**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549-0001**

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**FORM 10-Q**

**(MARK ONE)**

| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------|------------|-----------------------------------------------------------------------------------------------|
| ** ** |       | ** **                                                                                    |
| ** ** |       | **For the  quarterly period ended June 30, 2007**                                             |
| ** ** |       | ** **                                                                                    |
| ** ** |       | **OR**                                                                                        |
| ** ** |       | ** **                                                                                    |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**CommissionFile Number 000-50706**

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**ESCHELONTELECOM, INC.**(Exact name of registrant as specified in its charter)

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

 

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

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to the filing requirements for the past90 days. Yes x No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o |   | Accelerated  filer x |   | Non-accelerated filer o |
|---------------------------|--------|----------------------|--------|-------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o No x

As of July 31, 2007, thenumber of outstanding shares of the Registrant’s Common Stock, par value $.01per share, was 18,086,082 shares.

 

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**ESCHELON TELECOM, INC.INDEX TO FORM 10-Q**
| **PART I. FINANCIAL  INFORMATION** |
|------------------------------------|
| ** **                         |
| Item 1.                            |   | Financial  Statements: |
|                               |   |   |
|                               |   | Consolidated  Balance Sheets – June 30, 2007 (Unaudited) and December 31, 2006 |
|                               |   |   |
|                               |   | Unaudited  Consolidated Statements of Operations – Three months and six months ended  June 30, 2007 and 2006 |
|                               |   |   |
|                               |   | Unaudited  Consolidated Statements of Cash Flows – Six months ended June 30, 2007 and  2006 |
|                               |   |   |
|                               |   | Notes to  Consolidated Financial Statements |
|                               |   |   |
| Item 2.                            |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                               |   |   |
| Item 3.                            |   | Quantitative  and Qualitative Disclosures About Market Risk |
|                               |   |   |
| Item 4.                            |   | Controls and  Procedures |
|                               |   |   |
| **PART II. OTHER INFORMATION**     |
| ** **                         |
| Item 1.                            |   | Legal Proceedings |
|                               |   |   |
| Item  1A.                          |   | Risk  Factors |
|                               |   |   |
| Item 2.                            |   | Unregistered  Sales of Equity Securities and Use of Proceeds |
|                               |   |   |
| Item 3.                            |   | Defaults  Upon Senior Securities |
|                               |   |   |
| Item 4.                            |   | Submission  of Matters to a Vote of Security Holders |
|                               |   |   |
| Item 5.                            |   | Other Information |
|                               |   |   |
| Item  6.                           |   | Exhibits |
|                               |   |   |
| Signature                          |   |   |

 

2

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**PART I. FINANCIAL INFORMATION**

## **Item1.  Financial Statements**

**Eschelon Telecom, Inc.Consolidated Balance Sheets(In Thousands, Except Share and Per Share Amounts)**
| ** **                                                                                                                                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                           | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                           | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                      |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                           |       | $                 | 17,986     |                  | $          | 21,146 |   |
| Restricted cash                                                                                                                                                      |       | 560               |       | 1,224                 |       |
| Available-for-sale  securities                                                                                                                                       |       | —            |       | 17,097                |       |
| Accounts  receivable, net of allowance for doubtful accounts of $1,076 and $903,  respectively                                                                       |       | 29,573            |       | 27,592                |       |
| Other  receivables                                                                                                                                                   |       | 5,161             |       | 4,025                 |       |
| Inventories                                                                                                                                                          |       | 3,689             |       | 3,552                 |       |
| Prepaid expenses                                                                                                                                                     |       | 3,081             |       | 2,314                 |       |
| Total current assets                                                                                                                                                 |       | 60,050            |       | 76,950                |       |
|                                                                                                                                                                 |       |              |       |                  |       |
| Property and equipment,  net                                                                                                                                         |       | 151,752           |       | 145,785               |       |
|                                                                                                                                                                 |       |              |       |                  |       |
| Other assets                                                                                                                                                         |       | 1,522             |       | 2,185                 |       |
| Goodwill                                                                                                                                                             |       | 72,398            |       | 59,670                |       |
| Intangible assets, net                                                                                                                                               |       | 47,483            |       | 45,931                |       |
| Total assets                                                                                                                                                         |       | $                 | 333,205    |                  | $          | 330,521 |   |
|                                                                                                                                                                 |       |              |       |                  |       |
| **Liabilities and stockholders’  equity**                                                                                                                       | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                 |       |              |       |                  |       |
| Accounts payable                                                                                                                                                     |       | $                 | 11,950     |                  | $          | 17,641 |   |
| Accrued  telecommunication costs                                                                                                                                     |       | 5,508             |       | 5,730                 |       |
| Accrued office  rent                                                                                                                                                 |       | 2,489             |       | 2,521                 |       |
| Accrued interest  expense                                                                                                                                            |       | 3,851             |       | 3,829                 |       |
| Other accrued  expenses                                                                                                                                              |       | 9,193             |       | 7,433                 |       |
| Deferred revenue                                                                                                                                                     |       | 10,943            |       | 10,109                |       |
| Accrued  compensation expenses                                                                                                                                       |       | 6,649             |       | 4,174                 |       |
| Capital lease  obligations, current maturities                                                                                                                       |       | 1,572             |       | 3,131                 |       |
| Total current  liabilities                                                                                                                                           |       | 52,155            |       | 54,568                |       |
|                                                                                                                                                                 |       |              |       |                  |       |
| Long-term liabilities:                                                                                                                                               |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                                                       |       |              |       |                  |       |
| Other long-term  liabilities                                                                                                                                         |       | 1,713             |       | 1,262                 |       |
| Capital lease  obligations, less current maturities                                                                                                                  |       | 2,556             |       | 2,201                 |       |
| Notes payable                                                                                                                                                        |       | 142,909           |       | 141,040               |       |
| Total liabilities                                                                                                                                                    |       | 199,333           |       | 199,071               |       |
|                                                                                                                                                                 |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                           |       |              |       |                  |       |
| Common stock,  $0.01 par value per share; 200,000,000 shares authorized; issued and  outstanding shares – 18,083,569 shares and 17,997,869 shares, respectively |       | 177               |       | 176                   |       |
| Additional  paid-in capital                                                                                                                                          |       | 290,369           |       | 289,101               |       |
| Accumulated  other comprehensive income (loss)                                                                                                                       |       | —            |       | —                |       |
| Accumulated  deficit                                                                                                                                                 |       | (156,674          | )          | (157,827              | )          |
| Total stockholders’  equity                                                                                                                                     |       | 133,872           |       | 131,450               |       |
| Total liabilities and stockholders’ equity                                                                                                                      |       | $                 | 333,205    |                  | $          | 330,521 |   |

 

*Seeaccompanying notes.*

3

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**Eschelon Telecom, Inc.Unaudited Consolidated Statements of Operations(In Thousands, Except Share and Per Share Amounts)**
| ** **                                                          | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                          | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                          | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenue:                                                            |       |                             |       |                           |       |   |   |   |   |
| Network services                                                    |       | $                                | 78,251     |                           | $          | 60,920 |   | $ | 151,005 |   | $ | 113,705 |   |
| Business telephone systems                                          |       | 8,105                            |       | 7,330                          |       | 15,658 |   | 14,271 |   |
| Total revenue                                                       |       | 86,356                           |       | 68,250                         |       | 166,663 |   | 127,976 |   |
|                                                                |       |                             |       |                           |       |   |   |   |   |
| Costs and  expenses:                                                |       |                             |       |                           |       |   |   |   |   |
| Network services expense (excluding depreciation and  amortization) |       | 31,321                           |       | 24,780                         |       | 59,862 |   | 45,543 |   |
| Business telephone systems cost of revenue                          |       | 5,103                            |       | 4,414                          |       | 9,727 |   | 8,967 |   |
| Sales, general and administrative                                   |       | 30,854                           |       | 25,973                         |       | 60,753 |   | 48,672 |   |
| Depreciation and amortization                                       |       | 12,393                           |       | 9,795                          |       | 24,229 |   | 19,971 |   |
| Operating income                                                    |       | 6,685                            |       | 3,288                          |       | 12,092 |   | 4,823 |   |
|                                                                |       |                             |       |                           |       |   |   |   |   |
| Other income  (expense):                                            |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                     |       | 247                              |       | 759                            |       | 638 |   | 992 |   |
| Interest expense                                                    |       | (4,761                           | )          | (4,654                         | )          | (9,534 | ) | (8,054 | ) |
| Other income (expense), net                                         |       | (577                             | )          | 8                              |       | (1,580 | ) | 57 |   |
| Income (loss)  before taxes                                         |       | 1,594                            |       | (599                           | )          | 1,616 |   | (2,182 | ) |
| Income taxes                                                        |       | (463                             | )          | —                         |       | (463 | ) | — |   |
| Net income  (loss)                                                  |       | $                                | 1,131      |                           | $          | (599 | ) | $ | 1,153 |   | $ | (2,182 | ) |
|                                                                |       |                             |       |                           |       |   |   |   |   |
| Net income  (loss) per share:                                       |       |                             |       |                           |       |   |   |   |   |
| Basic                                                               |       | $                                | 0.06       |                           | $          | (0.04 | ) | $ | 0.07 |   | $ | (0.14 | ) |
| Diluted                                                             |       | $                                | 0.06       |                           | $          | (0.04 | ) | $ | 0.06 |   | $ | (0.14 | ) |
|                                                                |       |                             |       |                           |       |   |   |   |   |
| Weighted average  number of shares outstanding:                     |       |                             |       |                           |       |   |   |   |   |
| Basic                                                               |       | 17,706,348                       |       | 16,065,330                     |       | 17,677,418 |   | 15,376,909 |   |
| Diluted                                                             |       | 18,445,798                       |       | 16,065,330                     |       | 18,395,816 |   | 15,376,909 |   |

 

*Seeaccompanying notes.*

4

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**Eschelon Telecom, Inc.Unaudited Consolidated Statements of Cash Flows(In Thousands)**
| ** **                                                                                | ** ** | **Six months ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                | ** ** | **June 30,**              | ** ** |
| ** **                                                                                | ** ** | **2007**                       | ** ** | **2006** | ** ** |
| **Operating  activities**                                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net income  (loss)                                                                        |       | $                              | 1,153      |   | $ | (2,182 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                           |       |   |   |
| Depreciation and amortization expense                                                     |       | 24,229                         |       | 19,971 |   |
| Provision for bad debt expense                                                            |       | 836                            |       | 814 |   |
| Non-cash interest expense, net of non-cash interest  income                               |       | 2,508                          |       | 2,043 |   |
| Non-cash share-based compensation expense                                                 |       | 974                            |       | 638 |   |
| Other non-cash items                                                                      |       | (18                            | )          | (48 | ) |
| Changes in operating assets and liabilities:                                              |       |                           |       |   |   |
| Accounts receivable                                                                       |       | (1,345                         | )          | 1,004 |   |
| Inventories                                                                               |       | 20                             |       | (415 | ) |
| Prepaid expenses and other assets                                                         |       | (1,004                         | )          | (893 | ) |
| Accounts payable and accrued expenses                                                     |       | (5,702                         | )          | (5,024 | ) |
| Deferred revenue                                                                          |       | 280                            |       | 215 |   |
| Accrued compensation expense                                                              |       | 2,469                          |       | 181 |   |
| Net cash  provided by operating activities                                                |       | 24,400                         |       | 16,304 |   |
|                                                                                      |       |                           |       |   |   |
| **Investing  activities**                                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Purchase of  subsidiaries, net of cash acquired                                           |       | (13,879                        | )          | (19,956 | ) |
| Purchases of  available-for-sale securities                                               |       | (3,750                         | )          | (68,268 | ) |
| Proceeds from  sales of available-for-sale securities                                     |       | 20,850                         |       | 8,800 |   |
| Purchases of  property and equipment                                                      |       | (19,167                        | )          | (12,023 | ) |
| Cash paid for  customer installation costs                                                |       | (10,709                        | )          | (7,579 | ) |
| Decrease in  restricted cash                                                              |       | 664                            |       | 316 |   |
| Proceeds from  sales of assets                                                            |       | 53                             |       | 72 |   |
| Net cash used in  investing activities                                                    |       | (25,938                        | )          | (98,638 | ) |
|                                                                                      |       |                           |       |   |   |
| **Financing  activities**                                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Proceeds from  issuance of notes payable                                                  |       | —                         |       | 45,600 |   |
| Payments made on  notes and capital lease obligations                                     |       | (1,673                         | )          | (1,278 | ) |
| Proceeds from  issuance of stock, net of fees                                             |       | 295                            |       | 40,267 |   |
| Increase in debt  issuance costs                                                          |       | (244                           | )          | (1,311 | ) |
| Net cash (used  in) provided by financing activities                                      |       | (1,622                         | )          | 83,278 |   |
|                                                                                      |       |                           |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                     |       | (3,160                         | )          | 944 |   |
| Cash and cash  equivalents at beginning of period                                         |       | 21,146                         |       | 26,062 |   |
| Cash and cash  equivalents at end of period                                               |       | $                              | 17,986     |   | $ | 27,006 |   |
|                                                                                      |       |                           |       |   |   |
| **Supplemental  cash flow information**                                                   | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Cash paid for  interest                                                                   |       | $                              | 7,025      |   | $ | 6,010 |   |
|                                                                                      |       |                           |       |   |   |
| **Supplemental  non-cash activities**                                                     | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Equipment purchases  under capital leases                                                 |       | $                              | 303        |   | $ | 1,021 |   |
| Shared-based  compensation                                                                |       | $                              | —     |   | $ | 6,045 |   |

 

*Seeaccompanying notes.*

5

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**Eschelon Telecom, Inc.Notes to Consolidated Financial Statements(In Thousands, Except Share, Per Share and Per Unit Amounts)(Unaudited)**

**Note 1:   Basis of Presentation**

The accompanyingunaudited consolidated financial statements of Eschelon Telecom, Inc. and itssubsidiaries (the “Company”) have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and the instructions to Form 10-Q and Article 10of Regulation S-X promulgated by the United States Securities and ExchangeCommission (the “SEC”).  Accordingly,they do not include all of the information and notes required by GAAP forcomplete financial statements.  In theopinion of management, normal and recurring adjustments and accruals considerednecessary for a fair presentation for the periods indicated have beenincluded.  Operating results for thethree and six months ended June 30, 2007 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2007.

These financialstatements should be read in conjunction with the Company’s audited financialstatements and related notes thereto for the year ended December 31, 2006included in the Eschelon Telecom, Inc. Form 10-K filed with the SEC on March12, 2007.

## *Principles of Consolidation:*   The consolidated financial statementsinclude the accounts of the Company and its wholly owned subsidiaries.  All intercompany balances and transactionshave been eliminated in consolidation.

## *Reclassifications:*   Certain prior year items have beenreclassified to conform to current year presentation.

*Presentation of Taxes in theStatement of Operations:* The Company presents taxes and surcharges on a gross basis in theconsolidated statement of operations. Taxes collected from customers are reflected in revenues and taxessubmitted to governmental agencies are reflected in costs and expenses.  In accordance with EITF 06-3, *How Taxes Collected from Customers and Remitted to GovernmentalAuthorities Should Be Presented in the Income Statement*, thefollowing table summarizes the taxes reported in the consolidated statements ofoperations:
| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                    | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Taxes reflected in network  services revenues |       | $                                | 2,861      |                           | $          | 2,228 |   | $ | 5,165 |   | $ | 3,842 |   |
| Taxes reflected in network services expenses  |       | $                                | 2,861      |                           | $          | 2,177 |   | $ | 5,042 |   | $ | 3,699 |   |

 

## **Note2:   Recent Developments**

On March 20, 2007, theCompany announced that it signed a definitive agreement to be acquired byPortland, Oregon-based Integra Telecom, Inc. (“Integra”), a privately-heldintegrated communications provider offering retail services to customers inOregon, Washington, Utah, Idaho, California, Arizona, Minnesota, and NorthDakota.  Under the terms of theagreement, which was approved by the boards of directors of both companies,Integra Telecom will acquire Eschelon for $30.00 a share in cash, which equatesto a total equity value of approximately $566,000 on a fully diluted basis. Theacquisition will be financed through a fully committed senior credit facilityarranged by Deutsche Bank Securities.

On April 27, 2007, theCompany filed with the SEC and mailed to its stockholders a Definitive ProxyStatement in connection with the transaction. The Definitive Proxy Statementcontained important information about the Company, Integra, the Merger andrelated matters. On May 8, 2007, the Company made additional informationconcerning the transaction available to shareholders via a press release.  On May 25, 2007, the Company’s shareholdersvoted to approve the transaction.  As ofJune 30, 2007, the Company received all regulatory approvals required to closethe transaction.  The transaction isanticipated to close on August 31, 2007.

6

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## **Note3:   Investments**

Available-for-salesecurities consist of the following:
| ** **               | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|--------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | ** **                  | ** ** | **Unrealized**                  | ** ** | ** ** | ** ** | ** ** | ** ** | **Unrealized** | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **                  | ** ** | **Holding**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Holding** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Amortized**               | ** ** | **Gains/**                      | ** ** | ** ** | ** ** | **Amortized** | ** ** | **Gains/** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Cost Basis**         | ** ** | **(Losses)**                    | ** ** | **Fair Value** | ** ** | **Cost Basis** | ** ** | **(Losses)** | ** ** | **Fair Value** | ** ** |
|                     |       |                        |       |                            |       |   |   |   |   |   |   |   |   |
| Corporate  obligations   |       | $                           | —     |                            | $          | — |   | $ | — |   | $ | 1,497 |   | $ | — |   | $ | 1,497 |   |
| Auction rate  securities |       | —                      |       | —                          |       | — |   | 15,600 |   | — |   | 15,600 |   |
| Total                    |       | $                           | —     |                            | $          | — |   | $ | — |   | $ | 17,097 |   | $ | — |   | $ | 17,097 |   |

 

## **Note4:   Property and Equipment**

Property and equipmentconsist of the following:
| ** **                                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2007**          | ** ** | **2006**              | ** ** |
|                                       |       |              |       |                  |       |
| Vehicles                                   |       | $                 | 2,874      |                  | $          | 2,312 |   |
| Office furniture  and equipment            |       | 29,557            |       | 26,559                |       |
| Computer  equipment and software           |       | 52,461            |       | 49,620                |       |
| Leasehold  improvements                    |       | 28,826            |       | 27,272                |       |
| Switching and  data equipment and software |       | 189,413           |       | 172,899               |       |
|                                       |       | 303,131           |       | 278,662               |       |
| Less accumulated  depreciation             |       | (151,379          | )          | (132,877              | )          |
| Property and equipment,  net               |       | $                 | 151,752    |                  | $          | 145,785 |   |

 

## **Note5:   Goodwill and Other Intangible Assets**

Goodwill represents theexcess of cost over the fair value of net assets acquired.  The Company recorded $65,230 of goodwill inconnection with its 2006 and 2007 acquisitions of Oregon Telecom, Inc. (OTI),OneEighty Communications, Inc. (OneEighty), Mountain Telecommunications, Inc.(MTI), and United Communications, Inc. (UNICOM).  The goodwill related to the OneEighty, MTIand UNICOM acquisitions is not deductible for tax purposes.

In connection with theOTI and MTI acquisitions, the Company recorded intangible assets of $5,800 and$2,122, respectively.  The OTI intangibleassets consist of customer relationships and non-compete agreements and the MTIintangible assets consist of several right-to-use agreements.

In August 2006, theCompany entered into an agreement to purchase a selected customer base from TelWest Communications, LLC (Tel West) in exchange for five hundred dollars peraccess line, not to exceed $5,300.  As ofMarch 31, 2007, the Company paid Tel West $5,300 and recorded $5,415, includingtransaction fees, in customer installation costs.

Intangible assets consistof the following:
| ** **                   | ** ** | ** **                | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|------------------------------|------------|---------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **Useful  Life  (years)** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization**   | ** ** | **Net** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Customer  installation costs |       | 3-5                       |       | $                           | 107,307    |                            | $          | 71,832 |   | $ | 35,475 |   | $ | 96,565 |   | $ | 64,364 |   | $ | 32,201 |   |
| Debt issuance  costs         |       | 4-6                       |       | 7,245                       |       | 2,798                           |       | 4,447 |   | 7,001 |   | 2,159 |   | 4,842 |   |
| Customer  relationships      |       | 4                         |       | 8,520                       |       | 3,857                           |       | 4,663 |   | 8,520 |   | 2,792 |   | 5,728 |   |
| Right to use  agreements     |       | 10-20                     |       | 2,122                       |       | 115                             |       | 2,007 |   | 2,122 |   | 29 |   | 2,093 |   |
| Non-compete  agreements      |       | 3-5                       |       | 1,400                       |       | 525                             |       | 875 |   | 1,400 |   | 365 |   | 1,035 |   |
| Developed  technology        |       | 3                         |       | 94                          |       | 78                              |       | 16 |   | 94 |   | 62 |   | 32 |   |
| Total                        |       |                      |       | $                           | 126,688    |                            | $          | 79,205 |   | $ | 47,483 |   | $ | 115,702 |   | $ | 69,771 |   | $ | 45,931 |   |

 

7

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**Note 6:   Acquisitions**

*United Communications, Inc(UNICOM):*   On May1, 2007, the Company completed the acquisition of UNICOM, a competitiveservices provider based in Bend, Oregon. UNICOM provides services in the states of Oregon and Washington expanding the Company’s market presencein the Pacific Northwest.  The Companyhas benefited and expects to continue benefiting from operating synergies byconsolidating UNICOM’s operation into its existing business.  The results of UNICOM subsequent to May 1,2007 are included in the results of operations. In the UNICOM transaction, the Company acquired all of the outstandingshares of UNICOM in exchange for $13,867 (net of cash acquired) and certainassumed liabilities.

*Mountain Telecommunications, Inc(MTI):*   OnNovember 1, 2006, the Company completed the acquisition of MTI, a competitiveservices provider based in Tempe, Arizona. MTI provides services in Phoenix, Tucson and markets throughout thestate of Arizona expanding the Company’s market presence in Arizona.  The Company has benefited and expects tocontinue benefiting from operating synergies by consolidating MTI’s operationinto its existing business.  The resultsof MTI subsequent to November 1, 2006 are included in the results ofoperations.  In the MTI transaction, the Companyacquired all of the outstanding shares of MTI in exchange for $37,268 (net ofcash acquired) and certain assumed liabilities.

*OneEighty Communications, Inc (OneEighty):*   On October 1, 2006, the Company completedthe acquisition of OneEighty, a competitive services provider based in Billings,Montana.  The acquisition of OneEightyexpanded the Company’s market presence into Montana.  The Company has benefited and expects tocontinue benefiting through market growth, leveraging its size, existing investmentsin infrastructure and from operating synergies. The results of OneEighty subsequent to October 1, 2006 are included inthe results of operations.  In theOneEighty transaction, the Company acquired all of the outstanding shares ofOneEighty in exchange for $9,959 (net of cash acquired) and certain assumedliabilities.

*Oregon Telecom, Inc (OTI):*   On April 1, 2006, the Company completed theacquisition of OTI, a privately-held competitive services provider based inSalem, Oregon.  The acquisition of OTIexpanded the Company’s market presence in the Pacific Northwest.  The Company has benefited from operatingsynergies from consolidating OTI’s operation into its existing business.  The results of OTI subsequent to April 1,2006 are included in the results of operations. In the OTI transaction, the Company acquired all of the outstandingshares of OTI in exchange for $19,993 (net of cash acquired) and certainassumed liabilities.

The following tablesummarizes the allocation of the purchase price to the fair value of the assetsacquired and liabilities assumed at the date of each acquisition describedabove, including any adjustments to the purchase price allocation through June30, 2007:
| ** **                 | ** ** | **UNICOM**            | ** ** | **MTI**                    | ** ** | **OneEighty**             | ** ** | **OTI**                       | ** ** |
|----------------------------|------------|-----------------------|------------|----------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                 | ** ** | **May 1,  2007** | ** ** | **November 1,  2006** | ** ** | **October 1,  2006** | ** ** | **April 1,   2006** | ** ** |
| Current assets             |       | $                     | 1,816      |                       | $          | 2,728                     |       | $                             | 761        |   | $ | 3,297 |   |
| Property and  equipment    |       | 2,002                 |       | 6,938                      |       | 4,152                     |       | 529                           |       |
| Other assets               |       | 49                    |       | 21                         |       | 348                       |       | 57                            |       |
| Goodwill                   |       | 12,706                |       | 32,246                     |       | 5,643                     |       | 14,635                        |       |
| Intangible  assets         |       | 33                    |       | 2,122                      |       | —                    |       | 5,800                         |       |
| Total assets  acquired     |       | 16,606                |       | 44,055                     |       | 10,904                    |       | 24,318                        |       |
| Current  liabilities       |       | 2,632                 |       | 4,709                      |       | 739                       |       | 4,013                         |       |
| Long-term  liabilities     |       | 107                   |       | 2,020                      |       | —                    |       | —                        |       |
| Total  liabilities assumed |       | 2,739                 |       | 6,729                      |       | 739                       |       | 4,013                         |       |
| Net assets  acquired       |       | 13,867                |       | 37,326                     |       | 10,165                    |       | 20,305                        |       |
| Less cash  acquired        |       | —                |       | 58                         |       | 206                       |       | 312                           |       |
| Net cash paid              |       | $                     | 13,867     |                       | $          | 37,268                    |       | $                             | 9,959      |   | $ | 19,993 |   |

 

The OneEighty, MTI andUNICOM purchase prices have been allocated on a preliminary basis as of June30, 2007.  The Company is in the processof finalizing the fair value of the fixed assets and separately identifiableintangible assets acquired.

8

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In accordance with EITF95-3, *Recognition of Liabilities in Connection with aPurchase Business Combination*, the Company recorded acquisitionliabilities consisting of severance benefits, relocation and contracttermination penalties.   The followingtable summarizes the acquisition liabilities recorded:
| ** **         | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|--------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **         | ** ** | **UNICOM**                  | ** ** | **MTI**                         | ** ** | **OneEighty** | ** ** | **OTI** | ** ** | **MTI** | ** ** | **OneEighty** | ** ** | **OTI** | ** ** |
| Beginning  Balance |       | $                           | —     |                            | $          | 340 |   | $ | 21 |   | $ | 794 |   | $ | — |   | $ | — |   | $ | — |   |
| Accruals           |       | 258                         |       | —                          |       | — |   | — |   | 340 |   | 21 |   | 867 |   |
| Payments           |       | —                      |       | 49                              |       | 8 |   | 58 |   | — |   | — |   | 73 |   |
| Ending Balance     |       | $                           | 258        |                            | $          | 291 |   | $ | 13 |   | $ | 736 |   | $ | 340 |   | $ | 21 |   | $ | 794 |   |

 

**Note 7:   Share-based Compensation**

Share-based compensationrecognized under Statement of Financial Accounting Standards No. 123(R), *Share-Based Payment: an amendment to FASB Statement No. 123 and FASBStatement No. 95*, for the three months ended June 30, 2007 and 2006was $424 and $292, respectively, and for the six months ended June 30, 2007 and2006 was $974 and $638, respectively.

**Note8:   Benefit Contribution Plan**

The Company has a definedcontribution salary deferral plan covering substantially all employees underSection 401(k) of the Internal Revenue Code. The Company contributes an amount equal to 45 cents for each dollarcontributed by each employee up to a maximum of 6% of each employee’scompensation.  The Company recognizedexpense for contributions to the plan for the three months ended June 30, 2007and 2006 of $340 and $267, respectively and $621 and $497 for the six monthsended June 30, 2007 and 2006, respectively.

**Note9:   Preferred Stock**

The Company has125,000,000 of undesignated preferred shares authorized and no shares ofpreferred stock outstanding.

## **Note10:   Net Income (Loss) Per Share**

The following tablepresents a reconciliation of the numerators and denominators of basic anddiluted net income (loss) per share:
| ** **                                                 | ** ** | **Three Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Numerator:**                                             | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  (loss)                                         |       | $                                               | 1,131      |                                          | $          | (599 | ) | $ | 1,153 |   | $ | (2,182 | ) |
|                                                       |       |                                            |       |                                          |       |   |   |   |   |
| **Denominator:**                                           | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average  common shares outstanding – basic   |       | 17,706,348                                      |       | 16,065,330                                    |       | 17,677,418 |   | 15,376,909 |   |
| Employee stock  options                                    |       | 529,787                                         |       | —                                        |       | 517,548 |   | — |   |
| Restricted stock  awards                                   |       | 209,663                                         |       | —                                        |       | 200,850 |   | — |   |
| Weighted average  common shares outstanding – diluted |       | 18,445,798                                      |       | 16,065,330                                    |       | 18,395,816 |   | 15,376,909 |   |
|                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Basic income  (loss) per share                             |       | $                                               | 0.06       |                                          | $          | (0.04 | ) | $ | 0.07 |   | $ | (0.14 | ) |
| Diluted income (loss)  per share                           |       | $                                               | 0.06       |                                          | $          | (0.04 | ) | $ | 0.06 |   | $ | (0.14 | ) |

 

For the three and sixmonths ended June 30, 2006, the Company did not have any potentially dilutiveshares because a loss was reported.

**Note 11: Notes Payable**

On June 5, 2007, theCompany closed on a $15,000 revolving credit facility with Wachovia CapitalFinance Corporation.  The facilityexpires on June 5, 2009 and is secured by a first lien on all of the assets ofthe Company.  As of June 30, 2007 thefacility remained undrawn and the Company has no immediate plans to borrowunder it.

9

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**Note12:  Income Taxes**

Under the liabilitymethod of accounting for income taxes, a deferred tax asset represents futuretax benefits to be received when certain expenses and losses previouslyrecognized in the financial statements become deductible under applicableincome tax laws. The realization of a deferred tax asset is dependent on futuretaxable income against which these deductions can be applied.  Statement of Financial Accounting StandardsNo. 109, *Accounting for Income Taxes*, requiresthat a valuation allowance be established when it is more likely than not thatall or a portion of the deferred tax assets will not be realized.  The Company has a history of losses and hasconcluded that a full valuation allowance should be recorded against the netdeferred tax assets.  As of June 30,2007, the Company’s net deferred taxes were $56,081, consisting mainly of netoperating losses.  The net operatinglosses begin to expire in 2019.  Shouldthe Company incur an ownership change in the future, Section 382 of the UnitedStates Internal Revenue Code may limit the amount net operating lossesavailable to offset future taxable income.

In the second quarter of2007, the Company established a deferred tax liability related to intangibleassets that have an indefinite life for GAAP purposes. Because of theindefinite life, the deferred tax liability created by allowable tax goodwillamortization cannot be offset against our deferred tax assets when assessingour valuation allowance. As a result, the Company recorded a $463 deferred taxliability on its balance sheet and charged the same amount to the statement ofoperations as tax expense.

The company adopted FASBInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes — an Interpretation of FASB Statement No. 109* onJanuary 1, 2007 (FIN 48).  FIN 48clarifies the accounting and reporting for tax uncertainties. It requiresapplication of a “more likely than not” threshold to the recognition andderecognition of tax positions.  Inconnection with the adoption of FIN 48, management concluded that the Company’stax positions are either highly certain or immaterial in nature, therefore ithas not recorded any reserve for income tax contingencies as of June 30, 2007.

**Note13:   Condensed Consolidating FinancialInformation**

The Company’s 8 3/8%senior second secured notes due 2010 issued by Eschelon Operating Company arefully and unconditionally guaranteed jointly and severally by the Company andall existing subsidiaries and the indenture governing the notes requires thatany future subsidiaries that are organized in the United States must alsoguarantee the notes on the same basis.

The following tablespresent condensed consolidating balance sheets at June 30, 2007 and December31, 2006; condensed consolidating statements of operations for the three monthand six month periods ended June 30, 2007 and 2006; and condensed consolidatingstatements of cash flows for the six month periods ended June 30, 2007 and2006.

10

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**UnauditedCondensed Consolidating Balance SheetsAs of June 30, 2007(In Thousands)**
| ** **                                                 | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| **Assets**                                                 | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current assets:                                            |       |                   |       |          |       |             |       |             |       |             |       |
| Cash and cash equivalents                                  |       | $                      | 16,641     |          | $          | —           |       | $                | 1,345      |             | $          | — |   | $ | 17,986 |   |
| Restricted cash                                            |       | 560                    |       | —        |       | —           |       | —           |       | 560              |       |
| Available-for-sale securities                              |       | —                 |       | —        |       | —           |       | —           |       | —           |       |
| Accounts receivable, net                                   |       | —                 |       | —        |       | 29,573           |       | —           |       | 29,573           |       |
| Other receivables                                          |       | 1,974                  |       | —        |       | 3,187            |       | —           |       | 5,161            |       |
| Inventories                                                |       | —                 |       | —        |       | 3,689            |       | —           |       | 3,689            |       |
| Prepaid expenses                                           |       | 1,721                  |       | —        |       | 1,360            |       | —           |       | 3,081            |       |
| Total current  assets                                      |       | 20,896                 |       | —        |       | 39,154           |       | —           |       | 60,050           |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Property and  equipment, net                               |       | 104,206                |       | —        |       | 47,546           |       | —           |       | 151,752          |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Investment in  affiliates                                  |       | 140,709                |       | —        |       | —           |       | (140,709         | )          | —           |       |
| Other assets                                               |       | 303                    |       | —        |       | 1,219            |       | —           |       | 1,522            |       |
| Goodwill                                                   |       | —                 |       | —        |       | 72,398           |       | —           |       | 72,398           |       |
| Intangible  assets, net                                    |       | 16,851                 |       | 4,447         |       | 26,185           |       | —           |       | 47,483           |       |
| Total assets                                               |       | $                      | 282,965    |          | $          | 4,447            |       | $                | 186,502    |             | $          | (140,709 | ) | $ | 333,205 |   |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| **Liabilities  and stockholders’ equity (deficit)**   | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current  liabilities:                                      |       |                   |       |          |       |             |       |             |       |             |       |
| Accounts payable                                           |       | $                      | 9,803      |          | $          | —           |       | $                | 2,147      |             | $          | — |   | $ | 11,950 |   |
| Accrued telecommunication costs                            |       | —                 |       | —        |       | 5,508            |       | —           |       | 5,508            |       |
| Accrued office rent                                        |       | 1,637                  |       | —        |       | 852              |       | —           |       | 2,489            |       |
| Accrued interest expense                                   |       | —                 |       | 3,829         |       | 22               |       | —           |       | 3,851            |       |
| Other accrued expenses                                     |       | 1,208                  |       | —        |       | 7,985            |       | —           |       | 9,193            |       |
| Deferred revenue                                           |       | —                 |       | —        |       | 10,943           |       | —           |       | 10,943           |       |
| Accrued compensation expenses                              |       | 4,965                  |       | —        |       | 1,684            |       | —           |       | 6,649            |       |
| Capital lease obligations, current maturities              |       | 1,298                  |       | —        |       | 274              |       | —           |       | 1,572            |       |
| Total current  liabilities                                 |       | 18,911                 |       | 3,829         |       | 29,415           |       | —           |       | 52,155           |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Long-term  liabilities:                                    |       |                   |       |          |       |             |       |             |       |             |       |
| Other long-term liabilities                                |       | 476                    |       | —        |       | 1,237            |       | —           |       | 1,713            |       |
| Capital lease obligations, less current maturities         |       | 1,732                  |       | —        |       | 824              |       | —           |       | 2,556            |       |
| Notes payable                                              |       | —                 |       | 142,909       |       | —           |       | —           |       | 142,909          |       |
| Due to (from) affiliates                                   |       | 389,142                |       | (129,224      | )          | (259,918         | )          | —           |       | —           |       |
| Total  liabilities                                         |       | 410,261                |       | 17,514        |       | (228,442         | )          | —           |       | 199,333          |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Stockholders’  equity (deficit)                       |       | (127,296               | )          | (13,067       | )          | 414,944          |       | (140,709         | )          | 133,872          |       |
| Total liabilities and  stockholders’ equity (deficit) |       | $                      | 282,965    |          | $          | 4,447            |       | $                | 186,502    |             | $          | (140,709 | ) | $ | 333,205 |   |

 

11

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**UnauditedCondensed Consolidating Balance SheetsAs of December 31, 2006(In Thousands)**
| ** **                                                 | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| **Assets**                                                 | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current assets:                                            |       |                   |       |          |       |             |       |             |       |             |       |
| Cash and cash equivalents                                  |       | $                      | 18,868     |          | $          | —           |       | $                | 2,278      |             | $          | — |   | $ | 21,146 |   |
| Restricted cash                                            |       | 1,224                  |       | —        |       | —           |       | —           |       | 1,224            |       |
| Available-for-sale securities                              |       | 17,097                 |       | —        |       | —           |       | —           |       | 17,097           |       |
| Accounts receivable, net                                   |       | —                 |       | —        |       | 27,592           |       | —           |       | 27,592           |       |
| Other receivables                                          |       | 304                    |       | —        |       | 3,721            |       | —           |       | 4,025            |       |
| Inventories                                                |       | —                 |       | —        |       | 3,552            |       | —           |       | 3,552            |       |
| Prepaid expenses                                           |       | 893                    |       | —        |       | 1,421            |       | —           |       | 2,314            |       |
| Total current  assets                                      |       | 38,386                 |       | —        |       | 38,564           |       | —           |       | 76,950           |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Property and  equipment, net                               |       | 97,535                 |       | —        |       | 48,250           |       | —           |       | 145,785          |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Investment in  affiliates                                  |       | 126,830                |       | —        |       | —           |       | (126,830         | )          | —           |       |
| Other assets                                               |       | 513                    |       | —        |       | 1,672            |       | —           |       | 2,185            |       |
| Goodwill                                                   |       | —                 |       | —        |       | 59,670           |       | —           |       | 59,670           |       |
| Intangible  assets, net                                    |       | 16,011                 |       | 4,842         |       | 25,078           |       | —           |       | 45,931           |       |
| Total assets                                               |       | $                      | 279,275    |          | $          | 4,842            |       | $                | 173,234    |             | $          | (126,830 | ) | $ | 330,521 |   |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| **Liabilities  and stockholders’ equity (deficit)**   | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current  liabilities:                                      |       |                   |       |          |       |             |       |             |       |             |       |
| Accounts payable                                           |       | $                      | 14,070     |          | $          | —           |       | $                | 3,571      |             | $          | — |   | $ | 17,641 |   |
| Accrued telecommunication costs                            |       | —                 |       | —        |       | 5,730            |       | —           |       | 5,730            |       |
| Accrued office rent                                        |       | 1,768                  |       | —        |       | 753              |       | —           |       | 2,521            |       |
| Accrued interest expense                                   |       | —                 |       | 3,828         |       | 1                |       | —           |       | 3,829            |       |
| Other accrued expenses                                     |       | 911                    |       | —        |       | 6,522            |       | —           |       | 7,433            |       |
| Deferred revenue                                           |       | —                 |       | —        |       | 10,109           |       | —           |       | 10,109           |       |
| Accrued compensation expenses                              |       | 2,597                  |       | —        |       | 1,577            |       | —           |       | 4,174            |       |
| Capital lease obligations, current maturities              |       | 2,616                  |       | —        |       | 515              |       | —           |       | 3,131            |       |
| Total current  liabilities                                 |       | 21,962                 |       | 3,828         |       | 28,778           |       | —           |       | 54,568           |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Long-term  liabilities:                                    |       |                   |       |          |       |             |       |             |       |             |       |
| Other long-term liabilities                                |       | 25                     |       | —        |       | 1,237            |       | —           |       | 1,262            |       |
| Capital lease obligations, less current maturities         |       | 1,490                  |       | —        |       | 711              |       | —           |       | 2,201            |       |
| Notes payable                                              |       | —                 |       | 141,040       |       | —           |       | —           |       | 141,040          |       |
| Due to (from) affiliates                                   |       | 336,758                |       | (136,599      | )          | (200,159         | )          | —           |       | —           |       |
| Total  liabilities                                         |       | 360,235                |       | 8,269         |       | (169,433         | )          | —           |       | 199,071          |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Stockholders’  equity (deficit)                       |       | (80,960                | )          | (3,427        | )          | 342,667          |       | (126,830         | )          | 131,450          |       |
| Total liabilities and  stockholders’ equity (deficit) |       | $                      | 279,275    |          | $          | 4,842            |       | $                | 173,234    |             | $          | (126,830 | ) | $ | 330,521 |   |

 

12

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**UnauditedCondensed Consolidating Statement of OperationsFor the Three Months Ended June 30, 2007(In Thousands)**
| ** **                                                          | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                          | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                          | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Revenue:                                                            |       |                   |       |          |       |             |       |             |       |
| Network services                                                    |       | $                      | —     |          | $          | —           |       | $                | 78,251     |   | $ | 78,251 |   |
| Business telephone systems                                          |       | —                 |       | —        |       | 8,105            |       | 8,105            |       |
| Total revenue                                                       |       | —                 |       | —        |       | 86,356           |       | 86,356           |       |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Costs and  expenses:                                                |       |                   |       |          |       |             |       |             |       |
| Network services expense (excluding depreciation and  amortization) |       | —                 |       | —        |       | 31,321           |       | 31,321           |       |
| Business telephone systems cost of revenue                          |       | —                 |       | —        |       | 5,103            |       | 5,103            |       |
| Sales, general and administrative                                   |       | 16,248                 |       | —        |       | 14,606           |       | 30,854           |       |
| Depreciation and amortization                                       |       | 7,066                  |       | —        |       | 5,327            |       | 12,393           |       |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Operating income  (loss)                                            |       | (23,314                | )          | —        |       | 29,999           |       | 6,685            |       |
| Other income  (expense)                                             |       | (253                   | )          | (4,848        | )          | 10               |       | (5,091           | )          |
| Income (loss)  before income taxes                                  |       | (23,567                | )          | (4,848        | )          | 30,009           |       | 1,594            |       |
| Income taxes                                                        |       | (463                   | )          | —        |       | —           |       | (463             | )          |
| Net income (loss)                                                   |       | $                      | (24,030    | )             | $          | (4,848           | )          | $                | 30,009     |   | $ | 1,131 |   |

 

**UnauditedCondensed Consolidating Statement of OperationsFor the Three Months Ended June 30, 2006(In Thousands)**
| ** **                                                          | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                          | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                          | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Revenue:                                                            |       |                   |       |          |       |             |       |             |       |
| Network services                                                    |       | $                      | —     |          | $          | —           |       | $                | 60,920     |   | $ | 60,920 |   |
| Business telephone systems                                          |       | —                 |       | —        |       | 7,330            |       | 7,330            |       |
| Total revenue                                                       |       | —                 |       | —        |       | 68,250           |       | 68,250           |       |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Costs and  expenses:                                                |       |                   |       |          |       |             |       |             |       |
| Network services expense (excluding depreciation and  amortization) |       | —                 |       | —        |       | 24,780           |       | 24,780           |       |
| Business telephone systems cost of revenue                          |       | —                 |       | —        |       | 4,414            |       | 4,414            |       |
| Sales, general and administrative                                   |       | 13,411                 |       | —        |       | 12,562           |       | 25,973           |       |
| Depreciation and amortization                                       |       | 5,617                  |       | —        |       | 4,178            |       | 9,795            |       |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Operating income  (loss)                                            |       | (19,028                | )          | —        |       | 22,316           |       | 3,288            |       |
| Other income  (expense)                                             |       | 492                    |       | (4,380        | )          | 1                |       | (3,887           | )          |
| Income (loss)  before income taxes                                  |       | (18,536                | )          | (4,380        | )          | 22,317           |       | (599             | )          |
| Income taxes                                                        |       | —                 |       | —        |       | —           |       | —           |       |
| Net income (loss)                                                   |       | $                      | (18,536    | )             | $          | (4,380           | )          | $                | 22,317     |   | $ | (599 | ) |

 

13

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**UnauditedCondensed Consolidating Statement of OperationsFor the Six Months Ended June 30, 2007(In Thousands)**
| ** **                                                          | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                          | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                          | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Revenue:                                                            |       |                   |       |          |       |             |       |             |       |
| Network services                                                    |       | $                      | —     |          | $          | —           |       | $                | 151,005    |   | $ | 151,005 |   |
| Business telephone systems                                          |       | —                 |       | —        |       | 15,658           |       | 15,658           |       |
| Total revenue                                                       |       | —                 |       | —        |       | 166,663          |       | 166,663          |       |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Costs and  expenses:                                                |       |                   |       |          |       |             |       |             |       |
| Network services expense (excluding depreciation and  amortization) |       | —                 |       | —        |       | 59,862           |       | 59,862           |       |
| Business telephone systems cost of revenue                          |       | —                 |       | —        |       | 9,727            |       | 9,727            |       |
| Sales, general and administrative                                   |       | 32,486                 |       | —        |       | 28,267           |       | 60,753           |       |
| Depreciation and amortization                                       |       | 13,817                 |       | —        |       | 10,412           |       | 24,229           |       |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Operating income  (loss)                                            |       | (46,303                | )          | —        |       | 58,395           |       | 12,092           |       |
| Other income  (expense)                                             |       | (840                   | )          | (9,640        | )          | 4                |       | (10,476          | )          |
| Income (loss)  before income taxes                                  |       | (47,143                | )          | (9,640        | )          | 58,399           |       | 1,616            |       |
| Income taxes                                                        |       | (463                   | )          | —        |       | —           |       | (463             | )          |
| Net income (loss)                                                   |       | $                      | (47,606    | )             | $          | (9,640           | )          | $                | 58,399     |   | $ | 1,153 |   |

 

**UnauditedCondensed Consolidating Statement of OperationsFor the Six Months Ended June 30, 2006(In Thousands)**
| ** **                                                          | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                          | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                          | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Revenue:                                                            |       |                   |       |          |       |             |       |             |       |
| Network services                                                    |       | $                      | —     |          | $          | —           |       | $                | 113,705    |   | $ | 113,705 |   |
| Business telephone systems                                          |       | —                 |       | —        |       | 14,271           |       | 14,271           |       |
| Total revenue                                                       |       | —                 |       | —        |       | 127,976          |       | 127,976          |       |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Costs and  expenses:                                                |       |                   |       |          |       |             |       |             |       |
| Network services expense (excluding depreciation and  amortization) |       | —                 |       | —        |       | 45,543           |       | 45,543           |       |
| Business telephone systems cost of revenue                          |       | —                 |       | —        |       | 8,967            |       | 8,967            |       |
| Sales, general and administrative                                   |       | 26,133                 |       | —        |       | 22,539           |       | 48,672           |       |
| Depreciation and amortization                                       |       | 11,226                 |       | —        |       | 8,745            |       | 19,971           |       |
|                                                                |       |                   |       |          |       |             |       |             |       |
| Operating income  (loss)                                            |       | (37,359                | )          | —        |       | 42,182           |       | 4,823            |       |
| Other income  (expense)                                             |       | 736                    |       | (7,719        | )          | (22              | )          | (7,005           | )          |
| Income (loss)  before income taxes                                  |       | (36,623                | )          | (7,719        | )          | 42,160           |       | (2,182           | )          |
| Income taxes                                                        |       | —                 |       | —        |       | —           |       | —           |       |
| Net income (loss)                                                   |       | $                      | (36,623    | )             | $          | (7,719           | )          | $                | 42,160     |   | $ | (2,182 | ) |

 

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**UnauditedCondensed Consolidating Statement of Cash FlowsFor the Six Months Ended June 30, 2007(In Thousands)**
| ** **                                                                                           | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
| **Operating  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net income  (loss)                                                                                   |       | $                      | (47,606    | )             | $          | (9,640           | )          | $                | 58,399     |   | $ | 1,153 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                   |       |          |       |             |       |             |       |
| Depreciation and amortization                                                                        |       | 13,817                 |       | —        |       | 10,412           |       | 24,229           |       |
| Non-cash interest expense, net                                                                       |       | —                 |       | 2,508         |       | —           |       | 2,508            |       |
| Non-cash share-based compensation expense                                                            |       | 974                    |       |          |       | —           |       | 974              |       |
| Other non-cash items                                                                                 |       | (13                    | )          | —        |       | 831              |       | 818              |       |
| Changes in operating assets and liabilities:                                                         |       |                   |       |          |       |             |       |             |       |
| Accounts receivable                                                                                  |       | —                 |       | —        |       | (1,345           | )          | (1,345           | )          |
| Account payable and accrued expenses                                                                 |       | (3,637                 | )          | —        |       | (2,065           | )          | (5,702           | )          |
| Other operating assets and liabilities                                                               |       | 80                     |       | 1             |       | 1,684            |       | 1,765            |       |
| Net cash  provided by (used in) operating activities                                                 |       | (36,385                | )          | (7,131        | )          | 67,916           |       | 24,400           |       |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Investing  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Purchases of  subsidiaries, net of cash acquired                                                     |       | (13,879                | )          | —        |       | —           |       | (13,879          | )          |
| Purchases of  available-for-sale securities                                                          |       | (3,750                 | )          | —        |       | —           |       | (3,750           | )          |
| Proceeds from  sales of available-for-sale securities                                                |       | 20,850                 |       | —        |       | —           |       | 20,850           |       |
| Purchases of  property and equipment                                                                 |       | (16,398                | )          | —        |       | (2,769           | )          | (19,167          | )          |
| Cash paid for  customer installation costs                                                           |       | (4,678                 | )          | —        |       | (6,031           | )          | (10,709          | )          |
| Decrease in  restricted cash                                                                         |       | 664                    |       | —        |       | —           |       | 664              |       |
| Proceeds from  sale of assets                                                                        |       | 37                     |       | —        |       | 16               |       | 53               |       |
| Net cash used in  investing activities                                                               |       | (17,154                | )          | —        |       | (8,784           | )          | (25,938          | )          |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Financing  activities**                                                                            |       |                   |       |          |       |             |       |             |       |
| Payments made on  notes and capital lease obligations                                                |       | (1,367                 | )          | —        |       | (306             | )          | (1,673           | )          |
| Proceeds from  issuance of stock, net of fees                                                        |       | 295                    |       | —        |       | —           |       | 295              |       |
| Increase in debt  issuance costs                                                                     |       | —                 |       | (244          | )          | —           |       | (244             | )          |
| Change in due  to/from affiliates                                                                    |       | 52,384                 |       | 7,375         |       | (59,759          | )          | —           |       |
| Net cash  provided by (used in) financing activities                                                 |       | 51,312                 |       | 7,131         |       | (60,065          | )          | (1,622           | )          |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| Decrease in cash  and cash equivalents                                                               |       | (2,227                 | )          | —        |       | (933             | )          | (3,160           | )          |
| Cash and cash  equivalents at beginning of period                                                    |       | 18,868                 |       | —        |       | 2,278            |       | 21,146           |       |
| Cash and cash  equivalents at end of period                                                          |       | $                      | 16,641     |          | $          | —           |       | $                | 1,345      |   | $ | 17,986 |   |

 

15

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**UnauditedCondensed Consolidating Statement of Cash FlowsFor the Six Months Ended June 30, 2006(In Thousands)**
| ** **                                                                                           | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
| **Operating  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net income  (loss)                                                                                   |       | $                      | (36,623    | )             | $          | (7,719           | )          | $                | 42,160     |   | $ | (2,182 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                   |       |          |       |             |       |             |       |
| Depreciation and amortization                                                                        |       | 11,226                 |       | —        |       | 8,745            |       | 19,971           |       |
| Non-cash interest expense, net                                                                       |       |                   |       | 2,043         |       | —           |       | 2,043            |       |
| Non-cash share-based compensation expense                                                            |       | 638                    |       | —        |       | —           |       | 638              |       |
| Other non-cash items                                                                                 |       | (48                    | )          | —        |       | 814              |       | 766              |       |
| Changes in operating assets and liabilities:                                                         |       |                   |       |          |       |             |       |             |       |
| Accounts receivable                                                                                  |       | —                 |       | —        |       | 1,004            |       | 1,004            |       |
| Account payable and accrued expenses                                                                 |       | (3,949                 | )          | 1,183         |       | (2,258           | )          | (5,024           | )          |
| Other operating assets and liabilities                                                               |       | (314                   | )          | —        |       | (598             | )          | (912             | )          |
| Net cash  provided by (used in) operating activities                                                 |       | (29,070                | )          | (4,493        | )          | 49,867           |       | 16,304           |       |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Investing  activities**                                                                            | ** ** | ** **             | ** ** | ** **    | ** ** | ** **       | ** ** | ** **       | ** ** |
| Purchases of  subsidiaries, net of cash acquired                                                     |       | —                 |       | —        |       | (19,956          | )          | (19,956          | )          |
| Purchases of  available-for-sale securities                                                          |       | (68,268                | )          | —        |       | —           |       | (68,268          | )          |
| Proceeds from  sales of available-for-sale securities                                                |       | 8,800                  |       | —        |       | —           |       | 8,800            |       |
| Purchases of  property and equipment                                                                 |       | (10,444                | )          | —        |       | (1,579           | )          | (12,023          | )          |
| Cash paid for  customer installation costs                                                           |       | (4,224                 | )          | —        |       | (3,355           | )          | (7,579           | )          |
| Decrease in  restricted cash                                                                         |       | 316                    |       | —        |       | —           |       | 316              |       |
| Proceeds from  sale of assets                                                                        |       | 72                     |       | —        |       | —           |       | 72               |       |
| Net cash used in  investing activities                                                               |       | (73,748                | )          | —        |       | (24,890          | )          | (98,638          | )          |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| **Financing  activities**                                                                            |       |                   |       |          |       |             |       |             |       |
| Proceeds from  issuance of notes payable                                                             |       | —                 |       | 45,600        |       | —           |       | 45,600           |       |
| Payments made on  notes and capital lease obligations                                                |       | (1,223                 | )          | —        |       | (55              | )          | (1,278           | )          |
| Proceeds from  issuance of stock, net of fees                                                        |       | 40,267                 |       | —        |       | —           |       | 40,267           |       |
| Increase in debt  issuance costs                                                                     |       | —                 |       | (1,311        | )          | —           |       | (1,311           | )          |
| Change in due  to/from affiliates                                                                    |       | 64,939                 |       | (39,796       | )          | (25,143          | )          | —           |       |
| Net cash  provided by (used in) financing activities                                                 |       | 103,983                |       | 4,493         |       | (25,198          | )          | 83,278           |       |
|                                                                                                 |       |                   |       |          |       |             |       |             |       |
| Increase  (decrease) in cash and cash equivalents                                                    |       | 1,165                  |       | —        |       | (221             | )          | 944              |       |
| Cash and cash  equivalents at beginning of period                                                    |       | 25,070                 |       | —        |       | 992              |       | 26,062           |       |
| Cash and cash  equivalents at end of period                                                          |       | $                      | 26,235     |          | $          | —           |       | $                | 771        |   | $ | 27,006 |   |

 

16

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

**Forward-Lookingand Cautionary Statements**

We make “forward-lookingstatements” throughout this document. Whenever you read a statement that is not solely a statement ofhistorical fact (such as when we state that we “may,” “will” or “plan to”perform in a certain manner or that we “intend,” “believe,” “expect,” “anticipate,”“estimate” or “project” that an event will occur, or the negative thereof, andother similar statements), you should understand that our expectations may notbe correct, although we believe that they are reasonable.  You should also understand that our plans maychange.  We do not guarantee that theevents described in this document will happen as described or that any trendsnoted in this document will continue.

Forward-lookingstatements, such as those regarding management’s present plans or expectationsfor new product offerings, capital expenditures, cost-saving strategies andgrowth are not guarantees of future performance.  They involve risks and uncertainties relativeto return expectations and related allocation of resources, and changingeconomic or competitive conditions, as well as the negotiation of agreementswith third parties and other factors discussed herein, which could cause actualresults to differ from present plans or expectations, and such differencescould be material.  Similarly,forward-looking statements regarding management’s present expectations foroperating results and cash flow involve risks and uncertainties relative tothese and other factors, such as the ability to increase revenues and/or toachieve cost reductions and other factors discussed herein, which also wouldcause actual results to differ from present plans.  Such differences could be material.  All forward-looking statements attributableto us or by any persons acting on our behalf are expressly qualified in theirentirety by these cautionary statements.

As such, actualresults or circumstances may vary materially from such forward-lookingstatements or expectations.  Readers arealso cautioned not to place undue reliance on these forward-looking statementswhich speak only as of the date these statements were made.  Except as required by law, we do not have anyobligation to update these forward-looking statements, even if our situationchanges in the future.

**CompanyOverview**

We are a leadingfacilities-based provider of voice and data services and business telephonesystems in 53  markets in the westernUnited States.  As a facilities-basedcompetitive communications services provider, we provide services to ourcustomers primarily through our own network of telecommunications switches andrelated equipment and leased telecommunications lines, or transport.  We target the small and medium-sized businesssegment and currently serve more than 65,000 customers, primarily within thelocal service territory of Qwest.

We measure ouroperational performance using a variety of indicators including revenue growth,the percentage of our revenue that comes from customers that we serve on our switches,costs and expenses as a percentage of revenue and access line churn rates. Wemonitor key operating and customer service metrics to improve customer service,maintain the quality of our network and reduce costs.

Thetelecommunications industry is highly competitive.  We believe we compete principally by offeringsuperior customer service, accurate billing, a broad set of services andsystems and competitive pricing.  We competewith the Regional Bell Operating Companies (RBOCs), other competitivecommunications services providers, and long distance and data serviceproviders.  While wireless and cable providersare competing with us, we do not believe they are a significant competitivethreat in the markets we serve nor are they likely to be in the near future,because business customers generally require different service standards.

**Key Components of Results of Operations**

***Network Service Revenue.***  Our networkservices revenue consists primarily of local telephone service, long distanceservice, carrier access charges, and data and Internet access services. Revenuefrom local telephone service consists of charges for basic local dial-toneservice, including dedicated T1 access, and custom-calling features suchas call waiting and call forwarding. Revenue from long distance serviceconsists of flat rated and per-minute-of-use charges for a full range oftraditional switched and dedicated long distance, toll-free calling, internationalcalling, calling card and operator services. Carrier access revenue consistsprimarily of usage charges that we bill long distance carriers to originate andterminate calls to and from our customers. In addition, in some of our marketswe currently charge other local exchange carriers and wireless carriers usage

17

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charges to terminate local calls to our customers (otherwise known asreciprocal compensation).   For the sixmonths ended June 30, 2007 and 2006, we recorded reciprocal compensation revenueof $0.6 million and $0.4 million, respectively. Excluding carrier access and reciprocal compensation, less than onepercent of our revenue is wholesale revenue.  Revenue from data and Internet access servicesconsists primarily of monthly usage fees for DSL and T1 circuits and Internetaccess services. We typically commit our customers to contracts ranging fromone to three years and provide discounts for longer terms. Network servicesrevenue comprised 90.6% of our total revenue for the six months ended June 30,2007, and represents a predominantly recurring revenue stream.

***Business telephone systems revenue.***  Our businesstelephone systems revenue consists of revenue from the sale of telephoneequipment and the servicing of telephone equipment systems. Telephone equipmentrevenue is recognized upon delivery, completion of the installation andacceptance by the customer. Business telephone service revenue is recognizedupon completion of service or, in the case of maintenance agreements, is spreadequally over the life of the maintenance contract, which typically ranges fromone to two years.

***Network Services Expense.***  Ournetwork services expense consists primarily of the cost of operating ournetwork facilities. The network components for our facilities-basedbusiness include the cost of:

·                  leasing local loops and digital T1lines which connect our customers to our network;

·                  leasing high capacity digital linesthat connect our switching equipment to our colocations;

·                  leasing high capacity digital linesthat interconnect our network with the RBOCs;

·                  leasing space, power and terminalconnections in the RBOC central offices for colocating our equipment;

·                  signaling system networkconnectivity;

·                  leasing our ATM long-haul Internetbackbone network; and

·                  Internet transit and peering, whichis the cost of delivering Internet traffic from our customers to the publicInternet.

The costs to lease local loops, digital T1 lines and high capacitydigital interoffice transport facilities from the RBOCs vary by carrier and bystate and in many cases are regulated under federal and state laws. Invirtually all areas, we lease local loops, T1 lines and interoffice transportcapacity from the RBOCs. We lease interoffice facilities from carriers otherthan the RBOCs where possible in order to lower costs and improve networkredundancy; however, in most cases, the RBOCs are our only source for end-userlocal loops and T1 lines.  Historically,we purchased unbundled network elements platform, or UNE-P, from Qwest andVerizon, and customized network element packages, or UNE-E, from Qwest.  We also purchase, on a resale basis, Centrexservices, which are services for the portion of the public telephone switchthat is dedicated to a customer, from AT&T. The rates for UNE-P and Centrex were regulated and established by thevarious state corporation or utility commissions.  We entered into agreements with Qwest andVerizon for UNE-P replacement products in 2005. As of  June 30, 2007, we hadapproximately 98,000 access lines in service that are now provided undercommercial agreements.  The Qwest UNE-Eagreement was terminated with the adoption of Qwest’s commercial UNE-Preplacement product, QPP, and all Qwest UNE-E lines were moved to QPP onJanuary 1, 2005.

Our network services expense also includes the fees we pay for longdistance, data and other services. We have entered into wholesale purchasingagreements for these services.  Some ofthe agreements contain significant termination penalties and/or minimum usagevolume commitments. In the event we fail to meet minimum volume commitments, wemay be obligated to pay underutilization charges. We do not anticipate havingto pay any underutilization charges in the foreseeable future.

We account for all of our network depreciation in depreciation andamortization expense and do not have any depreciation expense in networkservices expense.

***Business Telephone Systems Cost of Revenue.***  Our mostsignificant business telephone systems costs of revenue are the equipmentpurchased from manufacturers and labor for service installation. To takeadvantage

18

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of volume purchase discounts, we purchase equipment primarily from threemanufacturers pursuant to master purchase agreements we have with thesemanufacturers. For all business telephone systems installations, our policy isto require a 30% deposit before ordering the equipment so our risk of excessinventory or inventory obsolescence is low. Business telephone systems cost ofrevenue also includes salaries and benefits of field technicians as well asvehicle and incidental expenses associated with equipment installation,maintenance and service provisioning.

***Sales, General and Administrative.***  Sales,general and administrative expenses are comprised primarily of employeecompensation and benefits, sales commissions, occupancy costs, bad debt, operatingtaxes, billing and professional services.

Determining our allowance for doubtful accounts receivable requiressignificant estimates. We consider two primary factors in determining theproper level of the allowance, including historical collections experience andthe aging of the accounts receivable portfolio. We perform a credit reviewprocess on each new customer that involves reviewing the customer’s currentservice provider bill and payment history, matching customers with the NationalTelecommunications Data Exchange database for delinquent customers and, in somecases, requesting credit reviews through Dun and Bradstreet. For the six monthsended June 30, 2007 and 2006, our bad debt expense as a percentage of revenuewas 0.5% and 0.6%, respectively.

***Depreciation and Amortization.***  Ourdepreciation and amortization expense includes depreciation for network relatedvoice and data equipment, back office systems, furniture, fixtures, leaseholdimprovements, office equipment and computers. All internal costs directlyrelated to the expansion of our network and operating and support systems,including salaries of certain employees, are capitalized and depreciated overthe lives of the switches or systems, as the case may be. Capitalized customerinstallation costs are amortized over periods approximating the average life ofcustomers. Detailed time studies are used to determine labor capitalizationrates. These time studies are based on employee time sheets for those engagedin capitalizable activities.

**Acquisitions**

On April 1, 2006, we completed our acquisition of Oregon Telecom, Inc.(OTI), a privately-held competitive services provider headquartered in Salem,Oregon.  OTI is a reseller of local, longdistance and Internet access services in Oregon to approximately 9,000 businesscustomers that have approximately 53,000 access lines.  We paid approximately $20.0 million in cash (netof cash acquired) to acquire OTI. The results of OTI subsequent to April1, 2006 are included in the results of operations.

OnOctober 1, 2006, we completed our acquisition of OneEighty Communications, Inc.(OneEighty), a competitive services provider headquartered in Billings, Montana.  OneEighty provides local, long distance andInternet access services in Montana to approximately 1,400 business customersthat have approximately 16,000 access lines. We paid approximately $10.0 million in cash (net of cash acquired) toacquire OneEighty.  The results ofOneEighty subsequent to October 1, 2006 are included in the results ofoperations.

OnNovember 1, 2006, we completed our acquisition of Mountain Telecommunications,Inc. (MTI), a competitive services provider headquartered in Tempe, Arizona.  MTI provides local, long distance and Internetaccess services in Arizona to approximately 1,400 business customers that haveapproximately 45,000 access lines.  Wepaid approximately $37.3 million in cash (net of cash acquired) to acquire MTI.  The results of MTI subsequent to November 1,2006 are included in the results of operations.

We have benefited and expect to continue benefiting from synergies as weintegrate OneEighty and MTI into our operations.  We estimate we will incur $1.0 - $2.0 millionintegrating MTI and approximately $0.4 million integrating OneEighty.

On May1, 2007, we completed our acquisition of United Communications, Inc. (UNICOM),a privately-held competitive services provider headquartered in Bend,Oregon.  UNICOM provides local, longdistance, Internet access services and business telephone systems throughoutOregon and parts of Washington. UNICOM customers have approximately 28,000access lines.  We paid approximately$13.9 million in cash (net of cash acquired) to acquire UNICOM.  The results of UNICOM subsequent to May 1,2007 are included in the results of operations. We expect to create significant synergies by integrating UNICOM with ourexisting operations.

19

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## **Recent Developments**

On March 20, 2007,we announced that we signed a definitive agreement to be acquired by Portland,Oregon-based Integra Telecom, Inc., a privately-held integrated communicationsprovider offering retail services to businesses in Oregon, Washington, Utah,Idaho, California, Arizona, Minnesota, and North Dakota.  Under the terms of the agreement, which wasapproved by the boards of directors of both companies, Integra Telecom willacquire us for $30.00 a share in cash, which equates to a total equity value ofapproximately $566 million on a fully diluted basis. The acquisition will be financedthrough a fully committed senior credit facility arranged by Deutsche BankSecurities.

On April 27, 2007,we filed with the SEC and mailed to our stockholders a Definitive ProxyStatement in connection with the transaction. The Definitive Proxy Statementcontained important information about us, Integra, the Merger and relatedmatters.  On May 8, 2007, we madeadditional information concerning the transaction available to shareholders viaa press release.  On May 25, 2007, ourshareholders voted to approve the transaction. As of June 30, 2007, we received all regulatory approvals required toclose the transaction.  The transactionis anticipated to close on August 31, 2007.

## **Results of Operations**

Selectedconsolidated financial and operating data for the three and six months ended June30, 2007 and 2006 is as follows (dollars in thousands, except per unitamounts):
| ** **                                                                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **% Change** | ** ** | **2007** | ** ** | **2006** | ** ** | **% Change** | ** ** |
| ** **                                                                  | ** ** | **(unaudited)**                                     | ** ** | **(unaudited)**                                   | ** ** | ** ** | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** | ** ** | ** ** |
| Total revenue                                                               |       | $                                                   | 86,356     |                                              | $          | 68,250 |   | 26.5 | % | $ | 166,663 |   | $ | 127,976 |   | 30.2 | % |
| Capital  expenditures                                                       |       | $                                                   | 12,472     |                                              | $          | 11,603 |   | 7.5 | % | $ | 30,179 |   | $ | 20,623 |   | 46.3 | % |
| Cash, restricted  cash and available-for-sale securities (at end of period) |       | $                                                   | 18,546     |                                              | $          | 91,876 |   | (79.8 | )% | $ | 18,546 |   | $ | 91,876 |   | (79.8 | )% |
|                                                                        |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Voice lines in  service (at end of period)                                  |       | 395,678                                             |       | 318,138                                           |       | 24.4 | % | 395,678 |   | 318,138 |   | 24.4 | % |
| Data lines in  service (at end of period)                                   |       | 283,132                                             |       | 177,913                                           |       | 59.1 | % | 283,132 |   | 177,913 |   | 59.1 | % |
| Total lines in  service (at end of period)                                  |       | 678,810                                             |       | 496,051                                           |       | 36.8 | % | 678,810 |   | 496,051 |   | 36.8 | % |
| Percent of lines  on switch (at end of period)                              |       | 85.3                                                | %          | 82.2                                              | %          | 3.8 | % | 85.3 | % | 82.2 | % | 3.8 | % |
| Lines sold                                                                  |       | 45,640                                              |       | 36,343                                            |       | 25.6 | % | 91,221 |   | 67,083 |   | 36.0 | % |
| Average monthly  access line churn (%)                                      |       | 1.32                                                | %          | 1.43                                              | %          | (8.0 | )% | 1.29 | % | 1.49 | % | (13.5 | )% |
| Average monthly  network services revenue per line                          |       | $                                                   | 39.32      |                                              | $          | 41.36 |   | (4.9 | )% | $ | 39.28 |   | $ | 41.48 |   | (5.3 | )% |
|                                                                        |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Total employees  (at end of period)                                         |       | 1,431                                               |       | 1,269                                             |       | 12.7 | % | 1,431 |   | 1,269 |   | 12.7 | % |
| Quota-carrying  network service salespeople (at end of period)              |       | 258                                                 |       | 273                                               |       | (5.5 | )% | 258 |   | 273 |   | (5.5 | )% |
| Quota-carrying  BTS salespeople (at end of period)                          |       | 47                                                  |       | 48                                                |       | (2.1 | )% | 47 |   | 48 |   | (2.1 | )% |
| Total quota-carrying  salespeople (at end of period)                        |       | 305                                                 |       | 321                                               |       | (5.0 | )% | 305 |   | 321 |   | (5.0 | )% |

 

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**Three Months Ended June 30, 2007 Compared to ThreeMonths Ended June 30, 2006**

***Revenue.***  Revenue for the three months ended June 30,2007 and 2006 is as follows:
|                            | ** ** | **2007**        | ** ** | **2006**        | ** ** | **% Change** | ** ** |
|----------------------------|------------|-----------------|------------|-----------------|------------|-------------------|------------|
| ** **                 | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** | ** **        | ** ** |
| Revenue (in  millions):    |       |            |       |            |       |              |       |
| Voice and data services    |       | $               | 61.0       |            | $          | 45.7              |       | 33.4 | % |
| Long distance              |       | 12.3            |       | 10.8            |       | 13.2              | %          |
| Access                     |       | 5.0             |       | 4.4             |       | 14.6              | %          |
| Total network services     |       | 78.3            |       | 60.9            |       | 28.4              | %          |
| Business telephone systems |       | 8.1             |       | 7.3             |       | 10.6              | %          |
| Total revenue              |       | $               | 86.4       |            | $          | 68.2              |       | 26.5 | % |

 

Networkservices revenue was $78.3 million for the three months ended June 30, 2007, anincrease of 28.4% from $60.9 million in the same period of 2006.  The revenue growth is primarily due to theinclusion of our OneEighty, MTI and UNICOM acquisitions and organic linegrowth.  Over the past 12 months thenumber of lines in service increased by 36.8% to 678,810 at June 30, 2007. Approximately89,000 lines in service of our overall growth of 182,759 lines in service is attributedto our OneEighty, MTI and UNICOM acquisitions. Our revenue growth from our access line growth was partially offset by adecline in data revenue per line due to a combination of customers purchasingmore bandwidth at discounted prices and general pricing pressures for dataservices in our markets.

Businesstelephone systems (BTS) revenue was $8.1 million for the three months ended June30, 2007, an increase of 10.6% from $7.3 million in the same period of 2006.  Theincrease in BTS revenue was primarily the result of increased new system sales,revenue from change orders and to a smaller extent the inclusion of our UNICOMacquisition.  We cannot predict the future trends in capital spending bysmall and medium-sized business customers, which drives our BTS business.

***Network Service Expense.***  Network services expense was $31.3 millionfor the three months ended June 30, 2007, an increase of 26.4% from $24.8million in the same period of 2006.  The increaseis due primarily to the inclusion of our OneEighty, MTI and UNICOM acquisitions,organic line growth and to a lesser extent TRRO cost increases.  As a percentage of related revenue, networkservices expense for the three months ended June 30, 2007, was 40.0% comparedto 40.7% for the same period of 2006.  Weexpect our network service expense as a percentage of related revenue todecrease in the future as we continue to sell more T1 lines and install morelines on our switches.

***BTS Cost of Revenue.***  BTS cost of revenue was $5.1 million for thethree months ended June 30, 2007, an increase of 15.6% from $4.4 million in thesame period of 2006.  As a percentage ofrelated revenue, BTS cost of revenue for the three months ended June 30, 2007 increasedto 63.0% from 60.2% for the same period of 2006.  The BTS cost of revenue increase is primarilydue to materials cost to support the higher level of new systems sales and to alesser extent the inclusion of our UNICOM acquisition. We do not expect thistrend in BTS cost of revenue as a percentage of related revenue to continue.

***Sales, General and Administrative Expense.***  Sales, general and administrative expenseswere $30.9 million for the three months ended June 30, 2007, an increase of 18.8%from $26.0 million in the same period of 2006. The increase is primarily due to the inclusion of our OneEighty, MTI andUNICOM acquisitions and an increase in employee compensation and benefitsexpense.  As a percentage of revenue,sales, general and administrative expenses for the three months ended June 30,2007, declined to 35.7% from 38.1% in the same period of 2006 due to theimproved efficiency of our existing operations resulting from our largely fixedcost structure supporting a higher level of revenue.  Our sales, general and administrativeexpenses are largely fixed as they are driven by the 1,431 associates that wereemployed at June 30, 2007.  We expect sales,general and administrative expenses as a percentage of revenue to continue todecline.

***Depreciation and Amortization.***  Depreciation and amortization expense was $12.4million for the three months ended June 30, 2007, an increase of 26.5% from $9.8million in the same period of 2006.  Thisincrease was primarily due to the inclusion of our OneEighty, MTI and UNICOMacquisitions along with the depreciation and amortization associated with our capitalexpenditures over the past 12 months.

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As a percentage ofrevenue, depreciation and amortization was 14.4% for the three months ended June30, 2007 and 2006.

***Other income (expense), net.***** Other expense, net of other income, for thethree months ended June 30, 2007, was $0.6 million compared to $8,300 of otherincome in the same period of 2006.  Theincrease in expense is related to expenses incurred in association with theagreement to be acquired by Integra Telecom, Inc.

***Income taxes.***** In the second quarter of 2007, we establisheda deferred tax liability related to intangible assets that have an indefinitelife for GAAP purposes. Because of the indefinite life, the deferred taxliability created by allowable tax goodwill amortization cannot be offsetagainst our deferred tax assets when assessing our valuation allowance. As aresult, we recorded a $0.5 million deferred tax liability on our balance sheetand charged the same amount to the statement of operations as income taxexpense.  We expect to continue toincrease this deferred tax liability and the associated income tax expenseuntil the goodwill is fully amortized for tax purposes or becomes impaired.

**Six Months Ended June 30, 2007 Compared to SixMonths Ended June 30, 2006**

***Revenue.***  Revenue for the six months ended June 30,2007 and 2006 is as follows:
|                            | ** ** | **2007**        | ** ** | **2006**        | ** ** | **% Change** | ** ** |
|----------------------------|------------|-----------------|------------|-----------------|------------|-------------------|------------|
| ** **                 | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** | ** **        | ** ** |
| Revenue (in  millions):    |       |            |       |            |       |              |       |
| Voice and data services    |       | $               | 117.5      |            | $          | 85.4              |       | 37.6 | % |
| Long distance              |       | 23.7            |       | 20.2            |       | 17.1              | %          |
| Access                     |       | 9.8             |       | 8.1             |       | 22.0              | %          |
| Total network services     |       | 151.0           |       | 113.7           |       | 32.8              | %          |
| Business telephone systems |       | 15.7            |       | 14.3            |       | 9.7               | %          |
| Total revenue              |       | $               | 166.7      |            | $          | 128.0             |       | 30.2 | % |

 

Networkservices revenue was $151.0 million for the six months ended June 30, 2007, anincrease of 32.8% from $113.7 million in the same period of 2006.  The revenue growth is primarily due to theinclusion of our OneEighty, MTI and UNICOM acquisitions and organic linegrowth.  Over the 12 months ended June30, 2007, the number of lines in service increased by 36.8% to 678,810. Approximately89,000 lines in service of our overall growth of 182,759 lines in service isattributed to our OneEighty, MTI and UNICOM acquisitions.  Our revenue growth from our access linegrowth was partially offset by a decline in data revenue per line due to acombination of customers purchasing more bandwidth at discounted prices andgeneral pricing pressures for data services in our markets.

Businesstelephone systems (BTS) revenue was $15.7 million for the six months ended June30, 2007, an increase of 9.7% from $14.3 million in the same period of2006.  The increase in BTS revenue was primarily the result of increased newsystem sales, revenue from change orders and to a smaller extent the inclusionof our UNICOM acquisition.  We cannot predict the future trends in capitalspending by small and medium-sized business customers, which drives our BTSbusiness.

***Network Service Expense.***  Network services expense was $59.9 millionfor the six months ended June 30, 2007, an increase of 31.4% from $45.5 millionin the same period of 2006.  The increaseis due primarily to the inclusion of our OneEighty, MTI and UNICOMacquisitions, organic line growth and to a lesser extent TRRO costincreases.  As a percentage of relatedrevenue, network services expense for the six months ended June 30, 2007, was 39.6%compared to 40.1% for the same period of 2006. We expect our network service expense as a percentage of related revenueto decrease in the future as we continue to sell more T1 lines and install morelines on our switches.

***BTS Cost of Revenue.***  BTS cost of revenue was $9.7 million for the sixmonths ended June 30, 2007, an increase of 8.5% from $9.0 million in the sameperiod of 2006.  As a percentage ofrelated revenue, BTS cost of revenue for the six months ended June 30, 2007 decreasedto 62.1% from 62.8% for the same period of 2006.  The BTS cost of revenue increase is primarilydue to materials costs to support the higher level of new systems sales and toa lesser extent our UNICOM acquisition.

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***Sales, General and AdministrativeExpense.***  Sales,general and administrative expenses were $60.8 million for the six months endedJune 30, 2007, an increase of 24.8% from $48.7 million in the same period of2006.  The increase is primarily due tothe inclusion of our OneEighty, MTI and UNICOM acquisitions and an increase inemployee compensation and benefits expense. As a percentage of revenue, sales, general and administrative expensesfor the six months ended June 30, 2007, declined to 36.5% from 38.0% in thesame period of 2006 due to the improved efficiency of our existing operationsresulting from our largely fixed cost structure supporting a higher level ofrevenue.  Our sales, general andadministrative expenses are largely fixed as they are driven by the 1,431associates that were employed at June 30, 2007. We expect sales, general and administrative expenses as a percentage ofrevenue to continue to decline.

***Depreciation and Amortization.***  Depreciation and amortization expense was $24.2million for the six months ended June 30, 2007, an increase of 21.3% from $20.0million in the same period of 2006.  Thisincrease was primarily due to the inclusion of our OneEighty, MTI and UNICOMacquisitions along with the depreciation and amortization associated with ourcapital expenditures over the past 12 months. As a percentage of revenue, depreciation and amortization for the sixmonths ended June 30, 2007 declined to 14.5% from 15.6% for the same period of 2006.

***Interest.*** Interest expense was $9.5 million for the six months ended June 30,2007, an increase of 18.4% from $8.1 million in the same period of 2006.  The increase was primarily due to our March29, 2006 offering of $48.0 million in face amount of 8 3/8% senior secondsecured notes due 2010 at a discount resulting in a 9.92% yield.

***Other income (expense), net.***** Other expense, net of other income for the sixmonths ended June 30, 2007, was $1.6 million compared to net other income of$56.8 thousand in the same period of 2006. The increase in expense is related to expenses incurred in associationwith the agreement to be acquired by Integra Telecom, Inc.

***Income taxes.***** In the second quarter of 2007, we establisheda deferred tax liability related to intangible assets that have an indefinitelife for GAAP purposes. Because of the indefinite life, the deferred taxliability created by allowable tax goodwill amortization cannot be offset againstour deferred tax assets when assessing our valuation allowance. As a result, werecorded a $0.5 million deferred tax liability on our balance sheet and chargedthe same amount to the statement of operations as income tax expense.  We expect to continue to increase thisdeferred tax liability and the associated income tax expense until the goodwillis fully amortized for tax purposes or becomes impaired.

**Liquidityand Capital Resources**

***Principal Sources and Uses of Liquidity.* **Ourprincipal sources of liquidity are cash from operations and our cash and cashequivalents.  Our principal liquidityrequirements consist of debt service, capital expenditures and working capital.  In June 2007, we closed on a $15.0 millionbank line of credit to supplement our liquidity needs.  As of June 30, 2007, we had not drawn down onthe line of credit.

***Cash Flows Provided by Operating Activities. ***Cash provided byoperating activities was $24.4 million for the six months ended June 30, 2007compared to cash provided by operating activities of $16.3 million for the sameperiod of 2006.  The increase in cash provided by operating activities is primarily due toan increase in operating income compared to the same period of 2006.

***Cash Flows Used in Investing Activities.***  Cash used in investing activities was $25.9million for the six months ended June 30, 2007 compared to $98.6 million forthe same period of 2006.  The decrease incash used in investing activities is primarily due to two factors: 1) lowerpurchases of available-for-sale securities, and 2) lower level of cash paid foracquisitions. this was partially offset by an increased level of capitalexpenditures.  The amount from sales of ourinvestments, net of purchases, was $17.1 million for the six months ended June30, 2007, compared to purchases of $59.5 million, net of sales for the sameperiod of 2006.  Capital expendituresincreased by $10.3 million compared to the same period of 2006.  The increase in capital expenditures isprimarily due to cash paid to add capacity and convert a selected customer basefrom Tel West Communications, LLC; greater capacity requirements to supportrecord line sales and associated installations; and the purchase of equipmentrelated to our VoIP rollout and new market expansion.

***Cash Flows Used in/Provided byFinancing Activities.*** Cash used in financing activities was $1.6 million for the six monthsended June 30, 2007, compared to $83.3 million of cash provided by financing

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activities for thesame period of 2006.  On March 29, 2006,we completed an offering of $48.0 million in face amount of 8 3/8% seniorsecond secured notes due 2010 at a discount resulting in a 9.92% yield.  On May 19, 2006, we completed an offering of2,550,000 shares of our common stock, $0.01 par value per share, at $15.70 pershare.  The net proceeds of $84.3 millionfrom the offerings were used to finance the acquisition of OTI, OneEighty, MTI,the selected Tel West Communications, Inc. customer base, and capitalexpenditures related to our new market expansion and VoIP roll out.

***Capital Requirements.***  For the six months ended June 30, 2007, wespent $30.2 million on capital expenditures, of which $0.3 million waspurchased under capital leases.  Weexpect to spend approximately $54.0 - $58.0 million on capital expenditures in2007.

Based on our current level of operations andanticipated growth, we believe that our existing cash and cash equivalents willbe sufficient to fund our operations.  In June 2007, we closed on a $15.0 million bankline of credit to supplement our liquidity needs.  As of June 30, 2007, we had not drawn down onthe line of credit.

# **Item 3.    Quantitative and Qualitative DisclosuresAbout Market Risk**

We are not exposedto market risks from changes in foreign currency exchange rates or commodity prices.  We do not hold any derivative financialinstruments nor do we hold any securities for trading or speculative purposes.

We are exposed tochanges in interest rates on our investments in cash equivalents and available-for-salesecurities.  However, interest income forthe six month period ended June 30, 2007 was $0.6 million, therefore notexposing us to any meaningful interest income risk had rates dropped.  We had $142.9 million in senior second securednotes outstanding as of June 30, 2007. These notes are at a fixed interest rate and are therefore not exposedto any interest rate risk.

# **Item 4:   Controls and Procedures**

*Evaluationof Disclosure Controls and Procedures*

We haveestablished disclosure controls and procedures to ensure that information requiredto be disclosed in our reports under the Securities Exchange Act of 1934 (the“Exchange Act”), as amended, is recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission’srules and forms, and that such information is accumulated and communicatedto our Board of Directors and senior management,including our principal executiveofficer and principal financial officer, as appropriate, to allow timelydecisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, and managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

Based on theirevaluation, the principal executive officer and principal financial officer ofthe Company have concluded, pursuant to the Exchange Act Rule 13a-15(b), thatthe design and operation of our disclosure controls and procedures wereeffective to ensure information required to be disclosed in this Form 10-Q wasprocessed, recorded, summarized and reported within the time periods specifiedin the rules and instructions for the Form 10-Q.

*Changesin Internal Controls Over Financial Reporting*

During the second quarter of fiscal 2007, there was nochange in our internal control over financial reporting (as defined in Rule13a-15(f) under the Exchange Act) that materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

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PART II. OTHERINFORMATION

# **Item 1.    Legal Proceedings**

On March 20, 2007,we announced that we signed a definitive agreement to be acquired by Portland,Oregon-based Integra Telecom, Inc.  Underthe terms of the agreement, which was approved by the boards of directors ofboth companies and by our stockholders, Integra Telecom will acquire us for$30.00 a share in cash, which equates to a total equity value of approximately$566 million on a fully diluted basis.

A stockholdercomplaint was filed on April 4, 2007 as a purported class action on behalf ofall public stockholders against us and each of our directors in the DistrictCourt of the Fourth Judicial District in and for Hennepin County,Minnesota.  The complaint alleged, amongother things, that our directors breached their fiduciary duties in connectionwith the proposed transaction mentioned above by failing to maximizestockholder value and by approving a transaction that purportedly benefitscertain members of management at the expense of our public stockholders.  Among other things, the complaint sought to enjoinus from proceeding with or consummating the merger.  The absence of an injunction arising fromthis matter prohibiting the consummation of the merger is a condition to theclosing of the merger.

Following discussions with plaintiff’s counsel, we agreed to provideadditional information concerning the transaction to our stockholders via apress release on May 8, 2007.  We enteredinto a Memorandum of Understanding with the plaintiff that, if approved by thecourt, will result in the dismissal with prejudice of all of the plaintiff’sclaims against us.  Under the terms ofthe settlement, we will pay the plaintiff’s attorneys fees and expenses up to$0.3 million.

We are party from time to time to ordinary course disputes that we donot believe to be material.

**Item 1A. Risk Factors**

***The communicationsindustry faces significant regulatory uncertainties and the resolution of thoseuncertainties could hurt our business, results of operations and financialcondition.***

On April 27, 2007,Qwest filed four separate petitions requesting that the Federal CommunicationsCommission (“FCC”) forbear from applying certain regulatory obligations onQwest in the metropolitan service areas of Denver, Minneapolis, Phoenix andSeattle.  Qwest seeks regulatory reliefin these areas similar to the relief the FCC granted it in December 2005 in theOmaha metropolitan service area.  Qwestseeks relief from its obligation to provide unbundled loops and dedicatedtransport as well as from dominant carrier regulation due to the significantinroads into its market share that competitive service providers havemade.  The FCC has set August 31, 2007 asthe filing date for initial comments and October 1, 2007 as the date for replycomments.  The outcome of these petitionscannot be predicted at this time. However, if Qwest’s petitions are granted, our ability to purchasewholesale network services from Qwest at prices that would allow us to achieve ourtarget profit margin in those markets could be adversely affected.

On March 9, 2007,the FCC partially granted Qwest’s petition for forbearance or interim waiversof some dominant carrier regulations applicable to the long distance servicesof former Bell Operating Companies (“BOCs”). The FCC thereby removed some of the competitive safeguards previouslyapplicable to Qwest’s long distance wholesale and retail services provided,including Qwest’s operations in states in which we operate.  Since the Qwest order is comparativelyrecent, we cannot predict the effect it will have on us.  Elimination of BOC regulatory constraintscould make it more difficult for us to compete with Qwest in offering longdistance services.

On June 26, 2007,Qwest filed for additional relief from unbundling obligations under theTriennial Review Remand Order (“TRRO”) in several states in which weoperate.  While we are continuing toreview Qwest’s filings, we do not believe that they will materially impact ourbusiness operations.  We cannot predictwhen Qwest may make additional filings for relief under the TRRO nor the impactupon us if such requests for relief are upheld.

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**Item 2.    Unregistered Sales of Equity Securities andUse of Proceeds**

On May 19, 2006,we completed an offering of 2,550,000 shares of our common stock, $0.01 parvalue per share, at $15.70 per share. After deducting fees and expenses related to the offering, we receivednet proceeds of $40.0 million.  Ouracquisition of MTI on November 1, 2006 was partially financed with $26.3million of the proceeds from the offering. The remaining proceeds of $13.7 million were used to fund capitalexpenditures associated with our VoIP rollout and new market expansion and tofund the acquisition of a selected customer base from Tel West Communications,LLC.

# **Item 3.    Defaults Upon Senior Securities**

None.

# **Item 4.    Submission of Matters to a Vote of SecurityHolders**

At the AnnualMeeting of Stockholders of Eschelon Telecom, Inc. on May 17, 2007, the Company’sstockholders approved the following matters by the vote indicated below:

(i) Election ofDirectors.
|                       | ** ** | **FOR**    | ** ** | **WITHHOLD** | ** ** |
|-----------------------|------------|------------|------------|--------------|------------|
| Richard A. Smith      |       | 16,363,142 |       | 128,469      |       |
| Clifford D.  Williams |       | 16,321,852 |       | 169,759      |       |
| Louis L. Massaro      |       | 16,363,156 |       | 128,455      |       |
| Marvin C. Moses       |       | 16,363,156 |       | 128,455      |       |
| Mark E. Nunnelly      |       | 16,162,038 |       | 329,573      |       |
| Ian K. Loring         |       | 16,065,240 |       | 426,371      |       |
| James P. TenBroek     |       | 16,203,268 |       | 288,343      |       |

 

(ii) Ratificationof Ernst & Young LLP as Independent Registered Public Accounting Firm for2007.
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** | **BROKER NON-VOTE** | ** ** |
|------------|------------|-------------|------------|-------------|------------|--------------------------|------------|
| 16,491,611 |       | 0           |       | 0           |       | 0                        |       |

 

# On March 20, 2007,we announced that we signed a definitive agreement to be acquired by Portland,Oregon-based Integra Telecom, Inc., a privately-held integrated communicationsprovider offering retail services to businesses in Oregon, Washington, Utah,Idaho, California, Arizona, Minnesota, and North Dakota.  Under the terms of the agreement, which wasapproved by the boards of directors of both companies, Integra Telecom willacquire us for $30.00 a share in cash, which equates to a total equity value ofapproximately $566 million on a fully diluted basis.

At the SpecialMeeting of Stockholders of Eschelon Telecom, Inc. on May 25, 2007, the Company’sstockholders approved the following matters by the vote indicated below:

(i) To adopt theAgreement and Plan of Merger, dated as of March 19, 2007, by and among EschelonTelecom, Inc., Integra Telecom Holdings, Inc., and ITH Acquisition Corp., assuch agreement may be amended from time to time, and approve the mergercontemplated by the Agreement and Plan of Merger.
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** | **BROKER NON-VOTE** | ** ** |
|------------|------------|-------------|------------|-------------|------------|--------------------------|------------|
| 13,571,536 |       | 3,253       |       | 0           |       | 0                        |       |

 

(ii) To approve aproposal to approve the adjournment of the Special Meeting, if necessary, tosolicit additional proxies if there are insufficient votes at the time of theSpecial Meeting.
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** | **BROKER NON-VOTE** | ** ** |
|------------|------------|-------------|------------|-------------|------------|--------------------------|------------|
| 13,343,597 |       | 230,242     |       | 950         |       | 0                        |       |

 

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# **Item 5.    Other Information**

None.

# **Item 6.    Exhibits**

| Exhibit  Number | ** ** | **Description**                                                                                      |
|-----------------|------------|------------------------------------------------------------------------------------------------------|
| 31.1*           |       | Certification by Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2*           |       | Certification by Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1†      |       | Certification by Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2†      |       | Certification by Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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*  Filed herewith.

†  Furnished herewith.

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## **SIGNATURE**

## Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

|                 | Eschelon Telecom, Inc.                                                     |
|----------------------|----------------------------------------------------------------------------|
|                 |
| Date: August 7, 2007 | By:                                                                        | /S/ Geoffrey M. Boyd |   |
|                 |
|                 | Name:                                                                      | Geoffrey M. Boyd |
|                 | Title:                                                                     | Chief Financial Officer |
|                 | (Principal Financial and  Accounting Officer and Duly  Authorized Officer) |

 

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