**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549-0001**

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** **

**FORM 10-Q/A**

**AMENDMENT NO. 1**

 
| **(MARK ONE)**                                          |
|---------------------------------------------------------|
|                                                    |
| **x**                                                   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                    |   |
| **For the  quarterly period ended March 31, 2006** |
|                                                    |   |   |
| **OR**                                                  |
|                                                    |   |   |
| **o**                                                   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                    |   |
| **Commission  File Number 000-50706**                   |

 

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**ESCHELONTELECOM, INC.**

(Exactname of registrant as specified in its charter)

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

 

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

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to the filingrequirements for the past 90 days. Yes  x    No  o

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

 

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

As of September 30, 2006, thenumber of outstanding shares of the Registrant’s Common Stock, par value $.01per share, was 17,946,744shares.

 

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EXPLANATORY NOTE

 

This Amendment No. 1 (the “Amendment”) on Form10-Q/A for the three months ended March 31, 2006 is being filed to includecondensed consolidating statements of cash flows for the three months endedMarch 31, 2005 and 2006 in the Notes to Consolidated Financial Statements inour Form 10-Q for the three months ended March 31, 2006 (the “Form 10-Q”), toamend the presentation of the Consolidated Statements of Operations and toamend certain typographical errors in the Form 10-Q.  The presentation of the Consolidated Statements ofOperations was amended to exclude the caption Gross Profit.  This Amendment amends and supersedes Part I, Item 1 of the Form 10-Q.

**ESCHELON TELECOM, INC.**

**INDEX TO FORM 10-Q**
| **PART I. FINANCIAL  INFORMATION** |   | **3**                                                                                                    |
|-----------------------------------------|--------|----------------------------------------------------------------------------------------------------------|
|                                    |   |                                                                                                     |   |   |
| Item 1.                                 |   | Financial  Statements:                                                                                   |   | 3 |
|                                    |   |                                                                                                     |   |   |
|                                    |   | Consolidated  Balance Sheets – December 31, 2005 and March 31, 2006 (Unaudited)           |   | 3 |
|                                    |   |                                                                                                     |   |   |
|                                    |   | Unaudited  Consolidated Statements of Operations – Three months ended March 31,  2005 and 2006 |   | 4 |
|                                    |   |                                                                                                     |   |   |
|                                    |   | Unaudited  Consolidated Statements of Cash Flows – Three months ended March 31,  2005 and 2006 |   | 5 |
|                                    |   |                                                                                                     |   |   |
|                                    |   | Notes to  Consolidated Financial Statements                                                              |   | 6 |
|                                         |   |                                                                                                     |   |   |
|                                    |   |                                                                                                     |   |   |
| **PART II. 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)**
| ** **                                                                                                                                                                                         | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                         | ** ** | **2005**              | ** ** | **2006**           | ** ** |
| ** **                                                                                                                                                                                         | ** ** | ** **            | ** ** | **(Unaudited)**    | ** ** |
| **Assets**                                                                                                                                                                                         | ** ** | ** **            | ** ** | ** **         | ** ** |
| Current assets:                                                                                                                                                                                    |       |                  |       |               |       |
| Cash and cash  equivalents                                                                                                                                                                         |       | $                     | 26,062     |               | $          | 73,580 |   |
| Restricted cash                                                                                                                                                                                    |       | 996                   |       | 893                |       |
| Available-for-sale  securities                                                                                                                                                                     |       | 4,760                 |       | 795                |       |
| Accounts  receivable, net of allowance for doubtful accounts of $492 and $649,  respectively                                                                                                       |       | 22,996                |       | 21,760             |       |
| Other  receivables                                                                                                                                                                                 |       | 3,052                 |       | 3,308              |       |
| Inventories                                                                                                                                                                                        |       | 2,927                 |       | 3,258              |       |
| Prepaid expenses                                                                                                                                                                                   |       | 2,294                 |       | 3,394              |       |
| Total current assets                                                                                                                                                                               |       | 63,087                |       | 106,988            |       |
|                                                                                                                                                                                               |       |                  |       |               |       |
| Property and equipment,  net                                                                                                                                                                       |       | 126,452               |       | 124,811            |       |
|                                                                                                                                                                                               |       |                  |       |               |       |
| Other assets                                                                                                                                                                                       |       | 1,506                 |       | 1,466              |       |
| Goodwill                                                                                                                                                                                           |       | 7,168                 |       | 7,168              |       |
| Intangible assets, net                                                                                                                                                                             |       | 33,333                |       | 34,546             |       |
| Total assets                                                                                                                                                                                       |       | $                     | 231,546    |               | $          | 274,979 |   |
|                                                                                                                                                                                               |       |                  |       |               |       |
| **Liabilities and stockholders’  equity**                                                                                                                                                     | ** ** | ** **            | ** ** | ** **         | ** ** |
| Current liabilities:                                                                                                                                                                               |       |                  |       |               |       |
| Accounts payable                                                                                                                                                                                   |       | $                     | 16,400     |               | $          | 15,418 |   |
| Accrued  telecommunication costs                                                                                                                                                                   |       | 4,227                 |       | 5,008              |       |
| Accrued office  rent                                                                                                                                                                               |       | 2,035                 |       | 1,864              |       |
| Accrued interest  expense                                                                                                                                                                          |       | 2,646                 |       | 579                |       |
| Other accrued  expenses                                                                                                                                                                            |       | 5,485                 |       | 6,149              |       |
| Deferred revenue                                                                                                                                                                                   |       | 7,921                 |       | 7,932              |       |
| Accrued  compensation expenses                                                                                                                                                                     |       | 2,809                 |       | 3,546              |       |
| Capital lease  obligations, current maturities                                                                                                                                                     |       | 2,430                 |       | 1,833              |       |
| Total current  liabilities                                                                                                                                                                         |       | 43,953                |       | 42,329             |       |
|                                                                                                                                                                                               |       |                  |       |               |       |
| Long-term liabilities:                                                                                                                                                                             |       |                  |       |               |       |
| Commitments and  contingencies                                                                                                                                                                     |       |                  |       |               |       |
| Other long-term  liabilities                                                                                                                                                                       |       | 251                   |       | 144                |       |
| Capital lease  obligations, less current maturities                                                                                                                                                |       | 2,964                 |       | 2,946              |       |
| Notes payable                                                                                                                                                                                      |       | 92,125                |       | 138,433            |       |
| Total liabilities                                                                                                                                                                                  |       | 139,293               |       | 183,852            |       |
|                                                                                                                                                                                               |       |                  |       |               |       |
| Stockholders’ equity:                                                                                                                                                                         |       |                  |       |               |       |
| Preferred stock,  $0.01 par value per share; 125,000,000 shares authorized; no shares issued  and outstanding                                                                                      |       | —                |       | —             |       |
| Common stock,  $0.01 par value per share; 200,000,000 shares authorized; issued and  outstanding shares – 14,634,279 shares at December 31, 2005; and  14,848,007 at March 31, 2006 |       | 146                   |       | 148                |       |
| Additional  paid-in capital                                                                                                                                                                        |       | 248,199               |       | 247,596            |       |
| Accumulated  other comprehensive income                                                                                                                                                            |       | 56                    |       | 13                 |       |
| Accumulated  deficit                                                                                                                                                                               |       | (155,047              | )          | (156,630           | )          |
| Deferred  compensation                                                                                                                                                                             |       | (1,101                | )          | —             |       |
| Total stockholders’  equity                                                                                                                                                                   |       | 92,253                |       | 91,127             |       |
| Total liabilities and stockholders’ equity                                                                                                                                                    |       | $                     | 231,546    |               | $          | 274,979 |   |

 

*See accompanying 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** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | **March 31,**               | ** ** |
| ** **                                                            | ** ** | **2005**                         | ** ** | **2006** | ** ** |
| Revenue:                                                              |       |                             |       |   |   |
| Network services                                                      |       | $                                | 48,668     |   | $ | 52,785 |   |
| Business telephone systems                                            |       | 5,865                            |       | 6,941 |   |
| Total revenue                                                         |       | 54,533                           |       | 59,726 |   |
|                                                                  |       |                             |       |   |   |
| Costs and expenses:                                                   |       |                             |       |   |   |
| Network services expenses  (excluding depreciation and  amortization) |       | 20,001                           |       | 20,763 |   |
| Business telephone systems cost of revenue                            |       | 3,630                            |       | 4,553 |   |
| Sales, general and administrative                                     |       | 22,365                           |       | 22,699 |   |
| Depreciation and amortization                                         |       | 8,574                            |       | 10,176 |   |
| Operating income  (loss)                                              |       | (37                              | )          | 1,535 |   |
|                                                                  |       |                             |       |   |   |
| Other income  (expense):                                              |       |                             |       |   |   |
| Interest income                                                       |       | 131                              |       | 233 |   |
| Interest expense                                                      |       | (4,862                           | )          | (3,400 | ) |
| Other income                                                          |       | —                           |       | 49 |   |
| Loss before  income taxes                                             |       | (4,768                           | )          | (1,583 | ) |
| Income taxes                                                          |       | —                           |       | — |   |
| Net loss                                                              |       | (4,768                           | )          | (1,583 | ) |
| Less preferred  stock dividends                                       |       | (1,079                           | )          | — |   |
| Net loss  applicable to common stockholders                           |       | $                                | (5,847     | ) | $ | (1,583 | ) |
|                                                                  |       |                             |       |   |   |
| Net loss per  share:                                                  |       |                             |       |   |   |
| Basic and diluted                                                     |       | $                                | (18.70     | ) | $ | (0.11 | ) |
|                                                                  |       |                             |       |   |   |
| Weighted average  number of shares outstanding:                       |       |                             |       |   |   |
| Basic and  diluted                                                    |       | 313,400                          |       | 14,680,783 |   |

 

*See accompanying notes.*

4

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**Eschelon Telecom, Inc.**

**Unaudited Consolidated Statements of Cash Flows**

**(In Thousands)**
| ** **                                                                            | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                            | ** ** | **March 31,**               | ** ** |
| ** **                                                                            | ** ** | **2005**                         | ** ** | **2006** | ** ** |
| **Operating  activities**                                                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net loss                                                                              |       | $                                | (4,768     | ) | $ | (1,583 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities:      |       |                             |       |   |   |
| Depreciation and amortization expense                                                 |       | 8,574                            |       | 10,176 |   |
| Other non-cash items                                                                  |       | 1,343                            |       | 1,488 |   |
| Changes in operating assets and liabilities:                                          |       |                             |       |   |   |
| Restricted cash                                                                       |       | 71                               |       | 103 |   |
| Accounts receivable                                                                   |       | (302                             | )          | 961 |   |
| Inventories                                                                           |       | (379                             | )          | (331 | ) |
| Prepaid expenses and other assets                                                     |       | 450                              |       | (1,416 | ) |
| Accounts payable and accrued expenses                                                 |       | (3,454                           | )          | (1,775 | ) |
| Deferred revenue                                                                      |       | 23                               |       | 11 |   |
| Accrued compensation expense                                                          |       | 793                              |       | 737 |   |
| Net cash  provided by operating activities                                            |       | 2,351                            |       | 8,371 |   |
|                                                                                  |       |                             |       |   |   |
| **Investing  activities**                                                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Purchase of  assets held for sale, net of liabilities                                 |       | (216                             | )          | — |   |
| Purchases of  available-for-sale securities                                           |       | (14,134                          | )          | — |   |
| Proceeds from  sales of available-for-sale securities                                 |       | 7,646                            |       | 4,000 |   |
| Purchases of  property and equipment                                                  |       | (4,972                           | )          | (5,360 | ) |
| Cash paid for  customer installation costs                                            |       | (3,343                           | )          | (3,640 | ) |
| Proceeds from  sales of assets                                                        |       | 5                                |       | 28 |   |
| Net cash used in  investing activities                                                |       | (15,014                          | )          | (4,972 | ) |
|                                                                                  |       |                             |       |   |   |
| **Financing  activities**                                                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Proceeds from  issuance of notes payable                                              |       | —                           |       | 45,600 |   |
| Payments made on  notes and capital lease obligations                                 |       | (453                             | )          | (638 | ) |
| Proceeds from  issuance of stock, net of fees                                         |       | 1                                |       | 153 |   |
| Increase in debt  issuance costs                                                      |       | (240                             | )          | (996 | ) |
| Net cash  provided by (used in) financing activities                                  |       | (692                             | )          | 44,119 |   |
|                                                                                  |       |                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                 |       | (13,355                          | )          | 47,518 |   |
| Cash and cash  equivalents at beginning of period                                     |       | 26,435                           |       | 26,062 |   |
| Cash and cash  equivalents at end of period                                           |       | $                                | 13,080     |   | $ | 73,580 |   |
| ** **                                                                            | ** ** | ** **                       | ** ** | ** ** | ** ** |
| **Supplemental  cash flow information**                                               | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cash paid for  interest                                                               |       | $                                | 3,643      |   | $ | 2,485 |   |
|                                                                                  |       |                             |       |   |   |
| **Supplemental  noncash activities**                                                  | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Equipment  purchases under capital leases                                             |       | $                                | 584        |   | $ | 21 |   |
| Value of common stock  issued to management and certain members of board of directors |       | $                                | 24         |   | $ | — |   |

 

*See accompanying notes.*

5

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**Eschelon Telecom, Inc.**

**Notes to Consolidated Financial Statements**

**(In Thousands, Except Share and Per Share Amounts)**

**(Unaudited)**

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

**Basis of Presentation**

Theaccompanying unaudited consolidated financial statements of EschelonTelecom, Inc. and its subsidiaries (the “Company”) have been prepared inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and the instructions toForm 10-Q and Article 10 of Regulation S-X promulgated by the UnitedStates Securities and Exchange Commission (the “SEC”). Accordingly, they do notinclude all of the information and notes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements. In the opinion of management, all adjustments (consisting of normaland recurring adjustments and accruals) considered necessary for a fairpresentation for the periods indicated have been included. Operating resultsfor the three month period ended March 31, 2006 are not necessarilyindicative of the results that may be expected for the year endingDecember 31, 2006. The consolidated balance sheet at December 31,2005 has been derived from the audited consolidated financial statements atthat date but does not include all of the information and footnotes required bygenerally accepted accounting principles for complete financial statements.These financial statements should be read in conjunction with the Company’saudited financial statements and related notes thereto for the year endedDecember 31, 2005 included in the Eschelon Telecom, Inc.Form 10-K filed with the SEC on March 17, 2006.

## **Principlesof Consolidation**

Theconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries. All intercompany balances and transactions have beeneliminated in consolidation.

## **Available-for-SaleSecurities**

Short-terminvestments are comprised of municipal and United States government debtsecurities with maturities of more than three months but less than one year. Inaccordance with Statement of Financial Accounting Standards (SFAS)No. 115, *Accounting for Certain Investments in Debtand Equity Securities*, and based on the Company’s intentions regardingthese instruments, all investments in debt securities are classified asavailable-for-sale and accounted for at fair value. Fair value is determined byquoted market prices, with unrealized gains and losses reported as a separatecomponent of stockholders’ equity. The Company uses the specific identificationof securities sold method to recognize realized gains and losses in earnings.

Thecost basis, unrealized holding gains and fair value of the investmentsecurities available-for-sale as of March 31, 2006 and December 31,2005, are as follows:
| ** **                                                  | ** ** | ** **          | ** ** | **Unrealized** | ** ** | ** **          | ** ** |
|-------------------------------------------------------------|------------|---------------------|------------|----------------|------------|---------------------|------------|
| ** **                                                  | ** ** | ** **          | ** ** | **Holding**    | ** ** | ** **          | ** ** |
| ** **                                                  | ** ** | **Cost Basis** | ** ** | **Gains**      | ** ** | **Fair Value** | ** ** |
|                                                        |       |                |       |           |       |                |       |
| Available-for-sale  securities as of March 31, 2006    |       | $                   | 782        |           | $          | 13                  |       | $ | 795 |   |
|                                                        |       |                |       |           |       |                |       |
| Available-for-sale  securities as of December 31, 2005 |       | $                   | 4,704      |           | $          | 56                  |       | $ | 4,760 |   |

 

Debtsecurities as of March 31, 2006, have maturities of less than six months.

## **Propertyand Equipment**

Propertyand equipment, including leasehold improvements, are stated at cost.Depreciation is provided using the straight-line method over the estimateduseful lives of the assets. Leasehold improvements are amortized over theshorter of the related lease term or the estimated useful life of the asset.

6

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Allinternal costs directly related to the construction of the switches andoperating and support systems, including compensation of certain employees, arecapitalized.

Propertyand equipment consist of the following:
| ** **                                 | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **2005**              | ** ** | **2006**           | ** ** |
|                                       |       |                  |       |               |       |
| Vehicles                                   |       | $                     | 1,375      |               | $          | 1,406 |   |
| Office furniture  and equipment            |       | 18,229                |       | 18,758             |       |
| Computer  equipment and software           |       | 41,897                |       | 42,885             |       |
| Leasehold  improvements                    |       | 23,765                |       | 24,511             |       |
| Switching and  data equipment and software |       | 134,661               |       | 137,604            |       |
|                                       |       | 219,927               |       | 225,164            |       |
| Less accumulated  depreciation             |       | (93,475               | )          | (100,353           | )          |
| Property and equipment,  net               |       | $                     | 126,452    |               | $          | 124,811 |   |

 

## **Goodwilland Other Intangible Assets**

Goodwillrepresents the excess of cost over the fair value of net assets acquired.

Intangiblesconsist of customer installation costs, debt issuance costs, customerrelationships, non-compete agreements and developed technology. The customerinstallation costs are being amortized over a period of 48 months, whichapproximates the average life of a customer contract. Debt issuance costs arebeing amortized over the term of the respective debt obligation. Non-competeagreement costs represent costs associated with a non-compete agreement with aformer employee. These costs are being amortized over the term of theagreement. Customer relationships and developed technology are being amortizedover four and three years, respectively.

Intangibleassets consist of the following:
| ** **                     | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                     | ** ** | **2005**              | ** ** | **2006**           | ** ** |
|                           |       |                  |       |               |       |
| Customer  installation costs   |       | $                     | 77,650     |               | $          | 81,370 |   |
| Debt issuance  costs           |       | 5,666                 |       | 6,662              |       |
| Customer  relationships        |       | 3,820                 |       | 3,820              |       |
| Non-compete  agreements        |       | 300                   |       | 300                |       |
| Developed  technology          |       | 94                    |       | 94                 |       |
|                           |       | 87,530                |       | 92,246             |       |
| Less accumulated  amortization |       | (54,197               | )          | (57,700            | )          |
| Intangible assets, net         |       | $                     | 33,333     |               | $          | 34,546 |   |

 

7

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## **Stock-BasedCompensation**

*StockOption Plan*

Atotal of 1,632,414 shares of the Company’s common stock have been authorizedfor issuance under the Eschelon Telecom, Inc. Stock Option Plan of 2002(the “2002 Plan”). The 2002 Plan provides for grants of incentive stockoptions, non-statutory stock options, stock appreciation rights, restricted orunrestricted stock awards, phantom stock, performance awards and otherstock-based awards to our employees, former employees, officers, directors andconsultants. The 2002 Plan is administered by the Compensation Committee of theBoard of Directors, which has sole discretion and authority, consistent withthe provisions of the 2002 Plan, to determine which eligible participants willreceive awards, when awards will be granted, the terms of awards, and thenumber of shares that will be subject to awards. The purpose of the 2002 Planis to enable the Company to attract, retain and reward the best-availablepersons, to provide participants with incentives to improve stockholder valueand to contribute to the growth and financial success of the Company throughtheir future services of the Company. All of the Company’s employees, formeremployees, officers and directors are eligible to participate in the 2002 Plan.

Theexercise price of incentive stock options may not be less than the fairmarket value of the stock on the date of grant and the options are exercisablefor a period not to exceed ten years from date of grant. Options and restrictedstock awards are typically subject to one of the following vesting schedules:  (1) 20% upon the initial grant and 20%per year over four years from the date of grant, (2) 20% per year over fiveyears from the date of grant, or (3) 33 1/3% upon the initial grant and 331/3% per year over two years from the date of grant. Awards granted may besubject to other vesting terms as determined by the Compensation Committee.

*StockOptions*

EffectiveJanuary 1, 2006, the Company adopted the provisions of SFAS No. 123R(SFAS 123R), *Share-Based Payment: an amendment of FASBStatement No. 123 and FASB Statement No. 95,*whichrequires the measurement and recognition of compensation expense for allshare-based payment awards to employees and directors based on estimated fairvalues. Prior to the adoption of SFAS 123R, the Company accounted for itsstock-based compensation under the recognition and measurement principles ofAccounting Principles Board Opinion No. 25 (APB 25), *Accountingfor Stock Issued to Employees,*and related interpretations. TheCompany recorded $336 of stock-based compensation expense under SFAS 123R forthe three months ended March 31, 2006 for stock option awards. Under APB25, $139 of stock-based compensation expense would have been recorded for thesame period. For the three months ended March 31, 2006, $10 was recordedfor vested restricted awards. At March 31, 2006, there is $1,064 of totalunrecognized compensation expense related to unvested shares granted under theCompany’s share-based payment plans, of which $1,053 relates to service-basedoption awards and $11 relates to restricted stock awards. The expense isexpected to be recognized over a weighted-average period of 1.1 years.

TheCompany adopted SFAS 123R using the modified prospective transition method andthe straight-line attribution method for recognizing compensation expense.Under the modified prospective transition method, compensation expenserecognized during the three months ended March 31, 2006, included:  (a) the quarterly prorated portion ofcompensation expense for all share-based awards granted prior toJanuary 1, 2006, but not yet vested, based on the grant date fair valueestimated in accordance with the original provisions of SFAS 123, and(b) the quarterly prorated portion of compensation expense for allshare-based awards granted subsequent to adoption of SFAS 123R, based on thegrant date fair value estimated in accordance with the provisions of SFAS 123R.In accordance with the modified prospective transition method, the Company’sconsolidated financial statements for periods prior to the adoption of SFAS123R have not been restated to reflect the impact of the provisions of SFAS123R.

TheCompany records compensation expense for employee stock options based on theestimated fair value of the options on the date of grant using assumptionsrequired by SFAS 123R. Due to insufficient history related to options, theCompany uses the short-cut method accepted by the SEC to determine the expectedlife of options. The Company expects to continue using the short-cut method foroptions granted through December 31, 2007, after which the use of the short-cutmethod is not permitted by the SEC. Volatility is estimated based on anexchange-traded telecommunications fund using data which corresponds to theexpected term of the options granted. The risk-free interest rate is based onthe Federal Reserve rate for U.S. government securities with a term thatcorresponds to the expected term of the options granted. The Company useshistorical data and other factors to estimate the expected forfeiture rate.

8

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Thefollowing table summarizes the assumptions used to estimate the fair value ofoptions granted during the three month periods ended March 31, 2005 and2006 using the Black-Scholes option-pricing model:
|                                  | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|
| ** **                       | ** ** | **2005**                                         | ** ** | **2006** | ** ** |
| Expected  dividend yield         |       | —                                           |       | — |   |
| Expected stock  price volatility |       | 25                                               | %          | 26 | % |
| Risk-free  interest rate         |       | 3.71                                             | %          | 4.56 | % |
| Expected life of  options        |       | 5 years                                          |       | 6 – 6.5 years |   |

 

Pro forma informationregarding net loss and net loss per share is required by SFAS 123, and has beendetermined as if the Company had accounted for its employee stock options underthe fair value method of SFAS 123. The following table illustrates the effecton net loss per share for the three months ended March 31, 2005, if theCompany had applied the fair value recognition provision of SFAS 123, *Accounting for Stock-Based Compensation,*to stock-basedemployee compensation:

 
|                                                                                                                    | ** ** | **Three months**        | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                         | ** ** | **Ended**                    | ** ** |
| ** **                                                                                                         | ** ** | **March 31, 2005** | ** ** |
| Net loss  applicable to common stockholders, as reported                                                           |       | $                            | (5,847     | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                                      |       | 12                           |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value-based  methods for all awards |       | (17                          | )          |
| Pro forma net  loss applicable to common stockholders                                                              |       | $                            | (5,852     | ) |
|                                                                                                               |       |                         |       |
| Net loss per  share:                                                                                               |       |                         |       |
| Basic and diluted - as reported                                                                                    |       | $                            | (18.70     | ) |
| Basic and  diluted - pro forma                                                                                     |       | $                            | (18.70     | ) |

 

Thefollowing table summarizes the option activity under the 2002 Plan:
| ** **                                                        | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------|------------|
|                                                              |       |                        |       |                                        |       |                                                 |       |                                |       |
| Outstanding at  December 31, 2005                            |       | 1,167,490                   |       | $                                           | 4.12       |                                                 |       |                                |       |   |
| Granted                                                           |       | 13,638                      |       | 12.00                                       |       |                                                 |       |                                |       |
| Canceled                                                          |       | (11,537                     | )          | 7.07                                        |       |                                                 |       |                                |       |
| Exercised                                                         |       | (218,214                    | )          | 0.72                                        |       |                                                 |       |                                |       |
| Outstanding at  March 31, 2006                               |       | 951,377                     |       | $                                           | 4.97       |                                                 | 8.22       |                                | $          | 10,227 |   |
|                                                              |       |                        |       |                                        |       |                                                 |       |                                |       |
| Vested and  expected to vest in the future at March 31, 2006 |       | 948,735                     |       | $                                           | 4.97       |                                                 | 8.22       |                                | $          | 10,204 |   |
| Exercisable at  March 31, 2006                               |       | 417,740                     |       | $                                           | 3.09       |                                                 | 7.63       |                                | $          | 5,274 |   |

##  

Theweighted-average grant-date fair value of options granted during the threemonths ended March 31, 2006 and 2005, was $4.35 and $2.27, respectively.The total intrinsic value for options exercised during the three months endedMarch 31, 2006 and 2005, was $2,708 and $1, respectively.

Cashreceived from option exercises for the three months ended March 31, 2006and 2005, was $153 and $1, respectively.

9

----

 

*Restrictedand Unrestricted Common Stock*

In2003, the Company granted 183,399 shares of restricted common stock to certainof its directors and members of management. The Company records compensationexpense as the restrictions are removed from the stock. In 2005, the Companygranted 9,350 shares of unrestricted common stock to certain directors. Totalcompensation expense related to restricted and unrestricted common stock forthe three months ended March 31, 2006 and 2005, is $10 and $36,respectively.

Thefollowing table summarizes the activity of the Company’s unvested restrictedcommon shares for the three months ended March 31, 2006:
|                                     | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|-------------------------------------|------------|----------------------------|------------|--------------------------------------------------------------|------------|
| ** **                          | ** ** | ** **                 | ** ** | ** **                                                   | ** ** |
| Unvested at  December 31, 2005 |       | 31,686                     |       | $                                                            | 0.68       |   |
| Granted                             |       | —                     |       | —                                                       |       |
| Vested                              |       | (15,842                    | )          | 0.68                                                         |       |
| Forfeited                           |       | —                     |       | —                                                       |       |
| Unvested at  March 31, 2006    |       | 15,844                     |       | $                                                            | 0.68       |   |

##  

## **NetIncome (Loss) Per Share**

Basicearnings per share is computed based on the weighted average number of commonshares outstanding. Diluted earnings per share is computed based on theweighted average number of common shares outstanding adjusted by the number ofadditional shares that would have been outstanding had potentially dilutivecommon shares been issued. Potentially dilutive shares of common stock includeunexercised stock options and unvested restricted stock grants. The Companydoes not have any potentially dilutive shares because net losses were reportedin all periods presented.

**2.)   Acquisitions**

***Advanced TelCom, Inc.***

Inconnection with the acquisition of Advanced TelCom, Inc. onDecember 31, 2004, the Company accrued $2,531 in acquisition relatedexpenses, which included severance benefits, relocation costs and contracttermination fees. During the fourth quarter of 2005 the Company finalized itsliabilities incurred in connection with the acquisition and recorded anadjustment to decrease the recorded liabilities by $403, which was recorded asa reduction to goodwill. As of March 31, 2006, $93 of the acquisitionrelated expenses have yet to be paid.

**3.)   Notes Payable**

OnMarch 29, 2006, the Company completed an offering of $48,000 of 8 3/8%senior second secured notes (“notes”) due 2010 at a discount resulting in a9.92% yield. The notes were entered into under a fourth supplemental indentureto the original indenture dated March 17, 2004, and have the same termsand conditions of the original indenture. The Company received net proceeds ofapproximately $44,604 after deducting fees and expenses associated with theoffering. The Company’s acquisition of Oregon Telecom, Inc. onApril 1, 2006, was financed with approximately $20,000 of the proceeds fromthe offering. The remaining proceeds will be used for general corporatepurposes and potential future acquisitions.

**4.)   Benefit Contribution Plan**

TheCompany has a defined contribution salary deferral plan covering substantiallyall employees under Section 401(k) of the Internal Revenue Code. TheCompany contributes an amount equal to 45 cents for each dollar contributed byeach employee up to a maximum of 6% of each employee’s compensation. TheCompany recognized expense for contributions to the plan for the three monthsended March 31, 2005 and 2006 of $227 and $230, respectively.

10

----

 

**5.)   Capital Stock**

**PreferredStock**

As aresult of the Company’s initial public offering of common stock inAugust 2005, all of the Company’s then-outstanding shares of convertiblepreferred stock and accumulated dividends were automatically converted tocommon stock.

Afterthe conversion, the Company has 125,000,000 of undesignated preferred sharesauthorized and no shares of preferred stock outstanding.

Priorto the conversion, under the terms of the Company’s Series A ConvertiblePreferred Stock and Series B Convertible Preferred Stock (collectively, “PreferredStock”), the holders were entitled to receive, when and if declared by theBoard of Directors, cumulative dividends on each share of Preferred Stock atthe rate of 8% per year which accrued daily and, to the extent not paid,accumulated quarterly in arrears. At March 31, 2005, dividends in arrearswere $9,856.

**6.)   Reverse Stock Split**

TheCompany completed a 0.0738-for-one reverse stock split affecting alloutstanding shares of common stock on August 2, 2005. All share and pershare data have been adjusted to reflect the stock split.

**7.)   Condensed Consolidating Financial Information**

TheCompany’s 8 3/8% senior second secured notes due 2010 issued by EschelonOperating Company are fully and unconditionally guaranteed jointly andseverally by the Company and all existing subsidiaries and the indenturegoverning the notes requires that any future subsidiaries that are organized inthe United States must also guarantee the notes on the same basis.

Thefollowing tables present condensed consolidating balance sheets atDecember 31, 2005 and March 31, 2006 and condensed consolidatingstatements of operations and cash flows forthe three-month periods ended March 31, 2005 and 2006.

11

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**Unaudited Condensed Consolidating Balance SheetsAs of December 31, 2005(In Thousands)**

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

 

12

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**Unaudited Condensed ConsolidatingBalance Sheets**

**As of March 31, 2006(In Thousands)**

 
| ** **                                                 | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| **Assets**                                                 |       |                   |       |          |       |             |       |             |       |             |       |
| Current assets:                                            |       |                   |       |          |       |             |       |             |       |             |       |
| Cash and cash equivalents                                  |       | $                      | 73,665     |          | $          | —           |       | $                | (85        | )                | $          | — |   | $ | 73,580 |   |
| Restricted cash                                            |       | 893                    |       | —        |       | —           |       | —           |       | 893              |       |
| Available-for-sale securities                              |       | 795                    |       | —        |       | —           |       | —           |       | 795              |       |
| Accounts receivable                                        |       | —                 |       | —        |       | 21,760           |       | —           |       | 21,760           |       |
| Other receivables                                          |       | —                 |       | —        |       | 3,308            |       | —           |       | 3,308            |       |
| Inventories                                                |       | —                 |       | —        |       | 3,258            |       | —           |       | 3,258            |       |
| Prepaid expenses                                           |       | 1,708                  |       | —        |       | 1,686            |       | —           |       | 3,394            |       |
| Total current  assets                                      |       | 77,061                 |       | —        |       | 29,927           |       | —           |       | 106,988          |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Property and  equipment, net                               |       | 83,397                 |       | —        |       | 41,414           |       | —           |       | 124,811          |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Investment in  affiliates                                  |       | 59,046                 |       | —        |       | —           |       | (59,046          | )          | —           |       |
| Other assets                                               |       | 509                    |       | —        |       | 957              |       | —           |       | 1,466            |       |
| Goodwill                                                   |       | —                 |       | —        |       | 7,168            |       | —           |       | 7,168            |       |
| Intangible  assets, net                                    |       | 14,492                 |       | 5,378         |       | 14,676           |       | —           |       | 34,546           |       |
| Total assets                                               |       | $                      | 234,505    |          | $          | 5,378            |       | $                | 94,142     |             | $          | (59,046 | ) | $ | 274,979 |   |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| **Liabilities  and stockholders’ equity (deficit)**   |       |                   |       |          |       |             |       |             |       |             |       |
| Current  liabilities:                                      |       |                   |       |          |       |             |       |             |       |             |       |
| Accounts payable                                           |       | $                      | 13,489     |          | $          | —           |       | $                | 1,929      |             | $          | — |   | $ | 15,418 |   |
| Accrued telecommunication costs                            |       | —                 |       | —        |       | 5,008            |       | —           |       | 5,008            |       |
| Accrued office rent                                        |       | 1,076                  |       | —        |       | 788              |       | —           |       | 1,864            |       |
| Accrued interest expense                                   |       | —                 |       | 578           |       | 1                |       | —           |       | 579              |       |
| Other accrued expenses                                     |       | 1,203                  |       | —        |       | 4,946            |       | —           |       | 6,149            |       |
| Deferred revenue                                           |       | —                 |       | —        |       | 7,932            |       | —           |       | 7,932            |       |
| Accrued compensation expenses                              |       | 2,799                  |       | —        |       | 747              |       | —           |       | 3,546            |       |
| Capital lease obligations, current maturities              |       | 1,721                  |       | —        |       | 112              |       | —           |       | 1,833            |       |
| Total current  liabilities                                 |       | 20,288                 |       | 578           |       | 21,463           |       | —           |       | 42,329           |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Long-term  liabilities:                                    |       |                   |       |          |       |             |       |             |       |             |       |
| Other long-term liabilities                                |       | 144                    |       | —        |       | —           |       | —           |       | 144              |       |
| Capital lease obligations, less current maturities         |       | 2,868                  |       | —        |       | 78               |       | —           |       | 2,946            |       |
| Notes payable                                              |       | —                 |       | 138,433       |       | —           |       | —           |       | 138,433          |       |
| Due to (from) affiliates                                   |       | 276,454                |       | (143,759      | )          | (132,695         | )          | —           |       | —           |       |
| Total  liabilities                                         |       | 299,754                |       | (4,748        | )          | (111,154         | )          | —           |       | 183,852          |       |
|                                                       |       |                   |       |          |       |             |       |             |       |             |       |
| Convertible  preferred stock                               |       | —                 |       | —        |       | —           |       | —           |       | —           |       |
| Stockholders’ equity  (deficit)                       |       | (65,249                | )          | 10,126        |       | 205,296          |       | (59,046          | )          | 91,127           |       |
| Total liabilities and  stockholders’ equity (deficit) |       | $                      | 234,505    |          | $          | 5,378            |       | $                | 94,142     |             | $          | (59,046 | ) | $ | 274,979 |   |

 

13

----

 

**Unaudited Condensed Consolidating Statement of OperationsFor the Three Months Ended March 31, 2005(In Thousands)**

 
| ** **                                                           | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                 |       |                   |       |          |       |             |       |             |       |
| Revenue:                                                             |       |                   |       |          |       |             |       |             |       |
| Network services                                                     |       | $                      | —     |          | $          | —           |       | $                | 48,668     |   | $ | 48,668 |   |
| Business telephone systems                                           |       | —                 |       | —        |       | 5,865            |       | 5,865            |       |
|                                                                 |       | —                 |       | —        |       | 54,533           |       | 54,533           |       |
|                                                                 |       |                   |       |          |       |             |       |             |       |
| Costs and expenses:                                                  |       |                   |       |          |       |             |       |             |       |
| Network services  expenses (excluding depreciation and amortization) |       | —                 |       | —        |       | 20,001           |       | 20,001           |       |
| Business telephone systems cost of revenue                           |       | —                 |       | —        |       | 3,630            |       | 3,630            |       |
| Sales, general and administrative                                    |       | 10,473                 |       | —        |       | 11,892           |       | 22,365           |       |
| Depreciation and  amortization                                       |       | 5,272                  |       | —        |       | 3,302            |       | 8,574            |       |
|                                                                 |       |                   |       |          |       |             |       |             |       |
| Operating income  (loss)                                             |       | (15,745                | )          | —        |       | 15,708           |       | (37              | )          |
| Other income  (expense)                                              |       | (67                    | )          | (4,674        | )          | 10               |       | (4,731           | )          |
| Income (loss)  before income taxes                                   |       | (15,812                | )          | (4,674        | )          | 15,718           |       | (4,768           | )          |
| Income taxes                                                         |       | —                 |       | —        |       | —           |       | —           |       |
| Net income (loss)                                                    |       | $                      | (15,812    | )             | $          | (4,674           | )          | $                | 15,718     |   | $ | (4,768 | ) |

 

14

----

**Unaudited Condensed Consolidating Statement ofOperationsFor the Three Months Ended March 31, 2006(In Thousands)**

 
| ** **                                                           | ** ** | ** **             | ** ** | **Eschelon**  | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|---------------|------------|------------------|------------|------------------|------------|
| ** **                                                           | ** ** | **Eschelon**           | ** ** | **Operating** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** |
| ** **                                                           | ** ** | **Telecom, Inc.** | ** ** | **Company**   | ** ** | **Subsidiaries** | ** ** | **Consolidated** | ** ** |
|                                                                 |       |                   |       |          |       |             |       |             |       |
| Revenue:                                                             |       |                   |       |          |       |             |       |             |       |
| Network services                                                     |       | $                      | —     |          | $          | —           |       | $                | 52,785     |   | $ | 52,785 |   |
| Business telephone systems                                           |       | —                 |       | —        |       | 6,941            |       | 6,941            |       |
|                                                                 |       | —                 |       | —        |       | 59,726           |       | 59,726           |       |
|                                                                 |       |                   |       |          |       |             |       |             |       |
| Costs and expenses:                                                  |       |                   |       |          |       |             |       |             |       |
| Network services expenses (excluding depreciation and  amortization) |       | —                 |       | —        |       | 20,763           |       | 20,763           |       |
| Business telephone systems cost of revenue                           |       | —                 |       | —        |       | 4,553            |       | 4,553            |       |
| Sales, general and administrative                                    |       | 12,722                 |       | —        |       | 9,977            |       | 22,699           |       |
| Depreciation and  amortization                                       |       | 5,609                  |       | —        |       | 4,567            |       | 10,176           |       |
|                                                                 |       |                   |       |          |       |             |       |             |       |
| Operating income  (loss)                                             |       | (18,331                | )          | —        |       | 19,866           |       | 1,535            |       |
| Other income  (expense)                                              |       | 99                     |       | (3,194        | )          | (23              | )          | (3,118           | )          |
| Income (loss)  before income taxes                                   |       | (18,232                | )          | (3,194        | )          | 19,843           |       | (1,583           | )          |
| Income taxes                                                         |       | —                 |       | —        |       | —           |       | —           |       |
| Net income (loss)                                                    |       | $                      | (18,232    | )             | $          | (3,194           | )          | $                | 19,843     |   | $ | (1,583 | ) |

 

15

----

**UnauditedCondensed Consolidating Statement of Cash FlowsFor the Three Months Ended March 31, 2005(In Thousands)**

 
|                                                                                                |   |               |    | Eschelon  |   |         |   |         |   |
|-----------------------------------------------------------------------------------------------------|--------|--------------------|---------|-----------|--------|--------------|--------|--------------|--------|
|                                                                                                |   | Eschelon           |    | Operating |   | Guarantor    |   |         |   |
|                                                                                                |   | Telecom, Inc. |    | Company   |   | Subsidiaries |   | Consolidated |   |
|                                                                                                |   |               |    |      |   |         |   |         |   |
| **Operating activities**                                                                            |   |               |    |      |   |         |   |         |   |
| Net income  (loss)                                                                                  |   | $                  | (15,812 | )         | $      | (4,674       | )      | $            | 15,718 |   | $ | (4,768 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |   |               |    |      |   |         |   |         |   |
| Depreciation and amortization expense                                                               |   | 5,272              |    | —    |   | 3,302        |   | 8,574        |   |
| Other non-cash items                                                                                |   | 36                 |    | 1,219     |   | 88           |   | 1,343        |   |
| Changes in operating assets and liabilities:                                                        |   |               |    |      |   |         |   |         |   |
| Accounts receivable                                                                                 |   | —             |    | —    |   | (302         | )      | (302         | )      |
| Accounts payable and accrued expenses                                                               |   | 379                |    | (3,455    | )      | (378         | )      | (3,454       | )      |
| Other operating assets and liabilities                                                              |   | 1,533              |    | —    |   | (575         | )      | 958          |   |
| Total cash provided by (used in) operating  activities                                              |   | (8,592             | )       | (6,910    | )      | 17,853       |   | 2,351        |   |
|                                                                                                |   |               |    |      |   |         |   |         |   |
| **Investing activities**                                                                            |   |               |    |      |   |         |   |         |   |
| Purchase of assets held for sale, net of  liabilities                                               |   | (216               | )       | —    |   | —       |   | (216         | )      |
| Purchases of available-for-sale securities                                                          |   | (14,134            | )       | —    |   | —       |   | (14,134      | )      |
| Proceeds from sales of available-for-sale  securities                                               |   | 7,646              |    | —    |   | —       |   | 7,646        |   |
| Purchases of property and equipment                                                                 |   | (3,034             | )       | —    |   | (1,938       | )      | (4,972       | )      |
| Cash paid for customer installation costs                                                           |   | (2,189             | )       | —    |   | (1,154       | )      | (3,343       | )      |
| Proceeds from sale of assets                                                                        |   | 5                  |    | —    |   | —       |   | 5            |   |
| Total cash used in investing activities                                                             |   | (11,922            | )       | —    |   | (3,092       | )      | (15,014      | )      |
|                                                                                                |   |               |    |      |   |         |   |         |   |
| **Financing activities**                                                                            |   |               |    |      |   |         |   |         |   |
| Payments made on notes and capital lease  obligations                                               |   | (428               | )       | —    |   | (25          | )      | (453         | )      |
| Proceeds from issuance of stock, net of fees                                                        |   | 1                  |    | —    |   | —       |   | 1            |   |
| Increase in debt issuance costs                                                                     |   | —             |    | (240      | )      | —       |   | (240         | )      |
| Change in due to/from affiliates                                                                    |   | 2,587              |    | 7,150     |   | (9,737       | )      | —       |   |
| Total cash provided by (used in) financing  activities                                              |   | 2,160              |    | 6,910     |   | (9,762       | )      | (692         | )      |
|                                                                                                |   |               |    |      |   |         |   |         |   |
| Increase (decrease) in cash and cash equivalents                                                    |   | (18,354            | )       | —    |   | 4,999        |   | (13,355      | )      |
| Cash and cash equivalents at beginning of period                                                    |   | 26,332             |    | —    |   | 103          |   | 26,435       |   |
| Cash and cash  equivalents at end of period                                                         |   | $                  | 7,978   |      | $      | —       |   | $            | 5,102  |   | $ | 13,080 |   |

 

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**UnauditedCondensed Consolidating Statement of Cash FlowsFor the Three Months Ended March 31, 2006(In Thousands)**

 
|                                                                                                |   |               |    | Eschelon  |   |         |   |         |   |
|-----------------------------------------------------------------------------------------------------|--------|--------------------|---------|-----------|--------|--------------|--------|--------------|--------|
|                                                                                                |   | Eschelon           |    | Operating |   | Guarantor    |   |         |   |
|                                                                                                |   | Telecom, Inc. |    | Company   |   | Subsidiaries |   | Consolidated |   |
|                                                                                                |   |               |    |      |   |         |   |         |   |
| **Operating activities**                                                                            |   |               |    |      |   |         |   |         |   |
| Net income  (loss)                                                                                  |   | $                  | (18,232 | )         | $      | (3,194       | )      | $            | 19,843 |   | $ | (1,583 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |   |               |    |      |   |         |   |         |   |
| Depreciation and amortization expense                                                               |   | 5,609              |    | —    |   | 4,567        |   | 10,176       |   |
| Other non-cash items                                                                                |   | 263                |    | 915       |   | 310          |   | 1,488        |   |
| Changes in operating assets and liabilities:                                                        |   |               |    |      |   |         |   |         |   |
| Accounts receivable                                                                                 |   | —             |    | —    |   | 961          |   | 961          |   |
| Accounts payable and accrued expenses                                                               |   | (1,263             | )       | (2,067    | )      | 1,555        |   | (1,775       | )      |
| Other operating assets and liabilities                                                              |   | 618                |    | —    |   | (1,514       | )      | (896         | )      |
| Total cash provided by (used in) operating  activities                                              |   | (13,005            | )       | (4,346    | )      | 25,722       |   | 8,371        |   |
|                                                                                                |   |               |    |      |   |         |   |         |   |
| **Investing activities**                                                                            |   |               |    |      |   |         |   |         |   |
| Proceeds from sales of available-for-sale  securities                                               |   | 4,000              |    | —    |   | —       |   | 4,000        |   |
| Purchases of property and equipment                                                                 |   | (4,877             | )       | —    |   | (483         | )      | (5,360       | )      |
| Cash paid for customer installation costs                                                           |   | (2,092             | )       | —    |   | (1,548       | )      | (3,640       | )      |
| Proceeds from sale of assets                                                                        |   | 28                 |    | —    |   | —       |   | 28           |   |
| Total cash used in investing activities                                                             |   | (2,941             | )       | —    |   | (2,031       | )      | (4,972       | )      |
|                                                                                                |   |               |    |      |   |         |   |         |   |
| Financing activities                                                                                |   |               |    |      |   |         |   |         |   |
| Proceeds from issuance of notes payable                                                             |   | —             |    | 45,600    |   | —       |   | 45,600       |   |
| Payments made on notes and capital lease  obligations                                               |   | (610               | )       | —    |   | (28          | )      | (638         | )      |
| Proceeds from issuance of stock, net of fees                                                        |   | 153                |    | —    |   | —       |   | 153          |   |
| Increase in debt issuance costs                                                                     |   | —             |    | (996      | )      | —       |   | (996         | )      |
| Change in due to/from affiliates                                                                    |   | 64,998             |    | (40,258   | )      | (24,740      | )      | —       |   |
| Total cash provided by (used in) financing  activities                                              |   | 64,541             |    | 4,346     |   | (24,768      | )      | 44,119       |   |
|                                                                                                |   |               |    |      |   |         |   |         |   |
| Increase (decrease) in cash and cash equivalents                                                    |   | 48,595             |    | —    |   | (1,077       | )      | 47,518       |   |
| Cash and cash equivalents at beginning of period                                                    |   | 25,070             |    | —    |   | 992          |   | 26,062       |   |
| Cash and cash  equivalents at end of period                                                         |   | $                  | 73,665  |      | $      | —       |   | $            | (85    | ) | $ | 73,580 |   |

 

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**8.)           SubsequentEvent**

 

On April 1, 2006,the Company completed its acquisition of Oregon Telecom, Inc., aprivately-held competitive services provider based in Salem, Oregon. TheCompany paid approximately $20,000 in cash to acquire Oregon Telecom, Inc.

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# **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 to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|                         |   | Eschelon Telecom, Inc. |
|-------------------------|--------|-----------------------------|
|                    |   |                        |
| Date: November 13, 2006 |   | 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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