115,482    |   | $ | 131,780 | ** ** | **$** | **201,835** | ** ** |
| Business telephone systems                                                        |       | 25,614                                     |       | 26,316 | ** ** | **25,908** | ** ** |
|                                                                              |       | 141,096                                    |       | 158,096 | ** ** | **227,743** | ** ** |
| Costs  and expenses:                                                              |       |                                       |       |   | ** ** | ** ** | ** ** |
| Network services expenses  (excluding depreciation and  amortization)             |       | 45,037                                     |       | 47,354 | ** ** | **85,914** | ** ** |
| Business telephone systems cost of revenue                                        |       | 15,784                                     |       | 15,979 | ** ** | **16,139** | ** ** |
| General and administrative                                                        |       | 39,297                                     |       | 41,755 | ** ** | **56,431** | ** ** |
| Sales and marketing                                                               |       | 26,955                                     |       | 27,500 | ** ** | **33,879** | ** ** |
| Depreciation and amortization                                                     |       | 30,099                                     |       | 31,105 | ** ** | **39,653** | ** ** |
| Operating loss                                                                    |       | (16,076                                    | )          | (5,597 | ) | **(4,273** | **)** |
| Other income (expense):                                                           |       |                                       |       |   | ** ** | ** ** | ** ** |
| Interest income                                                                   |       | 168                                        |       | 124 | ** ** | **691** | ** ** |
| Interest expense                                                                  |       | (1,754                                     | )          | (11,452 | ) | **(28,125** | **)** |
| Gain on extinguishment of debt                                                    |       | —                                     |       | 18,195 | ** ** | **—** | ** ** |
| Other income (expense)                                                            |       | 484                                        |       | (155 | ) | **65** | ** ** |
| Income (loss)  before income taxes                                                |       | (17,178                                    | )          | 1,115 | ** ** | **(31,642** | **)** |
| Income taxes                                                                      |       | (28                                        | )          | (4 | ) | **(4** | **)** |
| Net income  (loss) from continuing operations                                     |       | (17,206                                    | )          | 1,111 | ** ** | **(31,646** | **)** |
| Income from discontinued operation, net of tax                                    |       | —                                     |       | — | ** ** | **329** | ** ** |
| Gain on sale of discontinued operation, net of tax                                |       | —                                     |       | — | ** ** | **326** | ** ** |
| Net income  (loss)                                                                |       | (17,206                                    | )          | 1,111 | ** ** | **(30,991** | **)** |
| Less preferred  stock dividends and premium paid on repurchase of preferred stock |       | (3,426                                     | )          | (4,292 | ) | — |   |
| Net income  (loss) applicable to common stockholders                              |       | $                                          | (20,632    | ) | $ | (3,181 | ) | **$** | **(30,991** | **)** |
| Basic and diluted income (loss) per share:                                        |       |                                       |       |   | ** ** | ** ** | ** ** |
| Continuing operations                                                             |       | $                                          | (70.59     | ) | $ | (11.11 | ) | **$** | **(5.32** | **)** |
| Discontinued operation                                                            |       | —                                     |       | — | ** ** | **0.11** | ** ** |
| Net income (loss)                                                                 |       | $                                          | (70.59     | ) | $ | (11.11 | ) | **$** | **(5.21** | **)** |
| Weighted average shares outstanding:                                              |       |                                       |       |   |   | ** ** | ** ** |
| Basic and  diluted                                                                |       | 292,481                                    |       | 287,393 | ** ** | **5,949,310** | ** ** |

 

F-4

----

**EschelonTelecom, Inc.**

**Consolidated Statements of Stockholders’ Equity(Deficit)**

**(Dollarsin Thousands)**

 
| ** **                                                | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Accumulated** | ** ** | ** **   | ** ** | ** **       | ** ** | ** **   | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-------------------|------------|-----------------|------------|--------------|------------|------------------|------------|--------------|------------|
| ** **                                                | ** ** | ** **            | ** ** | **Paid-In** | ** ** | **Other**         | ** ** | ** **      | ** ** | ** **   | ** ** | ** **       | ** ** |
| ** **                                                | ** ** | **Common Stock** | ** ** | ** **  | ** ** | **Comprehensive** | ** ** | **Accumulated** | ** ** | **Deferred** | ** ** | ** **       | ** ** |
| ** **                                                | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income**      | ** ** | **Deficit**  | ** ** | **Compensation** | ** ** | **Total**    | ** ** |
| Balance at  December 31, 2002                        |       | 117,307               |       | $           | 1          |              | $          | 123,502         |       | $            | —     |             | $          | (107,961     | )          | $ | — |   | $ | 15,542 |   |
| Forfeiture of common  stock after corporate restructuring |       | (63                   | )          | —      |       | —            |       | —          |       | —       |       | —           |       | —       |       |
| Accumulated dividends in  connection with preferred stock |       | —                |       | —      |       | (3,426            | )          | —          |       | —       |       | —           |       | (3,426       | )          |
| Fees associated with  2002 sale of preferred stock        |       | —                |       | —      |       | (70               | )          | —          |       | —       |       | —           |       | (70          | )          |
| Issuance of restricted  common stock                      |       | 183,399               |       | 2           |       | 122               |       | —          |       | —       |       | (124             | )          | —       |       |
| Stock options exercised                                   |       | 28,290                |       | —      |       | 19                |       | —          |       | —       |       | —           |       | 19           |       |
| Amortization of deferred  compensation                    |       | —                |       | —      |       | —            |       | —          |       | —       |       | 70               |       | 70           |       |
| Net loss for the year                                     |       | —                |       | —      |       | —            |       | —          |       | (17,206      | )          | —           |       | (17,206      | )          |
| Balance at  December 31, 2003                        |       | 328,933               |       | 3           |       | 120,147           |       | —          |       | (125,167     | )          | (54              | )          | (5,071       | )          |
| Accumulated dividends in  connection with preferred stock |       | —                |       | —      |       | (3,435            | )          | —          |       | —       |       | —           |       | (3,435       | )          |
| Series A  convertible preferred stock repurchase     |       | —                |       | —      |       | (857              | )          | —          |       | —       |       | —           |       | (857         | )          |
| Issuance of restricted  common stock                      |       | 10,358                |       | —      |       | 14                |       | —          |       | —       |       | —           |       | 14           |       |
| Stock options exercised                                   |       | 11,843                |       | 1           |       | 7                 |       | —          |       | —       |       | —           |       | 8            |       |
| Unrealized gain on  available-for-sale securities         |       | —                |       | —      |       | —            |       | 30              |       | —       |       | —           |       | 30           |       |
| Amortization of deferred  compensation                    |       | —                |       | —      |       | —            |       | —          |       | —       |       | 20               |       | 20           |       |
| Net income for the year                                   |       | —                |       | —      |       | —            |       | —          |       | 1,111        |       | —           |       | 1,111        |       |
| Balance at  December 31, 2004                        |       | 351,134               |       | 4           |       | 115,876           |       | 30              |       | (124,056     | )          | (34              | )          | (8,180       | )          |
| Accumulated dividends in  connection with preferred stock | ** ** | **—**            | ** ** | **—**  | ** ** | **(2,648**        | **)**      | **—**      | ** ** | **—**   | ** ** | **—**       | ** ** | **(2,648**   | **)**      |
| Issuance of restricted  common stock                      | ** ** | **9,350**             | ** ** | **—**  | ** ** | **27**            | ** ** | **—**      | ** ** | **—**   | ** ** | **—**       | ** ** | **27**       | ** ** |
| Stock options exercised                                   | ** ** | **78,457**            | ** ** | **1**       | ** ** | **59**            | ** ** | **—**      | ** ** | **—**   | ** ** | **—**       | ** ** | **60**       | ** ** |
| Restricted stock  forfeited                               | ** ** | **(494**              | **)**      | **—**  | ** ** | **—**        | ** ** | **—**      | ** ** | **—**   | ** ** | **—**       | ** ** | **—**   | ** ** |
| Deferred compensation  related to stock options granted   | ** ** | **—**            | ** ** | **—**  | ** ** | **2,003**         | ** ** | **—**      | ** ** | **—**   | ** ** | **(2,003**       | **)**      | **—**   | ** ** |
| Amortization of deferred  compensation                    | ** ** | **—**            | ** ** | **—**  | ** ** | **—**        | ** ** | **—**      | ** ** | **—**   | ** ** | **936**          | ** ** | **936**      | ** ** |
| Unrealized gain on  available-for-sale securities         | ** ** | **—**            | ** ** | **—**  | ** ** | **—**        | ** ** | **26**          | ** ** | **—**   | ** ** | **—**       | ** ** | **26**       | ** ** |
| Convert preferred stock  to common stock                  | ** ** | **8,838,689**         | ** ** | **88**      | ** ** | **65,869**        | ** ** | **—**      | ** ** | **—**   | ** ** | **—**       | ** ** | **65,957**   | ** ** |
| Sale of common stock,  net of fees                        | ** ** | **5,357,143**         | ** ** | **53**      | ** ** | **67,013**        | ** ** | **—**      | ** ** | **—**   | ** ** | **—**       | ** ** | **67,066**   | ** ** |
| Net loss for the year                                     | ** ** | **—**            | ** ** | **—**  | ** ** | **—**        | ** ** | **—**      | ** ** | **(30,991**  | **)**      | **—**       | ** ** | **(30,991**  | **)**      |
| Balance at December 31, 2005                         | ** ** | **14,634,279**        | ** ** | **$**       | **146**    | ** **        | **$**      | **248,199**     | ** ** | **$**        | **56**     | ** **       | **$**      | **(155,047** | **)**      | **$** | **(1,101** | **)** | **$** | **92,253** | ** ** |

 

See accompanyingnotes.

F-5

----

**EschelonTelecom, Inc.**

**Consolidated Statements of Cash Flows**

**(InThousands)**
| ** **                                                                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Operating activities**                                                                  | ** ** | ** **                                 |       |   | ** ** | ** ** | ** ** |
| Net income (loss)                                                                         |       | $                                          | (17,206    | ) | $ | 1,111 | ** ** | **$** | **(30,991** | **)** |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |                                       |       |   | ** ** | ** ** | ** ** |
| Depreciation  and amortization expense                                                    |       | 30,099                                     |       | 31,105 | ** ** | **39,653** | ** ** |
| Provision  for bad debt expense                                                           |       | 500                                        |       | 721 | ** ** | **1,090** | ** ** |
| Noncash  interest expense                                                                 |       | 1,302                                      |       | 2,339 | ** ** | **7,288** | ** ** |
| Value  of stock issued to management and directors                                        |       | 70                                         |       | 34 | ** ** | **963** | ** ** |
| Loss  (gain) on write-off and sales of assets                                             |       | (484                                       | )          | 162 | ** ** | **260** | ** ** |
| Gain  on extinguishment of debt                                                           |       | —                                     |       | (18,195 | ) | **—** | ** ** |
| Gain  on sales of available-for-sale securities                                           |       | —                                     |       | (7 | ) | **(326** | **)** |
| Gain  on sale of discontinued operation                                                   |       | —                                     |       | — | ** ** | **(326** | **)** |
| Changes  in operating assets and liabilities:                                             |       |                                       |       |   | ** ** | ** ** | ** ** |
| Restricted  cash                                                                          |       | —                                     |       | (722 | ) | **(274** | **)** |
| Accounts  receivable                                                                      |       | (1,520                                     | )          | 658 | ** ** | **(5,145** | **)** |
| Other  receivables                                                                        |       | 904                                        |       | (546 | ) | **(76** | **)** |
| Inventories                                                                               |       | (393                                       | )          | 296 | ** ** | **(54** | **)** |
| Prepaid  expenses and other assets                                                        |       | (219                                       | )          | (209 | ) | **495** | ** ** |
| Discontinued  assets held for sale, net of liabilities                                    |       | —                                     |       | — | ** ** | **222** | ** ** |
| Accounts  payable and accrued expenses                                                    |       | 3,450                                      |       | 8,984 | ** ** | **2,133** | ** ** |
| Deferred  revenue                                                                         |       | (397                                       | )          | 878 | ** ** | **621** | ** ** |
| Accrued  compensation expenses                                                            |       | 582                                        |       | (1,216 | ) | **(779** | **)** |
| Net cash provided by  operating activities                                                |       | 16,688                                     |       | 25,393 | ** ** | **14,754** | ** ** |
| **Investing  activities**                                                                 |       |                                       |       |   | ** ** | ** ** | ** ** |
| Purchase of subsidiaries,  net of cash acquired                                           |       | —                                     |       | (45,495 | ) | **(48** | **)** |
| Purchase of assets held  for sale, net of liabilities                                     |       | —                                     |       | — | ** ** | **(216** | **)** |
| Purchases of  available-for-sale securities                                               |       | —                                     |       | (8,198 | ) | **(30,526** | **)** |
| Proceeds from sales of  available-for-sale securities                                     |       | —                                     |       | 2,041 | ** ** | **32,312** | ** ** |
| Purchases of property  and equipment                                                      |       | (13,367                                    | )          | (15,414 | ) | **(19,227** | **)** |
| Cash paid for customer  installation costs                                                |       | (11,669                                    | )          | (11,293 | ) | **(13,551** | **)** |
| Proceeds from sale of  assets                                                             |       | 28                                         |       | 25 | ** ** | **239** | ** ** |
| Proceeds from sale of  discontinued operation, net of fees                                |       | —                                     |       | — | ** ** | **320** | ** ** |
| Net cash used in  investing activities                                                    |       | (25,008                                    | )          | (78,334 | ) | **(30,697** | **)** |
| **Financing  activities**                                                                 |       |                                       |       |   | ** ** | ** ** | ** ** |
| Proceeds from issuance  of notes payable                                                  |       | —                                     |       | 136,163 | ** ** | **—** | ** ** |
| Payments made on notes  and capital lease obligations                                     |       | (2,697                                     | )          | (66,948 | ) | **(51,362** | **)** |
| Proceeds from (fees  associated with) issuance of preferred stock                         |       | (70                                        | )          | 15,000 | ** ** | **154** | ** ** |
| Payment on repurchase  of preferred stock                                                 |       | —                                     |       | (5,085 | ) | **—** | ** ** |
| Proceeds from issuance  of common stock, net of fees                                      |       | 19                                         |       | 8 | ** ** | **67,126** | ** ** |
| Increase in debt  issuance costs                                                          |       | (59                                        | )          | (8,368 | ) | **(348** | **)** |
| Net cash provided by  (used in) financing activities                                      |       | (2,807                                     | )          | 70,770 | ** ** | **15,570** | ** ** |
| Net increase  (decrease) in cash and cash equivalents                                     |       | (11,127                                    | )          | 17,829 | ** ** | **(373** | **)** |
| Cash and cash  equivalents at beginning of year                                           |       | 19,733                                     |       | 8,606 | ** ** | **26,435** | ** ** |
| Cash and cash  equivalents at end of year                                                 |       | $                                          | 8,606      |   | $ | 26,435 | ** ** | **$** | **26,062** | ** ** |
| **Supplemental  cash flow information**                                                   |       |                                       |       |   | ** ** | ** ** | ** ** |
| Cash paid for interest                                                                    |       | $                                          | 452        |   | $ | 9,114 | ** ** | **$** | **20,837** | ** ** |
| **Supplemental  noncash activities**                                                      |       |                                       |       |   | ** ** | ** ** | ** ** |
| Equipment purchases  under capital leases                                                 |       | $                                          | 1,430      |   | $ | 4,064 | ** ** | **$** | **3,127** | ** ** |
|                                                                                      |       |                                       |       |   | ** ** | ** ** | ** ** |
| Value of common  stock issued to management and certain members of the board of directors |       | $                                          | 124        |   | $ | 14 | ** ** | **$** | **27** | ** ** |

 

F-6

----

**EschelonTelecom, Inc.**

**Notes to Consolidated Financial Statements**

**(Dollarsin Thousands, Except per Share Amounts)**

**1.****   Summary of Significant Accounting Policies**

**Organization**

Eschelon Telecom, Inc. (the Company) is a competitivelocal exchange carrier, headquartered in Minneapolis, Minnesota. The Companywas incorporated in Delaware in 1996 under the name AdvancedTelecommunications, Inc. The Company is a facilities-based provider ofintegrated voice and data communications services to small and medium-sizedbusinesses in 19 markets in the western United States. The Company offers voiceand data services, which are referred to as network services. The Company alsosells, installs and maintains business telephone and data systems and equipmentreferred to as business telephone systems.

The Company offers the following products andservices:
| Voice Services            | ** ** | **Data Services**          | ** ** | **Business Telephone Systems**                       |
|---------------------------|------------|----------------------------|------------|------------------------------------------------------|
| Local and Long Distance   |       | Broadband Internet Access  |       | Customer Premise Telephone Equipment and Accessories |
| Vertical Features         |       | Dedicated Internet  Access |       | Data Communications  Equipment                       |
| Advanced Call  Management |       | Dial-up Internet Access    |       | Voice Mail Systems                                   |
| Other Enhanced Services   |       | E-Mail                     |       | IP Phone Systems                                     |
|                      |       | Web-Hosting                |       | After Market  Maintenance and Upgrade Contracts      |

 

**Principles ofConsolidation**

The consolidated financial statements include theaccounts of the Company and its wholly owned subsidiaries. All intercompanybalances and transactions have been eliminated in consolidation.

**Reclassifications**

Certain prior year items have been reclassified toconform to current year presentation.

**Cash and CashEquivalents**

The Company considers all highly liquid investmentswith maturities of three months or less at the time of purchase to be cashequivalents. Cash equivalents are carried at cost which approximates marketvalue. On December 31, 2004 and 2005, the Company had investments insecurities of $17,051 and $21,728, respectively, which are included in cash andcash equivalents.

**Restricted Cash**

In August 2004, a Nevada state court entered ajudgment against the Company in the amount of $376 plus costs. The Companyappealed the judgment and was required to hold $577 as restricted cash. Also in2004, the Company held $75 for collateral on bank credit cards and $70 forperformance bonds as restricted cash.

F-7

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements**

**(Dollarsin Thousands, Except per Share Amounts)**

**1.****   Summary of Significant Accounting Policies (Continued)**

In January 2005, the Company settled the Nevada statecourt judgment agreeing to pay a total of $300 in three annual installmentsstarting in January 2005. As part of the agreement the Company is required tohold the remaining installments in restricted cash. As a result, the Companyreduced the amount held in restricted cash from $577 to $200.

In 2005, the Company increased the amount held inrestricted cash for performance bonds from $70 to $720 as a result of the ATIacquisition. Also in 2005, the Company reduced the amount held in restrictedcash for collateral on bank credit cards from $75 to $55. Restricted cash alsoincludes $6 for interest earned on balances held.

**Available-for-SaleSecurities**

Short-term investments are comprised of municipal andUnited States government debt securities with maturities of more than threemonths but less than one year. In accordance with Statement of FinancialAccounting Standards (SFAS) No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*, and based onthe Company’s intentions regarding these instruments, all investments in debtsecurities are classified as available-for-sale and accounted for at fairvalue. Fair value is determined by quoted market prices, with unrealized gainsand losses reported as a separate component of stockholders’ equity (deficit).The Company uses the specific identification of securities sold method torecognize realized gains and losses in earnings.

**Property and Equipment**

Property andequipment, including leasehold improvements, are stated at cost. Depreciationis provided using the straight-line method over the estimated useful lives ofthe assets as follows:

| Vehicles                        |   | 5 years   |   |
|---------------------------------|--------|-----------|--------|
| Office furniture and  equipment |   | 5-7 years |   |
| Computer equipment              |   | 5 years   |   |
| Computer software               |   | 3 years   |   |
| Switching and data  equipment   |   | 12 years  |   |
| Switching and data software     |   | 5 years   |   |

 

Leasehold improvements are amortized over the shorterof the related lease term or the estimated useful life of the asset.

All internal costs directly related to theconstruction of the switches and operating and support systems, includingcompensation of certain employees, are capitalized.

F-8

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements**

**(Dollarsin Thousands, Except per Share Amounts)**

**1.****   Summary of Significant Accounting Policies (Continued)**

Property and equipment consists of the following:

|                                            | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Vehicles                                   |       | $                     | 590        | ** ** | **$** | **1,375** | ** ** |
| Office furniture and  equipment            |       | 16,746                | ** ** | **18,229** | ** ** |
| Computer equipment and  software           |       | 34,534                | ** ** | **41,897** | ** ** |
| Leasehold improvements                     |       | 19,504                | ** ** | **23,765** | ** ** |
| Switching and data  equipment and software |       | 99,736                | ** ** | **134,661** | ** ** |
|                                       |       | 171,110               | ** ** | **219,927** | ** ** |
| Less accumulated  depreciation             |       | (68,261               | )          | **(93,475** | **)** |
|                                       |       | $                     | 102,849    | ** ** | **$** | **126,452** | ** ** |

 

Total depreciation expense was $19,270, 18,684 and25,565 for the years ended December 31, 2003, 2004 and 2005, respectively.

The Company reviews all long-lived assets forimpairment in accordance with SFAS No. 144, *Accounting for the Impairment and Disposal of Long-Lived Assets*.Under SFAS No. 144, impairment losses are recorded on long-lived assetsused in operations when events and circumstances indicate the assets might beimpaired and the undiscounted cash flows estimated to be generated by thoseassets are less than the carrying amounts of those assets.

**Goodwill and OtherIntangible Assets**

Goodwill is tested at least annually for impairment atthe reporting unit level. If the implied fair value of a reporting unit is lessthan the carrying amount, an impairment charge is recognized. In accordancewith SFAS No. 142, *Goodwill and OtherIntangible Assets*, management completed its annual impairment testin the fourth quarter of 2004 and 2005 and determined that goodwill had notbeen impaired.

On September 15, 2005, the Company redeemed 35%of its outstanding 8 3/8% senior second secured notes due March 15, 2010.In connection with the redemption, the Company wrote off a proportionate amountof the associated debt issuance costs resulting in a net decrease to intangibleassets and a corresponding increase to interest expense of $2,579.

The following table represents other intangible assetsby category and accumulated amortization as of December 31, 2005 and 2004:

|                              | ** ** | **Gross**    | ** ** | ** **       | ** ** | ** ** | ** ** | **Estimated**       | ** ** |
|------------------------------|------------|--------------|------------|------------------|------------|------------|------------|---------------------|------------|
| ** **                   | ** ** | **Carrying** | ** ** | **Accumulated**  | ** ** | ** ** | ** ** | **Life Range** | ** ** |
| **2005**                     | ** ** | **Amount**   | ** ** | **Amortization** | ** ** | **Net**    | ** ** | **(in Years)** | ** ** |
| Customer installation  costs |       | $            | 77,650     |             | $          | 52,034     |       | $                   | 25,616     |   | 4 |   |
| Debt issuance costs          |       | 5,666        |       | 1,077            |       | 4,589      |       | 7                   |       |
| Customer relationships       |       | 3,820        |       | 955              |       | 2,865      |       | 4                   |       |
| Non-compete agreements       |       | 300          |       | 100              |       | 200        |       | 3                   |       |
| Developed technology         |       | 94           |       | 31               |       | 63         |       | 3                   |       |
| Total                        |       | $            | 87,530     |             | $          | 54,197     |       | $                   | 33,333     |   | 4 | (1) |

 

F-9

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements**

**(Dollarsin Thousands, Except per Share Amounts)**

**1.****   Summary of Significant Accounting Policies(Continued)**

|                              | ** ** | **Gross**    | ** ** | ** **       | ** ** | ** ** | ** ** | **Estimated**       | ** ** |
|------------------------------|------------|--------------|------------|------------------|------------|------------|------------|---------------------|------------|
| ** **                   | ** ** | **Carrying** | ** ** | **Accumulated**  | ** ** | ** ** | ** ** | **Life Range** | ** ** |
| **2004**                     | ** ** | **Amount**   | ** ** | **Amortization** | ** ** | **Net**    | ** ** | **(in Years)** | ** ** |
| Customer installation  costs |       | $            | 64,087     |             | $          | 39,019     |       | $                   | 25,068     |   | 4 |   |
| Debt issuance costs          |       | 8,368        |       | 476              |       | 7,890      |       | 7                   |       |
| Non-compete agreements       |       | 15           |       | 15               |       | —     |       | 5                   |       |
| Total                        |       | $            | 72,470     |             | $          | 39,512     |       | $                   | 32,958     |   | 4 | (1) |

 

----

(1)    Weightedaverage life.

Total amortization expense was $11,667, $13,076 and$15,153 for the years ended December 31, 2003, 2004 and 2005,respectively. Estimated amortization expense for each of the five succeedingfiscal years based on current intangible assets is expected to be $12,363,$10,045, $6,978, $2,978 and $969, respectively.

**RevenueRecognition**

Revenues from network services are recognized in theperiod in which subscribers use the related services. Revenues from equipmentsales and related installation charges are recognized upon delivery, completionof the installation of the related equipment, and acceptance by the customer,at which point legal title passes to the customer. Revenues for carrierinterconnection and access are recognized in the period in which the service isprovided.

**NetworkServices Expenses**

The Company carefully reviews all vendor invoices andfrequently disputes inaccurate or inappropriate charges. In cases where theCompany disputes certain charges, only undisputed amounts on vendor invoicesare paid in order to pay the proper amounts owed. The Company records costs netof disputed amounts based on the expected outcome of disputes that areinitiated. The Company uses significant estimates to determine the level ofsuccess in dispute resolution and considers past historical experience, basis ofdispute, financial status of the vendor and current relationship with thevendor and aging of prior disputes in quantifying estimates.

**Deferred Revenue**

Deferred revenue consists of voice and data servicesthat are billed in advance and recorded as a liability for services provided inthe future, maintenance contracts related to servicing business telephonesystems and estimated warranty costs associated with business telephonesystems.

Deferred revenue related to voice and data services isrecognized over the average customer life. Deferred revenue related tomaintenance contracts is recognized over the life of the contract. Deferredrevenue related to estimated warranty costs is recognized over the warrantyperiod, which typically ranges from one to two years.

**Advertising Costs**

Advertising costs are expensed as incurred. For theyears ended December 31, 2003, 2004 and 2005, the Company had advertisingexpense of $479, $464 and $589, respectively.

 

F-10

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**1.**              Summary of Significant AccountingPolicies (Continued)

**AccountsReceivable and Allowance for Doubtful Accounts**

Accounts receivable are initially recorded at fairvalue upon the sale of products or services to customers. Significant estimatesare required in determining the allowance for doubtful accounts receivable. TheCompany considers two primary factors in determining the proper level ofallowance, including historical collections experience and the aging of theaccounts receivable portfolio. The allowance for doubtful accounts is based onthe best facts available to the Company and is reevaluated and adjusted asadditional information is received.

**Use of Estimates**

The preparation of financial statements in conformitywith United States generally accepted accounting principles requires managementto make estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. Actual results could differ fromthose estimates.

**Accumulated OtherComprehensive Income**

Accumulated other comprehensive income representsunrealized gains on available-for-sale securities, net of tax. Accumulatedother comprehensive income is presented in the consolidated statements ofstockholders’ equity (deficit).

The components ofaccumulated other comprehensive income are as follows:
| Balance, December 31,  2003                     |   | $  | — |   |
|------------------------------------------------------|--------|----|--------|--------|
| Net unrealized gain  (loss) on financial instruments |   | 30 |   |
| Balance,  December 31, 2004                     |   | 30 |   |
| Net unrealized gain  (loss) on financial instruments |   | 26 |   |
| Balance, December 31, 2005                      |   | $  | 56     |   |

 

**Income Taxes**

The Company accounts for income taxes under theliability method in accordance with SFAS No. 109, *Accounting for Income Taxes*. Deferred taxliabilities are recognized for temporary differences that will result intaxable amounts in future years. Deferred tax assets are recognized fordeductible temporary differences and tax operating loss and tax creditcarryforwards. Deferred tax assets and liabilities are measured using theenacted tax rates expected to apply to taxable income in the periods in whichthe deferred tax asset or liability is expected to be realized or settled. TheCompany assesses the likelihood that its deferred tax assets will be recoveredfrom future taxable income and the Company records a valuation allowance toreduce its deferred tax assets to the amounts it believes to be realizable. TheCompany has concluded that a full valuation allowance against its deferred taxassets was appropriate.

**Net Income (Loss)Per Share**

Basic earnings per share is computed based on theweighted average number of common shares outstanding. Diluted earnings pershare is computed based on the weighted average number of common 

F-11

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**1.**              Summary of Significant AccountingPolicies (Continued)

shares outstandingadjusted by the number of additional shares that would have been outstandinghad the potentially dilutive common shares been issued. Potentially dilutiveshares of common stock include unexercised stock options and unvestedrestricted stock grants. The Company does not have any potentially dilutiveshares because net losses were reported in all periods presented.

**Stock-BasedCompensation**

The Company accounts for its stock-based employeecompensation under the recognition and measurement principles of AccountingPrinciples Board (APB) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations. UnderAPB No. 25, when the exercise price of stock options equals the marketprice of the underlying stock on the date of grant, no compensation expense isrecognized in the consolidated statements of operations.

The Company adopted the disclosure provisions of SFASNo. 148, *Accounting for Stock-BasedCompensation.* SFAS No. 148 requires disclosure of how stockcompensation expense would be computed under SFAS No. 123, *Accounting for Stock-Based Compensation*,using the fair value method.

The followingtable illustrates the effect on net income (loss) per share if the Company hadapplied the fair value recognition provision of SFAS No. 123 tostock-based employee compensation:
|                                                                                                                   | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net loss applicable to  common stockholders as reported                                                           |       | $                                          | (20,632    | ) | $ | (3,181 | ) | **$** | **(30,991** | **)** |
| Add: Stock-based  employee compensation expense included in reported net loss, net of related  tax effects        |       | 70                                         |       | 20 | ** ** | **963** | ** ** |
| Deduct: Total  stock-based employee compensation expense determined under fair value-based  method for all awards |       | (133                                       | )          | (45 | ) | **(1,303** | **)** |
| Pro forma net loss  applicable to common stockholders                                                             |       | $                                          | (20,695    | ) | $ | (3,206 | ) | **$** | **(31,331** | **)** |
| Net income (loss) per  share:                                                                                     |       |                                       |       |   |   |   |   |
| Basic and  diluted—as reported                                                                               |       | $                                          | (70.59     | ) | $ | (11.11 | ) | **$** | **(5.21** | **)** |
| Basic and diluted—pro  forma                                                                                 |       | (70.73                                     | )          | (11.11 | ) | **(5.27** | **)** |

 

The fair value of these options was estimated at thedate of grant using the Black-Scholes option pricing model with the followingweighted average assumptions:
|                                  | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Expected dividend yield          |       | —                                     |       | — | ** ** | **—** | ** ** |
| Expected stock price  volatility |       | 25                                         | %          | 25 | % | **25** | **%** |
| Risk-free interest rate          |       | 3.25                                       | %          | 3.88 | % | **4.45** | **%** |
| Expected life of options         |       | 5 years                                    |       | 5 years | ** ** | **5 years** | ** ** |

 

**New AccountingPronouncements**

In November 2004, the Financial AccountingStandards Board (FASB) issued SFAS No. 151, *Inventory Costs*. This statement requires that abnormal amountsof idle facility expense, freight, handling 

F-12

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**1.****              Summaryof Significant Accounting Policies (Continued)**

costs and spoilage berecognized as current-period charges. This statement also requires that fixedproduction overhead be allocated to inventory costs beginning in fiscal 2006.The Company does not expect that the adoption of this statement will have amaterial impact on its consolidated financial statements.

In December 2004, as amended on April 14,2005, the FASB issued SFAS No. 123R, *Share-BasedPayment: an amendment of FASB Statement No. 123 and FASB StatementNo. 95*, which requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values. Prior to SFAS No. 123R, only certainpro forma disclosures of fair value were required. SFAS 123R must be adopted nolater than the beginning of the first fiscal year beginning after June 15,2005. The Company adopted SFAS 123R on January 1, 2006.

The Company will use the modified prospective methodin which compensation cost is recognized beginning with the effective date(a) based on the requirements of SFAS 123R for all share-based paymentsgranted after the effective date and (b) based on the requirements of SFAS123 for all awards granted to employees prior to the effective date of SFAS123R that remain unvested on the effective date. The Company is evaluating thepotential impact on its financial statements.

In December 2004, the FASB issued SFASNo. 153, *Exchanges of NonmonetaryAssets*. SFAS No. 153 addresses the measurement of exchange ofnonmonetary assets. SFAS No. 153 eliminates the exception from fair valuemeasurement for nonmonetary exchanges of similar productive assets in paragraph21(b) of APB Opinion No. 29, *Accountingfor Nonmonetary Transactions*, and replaces it with an exception forexchanges that do not have commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. SFASNo. 153 is effective for nonmonetary asset exchanges occurring in fiscalperiods beginning after June 15, 2005. The Company will adopt the provisionsof SFAS No. 153 on January 1, 2006. The adoption of this statementwill not have a material impact on the Company’s consolidated financialstatements.

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections*.SFAS No. 154 replaces Accounting Principles Board Opinion No. 20, *Accounting Changes*, and FASB StatementNo. 3, *Reporting Accounting Changes inInterim Financial Statements*, and requires the direct effects ofaccounting principle changes to be retrospectively applied. The existingguidance with respect to accounting estimate changes and corrections of errorsis carried forward in SFAS No. 154. SFAS No. 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005.

**2.****              Acquisitions**

*AdvancedTelCom, Inc.*

On October 13, 2004 the Company entered into anagreement to purchase all of the outstanding common stock of AdvancedTelCom, Inc. (ATI) for $45,543, net of cash acquired. The transactionclosed on December 31, 2004. The closing of this transaction gives theCompany a leading market position among competitive local exchange carrierswithin the Pacific Northwest, acquiring more than 18,000 business customersthat utilize approximately 124,000 access lines. The Company expects to benefitfrom operating synergies from consolidating ATI’s operations into its existingbusiness.

F-13

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**2.****              Acquisitions(Continued)**

The following table summarizes the fair values of theassets acquired and liabilities assumed at the date of acquisition:
| Cash                       |   | $      | 321    |   |
|----------------------------|--------|--------|--------|--------|
| Other current assets       |   | 7,958  |   |
| Property and equipment     |   | 42,729 |   |
| Other assets               |   | 29     |   |
| Other intangible assets    |   | 3,913  |   |
| Total assets acquired      |   | 54,950 |   |
| Current liabilities        |   | 6,741  |   |
| Long-term liabilities      |   | 217    |   |
| Acquisition reserve        |   | 2,128  |   |
| Total liabilities  assumed |   | 9,086  |   |
| Net assets acquired        |   | $      | 45,864 |   |

 

On December 31, 2004, the Company allocated thepurchase price on a preliminary basis using the information then available.During the fourth quarter of 2005, the company completed an independentvaluation. Upon the completion of the independent valuation, the Companyadjusted its preliminary purchase price allocation by increasing the fair valueassigned to fixed assets and other intangible assets by $27,340 and $3,913respectively with a corresponding $31,253 reduction to goodwill. As a result ofincreasing the fair values associated with fixed asset and other intangibleassets the Company recorded additional depreciation expense and amortizationexpense of $4,285 in the fourth quarter of 2005. On December 31, 2004, theCompany accrued $2,531 in acquisition related expenses, which included severancebenefits, relocation costs and contract termination fees. During the fourthquarter of 2005 the Company finalized its liabilities incurred in connectionwith the acquisition and recorded an adjustment to decrease the recordedliabilities by $403, which was recorded as a reduction to goodwill. As ofDecember 31, 2005, $375 of the acquisition related expenses have yet to bepaid.

The following unaudited pro forma financialinformation was prepared in accordance with SFAS No. 141, *Business Combinations*, and assumes theacquisition had occurred at the beginning of the periods presented. Theunaudited pro forma information is provided for informational purposes only.These pro forma results are based upon the respective historical financialstatements of the respective companies, and do not incorporate, nor do theyassume any benefits from cost savings or synergies of operations of thecombined company. The pro forma results of operations do not necessarilyreflect the results that would have occurred had the acquisition occurred atthe beginning of the periods presented or the results which may occur in thefuture.

The pro formacombined results of continuing operations are as follows:
|                                           | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2003**                                   | ** ** | **2004** | ** ** |
| Revenue                                   |       | $                                          | 180,542    |   | $ | 217,187 |   |
| Net loss                                  |       | (19,673                                    | )          | (1,559 | ) |
| Net loss per share—basic and diluted |       | (6.06                                      | )          | (1.73 | ) |
|                                           |            |                                            |            |  |  |  |  |

 

F-14

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**2.****              Acquisitions(Continued)**

ATI’s consolidated financial information included inthe 2003 pro forma results represents the period from May 15, 2003 (thedate on which ATI emerged from bankruptcy) through December 31, 2003.

*General ElectricBusiness Productivity Solutions*

On October 13, 2004 the Company entered into anagreement with General Electric Capital Corporation to purchase substantiallyall other assets of General Electric Business Productivity Solutions, Inc.(GE BPS) for $100. The transaction closed on March 31, 2005 and was beaccounted for as a discontinued operation. GE BPS constitutes a group of assetsthat can be clearly distinguished operationally and for financial reportingpurposes from the rest of the Company. Management has determined that the groupof assets does not fit the Company’s future business model and committed tosell the net assets with an original carrying value of $216, which approximatedthe fair value less cost to sell the group of assets. At March 31, 2005the Company determined that the plan of sale criteria in SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, had been met and classified the assets andliabilities accordingly on the balance sheet.

On October 1, 2005, the Company sold itsdiscontinued operation for $320, net of sales costs incurred. The sale resultedin gain of $326 and is presented in the consolidated statement of operations.

**3.****              Investments**

AtDecember 31, 2005, available-for-sale securities consist of the following:
|                                     | ** ** | **Cost Basis** | ** ** | **Unrealized  Holding  Gains** | ** ** | **Fair Value** | ** ** |
|-------------------------------------|------------|---------------------|------------|--------------------------------|------------|---------------------|------------|
| U.S. government  agencies           |       | $                   | 1,961      |                           | $          | 26                  |       | $ | 1,987 |   |
| Corporate obligations               |       | 2,743               |       | 30                             |       | 2,773               |       |
| Total available-for-sale securities |       | $                   | 4,704      |                           | $          | 56                  |       | $ | 4,760 |   |

 

AtDecember 31, 2004, available-for-sale securities consists of thefollowing:
|                                     | ** ** | **Cost Basis** | ** ** | **Unrealized  Holding  Gains** | ** ** | **Fair Value** | ** ** |
|-------------------------------------|------------|---------------------|------------|--------------------------------|------------|---------------------|------------|
| U.S. government  agencies           |       | $                   | 2,300      |                           | $          | 11                  |       | $ | 2,311 |   |
| Corporate obligations               |       | 3,864               |       | 19                             |       | 3,883               |       |
| Total available-for-sale securities |       | $                   | 6,164      |                           | $          | 30                  |       | $ | 6,194 |   |

 

All debt securities as of December 31, 2004 and2005, have maturities of six months or less.

**4.****              NotesPayable**

In June 2002, the Company entered into anegotiated debt restructuring, which included the reduction of outstanding debtunder its senior secured credit facility from $139,293 to $57,062. In therestructuring, certain lenders with outstanding principal and interest due of$65,778 chose to receive $12,229 in cash to cancel all liabilities, as a resultof which the Company recorded a pre-tax gain of $53,549. In accordance 

F-15

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**4.****              NotesPayable (Continued)**

with SFAS No. 15, *Accounting by Debtors and Creditors for Troubled DebtRestructurings*, a portion of the reduction in the amount outstandingcould not be immediately recognized as a gain, but instead would be recognizedas a reduction to interest expense over the term of the new credit facility. Asof December 31, 2003, $21,871 of excess carrying value had yet to berecognized as a reduction in interest expense. For the years endedDecember 31, 2003 and 2004, the Company recognized, as a reduction tointerest expense, $4,470 and $998, respectively, of the excess carrying value.

In March 2004, the Company completed an offeringof $100,000 of 8 3/8% senior second secured notes (“notes”) due 2010 at adiscount resulting in a 12% yield. Proceeds from the offering were used toretire the Credit Agreement with a principal balance of $65,421 and provideadditional liquidity to the Company. The repayment of the Credit Agreementresulted in the Company recording $18,195 as a gain on extinguishment of debt,which represented $20,873 of excess carrying value less the write-off of $2,678of debt issuance costs associated with the 2002 Exchange Agreement.

In November 2004, the Company completed anoffering of $65,000 of 8 3/8% senior second secured notes (“notes”) due 2010 ata discount resulting in a 14% yield. Proceeds from the offering were used tofinance the acquisition of Advanced TelCom, Inc.

The notes will mature on March 15, 2010, andaccrue interest at an annual rate of 8 3/8% with interest payments made on asemiannual basis on each March 15 and September 15. On or afterMarch 15, 2007, the Company may redeem some or all of the notes at thefollowing redemption prices, expressed as percentages of their accreted value,plus accrued and unpaid interest, if any, to the date of redemption: 1) on orafter March 15, 2007, at 106%; 2) on or after March 15, 2008 at 103%;and 3) on or after March 15, 2009 at 100%. Prior to March 15, 2007,up to 35% of the aggregate principal amount at maturity of the notes may beredeemed at the Company’s option with the net proceeds of certain equityofferings at 112.000% of their accreted value, plus accrued and unpaidinterest, if any, to the date of redemption, provided that, following suchredemption, at least 65% of the aggregate principal amount at maturity of thenotes originally issued remains outstanding. In addition, the Company may, atits option upon a change of control, redeem all, but not less than all, of thenotes at any time prior to March 15, 2007, at 112.000% of their accretedvalue, plus accrued and unpaid interest, if any, to the redemption date. OnSeptember 15, 2009, if any notes are outstanding, the Company will berequired to redeem 3.5% of each then outstanding note’s aggregate accretedvalue, or the Mandatory Principal Redemption Amount, at a redemption price of100% of the accreted value of the portion of notes so redeemed; provided, thatthe Company shall simultaneously be required to redeem an additional portion ofeach note to the extent required to prevent such note from being treated as anApplicable High Yield Discount Obligation within the meaning ofSection 163(i)(1) of the Internal Revenue Code of 1986, as amended.The Mandatory Principal Redemption Amount represents, with respect to eachnote, an amount approximately equal to (i) the excess of the accreted valueof the outstanding notes over the original issue price thereof less(ii) an amount equal to one year’s simple uncompounded interest on theaggregate original issue price of such outstanding notes at a rate per annumequal to the yield to maturity on the outstanding notes.

On September 15, 2005, the Company redeemed$50,630 accreted value ($57,750 principal amount) of the Company’s 8 3/8%senior second secured notes due March 15, 2010 at a redemption price of112% of the accreted value. The $6,076 accreted-value premium was recorded asinterest expense. Proceeds from 

F-16

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**4.****              NotesPayable (Continued)**

the Company’s initialpublic offering of the Company common stock (see Note 8) were used to redeemthe notes.

The carrying value of the notes is comprised of thefollowing as of December 31:
|                            | ** ** | **2004** | ** ** | **2005**    | ** ** |
|----------------------------|------------|----------|------------|-------------|------------|
| Principal amount due       |       | $        | 165,000    | ** **  | **$**      | **107,250** | ** ** |
| Discount on notes  payable |       | (27,222  | )          | **(15,125** | **)**      |
|                       |       | $        | 137,778    | ** **  | **$**      | **92,125** | ** ** |

 

The accreted valueof notes payable as of December 31 of the following years is:
| 2006                |   | $       | 95,033 |   |
|---------------------|--------|---------|--------|--------|
| 2007                |   | 98,332  |   |
| 2008                |   | 102,076 |   |
| 2009                |   | 106,326 |   |
| March 15, 2010 |   | 107,250 |   |

 

The carrying amount, net of discount, of the Company’sdebt instruments in the consolidated balance sheets at December 31, 2004and 2005 approximates fair value.

**5.****              Commitmentsand Contingencies**

InApril 2003, the Company entered into a five-year agreement with MCI topurchase colocation/LIS transport services. The agreement requires that theCompany maintain monthly minimums as follows:
| April 2005—March 2006 |   | $ | 88/month |   |
|--------------------------------------|--------|---|----------|--------|
| April 2006—March 2007 |   | $ | 93/month |   |
| April 2007—March 2008 |   | $ | 97/month |   |

 

The Company will pay an underutilization charge forany amounts billed under the monthly minimum.

In 2000, the Companyentered into an amendment of an earlier Master Purchase and Services agreementwith Nortel Networks, Inc. (Nortel Networks). Under the amendment, theCompany committed to purchase and/or license $100,000 of Nortel Networks’equipment or services. However, the Company is confident that, due to NortelNetworks’ discontinuance of certain product lines contemplated in the AmendedMaster Purchase and Services agreement, neither party will be held to theconditions of the contract.

**Legal Proceedings**

InAugust 2004, a Nevada state court entered a judgment against the Companyfor intentionally interfering with a former salesperson’s economic relationshipwith his new employer in the amount of $376 plus costs. The Company had reasonto believe the former employee was violating his non-solicitation agreementwith the Company. The Company appealed the judgment because, among otherreasons, the 

F-17

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**5.****              Commitmentsand Contingencies (Continued)**

jurywas not instructed to consider whether the Company was justified in informingthe new employer of the agreement and the Company’s intent to enforce it. TheCompany settled this case in January 2005, agreeing to pay a total of $300over three annual installments.

In November of 2004, a former employee filed a suitagainst the Company in federal district court in Minnesota alleging thattermination of her employment violated the federal Civil Rights Act and theFamily Medical Leave Act, claiming $225 in damages. The Company is vigorouslydefending against these claims and filed a summary judgment motion as to allclaims.

A lawsuit is pending against the Company and others bya former customer in Utah state court. The suit alleges damages of $1,000regarding alleged improper assignment of an “800” number. The Company isvigorously defending this claim and believes it to be without merit. Thediscovery phase and period for making dispositive motions in the case haveconcluded.

In June 2005, the Company settled the lawsuitbrought against us by Global Crossing. The parties agreed to release each otherfrom all claims related to the dispute and to amend their agreement. Thesettlement agreement provided for the Company to pay Global Crossing $5,000 andfor Global Crossing to credit the Company’s future bills for approximately $564over the following six months. Under the terms of the Global Crossingsettlement, the Carrier Services Agreement between the parties, which hadprovided that Global Crossing was the Company’s exclusive provider of voice anddata services, subject to certain exceptions, and that the Company had apurchase commitment of $100,000, was amended to shorten the term of theagreement to July 1, 2006, to eliminate the exclusivity, purchasecommitment and shortfall provisions and to provide that Global Crossing will bethe Company’s preferred provider for Internet transit and long haul dataprivate line needs.

The Company cannot predict the outcome of any of theseproceedings or their effect on its business. The Company is party from time totime to other ordinary course matters not believe to be material.

**6.****              Operatingand Capital Leases**

The Company leases office space under operatingleases. The office leases generally require a base rent plus amounts coveringoperating expenses and property tax. Rent expense for the years endedDecember 31, 2003, 2004, and 2005 was $6,007, $5,087, and $7,468,respectively.

F-18

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**6.****              Operatingand Capital Leases (Continued)**

Future minimumlease payments under operating leases with a term in excess of one year as ofDecember 31, 2005 are as follows:
| 2006       |   | $     | 4,929  |   |
|------------|--------|-------|--------|--------|
| 2007       |   | 4,661 |   |
| 2008       |   | 4,526 |   |
| 2009       |   | 3,590 |   |
| 2010       |   | 2,155 |   |
| Thereafter |   | 4,272 |   |
|       |   | $     | 24,133 |   |

 

The Company also leasescertain furniture and equipment under capital leases. The cost of furniture andequipment in the accompanying balance sheets includes the following amountsunder capital leases:
|                                | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Cost                           |       | $                     | 6,020      | ** ** | **$** | **9,207** | ** ** |
| Less accumulated  depreciation |       | (782                  | )          | **(2,507** | **)** |
|                           |       | $                     | 5,238      | ** ** | **$** | **6,700** | ** ** |

 

Future minimum lease payments required under capitalleases together with the present value of the net future minimum lease paymentsat December 31, 2005 are as follows:
| 2006                                              |   | $      | 3,011  |   |
|---------------------------------------------------|--------|--------|--------|--------|
| 2007                                              |   | 2,592  |   |
| 2008                                              |   | 664    |   |
| 2009                                              |   | 27     |   |
| Total minimum lease  payments                     |   | 6,294  |   |
| Less amount  representing interest                |   | (900   | )      |
| Present value of net  minimum payments            |   | 5,394  |   |
| Less current portion                              |   | (2,430 | )      |
| Capital lease obligations, net of current portion |   | $      | 2,964  |   |

 

**7.****              BenefitContribution Plan**

TheCompany has a defined contribution salary deferral plan covering substantiallyall employees under Section 401(k) of the Internal Revenue Code. TheCompany contributes an amount equal to 45 cents for each dollarcontributed by each employee up to a maximum of 6% of each employee’scompensation. The Company recognized expense for contributions to the plan of$602, $764 and $962 in 2003, 2004 and 2005, respectively.

F-19

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**8.****              CapitalStock (Continued)**

**Initial PublicOffering**

On August 9, 2005, the Company consummated aninitial public offering of 5,357,143 of the Company’s common stock at $14.00per share. Net proceeds from the offering, after deducting underwritingdiscounts and commissions, were $69,750. Proceeds were used to redeem $50,630accreted value ($57,750 principal amount) of the Company’s 83¤8%senior second secured notes due March 15, 2010; to pay a $6,076 premiumdue upon redemption of the notes; and to pay $2,684 of fees and expensesassociated with the offering.

**Preferred Stock**

In December 2004, in connection with the ATIacquisition, the Company redeemed 6,780,541 shares of its Series AConvertible Preferred Stock held by a lender for $5,085.

In December 2004, the Company issued 20,000,000shares of its newly authorized Series B Convertible Preferred Stock,resulting in proceeds of $15,000.

Under the terms of the Series A and Series BConvertible Preferred Stock (collectively, Preferred Stock), the holders areentitled to receive, when and if declared by the Board of Directors, cumulativedividends on each share of Preferred Stock at the rate of 8% per year whichshall accrue daily and, to the extent not paid, shall accumulate quarterly inarrears. At December 31, 2004, dividends in arrears were $8,777.

As a result of the Company’s initial public offeringof common stock on August 9, 2005, all of the Company’s then-outstandingshares of convertible preferred stock and accumulated dividends wereautomatically converted to common stock.

After the conversion, the Company has 125,000,000 ofundesignated preferred shares authorized and no shares of preferred stockoutstanding.

**Stock Options**

In November 2002, the Board of Directors approvedthe Eschelon Telecom, Inc. Stock Option Plan of 2002 (the 2002 Plan). The2002 Plan provides for the issuance of incentive and nonqualified stock optionsto key management staff. Under the 2002 Plan, the exercise price of optionsgranted is determined by the Board of Directors, providing that incentive stockoptions are granted at exercise prices equal to the fair market value of theCompany’s stock on the date of grant and the options are exercisable for aperiod not to exceed ten years from date of grant. Options are typicallysubject to vesting over four years, with 20% of the award vested on the grantdate, and 20% of the award vesting on each subsequent anniversary of the grantdate. A total of 1,632,414 shares of the Company’s common stock have beenreserved for issuance under the 2002 Plan.

F-20

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**8.****              CapitalStock (Continued)**

The following table summarizes the options to purchaseshares of the Company’s common stock under the Eschelon Telecom, Inc.Stock Option Plan of 2002:
|                                    | ** ** | **Shares   Available for  Grant** | ** ** | **Plan   Options  Outstanding** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|--------------------------------------|------------|--------------------------------------------|------------|
| Balance at  December 31, 2002 |       | 1,041,966                                   |       | —                               |       | $                                          | 0.68       |   |
| Options granted                    |       | (786,294                                    | )          | 786,294                              |       | 0.68                                       |       |
| Restricted stock granted           |       | (183,399                                    | )          | —                               |       | 0.68                                       |       |
| Canceled                           |       | 65,120                                      |       | (65,120                              | )          | 0.68                                       |       |
| Exercised                          |       | —                                      |       | (28,290                              | )          | 0.68                                       |       |
| Balance at  December 31, 2003 |       | 137,393                                     |       | 692,884                              |       | 0.68                                       |       |
| Options granted                    |       | (101,984                                    | )          | 101,984                              |       | 1.35                                       |       |
| Canceled                           |       | 35,921                                      |       | (35,921                              | )          | 0.83                                       |       |
| Exercised                          |       | —                                      |       | (11,843                              | )          | 0.69                                       |       |
| Balance at  December 31, 2004 |       | 71,330                                      |       | 747,104                              |       | 0.77                                       |       |
| Additional shares reserved         |       | 590,448                                     |       | —                               |       | —                                     |       |
| Options granted                    |       | (533,536                                    | )          | 533,536                              |       | 8.24                                       |       |
| Restricted stock forfeited         |       | 494                                         |       | —                               |       | 0.68                                       |       |
| Restricted stock granted           |       | (9,350                                      | )          | —                               |       | 2.92                                       |       |
| Canceled                           |       | 34,693                                      |       | (34,693                              | )          | 3.18                                       |       |
| Exercised                          |       | —                                      |       | (78,457                              | )          | 0.76                                       |       |
| Balance at  December 31, 2005 |       | 154,079                                     |       | 1,167,490                            |       | $                                          | 4.12       |   |

 

The following table contains details of the stockoptions outstanding as of December 31, 2005:
|                                             | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                             | ** ** |
|---------------------------------------------|------------|------------------------------|------------|----------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number  Outstanding**      | ** ** | **Weighted-  Average  Remaining  Contractual Life** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $0.00 - $10.84                              |       | 962,162                      |       | 7.85 years                                               |       | $ | 2.38 |   | 521,144 |   | $ | 1.66 |   |
| $10.85 - $21.68                             |       | 205,328                      |       | 9.56 years                                               |       | $ | 12.24 |   | 41,261 |   | $ | 12.23 |   |
|                                        |       | 1,167,490                    |       | 8.15 years                                               |       | $ | 4.12 |   | 562,405 |   | $ | 2.43 |   |

 

**Restricted CommonStock**

In 2003, the Company granted 183,399 shares ofrestricted common stock to certain directors and members of management. TheCompany records compensation expense as the restrictions are removed from thestock. In 2005, the Company granted 9,350 shares of restricted common stock tocertain directors. Total compensation expense related to restricted commonstock for the years ended December 31, 2003, 2004 and 2005 was $70, $20and $39, respectively.

F-21

----

**Eschelon Telecom,Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**9.****              IncomeTaxes**

As of December 31, 2005, the Company had $176,780of net operating loss (NOL) carryforwards. The NOL carryforwards begin toexpire in the year 2019. Should the Company incur a change in ownership in thefuture, Section 382 of the United States Internal Revenue Code may limitthe amount of cumulative NOLs available to offset future income.

Components of the deferred tax asset atDecember 31, 2004 and 2005 are as follows:
|                                 | ** ** | **2004** | ** ** | **2005**    | ** ** |
|---------------------------------|------------|----------|------------|-------------|------------|
| Deferred tax  assets:           |       |     |       |        |       |
| Net operating loss carryforward |       | $        | 53,033     | ** **  | **$**      | **69,179** | ** ** |
| Bad debts                       |       | 157      | ** ** | **186**     | ** ** |
| Compensation accruals           |       | —   | ** ** | **174**     | ** ** |
| Inventory obsolescence          |       | 91       | ** ** | **104**     | ** ** |
| Other temporary differences     |       | 121      | ** ** | **437**     | ** ** |
|                            |       | 53,402   | ** ** | **70,080**  | ** ** |
| Deferred tax  liabilities:      |       |     |       |        |       |
| Depreciation                    |       | (7,252   | )          | **(12,259** | **)**      |
| Other                           |       | (11      | )          | **(21**     | **)**      |
|                            |       | 46,139   | ** ** | **57,800**  | ** ** |
| Valuation  allowance            |       | (46,139  | )          | **(57,800** | **)**      |
| Net deferred tax asset          |       | $        | —     | ** **  | **$**      | **—** | ** ** |

 

Income tax expensefor the year ended December 31, 2005, is comprised of federal taxes. Thereconciliation between the statutory federal income tax rate and the effectiverate is as follows:
|                                     | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Federal statutory  tax rate         |       | 35.00                                      | %          | 34.00 | % | **34.00** | **%** |
| State taxes                         |       | 5.16                                       |       | 0.25 | ** ** | **—** | ** ** |
| Permanent  differences              |       | —                                     |       | 2.74 | ** ** | **(0.01** | **)** |
| Utilization of  valuation allowance |       | (40.00                                     | )          | (36.61 | ) | **(34.00** | **)** |
| Effective tax rate                  |       | 0.16                                       | %          | 0.38 | % | **(0.01** | **)%** |

 

**10.****       CondensedConsolidating Financial Information**

The 83¤8% seniorsecond secured notes due 2010 issued by Eschelon Operating Company are fullyand unconditionally guaranteed jointly and severally by the Company and allexisting subsidiaries and the indenture governing the notes requires that anyfuture subsidiaries that are organized in the United States must also guaranteethe notes on the same basis.

Additional information regarding the 83¤8%senior second secured notes due 2010 is included in Note 4, Notes Payable.

F-22

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**10.****       CondensedConsolidating Financial Information (Continued)**

The following tables present condensed consolidatingbalance sheets for the years ended December 31, 2004 and 2005 andcondensed consolidating statements of operations for the years endedDecember 31, 2003, 2004 and 2005.

**CondensedConsolidating Balance SheetsAs of December 31, 2004**
|                                                            | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Assets**                                                 | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current assets:                                            |       |                   |       |          |       |             |       |             |       |             |       |
| Cash and cash equivalents                                  |       | $                      | 26,332     |          | $          | —           |       | $                | 103        |             | $          | — |   | $ | 26,435 |   |
| Restricted cash                                            |       | 722                    |       | —        |       | —           |       | —           |       | 722              |       |
| Available-for-sale securities                              |       | 6,194                  |       | —        |       | —           |       | —           |       | 6,194            |       |
| Accounts receivable                                        |       | —                 |       | —        |       | 18,941           |       | —           |       | 18,941           |       |
| Other receivables                                          |       | —                 |       | —        |       | 2,976            |       | —           |       | 2,976            |       |
| Inventories                                                |       | —                 |       | —        |       | 2,873            |       | —           |       | 2,873            |       |
| Prepaid expenses                                           |       | 1,227                  |       | —        |       | 1,183            |       | —           |       | 2,410            |       |
| Total current  assets                                      |       | 34,475                 |       | —        |       | 26,076           |       | —           |       | 60,551           |       |
| Property and  equipment, net                               |       | 82,550                 |       | —        |       | 20,299           |       | —           |       | 102,849          |       |
| Investment in  affiliates                                  |       | 58,998                 |       | —        |       | —           |       | (58,998          | )          | —           |       |
| Other assets                                               |       | 1,042                  |       | —        |       | 943              |       | —           |       | 1,985            |       |
| Goodwill                                                   |       | —                 |       | —        |       | 38,776           |       | —           |       | 38,776           |       |
| Intangible  assets, net                                    |       | 12,548                 |       | 7,890         |       | 12,520           |       | —           |       | 32,958           |       |
| Total assets                                               |       | $                      | 189,613    |          | $          | 7,890            |       | $                | 98,614     |             | $          | (58,998 | ) | $ | 237,119 |   |
| **Liabilities  and stockholders’ equity (deficit)**   |       |                   |       |          |       |             |       |             |       |             |       |
| Current  liabilities:                                      |       |                   |       |          |       |             |       |             |       |             |       |
| Accounts payable                                           |       | $                      | 4,314      |          | $          | —           |       | $                | 9,487      |             | $          | — |   | $ | 13,801 |   |
| Accrued telecommunication costs                            |       | —                 |       | —        |       | 2,190            |       | —           |       | 2,190            |       |
| Accrued office rent                                        |       | 1,722                  |       | —        |       | 614              |       | —           |       | 2,336            |       |
| Accrued interest expense                                   |       | —                 |       | 4,069         |       | 1                |       | —           |       | 4,070            |       |
| Other accrued expenses                                     |       | 489                    |       | —        |       | 5,509            |       | —           |       | 5,998            |       |
| Deferred revenue                                           |       | —                 |       | —        |       | 7,300            |       | —           |       | 7,300            |       |
| Accrued compensation expenses                              |       | 2,172                  |       | —        |       | 1,416            |       | —           |       | 3,588            |       |
| Capital lease obligation, current maturities               |       | 1,526                  |       | —        |       | 103              |       | —           |       | 1,629            |       |
| Total current  liabilities                                 |       | 10,223                 |       | 4,069         |       | 26,620           |       | —           |       | 40,912           |       |
| Long-term  liabilities:                                    |       |                   |       |          |       |             |       |             |       |             |       |
| Other long-term  liabilities                               |       | 76                     |       | —        |       | 554              |       | —           |       | 630              |       |
| Capital lease  obligation, less current maturities         |       | 2,607                  |       | —        |       | 217              |       | —           |       | 2,824            |       |
| Notes payable                                              |       | —                 |       | 137,778       |       | —           |       | —           |       | 137,778          |       |
| Due to (from)  affiliates                                  |       | 227,721                |       | (174,370      | )          | (53,351          | )          | —           |       | —           |       |
| Total  liabilities                                         |       | 240,627                |       | (32,523       | )          | (25,960          | )          | —           |       | 182,144          |       |
| Convertible  preferred stock                               |       | 63,155                 |       | —        |       | —           |       | —           |       | 63,155           |       |
| Stockholders’  equity (deficit)                       |       | (114,169               | )          | 40,413        |       | 124,574          |       | (58,998          | )          | (8,180           | )          |
| Total liabilities and  stockholders’ equity (deficit) |       | $                      | 189,613    |          | $          | 7,890            |       | $                | 98,614     |             | $          | (58,998 | ) | $ | 237,119 |   |

 

F-23

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**10.****       CondensedConsolidating Financial Information (Continued)**

**CondensedConsolidating Balance SheetsAs of December 31, 2005**
|                                                            | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Assets**                                                 | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current assets:                                            |       |                   |       |          |       |             |       |             |       |             |       |
| Cash and cash equivalents                                  |       | $                      | 25,070     |          | $          | —           |       | $                | 992        |             | $          | — |   | $ | 26,062 |   |
| Restricted cash                                            |       | 996                    |       | —        |       | —           |       | —           |       | 996              |       |
| Available-for-sale securities                              |       | 4,760                  |       | —        |       | —           |       | —           |       | 4,760            |       |
| Accounts receivable                                        |       | —                 |       | —        |       | 22,996           |       | —           |       | 22,996           |       |
| Other receivables                                          |       | —                 |       | —        |       | 3,052            |       | —           |       | 3,052            |       |
| Inventories                                                |       | —                 |       | —        |       | 2,927            |       | —           |       | 2,927            |       |
| Prepaid expenses                                           |       | 1,149                  |       | —        |       | 1,145            |       | —           |       | 2,294            |       |
| Total current  assets                                      |       | 31,975                 |       | —        |       | 31,112           |       | —           |       | 63,087           |       |
| Property and  equipment, net                               |       | 82,840                 |       | —        |       | 43,612           |       | —           |       | 126,452          |       |
| Investment in  affiliates                                  |       | 59,046                 |       | —        |       | —           |       | (59,046          | )          | —           |       |
| Other assets                                               |       | 507                    |       | —        |       | 999              |       | —           |       | 1,506            |       |
| Goodwill                                                   |       | —                 |       | —        |       | 7,168            |       | —           |       | 7,168            |       |
| Intangible  assets, net                                    |       | 13,695                 |       | 4,588         |       | 15,050           |       | —           |       | 33,333           |       |
| Total assets                                               |       | $                      | 188,063    |          | $          | 4,588            |       | $                | 97,941     |             | $          | (59,046 | ) | $ | 231,546 |   |
| **Liabilities  and stockholders’ equity (deficit)**   | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current  liabilities:                                      |       |                   |       |          |       |             |       |             |       |             |       |
| Accounts payable                                           |       | $                      | 14,602     |          | $          | —           |       | $                | 1,798      |             | $          | — |   | $ | 16,400 |   |
| Accrued telecommunication costs                            |       | —                 |       | —        |       | 4,227            |       | —           |       | 4,227            |       |
| Accrued office rent                                        |       | 1,485                  |       | —        |       | 550              |       | —           |       | 2,035            |       |
| Accrued interest expense                                   |       | —                 |       | 2,645         |       | 1                |       | —           |       | 2,646            |       |
| Other accrued expenses                                     |       | 944                    |       | —        |       | 4,541            |       | —           |       | 5,485            |       |
| Deferred revenue                                           |       | —                 |       | —        |       | 7,921            |       | —           |       | 7,921            |       |
| Accrued compensation expenses                              |       | 1,623                  |       | —        |       | 1,186            |       | —           |       | 2,809            |       |
| Capital lease obligation, current maturities               |       | 2,320                  |       | —        |       | 110              |       | —           |       | 2,430            |       |
| Total current  liabilities                                 |       | 20,974                 |       | 2,645         |       | 20,334           |       | —           |       | 43,953           |       |
| Long-term  liabilities:                                    |       |                   |       |          |       |             |       |             |       |             |       |
| Other long-term  liabilities                               |       | 251                    |       | —        |       | —           |       | —           |       | 251              |       |
| Capital lease  obligation, less current maturities         |       | 2,857                  |       | —        |       | 107              |       | —           |       | 2,964            |       |
| Notes payable                                              |       | —                 |       | 92,125        |       | —           |       | —           |       | 92,125           |       |
| Due to (from)  affiliates                                  |       | 211,456                |       | (103,502      | )          | (107,954         | )          | —           |       | —           |       |
| Total  liabilities                                         |       | 235,538                |       | (8,732        | )          | (87,513          | )          | —           |       | 139,293          |       |
| Convertible  preferred stock                               |       | —                 |       | —        |       | —           |       | —           |       | —           |       |
| Stockholders’  equity (deficit)                       |       | (47,475                | )          | 13,320        |       | 185,454          |       | (59,046          | )          | 92,253           |       |
| Total liabilities and  stockholders’ equity (deficit) |       | $                      | 188,063    |          | $          | 4,588            |       | $                | 97,941     |             | $          | (59,046 | ) | $ | 231,546 |   |

 

F-24

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**10.****       CondensedConsolidating Financial Information (Continued)**

**CondensedConsolidating Statement of OperationsFor the Year Ended December 31, 2003**
|                                                                      | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                             |       |                   |       |          |       |             |       |             |       |
| Network services                                                     |       | $                      | —     |          | $          | —           |       | $                | 115,482    |   | $ | 115,482 |   |
| Business telephone systems                                           |       | —                 |       | —        |       | 25,614           |       | 25,614           |       |
|                                                                 |       | —                 |       | —        |       | 141,096          |       | 141,096          |       |
| Costs and expenses:                                                  |       |                   |       |          |       |             |       |             |       |
| Network services  expenses (excluding depreciation and amortization) |       | —                 |       | —        |       | 45,037           |       | 45,037           |       |
| Business telephone systems cost of revenue                           |       | —                 |       | —        |       | 15,784           |       | 15,784           |       |
| Sales, general and administrative                                    |       | 35,274                 |       | —        |       | 30,978           |       | 66,252           |       |
| Depreciation and amortization                                        |       | 16,785                 |       | —        |       | 13,314           |       | 30,099           |       |
| Operating income  (loss)                                             |       | (52,059                | )          | —        |       | 35,983           |       | (16,076          | )          |
| Other income  (expense)                                              |       | (669                   | )          | (440          | )          | 7                |       | (1,102           | )          |
| Income (loss)  before income taxes                                   |       | (52,728                | )          | (440          | )          | 35,990           |       | (17,178          | )          |
| Income taxes                                                         |       | (28                    | )          | —        |       | —           |       | (28              | )          |
| Net income (loss)                                                    |       | $                      | (52,756    | )             | $          | (440             | )          | $                | 35,990     |   | $ | (17,206 | ) |

 

F-25

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**10.****       CondensedConsolidating Financial Information (Continued)**

**CondensedConsolidating Statement of OperationsFor the Year Ended December 31, 2004**
|                                                                      | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                             |       |                   |       |          |       |             |       |             |       |
| Network services                                                     |       | $                      | —     |          | $          | —           |       | $                | 131,780    |   | $ | 131,780 |   |
| Business telephone systems                                           |       | —                 |       | —        |       | 26,316           |       | 26,316           |       |
|                                                                 |       | —                 |       | —        |       | 158,096          |       | 158,096          |       |
| Costs and expenses:                                                  |       |                   |       |          |       |             |       |             |       |
| Network services expenses  (excluding depreciation and amortization) |       | —                 |       | —        |       | 47,354           |       | 47,354           |       |
| Business telephone systems cost of revenue                           |       | —                 |       | —        |       | 15,979           |       | 15,979           |       |
| Sales, general and administrative                                    |       | 37,400                 |       | —        |       | 31,855           |       | 69,255           |       |
| Depreciation and amortization                                        |       | 20,734                 |       | —        |       | 10,371           |       | 31,105           |       |
| Operating income  (loss)                                             |       | (58,134                | )          | —        |       | 52,537           |       | (5,597           | )          |
| Other income  (expense)                                              |       | (1,079                 | )          | 7,811         |       | (20              | )          | 6,712            |       |
| Income (loss)  before income taxes                                   |       | (59,213                | )          | 7,811         |       | 52,517           |       | 1,115            |       |
| Income taxes                                                         |       | (4                     | )          | —        |       | —           |       | (4               | )          |
| Net income (loss)                                                    |       | $                      | (59,217    | )             | $          | 7,811            |       | $                | 52,517     |   | $ | 1,111 |   |

 

F-26

----

**EschelonTelecom, Inc.**

**Notes toConsolidated Financial Statements (Continued)**

**(Dollarsin Thousands, Except per Share Amounts)**

**10.****       CondensedConsolidating Financial Information (Continued)**

**CondensedConsolidating Statement of OperationsFor the Year Ended December 31, 2005**
|                                                                      | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                             |       |                   |       |          |       |             |       |             |       |
| Network services                                                     |       | $                      | —     |          | $          | —           |       | $                | 201,835    |   | $ | 201,835 |   |
| Business telephone systems                                           |       | —                 |       | —        |       | 25,908           |       | 25,908           |       |
|                                                                 |       | —                 |       | —        |       | 227,743          |       | 227,743          |       |
| Costs and expenses:                                                  |       |                   |       |          |       |             |       |             |       |
| Network services  expenses (excluding depreciation and amortization) |       | —                 |       | —        |       | 85,914           |       | 85,914           |       |
| Business telephone systems cost  of revenue                          |       | —                 |       | —        |       | 16,139           |       | 16,139           |       |
| Sales, general and administrative                                    |       | 42,551                 |       | —        |       | 47,759           |       | 90,310           |       |
| Depreciation and amortization                                        |       | 22,160                 |       | —        |       | 17,493           |       | 39,653           |       |
| Operating income  (loss)                                             |       | (64,711                | )          | —        |       | 60,438           |       | (4,273           | )          |
| Other income  (expense)                                              |       | (342                   | )          | (27,093       | )          | 66               |       | (27,369          | )          |
| Income (loss)  before income taxes                                   |       | (65,053                | )          | (27,093       | )          | 60,504           |       | (31,642          | )          |
| Income taxes                                                         |       | (4                     | )          | —        |       | —           |       | (4               | )          |
| Net income  (loss) before discontinued operation                     |       | (65,057                | )          | (27,093       | )          | 60,504           |       | (31,646          | )          |
| Income from  discontinued operation, net of tax                      |       | —                 |       | —        |       | 329              |       | 329              |       |
| Gain on sale of discontinued operation, net of  tax                  |       | 326                    |       |          |       | —           |       | 326              |       |
| Net income (loss)                                                    |       | $                      | (64,731    | )             | $          | (27,093          | )          | $                | 60,833     |   | $ | (30,991 | ) |

 

F-27

----

 

**Condensed Consolidating Statementof Cash Flows **

**For the Twelve Months Ended December31, 2003 **

**(InThousands) **
| ** **                                                                                           | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Operating  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net income  (loss)                                                                                   |       | $                      | (52,756    | )             | $          | (440             | )          | $                | 35,990     |   | $ | (17,206 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                   |       |          |       |             |       |             |       |
| Depreciation and amortization expense                                                                |       | 16,785                 |       | —        |       | 13,314           |       | 30,099           |       |
| Noncash interest expense                                                                             |       | 840                    |       | 462           |       | —           |       | 1,302            |       |
| Value of stock issued to management and directors                                                    |       | 70                     |       | —        |       | —           |       | 70               |       |
| Other noncash items                                                                                  |       | (484                   | )          | —        |       | 500              |       | 16               |       |
| Changes in operating assets and liabilities:                                                         |       |                   |       |          |       |             |       |             |       |
| Accounts receivable                                                                                  |       | —                 |       | —        |       | (1,520           | )          | (1,520           | )          |
| Accounts payable and accrued expenses                                                                |       | 1,657                  |       | —        |       | 1,793            |       | 3,450            |       |
| Other operating assets and liabilities                                                               |       | 748                    |       | —        |       | (271             | )          | 477              |       |
| Total cash  provided by (used in) operating activities                                               |       | (33,140                | )          | 22            |       | 49,806           |       | 16,688           |       |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Investing  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Purchases of  property and equipment                                                                 |       | (8,051                 | )          | —        |       | (5,316           | )          | (13,367          | )          |
| Cash paid for  customer installation costs                                                           |       | (6,016                 | )          | —        |       | (5,653           | )          | (11,669          | )          |
| Proceeds from  sale of assets                                                                        |       | 28                     |       | —        |       | —           |       | 28               |       |
| Total cash used  in investing activities                                                             |       | (14,039                | )          | —        |       | (10,969          | )          | (25,008          | )          |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Financing  activities**                                                                            |       |                   |       |          |       |             |       |             |       |
| Payments made on  notes and capital lease obligations                                                |       | (2,697                 | )          | —        |       | —           |       | (2,697           | )          |
| Fees associated  with issuance of preferred stock                                                    |       | (70                    | )          | —        |       | —           |       | (70              | )          |
| Proceeds from  issuance of common stock, net of fees                                                 |       | 19                     |       | —        |       | —           |       | 19               |       |
| Increase in debt  issuance costs                                                                     |       | (59                    | )          | —        |       | —           |       | (59              | )          |
| Change in due  to/from affiliates                                                                    |       | 39,003                 |       | (22           | )          | (38,981          | )          | —           |       |
| Total cash  provided by (used in) financing activities                                               |       | 36,196                 |       | (22           | )          | (38,981          | )          | (2,807           | )          |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| Increase  (decrease) in cash and cash equivalents                                                    |       | (10,983                | )          | —        |       | (144             | )          | (11,127          | )          |
| Cash and cash  equivalents at beginning of period                                                    |       | 19,869                 |       | —        |       | (136             | )          | 19,733           |       |
| Cash and cash  equivalents at end of period                                                     |       | $                      | 8,886      |          | $          | —           |       | $                | (280       | ) | $ | 8,606 |   |

 

F-28

----

**Condensed Consolidating Statementof Cash Flows **

**For the Twelve Months Ended December31, 2004 **

**(InThousands) **
| ** **                                                                                           | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Operating  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net income  (loss)                                                                                   |       | $                      | (59,217    | )             | $          | 7,811            |       | $                | 52,517     |   | $ | 1,111 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                   |       |          |       |             |       |             |       |
| Depreciation and amortization expense                                                                |       | 20,734                 |       | —        |       | 10,371           |       | 31,105           |       |
| Noncash interest expense                                                                             |       | —                 |       | 2,339         |       | —           |       | 2,339            |       |
| Value of stock issued to management and directors                                                    |       | 34                     |       | —        |       | —           |       | 34               |       |
| Gain on extinguishment of debt                                                                       |       | —                 |       | (18,195       | )          | —           |       | (18,195          | )          |
| Other noncash items                                                                                  |       | 155                    |       | —        |       | 721              |       | 876              |       |
| Changes in operating assets and liabilities:                                                         |       |                   |       |          |       |             |       |             |       |
| Accounts receivable                                                                                  |       | —                 |       | —        |       | 658              |       | 658              |       |
| Accounts payable and accrued expenses                                                                |       | 3,002                  |       | 4,070         |       | 1,912            |       | 8,984            |       |
| Other operating assets and liabilities                                                               |       | (1,691                 | )          | —        |       | 172              |       | (1,519           | )          |
| Total cash  provided by (used in) operating activities                                               |       | (36,983                | )          | (3,975        | )          | 66,351           |       | 25,393           |       |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Investing  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Purchase of  subsidiaries, net of cash acquired                                                      |       | (45,816                | )          | —        |       | 321              |       | (45,495          | )          |
| Purchase of  available-for-sale securities                                                           |       | (8,198                 | )          | —        |       | —           |       | (8,198           | )          |
| Proceeds from  sales of available-for-sale securities                                                |       | 2,041                  |       | —        |       | —           |       | 2,041            |       |
| Purchases of  property and equipment                                                                 |       | (13,101                | )          | —        |       | (2,313           | )          | (15,414          | )          |
| Cash paid for  customer installation costs                                                           |       | (7,553                 | )          | —        |       | (3,740           | )          | (11,293          | )          |
| Proceeds from  sale of assets                                                                        |       | 25                     |       | —        |       | —           |       | 25               |       |
| Total cash used  in investing activities                                                             |       | (72,602                | )          | —        |       | (5,732           | )          | (78,334          | )          |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| Financing  activities                                                                                |       |                   |       |          |       |             |       |             |       |
| Proceeds from  issuance of notes payable                                                             |       | —                 |       | 136,163       |       | —           |       | 136,163          |       |
| Payments made on  notes and capital lease obligations                                                |       | (1,527                 | )          | (65,421       | )          | —           |       | (66,948          | )          |
| Proceeds from  issuance of preferred stock                                                           |       | 15,000                 |       | —        |       | —           |       | 15,000           |       |
| Payment of  repurchase of preferred stock                                                            |       | (5,085                 | )          | —        |       | —           |       | (5,085           | )          |
| Proceeds from  issuance of common stock                                                              |       | 8                      |       | —        |       | —           |       | 8                |       |
| Increase in debt  issuance costs                                                                     |       | —                 |       | (8,368        | )          | —           |       | (8,368           | )          |
| Change in due  to/from affiliates                                                                    |       | 118,635                |       | (58,399       | )          | (60,236          | )          | —           |       |
| Total cash  provided by (used in) financing activities                                               |       | 127,031                |       | 3,975         |       | (60,236          | )          | 70,770           |       |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| Increase  (decrease) in cash and cash equivalents                                                    |       | 17,446                 |       | —        |       | 383              |       | 17,829           |       |
| Cash and cash  equivalents at beginning of period                                                    |       | 8,886                  |       | —        |       | (280             | )          | 8,606            |       |
| Cash and cash  equivalents at end of period                                                     |       | $                      | 26,332     |          | $          | —           |       | $                | 103        |   | $ | 26,435 |   |

 

F-29

----

**Condensed Consolidating Statementof Cash Flows **

**For the Twelve Months EndedDecember 31, 2005 **

**(InThousands) **
| ** **                                                                                           | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Operating  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net income  (loss)                                                                                   |       | $                      | (64,731    | )             | $          | (27,093          | )          | $                | 60,833     |   | $ | (30,991 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                   |       |          |       |             |       |             |       |
| Depreciation and amortization expense                                                                |       | 22,160                 |       | —        |       | 17,493           |       | 39,653           |       |
| Noncash interest expense                                                                             |       | 116                    |       | 7,172         |       | —           |       | 7,288            |       |
| Value of stock issued to management and directors                                                    |       | 963                    |       | —        |       | —           |       | 963              |       |
| Gain on sale of discontinued operation                                                               |       | (326                   | )          | —        |       | —           |       | (326             | )          |
| Other noncash items                                                                                  |       | (66                    | )          | —        |       | 1,090            |       | 1,024            |       |
| Changes in operating assets and liabilities:                                                         |       |                   |       |          |       |             |       |             |       |
| Accounts receivable                                                                                  |       | —                 |       | —        |       | (5,145           | )          | (5,145           | )          |
| Accounts payable and accrued expenses                                                                |       | 10,392                 |       | (1,423        | )          | (6,836           | )          | 2,133            |       |
| Discontinued assets held for sale, net of  liabilities                                               |       | 222                    |       | —        |       | —           |       | 222              |       |
| Other operating assets and liabilities                                                               |       | (310                   | )          | —        |       | 243              |       | (67              | )          |
| Total cash  provided by (used in) operating activities                                               |       | (31,580                | )          | (21,344       | )          | 67,678           |       | 14,754           |       |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Investing  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Purchase of  subsidiaries, net of cash acquired                                                      |       | (48                    | )          | —        |       | —           |       | (48              | )          |
| Purchase of  assets held for sale, net of liabilities                                                |       | (216                   | )          | —        |       | —           |       | (216             | )          |
| Purchase of  available-for-sale securities                                                           |       | (30,526                | )          | —        |       | —           |       | (30,526          | )          |
| Proceeds from  sales of available-for-sale securities                                                |       | 32,312                 |       | —        |       | —           |       | 32,312           |       |
| Purchases of  property and equipment                                                                 |       | (13,580                | )          | —        |       | (5,647           | )          | (19,227          | )          |
| Cash paid for  customer installation costs                                                           |       | (7,116                 | )          | —        |       | (6,435           | )          | (13,551          | )          |
| Proceeds from  sale of assets                                                                        |       | 239                    |       | —        |       | —           |       | 239              |       |
| Proceeds from  sale of assets                                                                        |       | 320                    |       | —        |       | —           |       | 320              |       |
| Total cash used  in investing activities                                                             |       | (18,615                | )          | —        |       | (12,082          | )          | (30,697          | )          |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| Financing  activities                                                                                |       |                   |       |          |       |             |       |             |       |
| Payments made on  notes and capital lease obligations                                                |       | (2,083                 | )          | (49,176       | )          | (103             | )          | (51,362          | )          |
| Proceeds from  issuance of preferred stock                                                           |       | 154                    |       | —        |       | —           |       | 154              |       |
| Proceeds from  issuance of common stock, net of fees                                                 |       | 67,126                 |       | —        |       | —           |       | 67,126           |       |
| Increase in debt  issuance costs                                                                     |       | —                 |       | (348          | )          | —           |       | (348             | )          |
| Change in due  to/from affiliates                                                                    |       | (16,264                | )          | 70,868        |       | (54,604          | )          | —           |       |
| Total cash  provided by (used in) financing activities                                               |       | 48,933                 |       | 21,344        |       | (54,707          | )          | 15,570           |       |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| Increase  (decrease) in cash and cash equivalents                                                    |       | (1,262                 | )          | —        |       | 889              |       | (373             | )          |
| Cash and cash  equivalents at beginning of period                                                    |       | 26,332                 |       | —        |       | 103              |       | 26,435           |       |
| Cash and cash  equivalents at end of period                                                     |       | $                      | 25,070     |          | $          | —           |       | $                | 992        |   | $ | 26,062 |   |

 

**11.****       ReverseStock Split**

The Company completed a 0.0738-for-one reversestock split affecting all outstanding shares of common stock on August 2,2005. All share and per share data have been adjusted to reflect the stocksplit.

**12.****       SubsequentEvents**

In January 2006, the Company signed a definitiveagreement to acquire Oregon Telecom, Inc., a privately-held competitiveservices provider based in Salem, Oregon. The Company will pay $20,000 in cashto acquire Oregon Telecom. The transaction is expected to close early in thesecond quarter of 2006.

F-30

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