**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10-Q**
 
 [X]
        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 SECURITIES
        EXCHANGE ACT OF 1934
 
 **For
        the Quarterly Period Ended June 30, 2006**
 
 OR
 
 [
        ]
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 SECURITIES
        EXCHANGE ACT OF 1934
 
 Commission
        File Number: 000-27743
 
 
  **PAC-WEST
        TELECOMM, INC.**
 (Exact
        name of registrant as specified in its charter)
 
 **California**
              **68-0383568**(State
                  or other jurisdiction of
              (I.R.S.
                  Employer Identification No.)incorporation
                  or organization)**1776
                  W. March Lane, Suite 250
                  Stockton, California**
              **95207**(Address
                  of principal executive
                  offices)
              (Zip
                  Code)
 **** ****  ****      **(209)
        926-3300**
 (Registrant's
        telephone number, including area code)
 
 Indicate
        by check mark whether the registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days. Yes [X] No [ ]
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
        one):
 
 Large
        accelerated filer [ ]    Accelerated
        filer [ ]   Non-accelerated
        filer [X]
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act). Yes [ ] No [X]
 
 As
        of
        July 31, 2006, the Company had an aggregate of 37,667,528 shares of common
        stock
        issued and outstanding.
  
 
 **PAC-WEST
          TELECOMM, INC.**
 **Report
          on Form 10-Q For the Quarterly Period Ended June 30, 2006**
 **Table
          of Contents**
  **Part
                      I.**
                  **FINANCIAL
                      INFORMATION**
                  **Page**Item
                      1.
                  Financial
                      Statements (Unaudited)Condensed
                      Consolidated Balance SheetsJune
                      30, 2006 and December 31, 2005
                  3Condensed
                      Consolidated Statements of Operations and Comprehensive
                      Income(Loss)
                      - Three and six months ended June 30, 2006 and 2005
                  4Condensed
                      Consolidated Statements of Cash Flows - Sixmonths
                      ended June 30, 2006 and 2005
                  5Notes
                      to Unaudited Condensed Consolidated Financial Statements
                  7Item
                      2.
                  Management's
                      Discussion and Analysis of Financial Conditionand
                      Results of Operations
                  21Item
                      3.
                  Quantitative
                      and Qualitative Disclosures About Market Risks
                  37Item
                      4.
                  Controls
                      and Procedures
                  37**Part
                      II.**
                  **OTHER
                      INFORMATION**Item
                      1.
                  Legal
                      Proceedings
                  38Item 1A.
                  Risk
                      Factors
                  38Item 4.
                  Submission
                      of Matters to a Vote of Security Holders
                  38Item
                      6.
                  Exhibits
                  40Signatures
                  
                  41
 
 2


**PART
                  I. FINANCIAL INFORMATION****ITEM
                  1. FINANCIAL STATEMENTS****PAC-WEST
                  TELECOMM, INC.****Condensed
                  Consolidated Balance Sheets****(Dollars
                  in thousands except share and per share
                  data)**


**June
                  30,**
              
              **December
                  31,****2006**
              
              **2005****(Unaudited)****ASSETS**Current
                  Assets:Cash
                  and cash equivalents
              
              
              
              
              $
              20,199
              
              $
              26,681Short-term
                  investments
              
              
              
              
              
              295
              
              
              -Trade
                  accounts receivable, net of allowances of$838 and $368 at June 30, 2006 andDecember 31, 2005, respectively
              
              
              
              
              
              16,076
              
              
              7,806Receivable
                  from transition service agreement
              
              
              
              
              
              142
              
              
              1,170Prepaid
                  expenses and other current assets
              
              
              
              
              
              3,296
              
              
              3,129Total
                  current assets
              
              
              
              
              
              40,008
              
              
              38,786Property
                  and equipment, net
              
              44,729
              
              
              39,458Other
                  assets, net
              
              858
              
              
              1,079Total assets
              
              
              
              
              $
              85,595
              
              $
              79,323**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  Liabilities:Accounts
                  payable
              
              
              
              
              $
              11,711
              
              $
              6,578Current
                  obligations under notes payable and capital leases
              
              
              
              
              
              15,760
              
              
              5,392Accrued
                  interest
              
              
              
              
              
              2,193
              
              
              2,032Other
                  accrued liabilities
              
              
              
              
              
              7,610
              
              
              8,492Total current liabilities
              
              
              
              
              
              37,274
              
              
              22,494Senior
                  Notes
              
              36,102
              
              
              36,102Notes
                  payable and capital leases, less current portion
              
              3,578
              
              
              7,418Other
                  liabilities, net
              
              124
              
              
              72Total liabilities
              
              
              
              
              
              77,078
              
              
              66,086Commitments
                  and Contingencies (Note 8)Stockholders'
                  Equity:Preferred
                  stock, no par value, 600,000 shares authorized; noneissued and outstanding
              
              
              
              
              
              -
              
              
              -Common
                  stock, $.001 par value; 100,000,000 sharesauthorized, 37,667,528 and 37,204,093 shares issuedand outstanding at June 30, 2006 and December 31,2005, respectively
              
              
              
              
              
              37
              
              
              37Additional
                  paid-in capital
              
              
              
              
              
              191,255
              
              
              191,319Accumulated
                  deficit
              
              
              
              
              
              (182,820
              )
              
              (177,721
              )Accumulated
                  other comprehensive gain (loss)
              
              
              
              
              
              45
              
              
              (25
              )Deferred
                  stock compensation
              
              
              
              
              
              -
              
              
              (373
              )Total stockholders' equity
              
              
              
              
              
              8,517
              
              
              13,237Total liabilities and stockholders' equity
              
              
              
              
              $
              85,595
              
              $
              79,323




See
      notes
      to unaudited condensed consolidated financial statements.


3
 **PAC-WEST
                  TELECOMM, INC.****Condensed
                  Consolidated Statements of Operations****and
                  Comprehensive Income (Loss)****(Unaudited,
                  in thousands except per share
                  data)**


**Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30,**
              
              **June
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Revenues
              
              $
              27,028
              
              $
              21,869
              
              $
              46,656
              
              $
              50,000Costs
                  and Expenses:Network expenses (exclusive of depreciation shown separately
                  below)
              
              
              10,805
              
              
              9,707
              
              
              19,805
              
              
              20,273Selling, general and administrative
              
              
              14,940
              
              
              12,448
              
              
              28,522
              
              
              27,121Reimbursed transition expenses
              
              
              (2,766
              )
              
              (2,848
              )
              
              (5,670
              )
              
              (2,848
              )Depreciation and amortization
              
              
              3,113
              
              
              3,234
              
              
              5,945
              
              
              6,984Restructuring charges
              
              
              250
              
              
              222
              
              
              265
              
              
              606Total operating expenses
              
              
              26,342
              
              
              22,763
              
              
              48,867
              
              
              52,136Income (loss) from operations
              
              
              686
              
              
              (894
              )
              
              (2,211
              )
              
              (2,136
              )Interest expense, net
              
              
              1,529
              
              
              1,301
              
              
              2,904
              
              
              4,107Other income, net
              
              
              (16
              )
              
              (62
              )
              
              (16
              )
              
              (62
              )Loss (gain) on sale of enterprise customer base
              
              
              -
              
              
              169
              
              
              -
              
              
              (23,865
              )Loss on extinguishment of debt
              
              
              -
              
              
              -
              
              
              -
              
              
              2,138(Loss) income before income taxes
              
              
              (827
              )
              
              (2,302
              )
              
              (5,099
              )
              
              15,546Income
                  tax expense
              
              
              -
              
              
              13
              
              
              -
              
              
              522Net (loss) income
              
              $
              (827
              )
              $
              (2,315
              )
              $
              (5,099
              )
              $
              15,024Basic
                  (loss) income per share
              
              $
              (0.02
              )
              $
              (0.06
              )
              $
              (0.14
              )
              $
              0.41Diluted
                  (loss) income per share
              
              $
              (0.02
              )
              $
              (0.06
              )
              $
              (0.14
              )
              $
              0.39Weighted
                  Average Shares Outstanding:Basic
              
              
              37,599
              
              
              36,896
              
              
              37,404
              
              
              36,870Diluted
              
              
              37,599
              
              
              36,896
              
              
              37,404
              
              
              38,867Comprehensive
                  (Loss) Income:Net (loss) income
              
              $
              (827
              )
              $
              (2,315
              )
              $
              (5,099
              )
              $
              15,024Net unrealized gains on investments, net of tax
              
              
              5
              
              
              42
              
              
              56
              
              
              20Reclassification of net realized losses on sale of investments,
                  net of
                  tax
              
              
              22
              
              
              -
              
              
              14
              
              
              -Comprehensive (loss) income
              
              $
              (800
              )
              $
              (2,273
              )
              $
              (5,029
              )
              $
              15,044
  See
        notes
        to unaudited condensed consolidated financial statements.


4
 **PAC-WEST
                  TELECOMM, INC.****Condensed
                  Consolidated Statements of Cash Flows****(Unaudited,
                  in thousands)**


**Six
                  Months Ended****June
                  30,****2006**
              
              **2005****Operating
                  activities:**Net
                  (loss) income
              
              $
              (5,099
              )
              $
              15,024Adjustments
                  to reconcile net (loss) income to net cashprovided by operating activities:Depreciation and amortization
              
              
              5,945
              
              
              6,984Amortization of deferred financing costs
              
              
              114
              
              
              205Amortization of discount on notes payable
              
              
              -
              
              
              1,262Stock-based compensation
              
              
              278
              
              
              96Loss on extinguishment of debt
              
              
              -
              
              
              2,138Gain on sale of enterprise customer base
              
              
              -
              
              
              (23,865
              )Provision for doubtful accounts
              
              
              552
              
              
              (18
              )Net loss (gain) on disposal of property
              
              
              17
              
              
              (29
              )Other
              
              
              (33
              )
              
              -Changes
                  in operating assets and liabilities:Increase in accounts receivable
              
              
              (8,822
              )
              
              (145
              )Decrease (increase) in receivable from transition service
                  agreement
              
              
              1,028
              
              
              (1,751
              )Decrease in prepaid expenses and other assets
              
              
              168
              
              
              2,657Increase in accounts payable
              
              
              2,008
              
              
              984Increase in accrued interest
              
              
              161
              
              
              203Decrease in other current liabilities and other
                  liabilities
              
              
              (830
              )
              
              (1,242
              )Net cash (used in) provided by operating activities
              
              
              (4,513
              )
              
              2,503**Investing
                  activities:**Purchase
                  of property and equipment
              
              
              (7,664
              )
              
              (3,175
              )Proceeds
                  from disposal of property and equipment
              
              
              -
              
              
              95(Purchases)
                  redemptions of short-term investments, net
              
              
              (225
              )
              
              287Proceeds
                  from sale of enterprise customer base
              
              
              -
              
              
              26,953Returned
                  deposits associated with the enterprise customer base sale
              
              
              -
              
              
              (3,536
              )Other
              
              
              33
              
              
              200Net cash (used in) provided by investing activities
              
              
              (7,856
              )
              
              20,824**Financing
                  activities:**Repayments
                  of notes payable
              
              
              (1,860
              )
              
              (42,050
              )Proceeds
                  from the issuance of common stock
              
              
              31
              
              
              213Principal
                  payments on capital leases
              
              
              (256
              )
              
              (407
              )Net
                  proceeds from borrowing under notes payable
              
              
              7,972
              
              
              1,949Net cash provided by (used in) financing activities
              
              
              5,887
              
              
              (40,295
              )Net
                  decrease in cash and cash equivalents
              
              
              (6,482
              )
              
              (16,968
              )Cash
                  and cash equivalents:Beginning
                  of period
              
              
              26,681
              
              
              32,265End
                  of period
              
              $
              20,199
              
              $
              15,297


(continued)
 5
 **PAC-WEST
                  TELECOMM, INC.****Condensed
                  Consolidated Statements of Cash Flows****(Unaudited,
                  in thousands)**(continued)
 **Supplemental
                  Disclosure of Cash Flow Information:**Cash
                  paid during the period for:Interest
              
              $
              3,000
              
              $
              2,997Income
                  taxes
              
              $
              -
              
              $
              335Non-cash
                  Operating and Investing Activities:Acquisitions
                  of property and equipment included in accounts payable
              
              $
              3,125
              
              $
              -Non-cash
                  Operating and Financing Activities:Prepaid
                  maintenance agreement financed by notes payable
              
              $
              335
              
              $
              -Non-cash
                  Investing and Financing Activities:Equipment
                  acquired with capital lease obligations
              
              $
              297
              
              $
              -Equipment
                  acquired with notes payable obligations
              
              $
              39
              
              $
              -
   See
        notes
        to unaudited condensed consolidated financial statements.
 6


**AC-WEST
          TELECOMM, INC.**
 **AS
        OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006**
 
 The
        terms
        "the Company," "Pac-West," "we," "our," "us," and similar terms used in this
        Form 10-Q, refer to Pac-West Telecomm, Inc.
 
 **1.**
            **Organization
                and Basis of Presentation** 
 The
        Company is an independent provider of integrated communication solutions
        that
        enable communication providers to use the Pac-West network and its services
        as
        an alternative to building and maintaining their own network. The Company’s
        customers currently include Internet service providers (ISPs), enhanced
        communication service providers (ESPs) and other direct providers of
        communication services to business and residential end-users, collectively
        referred to as service providers (SPs). On March 11, 2005, the Company sold
        substantially all of its enterprise customer base to U.S. TelePacific Corp.
        (TelePacific) while retaining the Company’s associated network
        assets.
 
 These
        accompanying unaudited condensed consolidated financial statements have been
        prepared in accordance with accounting principles generally accepted for
        interim
        financial information in the United States of America pursuant to the rules
        and
        regulations of the Securities and Exchange Commission (SEC). Accordingly,
        they
        do not include all of the information and notes required by accounting
        principles generally accepted in the United States of America (US GAAP) for
        complete financial statements. In the opinion of management, all adjustments,
        consisting only of normal recurring adjustments, considered necessary for
        a fair
        presentation for the periods indicated, have been included. Operating results
        for the six months ended June 30, 2006 are not necessarily indicative of
        the
        results that may be expected for the year ending December 31, 2006. The
        condensed consolidated balance sheet at December 31, 2005 has been derived
        from
        the audited consolidated balance sheet at that date, but does not include
        all of
        the information and notes required by US GAAP for complete financial statements.
        These unaudited condensed consolidated financial statements should be read
        in
        conjunction with the audited consolidated financial statements and the notes
        thereto of the Company as of and for the year ended December 31, 2005, included
        in the Company's Annual Report on Form 10-K filed with the SEC on March 29,
        2006.
 
 Based
        on
        criteria established by Statement of Financial Accounting Standards (SFAS)
        No.
        131, “Disclosures about Segments of an Enterprise and Related Information,” the
        Company has determined that it has one reportable operating segment. While
        the
        Company monitors the revenue streams of its various services, the revenue
        streams share almost all of the various operating expenses. As a result the
        Company has determined that it has one reportable operating segment.
  These
        unaudited condensed consolidated financial statements include the results
        of
        operations of the Company and its subsidiaries. All intercompany accounts
        and
        transactions have been eliminated. Certain prior period amounts have been
        reclassified to conform to current period presentations.
 
 **Application
        of Critical Accounting Policies**
 
 *Critical
        Accounting Policies.* The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        estimates and assumptions that effect the reported amounts of assets and
        liabilities, disclosure of contingent assets and liabilities, and reported
        amounts of revenues and expenses for the reporting period. The Company considers
        the following accounting policies to be critical policies due to the estimation
        processes involved in each:
 
 7
 •  revenue
        recognition;
 
 •  provision
        for doubtful accounts receivable;
 
 •  estimated
        settlement of disputed billings;
  •  impairment
        for long-lived assets; and
 
 •  stock-based
        compensation.
 
 By
        their
        nature, these judgments are subject to an inherent degree of uncertainty.
        Thus,
        actual results could differ from estimates made and these differences could
        be
        material.
 
 *Revenue
        Recognition.* The
        Company recognizes revenue when:
 
 •  there
        is
        pervasive evidence of an arrangement;
 
 •  delivery
        of the product or performance of the service has occurred;
 
 •  the
        selling price is fixed and determined; and
 
 •  collectibility
        is reasonably assured.
 
 Non-refundable
        up-front payments received for installation services and installation related
        costs are recognized as revenue and expensed ratably over the term of the
        service contracts, generally 24 to 36 months.
 
 Revenues
        from service access agreements are recognized as the service is provided,
        except
        for intercarrier compensation fees paid by the Company’s intercarrier customers
        for completion of their customers’ calls through the Company’s network, and
        access charges paid by carriers for long distance traffic terminated on the
        Company’s network. The Company’s right to receive this type of compensation is
        the subject of numerous regulatory and legal challenges. The Company considers
        such issues in evaluating the four criteria above.
 
 Some
        incumbent local exchange carriers (ILECs) with which the Company has
        interconnection agreements have withheld payments from amounts billed by
        the
        Company under their agreements. The process of collection of such intercarrier
        compensation is subject to complex contracts, regulations and laws, and is
        routinely the subject of judicial and/or administrative processes. Often,
        disputes concerning intercarrier compensation are settled by the Company
        and the
        ILEC in a manner that results in the Company accepting a portion of what
        it
        believes is owed to it.
 
 8
 *Provision
        for doubtful accounts receivable.* Provisions for allowances for doubtful accounts receivable are estimated
        based
        upon:
 
 •  historical
        collection experience;
 
 •  customer
        delinquencies and bankruptcies;
 
 •  information
        provided by the Company’s customers;
 
 •  observance
        of trends in the industry; and
 
 •  other
        current economic conditions.
 
 *Estimated
        settlements for disputed billings.* During
        the ordinary course of business, the Company may be billed for carrier traffic
        for which management believes it is not responsible for. In such instances,
        the
        Company may dispute with the appropriate vendor and withhold payment until
        the
        matter is resolved. The Company’s current disputes are primarily related to
        incorrect facility rates or incorrect billing elements that the Company believes
        are being charged. Management regularly reviews and monitors all disputed
        items
        and, based on industry experience, records an accrual that represents what
        it
        estimates it may pay to settle the dispute. Although the Company continues
        to
        actively try to expedite resolutions, often times the state Public Utilities
        Commission must become involved to arbitrate such agreements. This process
        is
        often not timely and resolutions are often subject to appeal.
  *Long-lived assets.* In 2002,
        the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of
        Long-Lived Assets.” The Company evaluates its long-lived assets when events or
        changes in circumstances indicate that the carrying amount of such assets
        may
        not be fully recoverable. Recoverability of assets to be held and used is
        measured by a comparison of the carrying amount of an asset to the future
        undiscounted cash flows expected to be generated by the asset. When the Company
        considers an asset to be impaired, it is written down to its estimated fair
        market value. This is assessed based on factors specific to the type of asset.
        In assessing the recoverability of these assets, the Company makes assumptions
        regarding, among other things, estimated future cash flows to determine the
        fair
        value of the respective assets. If these estimates and the related assumptions
        change in the future, the Company may be required to record additional
        impairment charges for these assets.
  *Stock-based
        compensation.* On
        January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment,” and
        accounts for stock-based compensation in accordance with the fair value
        recognition provisions of SFAS No. 123R. The Company uses the Black-Scholes
        option-pricing model, which requires the input of subjective assumptions.
        These
        assumptions include estimating the length of time employees will retain their
        stock options (expected term), the estimated volatility of its common stock
        price over the expected term and the number of options that will cancel for
        failure to complete their vesting requirements (forfeitures). Changes in
        these
        assumptions could materially affect the estimate of fair value stock-based
        compensation and consequently, the related amount recognized on the consolidated
        statements of operations and comprehensive income (loss).
 
 **2.**
            **Need
                to Raise Additional Capital** 
 The
        Company’s principal sources of operating funds for the remainder of 2006 and the
        first half of 2007 are anticipated to be current cash and short-term investment
        balances and cash flows from operating activities. However, the Company believes
        that its requirements for operating funds over the next twelve months will
        cause
        its current cash and short-term investment balances to fall below those required
        by the terms of its financing arrangement with Comerica Bank (see Note 10).
        As a
        result, if the Company continues to fund its operations without obtaining
        an
        additional source of financing, Comerica Bank may exercise its rights under
        the
        Loan and Security Agreement, including the right to accelerate, or declare
        the
        entire loan amount due and payable. If Comerica accelerates the debt, the
        Company believes that other sources of its existing financing arrangements
        will
        have, and may exercise, similar rights and the Company will not have sufficient
        liquidity and capital resources for it to operate for the next 12 months.
 
 9
 In
        an
        effort to address its financing needs, the Company has retained the services
        of
        a financial advisory firm, and together with such firm is in the process
        of
        exploring strategic alternatives, including raising additional debt or equity
        financing, entry into strategic relationships or joint ventures and merger
        and
        acquisitions. While the Company has successfully raised capital in the past,
        there can be no assurance that sources of financing will continue to be
        available to the Company in amounts sufficient to meet its financial needs,
        or
        that any such financing will be available on terms acceptable to the
        Company.
 
 If
        the
        Company is unable to secure additional financing, (1) it may not be able
        to take
        advantage of business opportunities or respond to competitive pressures,
        or may
        be required to reduce the scope of its planned national expansion and other
        product development and marketing initiatives, any of which could have a
        negative impact on its business and operating results; (2) it could become
        necessary for the Company to significantly curtail its operations in order
        to
        meet its debt service obligations and (3) even if the Company did take such
        actions to permit it to service its debt, the Company might still violate
        certain covenants under the terms of its financing arrangements. Any action
        by
        the providers of the Company’s financing arrangements to declare the Company in
        default and accelerate its obligations under such financing arrangements
        would
        substantially and adversely impact the Company’s ability to continue to operate
        and to meet other obligations.
  **3.
        Stock-based Compensation**
 
 The
        Company has stock-based compensation plans that include employee options,
        restricted stock and an employee stock purchase plan. Effective January 1,
        2006,
        the Company adopted the provisions of SFAS No. 123R using the modified
        prospective transition method. SFAS No. 123R requires the Company to recognize
        the cost of employee services received in exchange for awards of equity
        instruments based on the grant-date fair value of those awards, with limited
        exceptions. Cost is recognized over the period during which an employee is
        required to provide services (usually the vesting period). The Company
        previously followed Accounting Principles Board Opinion (APB) No. 25,
        "Accounting for Stock Issued to Employees" for its stock-based compensation
        plans and adopted the disclosure-only provisions of SFAS No. 123, "Accounting
        for Stock-Based Compensation," to disclose pro forma information regarding
        stock-based compensation based on specified valuation techniques that produce
        estimated compensation charges.
 
 As a result of adopting SFAS No. 123R, the Company recorded approximately
          $105,000 and $202,000 in expense during the three and six months ended
          June 30,
          2006, respectively. There was no material impact on basic and diluted earnings
          per share or cash flow from either operations or financing activities due
          to the
          adoption of SFAS 123R.
 
 Total
        compensation expense recognized for stock-based awards for the three months
        ended June 30, 2006 and 2005 was $132,000 and $48,000, respectively. Total
        compensation expense recognized for stock-based awards for the six months
        ended
        June 30, 2006 and 2005 was $278,000 and $96,000, respectively. Total
        compensation expense recognized for stock-based awards is included in selling,
        general and administrative expenses in the condensed consolidated statements
        of
        operations and comprehensive income (loss). The Company recognized approximately
        $27,000 and $76,000 for the three and six months ended June 30, 2006,
        respectively, related to restricted stock awards. The Company recognized
        approximately $48,000 and $96,000 for the three and six months ended June
        30,
        2005, respectively, related to performance unit awards. Cash received for
        options exercised during the six months ended June 30, 2006 and 2005 was
        $31,000
        and $213,000, respectively.
 
 For
        the
        three and six months ended June 30, 2006 and the three months ended June
        30,
        2005, there was no impact on earnings per share from employee stock options
        since such options were anti-dilutive. Accordingly, for the three and six
        months
        ended June 30, 2006, 593,609 and 699,197 shares, respectively, were excluded
        from the diluted net loss per share calculation. In addition, 1,759,349 shares
        were excluded from the diluted net loss per share calculation for the three
        months ended June 30, 2005.
 
 10
 The
        effect of the change from applying the original provisions of SFAS 123 for
        the
        comparison periods are as follows:


**Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30, 2005**
              
              **June
                  30, 2005**(Dollars
                  in thousands except per share amounts)Net
                  (loss) income as reported
              
              $
              (2,315
              )
              $
              15,024Total
                  stock-based employee compensation included inreported net (loss) income, net of tax
              
              
              48
              
              
              93Total
                  stock-based employee compensation determinedunder the fair value based method
              
              
              (134
              )
              
              (278
              )Pro
                  forma
              
              $
              (2,401
              )
              $
              14,839Basic
                  net income (loss) per common share:As reported
              
              $
              (0.06
              )
              $
              0.41Pro forma
              
              $
              (0.07
              )
              $
              0.40Diluted
                  net income (loss) per common share:As reported
              
              $
              (0.06
              )
              $
              0.39Pro forma
              
              $
              (0.07
              )
              $
              0.38




**Stock
        Incentive Plans**
  In
        January 1999, the Company’s Board of Directors approved the terms of the 1999
        Stock Incentive Plan (the “Plan”) which authorizes the granting of stock
        options, including restricted stock, stock appreciation rights, dividend
        equivalent rights, performance units, performance shares or other similar
        rights
        or benefits to employees, directors, consultants and advisors. In addition,
        options have been granted pursuant to the Non-Qualified Stock Incentive Plans
        approved in 1998 and 2000. An aggregate of 7,601,750 shares of common stock
        are
        currently reserved for option grants under these plans (the Plans). Option
        awards are generally granted with an exercise price equal to the closing
        market
        price of the Company’s stock on the trading day prior to the date of grant;
        option awards generally vest ratably based on 4 years of continuous service
        and
        have 10-year contractual terms. Restricted stock awards vest over 3 to 4
        years.
        Certain options and stock awards provide for accelerated vesting if there
        is a
        change in control (as defined by the Plans). Stock options exercised are
        settled
        with new issuances of stock.
 
 As
        of
        June 30, 2006, there was $1.4 million of total unrecognized compensation
        cost
        related to the nonvested stock-based compensation arrangements granted under
        the
        Plans. That cost is expected to be recognized over a weighted-average period
        of
        2.8 years. The total fair value of shares vested during the three and six
        months
        ended June 30, 2006 was approximately $223,000 and $263,000, respectively.
        For
        the periods ended June 30, 2006, there was no stock-based compensation cost
        capitalized and no tax benefit recognized.
 11
 *Stock
        Options*
  The
        fair
        value of each stock option award granted under the Plans is estimated using
        the
        Black-Scholes option-pricing model. The application of this valuation model
        involves certain assumptions in the determination of compensation expense.
        The
        weighted average for key assumptions used in determining the fair value of
        options granted during the three and six months ended June 30, 2006 and 2005
        are
        presented as follows:




**Three
                  Months Ended**
              
              **Six
                  Months Ended**June
                  30,
              
              
              June
                  30,**2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**Expected
                  volatility
              
              
              109.2
              %
              
              106.0
              %
              
              110.0
              %
              
              106.0
              %Risk-free
                  interest rate
              
              
              5.0
              %
              
              3.9
              %
              
              4.8
              %
              
              3.8
              %Expected
                  term (years)
              
              
              5.9
              
              
              4.0
              
              
              6.1
              
              
              4.0Expected
                  dividend yield
              
              
              0.0
              %
              
              0.0
              %
              
              0.0
              %
              
              0.0
              %


Historical
        information was the primary basis for the selection of the expected volatility,
        dividend yield and the 2005 expected term. The expected term of the options
        granted during 2006 is calculated as the sum of the vesting term and the
        original contractual term divided by 2. The risk-free interest rate was selected
        based upon yields of U.S. Treasury issues with a term equal to the expected
        life
        of the option being valued.
 
 A
        summary
        of the option activity under the Plans as of June 30, 2006, and changes during
        the period then ended is presented below:





**Weighted****Weighted**
              
              **Average**
              
              **Aggregate****Number
                  of**
              
              **Average**
              
              **Remaining**
              
              **Intrinsic****Shares**
              
              **Exercise**
              
              **Contractual**
              
              **Value****(000's)**
              
              
              **Price**
              
              
              **Term**
              
              
              **(000's)**Outstanding
                  at January 1, 2006
              
              
              5,804
              
              $
              1.70Granted
              
              
              298
              
              $
              0.91Exercised
              
              
              (16
              )
              $
              0.50Cancelled
              
              
              (278
              )
              $
              1.39Outstanding
                  at June 30, 2006
              
              
              5,808
              
              $
              1.67
              
              
              6.2
              
              $
              104Vested
                  and exercisable atJune
                  30, 2006
              
              
              4,148
              
              $
              1.88
              
              
              4.9
              
              $
              94




The
      weighted-average fair value of options granted during the three months ended
      June 30, 2006 and 2005 was $0.71 and $0.98, respectively. The weighted-average
      fair value of options granted during the six months ended June 30, 2006 and
      2005
      was $0.78 and $1.03, respectively. The total intrinsic value of options
      exercised during three months ended June 30, 2006 and 2005 was approximately
      $2,000 and $132,000, respectively. The total intrinsic value of options
      exercised during the six months ended June 30, 2006 and 2005 was approximately
      $6,000 and $179,000, respectively.


12
 *Restricted
        Stock*
 
 As
        of
        June 30, 2006 and December 31, 2005, the Company had 400,000 nonvested shares
        of
        restricted stock outstanding. The restricted stock vests on June 30, 2009.
        However, 200,000 shares of restricted stock vest at such earlier time as
        (a) the
        monthly average fair market value of the Company’s common stock exceeds $3.00
        per share for a period of six consecutive months and (b) all of the shares
        of
        restricted stock shall vest at such earlier time as certain change in control
        transactions occur with respect to the Company. Total compensation expense
        for
        the restricted stock award was determined based upon the closing market price
        on
        the date of the award multiplied by the number of shares awarded. At
        June 30, 2006, there was approximately $337,000 of unrecognized compensation
        expense associated with this award. The Company expects to recognize this
        expense on a straight-line basis through June 30, 2009 or such shorter
        period if vesting is accelerated under the terms of the award.
  **Employee
        Stock Purchase Plan**
 
 The
        Company established the 2000 Employee Stock Purchase Plan (the Purchase Plan)
        under which one million shares of common stock have been reserved for issuance
        and 441,256 shares remained available for issuance as of June 30, 2006.
        Full-time employees may designate up to 10% of their compensation, not to
        exceed
        1,000 shares each six-month period, or $25,000 worth of common stock in any
        one
        calendar year, which is deducted each pay period for the purchase of common
        stock under the Purchase Plan. On the last business day of each six-month
        period, shares of common stock are purchased with the employees’ payroll
        deductions at 85% of the lesser of the market price on the first or last
        day of
        the six-month period. The Purchase Plan will terminate no later than May
        2,
        2020. Compensation expense for the periods ended June 30, 2006 and 2005 was
        computed, for disclosure purposes in 2005 and for recognition in 2006, based
        on
        the fair value of the employee’s purchase rights estimated using the
        Black-Scholes model with the following assumptions:


**Three
                  and Six Months Ended****June
                    30,****2006**
              
              
              **2005**Expected
                  volatility
              
              
              68.0
              %
              
              84.0
              %Risk-free
                  interest rate
              
              
              4.4
              %
              
              2.5
              %Expected
                  term (years)
              
              
              0.5
              
              
              0.5Expected
                  dividend yield
              
              
              0.0
              %
              
              0.0
              %


Expected
        volatility is based primarily on historical stock volatility for the most
        recent
        period equal to the expected term (which is equal to the actual purchase
        term).
        No dividends were expected during these terms and the risk-free interest
        rate is
        based on the six-month U.S. Treasury rate in effect at the beginning of the
        period. Since actual purchases occur semi-annually, the Company must, during
        the
        first and third quarters of the year, estimate future purchase levels based
        on
        observation of historical participation levels. Compensation expense recognized
        for the three and six months ended June 30, 2006 was approximately ($2,000)
        and
        $9,000, respectively.
  **4.
        Concentration of Customers and Suppliers**
 
 For
        the
        three and six months ended June 30, 2006 and 2005, the Company had the following
        concentrations of revenues and operation costs:




13


**Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30,**
              
              **June
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Largest
                  customers: Percentage of totalrevenuesCustomer
                  1
              
              
              39.2
              %
              
              25.7
              %
              
              32.7
              %
              
              23.1
              %Customer
                  2
              
              
              11.0
              %
              
              21.5
              %
              
              12.3
              %
              
              18.8
              %Customer
                  3
              
              
              9.5
              %
              
              10.5
              %
              
              9.2
              %
              
              8.6
              %Largest
                  supplier: Percentage of networkexpenses
              
              
              40.1
              %
              
              40.2
              %
              
              40.3
              %
              
              39.2
              %




During
      each of the comparison periods, no other customers accounted for more than
      10%
      of total revenues. Customer one represented 48.4% of trade accounts receivable
      as of June 30, 2006 and no other customers represented more than 10% of trade
      accounts receivable. At December 31, 2005, no customers represented more than
      10% of trade accounts receivable.


**5.
        Restructuring Charges**
 
 ***2001
        and 2002 Restructuring Plans***
 
 A
        summary
        of the activity for the six months ended June 30, 2006 pertaining to the
        Company's 2001 and 2002 restructuring plans, which is included in other accrued
        liabilities in the accompanying condensed consolidated balance sheets as
        of June
        30, 2006 and December 31, 2005, consist of the following:


**Restructuring**
              
              **Additional**
              
              
              
              **Restructuring****Liability**
              
              **Restructuring**
              
              
              
              **Liability****as
                  of**
              
              **Expense**
              
              **Cash**
              
              **as
                  of****Dec.
                  31, 2005**
              
              **Incurred**
              
              **Payments**
              
              **June
                  30, 2006**(Dollars
                  in thousands)Rent
                  expense for vacated premises
              
              $
              1,915
              
              $
              16
              
              $
              (229
              )
              $
              1,702


The amount of the reserve for vacated premises is equal to the monthly lease
        payment of the unoccupied space, less any estimated sublease income, multiplied
        by the remaining months on the lease. During the six months ended June 30,
        2006,
        the Company recorded additional restructuring charges of approximately $16,000
        due to increased common area operating expenses at the Colorado facility.
        The
        final cash payment to be recorded against the restructuring reserve is currently
        expected to occur in March 2010.
 
 14
 ***2005
        Restructuring Plan***
 
 A
        summary
        of the activity for the six months ended June 30, 2006 pertaining to the
        Company's 2005 restructuring plan, which is included in other accrued
        liabilities in the accompanying condensed consolidated balance sheets as
        of June
        30, 2006 and December 31, 2005, consist of the following:




**Restructuring**
              
              **Additional**
              
              
              
              **Restructuring****Liability**
              
              **Restructuring**
              
              
              
              **Liability****as
                  of**
              
              **Expense**
              
              **Cash**
              
              **as
                  of****Dec.
                  31, 2005**
              
              **Incurred**
              
              **Payments**
              
              **June
                    30, 2006**(Dollars
                  in thousands)One-time
                  employee termination benefits
              
              $
              41
              
              $
              11
              
              $
              (49
              )
              $
              3


The amount of the reserve is for benefits to employees who were involuntarily
        terminated in connection with the sale of substantially all of the Company’s
        enterprise customer base to TelePacific on March 11, 2005. Approximately
        80
        employees were terminated as part of this restructuring plan. During the
        six
        months ended June 30, 2006, the Company recorded additional restructuring
        charges of approximately $11,000 for employee termination benefits.
 
 The
        Company anticipates the total cash paid for employee termination benefits
        and
        rent expense for vacated premises to be approximately $530,000 and $56,000,
        respectively. Rent expense for vacated premises ended October 2005. The final
        cash payment to be recorded against the 2005 restructuring reserve is expected
        to occur in August 2006.
  ***2006
        Restructuring Plan***
 
 In June 2006, the Company implemented another restructuring plan, which included
        a workforce reduction of approximately 32 employees as part of a cost
        containment strategy. As a result of implementing this restructuring plan,
        the
        Company recorded $238,000 in restructuring charges related to employee
        termination benefits during the second quarter of 2006. The workforce reduction
        was completed in June 2006. The Company anticipates total cash paid for employee
        termination benefits to be $238,000. The final cash payment to be recorded
        against the 2006 restructuring reserve is expected to occur in September
        2006. A
        summary of the activity for the six months ended June 30, 2006 pertaining
        to the
        Company’s 2006 restructuring plan which is included in other accrued liabilities
        in the accompanying condensed consolidated balance sheets as of June 30,
        2006
        and December 31, 2005, consist of the following:




**Restructuring**
              
              **Additional**
              
              
              
              **Restructuring****Liability**
              
              **Restructuring**
              
              
              
              **Liability****as
                  of**
              
              **Expense**
              
              **Cash**
              
              **as
                  of****Dec.
                  31, 2005**
              
              **Incurred**
              
              **Payments**
              
              **June
                    30, 2006**(Dollars
                  in thousands)One-time
                  employee termination benefits
              
              $
              -
              
              $
              238
              
              $
              (210
              )
              $
              28




15




**6.
        Income Taxes**
 
 The
        Company's effective income tax rate for the three months ended June 30, 2006
        and
        2005 was 0.0% and 1.0%, respectively. The Company’s effective income tax rate
        for the six months ended June 30, 2006 and 2005 was 0.0% and 3.4%, respectively.
        As of June 30, 2006, there was an income tax receivable of $0.3
        million.
 
 **7.
        Other Comprehensive Income (Loss)**
 
 For
        the
        three months ended June 30, 2006 and 2005, there was $5,000 and $42,000,
        respectively, of other comprehensive income pertaining to net unrealized
        investment gains on available-for-sale marketable securities. Reclassifications
        of net realized losses on sales of investments during the three months ended
        June 30, 2006 and 2005 were $22,000 and $0, respectively. For the six months
        ended June 30, 2006 and 2005, there was $56,000 and $20,000, respectively,
        of
        other comprehensive income pertaining to net unrealized investment gains
        on
        available-for-sale marketable securities. Reclassification of net realized
        losses on sales of investments during the six months ended June 30, 2006
        was
        $14,000 and $0, respectively.
 
 **8.
        Commitments and Contingencies:**
 
 The
        Company has a five-year contract (the Contract) with an ILEC for transport
        services that expires in November 2006. The Contract requires that the Company
        meet certain minimum annual usage levels, which if met, trigger monthly credits
        to the Company. While the Company has met its minimum usage requirements
        through
        June 30, 2006, it has done so primarily through providing transition services
        to
        TelePacific. As TelePacific migrates the enterprise customer base to its
        system
        prior to September 12, 2006, which is the end of the current term of the
        TSA,
        the Company may decide to terminate the Contract. As a result, the Company
        could
        incur a termination fee. The amount of the termination fee, if any, is dependent
        on the remaining life of the Contract. The Company estimates the fee, if
        any,
        would approximate $0.5 million.
 
 From
        time
        to time, the Company is subject to audits with various tax authorities that
        arise during the normal course of business. During the third quarter of 2005,
        the Company received a tax assessment arising from a tax audit amounting
        to $4.8
        million. Subsequent to the third quarter of 2005, the Company filed an appeal
        against this assessment. The Company believes the resolution to this tax
        audit
        will not materially harm its business, financial condition or results of
        operations.
  On
        October 20, 2004, the Company filed a formal complaint with the California
        Public Utilities Commission (CPUC) against AT&T.  In the complaint
        proceeding, the Company alleged that AT&T owed the Company over $7.0 million
        for traffic terminated by the Company on behalf of AT&T, plus late payment
        fees.  On September 19, 2005, the presiding hearing officer released a
        decision granting the Company’s complaint in all regards, except for the
        Company’s claim for late payment fees.  On October 19, 2005, AT&T filed
        an appeal with the CPUC, claiming the decision was in error.  The Company
        filed a simultaneous appeal with the CPUC, asking for approval of late payment
        fees.  On June 29, 2006, the CPUC rejected both appeals, and reaffirmed the
        award of over $7.1 million to Pac-West. The Company received $7.1 million
        from
        AT&T on July 31, 2006.
 
 16
 There
        have been no other material developments in the litigation previously reported
        in the Company’s Annual Report on Form 10-K for the period ended December 31,
        2005 as filed with the SEC on March 29, 2006. From time to time, the Company
        is
        a party to litigation that arises in the ordinary course of business. The
        Company believes that the resolution of this litigation, and any other
        litigation the Company may be involved with in the ordinary course of business,
        will not materially harm its business, financial condition or results of
        operations.
  **9.
        Related Party Transactions**
 
 Bay
        Alarm, a significant stockholder of the Company, together with its subsidiary,
        InReach Internet, LLC (InReach), were customers of the Company. The Bay Alarm
        customer account was sold with the enterprise customer base to TelePacific
        on
        March 11, 2005. Additionally, as of November 2005, InReach was no longer
        a
        subsidiary of Bay Alarm and therefore the table below does not reflect revenues
        received from InReach subsequent to November 2005. Bay Alarm provides the
        Company with security monitoring services. The Company also leases a facility
        in
        Oakland, California from Bay Alarm. Certain information concerning these
        arrangements is as follows:


**Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30,**
              
              **June
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**(Dollars
                  in thousands)
              (Dollars
                  in thousands)Revenues
              
              $
              -
              
              $
              253
              
              $
              -
              
              $
              533Revenues
                  as a percentage of total revenues
              
              
              -
              
              
              1.2
              %
              
              -
              
              
              1.1
              %Security
                  monitoring costs
              
              $
              8
              
              $
              9
              
              $
              16
              
              $
              19Oakland
                  property rent payments
              
              $
              129
              
              $
              89
              
              $
              218
              
              $
              177


All
        expenses paid to Bay Alarm are included in selling, general and administrative
        expenses in the accompanying condensed consolidated statements of operations
        and
        comprehensive income (loss).
 
 **10.
        Debt and interest expense, net**
 
 At
        June
        30, 2006 and December 31, 2005, long-term debt and capital lease obligations
        consist of the following:


**June
                  30,**
              
              **December
                  31,****2006**
              
              **2005**(Dollars
                  in thousands)Senior
                  Notes
              
              $
              36,102
              
              $
              36,102Capital
                  lease obligations
              
              
              691
              
              
              651Notes
                  payable
              
              
              24,958
              
              
              12,159Less
                  current portion of notes payable and capital leases
              
              
              (22,071
              )
              
              (5,392
              )$
              39,680
              
              $
              43,520
  17
 The
          Senior Notes of which there is $36.1 million in principal amount outstanding
          at
          June 30, 2006 and December 31, 2005, mature on February 1, 2009 and bear
          interest at 13.5% per annum payable in semiannual installments, with all
          principal due in full on February 1, 2009.
 
 During
          2004, the Company entered into a secured financing arrangement with Merrill
          Lynch Capital (Merrill Lynch), a division of Merrill Lynch Business Financial
          Services, Inc., pursuant to which the Company could have borrowed up to
          an
          aggregate amount of $10.0 million, subject to certain conditions. This
          financing
          arrangement was structured in a manner that provided for multiple credit
          facilities up to an aggregate of $10.0 million with each facility having
          separate closing dates and repayment schedules. Additional borrowing under
          this
          secured financing arrangement expired on December 31, 2004. The principal
          and
          accrued interest of each facility is payable in 36 equal monthly installments.
          The Company has the option to prepay each outstanding facility after 18
          months
          subject to a maximum premium of 3% of the outstanding facility. Interest
          on each
          facility was fixed at 5% plus the 3-year swap rate, as published by Bloomberg
          Professional Services, determined two business days prior to the closing
          date of
          each facility. The Company used the proceeds of this financing arrangement
          to
          acquire a new telecommunication switch and related equipment, which secure
          borrowings under this financing arrangement.
 
 As
          of
          June 30, 2006, the Company had borrowed approximately $5.4 million under
          the
          Merrill Lynch arrangement under two credit facilities both with interest
          rates
          of 8.6%. As of June 30, 2006 and December 31, 2005, the principal balance
          was
          $2.1 million and $2.9 million, respectively, and is included under Notes
          Payable
          in the above table.
 
 The
          Company entered into a second secured financing arrangement with Merrill
          Lynch
          during 2005 pursuant to which the Company borrowed $1.9 million in May
          2005 and
          $4.5 million in November 2005 at fixed rates of 8.6% and 9.3%, respectively.
          In
          each case the principal and accrued interest is payable in 36 consecutive
          monthly installments. Principal payments on the May loan commenced July
          2005 and
          the November loan commenced January 2006. The Company has the option to
          prepay
          the outstanding balance after 18 months but prior to 24 months subject
          to a
          premium of 3%, and if paid thereafter, accompanied by a premium of 1%.
          The
          borrowing arrangement is secured by telecommunications switching and computer
          equipment. As of June 30, 2006 and December 31, 2005 the principal balances
          of
          $5.2 million and $6.0 million, respectively, are included in the above
          table
          under Notes Payable.
 
 In
          May
          2004, the Company completed financing agreements for various network equipment
          with Cisco Systems, Inc. (Cisco). These financing agreements were comprised
          of
          $1.4 million of equipment capital leases and a $1.6 million note payable
          exchanged for a 36-month maintenance services agreement. As of June 30,
          2006 and
          December 31, 2005, the principal balance for the capital lease portion
          of the
          arrangement was $0.4 million and $0.7 million, respectively, and is included
          in
          the above table under Capital Lease Obligations. As of June 30, 2006 and
          December 31, 2005, the principal balance of the note payable was $0.5 million
          and $0.7 million, respectively, and is included in the above table under
          Notes
          Payable.
 
 In
          March
          2006, the Company completed a new financing agreement with Cisco for various
          network equipment and related maintenance. This financing agreement was
          comprised of $0.3 million of equipment capital lease and a $0.2 million
          note
          payable exchanged for a 36-month maintenance services agreement. As of
          June 30,
          2006 the principal balance for the capital lease portion of the arrangement
          was
          $0.2 million, and is included in the above table under Capital Lease
          Obligations. As of June 30, 2006 the principal balance of the note payable
          was
          $0.2 and is included in the above table under Notes Payable.
 
 In
          November 2005, the Company entered into a Loan and Security Agreement
          (Agreement) with Comerica Bank, which provides for up to $5 million of
          revolving
          advances and up to $15 million of term loans, subject to certain conditions.
          Any
          revolving advances are not to exceed 80% of eligible accounts receivables
          and
          are due and payable in full on November 9, 2007. There were no revolving
          advances as of June 30, 2006.
 
 18
 The
          term
          loan portion of the Agreement, which is to be used within certain limitations
          to
          finance capital equipment expenditures and acquisitions or to refinance
          the
          Company’s Senior Notes, is structured into two tranches; the first included all
          term loan borrowings through June 9, 2006, at which point it expired, and
          is
          payable in thirty equal monthly installments commencing July 1, 2006. The
          second
          tranche started June 10, 2006 and continues through January 9, 2007 at
          which
          point it expires, and shall be payable in twenty-three equal monthly
          installments commencing February 1, 2007.
  Rates
          for
          borrowings under the Agreement float and are based, at the Company’s election,
          at 2.75% above a calculated Eurodollar rate for the revolving advances
          and 3.75%
          above a Eurodollar rate for the term loans or Comerica’s prime rate for the
          revolving advances and Comerica’s prime rate plus 0.5% for the term loans. The
          Company selected the bank prime rate base for the term loans resulting
          in an
          interest rate of 8.75% as of June 30, 2006 and a range of 7.75% to 8.75%
          during
          the six months ended June 30, 2006. The Agreement is secured by all personal
          property of the Company, prevents the distribution of any dividends without
          the
          written consent of Comerica and requires the Company to maintain certain
          financial and restrictive covenants including compensating cash balances.
          The
          Company shall maintain 80% of all cash balances with Comerica and compensating
          cash balances of not less than $15.0 million through December 30, 2006,
          $12.5
          million December 31, 2006 through June 29, 2007 and $10.0 million, thereafter.
          As of June 30, 2006 and December 31, 2005, the term loan principal balance
          was
          $10.5 million and $2.5 million, respectively, and is included in the above
          table
          under Notes Payable.
 
 On
          May
          30, 2006, the Company entered into the Third Amendment to the Loan and
          Security
          Agreement (Third Amendment) with Comerica Bank. The Third Amendment provided
          in
          part that the financial covenants based upon the adjusted quick ratio,
          debt
          service coverage ratio and total liabilities to effective tangible net
          worth
          under the Loan and Security Agreement were amended such that the Company
          would
          not be required to comply with such covenants as they were in effect prior
          to
          the amendment during the period commencing on May 1, 2006 through and including
          June 30, 2006.
 
 On
          July
          31, 2006, the Company entered into a Fourth Amendment to the Loan and Security
          Agreement (Fourth Amendment) with Comerica Bank. The Fourth Amendment provides
          in part that the financial covenants based upon the adjusted quick ratio,
          the
          debt service coverage ratio and the total liabilities to effective tangible
          net
          worth covenants under the Loan and Security Agreement were amended such
          that the
          Company would not be required to comply with such covenants as they were
          in
          effect prior to the amendment during the compliance periods through and
          including September 30, 2006; provided that the Company remains in compliance
          with the minimum cash covenant, as amended by the Fourth Amendment. As
          amended,
          the minimum cash covenant specifies that the Company is required to maintain
          a
          minimum balance of cash at Comerica Bank equal to $2.5 million in excess
          of the
          outstanding indebtedness during the period beginning July 1, 2006 through
          and
          including September 30, 2006. The Fourth Amendment also provides that the
          Company cannot request additional extensions of credit under the Loan and
          Security Agreement until it is in compliance with all of the financial
          covenants.
 
 If
          the
          Company violates the financial covenants in the Loan and Security Agreement,
          and
          Comerica Bank is unwilling to grant a waiver or enter into an amendment
          that
          relieves or modifies our obligation to comply with these financial covenants,
          Comerica Bank will have available to it all of the remedies provided for
          under
          the Loan and Security Agreement, including the right to accelerate, or
          declare
          due and payable, all outstanding amounts under the Loan and Security Agreement.
          Furthermore, the Company does not believe that it will be able to meet
          the
          original covenants included in the Loan and Security Agreement with Comerica
          Bank for periods following September 30, 2006, absent obtaining additional
          financing. As a result, the Company has classified its Comerica Bank debt
          as of
          June 30, 2006 of $10.5 million as a current liability in accordance with
          Emerging Issues Task Force No. (EITF) 86-30, “Classification of Obligations when
          a Violation is Waived by the Creditor.” EITF 86-30 reached a consensus that debt
          should be classified as current if a covenant violation has occurred at
          the
          balance sheet date or would have occurred absent a loan modification and
          it is
          probable that the borrower will not be able to comply with the covenants
          at
          measurement dates that are within the next 12 months.
 19
 
 Interest
          expense, net for the three and six months ended June 30, 2006 and 2005
          was as
          follows:
 **Three
                    Months Ended**
                
                **Six
                    Months Ended****June
                    30,**
                
                **June
                    30,****2006**
                
                **2005**
                
                **2006**
                
                **2005**(unaudited)
                
                (unaudited)(Dollars
                    in thousands)
                (Dollars
                    in thousands)Interest
                    on Senior Notes
                
                $
                1,218
                
                $
                1,218
                
                $
                2,437
                
                $
                2,437Accreted
                    discount on Senior Secured Note
                
                
                -
                
                
                -
                
                
                -
                
                
                1,262Amortization
                    of deferred financing costs
                
                
                57
                
                
                51
                
                
                114
                
                
                205Other
                    interest expense
                
                
                446
                
                
                158
                
                
                725
                
                
                519Less
                    interest income
                
                
                (192
                )
                
                (126
                )
                
                (372
                )
                
                (316
                )Interest expense, net
                
                $
                1,529
                
                $
                1,301
                
                $
                2,904
                
                $
                4,107


The
        weighted average interest rate on short-term borrowings outstanding as of
        June
        30, 2006 and 2005 was 8.36% and 6.06%, respectively.
 
 **11.
        Subsequent Event**
  On July 31, 2006, the Company entered into a Fourth Amendment to the Loan
        and
        Security Agreement (Fourth Amendment) with Comerica Bank. The Fourth Amendment
        provides in part that the financial covenants based upon the adjusted quick
        ratio, the debt service coverage ratio and the total liabilities to effective
        tangible net worth covenants under the Loan and Security Agreement were amended
        such that the Company would not be required to comply with such covenants
        as
        they were in effect prior to the amendment during the period commencing on
        July
        1, 2006 through and including September 30, 2006; provided that the Company
        remains in compliance with the minimum cash covenant, as amended by the Fourth
        Amendment. As amended, the minimum cash covenant specifies that the Company
        is
        required to maintain a minimum balance of cash at Comerica Bank equal to
        $2.5
        million in excess of the outstanding indebtedness during the period beginning
        July 1, 2006 through and including September 30, 2006. The Fourth Amendment
        also
        provides that the Company cannot request additional extensions of credit
        under
        the Loan and Security Agreement until it is in compliance with all of the
        financial covenants. Cash, cash equivalents and short-term investments as
        of
        June 30, 2006 were $20.5 million and the outstanding loan obligation to Comerica
        Bank as of June 30, 2006 was $10.5 million.
 
 The
        Company does not currently expect to be in compliance with all of the financial
        covenants in the Loan and Security Agreement for periods after September
        30,
        2006. As such, the Company expects that it will be necessary to negotiate
        with
        Comerica Bank an additional amendment to the Loan and Security Agreement
        to
        comply with these financial covenants for periods after September 30, 2006.
        There can be no assurances that Comerica Bank will agree to such a request.
  20
 **ITEM
        2.**  **MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
        OPERATIONS**
 
 ***Except
        for the historical information contained herein, this report contains
        forward-looking statements, subject to uncertainties and risks. In this
        Quarterly Report on Form 10-Q, our use of the words "outlook," "expect,"
        "anticipate," "estimate," "forecast," "project," "likely," "objective," "plan,"
        "designed," "goal," "target," and similar expressions is intended to identify
        forward-looking statements. While these statements represent our current
        judgment on what the future may hold, and we believe these judgments are
        reasonable, actual results may differ materially due to numerous important
        risk
        factors that are described in our Annual Report on Form 10-K for the period
        ended December 31, 2005, as filed with the SEC on March 29, 2006, which may
        be
        revised or supplemented in subsequent reports filed by us with the SEC. Such
        risk factors include, but are not limited to: our level of indebtedness;
        an
        inability to generate sufficient cash to service our indebtedness; regulatory
        and legal uncertainty with respect to intercarrier compensation payments
        received by us; other regulatory changes; the migration to broadband Internet
        access affecting dial-up Internet access; the loss of key executive officers
        could negatively impact our business prospects; an increase in our network
        expenses; migration of our enterprise customer base to U.S. TelePacific Corp.
        occurring sooner than contemplated; the possible delisting of our common
        shares
        from the Nasdaq Capital Market; customer acceptance of products, such as
        VoIP;
        and our principal competitors for local services and potential additional
        competitors have advantages that may adversely affect our ability to compete
        with them.***
 
 **Introduction**
  We
        are an
        independent provider of integrated communication solutions that enable
        communication providers to use our network and services as an alternative
        to
        building and maintaining their own network. Our customers include Internet
        service providers (ISPs), enhanced communication service providers (ESPs)
        and
        other direct providers of communication services to business and residential
        end-users, collectively referred to as service providers (SPs).
 
 While
        services that provide traditional dial-up access to the Internet have been
        and
        continue to be an important aspect of the services we provide SPs, we believe
        increased demand for access to the Internet, the desire for one-stop integrated
        communication services by end-users and new communications technologies such
        as
        voice over Internet protocol (VoIP) present significant growth opportunities
        for
        us. We are developing and overlaying new products and services that take
        advantage of these new technologies in an effort to increase the utilization
        of
        our network, particularly in light of reduced utilization as SP customers
        continue to migrate from dial-up access to broadband access. While we expect
        that the majority of dial-up Internet service will migrate to broadband over
        time and believe it is occurring more rapidly than expected, it is a target
        market for us and we remain focused on serving the needs of our
        customers.
 
 We
        announced in October 2005 the first phase of a planned national expansion.
        Under
        our expansion plan, we intend to offer our full suite of voice over Internet
        protocol (VoIP) and Internet access enabling services in 36 major metropolitan
        markets, covering more than 50% of the U.S. population. We are positioning
        ourselves as a key player in the SP space with a focus on expansion through
        enabling others to become communication service providers. This planned
        expansion is designed to provide a nationwide, single source platform that
        seamlessly bridges circuit-switching and packet-switching targeted at VoIP
        providers, wireless broadband providers, ISPs, carriers and other Next
        Generation service providers. We are in the business of enabling any company
        to
        become a custom telecommunications company.
 
 Prior
        to
        commencing our planned national expansion, we served customers in California,
        Arizona, Nevada, Oregon, Utah and Washington. We have subsequently placed
        into
        service network assets necessary to begin serving, and have begun to serve,
        customers in Alabama, Colorado, Florida, Idaho, Maryland, New Jersey, New
        York,
        North Carolina, Pennsylvania, South Carolina and Washington, D.C. **** In
        addition, our East Coast SuperPOP became operational in May 2006 in order
        to
        support customers in these markets. Our planned national expansion contemplates
        further investment in these markets as network traffic increases.
  21
 We
        announced in January 2006 an alliance with VeriSign, Inc. (VeriSign) to provide
        services that enable communications providers to offer converged IP, voice
        and
        data communications. The alliance contemplates that VeriSign will facilitate
        us
        with back office and database services including Calling Party Name, Local
        Number Portability, E911 related database updating, SS7 and provisioning
        services. Further, it is expected that we will contribute voice and data
        network
        services such as trunking, switching, E911 selective router trunking and
        IP
        transport. Our strategic alliance with VeriSign is expected to enhance our
        national expansion plans and strategy of being a single source for converged
        solutions offered by VoIP, wireless, broadband and other service providers,
        allowing both companies to drive adoption of next-generation
        applications.
 
 In
        June
        2006, we implemented another restructuring plan, which included a workforce
        reduction of approximately 32 employees as part of a cost containment strategy.
        As a result of implementing this restructuring plan, we recorded $238,000
        in
        restructuring charges related to employee termination benefits during the
        second
        quarter of 2006. The workforce reduction was completed in June 2006. We
        anticipate total cash paid for employee termination benefits to be $238,000.
        The
        final cash payment to be recorded against the 2006 restructuring reserve
        is
        expected to occur in September 2006.
 
 In
        connection with our transition to a business model based upon enabling other
        communication service providers, on March 11, 2005, we sold substantially
        all of
        our enterprise customer base to U.S. TelePacific Corp. (TelePacific) while
        retaining our associated network assets. Under the terms of this transaction,
        TelePacific acquired certain assets, such as property and equipment with
        a net
        book value of approximately $3.0 million and other assets of approximately
        $0.6
        million, and assumed certain liabilities of approximately $0.7 million, in
        exchange for $27.0 million in cash. As a result, we recorded a gain of $24.0
        million from this sale during the first quarter of 2005. Subsequent to the
        first
        quarter of 2005, we recorded a net gain of $0.1 million for adjustments
        associated with this sale and an amendment to the Asset Purchase Agreement
        (APA).
 
 In
        addition, on March 11, 2005, we entered into a Transition Service Agreement
        (TSA) with TelePacific that, among other things, obligates us to provide
        certain
        transition services to TelePacific at our estimated cost for a one-year period
        subject to extension for two additional three-month periods. The estimated
        costs
        to be reimbursed to us include network related and administrative support
        services which are provided exclusively to TelePacific and were capped at
        $10.5
        million. In accordance with the TSA, TelePacific received a $2.0 million
        credit
        against the total amount to be billed that occurred during the second quarter
        of
        2005. During the third quarter of 2005, we entered into an amendment with
        TelePacific to resolve certain disputed matters arising out of the APA and
        to
        amend and modify the TSA. The TSA amendment eliminated the cap of $10.5 million
        for certain types of network related services for which TelePacific is obligated
        to reimburse us during the initial 12 month transition period. During April
        2006, TelePacific exercised their second and final option to extend the
        transition period for an additional three months. This will extend the TSA
        transition period to September 12, 2006.
 
 For
        the
        three and six months ended June 30, 2006, we recorded reimbursed transition
        expenses of $2.8 million and $5.7 million, respectively, in accordance with
        the
        TSA. This amount is recorded as a reduction to costs and expenses on a separate
        line item in the condensed consolidated statements of operations and
        comprehensive income (loss). Costs billed under the TSA are based upon estimated
        costs to us, and we anticipate that no profit will be recognized on the services
        performed under the TSA. The enterprise services are provided by the same
        network assets and maintained and operated by the same employee base as other
        services provided by us. As such, our common network services or expenses
        cannot
        be segregated based upon the services provided and therefore the estimated
        costs
        have primarily been billed based upon a fixed fee per type of service or
        transaction. Due to the inseparability of our network, the absence of
        identifiable shared costs, and as no network assets were sold to TelePacific,
        we
        determined the transaction with TelePacific did not result in discontinued
        operations.
 
 22
 The
        following table shows our financial performance for the three and six months
        ended June 30, 2006 and 2005:


**Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30,**
              
              **June
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**(unaudited)
              
              (unaudited)(Dollars
                  in thousands)
              
              (Dollars
                  in thousands)Total
                  revenue
              
              $
              27,028
              
              $
              21,869
              
              $
              46,656
              
              $
              50,000Income
                  (loss) from operations
              
              $
              686
              
              $
              (894
              )
              $
              (2,211
              )
              $
              (2,136
              )Net
                  (loss) income
              
              $
              (827
              )
              $
              (2,315
              )
              $
              (5,099
              )
              $
              15,024(Loss)
                  income per share diluted
              
              $
              (0.02
              )
              $
              (0.06
              )
              $
              (0.14
              )
              $
              0.39


We
        derive
        our revenues from monthly recurring charges, usage charges and amortization
        of
        initial non-recurring charges. Since the sale of substantially all of the
        enterprise customer base on March 11, 2005, we provide services primarily
        to SP
        customers. Monthly recurring charges include the fees paid by customers for
        lines in service and additional features on those lines, as well as equipment
        collocation services. Usage charges consist of fees paid by end users for
        each
        call made, fees paid by our intercarrier customers as intercarrier compensation
        for completion of their customers’ calls through our network, and access charges
        paid by carriers for long distance traffic terminated on our network. Initial
        non-recurring charges consist of fees paid by end users for the installation
        of
        our service. Most installation revenues and costs associated with installation
        are recognized as revenue and expensed ratably over the term of the service
        contracts, which is generally 24 to 36 months. We recognize revenue when
        there
        is persuasive evidence of an arrangement, delivery of the product or performance
        of the service has occurred, the selling price is fixed or determinable and
        collectibility is reasonably assured.
 
 We
        have
        carrier customers who pay us to terminate their originating call traffic
        on our
        network. These payments consist of meet point access charges, third party
        transit traffic and intercarrier compensation payments, collectively referred
        to
        as intercarrier compensation. Intercarrier compensation payments are a function
        of the number of calls we terminate, the minutes of use associated with such
        calls and the rates at which we are compensated by the incumbent local exchange
        carriers (ILECs). Intercarrier compensation payments have historically been
        a
        significant portion of our revenues but the intercarrier carriers are not
        currently a targeted customer. Intercarrier compensation payments accounted
        for
        54.3% and 41.0% of our total revenues for the six months ended June 30, 2006
        and
        2005, respectively. The failure, for any reason, of one or more carriers
        from
        which we ordinarily receive intercarrier compensation payments to make all
        or a
        significant portion of such payments would adversely affect our financial
        results.
 
 Our
        right
        to receive intercarrier compensation payments from other carriers, as well
        as
        the right of competitive local exchange carriers (CLECs) and other competitors
        to receive such payments is the subject of numerous regulatory and legal
        challenges.
 
 On
        October 20, 2004, we filed a formal complaint with the California Public
        Utilities Commission (CPUC) against AT&T.  In the complaint proceeding,
        we alleged that AT&T owed us over $7.1 million for traffic terminated by us
        on behalf of AT&T, plus late payment fees.  On September 19, 2005, the
        presiding hearing officer released a decision granting our complaint in all
        regards, except for our claim for late payment fees.  On October 19, 2005,
        AT&T filed an appeal with the CPUC, claiming the decision was in
        error.  We filed a simultaneous appeal with the CPUC, asking for approval
        of late payment fees.  On June 29, 2006, the CPUC rejected both appeals,
        and reaffirmed to award of over $7.1 million to us. We received $7.1 million
        from AT&T on July 31, 2006.
 
 23
 As
        technology continues to evolve with the corresponding development of new
        products and services, there is no guarantee we will retain our customers
        with
        our existing product and service offerings or with any new products or services
        we may develop in the future. Traditional dial-up access to the Internet,
        although a mature technology, remains a large target market for us. Major
        segments of this market may experience migration to broadband access
        technologies where available and competitively priced. While we remain focused
        on serving the needs of our customers who provide dial-up access to their
        end-users, with the evolution of new technologies many new Internet protocol
        (IP) applications are now available, such as VoIP, which have presented us
        with
        new product development and sales opportunities. We are developing and
        overlaying new products and services that take advantage of these new
        technologies to further increase the utilization of our network and expect
        our
        planned national expansion will present additional sales
        opportunities.
 
 Competition
        in the communication services market has resulted in the consolidation of
        companies in our industry, a trend we expect to continue. In order to grow
        our
        business and better serve our customers, we continue to consider new business
        strategies, such as our planned national expansion and alliance with VeriSign,
        Inc., and including, but not limited to, potential acquisitions, partnerships,
        or new business services. We believe that the footprint of our network, which
        encompasses all of the major metropolitan areas of California, in addition
        to
        New York, Philadelphia, Baltimore, Jacksonville, Denver, Alabama, North
        Carolina, South Carolina, New Jersey, Washington, D.C., Oregon, Washington,
        Nevada, Arizona, Utah, as well as an initial expansion into Idaho, and our
        planned expansion, provides us with a significant competitive advantage that
        will enable us to successfully compete in the future, but we cannot guarantee
        that we will be able to achieve future growth.
 
 **Application
        of Critical Accounting Policies**
 
 *Critical
        Accounting Policies.* The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        estimates and assumptions that effect the reported amounts of assets and
        liabilities, disclosure of contingent assets and liabilities, and reported
        amounts of revenues and expenses for the reporting period. We consider the
        following accounting policies to be critical policies due to the estimation
        processes involved in each:
 
 •  revenue
        recognition;
 
 •  provision
        for doubtful accounts receivable;
 
 •  estimated
        settlement of disputed billings;
 
 •  impairment
        for long-lived assets; and
 
 •  stock-based
        compensation.
 
 By
        their
        nature, these judgments are subject to an inherent degree of uncertainty.
        Thus,
        actual results could differ from estimates made and these differences could
        be
        material.
 
 *Revenue
        Recognition.* We
        recognize revenue when:
 
 •  there
        is
        pervasive evidence of an arrangement;
 
 •  delivery
        of the product or performance of the service has occurred;
 
 24
 •  the
        selling price is fixed and determined; and
 
 •  collectibility
        is reasonably assured.
 
 Non-refundable
        up-front payments received for installation services and installation related
        costs, are recognized as revenue and expensed ratably over the term of the
        service contracts, generally 24 to 36 months.
  Revenues
        from service access agreements are recognized as the service is provided,
        except
        for intercarrier compensation fees paid by our intercarrier customers for
        completion of their customers’ calls through our network, and access charges
        paid by carriers for long distance traffic terminated on our network. Our
        right
        to receive this type of compensation is the subject of numerous regulatory
        and
        legal challenges. We consider such issues in evaluating the four criteria
        above.
 
 Some
        ILECs with which we have interconnection agreements have withheld payments
        from
        amounts billed by us under their agreements. The process of collection of
        such
        intercarrier compensation is subject to complex contracts, regulations and
        laws,
        and is routinely the subject of judicial and/or administrative processes.
        Often,
        disputes concerning intercarrier compensation are settled by us and the ILEC
        in
        a manner that results in accepting a portion of what we believe is owed to
        us.
 
 *Provision
        for doubtful accounts receivable.* Provisions for allowances for doubtful accounts receivable are estimated
        based
        upon:
 
 •  historical
        collection experience;
 
 •  customer
        delinquencies and bankruptcies;
 
 •  information
        provided by our customers;
 
 •  observance
        of trends in the industry; and
 
 •  other
        current economic conditions.
 
 *Estimated
        settlements for disputed billings.* During
        the ordinary course of business, we may be billed for carrier traffic for
        which
        management believes we are not responsible. In such instances, we may dispute
        with the appropriate vendor and withhold payment until the matter is resolved.
        Our current disputes are primarily related to incorrect facility rates or
        incorrect billing elements we believe we are being charged. Management regularly
        reviews and monitors all disputed items and, based on industry experience,
        records an accrual that represents what we estimate that we owe on the disputed
        billings. Although we continue to actively try to expedite resolutions, often
        times the state Public Utilities Commission must become involved to arbitrate
        such agreements. This process is often not timely and resolutions are often
        subject to appeal.
 
 *Long-lived
        assets.* In 2002,
        we adopted Statement of Financial Accounting Standards (SFAS) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets.” We evaluate
        our long-lived assets when events or changes in circumstances indicate that
        the
        carrying amount of such assets may not be fully recoverable. Recoverability
        of
        assets to be held and used is measured by a comparison of the carrying amount
        of
        an asset to the future undiscounted cash flows expected to be generated by
        the
        asset. When we consider an asset to be impaired, it is written down to its
        estimated fair market value. This is assessed based on factors specific to
        the
        type of asset. In assessing the recoverability of these assets, we make
        assumptions regarding, among other things, estimated future cash flows to
        determine the fair value of the respective assets. If these estimates and
        the
        related assumptions change in the future, we may be required to record
        additional impairment charges for these assets.
 
 25
 *Stock-based
        compensation.* On
        January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment,” and account
        for stock-based compensation in accordance with the fair value recognition
        provisions of SFAS No. 123R. We use the Black-Scholes option-pricing model,
        which requires the input of subjective assumptions. These assumptions include
        estimating the length of time employees will retain their stock options
        (expected term), the estimated volatility of the our common stock price over
        the
        expected term and the number of options that will cancel for failure to complete
        their vesting requirements (forfeitures). Changes in these assumptions could
        materially affect the estimate of fair value stock-based compensation and
        consequently, the related amount recognized on the consolidated statements
        of
        operations and comprehensive income (loss).
  **Results
        of Operations**
 
 *Quarter
        Ended June 30, 2006 Compared to the Quarter Ended June 30,
        2005*
  Our significant revenue components and operational metrics for the quarters
        ended June 30, 2006 and 2005 are as follows:




**Three
                  Months Ended****June
                  30,****2006**
              
              **2005**
              
              **%
                  Change**(unaudited)(Dollars
                  in millions)**Revenues:**Intercarrier
                  compensation
              
              $
              16.0
              
              $
              10.5
              
              
              52.4
              %Mature
                  Products
              
              $
              8.1
              
              $
              10.7
              
              
              (24.3
              )%Growth
                  Products
              
              $
              2.9
              
              $
              0.7
              
              
              314.3
              %Total revenues
              
              $
              27.0
              
              $
              21.9
              
              
              23.3
              %**Operational
                  metrics:**Minutes
                  of use (in billions)Intercarrier
              
              
              8.57
              
              
              12.04
              
              
              (28.8
              )%Mature
                  Products
              
              
              0.02
              
              
              0.07
              
              
              (71.4
              )%Growth
                  Products
              
              
              0.17
              
              
              0.06
              
              
              183.3
              %Total minutes of use
              
              
              8.76
              
              
              12.17
              
              
              (28.0
              )%
  Total revenues, which is composed of intercarrier, mature products and growth
        products, increased 23.3% to $27.0 million in the quarter ended June 30,
        2006
        from $21.9 million during the same period in 2005. This increase was primarily
        attributable to an increase in intercarrier compensation revenue resulting
        from
        receipt of administrative orders to make disputed payments and settlements
        for
        prior disputed billings of $9.4 million during the second quarter of 2006,
        offset by lower revenue resulting from lower minutes of use and a reduction
        in
        mature products services.
  Our
        mature products in our western footprint currently drive the majority of
        our
        intercarrier revenues. We anticipate continued declines due to a more rapid
        decline than expected in the Internet dial-up business as customers transition
        from dial-up to broadband in addition to competitive pressure for these
        businesses. However, we expect these declines to be gradually offset by
        increasing both our mature and growth products across our expanded
        footprint.
 26
 Intercarrier
          compensation revenues increased 52.4% to $16.0 million in the quarter ended
          June
          30, 2006 from $10.5 million during the same period in 2005 primarily due
          to the
          receipt of administrative orders to make disputed payments and settlements
          for
          prior disputed billings of $9.4 million during the period, offset by lower
          revenues from a decrease in intercarrier minutes of use primarily due to
          a
          competitor, who is a customer, building out their own network and a more
          rapid
          than expected decline in the Internet dial-up business.
  Mature
          products revenues include dial access services, collocation, and all enterprise
          products. Revenues from mature products decreased $2.6 million, or 24.3%
          in the
          quarter ended June 30, 2006 from $10.7 million during the same period in
          2005.
          The decrease was primarily due to lower revenues from lower minutes of
          use in
          addition to Internet dial-up ISPs reducing services.
 
 Growth
          products revenues include the VoiceSource suite (PSTN on Ramp, IFEX, PSTN
          on
          Ramp with NDS and Driver’s Seat), exchange advantage and enhanced dial access.
          Revenues from growth products increased $2.2 million, or 314.3% in the
          quarter
          ended June 30, 2006 from $0.7 million during the same period in 2005. The
          increase was due primarily to volume growth from existing products in addition
          to new products introduced subsequent to the quarter ended June 30, 2005.
          This
          increase is currently in the western footprint and we expect gradual increases
          in our eastern footprint along with our VeriSign alliance by the end of
          the
          year.
 
 Total
          minutes of use, which is composed of intercarrier, mature products and
          growth
          products declined 28.0% to 8.76 billion in the quarter ended June 30, 2006
          from
          12.17 billion for the same period in 2005. Intercarrier minutes of use
          are
          composed of minutes of use resulting from both mature products and growth
          products that are initiated on another carrier’s network but terminated on our
          network. Intercarrier minutes of use decreased to 8.57 billion in the quarter
          ended June 30, 2006 from 12.04 billion for the same period in 2005, primarily
          due to a competitor, who is a customer, building out their own network
          and a
          more rapid than expected decline in the Internet dial-up business. Mature
          products minutes of use decreased to 0.02 billion for the quarter ended
          June 30,
          2006 from 0.07 billion during the same period in 2005. Growth products
          minutes
          of use increased to 0.17 billion for the quarter ended June 30, 2006 from
          0.06
          billion during the same period in 2005. We believe that the decrease in
          the
          minutes of use for mature products and the increase in the minutes of use
          related to growth products reflects the changing focus of our business
          as well
          as the recent introduction of new products.
 
 The significant costs and expenses for the quarters ended June 30, 2006
          and 2005
          are as follows:
 **Three
                    Months Ended****June
                    30,****2006**
                
                **2005**
                
                **%
                    Change**(unaudited)(Dollars
                    in millions)**Costs
                    and expenses:**Network
                    expenses (exclusive of depreciation shown separately
                    below)
                
                $
                10.8
                
                $
                9.7
                
                
                11.3
                %Selling,
                    general and administrative
                
                
                14.9
                
                
                12.4
                
                
                20.2
                %Reimbursed
                    transition expenses
                
                
                (2.8
                )
                
                (2.8
                )
                
                0.0
                %Depreciation
                    and amortization
                
                
                3.1
                
                
                3.2
                
                
                (3.1
                )%Restructuring
                    charges
                
                
                0.3
                
                
                0.2
                
                
                50.0
                %Total costs and expenses
                
                $
                26.3
                
                $
                22.7
                
                
                15.9
                %




Consolidated
        network expenses increased $1.1 million, or 11.3% during the quarter ended
        June
        30, 2006 compared to $9.7 million during the same period in 2005 due primarily
        to increased expenses related to our national expansion, partially offset
        by
        former customers transitioning off our network as a result of the sale of
        substantially all of our enterprise customer base to TelePacific’s network.
        During this transition period, which ends September 12, 2006, we are obligated
        under the TSA, among other things, to provide certain transition services
        to
        TelePacific at our estimated cost. The estimated costs to be reimbursed to
        us
        include network related services and are included under “Reimbursed transition
        expenses.”
  27
 Consolidated
        selling, general and administrative expenses increased 20.2% to $14.9 million
        for the quarter ended June 30, 2006 from $12.4 million during the same period
        in
        2005. The increase was due primarily to the increase in full-time equivalent
        employees, primarily related to our national expansion plans and other expansion
        costs.
 
 We
        expect
        selling, general and administrative expenses to decline after the second
        quarter
        of 2006 primarily as a result of the 2006 restructuring plan, in which
        approximately 32 employees were terminated, a 10% reduction in pay for officers
        beginning in the third quarter of 2006 and other cost reduction activities
        implemented in the second quarter of 2006.
 
 Effective
        January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment,” utilizing the
        modified prospective method. We recorded approximately $105,000 in selling,
        general and administrative expense during the quarter ended June 30, 2006
        as a
        result of this adoption. Total compensation expense recognized for stock-based
        awards for the three months ended June 30, 2006 and 2005 was $132,000 and
        $48,000, respectively. Previously, we followed Accounting Principles Board
        Opinion (APB) No. 25, "Accounting for Stock Issued to Employees" for our
        stock-based compensation plans and the disclosure-only provisions of SFAS
        No.
        123, "Accounting for Stock-Based Compensation." As of June 30, 2006, we had
        unrecognized stock-based compensation of $1.4 million outstanding, which
        we
        expect to recognize over a weighted-average period of 2.8 years.
 
 Reimbursed
        transition expenses were $2.8 million for both quarters ended June 30, 2006
        and
        2005. The reimbursed transition expenses relate to network and administrative
        services provided to TelePacific in accordance with the TSA. Costs billed
        under
        the TSA are based upon estimated costs to us, and we anticipate that no profit
        will be recognized on the services performed under the TSA. The TSA ends
        on
        September 12, 2006 and expect reimbursement of transition expenses to end
        at
        that time. The enterprise services are provided by the same network assets
        and
        maintained and operated by the same employee base as other services provided
        by
        us until TelePacific can transition the enterprise customer base onto its
        own
        network. As such, our common network services or expenses cannot be segregated
        based upon the services provided and therefore the estimated costs have
        primarily been billed based upon a fixed fee per type of service or transaction.
        Due to the inseparability of our network, the absence of identifiable shared
        costs, and as no network assets were sold to TelePacific, we determined the
        transaction with TelePacific did not result in discontinued operations.
 
 Estimates
        and assumptions are used in setting depreciable lives. Assumptions are based
        on
        internal studies of use, industry data on average asset lives, recognition
        of
        technological advancements and understanding of business strategy. Consolidated
        depreciation and amortization expense decreased 3.1% to $3.1 million in the
        quarter ended June 30, 2006 from $3.2 million during the same period in 2005.
        The decrease in depreciation and amortization expense was primarily due to
        some
        assets becoming fully depreciated during the period, slightly offset by an
        increase in depreciation for new assets acquired in connection with our national
        expansion.
 
 Restructuring
        charges were approximately $0.3 million for the quarter ended June 30, 2006
        primarily due to employee termination benefits related to the June 2006
        reduction in force. Restructuring charges were $0.2 million for the same
        period
        in 2005. The 2005 charges related primarily to the completion of the sale
        of
        substantially all of our enterprise customer base for employee termination
        benefits and rent expense for vacated premises.
 
 28
 Consolidated
        income from operations was $0.7 million for the quarter ended June 30, 2006
        compared to a loss of $0.9 million during the same period in 2005 primarily
        due
        to the factors discussed in the preceding paragraphs.
  Consolidated
        interest expense, net increased to $1.5 million for the quarter ended June
        30,
        2006 compared to $1.3 million for the same period in 2005 due primarily to
        higher debt levels and increasing interest rates during 2006.


**Three
                  Months Ended****June
                  30,****2006**
              
              **2005**(unaudited)(Dollars
                  in thousands)Interest
                  on Senior Notes
              
              $
              1,218
              
              $
              1,218Amortization
                  of deferred financing costs
              
              
              57
              
              
              51Other
                  interest expense
              
              
              446
              
              
              158Less
                  interest income
              
              
              (192
              )
              
              (126
              )Interest expense, net
              
              $
              1,529
              
              $
              1,301
 For
          the
          quarters ended June 30, 2006 and 2005, our effective income tax rate was
          0.0%
          and 1.0%, respectively.
 
 Consolidated
          net loss was $0.8 million for the quarter ended June 30, 2006 compared
          to a loss
          of $2.3 million during the same period in 2005 primarily due to the factors
          discussed in the preceding paragraphs.
 
 *Six
          Months Ended June 30, 2006 Compared to the Six Months Ended June 30,
          2005*
 
 Our
          significant revenue components and operational metrics for the six months
          ended
          June 30, 2006 and 2005 are as follows:
 **Six
                    Months Ended****June
                    30,****2006**
                
                **2005**
                
                **%
                    Change**(unaudited)(Dollars
                    in millions)**Revenues:**Intercarrier
                    compensation
                
                $
                25.4
                
                $
                20.5
                
                
                23.9
                %Mature
                    Products
                
                
                16.7
                
                
                28.0
                
                
                (40.4
                )%Growth
                    Products
                
                
                4.6
                
                
                1.5
                
                
                206.7
                %Total revenues
                
                $
                46.7
                
                $
                50.0
                
                
                (6.6
                )%**Operational
                    metrics:**Minutes
                    of use (in billions)Intercarrier
                
                
                19.61
                
                
                24.14
                
                
                (18.8
                )%Mature
                    Products
                
                
                0.07
                
                
                0.13
                
                
                (46.2
                )%Growth
                    Products
                
                
                0.27
                
                
                0.12
                
                
                125.0
                %Total minutes of use
                
                
                19.95
                
                
                24.39
                
                
                (18.2
                )%






29




Total
        revenues, which are composed of intercarrier, mature products and growth
        products, decreased 6.6% to $46.7 million in the six months ended June 30,
        2006
        compared to $50.0 million for the same period in 2005. This decrease was
        primarily attributable to the sale of our enterprise customer base to
        TelePacific during the first quarter of 2005 as well as lower revenue resulting
        from lower minutes of use and a reduction in mature products services. These
        revenue decreases were offset by an increase in intercarrier compensation
        revenue resulting from receipt of administrative orders to make disputed
        payments and settlements for prior disputed billings of $10.3 million during
        2006.
 
 Our
        mature products in our western footprint currently drive the majority of
        our
        intercarrier revenues. We anticipate continued declines due to a more rapid
        decline than expected in the Internet dial-up business as customers transition
        from dial-up to broadband in addition to competitive pressure for these
        businesses. However, we expect these declines to be gradually offset by
        increasing both our mature and growth products across our expanded
        footprint.
 
 Intercarrier
        compensation revenues increased 23.9% to $25.4 million in the six months
        ended
        June 30, 2006 from $20.5 million during the same period in 2005 primarily
        due to
        the receipt of administrative orders to make disputed payments and settlements
        for prior disputed billings of $10.3 million during 2006, offset by lower
        revenues from a decrease in intercarrier minutes of use primarily due to
        a
        competitor, who is a customer, building out their own network and a more
        rapid
        than expected decline in the Internet dial-up business.
 
 Mature
        products revenues include dial access services, collocation, and all enterprise
        products. Revenues from mature products decreased $11.3 million, or 40.4%
        in the
        six months ended June 30, 2006 from $28.0 million during the same period
        in
        2005. The decrease was primarily due to the sale of substantially all of
        our
        enterprise customer base to TelePacific on March 11, 2005, lower revenues
        from
        lower minutes of use and Internet dial-up ISPs reducing services.
 
 Growth
        products revenues include the VoiceSource suite (PSTN on Ramp, IFEX, PSTN
        on
        Ramp with NDS and Driver’s Seat), exchange advantage and enhanced dial access.
        Revenues from growth products increased $3.1 million, or 206.7% in the six
        months ended June 30, 2006 from $1.5 million during the same period in 2005.
        The
        increase was due primarily to volume growth from existing products in addition
        to new products introduced subsequent to the six months ended June 30, 2005.
        This increase is currently in the western footprint and we expect gradual
        increases in our eastern footprint along with our VeriSign alliance by the
        end
        of the year.
 
 Total
        minutes of use, which is composed of intercarrier, mature products and growth
        products declined 18.2% to 19.95 billion in the six months ended June 30,
        2006
        from 24.39 billion for the same period in 2005. Intercarrier minutes of use
        are
        composed of minutes of use resulting from both mature products and growth
        products that are initiated on another carrier’s network but terminated on our
        network. Intercarrier minutes of use decreased 18.8% to 19.61 billion during
        the
        six months ended June 30, 2006 from 24.14 billion for the same period in
        2005,
        due to a competitor, who is a customer, building out their own network and
        a
        more rapid than expected decline in the Internet dial-up business. Mature
        products minutes of use decreased to 0.07 billion for the six months ended
        June
        30, 2006 from 0.13 billion for the same period in 2005. Growth products minutes
        of use increased to 0.27 billion for the six months ended June 30, 2006 from
        0.12 billion for the same period in 2005. We believe that the decrease in
        the
        minutes of use for mature products and the increase in the minutes of use
        related to growth products reflects the changing focus of our business as
        well
        as the recent introduction of new products.
 
 30
 The
        significant costs and expenses for the six months ended June 30, 2006 and
        2005
        are as follows:


**Six
                  Months Ended****June
                  30,****2006**
              
              **2005**
              
              **%
                  Change**(unaudited)(Dollars
                  in millions)**Costs
                  and expenses:**Network
                  expenses (exclusive of depreciation shown separately
                  below)
              
              $
              19.8
              
              $
              20.3
              
              
              (2.5
              )%Selling,
                  general and administrative
              
              
              28.5
              
              
              27.1
              
              
              5.2
              %Reimbursed
                  transition expenses
              
              
              (5.6
              )
              
              (2.8
              )
              
              100.0
              %Depreciation
                  and amortization
              
              
              5.9
              
              
              7.0
              
              
              (15.7
              )%Restructuring
                  charges
              
              
              0.3
              
              
              0.6
              
              
              (50.0
              )%Total costs and expenses
              
              $
              48.9
              
              $
              52.2
              
              
              (6.3
              )%




Consolidated
        network expenses decreased $0.5 million, or 2.5% during the six months ended
        June 30, 2006 compared to $20.3 million during the same period in 2005 due
        primarily to negotiated supplier credits received in 2006 in addition to
        former
        customers transitioning off our network as a result of the sale of substantially
        all of our enterprise customer base to TelePacific’s network, offset slightly by
        our national expansion. During this transition period, which ends September
        12,
        2006, we are obligated under the TSA, among other things, to provide certain
        transition services to TelePacific at our estimated cost. The estimated costs
        to
        be reimbursed to us include network related services and are included under
        “Reimbursed transition expenses.”
  Consolidated
        selling, general and administrative expenses increased 5.2% to $28.5 million
        for
        the six months ended June 30, 2006 from $27.1 million during the same period
        in
        2005. The increase was due primarily to costs associated with the national
        expansion plan.
 
 We
        expect
        selling, general and administrative expenses to decline after the second
        quarter
        of 2006 primarily as a result of the 2006 restructuring plan, in which
        approximately 32 employees were terminated, a 10% reduction in pay for officers
        beginning in the third quarter of 2006 and other cost reduction activities
        implemented in the second quarter of 2006.
 
 Effective
        January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment,” utilizing the
        modified prospective method. We recorded approximately $202,000 in selling,
        general and administrative expense during the six months ended June 30, 2006
        as
        a result of this adoption. Total compensation expense recognized for stock-based
        awards for the six months ended June 30, 2006 and 2005 was $278,000 and $96,000,
        respectively. Previously, we followed Accounting Principles Board Opinion
        (APB)
        No. 25, "Accounting for Stock Issued to Employees" for our stock-based
        compensation plans and the disclosure-only provisions of SFAS No. 123,
        "Accounting for Stock-Based Compensation." As of June 30, 2006, we had
        unrecognized stock-based compensation of $1.4 million outstanding, which
        we
        expect to recognize over a weighted-average period of 2.8 years.
 
 Reimbursed
        transition expenses were $5.7 million for the six months ended June 30, 2006
        compared to $2.8 million during the same period in 2005. The reimbursed
        transition expenses relate to network and administrative services provided
        to
        TelePacific in accordance with the TSA. Costs billed under the TSA are based
        upon estimated costs to us, and we anticipate that no profit will be recognized
        on the services performed under the TSA. This increase in reimbursed expenses
        during 2006 reflects six months of reimbursements during 2006 compared to
        three
        months during 2005 since the sale occurred during March 2005. The TSA ends
        on
        September 12, 2006 and expect reimbursement of transition expenses to end
        at
        that time. The enterprise services are provided by the same network assets
        and
        maintained and operated by the same employee base as other services provided
        by
        us until TelePacific can transition the enterprise customer base onto its
        own
        network. As such, our common network services or expenses cannot be segregated
        based upon the services provided and therefore the estimated costs have
        primarily been billed based upon a fixed fee per type of service or transaction.
        Due to the inseparability of our network, the absence of identifiable shared
        costs, and as no network assets were sold to TelePacific, we determined the
        transaction with TelePacific did not result in discontinued operations.
 
 31
 Estimates
        and assumptions are used in setting depreciable lives. Assumptions are based
        on
        internal studies of use, industry data on average asset lives, recognition
        of
        technological advancements and understanding of business strategy. Consolidated
        depreciation and amortization expense decreased 15.7% to $5.9 million in
        the six
        months ended June 31, 2006 from $7.0 million during the same period in 2005.
        The
        decrease in depreciation and amortization expense was primarily due to some
        assets becoming fully depreciated during the period in addition to the sale
        of
        some assets as part of the sale of substantially all of our enterprise customer
        base, partially offset by an increase in depreciation for new assets acquired
        in
        connection with our national expansion.
  Restructuring
        charges were approximately $0.3 million for the six months ended June 30,
        2006
        primarily due to employee termination benefits related to the June 2006
        reduction in force. Restructuring charges were $0.6 million for the same
        period
        in 2005. The 2005 charges related primarily to the completion of the sale
        of
        substantially all of our enterprise customer base for employee termination
        benefits and rent expense for vacated premises.
 
 Consolidated
        loss from operations was $2.2 million and $2.1 million for the six months
        ended
        June 30, 2006 and 2005, respectively.
  Consolidated
        interest expense, net decreased to $2.9 million for the six months ended
        June
        30, 2006 compared to $4.1 million for the same period in 2005 due primarily
        from
        the extinguishment of the Senior Secured Note during the first quarter of
        2005.
        Our interest expense, net was as follows:


**Six
                  Months Ended****June
                  30,****2006**
              
              **2005**(unaudited)(Dollars
                  in thousands)Interest
                   on Senior Notes
              
              $
              2,437
              
              $
              2,437Accreted
                  discount on Senior Secured Note
              
              
              -
              
              
              1,262Amortization
                  of deferred financing costs
              
              
              114
              
              
              205Other
                  interest expense
              
              
              725
              
              
              519Less
                  interest income
              
              
              (372
              )
              
              (316
              )Interest expense, net
              
              $
              2,904
              
              $
              4,107




During
        the six months ended June 30, 2005, we recorded a gain of $23.9 million from
        the
        sale of substantially all of our enterprise customer base that occurred during
        the first quarter of 2005.
 
 On
        March
        11, 2005, pursuant to the terms of a Payoff Letter, by and between us and
        Deutsche Bank, we utilized $26.9 million of the proceeds from the sale of
        substantially all of our enterprise customer base to TelePacific, as well
        as
        $13.8 million cash on hand, to prepay in full the $40 million Senior Secured
        Note (including all outstanding principal and accrued and unpaid interest)
        we
        had issued to Deutsche Bank on December 19, 2003. In addition, pursuant to
        the
        terms of the Payoff Letter, we retired the warrants to acquire up to 26,666,667
        shares of our common stock that were issued to Deutsche Bank in connection
        with
        the issuance of the Senior Secured Note, which decreased additional paid
        in
        capital by approximately $13.5 million. The prepayment of the Senior Secured
        Note and the retirement of the related warrants resulted in a $2.1 million
        loss
        on the extinguishment of debt.
 
 For
        the
        six months ended June 30, 2006 and 2005, our effective income tax rate was
        0.0%
        and 3.4%, respectively.
 
 Consolidated
        net loss was $5.1 million for the six months ended June 30, 2006 compared
        to net
        income of $15.0 million during the same period in 2005 primarily due to the
        factors discussed in the preceding paragraphs.
 
 32
 **Quarterly
        Operating and Statistical Data:**
 
 The
        following tables summarize the unaudited results of operations as a percentage
        of revenues for the three and six months ended June 30, 2006 and 2005. The
        following data should be read in conjunction with the unaudited condensed
        consolidated financial statements and notes thereto included elsewhere in
        this
        report:
  **Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30,**
              
              **June
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**(unaudited)
              
              (unaudited)**Consolidated
                  Statements of Operations****Data:**Revenue
              
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %Network
                  expenses (exclusive of depreciation shown separately
                  below)
              
              
              40.0
              %
              
              44.4
              %
              
              42.4
              %
              
              40.5
              %Selling,
                  general and administrative expenses
              
              
              55.3
              %
              
              56.9
              %
              
              61.1
              %
              
              54.2
              %Reimbursed
                  transition expenses
              
              
              (10.2
              )%
              
              (13.0
              )%
              
              (12.2
              )%
              
              (5.7
              )%Depreciation
                  and amortization expenses
              
              
              11.5
              %
              
              14.8
              %
              
              12.7
              %
              
              14.0
              %Income
                  (loss) from operations
              
              
              2.5
              %
              
              (4.1
              )%
              
              (4.7
              )%
              
              (4.3
              )%Net
                  (loss) income
              
              
              (3.1
              )%
              
              (10.6
              )%
              
              (10.9
              )%
              
              30.0
              %




The
        following table sets forth unaudited statistical data for each of the specified
        quarters of 2006 and 2005. The operating and statistical data for any quarter
        are not necessarily indicative of results for any future period.


**Three
                  Months Ended****2006**
              
              **2005****June
                  30,**
              
              **March
                  31,**
              
              **Dec.
                  31,**
              
              **Sept.
                  30,**
              
              **June
                  30,**(unaudited)
              
              
              (unaudited)
              
              
              (unaudited)
              
              
              (unaudited)
              
              
              (unaudited)Ports
                  equipped
              
              
              1,288,704
              
              
              1,151,616
              
              
              1,151,616
              
              
              1,054,848
              
              
              1,052,400Quarterly
                  minutes of useswitched (in billions)
              
              
              8.8
              
              
              11.2
              
              
              12.0
              
              
              12.2
              
              
              12.2Capital
                  additions(in thousands)
              
              
              $557
              
              
              $10,568
              
              
              $5,797
              
              
              $3,259
              
              
              $1,575Employees
              
              
              265
              
              
              305
              
              
              296
              
              
              273
              
              
              248


**Liquidity
        and Capital Resources:**
 
 *Sources
        and uses of cash.* At
        June
        30, 2006, cash and short-term investments decreased $6.2 million to $20.5
        million from $26.7 million at December 31, 2005. The decrease was primarily
        due
        to costs associated with our national expansion, debt interest payments and
        lower customer receipts.
 
 33
 Net
        cash
        used in operating activities was $4.5 million for the six months ended June
        30,
        2006 as compared to cash provided of $2.5 million for the same period ended
        in
        2005. The cash used for 2006 was primarily due to a loss from operations.
 
 Net
        cash
        used in investing activities was $7.9 million for the six months ended June
        30,
        2006 due primarily to the purchase of property and equipment. Net cash provided
        by investing activities was $20.8 million during the six months ended June
        30,
        2005 due primarily to proceeds from the sale of substantially all of our
        enterprise customer base in March 2005.
 
 Net
        cash
        provided by financing activities was $5.9 million for the six months ended
        June
        30, 2006 was primarily due to proceeds from borrowings under notes payable.
        Net
        cash used in financing activities was $40.3 million during the six months
        ended
        June 30, 2005 primarily due to the prepayment of the Senior Secured Note
        with
        proceeds from the sale of the enterprise customer base and cash on hand.
  *Cash
        requirements.* The
        telecommunications service business is capital intensive. Our operations
        have
        required the expenditure of substantial amounts of cash for the design,
        acquisition, construction and implementation of our network, particularly
        in
        connection with the national expansion. We continue to seek further ways
        to
        implement our national expansion and otherwise enhance our infrastructure
        in
        2006 and beyond. As a result of the national expansion, various other capital
        projects and our business plan, as currently contemplated, we anticipate
        making
        capital expenditures, excluding acquisitions, if any, of approximately $11.5
        million for the next twelve months. However, the actual cost of capital
        expenditures will depend on a variety of factors. Accordingly, our actual
        capital requirements may exceed, or fall below this amount.
 
 During
        the normal course of business, we may enter into agreements with some suppliers,
        which allow these suppliers to have equipment or inventory available for
        purchase based upon criteria as defined by us. As of June 30, 2006, we did
        not
        have any material future purchase commitments to purchase equipment from
        any of
        our vendors.
 
 *Debt
        outstanding.* At June
        30, 2006 and December 31, 2005, long-term debt and capital lease obligations
        consist of the following:


**June
                  30,**
              
              **December
                  31,****2006**
              
              **2005**(Dollars
                  in thousands)Senior
                  Notes
              
              $
              36,102
              
              $
              36,102Capital
                  lease obligations
              
              
              691
              
              
              651Notes
                  payable
              
              
              24,958
              
              
              12,159Less
                  current portion of notes payable and capital leases
              
              
              (22,071
              )
              
              (5,392
              )$
              39,680
              
              $
              43,520
 The
          Senior
          Notes of which there is $36.1 million in principal amount outstanding at
          June
          30, 2006 and December 31, 2005, mature on February 1, 2009 and bear interest
          at
          13.5% per annum payable in semiannual installments, with all principal
          due in
          full on February 1, 2009.
 
 34
 In
          March
          2006, we completed a new financing agreement with Cisco Systems, Inc. for
          various network equipment and related maintenance. This financing agreement
          was
          comprised of a $0.3 million equipment capital lease and a $0.2 million
          note
          payable exchanged for a 36-month maintenance services agreement. As of
          June 30,
          2006 the principal balance for the capital lease portion of the arrangement
          was
          $0.2 million, and is included in the above table under Capital Lease
          Obligations. As of June 30, 2006 the principal balance of the note payable
          was
          $0.2 and is included in the above table under Notes Payable.
 
 In
          November 2005, we entered into a Loan and Security Agreement (Agreement)
          with
          Comerica Bank, which provides for up to $5 million of revolving advances
          and up
          to $15 million of term loans, subject to certain conditions. Any revolving
          advances are not to exceed 80% of eligible accounts receivables and are
          due and
          payable in full on November 9, 2007. There were no revolving advances as
          of June
          30, 2006.
 
 The
          term
          loan portion of the Agreement, which is to be used within certain limitations
          to
          finance capital equipment expenditures and acquisitions or to refinance
          our
          Senior Notes, is structured into two tranches; the first included all term
          loan
          borrowings through June 9, 2006, at which point it expired, and is payable
          in
          thirty equal monthly installments commencing July 1, 2006. The second tranche
          started June 10, 2006 and continues through January 9, 2007 at which point
          it
          expires, and shall be payable in twenty-three equal monthly installments
          commencing February 1, 2007.
 
 Rates
          for
          borrowings under the Agreement float and are based, at our election, at
          2.75%
          above a calculated Eurodollar rate for the revolving advances and 3.75%
          above a
          Eurodollar rate for the term loans or Comerica’s prime rate for the revolving
          advances and Comerica’s prime rate plus 0.5% for the term loans. The Agreement
          is secured by all of our personal property and requires us to maintain
          certain
          financial and restrictive covenants. As of June 30, 2006 and December 31,
          2005,
          the term loan principal balance was $10.5 million and $2.5 million,
          respectively, and is included in the above table under Notes Payable.
  On
          May
          30, 2006, we entered into the Third Amendment to the Loan and Security
          Agreement
          (Third Amendment) with Comerica Bank. The Third Amendment provided in part
          that
          the financial covenants based upon the adjusted quick ratio, debt service
          coverage ratio and total liabilities to effective tangible net worth under
          the
          Loan and Security Agreement were amended such that we would not be required
          to
          comply with such covenants as they were in effect prior to the amendment
          during
          the period commencing on May 1, 2006 through and including June 30, 2006.
 
 On
          July
          31, 2006, we entered into a Fourth Amendment to the Loan and Security Agreement
          (Fourth Amendment) with Comerica Bank. The Fourth Amendment provides in
          part
          that the financial covenants based upon the adjusted quick ratio, the debt
          service coverage ratio and the total liabilities to effective tangible
          net worth
          covenants under the Loan and Security Agreement were amended such that
          we would
          not be required to comply with such covenants as they were in effect prior
          to
          the amendment during the period commencing on July 1, 2006 through and
          including
          September 30, 2006; provided that we remain in compliance with the minimum
          cash
          covenant. As amended, the minimum cash covenant specifies that we are required
          to maintain a minimum balance of cash at Comerica Bank equal to $2.5 million
          in
          excess of the outstanding indebtedness during the period beginning July
          1, 2006
          through and including September 30, 2006. The Fourth amendment also provides
          that we cannot request additional extensions of credit under the Loan and
          Security Agreement until we are in compliance with all of the financial
          covenants prior to giving effect to the amendments.
 
 35
 We
          do not
          currently expect to be in compliance with all of the financial covenants
          in the
          Loan and Security Agreement for periods after September 30, 2006. As such,
          we
          expect that it will be necessary to negotiate with Comerica Bank an additional
          amendment to the Loan and Security Agreement to comply with these financial
          covenants for periods after September 30, 2006. There can be no assurances
          that
          Comerica Bank will agree to such a request.
 
 If
          we
          violate the financial covenants in the Loan and Security Agreement, and
          Comerica
          Bank is unwilling to grant a waiver or enter into an amendment that relieves
          or
          modifies our obligation to comply with these financial covenants, Comerica
          Bank
          will have available to it all of the remedies provided for under the Loan
          and
          Security Agreement, including the right to accelerate, or declare due and
          payable, all outstanding amounts under the Loan and Security Agreement.
          Furthermore, we do not believe that we will be able to meet the original
          covenants included in the Loan and Security Agreement with Comerica Bank
          for
          periods following September 30, 2006, absent obtaining additional financing.
          As
          a result, we have classified our Comerica Bank debt as of June 30, 2006
          of $10.5
          million as a current liability in accordance with Emerging Issues Task
          Force No.
          (EITF) 86-30, “Classification of Obligations when a Violation is Waived by the
          Creditor.” EITF 86-30 reached a consensus that debt should be classified as
          current if a covenant violation has occurred at the balance sheet date
          or would
          have occurred absent a loan modification and it is probable that the borrower
          will not be able to comply with the covenants at measurement dates that
          are
          within the next 12 months.
 
 *Future
          uses and sources of cash* .
          Our
          principal sources of operating funds for the remainder of 2006 and the
          first
          half of 2007 are anticipated to be current cash and short-term investment
          balances and cash flows from operating activities. However, we believe
          that our
          requirements for operating funds over the next twelve months will cause
          our
          current cash and short-term investment balances to fall below those required
          by
          the terms of our financing arrangement with Comerica Bank. As a result,
          if we
          continue to fund our operations without obtaining an additional source
          of
          financing, Comerica Bank may exercise its rights under the Loan and Security
          Agreement, including the right to accelerate, or declare the entire loan
          amount
          due and payable. If Comerica accelerates the debt, we believe that other
          sources
          of our existing financing arrangements will have, and may exercise, similar
          rights and we will not have sufficient liquidity and capital resources
          to
          operate for the next 12 months. We currently expect to fund the following
          expenditures during the next 12 months:
 
 •  interest
          payments of approximately $6.1 million on Senior Notes and other
          notes;
 
 •  anticipated
          capital expenditures of approximately $11.5 million;
 
 •  debt
          principal payments of approximately $8.9 million; and
 
 •  capital
          lease payments (including interest) of approximately $0.6 million.
 
 36
 In
          an
          effort to address our financing needs, we have retained the services of
          a
          financial advisory firm, and together with such firm are in the process
          of
          exploring strategic alternatives, including raising additional debt or
          equity
          financing, entry into strategic relationships or joint ventures and merger
          and
          acquisitions. While we have successfully raised capital in the past, their
          can
          be no assurance that sources of financing will continue to be available
          to us in
          amounts sufficient to meet our financial needs, or that any such financing
          will
          be available on terms acceptable to us.
 
 If
          we are
          unable to secure additional financing, (1) we may not be able to take advantage
          of business opportunities or respond to competitive pressures, or may be
          required to reduce the scope of our planned national expansion and other
          product
          development and marketing initiatives, any of which could have a negative
          impact
          on our business and operating results; (2) it could become necessary for
          us to
          significantly curtail our operations in order to meet our debt service
          obligations and (3) even if we did take such actions to permit us to service
          our
          debt , we would not meet any of the debt covenants required under the Comerica
          loan agreement.
  In the event of our non-compliance with the covenants of the loan agreement,
          at
          any future time, Comerica could exercise its rights under the agreement,
          and
          call the loan. Such action would substantially and adversely impact our
          ability
          to continue to operate and to meet other obligations.
 
 To
          the
          extent that we raise additional financing through the sale of equity or
          convertible debt securities, the issuance of such securities may result
          in
          dilution to existing stockholders. If additional financing is raised through
          the
          issuance of debt securities, these securities may have rights; preferences
          and
          privileges senior to holders of common stock and the terms of such debt
          could
          impose restrictions on our operations.
 
 
 **ITEM
          3.**  **QUANTITATIVE
          AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**
  We
          are
          not exposed to market risks from changes in foreign currency exchange rates
          or
          commodity prices. We do not hold derivative financial instruments nor do
          we hold
          securities for trading or speculative purposes. At June 30, 2006, we had
          an
          outstanding note payable of $10.5 million to Comerica Bank (Comerica).
          This note
          is at Comerica’s prime rate plus 0.5%, which was 8.75% as of June 30, 2006. A
          hypothetical 1% point increase in short-term interest rates would reduce
          the
          annualized income before tax by approximately $0.1 million as a result
          of higher
          interest expense.
  We
          are
          exposed to changes in interest rates on our investments in cash equivalents
          and
          short-term investments. Approximately $20.2 million of our total cash and
          investments are in cash equivalents with original maturities of less than
          three
          months and the remainder in short-term investments with maturities of less
          than
          12 months. A hypothetical 1% decrease in short-term interest rates would
          reduce
          the annualized pretax interest income on our $20.5 million cash, cash
          equivalents and short-term investments at June 30, 2006 by approximately
          $0.2
          million.
 
 **ITEM
          4.**  **CONTROLS
          AND PROCEDURES**
 
 As
          of the
          end of the period covered by this Report, the Company carried out an evaluation,
          under the supervision and with the participation of the Company's management,
          including the Chief Executive Officer and Chief Financial Officer, of the
          effectiveness of the Company's “disclosure controls and procedures” (as defined
          in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the
          “Exchange Act”), in accordance with Rule 13a-15 of the Exchange Act. Based on
          that evaluation, the Chief Executive Officer and Chief Financial Officer,
          together with the other members of management participating in the evaluation,
          concluded that the Company's disclosure controls and procedures are effective
          at
          the reasonable assurance level.
 
 37
 There
          have been no changes in the Company's internal control over financial reporting
          that occurred during the quarter ended June 30, 2006 that have materially
          affected, or are reasonably likely to materially affect, the Company’s internal
          control over financial reporting. It should be recognized that the design
          of any
          system of controls is based upon certain assumptions about the scope of
          the
          tasks to be performed and the environment in which the tasks are to be
          performed. As such, the Company's internal controls provide the Company
          with a
          reasonable assurance of achieving their intended effect.
  **PART
          II**
 **OTHER
          INFORMATION**
 **ITEM
          1.** **Legal
          Proceedings**
  See
          Note
          8 to the Unaudited Condensed Consolidated Financial Statements included
          elsewhere in this Form 10-Q and “Management's Discussion and Analysis of
          Financial Condition and Results of Operations—Introduction” for a description of
          certain legal proceedings involving the Company.
 
 **ITEM
          1A. Risk Factors**
 
 There
          have been no material changes in the previously reported risk factors as
          noted
          in the Company’s Annual Report on Form 10-K for the period ended December 31,
          2005 filed with the SEC on March 29, 2006.
 
 **ITEM
          4. Submission of Matters to a Vote of Security Holders**
  The
          Company’s Annual Meeting of Shareholders was held on June 14, 2006 and
          considered the following proposals:
 
 The
          first
          proposal was to elect nine directors to the Board of Directors. Votes cast
          were
          as follows:
 **Percentage****Votes
                    cast**
                
                **of
                    total****(thousands)**
                
                **votes
                    cast**Wallace
                    W. GriffinFor
                
                
                31,186
                
                
                85.5
                %Withheld
                
                
                5,274
                
                
                14.536,460
                
                
                100.0
                %Henry
                    R. CarbelliFor
                
                
                31,162
                
                
                85.5
                %Withheld
                
                
                5,298
                
                
                14.536,460
                
                
                100.0
                %David
                    G. ChandlerFor
                
                
                35,467
                
                
                97.3
                %Withheld
                
                
                993
                
                
                2.736,460
                
                
                100.0
                %
  38
 Jerry
                    L. JohnsonFor
                
                
                31,202
                
                
                85.6
                %Withheld
                
                
                5,258
                
                
                14.436,460
                
                
                100.0
                %
 Samuel
                    A. PlumFor
                
                
                31,209
                
                
                85.6
                %Withheld
                
                
                5,251
                
                
                14.436,460
                
                
                100.0
                %Thomas
                    A. MunroFor
                
                
                35,228
                
                
                96.6
                %Withheld
                
                
                1,232
                
                
                3.436,460
                
                
                100.0
                %Timothy
                    A. SamplesFor
                
                
                35,228
                
                
                96.6
                %Withheld
                
                
                1,232
                
                
                3.436,460
                
                
                100.0
                %Frederick
                    D. LawernceFor
                
                
                35,458
                
                
                97.3
                %Withheld
                
                
                1,002
                
                
                2.736,460
                
                
                100.0
                %William
                    H. DavidsonFor
                
                
                35,467
                
                
                97.3
                %Withheld
                
                
                993
                
                
                2.736,460
                
                
                100.0
                %
  The
          second proposal was the approval of (a) an amendment to the Company’s Amended
          and Restated Articles of Incorporation giving effect to a reverse split
          of our
          common shares and (b) all ministerial actions required in connection with
          effecting such reverse share split. Votes cast were as follows:
 
 **Votes
                      cast (thousands)**
                  
                  
                  **Percentage
                      of total votes cast**For
                  
                  
                  34,711
                  
                  
                  95.2
                  %Against
                  
                  
                  1,711
                  
                  
                  4.7Abstain
                  
                  
                  39
                  
                  
                  0.136,461
                  
                  
                  100.0
                  %
   39
  The
              third
              proposal was to approve amendments to the Company’s Amended and Restated Bylaws
              authorizing our board of directors to (a) establish the size of the
              board and
              (b) divide the board members into either two or three classes if and
              when we are
              qualified as a listed company under California law. This proposal did
              not pass,
              as it required the majority of the issued and outstanding shares voting
              in favor
              of the proposal. Votes cast were as follows:
  **Votes
                        cast (thousands)**
                    
                    
                    **Percentage
                        of total votes cast**For
                    
                    
                    15,898
                    
                    
                    62.1
                    %Against
                    
                    
                    5,976
                    
                    
                    23.3Abstain
                    
                    
                    3,722
                    
                    
                    14.525,596
                    
                    
                    100.0
                    %


**ITEM
      6.** **Exhibits**





Exhibits




10.62
            Fourth
                Amendment to Loan and Security Agreement dated as of July 31, 2006,
                by and
                between Comerica Bank and the
                Company.





31.1
            Certification
                by Henry R. Carabelli, Chief Executive Officer pursuant to Section
                302 of
                the Sarbanes-Oxley Act of 2002.





31.2**
            Certification
                byMichael
                L. Sarina,
                Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act
                of 2002.


32.1
            Certification
                  by Henry R. Carabelli, Chief Executive Officer pursuant to Section
                  906 of
                  the Sarbanes-Oxley
                  Act of 2002.  32.2
            Certification
                  byMichael
                  L. Sarina,
                  Chief Financial Officer**pursuant
                  to Section 906 of the Sarbanes-Oxley Act of
                  2002.





**Note:
      ITEMS 2, 3 and 5 are not applicable and have been omitted.**


40





**SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned, thereunto
      duly authorized on August 11, 2006.
















PAC-WEST
      TELECOMM, INC.





/s/
      Henry
      R. Carabelli


_____________________________


Henry
      R.
      Carabelli


President
      and Chief Executive Officer




























/s/ Michael
      L. Sarina


______________________________


Michael
      L. Sarina


Chief
      Financial Officer





41