**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 September 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
      October 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 September 30,
      2006**


**Table
      of Contents**






**Part
                I.**
            **FINANCIAL
                INFORMATION**
            PageItem
                1.
            Financial
                Statements (Unaudited)Condensed
                Consolidated Balance SheetsSeptember 30, 2006 and December 31, 2005
            3Condensed
                Consolidated Statements of Operations and Comprehensive
                Income(Loss) - Three and nine months ended September 30, 2006 and
                2005
            4Condensed
                Consolidated Statements of Cash Flows - Ninemonths ended September 30, 2006 and 2005
            5Notes
                to Unaudited Condensed Consolidated Financial Statements
            7Item
                2.
            Management's
                Discussion and Analysis of Financial Conditionand Results of Operations
            23Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risks
            41Item
                4.
            Controls
                and Procedures
            42**Part
                II.**
            **OTHER
                INFORMATION**Item
                1.
            Legal
                Proceedings
            42Item 1A.
            Risk
                Factors
            42Item
                6.
            Exhibits
            43Signatures
            
            44







2


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


**September
                  30,**
              
              **December
                  31,****2006**
              
              **2005****(Unaudited)****ASSETS**Current
                  Assets:Cash
                  and cash equivalents
              
              
              
              
              $
              21,738
              
              $
              26,681Trade
                  accounts receivable, net of allowances of$1,034 and $368 at September 30, 2006 andDecember 31, 2005, respectively
              
              
              
              
              
              13,770
              
              
              7,806Receivable
                  from transition service agreement
              
              
              
              
              
              270
              
              
              1,170Prepaid
                  expenses and other current assets
              
              
              
              
              
              3,019
              
              
              3,129Total current assets
              
              
              
              
              
              38,797
              
              
              38,786Property
                  and equipment, net
              
              
              
              
              
              43,068
              
              
              39,458Other
                  assets, net
              
              
              
              
              
              787
              
              
              1,079Total assets
              
              
              
              
              $
              82,652
              
              $
              79,323**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  Liabilities:Accounts
                  payable
              
              
              
              
              $
              10,939
              
              $
              6,578Current
                  obligations under notes payable and capital leases
              
              
              
              
              
              5,404
              
              
              5,392Accrued
                  interest
              
              
              
              
              
              974
              
              
              2,032Other
                  accrued liabilities
              
              
              
              
              
              6,573
              
              
              8,492Total current liabilities
              
              
              
              
              
              23,890
              
              
              22,494Senior
                  Notes
              
              
              
              
              
              36,102
              
              
              36,102Notes
                  payable and capital leases, less current portion
              
              
              
              
              
              11,568
              
              
              7,418Other
                  liabilities, net
              
              
              
              
              
              135
              
              
              72Total liabilities
              
              
              
              
              
              71,695
              
              
              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 September 30, 2006 and December 31,2005, respectively
              
              
              
              
              
              37
              
              
              37Additional
                  paid-in capital
              
              
              
              
              
              191,373
              
              
              191,319Accumulated
                  deficit
              
              
              
              
              
              (180,496
              )
              
              (177,721
              )Accumulated
                  other comprehensive gain (loss)
              
              
              
              
              
              43
              
              
              (25
              )Deferred
                  stock compensation
              
              
              
              
              
              -
              
              
              (373
              )Total stockholders' equity
              
              
              
              
              
              10,957
              
              
              13,237Total liabilities and stockholders' equity
              
              
              
              
              $
              82,652
              
              $
              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**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Revenues
              
              $
              26,171
              
              $
              22,383
              
              $
              72,827
              
              $
              72,383Costs
                  and Expenses:Network expenses (exclusive of depreciation shown separately
                  below)
              
              
              9,906
              
              
              9,628
              
              
              29,711
              
              
              29,901Selling, general and administrative
              
              
              11,465
              
              
              13,006
              
              
              39,987
              
              
              40,127Reimbursed transition expenses
              
              
              (1,501
              )
              
              (4,470
              )
              
              (7,171
              )
              
              (7,318
              )Depreciation and amortization
              
              
              2,980
              
              
              3,365
              
              
              8,925
              
              
              10,349Restructuring charges, net of reversals
              
              
              (11
              )
              
              24
              
              
              254
              
              
              630Total operating expenses
              
              
              22,839
              
              
              21,553
              
              
              71,706
              
              
              73,689Income (loss) from operations
              
              
              3,332
              
              
              830
              
              
              1,121
              
              
              (1,306
              )Interest expense, net
              
              
              1,424
              
              
              1,091
              
              
              4,328
              
              
              5,198Other (income) expense, net
              
              
              (298
              )
              
              216
              
              
              (314
              )
              
              154Gain on sale of enterprise customer base
              
              
              -
              
              
              (267
              )
              
              -
              
              
              (24,132
              )Loss on extinguishment of debt
              
              
              -
              
              
              -
              
              
              -
              
              
              2,138Income (loss) before income taxes
              
              
              2,206
              
              
              (210
              )
              
              (2,893
              )
              
              15,336Income
                  tax (benefit) expense
              
              
              (118
              )
              
              (84
              )
              
              (118
              )
              
              438Net income (loss)
              
              $
              2,324
              
              $
              (126
              )
              $
              (2,775
              )
              $
              14,898Basic
                  income (loss) per share
              
              $
              0.06
              
              $
              (0.00
              )
              $
              (0.07
              )
              $
              0.40Diluted
                  income (loss) per share
              
              $
              0.06
              
              $
              (0.00
              )
              $
              (0.07
              )
              $
              0.38Weighted
                  Average Shares Outstanding:Basic
              
              
              37,268
              
              
              37,132
              
              
              37,230
              
              
              36,958Diluted
              
              
              37,293
              
              
              37,132
              
              
              37,230
              
              
              38,718Comprehensive
                  Income (Loss):Net income (loss)
              
              $
              2,324
              
              $
              (126
              )
              $
              (2,775
              )
              $
              14,898Net unrealized (losses) gains on investments, net of tax
              
              
              (58
              )
              
              31
              
              
              (2
              )
              
              51Reclassification of net realized losses on sale of investments,
                  net of
                  tax
              
              
              56
              
              
              -
              
              
              70
              
              
              -Comprehensive income (loss)
              
              $
              2,322
              
              $
              (95
              )
              $
              (2,707
              )
              $
              14,949












See
      notes
      to unaudited condensed consolidated financial statements.


4




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


**Nine
                  Months Ended****September
                  30,****2006**
              
              **2005****Operating
                  activities:**Net
                  (loss) income
              
              $
              (2,775
              )
              $
              14,898Adjustments
                  to reconcile net (loss) income to net cashprovided by operating activities:Depreciation and amortization
              
              
              8,925
              
              
              10,349Amortization of deferred financing costs
              
              
              171
              
              
              255Amortization of discount on notes payable
              
              
              -
              
              
              1,262Stock-based compensation
              
              
              396
              
              
              144Loss on extinguishment of debt
              
              
              -
              
              
              2,138Gain on sale of enterprise customer base
              
              
              -
              
              
              (24,132
              )Provision for doubtful accounts
              
              
              764
              
              
              172Net loss on disposal of property
              
              
              18
              
              
              187Other
              
              
              (33
              )
              
              -Changes
                  in operating assets and liabilities:(Increase) decrease in accounts receivable
              
              
              (6,728
              )
              
              964Decrease (increase) in receivable from transition service
                  agreement
              
              
              900
              
              
              (2,181
              )Decrease in prepaid expenses and other assets
              
              
              405
              
              
              2,814Increase in accounts payable
              
              
              1,397
              
              
              417Decrease in accrued interest
              
              
              (1,058
              )
              
              (1,116
              )Decrease in other current liabilities and other
                  liabilities
              
              
              (1,856
              )
              
              (1,203
              )Net cash provided by operating activities
              
              
              526
              
              
              4,968**Investing
                  activities:**Purchase
                  of property and equipment
              
              
              (9,091
              )
              
              (6,434
              )Proceeds
                  from disposal of property and equipment
              
              
              -
              
              
              99Redemptions
                  of short-term investments, net
              
              
              68
              
              
              3,547Proceeds
                  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
              
              
              (8,990
              )
              
              20,829**Financing
                  activities:**Repayments
                  of notes payable
              
              
              (4,081
              )
              
              (42,766
              )Proceeds
                  from the issuance of common stock
              
              
              31
              
              
              225Principal
                  payments on capital leases
              
              
              (401
              )
              
              (518
              )Net
                  proceeds from borrowing under notes payable
              
              
              7,972
              
              
              1,949Net cash provided by (used in) financing activities
              
              
              3,521
              
              
              (41,110
              )Net decrease in cash and cash equivalents
              
              
              (4,943
              )
              
              (15,313
              )Cash
                  and cash equivalents:Beginning
                  of period
              
              
              26,681
              
              
              32,265End
                  of period
              
              $
              21,738
              
              $
              16,952


(continued)


5


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


**Nine
                Months Ended****September
                30,****2006**
            
            **2005**


**Supplemental
                  Disclosure of Cash Flow Information:**Cash
                  paid during the period for:Interest
              
              $
              5,843
              
              $
              5,572Income
                  taxes
              
              $
              -
              
              $
              495Non-cash
                  Operating and Investing Activities:Acquisitions
                  of property and equipment included in accounts payable
              
              $
              2,964
              
              $
              -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


**PAC-WEST
        TELECOMM, INC.**
 **NOTES
        TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **AS
        OF AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 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.
 
 On
        November 15, 2006, after considering a variety of restructuring alternatives,
        including seeking court protection from creditors, and conducting an extensive
        search for financing sources, the Company completed a comprehensive
        restructuring of its financial obligations centered around an investment
        and
        refinancing provided by Columbia Ventures Corporation (Columbia Ventures),
        a
        private investment company focused principally on the domestic and international
        telecommunications industry (see Note 2).
 
 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 nine months ended September 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.
 
 7
 **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:
  •  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.
 
 8
 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.
  *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 condensed
        consolidated statements of operations and comprehensive income
        (loss).
 
 9
 **2.**
            **Restructuring
                of the Company** 
 On
        November 15, 2006, the Company completed a comprehensive restructuring of
        the
        Company’s financial obligations centered around an investment and refinancing
        provided by Columbia Ventures, a private investment company focused principally
        on the domestic and international telecommunications industry.
  As
        part
        of the financial restructuring on November 15, 2006, an affiliate of Columbia
        Ventures purchased the Company’s Senior Secured Credit Facility, which had an
        outstanding balance at purchase of $8,795,638, from its senior lender, Comerica
        Bank (Comerica). In connection with this purchase, Comerica assigned its
        rights
        and obligations under the Senior Secured Credit Facility to the loan purchaser
        and, concurrently with such purchase and assignment, such facility was amended
        and restated to provide, among other things, an increase in the maximum loan
        commitment to $24,000,000, consisting of an $8,805,638 (Tranche A), a $7,194,361
        term loan (Tranche B) and a revolving credit facility of $8,000,000. Tranche
        A
        was drawn on November 15, 2006 to fund the purchase from Comerica of the
        outstanding balance under the Senior Secured Credit Facility and reimburse
        Comerica for $10,000 in legal expenses associated with the purchase. Tranche
        B
        is generally expected to become available to the Company at the later to
        occur
        of (1) February 1, 2007, (2) the commercial availability of the Company’s DIDOD
        product release, and (3) the effective date of a long term binding agreement
        between the Company and VeriSign, Inc., a strategic alliance partner of the
        Company. The revolving line of credit is generally expected to become available
        to the Company after February 1, 2007.
  The
        Senior Secured Credit Facility is expected to be one of the principal sources
        of
        operating funds for the Company. However, there can be no assurance that
        the
        conditions to availability of borrowing under the Senior Secured Credit Facility
        will be satisfied. If such conditions are not satisfied, the Company will not
        be
        able to rely on its Senior Secured Credit Facility for operating funds, which
        may materially and adversely impact its ability to pursue its business plans
        and
        objectives.
  In
        addition, another affiliate of Columbia Ventures purchased 48,158 newly issued
        shares of Series B-1 Preferred Stock and 830,959 shares of newly issued shares
        of Series B-2 Preferred Stock, non-voting, convertible preferred stock for
        $999,999.98. Series B-1 Preferred Stock was issued at closing. The Series
        B-2
        Preferred Stock will be issued upon receipt of shareholder approval of an
        amendment to the Company’s articles of incorporation to authorize sufficient
        additional common stock to permit the conversion in full of the Series B-2
        Preferred Stock. The Series B-1 and B-2 Preferred Stock are convertible into
        approximately 51% and 95%, respectively, of the Company’s common stock on a
        fully-diluted basis, subject to satisfaction of certain conditions, including
        receipt of requisite regulatory approvals. The Company intends to use the
        proceeds for working capital and general corporate purposes.
  On
        November 14, 2006, the Company entered into a letter agreement with SMH Capital
        Advisors, Inc., an investment advisor who has represented that it has investment
        discretion with respect to approximately $21.0 million in principal amount
        of
        the 13.5% Senior Notes due 2009 (the Senior Notes), in which such investment
        advisor has agreed to exchange all Senior Notes for which it holds investment
        discretion for new 13.5% Notes due 2009 (the New Notes) as part of an exchange
        offer made to all holders of Senior Notes. The exchange is expected to be
        completed by February 1, 2007. The terms and conditions of the New Notes
        are
        expected to be substantially identical to the Senior Notes, except that the
        New
        Notes will provide that interest under the New Notes will not be payable
        until
        maturity and the holders of the New Notes will have the right to receive
        payment
        of all outstanding principal and accrued interest before the holders of the
        Senior Notes will have the right to receive any outstanding principal. Assuming
        SMH Capital Advisors, tenders $21.0 million in principal amount into such
        exchange offer, the affect of this transaction would be to defer payment
        of $2.9
        million of interest in 2007, and $2.9 million of interest in 2008 until
        maturity, which is February of 2009.
 
 *This
        communication is not an offer to exchange Senior Notes for New Notes or a
        solicitation of an offer to exchange Senior Notes for New Notes. The offer
        to
        exchange Senior Notes for New Notes is expected to be made pursuant to an
        exemption from registration pursuant to Section 3(a)(9) under the Securities
        Act
        of 1933, as amended, solely by means of an offering circular and disclosure
        statement and other documents provided to holders of the Senior
        Notes.*
 
 10
 The
        Company also reached an agreement with Merrill Lynch Capital to restructure
        approximately $5.7 million of its obligations to them. Such agreement provides
        for, among other things, deferral of payments of principal and interest due
        to
        them in January and February of 2007, waiver of compliance with certain
        covenants and a commitment to restructure the maturity date and payment terms
        on
        the remaining obligations should certain conditions be met. Pursuant to such
        agreement, subject to satisfaction of certain conditions, including the
        condition that both the revolving and term loan facilities under the Senior
        Secured Credit Facility as amended and restated, are available to the Company,
        the Company may elect to restructure its current obligations to Merrill Lynch
        of
        an aggregate of approximately $5.7 million into a single obligation bearing
        interest at a rate of 9.11% per annum to be paid over 30 months, with $75,000
        due each month for the first 15 months and $125,000 due each month for the
        next
        14 months with the balance due August 1, 2009. If the conditions to such
        restructuring are not met, the Company must continue to make its currently
        scheduled payments of principal and interest, with Merrill Lynch reserving
        all
        of its current rights and remedies. In addition, under such agreement, the
        Company agreed to pay Merrill Lynch Capital in respect of the Company’s
        obligations an amount equal to 20% of any interest savings achieved as a
        result
        of the tender of more than $21.0 million in principal amount of Senior Notes
        as
        part of the exchange offer the Company intends to conduct in respect of its
        Senior Notes.
 
 In
        addition, the Company reached an agreement with Tekelec, one of its key
        suppliers, to restructure approximately $1.9 million of its obligation to
        them.
        As part of its agreement with Tekelec, the Company paid them $535,000 to
        settle
        in full such obligation.
 
 **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 $90,000
        and
        $292,000 in expense during the three and nine months ended September 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 September 30, 2006 and 2005 was $118,000 and $48,000, respectively.
        Total
        compensation expense recognized for stock-based awards for the nine months
        ended
        September 30, 2006 and 2005 was $396,000 and $140,000, 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
        $28,000 and $105,000 for the three and nine months ended September 30, 2006,
        respectively, related to restricted stock awards. The Company recognized
        approximately $48,000 and $140,000 for the three and nine months ended September
        30, 2005, respectively, related to performance unit awards. Cash received
        for
        options exercised during the nine months ended September 30, 2006 and 2005
        was
        $31,000 and $225,000, respectively.
 
 11
 For
        the
        nine months ended September 30, 2006 and the three months ended September
        30,
        2005, there was no impact on earnings per share from employee stock options
        since such options were anti-dilutive. Accordingly, for the nine months ended
        September 30, 2006, 430,226 shares were excluded from the diluted net loss
        per
        share calculation. In addition, 1,181,326 shares were excluded from the diluted
        net loss per share calculation for the three months ended September 30,
        2005.
  The
        effect of the change from applying the original provisions of SFAS 123 for
        the
        comparison periods are as follows:




**Three
                Months Ended**
            
            **Nine
                Months Ended****September
                30, 2005**
            
            **September
                30, 2005**(Dollars
                in thousands except per share amounts)Net
                (loss) income as reported
            
            $
            (126
            )
            $
            14,898Total
                stock-based employee compensation included inreported net (loss) income, net of tax
            
            
            48
            
            
            140Total
                stock-based employee compensation determinedunder the fair value based method
            
            
            (168
            )
            
            (442
            )Pro
                forma
            
            $
            (246
            )
            $
            14,596Basic
                net income (loss) per common share:As reported
            
            $
            (0.00
            )
            $
            0.40Pro forma
            
            $
            (0.01
            )
            $
            0.39Diluted
                net income (loss) per common share:As reported
            
            $
            (0.00
            )
            $
            0.38Pro forma
            
            $
            (0.01
            )
            $
            0.38




**Stock
        Incentive Plans**
  In
        January 1999, the
        Company’s Board of Directors approved the terms of the 1999 Stock Incentive 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 September 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 2.6 years.
        The total fair value of shares vested during the three and nine months ended
        September 30, 2006 was approximately $27,000 and $289,000, respectively.
        For the
        periods ended September 30, 2006, there was no stock-based compensation cost
        capitalized and no tax benefit recognized.
 
 12
 *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 nine months ended September 30, 2006 and 2005 are presented
        as
        follows:




**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                    30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**Expected
                  volatility
              
              
              108.5
              %
              
              106.0
              %
              
              109.6
              %
              
              106.0
              %Risk-free
                  interest rate
              
              
              5.0
              %
              
              3.9
              %
              
              4.8
              %
              
              3.8
              %Expected
                  term
              
              
              6.2
              
              
              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 September 30, 2006, and changes during the nine
      months 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
              
              
              415
              
              $
              0.81Exercised
              
              
              (16
              )
              $
              0.50Cancelled
              
              
              (549
              )
              $
              1.24Outstanding
                  at September 30, 2006
              
              
              5,654
              
              $
              1.67
              
              
              6.0
              
              $
              0Vested
                  and exercisable atSeptember
                  30, 2006
              
              
              4,042
              
              $
              1.91
              
              
              4.8
              
              $
              0
  The
        weighted-average fair
        value of options granted during the three months ended September 30, 2006
        and
        2005 was $0.46 and $0.64, respectively. The weighted-average fair value of
        options granted during the nine months ended September 30, 2006 and 2005
        was
        $0.69 and $.90, respectively. The total intrinsic value of options exercised
        during the three months ended September 30, 2006 and 2005 was approximately
        $0
        and $14,000, respectively. The total intrinsic value of options exercised
        during
        the nine months ended September 30, 2006 and 2005 was approximately $6,000
        and
        $193,000, respectively.
 13
 *Restricted
          Stock*
  As
          of September 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 September 30, 2006,
          there was approximately $309,000 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 September 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.
  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 for the periods ended September
          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:
 **First
                    Semi-Annual Period**
                
                **Second
                    Semi-Annual Period****2006**
                
                
                **2005**
                
                
                **2006**
                
                
                **2005**Expected
                    volatility
                
                
                68.0
                %
                
                84.0
                %
                
                74.0
                %
                
                84.0
                %Risk-free
                    interest rate
                
                
                4.4
                %
                
                2.5
                %
                
                5.1
                %
                
                3.2
                %Expected
                    term
                
                
                0.5
                
                
                0.5
                
                
                0.5
                
                
                0.5Expected
                    dividend yield
                
                
                0.0
                %
                
                0.0
                %
                
                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.
  Compensation
          expense
          recognized for the three and nine months ended September 30, 2006 was
          approximately $5,000 and $13,000, respectively.
 14
 **4.
            Concentration of Customers and Suppliers**
  For
            the three and nine
            months ended September 30, 2006 and 2005, the Company had the following
            concentrations of revenues and operation costs:
  **Three
                      Months Ended**
                  
                  **Nine
                      Months Ended****September
                      30,**
                  
                  **September
                      30,****2006**
                  
                  **2005**
                  
                  **2006**
                  
                  **2005**Largest
                      customers: Percentage of total revenueCustomer
                      1
                  
                  
                  22.0
                  %
                  
                  25.2
                  %
                  
                  28.8
                  %
                  
                  23.8
                  %Customer
                      2
                  
                  
                  36.3
                  %
                  
                  14.3
                  %
                  
                  20.9
                  %
                  
                  17.4
                  %Largest
                      supplier: Percentage of network expenses
                  
                  
                  32.6
                  %
                  
                  60.2
                  %
                  
                  37.8
                  %
                  
                  45.9
                  %
  During
            each of the
            comparison periods, no other customers accounted for more than 10% of
            total
            revenues. Customer two represented 50.9% of trade accounts receivable
            as of
            September 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 nine months ended September 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 September
              30, 2006
              and December 31, 2005, consist of the following:
 **Restructuring**
                    
                    **Additional**
                    
                    
                    
                    **Restructuring****Liability**
                    
                    **Restructuring**
                    
                    
                    
                    **Liability****as
                        of**
                    
                    **Expense**
                    
                    **Cash**
                    
                    **as
                        of****31-Dec-05**
                    
                    **Incurred**
                    
                    **Payments**
                    
                    **30-Sep-06**(Dollars
                        in thousands)Rent
                        expense for vacated premises
                    
                    $
                    1,915
                    
                    $
                    16
                    
                    $
                    (342
                    )
                    $
                    1,589
   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 nine months ended September 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.
 15
 ***2005
                Restructuring Plan***
  A
                summary of the activity
                for the nine months ended September 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 September
                30, 2006 and
                December 31, 2005, consist of the following:
  **Restructuring**
                      
                      **Additional**
                      
                      
                      
                      **Restructuring****Liability**
                      
                      **Restructuring**
                      
                      
                      
                      **Liability****as
                          of**
                      
                      **Expense**
                      
                      **Cash**
                      
                      **as
                          of****31-Dec-05**
                      
                      **Incurred**
                      
                      **Payments**
                      
                      **30-Sep-06**(Dollars
                          in thousands)One-time
                          employee termination benefits
                      
                      $
                      41
                      
                      $
                      9
                      
                      $
                      (50
                      )
                      $
                      -
  The
                amount of the reserve
                was 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 nine months ended September
                30,
                2006, the Company recorded additional restructuring charges of approximately
                $9,000 for employee termination benefits.
  Total
                cash paid for
                employee termination benefits and rent expense was approximately
                $528,000 and
                $56,000, respectively. Rent expense for vacated premises ended October
                2005. The
                final cash payment for employee termination benefits was recorded
                against the
                2005 restructuring reserve in September 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. During the
                  third quarter of 2006 the Company recorded a reduction of termination
                  benefits
                  of approximately $9,000 primarily related to forfeited benefits.
                  The Company
                  anticipates total cash paid for employee termination benefits to
                  be
                  approximately $229,000. The final cash payment to be recorded against
                  the 2006
                  restructuring reserve is expected to occur in November 2006. A
                  summary of the
                  activity for the nine months ended September 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
                  September 30,
                  2006 and December 31, 2005, consists of the following:
 **Restructuring**
                        
                        **Additional**
                        
                        
                        
                        **Restructuring****Liability**
                        
                        **Restructuring**
                        
                        
                        
                        **Liability****as
                            of**
                        
                        **Expense**
                        
                        **Cash**
                        
                        **as
                            of****31-Dec-05**
                        
                        **Incurred**
                        
                        **Payments**
                        
                        **30-Sep-06**(Dollars
                            in thousands)One-time
                            employee termination benefits
                        
                        $
                        -
                        
                        $
                        229
                        
                        $
                        (214
                        )
                        $
                        15






16


**6.
        Income Taxes**
  The
          Company's effective
          income tax rate for the three months ended September 30, 2006 and 2005
          was 5.3%
          and 40.0%, respectively. The Company’s effective income tax rate for the nine
          months ended September 30, 2006 and 2005 was 4.1% and 2.9%, respectively.
          As of
          September 30, 2006, there was an income tax receivable of $0.4
          million.
  Due
        to the financial
        restructuring discussed (See Note 2), the Company believes that it is
        likely an ownership change, as defined by Section 382 of the Internal Revenue
        Code, has either occurred or will occur in conjunction with the completion
        of
        the transaction. As a result, the Company’s ability to utilize its net
        operating loss carryforwards in the future may be significantly
        reduced.
  **7.
        Other Comprehensive Income (Loss)**
  For
        the three months
        ended September 30, 2006 and 2005, there was $58,000 unrealized losses and
        $31,000 unrealized gains, respectively, of other comprehensive income pertaining
        to net unrealized investment gains and losses on available-for-sale marketable
        securities. Reclassifications of net realized losses on sales of investments
        during the three months ended September 30, 2006 and 2005 was $56,000 and
        $0,
        respectively. For the nine months ended September 30, 2006 and 2005, there
        was
        $2,000 unrealized losses and $51,000 unrealized gains, respectively, of other
        comprehensive income pertaining to net unrealized investment gains and losses
        on
        available-for-sale marketable securities. Reclassification of net realized
        losses on sales of investments during the nine months ended September 30,
        2006
        and 2005 was $70,000 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
        September 30, 2006, it has done so primarily through providing transition
        services to TelePacific. Although the TSA ended with TelePacific on September
        12, 2006, TelePacific is continuing to migrate the enterprise customer base
        to
        its system. Based upon current estimates and given that the Contract ends
        at the
        end of November 2006, the Company believes that it will meet certain minimum
        annual usage levels and therefore will have no need to terminate the Contract
        and hence not incur a termination fee.
  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.
  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.
 
 17
  **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**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**(Dollars
                  in thousands)Revenues
              
              $
              -
              
              $
              218
              
              $
              -
              
              $
              751Revenues
                  as a percentage of total revenues
              
              
              -
              
              
              1.0
              %
              
              -
              
              
              1.0
              %Security
                  monitoring costs
              
              $
              12
              
              $
              7
              
              $
              29
              
              $
              26Oakland
                  property rent payments
              
              $
              99
              
              $
              88
              
              $
              317
              
              $
              265
 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
          September 30, 2006 and December 31, 2005, long-term debt and capital lease
          obligations consisted of the following:
 **September
                    30,**
                
                **December
                    31,****2006**
                
                **2005**(Dollars
                    in thousands)Senior
                    Notes
                
                $
                36,102
                
                $
                36,102Capital
                    lease obligations
                
                
                548
                
                
                651Notes
                    payable
                
                
                16,424
                
                
                12,159Less
                    current portion of notes payable and capital leases
                
                
                (5,404
                )
                
                (5,392
                )$
                47,670
                
                $
                43,520
 18
 The
            Senior Notes, of which there was $36.1 million in principal amount outstanding
            at September 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.
 
 On
            November 15, 2006, the Company completed a comprehensive restructuring
            of its
            financial obligations centered around an investment and refinancing provided
            by
            Columbia Ventures, a private investment company focused principally on
            the
            domestic and international telecommunications industry (see Note 2).
            As part of
            the financial restructuring, the Company has received a commitment from
            SMH
            Capital Advisors, Inc., an investment advisor who has represented to
            the Company
            that it has discretion over approximately $21.0 million of the $36.1
            million of
            outstanding principal amount of the Senior Notes to tender into an exchange
            offer made to all holders of Senior Notes for New Notes expected to be
            completed
            prior to February 1, 2007.
 
 *This
            communication is not an offer to exchange Senior Notes for New Notes
            or a
            solicitation of an offer to exchange Senior Notes for New Notes. The
            offer to
            exchange Senior Notes for New Notes is expected to be made pursuant to
            an
            exemption from registration pursuant to Section 3(a)(9) under the Securities
            Act
            of 1933, as amended, solely by means of an offering circular and disclosure
            statement and other documents provided to holders of the Senior
            Notes.*
 
 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
            September 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 September 30, 2006 and December 31, 2005, the principal
            balance was $1.7 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 September 30, 2006 and December 31, 2005 the principal
            balances
            of $4.7 million and $6.0 million, respectively, are included in the above
            table
            under Notes Payable.
 
 19
 As
            part
            of the financial restructuring, the Company reached an agreement with
            Merrill
            Lynch Capital to restructure approximately $5.7 million of its obligations
            to
            them. Such agreement provides for, among other things, deferral of payments
            of
            principal and interest due to them in January and February of 2007, waiver
            of
            compliance with certain covenants and a commitment to restructure the
            maturity
            date and payment terms on the remaining obligations should certain conditions
            be
            met. In addition, under such agreement, the Company agreed to pay Merrill
            Lynch
            Capital in respect of the Company’s obligations an amount equal to 20% of any
            interest savings achieved as a result of the tender of more than $21.0
            million
            in principal amount of Senior Notes as part of the exchange offer the
            Company
            intends to conduct in respect of its Senior Notes (see Note 2).
 
 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 September
            30,
            2006 and December 31, 2005, the principal balance for the capital lease
            portion
            of the arrangement was $0.3 million and $0.7 million, respectively, and
            is
            included in the above table under Capital Lease Obligations. As of September
            30,
            2006 and December 31, 2005, the principal balance of the note payable
            was $0.3
            million and $0.7 million, respectively, and is included in the above
            table under
            Notes Payable. In March 2006, the Company completed a 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 September 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 September 30, 2006 the principal balance of
            the note
            payable was $0.1 and is included in the above table under Notes Payable.
            The
            Company’s obligations to Cisco were not restructured as part of the financial
            restructuring.
 
 In
            November 2005, the Company entered into a Senior Secured Credit Facility
            with
            Comerica, which provided for up to $5 million of revolving advances and
            up to
            $15 million of term loans, subject to certain conditions. Any revolving
            advances
            were not to exceed 80% of eligible accounts receivables and were due
            and payable
            in full on November 9, 2007. There were no revolving advances as of September
            30, 2006.
 
 The
            term
            loan portion of the Senior Secured Credit Facility, which was to be used
            within
            certain limitations to finance capital equipment expenditures and acquisitions
            or to refinance the Senior Notes, was structured into two tranches; the
            first
            included all term loan borrowings through June 9, 2006, at which point
            it
            expired, and was payable in thirty equal monthly installments commencing
            July 1,
            2006. The second tranche started June 10, 2006 and continued through
            January 9,
            2007 at which point it expired, and was payable in twenty-three equal
            monthly
            installments commencing February 1, 2007.
 
 Rates
            for
            borrowings under the Senior Secured Credit Facility floated and were
            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 September 30,
            2006 and a
            range of 7.75% to 8.75% during the nine months ended September 30, 2006.
            Borrowings under the Senior Secured Credit Facility were secured by all
            personal
            property of the Company. In addition, the Company was prevented from
            distributing dividends without the written consent of Comerica and was
            required
            to maintain certain financial and restrictive covenants including compensating
            cash balances. In particular, the Company was required to 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 September 30, 2006
            and
            December 31, 2005, the term loan principal balance was $9.5 million and
            $2.5
            million, respectively, and is included in the above table under Notes
            Payable.
 
 20
 On
            May
            30, 2006, July 31, 2006 and September 25, 2006, the Company entered into
            amendments to the Senior Secured Credit Facility with Comerica that provided,
            among other things, 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 Senior Secured Credit Facility
            were
            amended such that the Company would not be required to comply with such
            covenants as they were in effect prior to the amendments during the compliance
            periods through and including November 30, 2006; provided that the Company
            remained in compliance with the minimum cash covenant, which, as amended,
            required that the Company maintain a minimum balance of cash at Comerica
            equal
            to $2.5 million in excess of the outstanding indebtedness. The amendments
            also
            provided that the Company could not request additional extensions of
            credit
            under the Senior Secured Credit Facility until it was in compliance with
            all of
            the financial covenants.
 
 As
            part
            of the financial restructuring, an affiliate of Columbia Ventures purchased
            the
            Company’s Senior Secured Credit Facility, which had an outstanding balance at
            such time of approximately $8.8 million, from Comerica (see Note 2).
            In
            connection with this purchase, Comerica assigned its rights and obligations
            under the Senior Secured Credit Facility to the loan purchaser and, concurrently
            with such purchase and assignment, such facility was amended and restated
            to
            provide, among other things, an increase in the maximum loan commitment
            to $24.0
            million, consisting of Tranche A, an $8.8 million term loan, Tranche
            B, a $7.2
            million term loan, and an $8.0 million revolving credit facility. Tranche
            A was
            drawn on November 15, 2006 to fund the purchase from Comerica of the
            outstanding
            balance under the Senior Secured Credit Facility and reimburse Comerica
            for
            $10,000 in legal expenses associated with the purchase. The availability
            of the
            undrawn balance of such revolving and term loan commitments of approximately
            $8.0 million and $7.2 million, respectively, are subject to certain conditions,
            the earliest of which could be satisfied on February 1, 2007. However,
            as of
            November 15, 2006, the Company obtained access to cash in the amount
            of
            approximately $11.3 million previously held by Comerica under the terms
            of a
            compensating balance arrangement. As a result of the financial restructuring,
            the Company classified the majority of the outstanding balance of the
            Senior
            Secured Credit Facility as of September 30, 2006 as long-term.
 
 Interest
            expense, net for the three and nine months ended September 30, 2006 and
            2005 was
            as follows:
 **Three
                        Months Ended**
                    
                    **Nine
                        Months Ended****September
                        30,**
                    
                    **September
                        30,****2006**
                    
                    **2005**
                    
                    **2006**
                    
                    **2005**(unaudited)
                    
                    (unaudited)(Dollars
                        in thousands)
                    
                    (Dollars
                        in thousands)Interest
                        on Senior Notes
                    
                    $
                    1,218
                    
                    $
                    1,218
                    
                    $
                    3,655
                    
                    $
                    3,655Accreted
                        discount on Senior Secured Note
                    
                    
                    -
                    
                    
                    -
                    
                    
                    -
                    
                    
                    1,262Amortization
                        of deferred financing costs
                    
                    
                    57
                    
                    
                    50
                    
                    
                    171
                    
                    
                    255Other
                        interest expense
                    
                    
                    406
                    
                    
                    5
                    
                    
                    1,131
                    
                    
                    524Less
                        interest income
                    
                    
                    (257
                    )
                    
                    (182
                    )
                    
                    (629
                    )
                    
                    (498
                    )$
                    1,424
                    
                    $
                    1,091
                    
                    $
                    4,328
                    
                    $
                    5,198
 The
              weighted average interest rate on short-term borrowings outstanding
              as of
              September 30, 2006 and 2005 was 8.44% and 7.21%, respectively.
 
 21
 **11.
              Recent Accounting Pronouncements**
 
 In
              July
              2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
              No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes—an
              interpretation of FASB Statement No. 109.”  FIN 48 clarifies the
              accounting for uncertainty in tax positions by prescribing a financial
              statement
              recognition threshold and measurement attribute for tax positions taken
              or
              expected to be taken in a tax return. Further, FIN 48 expands the required
              disclosures associated with such uncertain tax positions. The provisions of
              FIN 48 are effective for fiscal years beginning after December 15,
              2006. The Company is currently evaluating the impact on the financial
              statements of adopting FIN 48.
 
 In
              September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which
              is effective for fiscal years beginning after November 15, 2007, and
              interim
              periods within those fiscal years. The standard applies whenever other
              standards
              require (or permit) assets or liabilities to be measured at fair value.
              The
              standard does not expand the use of fair value in any new circumstances.
              SFAS
              No. 157 clarifies the definition of fair value, provides enhanced guidance
              for
              using fair value to measure assets and liabilities, and requires expanded
              disclosures about fair value measurements. The Company does not expect
              the
              adoption of SFAS No. 157 to have a material impact on its financial
              position,
              results of operations, or cash flows.
 
 In
              September 2006, the SEC issued Staff Accounting Bulletin (SAB) No.
              108,
“Considering the Effects of Prior Year Misstatements When Quantifying
              Misstatements in Current Year Financial Statements,” to clarify how the effects
              of the carryover or reversal of prior year misstatements should be
              considered in
              quantifying a current year misstatement. The staff believes that registrants
              must quantify the impact of correcting all misstatements using two
              common
              approaches and would require adjustment when either approach results
              in
              quantifying a misstatement that is material, after considering all
              relevant
              quantitative and qualitative factors. SAB No. 108 is effective for
              annual
              financial statements covering the first fiscal year ending after November
              15,
              2006.
 
 In
              September 2006, the SEC issued new rule No. 33-8732A regarding Executive
              Compensation and Related Person Disclosure, adopting amendments to
              the
              disclosure requirements for executive and director compensation, related
              person
              transactions, director independence and other corporate governance
              matters and
              security ownership of officers and directors. Among other changes,
              the rule
              requires that disclosure under the amended items generally be provided
              in plain
              English. The rule is effective for Forms 8-K for triggering events
              that occur on
              or after November 7, 2006, and in Forms 10-K and in any proxy or information
              statements for fiscal years ending on or after December 15, 2006.
  22
  
 **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, including risk factors 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; our inability to comply with the covenants contained
              in, or the
              possibility of triggering a default under, our borrowing arrangements,
              our
              inability to execute our business plans and objectives, regulatory
              and legal
              uncertainty with respect to intercarrier compensation payments received
              by us;
              declines in liquidity and/or increases in volatility in the markets
              for
              securities; the migration to broadband Internet access affecting dial-up
              Internet access; the loss of key executive officers that could negatively
              impact
              our business prospects; an increase in our network expenses; our principal
              competitors for local services and potential additional competitors,
              which may
              have advantages that may adversely affect our ability to compete with
              them.***
 
 **Introduction**
 We
              are a
              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.
 
 On
              November 14, 2006, we filed a Form 12b-25 to extend the time to file
              our form
              10-Q for the quarterly period ended September 30, 2006, which was due
              on
              November 14, 2006. We required additional time to file our Form 10-Q
              in order
              for us to complete the preparation of our financial statements. In
              particular,
              in the course of preparing financial statements for inclusion in the
              Form 10-Q,
              we were unable to complete our assessment of certain long-lived assets
              that may
              have been impaired and were in the process of gathering information
              necessary to
              determine the extent, if any, of such an impairment. Based upon our
              analysis,
              the carrying amount of the asset group did not exceed the sum of the
              projected
              undiscounted net cash flows and therefore determined that the asset
              group was
              not impaired.
  23
 *Restructuring
              of the Company*
 
 After
              considering a variety of restructuring alternatives, including seeking
              court
              protection from creditors, and conducting an extensive search for financing
              sources, on November 15, 2006, we completed a comprehensive restructuring
              of our
              financial obligations centered around an investment and refinancing
              provided by
              Columbia Ventures Corporation (Columbia Ventures), a private investment
              company
              focused principally on the domestic and international telecommunications
              industry. With assistance from our financial advisor, restructuring
              advisor, and
              legal counsel, we concluded that the interests of all of our stakeholders,
              including shareholders, creditors, employees, customers and suppliers,
              were
              enhanced by this restructuring when compared to other alternatives
              available to
              us at that time.
 
 As
              part
              of the restructuring, an affiliate of Columbia Ventures purchased our
              Senior
              Secured Credit Facility, which had an outstanding balance at such time
              of
              approximately $8.8 million, from our senior lender, Comerica Bank (Comerica).
              In
              connection with this purchase, Comerica assigned its rights and obligations
              under the Senior Secured Credit Facility to the loan purchaser and,
              concurrently
              with such purchase and assignment, such facility was amended and restated
              to
              provide, among other things, an increase in the maximum loan commitment
              to $24.0
              million, consisting of an $8.0 million revolving credit facility and
              a $16.0
              million term loan in two tranches of approximately $8.8 million and
              $7.2
              million. The first tranche of the term loan, or approximately $8.8
              million, was
              used to purchase the senior credit facility. The availability of the
              undrawn
              balance of such revolving and term loan commitments of approximately
              $8.0
              million and $7.2 million, respectively, are subject to certain conditions,
              the
              earliest of which could be satisfied on February 1, 2007. However,
              there can be
              no assurance that we will be able to comply with the conditions allowing
              it to
              draw upon these funds. As of November 15, 2006, we obtained access
              to cash in
              the amount of approximately $11.3 million previously held by Comerica
              under the
              terms of a compensating balance arrangement.
 
 In
              addition, another affiliate of Columbia Ventures purchased an aggregate
              of
              879,117 shares of two series of newly-designated, non-voting, convertible
              preferred stock for aggregate consideration of approximately $1.0 million.
              The
              two series of preferred stock, one of which was issued at closing and
              the other
              of which will be issued upon receipt of shareholder approval of an
              amendment to
              our articles of incorporation to permit the issuance of the common
              stock
              issuable upon conversion of such series of preferred stock, are generally
              convertible into approximately 51% and 95%, respectively, of our outstanding
              common stock on a fully-diluted basis, subject to satisfaction of certain
              conditions, including receipt of requisite regulatory approvals.
 
 We
              are
              required to hold a shareholder meeting to seek approval for an amendment
              to our
              articles of corporation within 90 calendar days of receipt of a written
              request
              from the equity purchaser. We do not expect the equity purchaser to
              exercise
              such right until such time as they have converted the first series
              of preferred
              stock, which is expected to result in the equity purchaser holding
              51% of our
              outstanding common stock, on a fully-diluted basis, which is sufficient
              voting
              power under current applicable law and our articles of incorporation
              and bylaws
              to approve such amendment without participation from other
              shareholders.
 
 As
              part
              of the restructuring, we reached an agreement with Merrill Lynch Capital
              to
              restructure approximately $5.7 million of our obligations to them.
              Such
              agreement provides for, among other things, deferral of payments of
              principal
              and interest due to them in January and February of 2007, waiver of
              compliance
              with certain covenants and a commitment to restructure the maturity
              date and
              payment terms on the remaining obligations should certain conditions
              be met. In
              addition, we reached an agreement with Tekelec, one of our key suppliers,
              to
              restructure approximately $1.9 million of our obligation to them. As
              part of our
              agreement with Tekelec, we paid them approximately $535,000 to settle
              in full
              such obligation.
 
 24
 In
              addition, we have received a commitment from SMH Capital Advisors,
              Inc., an
              investment advisor who has represented to us that it has discretion
              over
              approximately $21.0 million of the $36.1 million of outstanding principal
              amount
              of our 13.5% Senior Notes due 2009 to tender into an exchange offer
              made to all
              holders of Senior Notes for newly designated 13.5% Notes due 2009.
              We expect to
              complete such exchange offer by February 1, 2007. *This
              communication is not an offer to exchange Senior Notes for New Notes
              or a
              solicitation of an offer to exchange Senior Notes for New Notes. The
              offer to
              exchange Senior Notes for New Notes is expected to be made pursuant
              to an
              exemption from registration pursuant to Section 3(a)(9) under the Securities
              Act
              of 1933, as amended, solely by means of an offering circular and disclosure
              statement and other documents provided to holders of the Senior
              Notes.*
 
 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 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 to complete our network and to
              support
              increased levels of network traffic.
 
 On
              September 25, 2006, our common stock was delisted from the Nasdaq Capital
              Market
              due to noncompliance with Nasdaq’s minimum bid price requirement. Our stock is
              now quoted in the Pink Sheets and on The OTC Bulletin Board®. Removal from the
              Nasdaq Capital Market could have a material adverse effect on our ability
              to
              raise additional equity capital should that become necessary.
  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 a restructuring plan, which included a workforce
              reduction
              of approximately 32 employees as part of a cost containment strategy.
              The
              workforce reduction was completed in June 2006. 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 and
              reduced that
              estimate approximately $9,000 during the third quarter of 2006, primarily
              due to
              forfeited benefits. We anticipate total cash paid for employee termination
              benefits to be $229,000. The final cash payment to be recorded against
              the 2006
              restructuring reserve is expected to occur in November 2006.
 
 25
 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, obligated 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 included network related and administrative
              support
              services which were 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
              was
              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. The TSA terminated
              on
              September 12, 2006 and continued services after this date are recorded
              as
              revenues.
 
 For
              the
              three and nine months ended September 30, 2006, we recorded reimbursed
              transition expenses of $1.5 million and $7.2 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 consolidated statements of
              operations
              and comprehensive income (loss). Costs billed under the TSA were based
              upon
              estimated costs to us, and we estimate that no profit was recognized
              on the
              services performed under the TSA. The enterprise services were 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
              could not be segregated based upon the services provided and therefore
              the
              estimated costs were primarily 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.
 
 The
              following table shows our financial performance for the three and nine
              months
              ended September 30, 2006 and 2005:
  **Three
                        Months Ended**
                    
                    **Nine
                        Months Ended****September
                        30,**
                    
                    **September
                        30,****2006**
                    
                    **2005**
                    
                    **2006**
                    
                    **2005**(unaudited)
                    
                    (unaudited)(Dollars
                        in thousands)
                    
                    (Dollars
                        in thousands)Total
                        revenue
                    
                    $
                    26,171
                    
                    $
                    22,383
                    
                    $
                    72,827
                    
                    $
                    72,383Income
                        (loss) from operations
                    
                    $
                    3,332
                    
                    $
                    830
                    
                    $
                    1,121
                    
                    $
                    (1,306
                    )Net
                        income (loss)
                    
                    $
                    2,324
                    
                    $
                    (126
                    )
                    $
                    (2,775
                    )
                    $
                    14,898Income
                        (loss) per share diluted
                    
                    $
                    0.06
                    
                    $
                    (0.00
                    )
                    $
                    (0.07
                    )
                    $
                    0.38
  26
 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
                47.1% and 44.9% of our total revenues for the nine months ended September
                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 over $7.1 million to us. We received $7.1
                million from
                AT&T on July 31, 2006. During August 2006 we received an additional
                $3.0
                million from AT&T for similar traffic terminations that occurred subsequent
                to our October 2004 complaint.
 
 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 expansion
                upon
                completion and expect such expansion will present additional sales
                opportunities.
 
 27
 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 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, Pennsylvania, Maryland, Florida, Colorado, Alabama, North
                Carolina,
                South Carolina, New Jersey, Washington, D.C., Oregon, Washington,
                Nevada,
                Arizona, Utah, Idaho, and our 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;
 
 •  the
                selling price is fixed and determined; and
 
 •  collectibility
                is reasonably assured.
 
 28
 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.
 
 29
 
  *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 September 30, 2006 Compared to the Quarter Ended September
                30,
                2005*
  Our
                significant revenue
                components and operational metrics for the quarters ended September
                30, 2006 and
                2005 are as follows:
  **Three
                          Months Ended****September
                          30,****2006**
                      
                      **2005**
                      
                      **%
                          Change**(unaudited)(Dollars
                          in millions)**Revenues:**Intercarrier
                          compensation
                      
                      $
                      8.9
                      
                      $
                      12.0
                      
                      
                      (25.8
                      )%Mature
                          Products
                      
                      
                      14.7
                      
                      
                      9.3
                      
                      
                      58.1
                      %Growth
                          Products
                      
                      
                      2.6
                      
                      
                      1.1
                      
                      
                      136.4
                      %Total
                          revenues
                      
                      $
                      26.2
                      
                      $
                      22.4
                      
                      
                      17.0
                      %**Operational
                          metrics:**Minutes
                          of use (in billions)Intercarrier
                      
                      
                      6.38
                      
                      
                      12.01
                      
                      
                      (46.9
                      )%Mature Products
                      
                      
                      -
                      
                      
                      0.07
                      
                      
                      (100.0
                      )%Growth Products
                      
                      
                      0.23
                      
                      
                      0.09
                      
                      
                      155.6
                      %Total minutes of use
                      
                      
                      6.61
                      
                      
                      12.17
                      
                      
                      (45.7
                      )%
  Total
                revenues, which is
                composed of intercarrier, mature products and growth products, increased
                17.0%
                to $26.2 million in the quarter ended September 30, 2006 from $22.4
                million
                during the same period in 2005. This increase was primarily attributable
                to
                settlements of $9.5 million during the third quarter of 2006 compared
                to $2.2
                million in 2005, partially offset by lower revenues 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.
 30
 
 Intercarrier
                    compensation
                    revenues decreased 25.8% to $8.9 million in the quarter ended
                    September 30, 2006
                    from $12.0 million during the same period in 2005 due primarily
                    to lower
                    revenues from a decrease in intercarrier minutes of use primarily
                    resulting from
                    a competitor, who is a customer, building out their own network,
                    and a more
                    rapid than expected decline in the Internet dial-up business.
                    The decline was
                    partially offset by an increase of third party transit traffic
                    of approximately
                    $0.7 million and settlements of $3.0 million in the third quarter
                    of 2006
                    compared to $2.2 million in 2005.
  Mature
                    products revenues include
                    dial access services, collocation, and all enterprise products.
                    Revenues from
                    mature products increased $5.4 million, or 58.1% in the quarter
                    ended September
                    30, 2006 from $9.3 million during the same period in 2005. The
                    increase was
                    primarily due to a settlement and restructuring agreement with
                    an ISP of $6.5
                    million during the third quarter of 2006, partially offset by
                    lower revenues
                    from lower minutes of use in addition to Internet dial-up ISPs
                    reducing
                    services. The settlement and restructuring agreement with the
                    ISP, assuming no
                    increase in volume, is expected to result in an increase in revenues
                    of $5.4
                    million for 2006 and a decrease in revenues of $4.6 million and
                    $2.6 million for
                    2007 and 2008, respectively.
  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 $1.5 million, or 136.4% in the quarter
                    ended September
                    30, 2006 from $1.1 million during the same period in 2005. The
                    increase was due
                    primarily to volume growth from products introduced in 2005.
                    This increase was
                    primarily in the western footprint and we expect gradual increases
                    in our
                    eastern footprint as we complete our expansion along with our
                    VeriSign, Inc.
                    alliance by the end of the year.
  Total
                    minutes of use,
                    which is composed of intercarrier, mature products and growth
                    products declined
                    45.7% to 6.61 billion in the quarter ended September 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 6.38 billion in the
                    quarter ended
                    September 30, 2006 from 12.01 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 0.01 billion for the quarter ended
                    September 30,
                    2006 from 0.07 billion during the same period in 2005. Growth
                    products minutes
                    of use increased to 0.23 billion for the quarter ended September
                    30, 2006 from
                    0.09 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 September
                  30, 2006 and
                  2005 are as follows:
  **Three
                            Months Ended****September
                            30,****2006**
                        
                        **2005**
                        
                        **%
                            Change**(unaudited)(Dollars
                            in millions)**Costs
                            and expenses:**Network
                            expenses (exclusive of depreciation shown separately
                            below)
                        
                        $
                        9.9
                        
                        $
                        9.6
                        
                        
                        3.1
                        %Selling,
                            general and administrative
                        
                        
                        11.5
                        
                        
                        13.0
                        
                        
                        (11.5
                        )%Reimbursed
                            transition expenses
                        
                        
                        (1.5
                        )
                        
                        (4.5
                        )
                        
                        (66.7
                        )%Depreciation
                            and amortization
                        
                        
                        3.0
                        
                        
                        3.4
                        
                        
                        (11.8
                        )%Total
                            costs and expenses
                        
                        $
                        22.9
                        
                        $
                        21.5
                        
                        
                        6.5
                        %
  31
 Consolidated
                    network expenses increased $0.3 million, or 3.1% during the three
                    months ended
                    September 30, 2006 compared to $9.6 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 in
                    addition to cost reduction efforts. During this transition period,
                    which ended
                    September 12, 2006, we were obligated under the TSA, among other
                    things, to
                    provide certain transition services to TelePacific at our estimated
                    cost. The
                    estimated costs reimbursed to us included network related services
                    and are
                    included under “Reimbursed transition expenses.”
  Consolidated
                    selling, general and administrative expenses decreased 11.5%
                    to $11.5 million
                    for the quarter ended September 30, 2006 from $13.0 million during
                    the same
                    period in 2005. The decrease was primarily due to suspended compensation
                    associated with company and individual team performance goals,
                    reduced
                    professional costs and cost reduction activities.
 
 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 $90,000
                    in selling,
                    general and administrative expense during the quarter ended September
                    30, 2006
                    as a result of this adoption. Total compensation expense recognized
                    for
                    stock-based awards for the three months ended September 30, 2006
                    and 2005 was
                    $118,000 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
                    September 30, 2006, we had unrecognized stock-based compensation
                    of $1.0 million
                    outstanding, which we expect to recognize over a weighted-average
                    period of 2.6
                    years.
 
 Reimbursed
                    transition expenses were $1.5 million and $4.5 million for the
                    quarters ended
                    September 30, 2006 and 2005, respectively. The reimbursed transition
                    expenses
                    related to network and administrative services provided to TelePacific
                    in
                    accordance with the TSA. Costs billed under the TSA were based
                    upon estimated
                    costs to us, and as such no profit was recognized on the services
                    performed
                    under the TSA. The TSA ended on September 12, 2006 and reimbursement
                    of
                    transition expenses ended at that time. Continued services provided
                    after
                    September 12, 2006 are recorded under revenues. The enterprise
                    services were
                    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.
 
 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 11.8% to $3.0
                    million in the
                    quarter ended September 30, 2006 from $3.4 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.
 
 32
 
  Consolidated
                      income from
                      operations was $3.3 million for the quarter ended September
                      30, 2006 compared to
                      $0.8 million during the same period in 2005 primarily due to
                      the factors
                      discussed in the preceding paragraphs.
  Consolidated
                      interest
                      expense, net increased to $1.4 million for the quarter ended
                      September 30, 2006
                      compared to $1.1 million for the same period in 2005 due primarily
                      to higher
                      debt levels and increasing interest rates during 2006.
  **Three
                              Months Ended****September
                              30,****2006**
                          
                          **2005**(unaudited)(Dollars
                              in thousands)Interest
                              on Senior Notes
                          
                          $
                          1,218
                          
                          $
                          1,218Amortization
                              of deferred financing costs
                          
                          
                          57
                          
                          
                          50Other
                              interest expense
                          
                          
                          406
                          
                          
                          5Less
                              interest income
                          
                          
                          (257
                          )
                          
                          (182
                          )$
                          1,424
                          
                          $
                          1,091
  For
                    the quarters ended
                    September 30, 2006 and 2005, our effective income tax rate was
                    5.3% and 40.0%,
                    respectively.
  Consolidated
                    net income
                    was $2.3 million for the quarter ended September 30, 2006 compared
                    to a net loss
                    of $0.1 million during the same period in 2005 primarily due
                    to the factors
                    discussed in the preceding paragraphs.
 *Nine
                      Months Ended September 30, 2006 Compared to the Nine Months
                      Ended September 30,
                      2005*
  Our
                      significant revenue
                      components and operational metrics for the nine months ended
                      September 30, 2006
                      and 2005 are as follows:
  **Nine
                                Months Ended****September
                                30,****2006**
                            
                            **2005**
                            
                            **%
                                Change**(unaudited)(Dollars
                                in millions)**Revenues:**Intercarrier
                                compensation
                            
                            $
                            34.3
                            
                            $
                            32.5
                            
                            
                            5.5
                            %Mature
                                Products
                            
                            
                            31.4
                            
                            
                            37.3
                            
                            
                            (15.8
                            )%Growth
                                Products
                            
                            
                            7.1
                            
                            
                            2.6
                            
                            
                            173.1
                            %Total
                                revenues
                            
                            $
                            72.8
                            
                            $
                            72.4
                            
                            
                            0.6
                            %**Operational
                                metrics:**Minutes
                                of use (in billions)Intercarrier
                            
                            
                            25.99
                            
                            
                            36.15
                            
                            
                            (28.1
                            )%Mature Products
                            
                            
                            0.07
                            
                            
                            0.20
                            
                            
                            (65.0
                            )%Growth Products
                            
                            
                            0.50
                            
                            
                            0.21
                            
                            
                            138.1
                            %Total minutes of use
                            
                            
                            26.56
                            
                            
                            36.56
                            
                            
                            (27.4
                            )%
  33
 Total
                        revenues, which is composed of intercarrier, mature products
                        and growth
                        products, increased 0.6% to $72.8 million in the nine months
                        ended September 30,
                        2006 compared to $72.4 million for the same period in 2005.
                        This increase was
                        primarily attributable to revenue resulting from receipt
                        of administrative
                        orders to make disputed payments, settlements with carriers
                        for prior disputed
                        billings and a settlement and restructuring agreement with
                        an ISP of $19.8
                        million during 2006 compared to settlements of $2.2 million
                        in 2005, partially
                        offset by lower revenues 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.
 
 Intercarrier
                        compensation revenues increased 5.5% to $34.3 million in
                        the nine months ended
                        September 30, 2006 from $32.5 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 approximately
                        $13.2 million during
                        2006 compared to settlements of $2.2 million in 2005, 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 $5.9 million,
                        or 15.8% in the
                        nine months ended September 30, 2006 from $37.3 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,
                        partially
                        offset by a settlement and restructuring agreement with an
                        ISP of $6.5 million
                        during the third quarter of 2006. The settlement and restructuring
                        agreement
                        with the ISP, assuming no increase in volume, is expected
                        to result in an
                        increase in revenues of $5.4 million for 2006 and a decrease
                        in revenues of $4.6
                        million and $2.6 million for 2007 and 2008, respectively.
 
 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 $4.5 million, or
                        173.1% in the nine
                        months ended September 30, 2006 from $2.6 million during
                        the same period in
                        2005. The increase was due primarily to volume growth from
                        products introduced
                        in 2005. This increase was primarily in the western footprint
                        and we expect
                        gradual increases in our eastern footprint as we complete
                        our expansion along
                        with our VeriSign, Inc. alliance by the end of the year.
 
 Total
                        minutes of use, which is composed of intercarrier, mature
                        products and growth
                        products declined 27.4% to 26.56 billion in the nine months
                        ended September 30,
                        2006 from 36.56 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 28.1% to 25.99
                        billion during the
                        nine months ended September 30, 2006 from 36.15 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
                        nine months ended
                        September 30, 2006 from 0.20 billion for the same period
                        in 2005. Growth
                        products minutes of use increased to 0.50 billion for the
                        nine months ended
                        September 30, 2006 from 0.21 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.
 
 34
 The
                        significant costs and expenses for the nine months ended
                        September 30, 2006 and
                        2005 are as follows:
  **Nine
                                  Months Ended****September
                                  30,****2006**
                              
                              **2005**
                              
                              **%
                                  Change**(unaudited)(Dollars
                                  in millions)**Costs
                                  and expenses:**Network
                                  expenses (exclusive of depreciation shown separately
                                  below)
                              
                              $
                              29.7
                              
                              $
                              29.9
                              
                              
                              (0.7
                              )%Selling,
                                  general and administrative
                              
                              
                              40.0
                              
                              
                              40.1
                              
                              
                              (0.2
                              )%Reimbursed
                                  transition expenses
                              
                              
                              (7.1
                              )
                              
                              (7.3
                              )
                              
                              (2.7
                              )%Depreciation
                                  and amortization
                              
                              
                              8.9
                              
                              
                              10.3
                              
                              
                              (13.6
                              )%Restructuring
                                  charges
                              
                              
                              0.3
                              
                              
                              0.6
                              
                              
                              (50.0
                              )%Total
                                  costs and expenses
                              
                              $
                              71.8
                              
                              $
                              73.6
                              
                              
                              (2.4
                              )%
  Consolidated
                          network expenses decreased $0.2 million, or 0.7% during
                          the nine months ended
                          September 30, 2006 compared to $29.9 million during the
                          same period in 2005 due
                          primarily to improved network efficiency 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
                          increased expenses associated with our national expansion.
                          During this
                          transition period, which ended September 12, 2006, we were
                          obligated under the
                          TSA, among other things, to provide certain transition
                          services to TelePacific
                          at our estimated cost. The estimated costs reimbursed to
                          us included network
                          related services and are included under “Reimbursed transition expenses.”
  Consolidated
                          selling, general and administrative expenses decreased
                          0.2% to $40.0 million for
                          the nine months ended September 30, 2006 from $40.1 million
                          during the same
                          period in 2005 due primarily to suspended compensation
                          associated with company
                          and individual team performance goals.
 
 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
                          $292,000 in selling,
                          general and administrative expense during the nine months
                          ended September 2006
                          as a result of this adoption. Total compensation expense
                          recognized for
                          stock-based awards for the nine months ended September
                          30, 2006 and 2005 was
                          $396,000 and $140,000, 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
                          September 30, 2006, we had unrecognized stock-based compensation
                          of $1.0 million
                          outstanding, which we expect to recognize over a weighted-average
                          period of 2.6
                          years.
 
 35
 Reimbursed
                          transition expenses were $7.1 million for the nine months
                          ended September 30,
                          2006 compared to $7.3 million during the same period in
                          2005. The reimbursed
                          transition expenses related to network and administrative
                          services provided to
                          TelePacific in accordance with the TSA. Costs billed under
                          the TSA were based
                          upon estimated costs to us, and as such no profit was recognized
                          on the services
                          performed under the TSA. The TSA ended on September 12,
                          2006 and reimbursement
                          of transition expenses ended at that time. Continued services
                          provided after
                          September 12, 2006 are recorded under revenues. The enterprise
                          services were
                          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.
 
 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 13.6% to
                          $8.9 million in the
                          nine months ended September 30, 2006 from $10.3 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 nine months
                          ended September 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
                          income from operations was $1.1 million for the nine months
                          ended September 30,
                          2006 compared to a consolidated loss from operations of
                          $1.3 million during the
                          same period in 2005.
  Consolidated
                          interest expense, net decreased to $4.3 million for the
                          nine months ended
                          September 30, 2006 compared to $5.2 million for the same
                          period in 2005 due
                          primarily from the extinguishment of the Senior Secured
                          Note during the first
                          quarter of 2005. The decrease was partially offset by higher
                          debt levels and
                          increasing interest rates during 2006. Our interest expense,
                          net was as
                          follows:
 **Nine
                                      Months Ended****September
                                      30,****2006**
                                  
                                  **2005**(unaudited)(Dollars
                                      in thousands)Interest
                                      on Senior Notes
                                  
                                  $
                                  3,655
                                  
                                  $
                                  3,655Accreted
                                      discount on Senior Secured Note
                                  
                                  
                                  -
                                  
                                  
                                  1,262Amortization
                                      of deferred financing costs
                                  
                                  
                                  171
                                  
                                  
                                  255Other
                                      interest expense
                                  
                                  
                                  1,131
                                  
                                  
                                  524Less
                                      interest income
                                  
                                  
                                  (629
                                  )
                                  
                                  (498
                                  )$
                                  4,328
                                  
                                  $
                                  5,198
  During
                            the nine months ended September 30, 2005, we recorded
                            a gain of $24.1 million
                            from the sale of substantially all of our enterprise
                            customer base that occurred
                            during the first quarter of 2005.
  36
 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
                            nine months ended September 30, 2006 and 2005, our effective
                            income tax rate was
                            4.1% and 2.9%, respectively.
 
 Consolidated
                            net loss was $2.8 million for the nine months ended September
                            30, 2006 compared
                            to net income of $14.9 million during the same period
                            in 2005 primarily due to
                            the factors discussed in the preceding paragraphs.
 
 **Quarterly
                            Operating and Statistical Data:**
 
 The
                            following tables summarize the unaudited results of operations
                            as a percentage
                            of revenues for the three and nine months ended September
                            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**
                                    
                                    **Nine
                                        Months Ended****September
                                        30, 2006**
                                    
                                    **September
                                        30, 2006****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)
                                    
                                    
                                    37.9
                                    %
                                    
                                    43.0
                                    %
                                    
                                    40.8
                                    %
                                    
                                    41.3
                                    %Selling,
                                        general and administrative expenses
                                    
                                    
                                    43.8
                                    %
                                    
                                    58.1
                                    %
                                    
                                    54.9
                                    %
                                    
                                    55.4
                                    %Reimbursed
                                        transition expenses
                                    
                                    
                                    (5.7
                                    )%
                                    
                                    (20.0
                                    )%
                                    
                                    (9.8
                                    )%
                                    
                                    (10.1
                                    )%Depreciation
                                        and amortization expenses
                                    
                                    
                                    11.4
                                    %
                                    
                                    15.0
                                    %
                                    
                                    12.3
                                    %
                                    
                                    14.3
                                    %Income
                                        (loss) from operations
                                    
                                    
                                    12.7
                                    %
                                    
                                    3.7
                                    %
                                    
                                    1.5
                                    %
                                    
                                    (1.8
                                    )%Net
                                        income (loss)
                                    
                                    
                                    8.9
                                    %
                                    
                                    (0.6
                                    )%
                                    
                                    (3.8
                                    )%
                                    
                                    20.6
                                    %
  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****Sept.
                30,**
            
            **June
                30,**
            
            **March
                31,**
            
            **Dec.
                31,**
            
            **Sept.
                30,**(unaudited)
            
            
            (unaudited)
            
            
            (unaudited)
            
            
            (unaudited)
            
            
            (unaudited)Ports
                equipped
            
            
            1,288,704
            
            
            1,288,704
            
            
            1,151,616
            
            
            1,151,616
            
            
            1,054,848Quarterly
                  minutes of use switched (in billions)
            
            
            6.6
            
            
            8.8
            
            
            11.2
            
            
            12.0
            
            
            12.2Capital
                  additions (in thousands)
            
            
            $1,266
            
            
            $557
            
            
            $10,568
            
            
            $5,797
            
            
            $3,259Employees
            
            
            236
            
            
            236
            
            
            266
            
            
            245
            
            
            234


37


**Liquidity
        and Capital Resources:**


*Sources
        and uses of cash.* At
        September 30, 2006, cash and short-term investments decreased $5.0 million
        to
        $21.7 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. Approximately $12.0 million of our
        cash
        and short-term investments was subject to a compensating balance arrangement
        with Comerica. As a result of the restructuring described above, on November
        15,
        2006, the compensating balance arrangement was terminated.
 
 Net
        cash
        provided by operating activities was $0.5 million for the nine months ended
        September 30, 2006 compared to $5.0 million for the same period ended in
        2005.
        The cash provided for 2006 was primarily due to income from operations.
 
 Net
        cash
        used in investing activities was $9.0 million for the nine months ended
        September 30, 2006 due primarily to the purchase of property and equipment.
        Net
        cash provided by investing activities was $20.8 million during the nine months
        ended September 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 of $3.5 million for the nine months ended
        September 30, 2006 was primarily due to proceeds from borrowings under notes
        payable. Net cash used in financing activities was $41.1 million during the
        nine
        months ended September 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 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 $6.8 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 September 30, 2006,
        we did
        not have any material future purchase commitments to purchase equipment from
        any
        of our vendors.
 
 38
 *Debt
        outstanding.* At
        September 30, 2006 and December 31, 2005, long-term debt and capital lease
        obligations consist of the following:





**September
                30,**
            
            **December
                31,****2006**
            
            **2005**(Dollars
                in thousands)Senior
                Notes
            
            $
            36,102
            
            $
            36,102Capital
                lease obligations
            
            
            548
            
            
            651Notes
                payable
            
            
            16,424
            
            
            12,159Less
                current portion of notes payable and capital leases
            
            
            (5,404
            )
            
            (5,392
            )$
            47,670
            
            $
            43,520




The
        Senior Notes of which there is $36.1 million in principal amount outstanding
        at
        September 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. As described above, we have received
        a commitment from an investment advisor that has represented that it has
        discretion over approximately $21.0 million of the $36.1 million of outstanding
        principal amount of the Senior Notes to tender into an exchange offer made
        to
        all holders of Senior Notes for newly designated 13.5% Notes due 2009.
 
 In
        March
        2006, we completed a 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 September
        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 September 30, 2006 the principal balance of the note payable
        was $0.1 and is included in the above table under Notes Payable. This obligation
        was not restructured in connection with the restructuring discussed above.
 
 In
        November 2005, we entered into a Senior Secured Credit Facility with Comerica,
        which provided for up to $5 million of revolving advances and up to $15 million
        of term loans, subject to certain conditions. Any revolving advances were
        not to
        exceed 80% of eligible accounts receivables and were due and payable in full
        on
        November 9, 2007. There were no revolving advances as of September 30,
        2006.
 
 The
        term
        loan portion of the Senior Secured Credit Facility, which was to be used
        within
        certain limitations to finance capital equipment expenditures and acquisitions
        or to refinance the Senior Notes, was structured into two tranches; the first
        included all term loan borrowings through June 9, 2006, at which point it
        expired, and was payable in thirty equal monthly installments commencing
        July 1,
        2006. The second tranche started June 10, 2006 and continued through January
        9,
        2007 at which point it expired, and was payable in twenty-three equal monthly
        installments commencing February 1, 2007.
 
 Rates
        for
        borrowings under the Senior Secured Credit Facility floated and were 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 Senior Secured Credit Facility was secured by all of
        our
        personal property and required us to maintain certain financial and restrictive
        covenants. As of September 30, 2006 and December 31, 2005, the term loan
        principal balance was $9.5 million and $2.5 million, respectively, and is
        included in the above table under Notes Payable.
 
 39
 On
        May
        30, 2006, July 31, 2006 and September 25, 2006 we entered into amendments
        to the
        Senior Secured Credit Facility with Comerica that
        provided, among other things, 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 Senior Secured Credit
        Facility were amended such that we would not be required to comply with such
        covenants as they were in effect prior to the amendments during the compliance
        periods through and including November 30, 2006; provided that we remained
        in
        compliance with the minimum cash covenant, which, as amended, required the
        minimum cash covenant specifies that we maintain a minimum balance of cash
        at
        Comerica equal to $2.5 million in excess of the outstanding indebtedness.
        The
        Amendments also provided that we could not request additional extensions
        of
        credit under the Senior Secured Credit Facility until we was in compliance
        with
        all of the financial covenants.
  As
        described above, as part of the restructuring, on November 15, 2006, an
        affiliate of Columbia Ventures purchased our Senior Secured Credit Facility,
        which had an outstanding balance at such time of approximately $8.8 million,
        from our senior lender, Comerica. In connection with this purchase, Comerica
        assigned its rights and obligations under the Senior Secured Credit Facility
        to
        the loan purchaser and, concurrently with such purchase and assignment, such
        facility was amended and restated to provide, among other things, an increase
        in
        the maximum loan commitment to $24.0 million, consisting of an $8.0 million
        revolving credit facility and a $16.0 million term loan in two tranches of
        approximately $8.8 million and $7.2 million.
 
 Under
        revolving facility, as amended and restated, on and after February 1, 2007,
        the
        debt purchaser will make revolving loans to us of not less than $250,000,
        not to
        exceed the least of (i) $8,000,000, (ii) 85% of eligible accounts receivable,
        and (iii) the amount necessary to replenish the aggregate amount of our
        unrestricted cash and cash equivalents to $5,000,000 until December 31, 2008,
        at
        which time the revolving loans become due and payable. The revolving loans
        will
        accrue interest at 12% per annum. The interest accrued becomes due and payable
        at maturity.
  Under
        the
        term loan facility, as amended and restated, approximately $8.8 million,
        the
        maximum amount of the first tranche, was drawn on November 15, 2006 in order
        to
        fully refinance the aggregate obligations outstanding to Comerica under the
        Senior Secured Credit Facility and reimburse Comerica for its legal expenses
        in
        connection with such transaction. We may borrow from the loan purchaser up
        to an
        aggregate of approximately $7.2 million under the second tranche upon the
        latest
        to occur of (i) February 1, 2007, (ii) the commercial availability of our
        DIDOD
        Release 1.1 and (iii) the effective date of long term binding agreements
        between
        us and VeriSign, Inc. acceptable to the loan purchaser. Any amounts borrowed
        under the term loan facility are due and payable on December 31, 2008 and
        will
        accrue interest at 12% per annum, such interest to become due and payable
        at
        maturity. There can be no assurance that we will meet the conditions in order
        to
        draw upon these funds.
 
 Obligations
        under the Senior Secured Credit Facility, as amended and restated, are secured
        by all of our personal property. Such facility contains usual and customary
        events of default or facilities of this nature and provides that upon the
        occurrence of an event of default, the loan purchaser may, among other things,
        accelerate the payment of all amounts payable under the facility and cease
        to
        advance money or extend credit for our benefit. Under the terms of the Senior
        Secured Credit Facility, as amended and restated, we are also required to
        maintain certain financial and restrictive covenants which limit, among other
        things, our ability to incur additional indebtedness, create liens, acquire,
        sell or dispose of certain assets, engage in certain mergers and acquisitions,
        pay dividends and make certain capital expenditures. Our ability to borrow
        additional amounts under such facility is also subject to receipt of specified
        regulatory approvals and the satisfaction of other customary
        conditions.
 
 40
 In
        addition, as described above, as part of the restructuring, we reached an
        agreement with Merrill Lynch Capital to restructure approximately $5.7 million
        of our obligations to them. Such agreement provides for, among other things,
        deferral of payments of principal and interest due to them in January and
        February of 2007, waiver of compliance with certain covenants and a commitment
        to restructure the maturity date and payment terms on the remaining obligations
        should certain conditions be met. In addition, under such agreement, we agreed
        to pay Merrill Lynch Capital in respect of our obligations an amount equal
        to
        20% of any interest savings achieved as a result of the tender of more than
        $21.0 million in principal amount of Senior Notes as part of the exchange
        offer
        we intend to conduct in respect of our Senior Notes.
  *Future
        uses and sources of cash* .
        Our
        principal sources of operating funds for the remainder of 2006 and the first
        nine months of 2007 are anticipated to be current cash and short-term investment
        balances, borrowing under our Senior Secured Credit Facility, as amended
        an
        restated, and cash flows from operating activities. However, there can be
        no
        assurance that the conditions to availability of borrowing under our Senior
        Secured Credit Facility will be satisfied. If such conditions are not satisfied,
        we will not be able to rely on our Senior Secured Credit Facility for operating
        funds, which may materially and adversely impact our ability to pursue our
        business plans and objectives. We currently expect to fund the following
        expenditures during the next 12 months:
  •   interest
        payments of approximately $2.5 million on notes (assumes tender of $21.0
        million
        of Senior Notes and the restructuring of our obligations to Merrill Lynch
        Capital is completed);
 
 •  anticipated
        capital expenditures of approximately $6.8 million;
  •   debt
          principal payments of approximately $2.4 million (assumes the restructuring
          of
          our obligations to Merrill Lynch Capital is completed); and
 •  capital
        lease
        payments (including interest) of approximately $0.4 million.
 
 On
        September 25, 2006, the Company’s common stock was delisted from the Nasdaq
        Capital Market due to noncompliance with Nasdaq’s minimum bid price requirement.
        The Company’s stock is now quoted in the Pink Sheets and on The OTC Bulletin
        Board®. Removal from the Nasdaq Capital Market could have a material adverse
        effect on the Company’s ability to raise additional equity capital should that
        become necessary.
 
 **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 September 30, 2006, we
        had an
        outstanding note payable of $9.5 million to Comerica Bank (Comerica). This
        note
        is at Comerica’s prime rate plus 0.5%, which was 8.75% as of September 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. As of September 30, 2006 all of our cash and investments
        are in cash equivalents. A hypothetical 1% decrease in short-term interest
        rates
        would reduce the annualized pretax interest income on our $21.7 million cash
        and
        cash equivalents at September 30, 2006, by approximately $0.2
        million.
 
 41
 **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.
  There
        have been no changes in the Company's internal control over financial reporting
        that occurred during the quarter ended September 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**
 
 Below
        are material
        changes from 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.
  ***We
          may not be able to satisfy the conditions to borrow and comply with certain
          financial covenants and events of default under our Senior Secured Credit
          Facility, as amended and restated.***
  Our
          Senior Secured Credit
          Facility, as amended and restated, is expected to be one of our principal
          sources of operating funds. However, there can be no assurance that the
          conditions to availability of borrowing under the Senior Secured Credit
          Facility
          will be satisfied. If such conditions are not satisfied, we will not be
          able to
          rely on our Senior Secured Credit Facility for operating funds, which may
          materially and adversely impact our ability to pursue our business plans
          and
          objectives.
  In
          addition, we are
          subject to certain financial and operational covenants and events of default
          under the Senior Secured Credit Facility, including an event of default
          based
          upon our failure to obtain tenders for 51% of the Senior Notes in the planned
          exchange offer. Failure to comply with such covenants and events of default
          could result in certain remedies being exercised by the loan purchaser
          that
          could give the loan purchaser the right to accelerate, or declare due and
          payable, all outstanding amounts under the Senior Secured Credit Facility,
          as
          amended and restated.
 ***A
        decline in liquidity and/or increase in volatility associated with the delisting
        of our common stock from the Nasdaq Capital market.***
  We
        have been delisted
        from the Nasdaq Capital Market. Our common stock is currently traded in the
        over-the-counter market. Trading in the over-the-counter market may adversely
        impact our stock price and liquidity, and the ability of our stockholders
        to
        purchase and sell our shares in an orderly manner. Furthermore, the delisting
        of
        our shares could damage our general business reputation.
 42
 **ITEM
        6.** **Exhibits**
 Exhibits
  10.66
              Fifth
                  Amendment to Loan and Security Agreement dated September 25, 2006,
                  by and
                  between
                  Comerica Bank and the Company.
 10.67
              Settlement
                  and Restructuring agreement dated September 29, 2006, by and between
                  Qwest
                  Communication
                  Corporation, Qwest Corporation and the
                  Company.Certain
                  confidential portions have been omitted and filed separately with
                  the
                  Securities and Exchange Commission pursuant to a request for confidential
                  treatment.)
 10.68
              Agreement
                  regarding compensation on change of control dated August 30, 2006,
                  made by
                  and
                  between the Company and Michael Hawn, Vice President of Customer
                  Network Services.
 10.69
              Agreement
                  regarding compensation on change of control dated August 30, 2006,
                  made by
                  and
                  between the Company and Eric Jacobs, Vice President of
                  Sales.
 10.70
              Agreement
                  regarding compensation on change of control dated August 30, 2006,
                  made by
                  and
                  between the Company and Ravi Brar, Chief Operating
                  Officer.
 10.71
              Agreement
                  regarding compensation on change of control dated August 30, 2006,
                  made by
                  and
                  between the Company and Todd Putnam, Chief Information
                  Officer.
 10.72
              Separation
                  Agreement with Wallace W. Griffin, dated October 25,
                  2006.
 
 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, 4 and 5 are not applicable and have been
        omitted.**




43


**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 November 20, 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
    44