**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 March 31, 2005**
 
 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 an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes [ ] No [X]
 
 As of
April 30, 2005, the Company had an aggregate of 36,850,677 shares of common
stock issued and outstanding.
  
 **PAC-WEST
TELECOMM, INC.**
 **Report
on Form 10-Q For the Quarterly Period Ended March 31, 2005** ****
 **Table of
Contents**
 **Part
      I.**
    **FINANCIAL
      INFORMATION**
    **Page**Item 1.
    Financial
      Statements (Unaudited)Condensed
      Consolidated Balance SheetsMarch
      31, 2005 and December 31, 2004
    3Condensed
      Consolidated Statements of Operations and Comprehensive
      Income/Loss
      - Three months ended March 31, 2005 and 2004
    4Condensed
      Consolidated Statements of Cash Flows - Threemonths
      ended March 31, 2005 and 2004
    5Notes
      to Unaudited Condensed Consolidated Financial Statements
    6Item
      2.
    Management's
      Discussion and Analysis of Financial Conditionand
      Results of Operations
    12Item
      3.
    Quantitative
      and Qualitative Disclosures About Market Risks
    21Item
      4.
    Controls
      and Procedures
    22**Part
      II.**
    **OTHER
      INFORMATION**Item
      1.
    Legal
      Proceedings
    22Item 5.
    Other
      Information
    22Item
      6.
    Exhibits
    22Signatures
    
    23
 2
   **PART
      I****ITEM
      1. FINANCIAL STATEMENTS****PAC-WEST
      TELECOMM, INC.****Condensed
      Consolidated Balance Sheets****(Dollars
      in thousands except share and per share
data)**
   **March
      31,**
    
    **December
      31,****2005**
    
    **2004****(Unaudited)****ASSETS**
    
    ****Current
      Assets:Cash
      and cash equivalents
    
    
    
    
    $
    11,596
    
    $
    32,265Short-term
      investments
    
    
    
    
    
    10,272
    
    
    10,501Trade
      accounts receivable, net of allowances of$174
      and $366 at March 31, 2005 andDecember
      31, 2004, respectively
    
    
    
    
    
    9,665
    
    
    12,774Prepaid
      expenses and other current assets
    
    
    
    
    
    7,142
    
    
    5,316Total
      current assets
    
    
    
    
    
    38,675
    
    
    60,856Property
      and equipment, net
    
    38,269
    
    
    43,413Other
      assets, net
    
    1,734
    
    
    2,783Total
      assets
    
    
    
    
    $
    78,678
    
    $
    107,052**LIABILITIES
      AND STOCKHOLDERS' EQUITY**Current
      Liabilities:Accounts
      payable
    
    
    
    
    $
    5,451
    
    $
    5,684Current
      obligations under notes payable and capital leases
    
    
    
    
    
    2,844
    
    
    2,889Accrued
      interest
    
    
    
    
    
    920
    
    
    2,208Other
      accrued liabilities
    
    
    
    
    
    8,134
    
    
    13,291Total
      current liabilities
    
    
    
    
    
    17,349
    
    
    24,072Senior
      Notes
    
    36,102
    
    
    36,102Notes
      payable and capital leases, less current portion
    
    3,690
    
    
    28,936Other
      liabilities, net
    
    52
    
    
    353Total
      liabilities
    
    
    
    
    
    57,193
    
    
    89,463Commitments
      and Contingencies (Note 8)Stockholders'
      Equity:Common
      stock, $.001 par value; 100,000,000 sharesauthorized,
      36,834,377 and 36,792,426 shares issuedand
      outstanding at March 31, 2005 and December 31,2004,
      respectively
    
    
    
    
    
    37
    
    
    37Additional
      paid-in capital
    
    
    
    
    
    191,071
    
    
    204,540Accumulated
      deficit
    
    
    
    
    
    (168,970
    )
    
    (186,309
    )Accumulated
      other comprehensive loss
    
    
    
    
    
    (136
    )
    
    (114
    )Deferred
      stock compensation
    
    
    
    
    
    (517
    )
    
    (565
    )Total
      stockholders' equity
    
    
    
    
    
    21,485
    
    
    17,589Total
      liabilities and stockholders' equity
    
    
    
    
    $
    78,678
    
    $
    107,052
  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****March
      31,****2005**
    
    **2004**REVENUES
    
    $
    28,131
    
    $
    29,423COSTS
      AND EXPENSES:Network
      expenses (exclusive of depreciation shown separately
below)
    
    
    10,566
    
    
    10,492Selling,
      general and administrative
    
    
    14,673
    
    
    14,231Depreciation
      and amortization
    
    
    3,750
    
    
    9,085Restructuring
      charges
    
    
    384
    
    
    -Total
      operating expenses
    
    
    29,373
    
    
    33,808Loss
      from operations
    
    
    (1,242
    )
    
    (4,385
    )Interest
      expense, net
    
    
    2,806
    
    
    2,781Gain
      on asset dispositions, net
    
    
    -
    
    
    (4
    )Gain
      on sale of enterprise customer base
    
    
    (24,034
    )
    
    -Loss
      on extinguisment of debt
    
    
    2,138
    
    
    -Income
      (loss) before income taxes
    
    
    17,848
    
    
    (7,162
    )Income
      tax expense
    
    
    509
    
    
    3Net
      income (loss)
    
    $
    17,339
    
    $
    (7,165
    )Basic
      income (loss) per share
    
    $
    0.47
    
    $
    (0.20
    )Diluted
      income (loss) per share
    
    $
    0.45
    
    $
    (0.20
    )WEIGHTED
      AVERAGE SHARES OUTSTANDING:Basic
    
    
    36,803
    
    
    36,608Diluted
    
    
    38,889
    
    
    36,608COMPREHENSIVE
      INCOME (LOSS):Net
      income (loss)
    
    $
    17,339
    
    $
    (7,165
    )Unrealized
      loss on investments
    
    
    (22
    )
    
    -Comprehensive
      income (loss)
    
    $
    17,317
    
    $
    (7,165
    )
  See notes
to unaudited condensed consolidated financial statements.
  4
 **PAC-WEST
      TELECOMM, INC.****Condensed
      Consolidated Statements of Cash Flows****(Unaudited,
      in thousands)**
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**Operating
      activities:Net
      income (loss)
    
    $
    17,339
    
    $
    (7,165
    )Adjustments
      to reconcile net income (loss) to net cashprovided
      by (used in) operating activities:Depreciation
      and amortization
    
    
    3,750
    
    
    9,085Amortization
      of deferred financing costs
    
    
    154
    
    
    168Amortization
      of discount on notes payable
    
    
    1,262
    
    
    1,255Amortization
      of deferred stock compensation
    
    
    48
    
    
    46Loss
      on extinguishment of debt
    
    
    2,138
    
    
    -Gain
      on sale of enterprise customer base
    
    
    (24,034
    )
    
    -Provision
      for doubtful accounts
    
    
    77
    
    
    48Net
      (gain) loss on disposal of property
    
    
    -
    
    
    (4
    )Changes
      in operating assets and liabilities:Decrease
      (increase) in accounts receivable
    
    
    413
    
    
    (1,585
    )(Increase)
      decrease in prepaid expenses and other current assets
    
    
    (4
    )
    
    1,029Decrease
      (increase) in other assets
    
    
    122
    
    
    (19
    )(Decrease)
      increase in accounts payable
    
    
    (477
    )
    
    2,432Decrease
      in accrued interest
    
    
    (1,008
    )
    
    (1,093
    )Increase
      in income tax payable
    
    
    508
    
    
    -Decrease
      in accrued payroll and relatedexpenses
      and other liabilities
    
    
    (1,547
    )
    
    (4,150
    )Net
      cash (used in) provided by operating activities
    
    
    (1,259
    )
    
    47Investing
      activities:Purchase
      of property and equipment
    
    
    (1,600
    )
    
    (689
    )Proceeds
      from disposal of property and equipment
    
    
    -
    
    
    103Redemptions
      of short-term investments, net
    
    
    207
    
    
    -Business
      acquisitions
    
    
    -
    
    
    (576
    )Returned
      deposits associated with the enterprise customer base sale
    
    
    (3,500
    )
    
    -Other
    
    
    50
    
    
    -Net
      cash used in investing activities
    
    
    (4,843
    )
    
    (1,162
    )Financing
      activities:Repayments
      of notes payable
    
    
    (14,488
    )
    
    (3
    )Proceeds
      from the issuance of common stock
    
    
    21
    
    
    10Principal
      payments on capital leases
    
    
    (100
    )
    
    (1,514
    )Payments
      for deferred financing costs
    
    
    -
    
    
    (64
    )Net
      cash used in financing activities
    
    
    (14,567
    )
    
    (1,571
    )Net
      increase (decrease) in cash and cash equivalents
    
    
    (20,669
    )
    
    (2,686
    )Cash
      and cash equivalents:Beginning
      of period
    
    
    32,265
    
    
    34,657End
      of period
    
    $
    11,596
    
    $
    31,971Supplemental
      Disclosure of Cash Flow Information:Cash
      paid for interest
    
    $
    2,832
    
    $
    2,492Non
      cash Investing and Financing Activities:Deferred
      payments on equipment acquisitions
    
    $
    -
    
    $
    2,167Proceeds
      from sale of enterprise customer base used to pay note
    payable
    
    $
    26,953
    
    $
    -
 See notes
to unaudited condensed consolidated financial statements.
  5
 **PAC-WEST
TELECOMM, INC.**
 **NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **AS
OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2005**
 
 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 a high-value independent provider of integrated communication solutions that
enable communication providers to use its network and services as an alternative
to building and maintaining their own network. The Company’s customers currently
include Internet service providers (ISP), enhanced communication service
providers (ESPs) and other direct providers of communication services to
business or 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 its
associated network assets.
  These
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted for interim
financial information in the United States of America pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). Accordingly, they
do not include all of the information and notes required by accounting
principles generally accepted in the United States of America (US GAAP) for
complete financial statements. In the opinion of management, all adjustments,
consisting only of normal recurring adjustments, considered necessary for a fair
presentation for the periods indicated, have been included. Operating results
for the three months ended March 31, 2005 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2005. The
condensed consolidated balance sheet at December 31, 2004 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, 2004, included
in the Company's Annual Report on Form 10-K filed with the SEC on March 30,
2005.
  Based on
criteria established by Statement of Financial Accounting Standards No. 131
(SFAS 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 our various services,
the revenue streams share almost all of the various operating expenses. As a
result the Company has determined that it has one reportable operating segment.
  These
unaudited condensed consolidated financial statements include the results of
operations of the Company and its subsidiaries. All intercompany accounts and
transactions have been eliminated. Certain prior period amounts have been
reclassified to conform to current period presentations.
 
 **2.**
    ****Sale of Substantially All of the Enterprise Customer
      Base:**** On March 11,
2005, the Company sold substantially all of its enterprise customer base to
TelePacific while retaining its associated network assets, impacting
approximately 150 employees. 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 $26.9
million in cash. As a result, the Company recorded a gain of $24.0 million from
this sale during the first quarter of 2005. In addition, the Company entered
into a Transition Service Agreement (TSA) with TelePacific that, among other
things, obligates it to provide certain transition services to TelePacific at
its estimated cost. The estimated costs to be reimbursed to the Company include
network related and administrative support services. TelePacific’s obligation to
pay the Company for circuit and usage costs during the initial 12 month
transition period is limited to $10.5 million, and TelePacific will receive an
initial $2.0 million credit against the total amount to be billed. The Company
believes that the $8.5 million of reimbursed circuit and usage costs is adequate
to cover the estimated network related costs based upon the Company’s
understanding of TelePacific’s transition plan. However if the number or timing
of customers transitioned off the Company’s network by TelePacific changes
significantly from the Company’s understanding, the Company may incur additional
expenses that will not be reimbursed by TelePacific. The TSA is for a one-year
period subject to extension for two additional three-month periods. Due to the
inseparability of the Company’s network, the absence of identifiable shared
costs, and as no network assets were sold to TelePacific, the Company determined
the assets sold did not constitute discontinued operations.
 
 6
 
 
 In addition
to the $26.9 million in cash for the acquired assets and assumed liabilities
stated above, as of March 31, 2005 the Company has a receivable of approximately
$3.1 million primarily for enterprise customers that had an account receivable
balance as of March 11, 2005, and were part of substantially all of the
enterprise customer base purchased by TelePacific. The receivable from
TelePacific is included in prepaid expenses and other current assets in the
condensed consolidated balance sheet.
 **3.**
    **Stock Based Compensation:**
 The
Company follows Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issues to Employees" for its stock based compensation plans. The Company
has adopted the disclosure-only provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," to disclose
pro forma information regarding options granted to its employees based on
specified valuation techniques that produce estimated compensation charges. If
compensation expense for our stock-based compensation plans had been determined
in accordance with the fair value as prescribed in SFAS No. 123, the Company's
net income (loss) per share would have been as follows:
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**(Dollars
      in thousands except per share amounts)Net
      income (loss) as reported
    
    
    
    
    $
    17,339
    
    $
    (7,165
    )Total
      stock-based employee compensation included inreported
      net income (loss), net of tax
    
    
    
    
    
    48
    
    
    46Total
      stock-based employee compensation determinedunder
      the fair value based method
    
    
    
    
    
    (155
    )
    
    (711
    )Pro
      forma
    
    
    
    
    $
    17,232
    
    $
    (7,830
    )Basic
      net income (loss) per common share:As
      reported
    
    
    
    
    $
    0.47
    
    $
    (0.20
    )Pro
      forma
    
    
    
    
    $
    0.47
    
    $
    (0.21
    )Diluted
      net income (loss) per common share:As
      reported
    
    
    
    
    $
    0.45
    
    $
    (0.20
    )Pro
      forma
    
    
    
    
    $
    0.44
    
    $
    (0.21
    )
 
 For the three
months ended March 31, 2004, potential common stock was antidilutive, as it
decreased the net loss per share. Accordingly, for the three months ended March
31, 2004, 2,639,708 shares were excluded from the diluted net loss per share
calculation for March 31, 2004.
 The
Company uses the Black-Scholes option-pricing model to derive the theoretical
fair value of employee stock option grants. The fair value of each option was
estimated on the date of grant using the Black-Scholes option pricing model with
the following assumptions in the quarters ended March 31, 2005 and 2004,
respectively:
   7
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**Risk-free
      interest rate
    
    
    3.77
    %
    
    2.59
    %Expected
      volatility
    
    
    106
    %
    
    115
    %Expected
      dividend yield
    
    
    -
    
    
    -Expected
      life
    
    
    4
      years
    
    
    4
      yearsFair
      value of options granted
    
    $
    1.09
    
    $
    1.73
 ****
 **4.**
    **Concentration of Customers and
Suppliers:**
 For the
three months ended March 31, 2005 and 2004, the Company had the following
concentrations of revenues and operation costs.
 
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**Largest
      customers: Percentage of totalrevenuesCustomer
      1
    
    
    21.1
    %
    
    17.9
    %Customer
      2
    
    
    16.7
    %
    
    20.5
    %Largest
      supplier: Percentage of networkexpenses
    
    
    38.3
    %
    
    39.7
    %
 During
each of the comparison periods, no other customer accounted for more than 10% of
total revenues. Customers representing more than 10% of trade accounts
receivable as of March 31, 2005 were from two customers, representing 20.0% and
13.6% and at December 31, 2004, one customer represented 12% of trade accounts
receivable.
 **5.**
    **Restructuring Charges:**
 ***2001
and 2002 Restructuring Plans***
  A summary of
the associated liability pertaining to the Company's 2001 and 2002 restructuring
plans, which is included in other accrued liabilities in the accompanying
condensed consolidated balance sheet as of March 31, 2005 and December 31, 2004,
consist of the following:
 **Restructuring**
    ****
    **Additional**
    ****
    ****
    ****
    **Restructuring**
    ********
    ****
    **Liability**
    ****
    **Restructuring**
    ****
    ****
    ****
    **Liability**
    ********
    ****
    **as
      of**
    ****
    **Expense**
    ****
    **Cash**
    ****
    **as
      of**
    ********
    ****
    **Dec.
      31, 2004**
    ****
    **Incurred**
    ****
    **Payments**
    ****
    **Mar.
      31, 2005**(Dollars
      in thousands)Rent
      expense for vacated premises
    
    $
    2,464
    
    $
    -
    
    $
    (175
    )
    $
    2,289
 
 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. The final cash payment to be recorded against the
restructuring reserve is currently expected to occur in March 2010.
  8
 ***2005
Restructuring Plan***
  On March 11,
2005, the Company recorded restructuring charges in connection with the
completion of the sale of substantially all of its enterprise customer base to
TelePacific, primarily consisting of employee separation costs. Of the 150
employees affected by the sale to TelePacific, approximately 85 employees have
been or will be involuntarily terminated. It is anticipated that the majority of
the employees associated with this separation plan will leave their positions by
the end of 2005. The final cash payment to be recorded against the 2005
restructuring reserve is expected to occur in March 2006. However, should
TelePacific exercise its option to extend the term of the TSA, the Company may
incur additional employee termination benefit costs and the timing of the
Company’s final cash payments under the 2005 restructuring plan would also be
extended.
  The costs
incurred in connection with the restructuring plan are comprised of benefits to
employees who were or will be involuntarily terminated and costs related to rent
expense for vacated premises. These costs are included in restructuring charges
in the accompanying condensed consolidated statement of operations and
comprehensive income (loss). During the quarter ended March 31, 2005, costs
incurred for employee termination benefits for approximately 85 employees
amounted to $372,000 and costs incurred for vacated premises totaled $12,000. As
of March 31, 2005, 55 employees had been involuntarily terminated. The Company
anticipates the total cash paid for employee termination benefits, which is
contingent upon the actual termination date of the remaining employees, and rent
expense for vacated premises upon completion of the restructuring, which is
estimated to be March 2006, to be approximately $558,000 and $66,000,
respectively. However, should TelePacific exercise its option to extend the term
of the TSA, the Company may incur additional employee termination benefit costs.
  A summary of
the restructuring expenses and the associated liability pertaining to the
Company's 2005 restructuring plan, which is included in other accrued
liabilities in the accompanying condensed consolidated balance sheet as of March
31, 2005, consist of the following:
 **Restructuring**
    ****
    **Additional**
    ****
    ****
    ****
    **Restructuring**
    ********
    ****
    **Liability**
    ****
    **Restructuring**
    ****
    ****
    ****
    **Liability**
    ********
    ****
    **as
      of**
    ****
    **Expense**
    ****
    **Cash**
    ****
    **as
      of**
    ********
    ****
    **Dec.
      31, 2004**
    ****
    **Incurred**
    ****
    **Payments**
    ****
    **Mar.
      31, 2005**(Dollars
      in thousands)One-time
      employee termination benefits
    
    $
    -
    
    $
    372
    
    $
    (284
    )
    $
    88Rent
      expense for vacated premises
    
    
    -
    
    
    12
    
    
    (12
    )
    
    -$
    -
    
    $
    384
    
    $
    (296
    )
    $
    88
 ****
 **6.**
    **Income Taxes:**
 
 The Company's
effective income tax rate for the quarters ended March 31, 2005 and 2004 was
2.9% and 0.0%, respectively. The Company anticipates using its available tax net
operating losses to offset the majority of any income tax owed on the gain from
the sale of substantially all of its enterprise customer base to TelePacific. As
of March 31, 2005, the Company had recorded income taxes payable of $0.5
million, which is included in other accrued liabilities in the accompanying
condensed consolidated balance sheet.
  **7.**
    **Other Comprehensive Loss:**
 
 For the quarters ended
March 31, 2005 and 2004, there was $22,000 and $0, respectively, of other
comprehensive loss pertaining to net unrealized investment losses on
available-for-sale marketable securities.
 
 **8.**
    **Commitments and Contingencies:**
 
 From time to
time, the Company is subject to audits with various tax authorities that arise
during the normal course of business. The Company believes resolutions to
various tax audits that the Company may be involved with in the normal course of
business, will not materially harm its business, financial condition or results
of operations.
  
 9
 
 There have been no
material developments in the litigation previously reported in the Company’s
Annual Report on Form 10-K for the period ended December 31, 2004 as filed with
the SEC on March 30, 2005. 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.
 
 As noted above, the
Company’s TSA with TelePacific includes a cap during the first 12 months on
certain types of network related services for which TelePacific is obligated to
reimburse the Company. The Company believes that the $8.5 million of reimbursed
circuit and usage costs is adequate to cover the estimated network related costs
based upon the Company’s understanding of TelePacific’s transition plan. However
if the number or timing of customers transitioned off the Company’s network by
TelePacific changes significantly from the Company’s understanding, the Company
may incur additional expenses that will not be reimbursed by
TelePacific.
  **9.**
    **Related Party Transactions:**
  A
significant stockholder of the Company, Bay Alarm, together with its subsidiary
InReach Internet, LLC, is a customer of the Company. As of March 11, 2005, Bay
Alarm was included in the sale of substantially all of the enterprise customer
base to TelePacific, however InReach Internet, LLC, remains a customer of the
Company. Bay Alarm continues to provide the Company with security monitoring
services at its normal commercial rates. The Company also leases a facility in
Oakland, California from Bay Alarm. Certain information concerning these
arrangements with Bay Alarm are as follows:
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**(Dollars
      in thousands)Revenues
    
    $
    280
    
    $
    394Revenues
      as a percentage of total revenues
    
    
    1.0
    %
    
    1.3
    %Security
      monitoring costs
    
    $
    10
    
    $
    10Oakland
      property rent payments
    
    $
    88
    
    $
    97
 
 At both March 31, 2005 and
December 31, 2004 the Company had no amounts receivable from Bay Alarm. All
expenses paid to Bay Alarm are included in selling, general and administrative
expenses in the accompanying condensed consolidated statements of
operations.
 **10.**
    **Debt and interest expense, net:**
 
 At March 31, 2005 and
December 31, 2004, long-term debt and capital lease obligations consist of the
following:
 **March
      31,**
    
    **December
      31,****2005**
    
    **2004**(Dollars
      in thousands)Senior
      Notes
    
    $
    36,102
    
    $
    36,102Senior
      Secured Note
    
    
    -
    
    
    24,500Capital
      lease obligations
    
    
    1,184
    
    
    1,285Notes
      payable
    
    
    5,350
    
    
    6,040Less
      current portion of notes payable and capital leases
    
    
    (2,844
    )
    
    (2,889
    )$
    39,792
    
    $
    65,038
 
 
 10
 The
Senior Notes of which there is $36.1 million in principal amount outstanding at
March 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.

The
Senior Secured Note, which was initially issued in the principal amount of $40.0
million accrued interest at a rate of LIBOR plus 0.5%, and was to mature
December 2006. On March 11, 2005, pursuant to the terms of a Payoff Letter, by
and between the Company and Deutsche Bank AG — London (Deutsche Bank), the
Company utilized $26.9 million of proceeds from the sale of substantially all of
its enterprise customer base to TelePacific, as well as $13.8 million from cash
on hand, to prepay in full the Senior Secured Note (including all outstanding
principal and accrued and unpaid interest). In addition, pursuant to the terms
of the Payoff Letter, the Company retired the related warrants to acquire up to
26,666,667 shares of the Company’s common stock in connection with 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.

During
the second quarter of 2004, the Company entered into a secured financing
arrangement with Merrill Lynch Capital, a division of Merrill Lynch Business
Financial Services, Inc., pursuant to which the Company may borrow up to an
aggregate amount of $10.0 million, subject to certain conditions. This financing
arrangement was structured in a manner that provides 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 shall be payable in 36 equal monthly
installments. The Company has the option to prepay the 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 new telecommunication switch and related
equipment, which secure borrowings under this financing
arrangement.

As of
March 31, 2005, the Company had borrowed approximately $5.4 million under the
Merrill Lynch Capital financing arrangement under two credit facilities both
with interest rates of 8.6%. As of March 31, 2005, the principal balance was
$4.2 million and is included under Notes Payable in the above table.

In May
2004, the Company completed financing agreements for various network equipment
with Cisco Systems, Inc. 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 March 31, 2005 the
principal balance for each the capital lease and the note payable was $1.1
million.

Interest
expense, net for the quarters ended March 31, 2005 and 2004 was as
follows:
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**(Dollars
      in thousands)Interest
      on Senior Notes
    
    $
    1,218
    
    $
    1,232Accreted
      discount on Senior Secured Note
    
    
    1,262
    
    
    1,255Amortization
      of deferred financing costs
    
    
    154
    
    
    168Other
      interest expense
    
    
    362
    
    
    167Less
      interest income
    
    
    (190
    )
    
    (41
    )$
    2,806
    
    $
    2,781
   11
 **11.**
    **Recent Accounting Pronouncements:**
 
 In December
2004, the Financial Accounting Standards Board issued SFAS No. 123R,
“Share-Based Payment.” Among other items, the standard requires the Company to
recognize compensation cost for all share-based payments, in the Company’s
consolidated statements of operations. Depending on the model used to calculate
stock-based compensation expense in the future and other requirements of SFAS
No. 123R, the pro forma disclosure in Note 3 may not be indicative of the
stock-based compensation expense that will be recognized in the Company’s future
financial statements. On April 14, 2005, the Securities and Exchange Commission
(SEC) amended Regulation S-X to allow SEC registrants to delay the
implementation date of SFAS No. 123R to the beginning of the first fiscal year
after June 15, 2005. The Company plans to implement SFAS No. 123R beginning with
its first quarterly report after January 1, 2006. The Company is currently
evaluating the new standard and models, which may be used to calculate future
stock-based compensation expense.
 
 In March
2005, the SEC issued Staff Accounting Bulletin (SAB) No. 107, "Share-Based
Payment," which provides the staff's views regarding the valuation of
share-based payment arrangements for public companies.
  ****
 **ITEM
2.**  **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS**
 
 ***Except
for the historical information contained herein, this report contains
forward-looking statements, subject to uncertainties and risks. In this
Quarterly Report on Form 10-Q, our use of the words "outlook," "expect,"
"anticipate," "estimate," "forecast," "project," "likely," "objective," "plan,"
"designed," "goal," "target," and similar expressions is intended to identify
forward-looking statements. While these statements represent our current
judgment on what the future may hold, and we believe these judgments are
reasonable, actual results may differ materially due to numerous important risk
factors that are described in our Annual Report on Form 10-K for the period
ended December 31, 2004, as filed with the SEC on March 30, 2005, which may be
revised or supplemented in subsequent reports filed by us with the SEC. Such
risk factors include, but are not limited to our level of indebtedness; an
inability to generate sufficient cash to service our indebtedness; regulatory
and legal uncertainty with respect to intercarrier compensation payments
received by us; the inability to expand our business as a result of the
unavailability of funds to do so; the migration to broadband Internet access
affecting dial-up Internet access; the loss of key executive officers could
negatively impact our business prospects; an increase in our network expenses
which could result if the migration of our enterprise customer base to U.S.
TelePacific Corp. occurs sooner or later than contemplated; and our principal
competitors for local services and potential additional competitors have
advantages that may adversely affect our ability to compete with
them.***
 **Introduction**
  We are a
high-value independent provider of integrated communication solutions that
enable communication providers to use our network and services as an alternative
to building and maintaining their own network. Our customers currently include
Internet service providers (ISP), enhanced communication service providers
(ESPs) and other direct providers of communication services to business or
residential end-users, collectively referred to as service providers
(SPs).
 
 We built our
facilities-based network to capitalize on the significant growth in Internet
usage and in the related demand for local telephone service by SPs, as well as
the increasing demand of small and medium business enterprise market
(enterprise) for customized and integrated voice and data communication
services. We believe the statewide footprint of our network, which encompasses
all of the major metropolitan areas of California, provides us with a
competitive advantage over incumbent local exchange carriers (ILECs) and
competitive local exchange carriers (CLECs). Our ubiquitous network in
California and our growing networks in Arizona, Nevada, Oregon and Washington,
enable SPs to provide their end-users with access to Internet, paging and other
data and voice services from almost any point in the state through a local call.
We believe the breadth of our product offerings and the structure of our network
enables us to generate high network utilization.
   12
 
 In response
to our evolving business model, which as described above, is focused on
providing communication solutions to other communication 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,
impacting approximately 150 employees. 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 $26.9 million in cash. As a result, we recorded a gain of $24.0
million from this sale during the first quarter of 2005. In addition, we entered
into a Transition Service Agreement (TSA) with TelePacific that, among other
things, obligates us to provide certain transition services to TelePacific at
our estimated cost. The estimated costs to be reimbursed to us include network
related and administrative support services. TelePacific’s obligation to pay us
for circuit and usage costs during the initial 12 month transition period is
limited to $10.5 million, and TelePacific will receive an initial $2.0 million
credit against the total amount to be billed. We believe that the $8.5 million
of reimbursed circuit and usage costs is adequate to cover the estimated network
related costs based upon our understanding of TelePacific’s transition plan.
However the number or timing of customers transitioned off our network by
TelePacific changes significantly from our understanding, we may incur
additional expenses that will not be reimbursed by TelePacific. The TSA is for a
one-year period subject to extension for two additional three-month periods. Due
to the inseparability of our network and the absence of identifiable shared
costs, and as no network assets were sold to TelePacific, we determined the
assets sold did not constitute discontinued operations.
  In connection
with the completion of the sale of substantially all of our enterprise customer
base to TelePacific on March 11, 2005, we recorded during the first quarter of
2005 net restructuring charges of approximately $384,000 primarily consisting of
employee separation costs for approximately 85 employees previously associated
with the enterprise customer base who have been or will be involuntarily
terminated, as well as rent expense for vacated premises. We anticipate that
future cash requirements associated with the separation plan will be
approximately $0.3 million, the timing of which is contingent upon the actual
termination date of the remaining employees. We anticipate that the majority of
the employees associated with this separation plan will leave their positions by
the end of 2005. The final cash payment to be recorded against this reserve is
expected to occur in March 2006. However, should TelePacific exercise its option
to extend the term of the TSA, we may incur additional employee termination
benefit costs and the timing of our final cash payments under the restructuring
plan would be extended.
  The following
table shows our financial performance for the three months ended March 31, 2005
and 2004:
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**(unaudited)
    
    (unaudited)(Dollars
      in thousands)Total
      revenues
    
    $
    28,131
    
    $
    29,423Net
      income (loss)
    
    $
    17,339
    
    $
    (7,165)Income
      (loss) per share diluted
    
    $
    0.45
    
    $
    (0.20)
 
 We derive our
revenues from monthly recurring charges, usage charges and amortization of
initial non-recurring charges. We provide services to both retail and wholesale
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 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. These payments and related costs up to the amount of revenues are
recognized as revenue and expense 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.
  13
 
 We have
carrier customers who pay us to terminate their originating call traffic on our
network. These payments consist of meet point, 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 ILECs. Intercarrier compensation payments have
historically been a significant portion of our revenues but the intercarrier
payments are not currently a targeted customer. Intercarrier compensation
payments accounted for 31.0% and 27.2% of our total revenues for the quarters
ended March 31, 2005 and 2004, respectively. Although the rate at which we
believe we will be compensated by the ILECs in 2005 is expected to be consistent
with 2004, the sale of our enterprise customer base to TelePacific may affect
the percentage of total revenues represented by intercarrier compensation in
2005. The failure, for any reason, of one or more ILECs 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 ILECs, as well as the right of CLECs and
other competitors to receive such payments is the subject of numerous regulatory
and legal challenges. For example, in 2003, Verizon and SBC adopted the Federal
Communications Commission’s, or FCC’s, Intercarrier ISP Compensation Order. The
FCC ISP order introduced a series of declining intercarrier compensation pricing
tiers for minutes of use, at rates starting below the rates previously
negotiated in our interconnection agreements (ICAs) with both carriers. The
lowest pricing tier specified by the FCC ISP order was reached on June 15, 2003
and will remain in effect until such time that a replacement FCC ISP order, may
become effective. Additionally, the FCC ISP order introduced artificial annual
growth limits on compensable minutes of use subject to intercarrier compensation
based on the composition and balance of traffic between carriers. The FCC ceased
enforcing the growth cap in October 2004.
  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.
  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, including potential acquisitions or new business lines. We believe
that the statewide footprint of our network, which encompasses all of the major
metropolitan areas of California, 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 sustain continued 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; and

•impairment
for long-lived assets.
 
 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.
 14

**
*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.
Non-refundable
up-front payments received for installation services and related costs up to the
amount of installation revenues, are recognized as revenue and expense ratably
over the term of the service contracts, generally 24 to 36 months. Any costs in
excess of recognized revenues are expensed in the current period.

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. Until all issues affecting a given item of revenue are
resolved, we will continue to recognize intercarrier compensation as revenue
when the price becomes fixed and determinable and collectibility is reasonably
assured.

Some ILECs
with which we have interconnection agreements had withheld payments from amounts
billed by us under their agreements. The process of collection of intercarrier
compensation can be complex and subject to interpretation of regulations and
laws. This can lead to the requirement for negotiated settlements between us and
the ILEC where we agree to accept a portion of what we believe is owed to us.
These settlements generally reflect the mutual agreements of both parties that
exist at the date of the settlement.

*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.
*Accruals 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.
 15
 
 **
 *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.
  *Warrant
Valuation* . During
the quarter ended March 31, 2005, we performed an internal evaluation of the
warrants related to the Senior Secured Note. We used the Black Scholes model to
value the warrants at March 11, 2005. This valuation was used to record the
value of the warrants related to the prepayment of the Senior Secured
Note.
  **Results
of Operations**
 *Quarter
Ended March 31, 2005 Compared to the Quarter Ended March 31,
2004*
 
 Our
significant revenue components and operational metrics for the quarters ended
March 31, 2005 and 2004 are as follows:
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**
    
    **%
      Change**(unaudited)
    
    (unaudited)(Dollars
      in millions)**Revenues:**Intercarrier
      compensation
    
    $
    8.7
    
    $
    8.0
    
    
    8.8
    %Direct
      billings to SP customers
    
    
    10.0
    
    
    11.1
    
    
    (9.9
    )%Direct
      billings to enterprise customers
    
    
    4.8
    
    
    4.7
    
    
    2.1
    %Other
    
    
    4.6
    
    
    5.6
    
    
    (17.9
    )%Total
      revenues
    
    $
    28.1
    
    $
    29.4
    
    
    (4.4
    )%**Operational
      metrics:**Minutes
      of use (in billions)
    
    
    12.2
    
    
    11.3
    
    
    8.0
    %
 
 Consolidated
revenues decreased 4.4% to $28.1 million in the quarter ended March 31, 2005
from $29.4 million during the same period in 2004. The decrease in revenue was
primarily the result of a decrease of $1.1 million in direct billings to SP
customers and a decrease of $0.8 million in outbound local and long distance,
partially offset by increases in intercarrier compensation.
 Intercarrier
compensation increased 8.8% to $8.7 million in the quarter ended March 31, 2005
from $8.0 million during the same period in 2004 primarily due to approximately
a 9% increase in minutes of use compared to the same period in
2004.
 
 Direct
billings to SP customers decreased from the same period in 2004 by $1.1 million,
or 9.9%, to $10.0 million from $11.1 million during the quarter ended March 31,
2004 primarily due to customers disconnecting lines not in use.
 
 Direct
billings to enterprise customers remained relatively constant at $4.8 million in
the quarter ended March 31, 2005 compared to $4.7 million during the same period
in 2004. Due to the sale of substantially all of our enterprise customer base to
TelePacific on March 11, 2005, we expect direct billings to enterprise customers
to significantly decrease after this date.
   16
 Other
revenues decreased 17.9% to $4.6 million in the quarter ended March 31, 2005
from $5.6 million during the same period in 2004. The decline is principally due
to a $0.8 million decrease in outbound local and long distance revenues
primarily due to a decrease in minutes of use resulting from the sale of
substantially all of our enterprise customer base. As a result of this sale we
expect these revenues to continue to decrease in future periods.
 
 Minutes
of use increased 8.0% to 12.2 billion in the quarter ended March 31, 2005
compared to 11.3 billion during the same period in 2004.
  The
significant costs and expenses for the quarters ended March 31, 2005 and 2004
are as follows:
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**
    
    **%
      Change**(unaudited)
    
    (unaudited)(Dollars
      in millions)**Costs
      and expenses:**Network
      expenses (exclusive of depreciation shown separately
below)
    
    $
    10.6
    
    $
    10.5
    
    
    1.0
    %Selling,
      general and administrative
    
    
    14.7
    
    
    14.2
    
    
    3.5
    %Depreciation
      and amortization
    
    
    3.7
    
    
    9.1
    
    
    (59.3
    )%Restructuring
      charges
    
    
    0.4
    
    
    -
    
    
    100.0
    %Total
      costs and expenses
    
    $
    29.4
    
    $
    33.8
    
    
    (13.0
    )%
 
 Consolidated
network expenses remained relatively constant at $10.6 million in the quarter
ended March 31, 2005 compared to $10.5 million during the same period in 2004.
As a result of the sale of substantially all of our enterprise customer base, we
expect our network expenses to decrease in future periods as former customers
transition to TelePacific’s network. During this transition period, we are
obligated under the TSA, among other things, to provide certain transition
services to TelePacific at our estimated cost. The estimated costs to be
reimbursed to us include network related services. TelePacific’s obligation to
pay us for circuit and usage costs during the initial 12 month transition period
is limited to $10.5 million, and TelePacific will receive an initial $2.0
million credit against the total amount to be billed. We believe that the $8.5
million of reimbursed circuit and usage costs is adequate to cover the estimated
network related costs based upon our understanding of TelePacific’s transition
plan. However if the number or timing of customers transitioned off our network
by TelePacific changes significantly from our understanding, we may incur
additional expenses that will not be reimbursed by TelePacific.
  Consolidated
selling, general and administrative expenses increased 3.5% to $14.7 million in
the quarter ended March 31, 2005 from $14.2 million during the same period in
2004. The increase was primarily the result of employee compensation for those
who were affected by the sale of substantially all of our enterprise customer
base to TelePacific during the first quarter of 2005, and increased employee
benefits due to an increase in rates. As part of the TSA with TelePacific, we
may bill TelePacific for selling, general and administrative expenses that are
incurred on their behalf.
  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 59.3% to $3.7 million in the
quarter ended March 31, 2005 from $9.1 million during the same period in 2004.
The decrease in depreciation and amortization expense was primarily due to
recording a non-cash asset impairment charge of $54.6 million for our tangible
assets during the fourth quarter of 2004. The impairment resulted in a new cost
basis for these assets resulting in a reduction of gross property and equipment.
As a result, future depreciation expense is expected to be less for the affected
assets than in prior years. In addition, as part of the sale of substantially
all of our enterprise customer base, we sold property and equipment with a net
book value of approximately $3.0 million.
 17
 
 
 Restructuring
charges were $0.4 million in the quarter ended March 31, 2005. There were no
restructuring charges in the quarter ended March 31, 2004. These charges related
to the completion of the sale of substantially all of our enterprise customer
base primarily for employee termination benefits and rent expense for vacated
premises. We anticipate that future cash requirements associated with the
separation plan will be approximately $0.3 million, the timing of which is
contingent upon the actual termination date of the remaining employees. We
anticipate that the majority of the employees associated with this separation
plan will leave their positions by the end of 2005. The final cash payment to be
recorded against this reserve is expected to occur in March 2006. However,
should TelePacific exercise its option to extend the term of the TSA, we may
incur additional employee termination benefit costs and the timing of our final
cash payments under the restructuring plan would be extended.
  Consolidated
loss from operations improved 72.7% to $1.2 million in the quarter ended March
31, 2005 from $4.4 million during the same period in 2004 primarily due to the
factors discussed in the preceding paragraphs.
 Consolidated
interest expense, net remained relatively constant at $2.8 million for both the
quarter ended March 31, 2005 and the same period in 2004. Our interest expense,
net was as follows:
 **Three
      Months Ended****March
      31,****2005**
    
    **2004**(unaudited)
    
    (unaudited)(Dollars
      in thousands)**Interest
      expense, net:**Interest
      on Senior Notes
    
    $
    1,218
    
    $
    1,232Accreted
      discount on Senior Secured Note
    
    
    1,262
    
    
    1,255Amortization
      of deferred financing costs
    
    
    154
    
    
    168Other
      interest expense, net
    
    
    172
    
    
    126$
    2,806
    
    $
    2,781
 
 Interest
expense, net is expected to decrease during 2005 due to the termination of the
discount accretion on the extinguishment of the senior secured
note.
  During the
first quarter of 2005, we recorded a gain of $24.0 million from the sale of
substantially all of our enterprise customer base.
  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 Senior Secured Note (including all
outstanding principal and accrued and unpaid interest). In addition, pursuant to
the terms of the Payoff Letter, we retired the related warrants to acquire up to
26,666,667 shares of our common stock in connection with 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
quarters ended March 31, 2005 and 2004, our effective income tax rate was 2.9%
and 0.0%, respectively.
  Consolidated
net income was $17.3 million in the quarter ended March 31, 2005 compared to a
net loss of $7.2 million during the same period in 2004 primarily due to the
factors discussed in the preceding paragraphs.
 18
 **Quarterly
Operating and Statistical Data:**
  The following
tables summarize the unaudited results of operations as a percentage of revenues
for the quarters ended March 31, 2005 and 2004. 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****March
      31,****2005**
    
    **2004**(unaudited)
    
    (unaudited)**Consolidated
      Statements of Operations****Data:**Revenue
    
    
    100.0
    %
    
    100.0
    %Network
      expenses (exclusive of depreciation shown separately
below)
    
    
    37.6
    %
    
    35.7
    %Selling,
      general and administrative expenses
    
    
    52.2
    %
    
    48.4
    %Depreciation
      and amortization expenses
    
    
    13.3
    %
    
    30.9
    %Loss
      from operations
    
    
    (4.4
    )%
    
    (14.9
    )%Net
      income (loss)
    
    
    61.6
    %
    
    (24.4
    )%
 
 The following
table sets forth unaudited statistical data for each of the specified quarters
of 2005 and 2004. The operating and statistical data for any quarter are not
necessarily indicative of results for any future period.
 
 **Three
      Months Ended**
    ********
    ****
    **2005**
    ****
    **2004**
    ********
    ****
    **March
      31,**
    ****
    **Dec.
      31,**
    ****
    **Sept.
      30,**
    ****
    **June
      30,**
    ****
    **March
      31,**(unaudited)
    
    
    (unaudited)
    
    
    (unaudited)
    
    
    (unaudited)
    
    
    (unaudited)Ports
      equipped
    
    
    1,052,400
    
    
    1,052,400
    
    
    998,400
    
    
    998,400
    
    
    998,400Quarterly
      minutes of useswitched
      (in billions)
    
    
    12.2
    
    
    11.9
    
    
    11.3
    
    
    10.2
    
    
    11.3Capital
      additions(in
      thousands)
    
    $
    1,600
    
    $
    1,205
    
    $
    5,201
    
    $
    3,488
    
    $
    689Employees
    
    
    250
    
    
    373
    
    
    392
    
    
    398
    
    
    389
  **Liquidity
and Capital Resources:**
  *Sources and
use of cash.* At March
31, 2005 cash and short term investments decreased $20.9 million to $21.9
million from $42.8 million at December 31, 2004. The decrease was primarily due
to the prepayment of the $40.0 million Senior Secured Note (including all
outstanding principal and accrued and unpaid interest) with cash on hand and
proceeds of $26.9 million from the sale of substantially all of the enterprise
customer base to TelePacific.
  Net cash used
in operating activities was $1.3 million for the quarter ended March 31, 2005 as
compared to net cash provided by operating activities of $47,000 for the same
period ended in 2004. The decrease was primarily due to lower sales and higher
selling, general and administrative expenses in 2005 compared to the same period
in 2004.
  Net cash used
in investing activities was $4.8 million for the quarter ended March 31, 2005
compared to $1.2 million during the same period in 2004. We returned to
TelePacific $3.5 million of deposits related to the then pending sale of
substantially all of our enterprise customer base during January 2005.
  Net cash used
in financing activities was $14.6 million in the quarter ended March 31, 2005
compared to $1.6 million for the same period in 2004. We prepaid the Senior
Secured Note with proceeds from the sale of the enterprise customer base and
cash on hand. Cash proceeds from the sale of substantially all of our enterprise
customer base were paid directly to Deutsche Bank by TelePacific.
   **
 19
 **
 *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. We continue to seek
further ways to enhance our infrastructure in 2005 and beyond. As a result of
various capital projects and our business plan, as currently contemplated, we
anticipate making capital expenditures, excluding acquisitions, of approximately
$7.3 million for the next 12 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, the amount described
above.
 Under the TSA
with TelePacific we are obligated, among other things, to provide certain
transition services to TelePacific at our estimated cost. The estimated costs to
be reimbursed to us include network related and administrative support services.
TelePacific’s obligation to pay us for circuit and usage costs during the
initial 12 month transition period is limited to $10.5 million and TelePacific
will receive an initial $2.0 million credit against the total amount to be
billed. We believe that the $8.5 million of reimbursed circuit and usage costs
is adequate to cover the estimated network related costs based upon our
understanding of TelePacific’s transition plan. However if the number or timing
of customers transitioned off our network by TelePacific changes significantly
from our understanding, we may incur additional expenses that will not be
reimbursed by TelePacific. The TSA is for a one-year period subject to extension
for two additional three-month periods.
  We anticipate
that future cash requirements associated with the separation plan due to the
sale of substantially all of our enterprise customers will be approximately $0.3
million, the timing of which is contingent upon the actual termination date of
the remaining employees. We anticipate that the majority of the employees
associated with this separation plan will leave their positions by the end of
2005. The final cash payment to be recorded against this reserve is expected to
occur in March 2006. However, should TelePacific exercise its option to extend
the term of the TSA, we may incur additional employee termination benefit costs
and the timing of our final cash payments under the restructuring plan would be
extended.
 
 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 March 31, 2005, we did not
have any material future purchase commitments to purchase equipment from any of
our vendors.
 **
 *Debt
outstanding.* At March
31, 2005 and December 31, 2004 long-term debt and capital lease obligations
consist of the following:
 **March
      31,**
    
    **December
      31,****2005**
    
    **2004**(unaudited)
    
    (unaudited)(Dollars
      in thousands)Senior
      Notes
    
    $
    36,102
    
    $
    36,102Senior
      Secured Note
    
    
    -
    
    
    24,500Capital
      lease obligations
    
    
    1,184
    
    
    1,285Notes
      payable
    
    
    5,350
    
    
    6,040Less
      current portion of notes payable and capital leases
    
    
    (2,844)
    
    
    (2,889)$
    39,792
    
    $
    65,038
 
 The Senior
Notes, of which there is $36.1 million in principal amount outstanding at March
31, 2005, bear interest at 13.5% per annum payable in semiannual installments,
with all principal due in full on February 1, 2009.
 The
Senior Secured Note, which was initially issued in the principal amount of $40.0
million, accrued interest at a rate of LIBOR plus 0.5%, and was to mature
December 2006. On March 11, 2005, pursuant to the terms of the 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 Senior Secured Note
(including all outstanding principal and accrued and unpaid interest). In
addition, pursuant to the terms of the Payoff Letter, we retired the related
warrants to acquire up to 26,666,667 shares of our common stock in connection
with 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.
 
 20
 **
 *Future uses
and sources of cash.* Our
principal sources of funds for 2005 are anticipated to be current cash and
short-term investment balances and cash flows from operating activities. We
believe that these funds will provide us with sufficient liquidity and capital
resources to fund our business plan for the next 12 months. No assurance can be
given, however, that this will be the case. We may also seek to obtain leases or
additional lines of credit in 2005. There can be no assurance that additional
lines of credit or leases will be made available to us on terms that we find
acceptable. As currently contemplated, we expect to fund, among other
things:
 
 •  interest
payments of approximately $5 million on Senior Notes and other
notes;
 
 •  anticipated
capital expenditures of approximately $7.3 million; and
 
 •  capital
lease payments (including interest) of approximately $0.6 million.
 The foregoing
statements do not take into account (i) acquisitions, which, if made, are
expected to be funded through a combination of cash and equity (ii) the
repurchase of any of our remaining outstanding Senior Notes or (iii) any
potential payments made in respect of adjustments which may arise from our
ongoing tax audits. Depending upon our rate of growth and profitability, among
other things, we may require additional equity or debt financing to meet our
working capital requirements or capital needs. There can be no assurance that
additional financing will be available when required, or, if available, will be
on terms satisfactory to us. Key factors which could affect our liquidity
include:
  •  future
demand of our services;
 
 •  financial
stability of our customers;
 
 •  outcomes
of regulatory proceedings involving intercarrier compensation;
 
 •  capital
expenditures;
 
 •  our debt
payments;
 
 •  capital
lease repayments;
 
 •  loss of
enterprise revenues due to the sale of our enterprise customer
base;
 
 •  interest
expense on debt; and
 
 •  development
and market rollout of new service offerings.
 
 **ITEM
3.**  **QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**
 The SEC's
rule related to market risk disclosure requires that we describe and quantify
our potential losses from market risk sensitive instruments attributable to
reasonably possible market changes. Market risk sensitive instruments include
all financial or commodity instruments and other financial instruments that are
sensitive to future changes in interest rates, currency exchange rates,
commodity prices or other market factors. 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. Since the payoff of our Senior Secured Note on March 11,
2005, our remaining debt carries fixed interest rates. Therefore, we are not
exposed to changes in interest rates associated with our debt as of March 31,
2005.
 21
  We are
exposed to changes in interest rates on our investments in cash equivalents and
short-term investments. Approximately half of our investments are in cash
equivalents with original maturities of less than three months and the other
half in short-term investments with maturities of less than 12 months. A
hypothetical 1% decrease in short-term interest rates would reduce the
annualized pretax interest income on our $21.9 million cash, cash equivalents
and short-term investments at March 31, 2005 by approximately $0.2
million.
 **ITEM
4.**  **CONTROLS
AND PROCEDURES**
 As of the
end of the period covered by this Report, the Company carried out an evaluation,
under the supervision and with the participation of the Company's management,
including the Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the Company's “disclosure controls and procedures” (as defined
in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”), in accordance with Rule 13a-15 of the Exchange Act. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer,
together with the other members of management participating in the evaluation,
concluded that the Company's disclosure controls and procedures are effective at
the reasonable assurance level.

There have
been no significant changes in the Company's internal control over financial
reporting that occurred during the quarter ended March 31, 2005 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—Factors Affecting Operations—Revenues” for a
description of certain legal proceedings involving the Company.
  **ITEM
5. Other Information**
 None.
 **ITEM
6.** **Exhibits**
 
 Exhibits
 
 31.1
    Certification
      by Henry R. Carabelli, Chief Executive Officer pursuant to Section 302 of
      the Sarbanes-Oxley Act of 2002.
 
 31.2**
    Certification
      by H. Ravi Brar, Chief Financial Officer and Vice President of Human
      Resources 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
      by H. Ravi Brar, Chief Financial Officer**and
      Vice President of Human Resources pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002.
 **Note:
ITEMS 2, 3 and 4 are not applicable and have been omitted.**
  22
 
 
 **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 May 16, 2005.
 
 PAC-WEST
TELECOMM, INC.
 
 /s/ Henry
R. Carabelli
 _____________________________
 Henry R.
Carabelli
 President
and Chief Executive Officer
 
 
 
 
 
 
 
 
 
 /s/ H.
Ravi Brar
 ______________________________
 H. Ravi
Brar
 Chief
Financial Officer and Vice President
 of Human
Resources
 
 23