**UNITED
      STATES**




**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**





**(Mark
      One)**





x
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





**For
      the Fiscal Year Ended December 31, 2005**





**OR**





o
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





**For
      the transition period from __________ to __________**





**Commission
      File Number 0-32941**





**Mpower
      Holding Corporation**


(Exact
      name of registrant as specified in its charter)





**DELAWARE**
            
            **52-2232143**(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                Employer Identification No.)**175
                Sully's Trail, Suite 300,****Pittsford,
                NY**
            
            **14534**(Address
                of principal executive offices)
            
            (Zip
                Code)





**(585)
      218-6550**


(Registrant's
      telephone number, including area code)





**Securities
      registered pursuant to Section 12(b) of the Act:**





**Title
                of each class**
            
            **Name
                of each exchange on which registered**Common
                stock, $0.001 par value per common share
            
            American
                Stock Exchange





**Securities
      registered pursuant to Section 12(g) of the Act:**


None





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


YES o NO x





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.


YES o NO x








Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days.


YES x NO o





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
      be contained, to the best of registrant’s knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this Form 10-K
      or any amendment to this Form 10-K.


**x**





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filed. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):





Large
                accelerated filero
            Accelerated
                filerx
            Non-accelerated
                filero





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


YES o NO x





As
      of
      June 30, 2005, the aggregate market value of common stock held by non-affiliates
      of the registrant, based on the last sale price of such stock in the American
      Stock Exchange Act on June 30, 2005, was approximately $112.1
      million.








Indicate
      by check mark whether the registrant has filed all documents and reports
      required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange
      Act
      of 1934 subsequent to the distribution of securities under a plan confirmed
      by a
      court.


YES x NO o





As
      of
      February 22, 2006, the registrant had 91,609,999 shares of common stock
      outstanding.





DOCUMENTS
      INCORPORATED BY REFERENCE


Not
      Applicable





Exhibit
      Index is located on page 72.





**PART
      I**





**Item
      1.** ***Business***


**THE
      COMPANY**





We
      were
      one of the first facilities-based competitive local telephone companies founded
      after the inception of the Telecommunications Act of 1996, which opened up
      the
      local telephone market to competition. Today, we offer local and long distance
      voice services as well as high-speed Internet access and voice over internet
      protocol (“VOIP”) by way of a variety of broadband product and service offerings
      over our network of collocations, switches and fiber network. On January 1,
      2005, we acquired certain assets and assumed certain liabilities of ICG
      Communications, Inc. (“ICG”) in California. The assets acquired include ICG’s
      customer base and certain network assets in California, including a 1,412 route
      mile state-wide fiber ring and 915 miles of metropolitan fiber rings that
      connect 128 commercial buildings throughout major cities in California. Our
      services have historically been offered primarily to small and medium-sized
      business customers in all of our markets and residential customers primarily
      in
      the Las Vegas, Nevada market through our wholly-owned subsidiary, Mpower
      Communications Corp. (“Communications”). Our markets include Los Angeles,
      California, San Diego, California, Northern California (the San Francisco Bay
      area and Sacramento), Las Vegas, Nevada and Chicago, Illinois. As of February
      2006, we have approximately 48,700 business customers and approximately 14,600
      residential customers. Many of the ICG customers acquired are larger accounts
      that generate more average monthly revenue than our existing customer base.
      We
      also bill a number of major local and long distance carriers for the costs
      of
      originating and terminating traffic on our network for our local service
      customers. We do not have any unbundled network element platform (“UNE-P”)
      revenues although we are actively pursuing opportunities to provide
      network-based alternatives to UNE-P carriers on a wholesale basis in light
      of
      recent regulatory changes. During 2005, we acquired approximately 67% of our
      new
      retail sales through our direct sales force and supporting staff, with the
      remainder acquired through agent relationships and outbound
      telemarketing.





As
      used
      in this report, the terms “we,” “us,” “our,” “our company” and “Mpower” mean
      Mpower Holding Corporation and its subsidiaries.





***Financial
      History***





We
      were
      formed in 1996 and completed our initial public offering of common stock in
      May
      1998, raising net proceeds of $63.0 million. From May 1999 to March 2000, we
      raised over $900 million of additional funds through debt and equity issuances
      to pursue an aggressive business plan to rapidly expand our business using
      a
      facility-based strategy. Our business plan required significant up-front capital
      expenditures in each market as well as lower recurring margins in its early
      phase. In mid-2000, the capital markets became virtually inaccessible to early
      stage communications ventures. Consequently, in September 2000, we commenced
      a
      process to restructure our business, both operationally and
      financially.





From
      September 2000 through May 2001, we significantly scaled back our operations,
      canceling more than 500 existing collocations, and canceling plans to enter
      the
      Northeast and Northwest Regions (representing more than 350
      collocations).





From
      February 2002 through July 2002, we undertook a comprehensive recapitalization
      through a Chapter 11 bankruptcy plan that eliminated $593.9 million in carrying
      value of long-term debt and preferred stock (as well as $65.3 million of
      associated annual interest and dividend costs) in exchange for cash and 98.5%
      of
      our common stock.





In
      January 2003, we announced a series of strategic sale transactions to further
      strengthen us financially and focus our operations on our California, Nevada
      and
      Illinois markets. The sale of our customers and assets in Florida, Georgia,
      Ohio, Michigan and Texas to other service providers (the “Asset Sales”) brought
      more geographic concentration to our business. The Asset Sales in Ohio, Michigan
      and Texas were completed in March 2003. The Asset Sales in Georgia and Florida
      were completed in April 2003.





In
      September 2003, we raised net proceeds of approximately $16.0 million through
      a
      private placement of shares of our common stock and warrants to purchase
      additional shares of common stock.





In
      January 2005, we acquired certain assets and assumed certain liabilities of
      ICG
      in California. We purchased these assets for $16.6 million, excluding
      liabilities assumed. The assets acquired include ICG’s customer base and certain
      network assets in California, including a 1,412 route mile state-wide fiber
      ring
      and 915 miles of metropolitan fiber rings that connect 128 commercial buildings
      throughout major cities in California.





**ICG
      California Acquisition**





On
      January 1, 2005, we completed the acquisition of ICG’s retail and wholesale
      customers in California; a 1,412 route mile state-wide fiber ring and 915 route
      miles of metropolitan fiber rings which connect 128 commercial buildings across
      major cities in California, along with certain network assets and assumed
      certain liabilities related to those assets (“ICG California”) pursuant to an
      Asset Purchase Agreement (“Agreement”) dated October 22, 2004 by and among MCCC
      ICG Holdings, LLC (“MCCC”), ICG and us. MCCC is a joint venture between Columbia
      Capital and M/C Venture Partners. ICG is a Denver-based nationwide
      communications provider focused on delivering data and voice services to
      corporate customers, internet service providers and telecommunication carriers
      using a network that it owned and operated. It was a publicly held company
      until
      October 18, 2004 when it became a private entity through a merger transaction.
      As a result of this merger, MCCC owns 100% of the voting stock of
      ICG.


**1**


**Future
      Plans**





The
      next
      step in our business plan is to accelerate our growth in the markets within
      which we currently operate while continuing to retain our current customers.
      We
      intend to accomplish this growth by pursuing other in-market acquisition
      opportunities that may become available, such as the 2005 ICG asset purchase
      as
      described above. In addition, we intend to grow through the introduction of
      new
      products and technologies and organic growth - especially in our higher margin
      T1 products. We will also focus on the wholesale channel and increase investment
      in our direct sales force and alternative sales channels, all of which we expect
      to result in the acceleration in the growth of our customer base, while
      maintaining our existing customer base. We intend to accomplish these goals
      while maintaining a simple and conservative capital structure as we invest
      in
      these initiatives. In terms of strategic transactions, we will continue to
      explore opportunities to increase our customer base and service offerings
      through merger and/or acquisition transactions that we would expect to be
      accretive to shareholder value.





**Company
      Overview**





Mpower
      Communications Corp. is a facilities-based communications provider offering
      an
      integrated bundle of broadband data and voice communication services to business
      and wholesale customers. We provide a full range of telephone, high-speed data,
      Internet access, VOIP, Web hosting and network access solutions in Las Vegas,
      Nevada, Chicago, Illinois and throughout California. Our service offerings
      have
      been increased through the January 2005 ICG California acquisition.





As
      a
      facilities-based provider, we own and control a substantial amount of our
      network infrastructure and bring the power of that directly to our customers.
      Our regional footprint provides us concentrated service coverage and experience
      in the markets we serve. With the addition of the ICG California assets, we
      added a statewide SONET-based fiber network to our deep collocation and
      switching infrastructure, which has allowed us to offer new products such as
      private line, has accelerated our speed-to-market with VOIP Centrex
      capabilities, has positioned us as a strong player in the wholesale market,
      and
      has reduced our reliance on the incumbent local exchange carriers (“ILEC”). In
      our markets, Verizon, Sprint, and AT&T (formerly known as “SBC”) are the
      ILECs.





We
      have
      acquired new customers primarily through our dedicated account managers (sales
      representatives) who personally work with customers to find the best solution
      for their unique communications needs. We also maintain relationships with
      agents, vendors, and have a telemarketing sales organization. We intend to
      aggressively grow all of our sales channels through continued hiring for our
      direct sales force, attracting agents and partnering with equipment vendors,
      systems integrators, and other similar companies in our markets. We plan to
      continue to evolve our product and service offerings in order to maximize the
      value perceived by our customers while delivering such products and services
      as
      cost-effectively as possible. With the acquisition of ICG’s California
      customers, we became a wholesale provider to many large interexchange carriers
      (“IXCs”), competitive local exchange carriers (“CLECs”), and internet service
      providers (“ISPs”) and we have established a dedicated wholesale channel to
      focus on the unique needs of this customer segment. With access to our
      facilities-based distributed network architecture and a broad range of products
      and services, we offer wholesale customers opportunities to enhance or expand
      their business models.





**Available
      Information**





We
      maintain a website with the address www.mpowercom.com .
      We have
      not incorporated by reference into this report on Form 10-K the information
      on
      our website and you should not consider it to be a part of this document. Our
      website address is included in this document for reference only. We file with
      the Securities and Exchange Commission (“SEC”) our annual report on Form 10-K,
      quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
      to
      those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the
      Securities Exchange Act of 1934. These reports are accessible free of charge
      at www.mpowercom.com through
      a link to the EDGAR database, as soon as reasonably practicable after we
      electronically file such material with, or furnish it to, the SEC.
      Alternatively, such reports may be accessed at the internet address of the
      SEC,
      which is www.sec.gov .
      Also,
      the public may read and copy any materials that we file with the SEC at the
      SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 205049.
      The public may obtain information on the operation of the Public Reference
      Room
      by calling the SEC at 1-800-SEC-0330.





**Market
      Opportunity**





We
      believe we have a significant market opportunity as a result of the following
      factors:





***Impact
      of the Telecommunications Act of 1996***





The
      Telecommunications Act of 1996 allowed CLECs to use the existing infrastructure
      established by incumbent carriers, as opposed to building a competing
      infrastructure at significant cost. The Telecommunications Act requires all
      incumbent carriers to allow CLECs to collocate their equipment in the incumbent
      carrier's central offices. This enables us to access customers through existing
      telephone line connections. See "Business - Government
      Regulations”.


**2**


***Needs
      of Small and Medium-Sized Businesses for Integrated Communications
      Solutions***





Small
      and
      medium-sized businesses are our primary customer target. Small and medium-sized
      businesses can be subject to the cost and complexity of using multiple service
      providers: local dial-tone providers, long distance carriers, Internet service
      providers and equipment integrators. We believe these businesses can benefit
      significantly from an integrated cost-effective communications solution
      delivered by a single provider.





***Continued
      Growing Market Demand for High-Speed Data Services***





The
      use
      of the Internet as a commercial medium as well as a necessary business tool
      continues to drive the demand for high-speed data services. Businesses are
      increasingly establishing website and corporate intranets and extranets to
      expand their customer reach and improve their communications efficiency. To
      remain competitive, small and medium-sized businesses increasingly need
      high-speed data and Internet connections to access critical business information
      and communicate more effectively with employees, customers, vendors and business
      partners.





***Shrinking
      Competitive Landscape***





The
      shake
      out in the telecommunications industry in recent years has significantly reduced
      the number of competitors in the marketplace. Many companies in the competitive
      communications industry have succumbed to heavy debt loads and burdensome
      interest payments without the revenue streams to compensate, and therefore
      have
      not been able to sustain their business model. Some larger telecommunications
      providers have merged. Verizon has purchased MCI and SBC has acquired AT&T.
      In addition, as a result of recent Federal Communications Commission (“FCC”)
      rulings, UNE-P based CLEC business models may no longer be viable. As a result
      of these factors and consolidation among surviving companies, fewer competitors
      are vying for the same customers and we believe that companies such as ours,
      with a focus on larger markets, broad service offerings, a debt-free balance
      sheet and a deep and dense facilities-based network, have significant market
      opportunities.





**The
      Mpower Solution**





In
      today’s competitive business landscape, businesses must utilize every advantage
      to gain additional market share. We believe companies that most efficiently
      meet
      customer needs will have the upper hand in gaining new business and being
      successful. Advances in telecommunications and technology are vital resources
      in
      this environment. We believe stakeholders will tend to choose communications
      providers that have a proven track record of successfully providing solutions
      that help overcome business challenges, maintain a solid balance sheet, are
      “easy to do business with” and offer a compelling business
      proposition.





We
      believe we are such a service provider. The continually growing and evolving
      product and service offerings we deliver are designed to assist businesses
      in
      enhancing the efficiency and effectiveness of an organization, while decreasing
      expenses in both hard and soft dollars. We seek to understand business
      challenges and build the appropriate solutions. We believe we have both the
      agility and capability to tailor our services in the most meaningful
      configuration for our customers.





**Facilities-Based
      Network**





We
      were
      one of the first competitive communications carriers to implement a
      facilities-based network strategy. As a result, we own the network switches
      that
      control how voice and data communications originate and terminate, and we lease
      the telephone lines or transport systems over which the voice and data traffic
      are transmitted. We install much of our network equipment at collocation sites
      of the incumbent carriers from whom we lease access lines in areas where we
      do
      not have our own direct fiber connection. As we have already invested in and
      built our network, we believe our strategy has allowed us to establish and
      sustain service in our markets at a comparatively low cost while maintaining
      control of the access to our customers.





Our
      network consists of 297 incumbent carrier central office collocation sites,
      from
      which we can provision plain old telephone service (“POTS”), DSL, T1, and VOIP
      services. In April 2004, we began selling T1 services to customers using
      facilities that do not directly connect to our collocation sites. We refer
      to
      this as “off-network.” Currently, there are 182 off-network locations that can
      be provisioned with T1 service. Having off-network facilities increases the
      number of our potential customers. We have seven switches in our network,
      including one soft switch we installed in our Los Angeles market in September
      2005. A soft switch enables us to provide more features to our customers at
      lower on-going costs and less capital expenditures than traditional Class 5
      switch equipment. As of February 2006, we have over 311,000 billable switched
      lines in service and an additional 2,900 private line circuits in service.
      The
      services we provide for these billable lines generate our revenue.





With
      the
      ICG California acquisition, our network now also includes 1,412 route mile
      intrastate SONET-based fiber ring connecting all the major cities in California:
      San Diego, Los Angeles, San Francisco, Oakland, San Jose, Sacramento, Stockton,
      Fresno, Bakersfield, Anaheim, plus 915 miles of metropolitan fiber rings in
      San
      Diego, Los Angeles, San Francisco, Oakland, San Jose, Sacramento, and Anaheim
      connecting 128 commercial buildings.





In
      June
      2005, we also entered into an asset purchase agreement with IDACOMM, a
      subsidiary of IDACORP, Inc., to acquire four strands of dark fiber within a
      fiber network that IDACOMM is currently constructing in Las Vegas, Nevada.
      This
      is a 141-route mile fiber network with three fully survivable rings. We
      anticipate accepting this network in the first quarter of 2006.


**3**


**Business
      Strategies**





*Targeting
      Small and Medium-Sized Businesses.* We
      target suburban areas of the metropolitan areas we serve because these areas
      have high concentrations of small and medium-sized businesses. By providing
      a
      package of voice and data services and focusing on small and medium-sized
      business sales, we believe we will gain a competitive advantage over the
      incumbent carrier, our primary competitor for these customers.





*Targeting
      Wholesale Customers* .
      We
      believe that our deep and dense network of fiber and collocations provides
      the
      breadth and depth of transport services that other carriers need. One example
      of
      this is the $3.3 million (total contract value), 30
      month
      agreement for private line services that we signed in January 2005 with
      Tierzero, a California internet service provider. In addition, our switch
      services offer an alternative for local services provided by UNE-P resellers
      who
      do not have their own network facilities.





*Direct
      Sales Force.* In
      order
      to better align the needs of our customers with the skills of our direct sales
      force, we have established distinct sales channels to create a strategy that
      allows us to benefit from the unique talents in our sales organization and
      various customers needs.





Direct
      Account Managers: This
      channel sells all of our product and service offerings with a focus on primary
      rate interfaces (“PRIs”), trunks, integrated and data-only T1 services,
      VoicePipe (described below), private lines, virtual private networks (“VPNs”)
      and long distance. Our direct account managers do not actively sell POTS or
      DSL
      unless it is part of a larger, bundled customer solution.





Wholesale
      Channel :
      This
      sales channel focuses on the needs of IXCs, CLECs, ISPs and other service
      providers needing network services on a wholesale basis.





Agent
      Channel: This
      sales channel works with master agents, who are independent parties that have
      agreements with various providers such as us. Master agents usually have
      sub-agents working on their behalf.





Vendor
      Channel: This
      sales channel includes independent equipment vendors and IT system integrators
      with whom we partner to deliver customers a turn-key solution.





Base
      Management: This
      sales channel seeks to maintain relationships with our current customers in
      order to retain their business and keep them abreast of our various service
      offerings and products.





Inside
      Sales: This
      sales channel sells voice and data services over the phone to the lower end
      segment of business customers and provides lead generation for the direct sales
      force.





We
      expect
      to have a total of 115 sales people who carry a quota by the end of 2006. The
      number of account managers allocated to these channels could change based on
      business results of each channel. As of February 2006, we have approximately
      114
      sales people who carry a quota.





*Product
      and Service Offerings.* We focus
      on offering bundled communications packages to our small and medium-sized
      business customers. These services include integrated T1 services, trunks and
      PRIs, as well as traditional voice and data services and VOIP telephony
      solutions. See “Product & Service Offerings” below.





*Increase
      Market Share and Profitable Revenue.* We plan
      to continue to aggressively sell into our existing network footprint and target
      customers within that footprint with the product and service offerings that
      we
      believe will generate the highest margin revenue. We expect that the vast
      majority of these services will be delivered to our customers under term
      contracts of up to three years. We believe that this strategy will further
      increase the quality of our revenue streams. We expect that the majority of
      network expansion will be centered around augmentation of our existing network
      to further enhance our product and service offerings and service delivery
      capabilities.





*Control
      Customer Relationship.* By
      connecting the standard telephone line originating at our customer's site to
      our
      central office collocation, we effectively place the customer on our network.
      This connection serves as the platform for delivering our current and future
      communications services to our customers. Any future changes our customers
      want
      to make to their services, including purchasing more services from us, are
      under
      our direct control. The one exception is for repairs, which are infrequent
      but
      may require the participation of the incumbent carrier's network maintenance
      staff.





*Capital
      Efficient Network.* We were
      one of the first CLECs to implement a facilities-based network strategy of
      purchasing and installing switches, collocating in the central offices of the
      incumbent carrier and leasing local network lines, referred to as a "smart
      build" strategy. This network footprint is complete and operational. Even before
      our acquisition of ICG California, we had installed SDSL technology across
      our
      existing network, and have T1 or greater technology in our network
      collocations.





*Optimize
      Current Network Infrastructure.* The
      footprint of our facilities-based network is built out and operational. Our
      strategy going forward is to maximize the investment in the network
      infrastructure and increase market share in the areas we serve. Our ability
      to
      provide certain of our T1 service offerings off-network is a part of our overall
      strategy to increase our market share while containing costs.


**4**


*Dynamic
      Allocation of Bandwidth.* As part
      of our product and service offerings for businesses, our voice and data
      integrated solutions product, as described below, is designed to give customers
      the ability to use dynamically allocated bandwidth coupled with combining our
      customer’s data and voice needs on one medium. This simply means that data
      bandwidth fluctuates (increases or decreases) based on phone usage. Customers
      serviced by many of our competitors will typically be required to designate
      certain amounts of bandwidth for data traffic and certain amounts for voice
      traffic. Our integrated T1 service provides the ability for our customers to
      use
      the entire circuit for data transfers while still being able to place and
      receive phone calls all on one circuit.





*National
      Network Operations Center and Traffic Monitoring.* Our
      national operations center (“NOC”) provides a high standard of network
      availability. Our network reliability was 99.979% for the fourth quarter of
      2005
      and 99.990% for all of 2005. We expect our network reliability to improve in
      2006 as the integration of ICG California is now complete. Our NOC utilizes
      Fault, Configuration, Accounting, Performance and Security management to manage
      our network footprint.





*Operations
      Support System.* We have
      a comprehensive operations support system to manage our business. Our system
      provides integrated features addressing customer care, consolidated billing
      and
      collections, on-line bill viewing and bill payment, general ledger, payroll,
      fixed asset tracking, and personnel management. Our systems have the ability
      to
      adapt to multiple incumbent carrier provisioning systems, which can improve
      our
      operating efficiencies and effectiveness. We recently upgraded our provisioning
      system capabilities to support optical and IP technologies. We have implemented
      a sales automation tool and are in the process of implementing a new sales
      commissioning package.





*Timely
      and Accurate Provisioning for Customers.* We
      believe one of the keys to our success is effectively managing the provisioning
      process for new customers. We have a standardized service delivery process
      and
      consolidated service delivery centers, which significantly reduce our
      provisioning intervals and improve our provisioning quality metrics. In
      addition, through electronic order interfaces with all of the incumbent
      carriers, we have been able to substantially reduce the time, number of steps
      and duplication of work typically involved in the provisioning process. Our
      implementation team ensures that services are typically installed in a smooth
      and timely fashion. This team manages the migration of existing services from
      data and information gathering through installation and service
      activation.





*Quality
      Customer Care.* We have
      a professionally trained workforce that seeks to generate customer satisfaction.
      We operate one main call center that handles general billing, customer care
      and
      related issues for all of our customers. Through low employee attrition, we
      believe our call center has been able to develop a professional “teamwork”
approach to assisting with any customer issues.





We
      believe our call center performs at a high level of proficiency, while
      continually meeting service level targets for our customers. Our call center
      is
      focused on first call resolution, which involves both an enhanced automated
      call
      distribution system that directs callers into the customer service center based
      on the type of question they have, and specially trained agents with the tools
      to resolve customer issues. We enhanced our call center functionality with
      the
      implementation of an interactive voice response (“IVR”) system in 2004. Our
      service representatives use our operations support system to gain immediate
      access to our customers' data, enabling quick responses to customer requests
      and
      needs at any time. This system also allows us to present our customers with
      one
      fully integrated monthly billing statement for all communication services.
      We
      believe that providing quality customer service is essential to offering a
      superior product and service offering to our customers and creating customer
      loyalty.





One
      measure of customer satisfaction is “churn.” Churn is defined as the percentage
      of lines that are disconnected in any given period of time. Our average monthly
      churn for business lines during the fourth quarter of 2005 was 1.8% and has
      been
      approximately at that level over the prior several quarters. We expect our
      monthly churn for business lines in 2006 to be similar to what we experienced
      in
      the fourth quarter of 2005.


**5**


**Sales
      Approach**





We
      provide personal relationships for businesses that are designed to save our
      customers time, energy and money. The Mpower team consists of the following
      functions, whose responsibilities are as indicated below:





•
            **Dedicated
                Account Managers:**Understand our customers’ businesses and determine the best communications
                solution to meet their needs.•
            **Sales
                Engineers:**Provide technical expertise, solution design and interface with IT
                partners and vendors.•
            **VOIP
                Application Specialists:**Provide support and subject matter expertise to our other sales
                personnel.•
            **Field
                Marketing**:
                Provide focused materials and qualified leads for key vertical markets
                such as real estate, automotive, financial and retail
                food.•
            **Provisioning
                Representatives:**Communicate with customers to ensure high quality
                conversions.•
            **Field
                Technicians:**Provide smooth installations and timely field repair.•
            **Customer
                Care Associates:**Committed
                to exceeding customer expectations.•
            **Customer
                Account Managers:**Located in each market to provide local-level
                support.





As
      of
      February 2006, we have approximately 114 people who carry a quota. During 2005,
      approximately 67% of our new retail sales were acquired through our direct
      sales
      force and supporting staff. Our account managers personally meet with customers
      to determine the best communications solution for them. As a result of this
      design, much of our business comes through referrals and networking. We have
      a
      highly focused relationship-building approach that seeks to generate
      well-managed, profitable growth through increased market share with minimal
      customer turnover. Our account managers are divided into teams within markets.
      Our telemarketing, agent and vendor channels complement our direct sales
      efforts.





Our
      account managers are supported by sales engineers, product specialists, sales
      coordinators, customer account managers, service delivery personnel and lead
      generators. These support personnel function as the liaison between the small
      business customer and our operational personnel to effect a coordinated transfer
      of service from the incumbent carrier's network to our network. Field
      technicians are responsible for the installation of customer premise equipment,
      if required.





**Product
      & Service Offerings**





As
      an
      integrated service provider, we offer a variety of voice and data services
      that
      come as a bundled solution, or can be conveniently packaged or purchased as
      stand-alone products.





***Data
      and Internet Services***





Our
      IP
      network is designed to provide data solutions that meet the needs of today’s
      growing businesses. We believe that our IP network is secure, reliable and
      advanced. We deliver data in three ways:





•
            Over
                an economic variable speed loop with Modem (SDSL),•
            Over
                a dedicated circuit (typically a T1, which we call “MpowerConnect”),
                and•
            Integrated
                with Voice (typically over a T1, which we call
                “MpowerOffice”).





**6**


***Voice
      and Data Integrated Solutions***





Our
      IP
      network infrastructure enables integration of business voice and data
      communications and e-commerce applications, while streamlining business
      processes by way of the Internet (also known as VOIP). We package voice and
      data
      applications to provide value-added solutions from one provider, one point
      of
      contact and one invoice.





The
      MpowerOffice service offering includes:





•
            High
                speed Internet access: 768k, 1.1 Megabit (“Mb”) or
                1.5Mb•
            Voice
                lines: 4 - 24 lines•
            Choice
                of call control services: unlimited features or Centrex•
            Remote
                Internet access: 3 dialup accounts•
            IP
                applications: 20 email accounts, 70Mb web space and domain name service
                (“DNS”) (up to 4 domains)





The
      MpowerEnterprise service offering includes:





•
            High
                speed Internet access: 1.544 Megabits per second
                (“Mbps”)•
            Integrated
                services digital network (“ISDN”) PRI: 23 channels•
            Choice
                of call control services: direct inward dialing (“DIDs”), CallerID,
                Automatic Channel Selection and Hunting•
            Long
                Distance: varying amounts of free domestic minutes are bundled depending
                on the sales




***VoicePipe***





With
      the
      acquisition of ICG, we have accelerated our speed-to-market with IP Centrex
      and
      launched VoicePipe service.





•
            VoicePipe
                is an IP Telephony technology that converges (or combines) customers’
                voice, data and long distance over a single connection. Its dynamic
                bandwidth allocation provides 100% availability of all bandwidth
                and
                digital call quality.•
            It
                requires no investment in a telephone system and works with both
                analog
                and certain Internet protocol phones•
            It
                offers all the features and functionality of a traditional phone
                system
                while providing a web interface/portal for each
                user





**7**


***SDSL
      High Speed Internet***





SDSL
      High-Speed Internet uploads and downloads files at equally fast rates, providing
      Internet access at high speeds. Our SDSL service offers equal upstream and
      downstream speeds of up to 1.5 Mbps. Unlike Asymmetrical Digital Subscriber
      Line
      (“ADSL”), which only allows quick downloads, SDSL has the power to both receive
      and send large amounts of data at high speeds. SDSL can move data 50 times
      faster than a dial-up modem and 10 times faster than ISDN. Our SDSL service
      offering includes:





•
            Multiple
                convenient tiers of speed up to 1.544 Mbps•
            SDSL
                modem•
            Web
                hosting•
            Email
                addresses•
            Domain
                name hosting•
            Always-on,
                secure high-speed Internet connection•
            24/7
                repair support•
            Full
                domain name registration and email
                support





***MpowerConnect***





MpowerConnect
      is fast, reliable Internet access with up to a full T1-worth of bandwidth.
      Use
      of a T1 bypasses distance limitations associated with some technologies and
      offers many benefits in terms of service quality while providing 1.544 Mbps
      of
      bandwidth. Our product and service offering includes both integrated voice
      and
      data T1 packages, as well as a data-only T1 service. Delivered through a
      combination of telephone and data network facilities, MpowerConnect is designed
      to be predictable, stable, fully symmetric, and feature speeds of up to 1.544
      Mbps. Additional features, such as blocks of IP addresses, custom email
      accounts, and Web Hosting, are also available.





Standard
      packages are available at either 768 Kilobits per second (“Kbps”) or 1.544 Mbps
      Internet access speeds, with a variety of feature package upgrades and a la
      carte feature options including:





•
            DNS
                of public IP services such as Web Hosting and email•
            Custom
                email addresses•
            40,
                70, or 100 Mb Web Hosting•
            Dial-up
                Internet account•
            Block
                of up to 4, 8, or 16 IP addresses





Web
      hosting: Our customers can register a new domain name or transfer a current
      domain name to our servers. Our servers will be the origination point for our
      business customers’ online presence including their email services. Additional
      options are available to build online storefronts with secure online credit
      card
      transactions.





Email: We
      offer
      email services with many features and hosted in our data centers. We offer Username@mpowermail.net email
      addresses and domained email accounts are also available.





***Mpower
      OfficeScreen***





•
            A
                turn-key all inclusive managed security and VPN solution for businesses
                that need secure connectivity for remote offices and mobile users
                for
                secure offices with up to 1,000 PCs going to the Internet concurrently
                and
                100 VPN tunnels and/or remote
                clients.





**8**


***Mpower’s
      Dedicated Internet Access (DIA)***





•
            Designed
                for customers who normally need to rely on a specific amount of bandwidth
                above T1 speed, but may occasionally require more bandwidth due to
                traffic
                peaks. Our DIA product allows our customers with dynamic traffic
                needs to
                sporadically “burst” above the selected minimum port speed, so higher
                volume traffic gets through when it needs
                to.





***Voice*** ***Services***





Our
      intelligent network has been designed to provide the platform to provide the
      highest level of quality and reliability to deliver local and long distance
      telephone services. We offer many combinations of voice services. A full suite
      of features and calling plans are also available. Voice services options
      include:





•
            PRI:
                A solution for businesses with high call volumes, includes local
                service,
                40 direct-dial numbers, caller ID, flat rate local and local-toll
                usage,
                low long distance rates, among other features.•
            Trunks:
                Cost-effective, digital voice communications with applications for
                call
                centers, general office use, smaller offices and sales
                offices.•
            Business
                Voice Services: A complete menu of custom calling features, local
                number
                portability, 911, directory, long distance information services,
                among
                other features.•
            Centrex:
                Standard features include unique phone numbers for each employee,
                3-way
                calling, last number redial with additional features
                available.•
            Long
                Distance: Long distance service across the country and internationally
                at
                competitive rates.•
            Calling
                Card: Customers can make calls from anywhere and take advantage of
                our low
                rates.•
            Business
                Toll-Free Service: Toll-free phone numbers with no setup fees, monthly
                fees or minimums. Service options available for U.S., Canada and
                the
                Caribbean.•
            Voicemail:
                Retrieve messages from any touch-tone phone, post greeting announcements
                and store messages for up to 30 days. Optional features allow for
                expansion of voice mail capacity.•
            Local
                Operator Services support analog business lines, digital trunks and
                ISDN
                PRI.•
            Long
                Distance Operator Services are provided for domestic (1+ and Toll
                Free),
                international and calling card.•
            Features
                - Call control services: An extensive list of customer calling and
                Centrex
                features in addition to voicemail and audio and web
                conferencing.•
            Conference
                Calling: Automated 24/7 Reservationless Conferencing for virtual
                meetings
                24 hours a day, seven days a week.•
            Long
                Distance Account Codes: Group and track calls for accounting and
                billing
                purposes and prevent unwanted long distance calls over your company’s
                phone lines.


**9**


***Wholesale
      Products***





•
            Mpower
                PRI: A communications package for businesses with high call volumes.
                Includes local service, 40 direct-dial numbers, caller ID, flat rate
                local
                and local-toll usage, low long distance rates, and other
                features.•
            Mpower
                Collocation: Leasing managed collocation space from us allows carriers
                to
                establish a presence in new markets quickly and cost effectively,
                improve
                their network performance, and take advantage of our broad portfolio
                of
                services.•
            Mpower
                Inbound PRI: Allows customers to manage incoming modem and voice
                traffic.
                Offers the features of caller ID, DID, and hunting.•
            Mpower
                Private Line: Local and Inter-city Private Line Service. Dedicated
                bandwidth between LATAs, cities, or buildings.•
            Mpower
                Trunks: Cost-effective, digital voice communications that allow carriers
                to expand operations. Provides options for call centers, general
                office
                use, smaller offices, and sales offices.•
            Mpower
                UNE-P Solution: An alternative solution for UNE-P resellers. Provides
                carriers with access to our facilities-based deep and dense network
                with
                POTS switching service distributed over 297 wire
                centers.







**Markets**





As
      of
      February 2006, we operate in five markets in three states and have 297 incumbent
      carrier central office collocation sites and 182 off-network collocations.
      The
      major markets in our footprint are: Los Angeles, California, San Diego,
      California, Northern California (the San Francisco Bay area and Sacramento),
      Las
      Vegas, Nevada and Chicago, Illinois. The table below shows the distribution
      of
      our central office collocation sites within these markets.





**Number
                of Collocations****Market**
            
            **On-Network**
            **Off-Network**Los
                Angeles
            
            142
            64San
                Diego
            
            28
            19Northern
                California
            
            43
            68Las
                Vegas
            
            18
            —Chicago
            
            66
            31Totals
            
            297
            182





We
      believe there is significant scaling potential within our existing market
      footprint. In addition, our network backbone is scalable and can provide
      reliability and service quality across our collocation footprint, while
      affording us the benefit of spreading the fixed costs across our markets. Use
      of
      off-network facilities will also allow us to sell certain T1 services to
      customers that are not within the geographic reach of our collocation
      sites.





With
      the
      acquisition of ICG California, our network now also includes a 1,412 route
      mile
      intrastate SONET-based fiber ring connecting all the major cities in California:
      San Diego, Los Angeles, San Francisco, Oakland, San Jose, Sacramento, Stockton,
      Fresno, Bakersfield, and Anaheim, plus 915 miles of metropolitan fiber rings
      in
      San Diego, Los Angeles, San Francisco, Oakland, San Jose, Sacramento, and
      Anaheim connecting 128 commercial buildings.





In
      June
      2005, we also entered into an asset purchase agreement with IDACOMM, a
      subsidiary of IDACORP, Inc., to acquire four strands of dark fiber within a
      fiber network that IDACOMM is currently constructing in Las Vegas, Nevada.
      This
      is a 141-route mile fiber network with three fully survivable rings. We
      anticipate accepting this network in the first quarter of 2006.





**Network
      Architecture and Technology**


**10**


**Network
      Architecture**





Our
      IP
      network uses an integrated IP-based architecture to deliver converged voice
      and
      data over a single platform with seamless integration and delivery. We control
      the bandwidth and use dynamic bandwidth allocation when we offer integrated
      voice and data services. We believe that our voice offerings, which are
      delivered over T1s, are high quality VOIP.





Our
      integrated voice and data offerings are delivered over a single, IP-based
      network with a single invoice as opposed to an alternative which cobbles
      together products and services over multiple networks and manages multiple
      business support systems.





Network
      Technology:





•
            Facilities-based
                network•
            Can
                support multiple “last mile loop” access methods•
            Single,
                integrated voice and data network•
            Network
                design benefits from favorable economics of VOIP, Internet and
                packet-based technologies.





We
      believe our network technology offers the following benefits to our
      customers:





•
            Seamless
                installation, integration and lower costs•
            Dynamic,
                efficient use of bandwidth - all applications using the same
                facility•
            Single
                bandwidth facility easier to manage as compared to voice channels
                and
                bandwidth•
            Today’s
                data business applications utilize IP
                protocol







Traditional
      networks provide narrowband voice and data services over a circuit-switched
      network. When these services are bundled, they are delivered over “separate”
voice and data networks. Our IP network infrastructure enables integration
      of
      business communication and commerce applications, while streamlining business
      processes by way of the Internet.




Our
      facilities-based, local telephone and data network consists of seven switches
      and 479 network access points providing extensive service coverage in Las Vegas,
      Nevada, Chicago, Illinois and throughout California. Our network
      features:





•
            Recognized
                vendors at every layer of network architecture•
            Comprehensive
                collocation coverage in every market•
            Network
                architecture which fully supports integrated communications services
                from
                POTS to Integrated Voice and Data over IP, and designed to support
                future
                technologies•
            Our
                network reliability was 99.979% for the fourth quarter of 2005 and
                99.990%
                for all of 2005. We expect our reliability to improve in
                2006.





We
      were
      one of the first competitive communications carriers to implement a
      facilities-based network strategy. As a result, we own the network switches
      that
      control how voice and data transmissions originate and terminate, and we lease
      from the incumbent local carrier only the telephone lines over which the voice
      and data traffic are transmitted. In addition, FCC regulations currently require
      incumbent carriers to lease telephone lines to us at just and reasonable rates.
      Because we have already invested and built our network, we are able to serve
      our
      markets at a comparatively low cost while maintaining control of the access
      to
      our customers. By comparison, many CLECs do not control their own facilities
      and, therefore, are more dependent upon the incumbent local exchange carriers
      (ILECs) and the federal and state regulatory environment in order to ensure
      the
      viability of their business plans.


**11**


We
      have
      implemented a strategy enabling us to own the hardware that routes voice calls
      and data traffic, which we refer to as network elements while leasing the
      network access lines over which the voice calls and data traffic are actually
      transmitted, which we refer to as "transport." We use three basic types of
      transport to transmit voice calls and data traffic. First, we lease the network
      access line from the incumbent carrier. This allows us to move voice calls
      and
      data traffic from a customer's location to the nearest central office owned
      by
      the incumbent carrier. Inside these central offices, we have equipment that
      allows us to deliver the services we sell to our customers. Second, we lease
      network capacity from other communications companies, which connects the
      equipment we installed in the central office of the incumbent carrier to our
      switches. Third, we lease additional network capacity from other communications
      companies, which connect our network elements to each other and allow us to
      complete our customers' long distance calls to national and international
      destinations in addition to providing our customers connectivity to the
      Internet. We believe this network strategy provides us an efficient capital
      deployment plan, which should allow us to achieve an attractive return on our
      invested capital.





We
      believe that leasing the standard telephone line from the incumbent carrier’s
      central office to the end-user provides a cost-efficient solution for gaining
      control of access to our customers. Leasing costs are not incurred until we
      have
      acquired a customer and revenue can be generated. It is our experience that
      the
      network required to connect our collocation equipment located at an incumbent
      carrier’s central office to our switching hardware and the network required to
      connect our customers' voice calls and data traffic to the Internet and other
      telephones is available at competitive rates in all of our current markets.
      Because the network connection required to transport voice calls and data
      traffic has become a readily available service from numerous other
      communications companies, we focused our efforts on owning and installing the
      hardware that determines where to route voice calls and data traffic and on
      selling and delivering our services to our customers.





We
      have
      seven operational voice switches, including one soft switch we installed in
      our
      Los Angeles market in September 2005. A soft switch enables us to provide more
      features to our customers at lower on-going operating costs and less capital
      expenditures than traditional Class 5 switch equipment.





Once
      we
      install equipment in the collocation sites we lease from the incumbent carrier,
      we initiate service to a customer by arranging for the incumbent carrier to
      physically disconnect a network access line from their equipment and reconnect
      the same network access line to our equipment. When the standard telephone
      line
      has been connected to our equipment, we have direct access to the customer
      and
      can deliver our voice and data services. Any future changes the customer wishes
      to make, such as purchasing more services from us, are under our direct
      control.





We
      have
      installed our equipment in 297 collocation sites as of February 2006, and serve
      another 182 adjacent collocations by way of off-network facilities for a total
      of 479 collocations in our five markets. Our seven host switching sites are
      connected to each other, which allows us to transmit data traffic using
      asynchronous transfer mode (“ATM”) technology. ATM technology allows both voice
      calls and data traffic to be transported in digital form over a single cable
      connection at high speeds and reasonable costs. By deploying SDSL and T1
      technology into our network, we are now able to transport both voice calls
      and
      data traffic in digital form on a single network access line from a customer's
      location to one of our network elements.





**SDSL
      Technology**





Using
      SDSL technology, we can increase the amount of information we carry on a network
      access line, which we refer to as bandwidth, to up to 1.5 Mbps. This bandwidth
      is the equivalent of 24 regular voice telephone lines. Our SDSL equipment is
      programmed to allocate the available bandwidth.





We
      believe the SDSL technology significantly reduces our customers' potential
      for
      service outages when the incumbent carrier moves the network access line from
      their equipment to ours. Additionally, we believe this technology reduces our
      costs since we lease a reduced number of standard telephone lines per customer
      from the incumbent carrier. For example, if a customer today has eight voice
      lines, we must order from and provision through the incumbent carrier eight
      individual standard telephone lines. If the same customer were to buy our
      service offering and we deliver the service using SDSL technology, we only
      order
      and provision one standard telephone line from the incumbent carrier and are
      still able to provide eight voice lines to the customer.





**T1
      Technology**





With
      T1
      technology we eliminate the impact of distance limitations and service quality
      sometimes associated with SDSL. A T1 will consistently offer 1.544 million
      Mbps
      data speed. With this technology, we have an alternative to SDSL when network
      restrictions will not permit SDSL usage. Our T1 product and service offerings
      provide customers a choice between integrated service, data-only service and
      trunks. All use the same underlying transport and equipment technology. We
      also
      provide bonded T1 services for customers requiring more than one T1 to a single
      location.





"Integrated"
      service refers to the combination of both traditional voice services such as
      local and long distance service, and high speed Internet connectivity. It refers
      to a service that offers both voice and data across a single cable. Hardware
      specifically designed to manage these various types of traffic is needed at
      both
      the customer premise and within our network. This service allocates unused
      bandwidth from telephone lines not in use to the usable data bandwidth. For
      example: A customer purchases a package of 8 voice lines and 1 Mbps of data
      bandwidth. When the customer is not using any of the voice lines, the customer
      will receive the full 1.544 Mbps for data. However, if the customer is using
      all
      of the voice lines, only 1 Mbps will be available for data.


**12**


The
      "data-only" T1 service provides a more robust and higher bandwidth data offering
      that routes Internet traffic directly to the Internet backbone. Customers
      receiving this service will not receive any voice lines, but likewise there
      will
      be no voice lines to limit bandwidth. Even though no voice lines come with
      the
      package, the same customer premise device is used in order to maintain a
      consistency of equipment in our network.





The
      “trunk” service provides up to 24 channels over a single T1 for carrying voice
      or data traffic to and from the customers Private Branch Exchange (“PBX”) or Key
      System. With our trunk service, the customer provides the equipment at their
      premise. Our T1 trunk services offer various features with five different
      pathing options including Direct Inward Dialing (“DID”).





***Interconnection
      Agreements and Competitive Carrier Certifications***





In
      the
      ordinary course of business, we have negotiated interconnection agreements
      with
      SBC Corp. (now known as AT&T) including its California and Illinois
      subsidiaries, Sprint Nevada and Verizon California. These agreements specify
      the
      terms and conditions under which we lease unbundled network elements (“UNEs”)
      including type of UNE, price, delivery schedule, and maintenance and service
      levels. The term of these agreements is generally two years. While the initial
      terms of these agreements have expired, the agreements provide for continued
      enforceability while the parties negotiate and, if necessary, arbitrate the
      terms and conditions of a new agreement or amendments to existing agreements.
      Although we are not currently negotiating new agreements, we are in the process
      of amending our interconnection agreements to conform to the Triennial Review
      Order and Triennial Review Remand Order (“TRO/TRRO”).





We
      possess certificates of public convenience and necessity in each of our markets.
      This certifies that we are approved to provide telephone service as both a
      local
      telephone company and long distance carrier in all of our existing
      markets.





**Government
      Regulations**





***Overview***





Our
      services are regulated at the federal, state and local levels. The FCC exercises
      jurisdiction over all facilities of, and services offered by, communications
      common carriers like us, when those facilities are used in connection with
      interstate or international communications. State regulatory commissions have
      some jurisdiction over most of the same facilities and services when they are
      used in connection with communications within the state. In recent years, there
      has been a dramatic change in the regulation of telephone services at both
      federal and state levels as both legislative and regulatory bodies seek to
      enhance competition in both the local exchange and interexchange service
      markets. These efforts are ongoing and many of the legislative measures and
      regulations adopted are subject to judicial review. We cannot predict the impact
      on us of the results of these ongoing legislative and regulatory efforts or
      the
      outcome of any judicial review.





***Federal
      Regulation***





The
      FCC
      regulates interstate and international communications services, including access
      to local telephone facilities to place and receive interstate and international
      calls. We provide these services as a common carrier. The FCC imposes more
      regulation on common carriers that have some degree of market power, such as
      incumbent local exchange carriers. The FCC imposes less regulation on common
      carriers without market power, including competitive carriers like us. The
      FCC
      grants automatic authority to carriers to provide interstate long distance
      service, but requires common carriers to receive an authorization to construct
      and operate communications facilities, and to provide or resell communications
      services, between the United States and international points.





The
      FCC
      has required competitive carriers like us to cancel their tariffs for domestic
      interstate and international long distance services, which were schedules
      listing the rates, terms and conditions of all these services offered. Even
      without tariff filing, however, carriers offering interstate and international
      services must charge just and reasonable rates and must not discriminate among
      customers for like services. The FCC may adjudicate complaints against carriers
      alleging violations of these requirements.





Our
      charges for interstate access services, which includes the use of our local
      facilities by other carriers to originate and terminate interstate calls, remain
      governed by tariffs. In April 2001, the FCC adopted new rules that limit our
      rates for these services. Under these rules, which took effect on June 20,
      2001,
      competitive carriers were required to reduce their switched access charges
      to
      rates no higher than 2.5 cents per minute. After one year (effective June 2002),
      the rate ceiling was reduced to 1.8 cents and after two years (effective June
      2003) to 1.2 cents per minute. After three years (effective June 2004), all
      competitive carriers were required to charge rates no higher than the incumbent
      telephone company, currently in the range of 0.7 to 1.0 cents per minute. No
      other rate decreases are currently mandated.





The
      FCC
      imposes numerous other regulations on carriers subject to its jurisdiction,
      some
      of the most important of which are discussed below. The FCC also hears
      complaints against carriers filed by customers or other carriers and levies
      various charges and fees.


**13**


Except
      for certain restrictions placed on the Bell operating companies, the
      Telecommunications Act permits virtually any entity, including cable television
      companies and electric and gas utilities, to enter any communications market.
      The Telecommunications Act takes precedence over inconsistent state regulation.
      However, entities that enter communications markets must follow state
      regulations relating to safety, quality, consumer protection and other matters.
      Implementation of the Telecommunications Act continues to be affected by
      numerous federal and state policy rulemaking proceedings and review by courts.
      We are uncertain as to how our business may be affected by these
      proceedings.





The
      Telecommunications Act is intended to promote competition. The
      Telecommunications Act opens the local services market to competition by
      requiring incumbent carriers to permit interconnection to their networks and
      by
      establishing incumbent carrier and competitive carrier obligations with respect
      to:





*Reciprocal
      Compensation.* All
      incumbent carriers and competitive carriers are currently required to complete
      local calls originated by each other under reciprocal arrangements at prices
      based on tariffs or negotiated prices.





*Resale.* All
      incumbent carriers and competitive carriers are required to permit resale of
      their communications services without unreasonable restrictions or conditions.
      In addition, incumbent carriers are required to offer wholesale versions of
      all
      retail services to other common carriers for resale at discounted rates, based
      on the costs avoided by the incumbent carrier by offering these services on
      a
      wholesale basis.





*Interconnection.* All
      incumbent carriers and competitive carriers are required to permit their
      competitors to interconnect with their facilities. All incumbent carriers are
      required to permit interconnection at any feasible point within their networks,
      on nondiscriminatory terms, at prices based on cost, which may include a
      reasonable profit. At the option of the carrier requesting interconnection,
      collocation of the requesting carrier's equipment in the incumbent carriers'
      premises must be offered.





*Unbundled
      Access.* All
      incumbent carriers are required to provide access to specified individual
      components of their networks, which are sometimes referred to as UNEs, on
      nondiscriminatory terms and at prices based on cost, which may include a
      reasonable profit.





*Number
      Portability.* All
      incumbent carriers and competitive carriers are required to permit users of
      communications services to retain their existing telephone numbers without
      impairing quality, reliability or convenience when switching from one common
      carrier to another.





*Dialing
      Parity.* All
      incumbent carriers and competitive carriers are required to provide "1+" equal
      access dialing to competing providers of long distance service, and to provide
      nondiscriminatory access to telephone numbers, operator services, directory
      assistance and directory listing, with no unreasonable dialing
      delays.





*Access
      to Rights-of-Way.* All
      incumbent carriers and competitive carriers are required to permit competing
      carriers access to their poles, ducts, conduits and rights-of-way at regulated
      prices.





Incumbent
      carriers are required to negotiate in good faith with carriers requesting any
      or
      all of the above arrangements. If the negotiating carriers cannot reach
      agreement within a predetermined amount of time, either carrier may request
      arbitration of the disputed issues by the state regulatory
      commission.





Our
      business relies to a considerable degree on the use of incumbent carrier network
      elements, which we access through collocation arrangements in incumbent carrier
      offices. The terms and conditions, including prices, of these network elements
      and collocation elements are largely dictated by regulatory decisions, and
      changes in the availability or pricing of these facilities can have significant
      effects on our business plan and operating results.





The
      requirement that incumbent carriers unbundle their network elements has been
      implemented through rules adopted by the FCC. In January 1999, the United States
      Supreme Court confirmed the FCC's broad authority to issue these rules, but
      vacated a particular rule that defined the network elements the incumbent
      carriers must offer. In a November 1999 order, the FCC reaffirmed that incumbent
      carriers must provide unbundled access to a minimum of six network elements
      including local loop and transport facilities (the elements in primary use
      by
      us).







We
      rely
      on access to the incumbents’ network including DS-1 loop and transport network
      elements purchased as UNEs in order to provide service to our customers. In
      August 2003, the FCC released its Triennial Review Order (“TRO”) that largely
      preserved our access to these UNEs at forward-looking or Total Element Long
      Run
      Incremental Cost (“TELRIC”) rates, which reflect efficient costs plus a
      reasonable profit. The TRO substantially reduced or eliminated access to
      packet-switching capability of incumbent networks as well as to fiber/broadband
      connections to mass market end user premises, but largely preserved access
      to
      the copper DS-1 and digital signal level 3 (“DS-3”) loops and transport that we
      currently use. In March 2004, the U.S. Court of Appeals for the District of
      Columbia Circuit issued its opinion in United States Telecom Associations v.
      FCC, No. 00-1012 (“USTA Decision”) affirming the de-regulation of access to the
      incumbent carriers’ packet-switching and fiber/broadband
      networks.


**14**


In
      February 2005, the FCC issued its Triennial Review Remand Order (“TRRO”) that
      again modified the unbundling obligations for the copper DS-1 UNEs that we
      purchase from ILECs. The new rules remove under certain circumstances an ILEC’s
      unbundling obligations with regard to local loops and dedicated transport.
      The
      order also eliminated local switching as a UNE, but this does not affect us
      as
      we own our own switch sites and do not rely on the ILEC for the switching UNE.
      The availability of loops and transport UNEs varies based upon the capacity
      of
      the loop and availability of competitive alternatives to the ILEC at or between
      specific ILEC wire centers. Few of our loops and transport are currently
      affected. For the few loops and transport that are affected, those elements
      are
      priced at 15% above TELRIC rates through March 10, 2006. To the extent loops
      and
      transport are not available at UNE prices, we will be able to purchase them
      from
      ILECs at market prices and/or regulated prices as special access. Regardless
      of
      the FCC’s UNE rules, we continue to purchase some network elements from other
      competitive local telephone companies at market rates (e.g., transport which
      is
      used to connect parts of our network). The TRRO has been appealed by both ILECs
      and competitive carriers. We cannot anticipate the outcome of that appeal or
      its
      effect on our business.





In
      addition to rules regulating access to the incumbent’s network, the FCC is
      studying other significant telecommunications issues that may have an impact
      on
      our operations in the future. The following summarizes areas of FCC
      inquiry.





Since
      May
      1997, providers of interstate telecommunications service, including us, must
      contribute to expanded federal universal service programs that subsidize
      services provided to qualifying schools, libraries, rural health providers
      and
      high-cost carriers e.g. rural providers, and services provided to low-income
      consumers. Subsequently, the FCC created additional subsidies that primarily
      benefit incumbent telephone companies. On a quarterly basis, the FCC announces
      the contribution factor proposed for the next quarter. For the first quarter
      of
      the year 2006, the contribution factor is 10.2% of a provider’s interstate and
      international revenue for the third quarter of 2005. We recover our share of
      these costs through charges assessed directly to our customers and participation
      in federally subsidized programs. Amounts received from customers, and payments
      made, are pass-through items only that do not get recorded as revenue or costs
      of revenue. Currently, the FCC is considering proposals to change the way
      contributions are assessed, as well as eligibility for participation by carriers
      in universal service programs. We cannot predict when or whether the FCC will
      act on these proposals. However, we anticipate that any changes will be designed
      to be competitively neutral and not disproportionately affect competitive
      carriers like us.





Since
      2001, the FCC has been examining possible modification to rules governing the
      compensation, including access charges and reciprocal compensation, that
      telecommunications carriers pay to each other for exchange of traffic. In
      February 2005, the FCC asked for further comment on various plans that had
      been
      submitted to it for reform of intercarrier compensation, including some plans
      that, if adopted by the FCC, could establish “bill-and-keep” for intercarrier
      compensation, which could eliminate or substantially restrict our ability to
      recover access charges and/or reciprocal compensation. Although this could
      adversely affect our revenues, it is not clear at this point when or whether
      the
      FCC will adopt any such reform program or when it will complete this proceeding.
      We do anticipate, however, that if the FCC were to adopt “bill-and-keep” it
      would provide some time for us to adjust our rates and prices to offset any
      lost
      revenues.





In
      November 2001, the FCC initiated two rulemaking proceedings to establish a
      core
      set of national performance measurements and standards for evaluating an
      incumbent carrier’s performance in provisioning wholesale facilities and
      services to competitors including UNEs and special access. It sought comment
      on
      a set of specific performance measurements and on related issues of
      implementation, reporting requirements, and enforcement mechanisms. We cannot
      predict the ultimate outcome of these proceedings or its effect on our business,
      and it is not clear when, or if, the FCC will complete these
      proceedings.





In
      2003
      the FCC initiated a proceeding to address the methodology used to price UNEs,
      known as TELRIC. The FCC is examining, among other issues, whether ILECs should
      be permitted to recover their historic or “actual” network costs and whether the
      time frame for recovery of costs should be modified. It is unlikely that the
      FCC
      will complete this proceeding this year, but we cannot be certain as to the
      timing or result of the FCC’s proceeding or its effect on our business.





In
      March
      2004, the FCC initiated a rulemaking concerning Internet Protocol (“IP”) enabled
      services including Voice over IP (“VOIP”) services. The FCC is considering the
      extent to which VOIP providers should be classified and regulated as common
      carriers and the extent to which they should be subject to rules governing
      intercarrier compensation including access charges. In June 2005, the FCC
      determined the “interconnected” VOIP providers must provide 911 access to their
      customers within 120 days. To the extent we provide VOIP service, we believe
      that such service is in substantial compliance. It is possible that other
      determinations by the FCC could affect our current or future IP-enabled service
      offers, but we cannot predict the timing or the outcome of the FCC’s proceeding
      concerning these issues or its effect on our business.





In
      January 2005, the FCC initiated a proceeding to examine its rules governing
      provision of special access services by ILECs subject to price cap regulation.
      Under current rules, these carriers may obtain “pricing flexibility” based on
      showings of competition in a metropolitan statistical area. Depending on the
      showing of competition, this flexibility includes, among other items, customer
      specific pricing, volume and term discounts for some services, streamlined
      tariffing, and removal from price cap regulation. The FCC is considering in
      this
      proceeding whether pricing flexibility has permitted price cap ILECs to raise
      prices, whether to reset pricing for special access and/or modify the price
      cap
      and pricing flexibility rules governing price cap carrier provision of special
      access service. We are not able to predict the timing or outcome of this
      proceeding or the effect on our business.


**15**




In
      September 2005, the FCC released an order that determined that
      telecommunications transmission components that local telephone carriers,
      including CLECs, use to provide broadband Internet access service are not
      subject to common carrier regulation. The FCC removed long-standing rules that
      require carriers to offer any such transmission component as a common carrier
      offering to third party providers. This order does not appear to impact our
      rights to access ILEC networks to obtain services that we need to provide
      telecommunications service.





The
      mergers between Verizon and MCI and between SBC and AT&T received regulatory
      approval in October 2005 and were recently completed. The FCC imposed a number
      of conditions on the merger entities including conditions that: limit their
      ability to seek increases in state-approved rates for UNEs for two years, except
      in some cases where proceedings had been appealed; limit increases in the rates
      of AT&T (in SBC region) and MCI (in Verizon region) for wholesale DS1 and
      DS3 local private line services for 30 months; limit price increases for
      interstate special access for two years; and impose some performance standards
      for provision of interstate special access.





The
      United States Congress is in the process of considering a number of proposals
      that, if enacted, could result in changes to aspects of the regulatory framework
      governing ILECs and CLECs including universal service, intercarrier
      compensation, IP-enabled services, and access to some features and functions
      of
      ILEC networks. We cannot predict the precise subject matter of any such
      legislation or its timing or its effect on our business.





***State
      Regulation***





To
      provide services within a state, we generally must obtain a certificate of
      public convenience and necessity from the state regulatory agency and comply
      with state requirements for telecommunications utilities, including state
      tariffing requirements. We have satisfied state requirements to provide local
      and intrastate long distance services in the states in which we currently
      operate.





State
      regulatory agencies have jurisdiction over our intrastate services, including
      our rates. State agencies require us to file periodic reports, pay various
      fees
      and assessments and comply with rules governing quality of service, consumer
      protection and similar issues. These agencies may also have to approve the
      transfer of assets or customers located in the state, a change of control of
      our
      company or our issuance of securities or assumption of debt. The specific
      requirements vary from state to state. State regulatory agencies also must
      approve our interconnection agreements with incumbent carriers. Price cap or
      rate of return regulation for competitive carriers does not apply in any of
      our
      current markets. Imposition of new regulatory burdens in a particular state
      could affect the profitability of our services in that state.





***Local
      Regulation***





Our
      networks must comply with numerous local regulations such as building codes,
      municipal franchise requirements and licensing. These regulations vary on a
      city
      by city and county by county basis. In some of the areas where we provide
      service, we may have to comply with municipal franchise requirements and be
      required to pay license or franchise fees based on a percentage of gross revenue
      or other factors. Municipalities that do not currently impose fees may seek
      to
      impose fees in the future. Fees may not remain at their current levels following
      the expiration of existing franchises.


**16**


**Competition**





The
      communications industry is highly competitive. We believe the principal
      competitive factors affecting our business are:





•
            pricing
                levels and policies•
            transmission
                speed•
            customer
                service•
            breadth
                of service availability•
            network
                security•
            ease
                of access and use•
            bundled
                service offerings•
            brand
                recognition•
            operating
                experience•
            capital
                availability•
            exclusive
                contracts•
            accurate
                billing





To
      maintain our competitive posture, we believe we must be in a position to reduce
      our prices to meet any reductions in rates by our competitors. Any reductions
      could adversely affect us. Many of our current and potential competitors have
      financial, personnel and other resources, including brand name recognition,
      substantially greater than ours, as well as other competitive advantages over
      us. In addition, competitive alternatives may result in substantial customer
      turnover in the future. Many providers of communications and networking services
      experience high rates of customer turnover.





A
      continuing trend toward consolidation of communications companies and the
      formation of strategic alliances within the communications industry, as well
      as
      the development of new technologies, could give rise to significant new
      competitors that could put us at a competitive disadvantage.





***Local
      Dial-tone Services***





*Incumbent
      Carriers*





In
      each
      of the markets we target, we compete principally with the incumbent carrier
      serving that area. We have not achieved, and do not expect to achieve, a
      significant market share for any of our services. The incumbent carriers have
      long-standing relationships with their customers, have financial, technical
      and
      marketing resources substantially greater than ours and have the potential
      to
      subsidize competitive services with revenues from a variety of
      businesses.





Incumbent
      carriers also have long-standing relationships with regulatory authorities
      at
      the federal and state levels. While regulatory initiatives that allow
      competitive carriers to interconnect with incumbent carrier facilities provide
      increased business opportunities for us, interconnection opportunities have
      been
      and likely will continue to be accompanied by increased pricing flexibility
      for,
      and relaxation of regulatory oversight of, the incumbent carriers. If the
      incumbent carriers are allowed by regulators to offer discounts to large
      customers through contract tariffs, engage in aggressive volume and term
      discount pricing practices for their customers, and/or seek to charge
      competitors excessive fees for interconnection to their networks, our operating
      margins could be materially adversely affected. Future regulatory decisions
      that
      give the incumbent carriers increased pricing flexibility or other regulatory
      relief could have a material adverse effect on us.


**17**


*Competitive
      Carriers/Long Distance Carriers/Other Market Entrants*





We
      face,
      and expect to continue to face, competition from long distance carriers seeking
      to enter, re-enter or expand entry into the local exchange market. We also
      compete with other competitive carriers, resellers of local dial-tone services,
      cable television companies, electric utilities, microwave carriers and wireless
      telephone system operators.




The
      Telecommunications Act includes provisions that impose regulatory requirements
      on all incumbent carriers and competitive carriers but grants the FCC expanded
      authority to reduce the level of regulation applicable to these common carriers.
      The manner in which these provisions of the Telecommunications Act are
      implemented and enforced could have a material adverse effect on our ability
      to
      successfully compete against incumbent carriers and other communications service
      providers.





The
      Telecommunications Act radically altered the market opportunity for competitive
      carriers. Many existing competitive carriers that entered the market before
      1996
      had to build a fiber infrastructure before offering services. With the
      Telecommunications Act requiring unbundling of the incumbent carrier networks,
      competitive carriers have been able to enter the market more rapidly by
      installing switches and leasing standard telephone lines and cable or by means
      of a type of resale known as an UNE-P. However, under an FCC order issued in
      February 2005, the ILECs will no longer be required to offer a UNE-P
      alternative. The FCC order is subject to appellate court review. See “Business -
      Government Regulations” above.





A
      number
      of competitive carriers are in our markets. We believe that not all competitive
      carriers, however, are pursuing the same target customers we pursue. We intend
      to keep our prices at competitive levels while seeking to provide, in our
      opinion, a higher level of service and responsiveness to our customers.
      Innovative packaging and pricing of services are expected to provide competitive
      differentiation for us in each of our markets.





***Long
      Distance Services***





The
      long
      distance services industry is very competitive and many long distance providers
      experience a high average turnover rate as customers frequently change long
      distance providers in response to offerings of lower rates or promotional
      incentives by competitors. Prices in the long distance market have declined
      significantly in recent years. We expect to face increasing competition from
      companies offering long distance, data and voice services over the Internet.
      Companies offering these services over the Internet could enjoy a significant
      cost advantage because they do not currently pay common carrier access charges
      or universal service fees.





**18**


***Data
      and Internet Services***





We
      expect
      the level of competition with respect to data and Internet services to intensify
      in the future. We expect significant competition from:





•
            *Incumbent
                Carriers.*Incumbent
                carriers sell commercial data and internet services. Some incumbent
                carriers have announced they intend to aggressively market these
                services
                to their residential customers at attractive prices. The incumbent
                carriers have an established brand name in their service areas, possess
                sufficient capital to deploy their services rapidly, invest in new
                technologies, and are in a position to offer service from central
                offices
                where we may be unable to secure collocation space.•
            *Traditional
                Long Distance Carriers.*Many
                of the leading traditional long distance carriers have expanded their
                capabilities to support high-speed, end-to-end networking services.
                These
                carriers have extensive fiber networks in many metropolitan areas
                that
                primarily provide high-speed data and voice services to large companies.
                They could deploy DSL services in combination with their current
                fiber
                networks. They also have interconnection agreements with many incumbent
                carriers and have secured collocation space from which they could
                begin to
                offer competitive DSL services. It is unclear at this time how the
                announced combinations of some of the traditional long distance carriers
                and certain ILECs will impact us.•
            *Newer
                Long Distance Carriers.*Numerous
                long distance carriers are managing high-speed networks nationwide,
                with
                direct sales forces, and are partnering with Internet service providers
                to
                offer services directly to business customers. They could extend
                their
                existing networks either alone or in partnership with
                others.•
            *Cable
                Modem Service Providers.*Cable
                television operators are now offering high-speed Internet access
                over
                cable networks to consumers and businesses. These networks provide
                high-speed data services similar to our services, and in some cases
                at
                higher speeds. These companies use a variety of new and emerging
                technologies, including point-to-point and point-to-multipoint wireless
                services, satellite-based networking and high-speed wireless digital
                communications.•
            *Internet
                Service Providers.*Internet
                service providers offer Internet portal services which compete with
                our
                service. We offer basic web hosting and e-mail services and anticipate
                offering an enhanced set of Internet product and service offerings
                in the
                future. The competitive Internet service providers generally provide
                more
                features and functions than our current Internet
                portal.•
            *Wireless
                Broadband Providers*.
                Wireless technology is now available for certain business applications
                both in licensed and unlicensed spectrums. As this technology becomes
                more
                acceptable and as the cost of required equipment continues to decrease,
                wireless broadband providers will become more competitive with us.
                We
                recognize the potential of this medium and are conducting feasibility
                studies to assess the current technological and economic viability
                as a
                service offering.





**Personnel**





As
      of
      February 2006, we had approximately 825 employees. This is a 7% increase from
      the approximate 775 employees at December 31, 2004. None of our employees are
      represented by a collective bargaining unit.




**Item
      1A.** ***Risk
      Factors***





*Before
      you invest in shares of our securities, you should be aware of various risks,
      including the risks described below. Our business, financial condition or
      results of operations could be materially adversely affected by any of these
      risks. The risks and uncertainties described below or elsewhere in this report
      are not the only ones facing us. Additional risks and uncertainties not
      presently known to us or that we currently deem immaterial may also adversely
      affect our business and operations. If any of the matters included in the
      following risks were to occur, our business, financial condition, results of
      operations, cash flows or prospects could be materially adversely affected.
      In
      such case, you could lose all or part of your investment.*





**We
      may not be able to reverse our history of losses.**





We
      have
      incurred net losses in each year of our existence. We will need to continue
      to
      improve our operating results to achieve net income.





**We
      may not be able to generate sufficient cash flow to cover our operating
      commitments.**





We
      generated positive cash flows from continuing operations for the year ended
      December 31, 2005 and we expect the same in 2006. We have contractual
      commitments for approximately $22.1 million of payments during 2006 and plan
      to
      make capital expenditures during the year. In addition, we have announced our
      intention to repurchase up to $10.0 million of our common stock. If the revenues
      generated from our operations are not sufficient to cover these commitments
      and
      other operating expenses, we will need to rely on our cash balances, credit
      facility, or other financing. Under any of these circumstances, our financial
      condition will be weakened.





**19**


**Market
      conditions and our past performance resulted in our bankruptcy reorganization
      in
      2002.**





We
      filed
      for bankruptcy protection in April 2002 and completed our bankruptcy
      reorganization in July 2002. Although we eliminated substantially all of our
      substantial debt burden in the reorganization and have improved our operating
      performance, we still face many of the same business challenges that existed
      prior to the bankruptcy and that resulted in the failure of a number of
      companies in our industry. In particular, we still have to compete with
      well-entrenched telephone companies such as Verizon and SBC (now called
      AT&T), and we must still look to these aggressive competitors to supply us
      with access to their facilities in order for us to serve our own
      customers.





**Our
      failure to achieve or sustain market acceptance at desired pricing levels could
      impair our ability to achieve profitability or positive cash
      flow.**





Prices
      for data communication services have fallen historically, a trend that may
      continue. Accordingly, we cannot predict to what extent we may need to reduce
      our prices to remain competitive or whether we will be able to sustain future
      pricing levels as our competitors introduce competing services or similar
      services at lower prices. Our ability to meet price competition may depend
      on
      our ability to operate at costs equal to or lower than our competitors or
      potential competitors. There is a risk that competitors may undercut our rates,
      increase their services or take other actions that could be detrimental to
      us.
      Lower prices will negatively affect our ability to achieve and sustain
      profitability.





**Changes
      in laws or regulations could restrict the way we operate our business and
      negatively affect our costs and competitive position** *.*





A
      significant number of the services we offer are regulated at the federal, state
      and/or local levels. If these laws and regulations change or if the
      administrative implementation of laws develops in an adverse manner, there
      could
      be an adverse impact on our costs and competitive position. In addition, we
      may
      expend significant financial and managerial resources to participate in
      administrative proceedings at either the federal or state level, without
      achieving a favorable result. We believe incumbent carriers and others may
      work
      aggressively to modify or restrict the operation of many provisions of the
      Telecommunications Act. We expect ILECs and others to continue to pursue
      litigation in courts, institute administrative proceedings with the FCC and
      other state regulatory agencies and lobby the United States Congress, all in
      an
      effort to affect laws and regulations in a manner favorable to them and against
      the interest of competitive carriers. Adverse regulatory developments could
      negatively affect our operating expenses and our ability to offer services
      sought by our existing and prospective customers.




**The
        prices we charge for our services and pay for the use of services of ILECs
        and
        other competitive carriers may be negatively affected in regulatory proceedings,
        which could result in decreased revenues, increased costs and loss of
        business.**





If
      we
      were required to decrease the prices we charge for our services or to pay higher
      prices for services we purchase from ILECs and other competitive carriers,
      it
      would have an adverse effect on our ability to achieve profitability and offer
      competitively priced services. We must file tariffs with state and federal
      regulators, which indicate the prices we charge for our services. In addition,
      we purchase some tariffed services from ILECs and/or competitive carriers.
      The
      rates we pay for other services we purchase from ILECs and other competitive
      carriers are set by negotiations between the parties. All of the tariffed prices
      may be challenged in regulatory proceedings by customers, including ILECs,
      competitive carriers and long distance carriers who purchase these services.
      Negotiated rates are also subject to regulatory review. During the pendency
      of
      the negotiations, or if the parties cannot agree, the local carrier must charge
      the long distance carrier the appropriate benchmark rate established by
      regulation. This could have an adverse impact on our expected revenues and
      operating results. The prices charged by incumbent carriers for unbundled
      network elements, collocations and other services upon which we rely are subject
      to periodic review by state regulatory agencies. Change in these prices may
      adversely affect our business. For
      more
      details about our regulatory situation, please see “Business - Government
      Regulations.”


**Our
        changes in sales channel strategy and ability to attract and retain sales
        personnel and independent agents and vendors may adversely affect our operating
        results.**
 
 The
        changes in our sales strategy will impact the number of account managers
        we
        have, and the amounts we will invest in new sales recruits for training and
        professional development. Our strategy to increase the quality and number
        of
        independent agents and vendors is expected to have challenges related to
        recruiting and retaining effective partners for us in these sales channels.
        We
        will also be investing in operating support system enhancements to make our
        product offerings more attractive to these alternative sales channels. Delays
        in
        the effectiveness of any of these strategy changes will adversely affect
        our
        operating results.
 **20**
 **Our
        services may not achieve sufficient market acceptance to allow us to become
        profitable.**
 
 To
        be
        successful, we must develop and market services that are widely accepted
        by
        businesses at profitable prices. Our success will depend upon the willingness
        of
        our target customers to accept us as an alternative provider of local, long
        distance, high-speed data and Internet services. Although always in the process
        of evaluating and rolling out additional products and services, we might
        not be
        able to provide the range of communication services our target business
        customers need or desire. A failure to develop acceptable product and service
        offerings will adversely affect our ability to attract or retain customers,
        which will adversely affect our revenues and ability to achieve
        profitability.
 
 **If
        we are not able to compete successfully in the highly competitive
        telecommunications industry with competitors that have greater resources
        than we
        do, our revenues and operating results will be negatively
        affected.**
 
 Our
        success depends upon our ability to compete with other telecommunications
        providers in each of our markets, many of which have substantially greater
        financial, marketing and other resources than we have. In addition, competitive
        alternatives may result in substantial customer turnover in the future. A
        growing trend towards consolidation of communications companies and the
        formation of strategic alliances within the communications industry, as well
        as
        the development of new technologies, could give rise to significant new
        competitors. If we cannot compete successfully, our revenues and operating
        results will suffer.


**If
      we are not able to obtain additional funds if and when needed, our ability
      to
      grow our business and our competitive position in our markets will be
      jeopardized.**





If
      we
      cannot generate or otherwise obtain sufficient funds, if needed, we may not
      be
      able to grow our business or devote the funds to marketing, new technologies
      and
      working capital necessary to compete effectively in the communications industry.
      We expect to fund any and all capital requirements through existing resources,
      internally generated funds and debt or equity financing, if needed. We may
      not
      be able to raise sufficient debt or equity financing, if and when needed, on
      acceptable terms or at all. This could result in stagnant or declining revenues
      and hence, additional losses.




**Fluctuating
      operating results may negatively affect our stock price.**





Our
      annual and quarterly operating results may fluctuate as a result of numerous
      factors, many of which are outside of our control. These factors
      include:





•
            delays
                in the generation of revenue because certain network elements have
                lead
                times that are controlled by incumbent carriers and other third
                parties•
            the
                ability to develop and commercialize new services by us or our
                competitors•
            the
                ability to deploy on a timely basis our services to adequately satisfy
                customer demand•
            our
                ability to successfully operate and maintain our
                networks•
            the
                rate at which customers subscribe to our services•
            decreases
                in the prices for our services due to competition, volume-based pricing
                and other factors•
            the
                development and operation of our billing and collection systems and
                other
                operational systems and processes•
            the
                rendering of accurate and verifiable bills from the ILECs from whom
                we
                lease transport and resolution of billing disputes•
            the
                incorporation of enhancements, upgrades and new software and hardware
                products into our network and operational processes that may cause
                unanticipated disruptions•
            the
                interpretation and enforcement of regulatory developments and court
                rulings concerning the 1996 Telecommunications Act, interconnection
                agreements and the antitrust laws





If
      our
      operating results fluctuate so as to cause us to miss earnings expectations,
      our
      stock price may be adversely affected.


**21**


**The
      unplanned loss of senior members of our management team may adversely affect
      our
      operating results.**





The
      unplanned loss of senior management personnel could impair our ability to carry
      out our business plan. We believe our future success will depend in large part
      on our ability to attract and retain highly skilled and qualified personnel.
      If
      one or more senior members of our management team unexpectedly leaves us, it
      may
      be difficult to find suitable replacements. This loss of senior management
      personnel may adversely affect our operating results as we incur costs to
      replace the departed personnel and potentially lose opportunities in the
      transition of important job functions. We do not maintain key man insurance
      on
      any of our officers.





**If
      our equipment does not perform as we expect, it could delay our introduction
      of
      new services resulting in the loss of existing or prospective
      customers.**





In
      implementing our strategy, we may use new or existing technologies to offer
      additional services. We also plan to use equipment manufactured by multiple
      vendors to offer our current services and future services in each of our
      markets. If we cannot successfully install and integrate the technology and
      equipment necessary to deliver our current services and any future services
      within the time frame and with the cost effectiveness we currently contemplate,
      we could be forced to delay or abandon the introduction of new services. This
      could adversely affect our ability to attract and retain customers, resulting
      in
      a reduction of expected revenues.





**The
      failure of our operations support system to perform as we expect could impair
      our ability to retain customers and obtain new customers or could result in
      increased capital expenditures.**





Our
      operations support system is an important factor in our success and we continue
      to invest funds in maintaining and improving it. If our operations support
      system fails or is unable to perform, we could suffer customer dissatisfaction,
      loss of business or the inability to add customers on a timely basis, any of
      which would adversely affect our business, financial condition and results
      of
      operations. Furthermore, problems may arise with higher processing volumes
      or
      with additional automation features, which could potentially result in system
      breakdowns and delays and additional, unanticipated expense to remedy the defect
      or to replace the defective system with an alternative system.





**Our
      failure to manage growth could result in increased costs.**





We
      may be
      unable to manage our growth effectively. This could result in increased costs
      and delay our introduction of additional services resulting in a reduction
      of
      expected revenues. The development of our business will depend on, among other
      things, our ability to achieve the following goals in a timely manner, at
      reasonable costs and on satisfactory terms and conditions:





•
            purchase,
                install and operate equipment•
            negotiate
                suitable interconnection agreements with, and arrangements for installing
                our equipment at the central offices of, ILECs on satisfactory terms
                and
                conditions•
            hire
                and retain qualified personnel•
            lease
                suitable access to transport networks•
            obtain
                required government authorizations.





Any
      significant growth will place a strain on our operational, human and financial
      resources and will also increase our operating complexity as well as the level
      of responsibility for both existing and new management personnel. Our ability
      to
      manage our growth effectively will depend on the continued development of plans,
      systems and controls for our operational, financial and management needs and
      on
      our ability to expand, train and manage our employee base.





**22**


**If
      we are unable to negotiate and enforce favorable interconnection agreements,
      we
      may incur higher costs that would impair our ability to operate profitably
      in
      our existing markets.**





We
      are in
      the process of amending our interconnection agreements to conform to the
      Triennial Review Order and Triennial Review Remand Order (“TRO/TRRO”).
      Relatively few of our circuits are affected by the TRO/TRRO. As a result, the
      TRO/TRRO amendments being negotiated/arbitrated at present will not have a
      significant impact on us. However, it is not possible to predict how the
      TRO/TRRO will affect our future long-term rates.





**Delays
      by the ILECs in connecting our customers to our network could result in customer
      dissatisfaction and loss of business.**





We
      rely
      on the timeliness of ILECs and other competitive carriers in processing our
      orders for customers switching to our service and in maintaining the customers’
standard telephone lines to assure uninterrupted service. Therefore, the ILECs
      might not be able to provide and maintain leased standard telephone lines in
      a
      prompt and efficient manner as the number of standard telephone lines requested
      by competitive carriers increases. This may result in customer dissatisfaction
      and the loss of new business.




**Our
      reliance on a limited number of equipment suppliers could result in additional
      expenses and loss of revenues.**





We
      currently rely and expect to continue to rely on a limited number of third
      party
      suppliers to manufacture the equipment we require. In recent years, at least
      one
      supplier went out of business, and there is the risk that others could do so
      in
      the future. If one or more additional suppliers go out of business, or if our
      competitors enter into exclusive or restrictive arrangements with our suppliers
      it may materially and adversely affect the availability and pricing of the
      equipment we purchase. Our reliance on third-party suppliers involves a number
      of additional risks, including the absence of guaranteed supply and reduced
      control over delivery schedules, quality assurance, production yields and
      costs.





Our
      suppliers may not be able to meet our needs in a satisfactory and timely manner
      in the future and we may not be able to obtain alternative suppliers when and
      if
      needed. It could take a significant period of time to establish relationships
      with alternative suppliers for critical technologies and to introduce substitute
      technologies into our network. In addition, if we change suppliers, we may
      need
      to replace all or a portion of the equipment deployed within our network at
      significant expense in terms of equipment costs and loss of revenues in the
      interim.





**If
      we are not able to obtain or implement new technologies, we may lose business
      and limit our ability to attract new customers.**





We
      may be
      unable to obtain access to new technology on acceptable terms or at all. We
      may
      be unable to adapt to new technologies and offer services in a competitive
      manner. If these events occur, we may lose customers to competitors offering
      more advanced services and our ability to attract new customers would be
      hindered. This will adversely affect our revenues and operating results. Rapid
      and significant changes in technology are expected in the communications
      industry. We cannot predict the effect of technological changes on our business.
      Our future success will depend, in part, on our ability to anticipate and adapt
      to technological changes, evolving industry standards and changing needs of
      our
      current and prospective customers.





**A
      system failure or breach of network security could cause delays or interruptions
      of service to our customers and result in customer dissatisfaction and loss
      of
      business.**





Interruptions
      in service, capacity limitations or security breaches could have a negative
      effect on customer acceptance and, therefore, on our ability to retain existing
      customers and attract new customers. Our networks may be affected by physical
      damage, power loss, capacity limitations, software defects, breaches of security
      by computer viruses, break-ins or otherwise and other factors which may cause
      interruptions in service or reduced capacity for our customers. The loss of
      existing or prospective customers would have a negative effect on our business,
      financial condition and results of operations.





**If
      we are unable to effectively deliver our services to a substantial number of
      customers, we may not achieve our revenue goals.**





Our
      network may not be able to connect and manage a substantial number of customers
      at high transmission speeds. If we cannot achieve and maintain digital
      transmission speeds that are otherwise available in a particular market, we
      may
      lose customers to competitors with higher transmission speeds and we may not
      be
      able to attract new customers. While digital transmission speeds of up to 1.5
      Mbps are possible on portions of our network, that speed may not be available
      over a majority of our network. Actual transmission speeds on our network will
      depend on a variety of factors many of which are beyond our control, including
      the distance an end user is located from a central office, the quality of the
      telephone lines, the presence of interfering transmissions on nearby lines
      and
      other factors. The loss of existing or prospective customers would have a
      negative effect on our business, financial condition and results of
      operations.





**23**


**We
      may lose customers or potential customers because the telephone lines we require
      may be unavailable or in poor condition.**





Our
      ability to provide some of our services to potential customers depends on the
      quality, physical condition, availability and maintenance of telephone lines
      within the control of the ILECs. In addition, the ILECs may not maintain the
      telephone lines in a condition that will allow us to implement certain services
      effectively or may claim they are not of sufficient quality to allow us to
      fully
      implement or operate certain services. If the telephone lines are not adequate,
      we may not be able to provide certain services to many of our target customers.
      Under these circumstances, we will likely suffer customer dissatisfaction and
      the loss of existing and prospective customers.




**Interference
      or claims of interference could result in customer dissatisfaction and loss
      of
      customers.**





Interference,
      or claims of interference by the ILECs, if widespread, could adversely affect
      our speed of deployment, reputation, brand image, service quality and customer
      satisfaction and retention. Technologies deployed on copper telephone lines,
      such as DSL, have the potential to interfere with other technologies on the
      copper telephone lines. Interference could degrade the performance of our
      services or make us unable to provide service on selected lines and the
      customers served by those lines. Although we believe our DSL technologies,
      like
      other technologies, do not interfere with existing voice services, ILECs may
      claim the potential for interference permits them to restrict or delay our
      deployment of DSL services. The procedures to resolve interference issues
      between competitive carriers and ILECs are still being developed. We may be
      unable to successfully resolve interference issues with ILECs on a timely basis.
      These problems will likely result in customer dissatisfaction and the loss
      of
      existing and prospective customers.


**Our
        future revenues and success will depend on continued growth in the demand
        for
        Internet access and high-speed data services.**
 
 Demand
        for Internet services is still uncertain and depends on a number of factors,
        including the growth in consumer and business use of new interactive
        technologies, the development of technologies that facilitate interactive
        communication between organizations and targeted audiences, security concerns
        and increases in data transport capacity. If the markets for the services
        we
        offer, including Internet access and high-speed data services, fail to develop,
        grow more slowly than anticipated or become saturated with competitors, we
        may
        not be able to achieve our projected revenues.
 
 In
        addition, the market for high-speed data transmission is still evolving.
        Various
        providers of high-speed digital services are testing products from various
        suppliers for various applications, and no industry standard has been broadly
        adopted. Critical issues, including security, reliability, ease of use and
        cost
        and quality of various service options, remain unresolved and may impact
        the
        growth of these services.





**The
      desirability and marketability of our Internet service and our revenues may
      be
      adversely affected if we are not able to maintain reciprocal relationships
      with
      other Internet service providers.**





The
      Internet is comprised of many Internet service providers and underlying
      transport providers who operate their own networks and interconnect with other
      Internet service providers at various points. As we continue the operation
      of
      Internet services, connections to the Internet will be provided through
      wholesale carriers. We anticipate as our volume increases, we will enter into
      reciprocal agreements with other Internet service providers. Other national
      Internet service providers may not maintain reciprocal relationships with us.
      If
      we are unable to maintain these relationships, our Internet services may not
      be
      attractive to our target customers, which would impair our ability to retain
      and
      attract customers and negatively affect revenues. In addition, the requirements
      associated with maintaining relationships with the major national Internet
      service providers may change. We may not be able to expand or adapt our network
      infrastructure to meet any new requirements on a timely basis, at a reasonable
      cost, or at all.





**24**


**We
      may incur liabilities as a result of our Internet service
      offerings.**





United
      States law relating to the liability of on-line service providers and Internet
      service providers for information carried on, disseminated through, or hosted
      on
      their systems is currently unsettled. If liability is imposed on Internet
      service providers, we would likely implement measures to seek to minimize our
      liability exposure. These measures could require us to expend substantial
      resources or discontinue some of our product or service offerings. In addition,
      increased attention to liability issues, as a result of litigation, legislation
      or legislative proposals could adversely affect the growth and use of Internet
      services. Under these circumstances, our revenues and operating expenses may
      be
      negatively affected.





**RISK
      FACTORS RELATED TO OUR COMMON STOCK**





**Our
      stock price has been volatile historically and may continue to be volatile.
      The
      price of our stock may fluctuate significantly, which may make it difficult
      for
      holders to sell our shares of stock when desired or at attractive
      prices** .





The
      market price for our stock has been and may continue to be volatile. We expect
      our stock price to be subject to fluctuations as a result of a variety of
      factors, including factors beyond our control. These factors
      include:





•
            actual
                or anticipated variations in our operating results or our competitors’
                operating results•
            announcements
                of new product and service offerings by us or our
                competitors•
            changes
                in the economic performance or market valuations of communications
                carriers•
            changes
                in recommendations or earnings estimates by securities
                analysts•
            announcements
                of new contracts or customers by us or our competitors, and timing
                and
                announcement of acquisitions by us or our competitors•
            conditions
                and trends in the telecommunications industry•
            adverse
                rulings in one or more of the regulatory proceedings affecting
                us•
            conditions
                in the local markets or regions in which we
                operate.




Because
        of this volatility, we may fail to meet the expectations of our stockholders
        or
        of securities analysts at some time in the future, and the trading prices
        of our
        stock could decline as a result. In addition, the stock market has experienced
        significant price and volume fluctuations that have particularly affected
        the
        trading prices of equity securities of many telecommunication companies,
        including ours. Our stock price has varied between $1.15 and $1.87 within
        the
        last 12 months, based on end of day stock quotes. These fluctuations have
        often
        been unrelated or disproportionate to our operating performance. In addition,
        any negative change in the public’s perception of competitive local exchange
        carriers could depress our stock price regardless of our operating
        results.
 
 **The
        value of our common stock may be negatively affected by additional issuances
        of
        restricted or unrestricted common stock by us and general market
        factors.**
 
 Future
        issuances or sales of our common stock by us will likely be dilutive to our
        existing common stockholders. Future issuances or sales of common stock by
        us,
        or the availability of such common stock for future issue or sale, could
        have a
        negative impact on the price of our common stock prevailing from time to
        time.
        Sales of substantial amounts of our common stock in the public or private
        market, a perception in the market that such sales could occur, or the issuance
        of securities exercisable or convertible into our common stock could also
        adversely affect the prevailing price of our common stock.


**25**


**The
      attractiveness of our stock to potential purchasers and our stock price may
      be
      negatively affected by our rights plan and provisions of our certificate of
      incorporation, by-laws and Delaware General Corporate Law, which may have
      anti-takeover effects.**





Our
      certificate of incorporation and by-laws contain provisions which may deter,
      discourage or make more difficult a takeover or change of control of our company
      by another corporation. These anti-takeover provisions include:





•
            the
                authority of our board of directors to issue shares of preferred
                stock
                without stockholder approval on such terms and with such rights as
                our
                board of directors may determine, and•
            the
                requirement of a classified board of directors serving staggered
                three-year terms.





We
      have
      also adopted a rights plan, which may make it more difficult to effect a change
      in control of our company and replace incumbent management.





Potential
      purchasers seeking to obtain control of a company may not be interested in
      purchasing our stock as a result of these matters. This may reduce demand for
      our stock and thereby negatively affect our stock price.





**The
      attractiveness of our stock to potential purchasers and our stock price may
      be
      negatively affected since we do not pay dividends on our common
      stock.**





We
      have
      never paid a cash dividend on our common stock and do not plan to pay dividends
      on our common stock for the foreseeable future. Potential purchasers of our
      stock seeking a regular return on their investment may not be interested in
      purchasing our stock as a result. This may reduce demand for our stock and
      thereby negatively affect our stock price.





**Item
      1B.** ***Unresolved
      Staff Comments***





Not
      Applicable.





**Item
      2.** ***Properties***





We
      have
      leased office space in Pittsford, New York, a suburb of Rochester, where we
      maintain our corporate headquarters. The lease expires in March 2010, but
      provides we can terminate at any time without cost or penalty with three months’
notice. We currently have no plans to terminate this lease.





We
      also
      lease space in Las Vegas, Nevada for our national customer service operations
      including our call center, national network operating center, IT data center
      and
      local sales personnel. This lease expires in October 2009.





We
      own
      property housing three of our switches in California and one in Illinois. We
      also lease space for 18 other switch and equipment hub sites in Nevada and
      California that expire through 2015. During February 2005, we entered into
      an
      agreement with the landlord to terminate our Nevada switch lease as of June
      2006. We have entered into a lease for a new switch site in Las Vegas. We will
      move to the new leased site and have a new switch operational, prior to closing
      the existing switch and vacating the premises. In addition, we have leased
      facilities to house our local sales and administration staff in the markets
      in
      which we operate.





With
      the
      ICG California acquisition, we acquired an additional nine switch and four
      equipment hub sites all within our existing markets. These sites are all leased,
      with lease terms expiring through 2010. We did not acquire any of the switches
      in these facilities.


**26**




**Item
      3.** ***Legal
      Proceedings***





We
      are
      party to numerous state and federal administrative proceedings. In these
      proceedings, we are seeking to define and/or enforce incumbent carrier
      performance requirements related to:





•
            the
                cost and provisioning of those network elements we
                lease;•
            the
                establishment of customer care and provisioning;•
            the
                allocation of subsidies; and•
            collocation
                costs and procedures.





The
      outcome of these proceedings will establish the rates and procedures by which
      we
      obtain and provide leased network elements and could have a material effect
      on
      our operating costs.




On
      February 17, 2005, a class action lawsuit was commenced against us, alleging
      violations of California Labor Code Sections 2802 and 2804. The group of
      plaintiffs attempting to be formed and certified as a class would include our
      sales representatives in California for the past four years. The plaintiffs
      are
      seeking to recover what they claim to be unreimbursed expenses incurred in
      the
      performance of their duties, including additional mileage reimbursement. The
      action is pending in Superior Court of the State of California for the County
      of
      Los Angeles. We deny any liability to the plaintiffs, and intend to vigorously
      defend the action, and believe that ultimate settlement or damages awarded,
      if
      any, will not have a material adverse effect on our financial position, results
      of operations or cash flows.





We
      were
      party to an equipment lease dispute that resulted in claims being made against
      us and certain of our subsidiaries. On November 1, 2002, the plaintiff initiated
      the first of several actions against our subsidiary in the Circuit Court of
      St.
      Louis County, Missouri, and also filed actions in the U.S. Bankruptcy Court
      for
      the District of Delaware for recovery of claimed damages. In July 2005, a
      settlement was reached for all legal actions and the $0.6 million difference
      between the estimated liability previously recorded and the settlement amount
      was reflected as a reduction of selling, general and administrative expense
      on
      our consolidated statements of operations in the second quarter ended June
      30,
      2005. The final settlement payment of $0.8 million was made by us in October
      2005.





From
      time
      to time, we engage in other litigation and governmental proceedings in the
      ordinary course of our business, including some claims that we have asserted
      against others, in which monetary damages are sought. The result of current
      or
      future litigation is inherently unpredictable; however, we do not believe any
      other asserted or pending litigation or governmental proceeding will have a
      material adverse effect on our financial condition, results of operations or
      cash flows.





We
      are
      also affected by regulatory proceedings, including those discussed above under
      “Business-Government Regulations” and the following:





**California**





On
      September 23, 2004, the California Public Utilities Commission (“CPUC”) adopted
      new rates increasing the cost of 2-wire loops but decreasing the cost of
      high-capacity digital loops that SBC (now AT&T) may charge us and other
      competitive local telephone companies for access to its network. Thereafter,
      in
      March 2005, the CPUC revised UNE rates downward by approximately 2% and ordered
      a retroactive true up of rates dating back to May 2002. Neither the revised
      rates nor the retroactive true up have had or are expected to have a material
      adverse effect on our business, financial condition or results of
      operations.





On
      November 22, 2005, the Administrative Law Judge (“ALJ”) issued a draft decision
      (final decision by CPUC expected in the first quarter 2006) in the Verizon
      unbundled network elements (“UNEs”) rate case regarding permanent rates for UNEs
      purchased by competitive carriers from Verizon in California. In March 2003,
      the
      CPUC issued an interim rate order setting Verizon UNEs rates at a level expected
      to be a close approximation of permanent rates (subject to a true up after
      permanent rates are determined). If the recent draft decision is adopted by
      the
      CPUC, the cost of 2-wire loops will increase but the cost of high-capacity
      digital loops will decrease. We do not believe that the establishment of
      permanent rates or the retroactive true up will have a material adverse effect
      on our business, financial condition, or results of operations.





On
      July
      8, 2005, SBC petitioned the CPUC to rule on collocation rates. As the record
      was
      submitted for decision in 2000, SBC also petitioned to reopen the record for
      the
      submission of updated cost studies and the issuance of a final decision setting
      collocation prices and ordering a true up to those rates. We are not able to
      predict the timing or outcome of this proceeding or its effect on our
      business.


**27**


**Illinois**





Subsequent
      to the May 2004 UNE rate increase, the Illinois Commerce Commission (“ICC”)
      opened a proceeding (“Imputation Docket”) to analyze whether the UNE rates
      charged by SBC Illinois to competitive local telephone companies are
      competitively fair in light of the rates SBC charges its retail customers.
      In
      June 2005, the ICC ruled that SBC’s retail rates for access lines and for
      integrated service digital network (“ISDN”) pass the imputation test but that
      some pay phone rates failed the test. The ICC is being petitioned for rehearing.
      While the ICC requiring SBC to raise its payphone rates may have the effect
      of
      making our payphone product more competitive, we do not believe this will
      materially increase revenues.





On
      September 15, 2005, SBC filed a collocation tariff in Illinois that would
      significantly change how power usage in CLEC facilities used to interconnect
      with the ILEC is measured and billed. The ICC stayed the tariff and opened
      a
      docket to investigate the proposed changes and anticipates making a decision
      in
      the third quarter of 2006. We are unable to predict the outcome of this
      proceeding or its effect on our business.





**Item
      4.** ***Submission
      of Matters to a Vote of Security Holders***





Not
      applicable.


**28**


**PART
      II**





**Item
      5.** ***Market
      for Registrant's Common Equity, Related Stockholder Matters, and Issuer
      Purchases of Equity Securities***





**Market
      Information**





Our
      common stock, $0.001 par value, traded on the National Association of Securities
      Dealers Over the Counter Bulletin Board, a regulated service that displays
      real-time quotes, last-sale prices and volume information in over-the-counter
      equity securities under the symbol “MPOW.OB” until May 20, 2004, when our common
      stock was approved for trading on the American Stock Exchange under the symbol
      “MPE”. As of February 22, 2006, the closing price of our common stock was $1.33.
      The following sets forth the reported high and low sale prices for the common
      stock for each quarterly period in fiscal 2004 and 2005.




**High**
            
            **Low**Quarter
                Ending March 31, 2004
            $1.72
            
            $1.31Quarter
                Ending June 30, 2004
            $1.47
            
            $1.18Quarter
                Ending September 30, 2004
            $1.33
            
            $1.06Quarter
                Ending December 31, 2004
            $1.90
            
            $1.20Quarter
                Ending March 31, 2005
            $1.87
            
            $1.41Quarter
                Ending June 30, 2005
            $1.79
            
            $1.38Quarter
                Ending September 30, 2005
            $1.51
            
            $1.22Quarter
                Ending December 31, 2005
            $1.47
            
            $1.15





As
      of
      February 22, 2006, there were approximately 258 holders of record of our common
      stock.





**Dividends**





No
      cash
      dividends have ever been declared by us on our common stock. We do not
      anticipate that any dividends will be declared on our common stock for the
      foreseeable future. Future payments of cash dividends, if any, will depend
      on
      our financial condition, results of operations, business conditions, capital
      requirements, restrictions contained in agreements, future prospects and other
      factors deemed relevant by our board of directors. Our ability to declare and
      pay dividends on our common stock in the future may be restricted by covenants
      in debt indentures we may enter into.





**29**


**Item
      6.** ***Selected
      Financial Data***





The
      information required by this Item is as follows (in thousands except per common
      share amounts):





**Reorganized**
            
            **Predecessor****Mpower**
            
            **Mpower**
            
            **Year
                Ended****Year
                Ended December 31,**
            
            **Holding**
            
            **Holding**
            
            **December
                31,****2005**
            
            
            **2004**
            
            
            **2003**
            
            
            **2002
                (1)**
            
            
            **2002
                (1)**
            
            
            **2001**Operating
                revenues
            
            $
            193,017
            
            $
            151,010
            
            $
            148,172
            
            $
            62,815
            
            $
            83,289
            
            $
            136,116(Loss)
                income from continuing operations
            
            
            (1,301
            )
            
            (6,313
            )
            
            (18,765
            )
            
            17,754
            
            
            (43,204
            )
            
            (400,343
            )(Loss)
                income from continuing operations per common share
            
            
            (0.01
            )
            
            (0.08
            )
            
            (0.27
            )
            
            0.27
            
            
            (0.79
            )
            
            (7.13
            )Total
                assets (2)
            
            
            138,004
            
            
            104,964
            
            
            109,029
            
            
            127,423
            
            
            —
            
            
            613,647Long-term
                debt and capital lease obligations including current maturities
                (2)
            
            
            23,660
            
            
            —
            
            
            256
            
            
            5,009
            
            
            —
            
            
            430,686Predecessor
                Mpower Holding Series C Convertible Redeemable Preferred Stock
                (2)
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            46,610Predecessor
                Mpower Holding Series D Convertible Redeemable Preferred Stock
                (2)
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            156,220





(1)
            As
                a consequence of the reorganization occurring as of July 30, 2002,
                the
                2002 financial results have been separately presented under the label
                “Predecessor Mpower Holding” for the period January 1 to July 30, 2002 and
                “Reorganized Mpower Holding” for the period July 31 to December 31, 2002.
                All periods after December 31, 2002 are “Reorganized Mpower Holding” and
                the year ended December 31, 2001 is “Predecessor Mpower
                Holding.”(2)
            Not
                provided for “Predecessor Mpower Holding 2002” column since year-end
                information is indicated in “Reorganized Mpower Holding 2002”
                column.





The
      numbers reflected above may not be comparable because of our reduction of
      markets from 2001 to 2003 and the elimination of a substantial portion of our
      debt and all of our preferred stock, the application of fresh-start accounting
      in connection with our reorganization in 2002, and the acquisition of ICG
      California in 2005.





**Item
      7.** ***Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation***





**Introduction**





The
      following Management's Discussion and Analysis ("MD&A") is written to help
      the reader understand our company. The MD&A is provided as a supplement to,
      and should be read in conjunction with, our consolidated financial statements
      and the accompanying financial notes ("Notes") appearing elsewhere in this
      report. This overview provides our perspective on the individual sections of
      MD&A, which include the following:





*Executive
      Summary* -
      an
      executive review of our performance for the year ended December 31,
      2005.





*Company
      Overview -* a
      general
      description of our business, the services we offer, the markets we serve, our
      recapitalization and our January 1, 2005 acquisition of certain assets and
      assumption of certain liabilities from ICG Communications, Inc.
      (“ICG”).


**30**


*Liquidity
      and Capital Resources -* an
      analysis of historical information regarding our sources of cash and capital
      expenditures, the existence and timing of commitments and contingencies, changes
      in capital resources and a discussion of balance sheet and cash flow items
      affecting liquidity.





*Results
      from Continuing Operations* - an
      analysis of our results of operations for the three years presented in our
      financial statements including a review of the material items and known trends
      and uncertainties.





*Discontinued
      Operations* - an
      analysis of our discontinued operations over the past three years.





*Application
      of Critical Accounting Estimates* - an
      overview of accounting policies that require critical judgments and
      estimates.





*Effects
      of New Accounting Standards -* a
      discussion of new accounting standards and any implications related to our
      financial statements.





*Forward
      Looking Statements* -
      cautionary information about forward-looking statements and a description of
      certain risks and uncertainties that could cause our actual results to differ
      materially from our historical results or our current expectations or
      projections.




**Executive
      Summary**





As
      we
      look back over our 2005 results, it was clearly a year of progress for our
      business.





*2005
      Events*





**•**
            We
                integrated the ICG California business during 2005. With this January
                2005
                acquisition we added approximately $30.0 million in annual revenue,
                an
                extensive fiber network, and a wholesale revenue base and capability.
                We
                migrated this acquired revenue to our network platform and accomplished
                our goal of achieving network cost synergies during the latter half
                of
                2005.**•**
            We
                continued the evolution of our business from one that was previously
                a
                plain old telephone service (“POTS”) business, to one that is now
                primarily a higher margin T1 business.**•**
            We
                evolved our revenue growth strategy to focus more resources on selling
                through our agent and vendor channels as the CLEC industry has shifted
                to
                more of an indirect sale model by selling through such agents and
                vendors.
                Our billed customer revenue attributed to the agent channel increased
                57%
                in 2005, over 2004 results.**•**
            We
                installed our first soft switch in Southern California. This will
                further
                expand our network capabilities and maximize our opportunities in
                both
                hosted VOIP and future SIP trunking applications. These technologies
                provide capabilities such as redirecting calls, scheduling meetings,
                sharing of documents and performing directory look-ups. In addition,
                we
                moved our current hosted VOIP product to a new application platform
                and
                moved our existing hosted IP customers to that new platform. We have
                committed to hiring VOIP product specialists to support our sales
                account
                managers in all our markets.**•**
            We
                bought a 141-route mile fiber network with three fully survivable
                rings in
                Las Vegas from IDACOMM and anticipate accepting the network in the
                first
                quarter of 2006.**•**
            We
                launched our first wireless broadband trials in our Las Vegas
                market.


**31**




Operating
      in today’s telecommunications environment continues to provide unique
      opportunities for our company. Challenges accompany these opportunities. Looking
      forward, we have identified three key challenges, which are:





*Continually
                Evolving Regulatory Environment*•
            In
                2004, we were required to absorb substantial price increases in our
                basic
                copper voice-grade equivalent loops, but the increased costs were
                offset
                (to a large extent) by lower T1 loop pricing. This ruling will continue
                to
                positively impact us as we shift away from 2-wire loops (POTS) and
                focus
                on T1 products.•
            In
                November 2005, a draft decision was rendered in California that would
                increase the cost of 2-wire loops we purchase from Verizon but would
                also
                lower our T1 loop pricing. There may also be a retroactive true-up.
                We do
                not believe the final rate decision will have a material adverse
                effect on
                our business.•
            In
                California, SBC petitioned the Public Utilities Commission to rule
                on the
                rates it can charge companies like us. We are unable to predict the
                timing
                or outcome of this proceeding.•
            The
                FCC ruled in its triennial review order, that the incumbent local
                phone
                companies (“ILECs”) will no longer have to provide unbundled network
                element platform (“UNE-P”) level services. That ruling went into effect
                March 2005 for new customers, and March 2006 for existing bases of
                customers. We are still evaluating the opportunities this ruling
                may have
                for us, but we are actively pursuing opportunities to provide
                network-based alternatives to UNE-P carriers on a wholesale basis
                in light
                of recent regulatory changes.




*Growing
                Our Direct Sales Force*•
            We
                have found it a challenge to recruit, retain and make successful,
                account
                managers who are experienced in the telecommunications field. In
                2006, we
                are shifting our approach to focus our recruiting on raw sales talent
                and
                then to seek to mold them to be successful with our products and
                processes. This will involve hiring inexperienced people who will
                be paid
                less initially. We will then provide them with extensive, formalized
                training in our procedures and operations.*Mergers
                and Acquisitions*•
            We
                continue to believe there will be consolidation in our industry and
                we
                intend to participate as a buyer or a seller as has always been our
                strategy. We will, however, continue to be disciplined in our approach
                and
                only evaluate opportunities that are accretive to our
                shareholders.





**Company
      Overview**





We
      were
      one of the first facilities-based competitive local telephone companies founded
      after the inception of the Telecommunications Act of 1996, which opened up
      the
      local telephone market to competition. Today, we offer local and long distance
      voice services as well as high-speed Internet access and voice over internet
      protocol (“VOIP”) by way of a variety of broadband product and service offerings
      over our own network of collocations, switches and fiber network. On January
      1,
      2005 we acquired certain assets and assumed certain liabilities of ICG in
      California. The assets acquired include ICG’s customer base and certain network
      assets in California, including a 1,412 route mile state-wide fiber ring and
      915
      miles of metropolitan fiber rings that connect 128 commercial buildings and
      33
      collocations throughout major cities in California.





All
      of
      our services are offered through our wholly-owned subsidiary, Mpower
      Communications Corp. (“Communications”), primarily to small and medium-sized
      business customers in all of our markets and residential customers primarily
      in
      the Las Vegas, Nevada market. Our other markets include Los Angeles, California,
      San Diego, California, Northern California (the San Francisco Bay area and
      Sacramento) and Chicago, Illinois. As of February 2006, we have approximately
      48,700 business customers and approximately 14,600 residential customers. Many
      of the ICG customers acquired are larger accounts that generate more average
      monthly revenue than our existing customer base. We also bill a number of major
      local and long distance carriers for the costs of originating and terminating
      traffic on our network for our local services customers. We do not have any
      unbundled network element platform (“UNE-P”) revenues, although we are actively
      pursuing opportunities to provide network-based alternatives to UNE-P carriers
      on a wholesale basis in light of recent regulatory changes. During 2005, we
      acquired approximately 67% of our new retail sales through our direct sales
      force and supporting staff compared to 2004 when we acquired 78% of our new
      retail sales through our direct sales force. The remainder of our new retail
      sales were acquired through agent relationships and outbound
      telemarketing.





As
      a
      facilities-based provider, we own and control a substantial amount of our
      network infrastructure. Our network reaches across 297 central office
      collocation sites. In April 2004, we began selling T1 services to customers
      using facilities that do not directly connect to these collocation sites. We
      refer to this as “off-network.” Currently, there are 182 off-network locations
      that can be provisioned with T1 service. Having off-network facilities increases
      the number of our potential customers. We have seven switches in our network,
      including one Lucent “soft switch” we installed in our Los Angeles market in
      September 2005. A soft switch enables us to provide more features to our
      customers at lower on-going costs and less capital expenditures than traditional
      Class 5 switch equipment.


**32**


The
      addition of the ICG California assets in January 2005, including a statewide
      SONET-based fiber network in California, and the June 2005 agreement to purchase
      a 141 route mile fiber network with three survivable rings in Las Vegas will
      add
      to our deep collocation and switching infrastructure. These network additions
      allow us to offer new products such as private line, accelerate our
      speed-to-market with IP Centrex capabilities, including VOIP, position us as
      a
      strong player in the wholesale market, and reduce our reliance on the
      ILECs.





We
      have
      over 311,000 billable switched lines in service and an additional 2,900 private
      line circuits in service. The services we provide for these billable lines
      generate our revenues. As of February 2006, we have approximately 825 employees.
      We have established working relationships with Verizon, Sprint, and AT&T
      (formerly known as SBC, including its operating subsidiaries Pac Bell and
      Ameritech).





We
      were
      one of the first competitive communications carriers to implement a
      facilities-based network strategy. As a result, we own the network switches
      that
      control how voice and data communications originate and terminate, we install
      our network equipment at collocation sites of the incumbent carriers, and we
      lease the telephone lines or transport systems, over which the voice and data
      traffic are transmitted. As a result of the ICG acquisition, we now also have
      a
      fiber ring network in California that gives us additional network and traffic
      routing options. We are currently installing a fiber ring in our Las Vegas
      market. As we have already invested in and built out our own network, we believe
      that our strategy has allowed us to establish and sustain service in our markets
      at a comparatively low cost, while maintaining control of the access to our
      customers.





Our
      business is to deliver integrated voice and broadband data solutions. Our
      emphasis is on providing small, medium-sized and now larger size business
      customers, as well as wholesale customers, with a full suite of communications
      services and features, integrated on one bill, with the convenience of a single
      source provider. For our business customers, we provide local voice
      telephone service
      and broadband Internet by way of SDSL and T1. By using our existing equipment
      and interconnection agreements with incumbent carriers and network capabilities,
      we are able to offer fully integrated and channelized voice and data product
      and
      service offerings over a T1 connection. In order to serve the largest portion
      of
      our target audience, our combined voice and data network allows us to deliver
      services in several combinations over the most favorable technology: basic
      phone
      service on the traditional phone network, SDSL service, integrated T1 voice
      and
      data service, or data-only T1 connectivity. Our service offerings have been
      increased through the acquisition of ICG, providing us with the ability to
      be a
      wholesale provider to large interexchange carriers (“IXCs”), competitive local
      exchange carriers (“CLECs”), and internet service providers (“ISPs”). We have
      established a dedicated wholesale channel to focus on the unique needs of this
      customer base. With access to our facilities-based distributed network
      architecture and broad range of products and services, we offer wholesale
      customers opportunities to enhance or expand their business models.





We
      operate our business as one segment and as a consolidated entity managed at
      a
      national level. Our products and services have similar network operations,
      back-office support and technology requirements. Therefore, we manage these
      services as a single segment that are sold in geographic areas, or markets,
      within the United States, or that are sold to customers with a presence across
      geographical markets. We regularly evaluate the makeup of our business to
      determine whether more than a single segment exists as our business evolves
      and
      develops.





*ICG
      California Acquisition*





On
      January 1, 2005, we completed the acquisition of ICG’s retail and wholesale
      customers in California; a 1,412 route mile state-wide fiber ring and 915 route
      miles of metropolitan fiber rings which connect 128 commercial buildings across
      major cities in California, along with certain network assets and assumed
      certain liabilities related to those assets (“ICG California”) pursuant to an
      Asset Purchase Agreement (“Agreement”) dated October 22, 2004 by and among MCCC
      ICG Holdings, LLC (“MCCC”), ICG and us. MCCC is a joint venture between Columbia
      Capital and M/C Venture Partners. ICG is a Denver-based nationwide
      communications provider focused on delivering data and voice services to
      corporate customers, ISPs and telecommunication carriers using a network that
      it
      owned and operated. It was a publicly held company until October 18, 2004,
      when
      it became a private entity through a merger transaction. As a result of this
      merger, MCCC owns 100% of the voting stock of ICG.


**33**


We
      purchased these assets for $16.6 million excluding liabilities assumed,
      comprised of (i) $14.1 million in the form of 10,740,030 shares of our common
      stock, (ii) $1.2 million in the form of warrants dated January 1, 2005, to
      purchase another 2,000,000 shares of our common stock exercisable on or prior
      to
      the fifth anniversary of the date of issuance at an exercise price of $1.38
      per
      share and (iii) $1.3 million of direct acquisition costs (described below).
      We
      also assumed certain of ICG’s capital lease obligations in California, including
      its long-term leases for its fiber network that had a fair value of $26.0
      million as of January 1, 2005. The $14.1 million value of 10,740,030 shares
      of
      common stock was determined using an average stock price of $1.31 during the
      three days before and three days after the date the acquisition was announced.
      The fair value of the warrants was determined using the Black-Scholes method,
      with the following assumptions: dividend yield of 0%; expected warrant life
      of 5
      years; risk free interest rate of 3.35%; and an expected volatility of
      57%.




Upon
      completion of the ICG California acquisition on January 1, 2005, consideration
      was paid and we took title to that business. We retained independent appraisers
      to assist us in determining the fair value of certain assets acquired and
      liabilities assumed as required under SFAS No. 141, “Business Combinations.” The
      following table summarizes the final purchase price allocation for the ICG
      California acquisition (in thousands):





**Assets
                Acquired**
            
            
            **January
                1,****2005**Accounts
                receivable
            
            $
            1,526Other
                receivables
            
            
            301Prepaid
                expenses and other current assets
            
            
            60Property
                and equipment
            
            
            32,299Goodwill
            
            
            8,861Other
                intangibles
            
            
            3,096Other
                long-term assets
            
            
            250Total
                assets acquired
            
            
            46,393**Liabilities
                Assumed**Current
                maturities of capital lease obligations
            
            
            2,476Deferred
                revenue
            
            
            1,613Accrued
                other expenses
            
            
            1,723Long-term
                capital lease obligations
            
            
            23,526Long-term
                deferred revenue
            
            
            78Asset
                retirement obligations
            
            
            336Total
                liabilities assumed
            
            
            29,752Total
                purchase price (exclusive of liabilities assumed)
            
            $
            16,641





The
      assets of ICG California consist primarily of:





•
            Certain
                switching and routing equipment, located both in ICG California facilities
                and in facilities operated by one or more incumbent local exchange
                carriers;•
            Customer
                and sales agreements that constitute a majority of ICG California’s voice
                and data revenues;•
            Lit
                fiber capacity originally purchased by ICG as well as leased fiber
                network
                capacity, which are both expansive of our current
                network.





Of
      the
      $3.1 million of other intangible assets acquired as a result of the ICG
      California acquisition, approximately $2.6 million was assigned to customer
      relationships, which have an estimated useful life of 3 years. Approximately
      $0.3 million was assigned to software and $0.2 million was assigned to a product
      licensing agreement, which have estimated useful lives of 3 years and 5 years,
      respectively.


**34**


The
      ICG
      transaction described above involved a management services agreement and a
      transition services agreement that maintained the continuity of the ICG
      operations in California and prepared for the transfer of required business
      functions to us. Under the management services agreement, we reimbursed ICG
      for
      the cost of specific services provided by ICG on our behalf between the date
      the
      definitive agreement was signed (October 22, 2004) and final closing (January
      1,
      2005). We recognized gross direct acquisition costs of $0.5 million for services
      and fees incurred under the management services agreement. The management
      services agreement also provided that the operating results of the ICG
      California operations accrued to our benefit during the period of the agreement.
      During this period, ICG’s California operations generated positive cash flows
      from operations of $0.3 million, which has been recorded as an offset to the
      gross direct acquisition costs we incurred under the management services
      agreement. We recorded additional direct acquisition costs of $1.1 million
      primarily for legal and consulting fees incurred in connection with the ICG
      California acquisition. The $1.3 million of net direct acquisition costs
      described above was included as a component of the purchase price in accordance
      with SFAS No. 141, “Business Combinations.”





Commencing
      on the transaction closing date, January 1, 2005, certain services have been
      provided by ICG to us under a transition services agreement providing for
      services through December 31, 2005. For the year ended December 31, 2005, we
      incurred $1.3 million of expense under the transition services agreement,
      primarily related to accounting, billing, collections, provisioning, call center
      and network support services performed by ICG on our behalf, which are included
      in selling, general and administrative expenses in our consolidated statements
      of operations.




At
      December 31, 2005, approximately $0.2 million of cash has been received by
      ICG
      from customer payments on our behalf, which amounts are to be remitted to us
      under the terms of the transition services agreement. This amount is recorded
      on
      our consolidated balance sheet in other receivables and we expect to receive
      this amount in the first quarter of 2006, net of amounts due to ICG under the
      transition services agreement and other operating expenses paid on our behalf
      by
      ICG. At December 31, 2005, approximately $1.0 million of vendor invoices have
      been paid on our behalf by ICG, which amounts are to be remitted to ICG under
      the terms of the transition services agreement. This amount is recorded in
      our
      consolidated balance sheet in accounts payable. We paid $0.8 million of this
      amount in January 2006.





*Markets*





As
      of
      February 2006, we operate in five markets in three states and have 297 incumbent
      carrier central office collocation sites and 182 off-network collocation sites.
      The major markets in our footprint are: Los Angeles, California, San Diego,
      California, Northern California (the San Francisco Bay area and Sacramento),
      Las
      Vegas, Nevada and Chicago, Illinois. The table below shows the distribution
      of
      our central office collocation sites within these markets.





**Number
                of Collocations****Market**
            
            **On-Network**
            **Off-Network**Los
                Angeles
            
            142
            64San
                Diego
            
            28
            19Northern
                California
            
            43
            68Las
                Vegas
            
            18
            —Chicago
            
            66
            31Totals
            
            297
            182





We
      believe there is significant growth potential within our existing market
      footprint, especially in California, with the customer base, network assets
      and
      services offerings acquired from our ICG California acquisition. In addition,
      our network backbone, including our ICG California fiber ring acquisition,
      is
      scalable and can provide reliability and service quality across our collocation
      footprint, while affording us the benefit of spreading the fixed costs across
      our base of markets. Use of off-network facilities will also allow us to sell
      certain T1 services to customers that are not within the geographic reach of
      our
      collocation sites.





**Future
      Plans**





The
      next
      step in our business plan is to accelerate our growth in the markets within
      which we currently operate while continuing to retain our current customers.
      We
      intend to accomplish this growth by pursuing other in-market acquisition
      opportunities that may become available, such as the 2005 ICG asset purchase
      as
      described above. In addition, we intend to grow through the introduction of
      new
      products and technologies and organic growth (especially in our higher margin
      T1
      products). We will also focus on the wholesale channel and increase investment
      in our direct sales force and alternative sales channels, all of which we expect
      to result in the acceleration in the growth of our customer base, while
      maintaining our existing customer base. We intend to accomplish these goals
      while maintaining a simple and conservative capital structure as we invest
      in
      these initiatives. In terms of strategic transactions, we will continue to
      explore opportunities to increase our customer base and service offerings
      through merger and/or acquisition transactions that we would expect to be
      accretive to shareholder value.


**35**


***Summary***





We
      have
      experienced net losses since our inception as a result of efforts to build
      our
      customer base, develop and construct our communications network infrastructure,
      build our back-office capabilities, and expand our market base. We intend to
      continue to focus on increasing our customer base through growing our direct
      quota carrying sales representatives selling our services, selling through
      our
      agent and vendor channels, expanding our inside sales efforts, focusing on
      serving our customer base and establishing a wholesale channel. We will seek
      to
      bring increased capabilities to our existing customer base, along with seeking
      to increase our operating margins by improving the cost effectiveness of our
      network, offering higher margin products and services to our customers as well
      as streamlining our general and administrative functions.





With
      a
      challenging and rapidly changing competitive and regulatory environment, we
      may
      be forced to change our strategy. The following trends and uncertainties may
      affect both us and our industry, but we have concluded that it is not reasonably
      likely that these trends and uncertainties will have a material effect on our
      liquidity, capital resources or results of operations.





•
            Competing
                technologies continue to emerge and grow that challenge our business
                such
                as various wireless and VOIP applications.•
            Consolidation
                in the industry may strengthen the surviving companies that compete
                with
                us.•
            The
                regulatory environment in the telecommunications industry in which
                we
                compete continues to evolve. We anticipate we will continue to grow
                in the
                midst of this environment, but may need to change our strategy in
                response
                to future changes to the competitive or regulatory
                environment.






**Liquidity
      and Capital Resources**





We
      generated positive cash flows from operating activities for each of the last
      two
      years. As of December 31, 2005, we had $28.4 million in unrestricted cash,
      cash
      equivalents and short and long-term investments available-for-sale. We believe
      that these balances, when combined with the initiatives described below that
      are
      the basis for our on-going business model, will generate enough liquidity to
      fully fund our business, including capital expenditures, on a continuing basis.
      In addition, we believe our operating cash flow will also be sufficient to
      fund
      our recently announced stock repurchase program.





Our
      working capital increased from December 31, 2004 to December 31, 2005 to $10.2
      million. Our working capital plus long-term investments available-for-sale
      decreased slightly from December 31, 2004, to December 31, 2005.





**Working
                Capital:**
            
            **As
                of December 31,****(in
                thousands)**
            
            **2005**
            
            **2004**
            
            **2003**Current
                Assets
            
            $
            44,916
            
            $
            51,755
            
            $
            53,001Current
                Liabilities
            
            
            34,712
            
            
            41,975
            
            
            40,577Working
                Capital
            
            $
            10,204
            
            $
            9,780
            
            $
            12,424Long-term
                investments available-for-sale
            
            $
            1,317
            
            $
            2,041
            
            $
            —





In
      February 2005, we entered into an amendment to the lease with our landlord
      for
      our switch site in Las Vegas, Nevada. Under the amendment, our landlord paid
      us
      the sum of $7.7 million of cash and agreed to $0.3 million in rent abatement
      in
      consideration for our agreement to terminate our lease early and vacate the
      switch site by June 30, 2006. The rent abatement applies to our rent obligations
      from February 1, 2005 through June 30, 2006. In addition, in the event we need
      to supply fiber optic cable to our new location, the landlord has agreed to
      reimburse us for the actual costs incurred up to $0.5 million. We expect to
      spend $0.5 million and receive reimbursement from the landlord by June 30,
      2006.
      We are expending a portion of the $7.7 million to construct a new switch
      facility in the Las Vegas market, so that the new switch will be operational
      prior to closing the old switch and vacating the existing premises. Through
      December 31, 2005, approximately $2.6 million has been expended. We expect
      that
      most of the cash expenditures associated with this relocation will be completed
      by March 31, 2006. A substantial portion of these expenditures will be capital
      expenditures.


**36**


In
      January 2006, we announced that our board of directors had approved a stock
      repurchase program pursuant to Rule 10b-18 under which we are authorized to
      acquire up to $10 million of our outstanding common stock in the open market
      over the next 12 months. We also announced we intend to adopt a prearranged
      Rule
      10b5-1 stock trading plan and use a portion of the $10 million to repurchase
      our
      stock pursuant to that plan. The 10b5-1 plan will be implemented when permitted
      consistent with company-imposed blackout periods and insider trading law
      restrictions. Our 10b-18 stock repurchase program will allow us to make share
      purchases from time to time during our normal trading windows, depending on
      market conditions, share price and other factors. The 10b5-1 trading plan,
      when
      adopted, will allow us to also repurchase shares at times when we otherwise
      might be prevented from doing so under the insider trading laws or because
      of
      self-imposed trading blackout periods.





We
      have
      completed, and continue to pursue, several initiatives intended to continue
      to
      increase liquidity and better position us to compete under current conditions
      and anticipated changes in the telecommunications sector. These
      include:





•
            Continue
                to generate cash flow from operations, with a focus on growing revenue
                from our most profitable products, improving profit margins by introducing
                new products and services with greater profit margins and reducing
                our
                cost of operating revenues through improvements in the cost structure
                of
                our network.•
            Having
                a $250 million shelf registration statement on Form S-3 declared
                effective
                by the Securities and Exchange Commission during May
                2004;•
            Extending
                our $7.5 million funding credit facility secured by certain customer
                accounts receivables to April 24, 2006 as we investigate other funding
                sources, or determine that such a facility is not
                needed;•
            Pursuing
                discussions with companies who may be interested in acquiring our
                assets
                or business, in whole or in part, and discussions with companies
                who may
                be interested in selling their assets or business, in whole or in
                part, to
                us;•
            Analyzing
                the pricing of our current products and services to ensure they are
                competitive and meet our objectives; and•
            Re-deploying
                our assets held for future use to reduce the requirement for capital
                expenditures.




We
      negotiated an extension on our $7.5 million line of credit and it will now
      expire on April 24, 2006. We do not expect to draw from this line of credit
      before this expiration date. Our investments available-for-sale consist of
      auction rate securities, government agency notes, certificates of deposit and
      corporate bonds. All investments are made in accordance with our investment
      policy and guidelines approved by our board of directors.




Developing
      and maintaining our network and business has required and will continue to
      require us to incur capital expenditures primarily consisting of the costs
      of
      purchasing network and customer premise equipment and upgrading and maintaining
      our operations support system. Cash outlays for capital expenditures for the
      year ended December 31, 2005 were $16.8 million, which is exclusive of
      capitalized labor of $1.6 million. In June 2005, we paid a $1.3 million deposit,
      which is approximately one half of the total purchase price, for a 141-route
      mile fiber network with three fully survivable rings in Las Vegas. This deposit
      is recorded as an other long-term asset on our December 31, 2005 consolidated
      balance sheet and will be recognized as a capital expenditure when the
      conditions of the purchase agreement are met. This is expected to be in the
      first quarter of 2006.





Our
      capital expenditures in 2006 will focus on upgrading and maintaining our
      operating support system and our network to add new product and service
      offerings and customers and improving the cost efficiency of our network. In
      addition, as discussed above, we will complete the spending on the Las Vegas
      switch move and the fiber build started in Las Vegas.


**37**


We
      expect
      that funding for our capital expenditures will be from cash on hand as well
      as
      cash generated from operations. Included in our total planned capital
      expenditures are the following:





*Network
      Capacity and Capability:* Based on
      our planned customer growth, we anticipate spending approximately between $7.0
      million and $9.0 million in 2006 to add to the capacity of our voice and data
      network as well as adding additional capability and features for new product
      and
      service offerings.





*Information
      Technology:* We
      anticipate spending approximately $3.9 million in 2006 in information technology
      that we expect to improve our back-office productivity and improve the quality
      of our interactions with customers, agents, vendors and other such
      stakeholders.





*Customer
      Acquisition:* We
      anticipate spending approximately $2.0 million in 2006 in acquiring customer
      premise equipment that will support the addition of new customers to our
      network.





*Completion
      of the Las Vegas switch move and fiber build in Las Vegas:* We
      anticipate our expenditures for the completion of these two projects to be
      approximately $4.6 million.





We
      continually evaluate our capital requirements plan in light of developments
      in
      the telecommunications industry and market acceptance of our service offerings.
      The actual amount and timing of future capital requirements may differ
      materially from our estimates as a result of, among other things:





•
            the
                cost of the development and support of our networks in each of our
                markets•
            the
                extent of price and service competition for telecommunication services
                in
                our markets•
            the
                demand for our services•
            regulatory
                and technological developments•
            our
                ability to develop, acquire and integrate necessary operating support
                systems•
            our
                ability to re-deploy assets held for future
                use





As
      such,
      actual costs and revenues may vary from expected amounts, possibly to a material
      degree, and such variations are likely to affect our future capital
      requirements.





*Shelf
      Registration*





During
      February 2004, we filed a universal shelf registration statement on Form S-3
      with the Securities and Exchange Commission (“SEC”) seeking to register up to
      $250 million of new securities, which could include shares of our common stock,
      preferred stock, warrants to purchase common stock, or debt securities. This
      filing was declared effective during May 2004. The filing of this shelf
      registration statement could facilitate our ability to raise capital, should
      we
      decide to do so, in the future. The amounts, prices and other terms of any
      new
      securities would be determined at the time of any particular
      transaction.





During
      January 2004, we adopted a warrant program under which up to 1,000,000 shares
      of
      our common stock are authorized for issuance. The shares issuable under the
      warrant program are covered by our shelf registration statement on Form S-3
      filed in 2004. The intent of the warrant program is to make warrants to purchase
      shares of our common stock available to independent sales agents hired by us,
      with the number of warrants to be granted based on the increase in baseline
      sales performance achieved by these independent sales agents. For the years
      ended December 31, 2005 and 2004, we issued warrants to purchase 728,508 and
      260,430 shares of common stock, respectively, through this program with a
      weighted average exercise price of $1.42 and $1.38 per common share,
      respectively. These warrants are exercisable at any time and expire three years
      from the date of issuance. A similar warrant program is being developed for
      2006.





This
      shelf registration was also used for the sale of 1,988,894 shares of our common
      stock to the owners of ICG in connection with the acquisition of certain ICG
      assets in January 2005.


**38**




*Registration
      Statement*





During
      September 2005, we filed with the SEC a registration statement on Form S-8
      to
      register 11,500,000 shares of our common stock issuable by us upon the exercise
      of options and other stock-based awards that have been granted or may be granted
      under our 2005 Long-Term Incentive Plan (the “2005 Plan”). The 2005 Plan
      replaces our previous non-stockholder approved plans, the Mpower Holding
      Corporation Stock Option Plan I and Mpower Holding Corporation Stock Option
      Plan
      II (together, the “Prior Plans”) and became effective upon approval of the
      stockholders on August 16, 2005 at our annual stockholders meeting. Additionally
      during September 2005, we filed Post-Effective Amendment No. 1 to a previously
      filed Form S-8 to deregister a total of 2,460,954 unissued shares of our common
      stock that had been available for issuance under the Prior Plans since no
      further options may be granted under the Prior Plans. The prior registration
      statement remains in effect for outstanding options under the Prior
      Plans.





*Cash
      Flow Discussion*





In
      summary, our cash flows for the year ended December 31, 2005 were as follows
      (in
      thousands):





**Year
                Ended December 31,****2005**Net
                Cash Provided by Operating Activities
            
            $
            8,656Net
                Cash Used in Investing Activities
            
            $
            17,490Net
                Cash Used in Financing Activities
            
            $
            215





The
      above
      summary of cash flows includes cash and cash equivalents.





For
      the
      year ended December 31, 2005, we achieved positive cash from operations for
      the
      second year in our history. We were able to achieve cash from operations
      primarily as a result of a one-time payment in consideration for our agreement
      to accelerate the expiration date of our Las Vegas, Nevada switch site lease,
      as
      well as the generation of higher margin revenue streams, operational
      efficiencies and associated expense reductions.





*Cash
      and Cash Equivalents:* At
      December 31, 2005, cash, cash equivalents, and short and long-term investments
      available-for-sale were $28.4 million. This balance has the following components
      (in thousands):





Cash
                and cash equivalents
            
            $
            18,278Investments
                available-for-sale
            
            
            8,845Long-term
                investments available-for-sale
            
            
            1,317Total
                at December 31, 2005
            
            $
            28,440





*Long-term
      Restricted Cash:* Long-term restricted cash amounted to $9.2 million as of December 31, 2005.
      We
      have committed to pay severance benefits to certain employees in the event
      they
      are terminated involuntarily, without cause or resign voluntarily for good
      reason. We maintain two irrevocable grantor trusts, which have been funded
      at a
      level sufficient to pay a portion of the severance benefit obligations pursuant
      to employment agreements. We restricted $7.5 million of cash and cash
      equivalents for these severance benefits as of December 31, 2005 and 2004.
      As of
      December 31, 2005, $0.3 million of restricted cash and cash equivalents,
      representing severance obligations to be paid during the next twelve months,
      were included in prepaid expenses and other current assets on our consolidated
      balance sheet. For the years ended December 31, 2005, 2004 and 2003, we paid
      out
      $0.1 million, $0.1 million and $2.1 million, respectively, relating to these
      severance commitments.





In
      addition, we maintain a trust for the future purchase, if needed, of run-off
      insurance for our directors and officers. As of December 31, 2005 and 2004,
      we
      restricted $2.0 million of cash and cash equivalents for the purchase of run-off
      insurance.





The
      trusts referred to above were all established prior to our filing bankruptcy
      in
      2002 to reassure key employees and members of our board of directors that our
      obligations to pay severance benefit obligations and to obtain run-off insurance
      coverage could be met in any event. This was essential to the success of our
      business plan, in that without the retention of key employees and members of
      the
      board of directors, the ability to successfully carry out our business plan
      would have been greatly hampered. Key employees and members of the board of
      directors needed the assurance that the severance benefits they were relying
      on
      were funded and could be paid in any event, and that they would be protected
      with run-off insurance in the event of a merger, acquisition or other event
      requiring such insurance coverage.


**39**


The
      trusts established to cover commitments for severance payments will terminate
      when all employees have been paid all amounts due them pursuant to the terms
      and
      conditions of those trust agreements. The trust to purchase run-off insurance
      will terminate when the funds in the trust have been used to purchase run-off
      insurance in the event of a merger, acquisition or other event requiring such
      insurance.




***Cash
      Flows from Operating Activities and Investing
      Activities***





Our
      statements of cash flows are summarized as follows (in thousands):




**Year
                Ended December 31,****2005**
            
            
            **2004**
            
            
            **2003**Net
                cash provided by (used in) operating activities
            
            $
            8,656
            
            $
            14,342
            
            $
            (9,444
            )Cash
                flows (used in) provided by investing activities:Purchases
                of property and equipment, net of payables
            
            $
            (16,754
            )
            $
            (5,623
            )
            $
            (7,229
            )Deposits
                on property and equipment purchase commitments
            
            
            (1,349
            )
            
            —
            
            
            —Proceeds
                from sale of assets from continuing operations
            
            
            218
            
            
            407
            
            
            872Proceeds
                from sale of assets from discontinued operations
            
            
            1,093
            
            
            63
            
            
            19,364Costs
                associated with sale of assets from discontinued
                operations
            
            
            —
            
            
            —
            
            
            (1,239
            )Purchase
                of investments available-for-sale, net
            
            
            (2,578
            )
            
            (10,505
            )
            
            —Sale
                of investments available-for-sale, net
            
            
            2,393
            
            
            362
            
            
            —(Purchase)
                sale of restricted investments, net
            
            
            (134
            )
            
            114
            
            
            4,002Other
            
            
            (379
            )
            
            —
            
            
            —Net
                cash (used in) provided by investing activities
            
            $
            (17,490
            )
            $
            (15,182
            )
            $
            15,770





*Operating
      Activities:* Cash
      flows from operating activities were $8.7 million for the year ended December
      31, 2005. This is a decrease of $5.7 million compared to the year ended December
      31, 2004. The decrease is primarily a result of an increase in accounts
      receivable due to the increased revenue generated from adding the ICG California
      customers, a reduction in accounts payable due to certain significant payments
      for services delivered at the end of 2004 not being paid for until the first
      quarter of 2005, and timing differences in other working capital accounts.
      These
      decreases more than offset the $7.7 million we received in February 2005 for
      the
      Las Vegas switch site lease amendment. The Las Vegas switch site lease amendment
      and related impact on cash will not be recurring. Cash flows provided by
      operating activities increased for 2004 compared to 2003. The key component
      of
      this improvement was a substantial reduction in net loss significantly
      attributable to a 7% reduction in operating expenses from continuing operations
      and generation of higher margin revenue streams.





*Investing
      Activities:* For
      the
      year ended December 31, 2005, we used $17.5 million in cash for investing
      activities as compared to $15.2 million for the year ended December 31, 2004,
      which included a $10.5 million purchase of investments available-for-sale.
      The
      cash used in 2005 primarily represents the investment of $16.8 million in
      capital expenditures and the $1.3 million initial deposit made for the purchase
      of the Las Vegas market fiber ring, partially offset by $1.1 million of funds
      received from escrowed amounts related to previous asset sales from discontinued
      operations.





***Cash
      Flows from Financing Activities***





Our
      cash
      flows from financing are summarized as follows (in thousands):





**Year
                Ended December 31,****2005**
            
            
            **2004**
            
            
            **2003**Cash
                flows (used in) provided by financing activities:Payments
                on capital lease obligations
            
            $
            (2,504
            )
            $
            (256
            )
            $
            (1,569
            )Payment
                of deferred debt financing costs
            
            
            (262
            )
            
            —
            
            
            (131
            )Proceeds
                from issuance of common stock, net of costs
            
            
            2,551
            
            
            81
            
            
            16,062Repurchase
                of senior notes
            
            
            —
            
            
            —
            
            
            (2,154
            )Other
            
            
            —
            
            
            (965
            )
            
            —Net
                cash (used in) provided by financing activities
            
            $
            (215
            )
            $
            (1,140
            )
            $
            12,208


**40**


*Financing
      Activities:* For the
      year ended December 31, 2005, we used $0.2 million in cash for financing
      activities as compared to $1.1 million for the year ended December 31, 2004,
      which primarily consisted of costs incurred in connection with the planned
      acquisition of ICG California. The cash used in 2005 primarily represents cash
      paid for capital lease obligations offset by the proceeds from the issuance
      of
      common stock to MCCC ICG Holdings, LLC (“MCCC”) in connection with the
      acquisition of ICG California. Cash paid for capital lease obligations increased
      in 2005 as a result of the assumption of the capital lease obligations in
      connection with the ICG California acquisition.




The
      cash
      provided in 2003 primarily represents the net effect of cash received from
      the
      issuance of common stock in September 2003, partially offset by the repurchase
      of our remaining senior notes and payments on capital lease obligations. In
      September 2003, we entered into a securities purchase agreement under which
      we
      raised approximately $16.0 million, net of selling costs, through the private
      placement of 12,940,741 shares of common stock at $1.35 per common
      share.




Commitments
        and Contingencies
 
 We
        have
        entered into various operating lease agreements with expirations through
        2015
        for our switching facilities and offices (the “Operating Lease
        Obligations”).
 
 On
        February 10, 2005, we signed an amendment to our Las Vegas, Nevada switch
        site
        lease. In consideration for our agreement to accelerate the original expiration
        date of the lease to an earlier date, the landlord paid us $7.7 million in
        cash
        and agreed to $0.3 million in rent abatement from February 1, 2005 through
        the
        new lease expiration at June 30, 2006. The cash was received in February
        2005.
        This $8.0 million settlement, net of $0.8 million of estimated costs to exit
        the
        facility, has been included in other income in our consolidated statement
        of
        operations for the year ended December 31, 2005. The impact of this early
        termination of our existing lease as of December 31, 2005 reduced our lease
        obligations by approximately $0.9 million and changed the lease expiration
        date
        from August 2011 to June 2006. We entered into a lease for a new switch site
        with a third party during the second quarter of 2005. A portion of the $7.7
        million one-time payment is being used to construct a new switch facility
        in the
        Las Vegas market and to cover exit costs related to the existing switch
        site.
 
 In
        the
        ordinary course of business, we enter into purchase agreements with our vendors.
        As of December 31, 2005, we had total unfulfilled commitments with vendors
        of
        $2.9 million. Included in this amount is the remaining $1.2 million purchase
        commitment with IDACOMM for the Las Vegas market fiber ring.
 
 We
        also
        have various agreements with certain carriers for transport, long distance
        and
        other network services. At December 31, 2005, our minimum commitments under
        these agreements are $15.7 million, which expire through December 2026. Circuit
        lease expenses for the periods ended in 2005, 2004 and 2003 are included
        in cost
        of operating revenues in our consolidated statements of operations.
  Pursuant
          to the acquisition of ICG California in January 2005, we assumed certain
          capital
          leases of ICG, including certain long-term leases for its fiber network,
          which
          had a fair value of $26.0 million as of January 1, 2005. The assumed capital
          lease obligations have terms that range from 2 to 16 years.
 **41**
 As
            of
            December 31, 2005, we are obligated to make cash payments in connection
            with
            lease obligations and purchase commitments. All of these obligations
            require
            cash payments to be made by us over varying periods of time. Certain
            of these
            arrangements are cancelable on short notice and others require payments
            for
            early terminations, if any. Included in the table below are future commitments
            in effect as of December 31, 2005 (in thousands):
 
 **Continuing
                      Operations:**
                  
                  **2006**
                  
                  **2007**
                  
                  **2008**
                  
                  **2009**
                  
                  **2010**
                  
                  **Thereafter**Operating
                      lease obligations
                  
                  $
                  7,710
                  
                  $
                  6,656
                  
                  $
                  4,931
                  
                  $
                  3,652
                  
                  $
                  1,831
                  
                  $
                  1,739Circuit
                      lease obligations
                  
                  
                  7,406
                  
                  
                  3,501
                  
                  
                  773
                  
                  
                  461
                  
                  
                  426
                  
                  
                  3,157Capital
                      lease obligations, including interest
                  
                  
                  4,062
                  
                  
                  4,031
                  
                  
                  4,031
                  
                  
                  3,997
                  
                  
                  3,986
                  
                  
                  39,805Purchase
                      commitments
                  
                  
                  2,918
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —Total
                  
                  $
                  22,096
                  
                  $
                  14,188
                  
                  $
                  9,735
                  
                  $
                  8,110
                  
                  $
                  6,243
                  
                  $
                  44,701
 Approximately
                $0.1 million of the operating lease payments and circuit lease payments
                remain
                as part of our accrued network optimization costs originally recorded
                in June
                2001 and February 2002.
 
 We
                have
                sufficient liquidity and capital resources to fund these obligations
                in 2006 and
                we believe our future cash flow from operations will be sufficient
                to continue
                to pay these obligations as they become due in the future.
 
 As
                provided in the asset sale agreements for the discontinued markets
                sold to third
                parties in 2003, the purchasers of these assets assumed the liabilities
                associated with the markets acquired. However, we remain contingently
                liable for
                several of the obligations in these markets. We are
                guarantor of future lease obligations with expirations through 2015.
                The
                guarantees arose from the assignment of certain leases as a part
                of the asset
                sales. We are fully liable for all obligations under the lease terms
                in the
                event the assignee fails to pay any sums due under the lease. The
                remaining
                maximum potential amount of future payments we could be required
                to make under
                the guarantees at December 31, 2005 was $7.6 million. No payments
                have been made
                to date and none are expected to be required to be made in the future.
                In
                accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and
                Disclosure Requirements for Guarantees, Including Indirect Guarantees
                of
                Indebtedness to Others,” no liability has been recorded on our consolidated
                balance sheet at December 31, 2005 or 2004 as those guarantees are
                not subject
                to the recognition provisions.
 
 From
                time
                to time, we are involved in legal proceedings arising in the ordinary
                course of
                business, including some claims asserted by us against others, in
                which monetary
                damages are sought. The result of any current or future litigation
                is inherently
                unpredictable; however, we believe there is no litigation asserted
                or pending
                against us that could have, individually or in the aggregate, a material
                adverse
                effect on our financial position, results of operations or cash
                flows.
 
 On
                February 17, 2005, a class action lawsuit was commenced against us,
                alleging
                violations of California Labor Code Sections 2802 and 2804. The group
                of
                plaintiffs attempting to be formed and certified as a class would
                include our
                sales representatives in California for the past four years. The
                plaintiffs are
                seeking to recover what they claim to be unreimbursed expenses incurred
                in the
                performance of their duties, including additional mileage reimbursement.
                The
                action is pending in Superior Court of the State of California for
                the County of
                Los Angeles. We deny any liability to the plaintiffs and intend to
                vigorously
                defend the action, and believe that ultimate damages awarded, if
                any, will not
                have a material adverse effect on our financial position, results
                of operations
                or cash flows.
 **42**
 **Results
                    of Continuing Operations**
 
 Our
                    revenues are generated from the sale of communications services
                    consisting
                    primarily of local and long distance voice services as well as
                    high-speed
                    Internet broadband and VOIP services to our customers and switched
                    access
                    billings to other carriers. As a result of the ICG acquisition,
                    we also provide
                    services on a wholesale basis. Local, long distance and data
                    services are
                    generally provided and billed as a bundled offering under which
                    customers pay a
                    fixed amount for a package of combined local, long distance and
                    data services.
                    Our revenues consist of:
 
 •
                          the
                              monthly recurring charge for basic local voice and
                              data
                              services;•
                          usage-based
                              charges for local and toll calls in certain markets,
                              including long
                              distance services;•
                          charges
                              for services such as call waiting and call forwarding;•
                          certain
                              non-recurring charges, such as set-up charges for additional
                              lines for
                              existing customers; and•
                          revenues
                              from switched access charges to long distance
                              carriers.
 
 Our
                    switched access revenues historically have been subject to uncertainties
                    such as
                    various federal and state regulations and disputes with our long
                    distance
                    carriers. The FCC in April 2001 adopted new rules that limit
                    the rates we can
                    charge carriers for use of our facilities. Under these rules,
                    which took effect
                    on June 20, 2001, competitive carriers were required to reduce
                    their tariffed
                    interstate access charges to agreed upon contract rates or rates
                    no higher than
                    2.5 cents per minute. After one year, the rate ceiling was reduced
                    to 1.8 cents
                    and after two years to 1.2 cents per minute. As of June 2004,
                    all competitive
                    carriers are required to charge rates no higher than the incumbent
                    telephone
                    company. No further price decreases are mandated. However, the
                    FCC is
                    considering further changes to the access rate structure that
                    could result in a
                    further reduction or elimination of access charges. We are unable
                    to predict at
                    this time the extent of any such decline.
 
 As
                    a
                    result of our switched access agreements, the final FCC rate
                    step-down and
                    growth in our core customer trade revenue, we anticipate a continued
                    decrease of
                    switched access revenues as a percent of total revenue. Switched
                    access revenue
                    as a percent of total revenue was 7% for the year ended December
                    31, 2005, and
                    10% and 13% for the years ending December 31, 2004 and 2003,
                    respectively.
                    Correspondingly, revenue from core trade customers (our business
                    and residential
                    customers) increased to 93% of total year 2005 revenues as compared
                    to 90% and
                    87% of total revenues for the two previous years.
 
 Our
                    principal operating expenses consist of cost of operating revenues,
                    selling
                    expenses, general and administrative expenses, and depreciation
                    and amortization
                    expense. Cost of operating revenues consists primarily of access
                    charges, line
                    installation expenses, transport expenses, long distance expenses
                    and lease
                    expenses for our switch sites and our collocation sites. Cost
                    of operating
                    revenues and selling, general and administrative expenses do
                    not include an
                    allocation of our depreciation or amortization expense as those
                    expenses are
                    presented separately.
 
 Selling
                    expenses consist primarily of salaries, commissions and related
                    personnel costs
                    attributable to our sales personnel, marketing costs and facilities
                    costs.
                    General and administrative expenses consist primarily of all
                    other salaries and
                    related personnel costs, the cost of maintaining the hardware
                    and software in
                    our network and back office systems, provision for bad debts,
                    professional fees,
                    insurance, property taxes, customer care and billing expense,
                    facilities expense
                    and agent selling expense.
 
 Depreciation
                    and amortization expense includes depreciation of switching and
                    collocation
                    equipment as well as general property and equipment and the amortization
                    of
                    certain intangible assets.
 
 Other
                    income in 2005 was primarily related to the early termination
                    of our Las Vegas,
                    Nevada switch site lease, net of exit expenses. Other income
                    in 2003 resulted
                    from the reversal of a sales tax contingency reserve deemed no
                    longer
                    needed.
  Gross
                      interest expense is primarily attributable to our capital lease
                      commitments and
                      commitment fees and interest paid relating to our line of credit.
 
 Interest
                      income results from the investment of cash and cash equivalents,
                      and investments
                      available-for-sale. These investments available-for-sale consist
                      of auction rate
                      securities, government agency notes, certificates of deposit
                      and corporate
                      bonds. All investments are made in accordance with our investment
                      policy and
                      guidelines approved by our of
                      directors. **43**
 ***Analysis
                        of Consolidated Statements of Operations*** (in
                        thousands):
 **Year
                  Ended**
                **December
                  31, 2005**
              
              **Year
                  Ended**
                ******December
                  31, 2004**
              
              **Year
                  Ended**
                **December
                  31, 2003**
              
              **Percentage
                  Change****Increase/(Decrease)****$**
              
              
              **%
                  ofRevenue**
              
              
              **$**
              
              
              **%
                    ofRevenue**
              
              
              **$**
              
              
              **%
                    ofRevenue**
              
              
              **2005
                  vs.****2004**
              
              
              **2004
                  vs.****2003**Operating
                  revenuesCore
                  customer trade revenue
              
              $
              179,946
              
              
              93
              %
              $
              135,647
              
              
              90
              %
              $
              129,562
              
              
              87
              %
              
              33
              %
              
              5
              %Switched
                  access revenue
              
              
              13,071
              
              
              7
              %
              
              15,363
              
              
              10
              %
              
              18,610
              
              
              13
              %
              
              (15
              %)
              
              (17
              %)Total
                  revenue
              
              
              193,017
              
              
              100
              %
              
              151,010
              
              
              100
              %
              
              148,172
              
              
              100
              %
              
              28
              %
              
              2
              %Cost
                  of operating revenues (1)
              
              
              88,222
              
              
              46
              %
              
              69,279
              
              
              46
              %
              
              75,445
              
              
              51
              %
              
              27
              %
              
              (8
              %)Selling,
                  general and administrative (2)
              
              
              89,303
              
              
              46
              %
              
              73,111
              
              
              48
              %
              
              77,609
              
              
              52
              %
              
              22
              %
              
              (6
              %)Other
                  operating expenses
              
              
              21,531
              
              
              11
              %
              
              15,533
              
              
              10
              %
              
              15,415
              
              
              10
              %
              
              39
              %
              
              1
              %Interest
                  income
              
              
              (869
              )
              
              —
              
              
              (430
              )
              
              —
              
              
              (199
              )
              
              —
              
              
              *
              
              
              *Interest
                  expense
              
              
              3,817
              
              
              2
              %
              
              248
              
              
              —
              
              
              526
              
              
              —
              
              
              *
              
              
              *Other
                  income
              
              
              (7,686
              )
              
              —
              
              
              (418
              )
              
              —
              
              
              (1,859
              )
              
              —
              
              
              *
              
              
              *Loss
                  from continuing operations
              
              
              (1,301
              )
              
              (1
              %)
              
              (6,313
              )
              
              (4
              %)
              
              (18,765
              )
              
              (13
              %)
              
              (79
              %)
              
              (66
              %)Discontinued
                  operations:(Loss)
                  income from discontinued operations
              
              
              (48
              )
              
              (0
              %)
              
              908
              
              
              1
              %
              
              (2,368
              )
              
              (2
              %)
              
              *
              
              
              *Net
                  loss
              
              $
              (1,349
              )
              
              (1
              %)
              $
              (5,405
              )
              
              (4
              %)
              $
              (21,133
              )
              
              (14
              %)
              
              (75
              %)
              
              (74
              %)
 
 *
              Calculation
                  is not meaningful.(1)
              Exclusive
                  of depreciation and amortization included in other operating expenses
                  of
                  $15.6 million, $8.0 million and $7.7 million for the years ended
                  December
                  31, 2005, 2004 and 2003, respectively.(2)
              Exclusive
                  of depreciation and amortization included in other operating expenses
                  of
                  $6.0 million, $7.5 million and $8.7 million for the years ended
                  December
                  31, 2005, 2004 and 2003,
                  respectively.
 **44**
 *Year
        Ended December 31, 2005 vs. 2004*
 
 ***Operating
        Revenues.*** Total
        operating revenues increased to $193.0 million for the year ended December
        31,
        2005 as compared to $151.0 million for the year ended December 31, 2004.
        The 28%
        increase in revenue was primarily the result of:
 
 •
              An
                  increase of $25.9 million in our higher-end integrated voice and
                  data
                  services revenue resulting from an increase of approximately 4,100
                  average
                  loops in service from a combination of the addition of the ICG
                  California
                  business and growth in our pre-ICG California business.•
              An
                  increase of $17.5 million in our private line revenue from our
                  ICG
                  California acquisition.•
              An
                  increase of $3.1 million in our toll revenue primarily due to more
                  minutes
                  per customer, which resulted in an overall increase in minutes
                  of use.•
              An
                  increase of $1.7 million of directory assistance revenue as a result
                  of a
                  rate increase in the quarter ended March 31,
                  2005.
 
 These
        increases were offset by:
 
 •
              A
                  decrease in POTS revenue of $3.7 million, the result of an average
                  of
                  14,000 fewer POTS billable lines in service for the year ended
                  December
                  31, 2005 compared to the year ended December 31, 2004. The decrease
                  occurred despite the addition of approximately $1.6 million of
                  ICG
                  California POTS revenue in 2005.•
              A
                  decrease of $2.3 million in switched access revenues primarily
                  a result of
                  a decrease of $1.4 million due to a reduction in the types of the
                  Intralata toll traffic we agreed to bill to one of the ILECs during
                  the
                  first quarter of 2005, and a decrease of $1.4 million in Primary
                  Interexchange Carrier Charge ("PICC") revenue. The decrease occurred
                  despite the addition of approximately $1.5 million of ICG California
                  switched access revenue in 2005.
   ***Cost
        of Operating Revenues.*** Cost of
        operating revenues (excluding depreciation and amortization) for the year
        ended
        December 31, 2005, was $88.2 million as compared to $69.3 million for the
        year
        ended December 31, 2004. The 27% or $18.9 million increase in the cost of
        operating revenues is primarily due to:
 
 •
              An
                  increase in our customer T1 expense of $9.2 million. Our pre-ICG
                  California business accounted for $3.8 million of the increase.
                  For the
                  year ended December 31, 2005, we had an increase in the number
                  of customer
                  lines in service and an increase in the average cost per T1 resulting
                  from
                  ordering higher cost circuits to meet customer needs. The remaining
                  $5.4
                  million increase is attributable to the ICG California acquired
                  customer
                  T1 lines.•
              An
                  increase of $5.8 million in rent and utilities, as a result of
                  the
                  acquisition of ICG California leased switch sites.•
              An
                  increase of $4.8 million for network access expense. This increase
                  is
                  attributable to the transition of the ICG California network to
                  our
                  existing network in early 2005. In May 2005 we started the conversion
                  of
                  the ICG California network to our network. In September 2005 we
                  began the
                  process of reducing duplicate circuits. We anticipate a reduction
                  in
                  network access expense in the year ending December 31, 2006 as
                  a result of
                  a continued cost and utilization grooming of our
                  network.•
              Collocation
                  cost increased $0.6 million or an 8% increase. This is a result
                  of the
                  assumption of the rented space in the ICG California collocation
                  sites.•
              An
                  increase in non-recurring charges of $0.6 million. This increase
                  is a
                  result of an ILEC settlement credit in March 2004 and from a modest
                  increase in installation expense for the twelve months ended December
                  31,
                  2005 compared to the twelve months ended December 31,
                  2004.
 
 These
        increases were offset by:
 
 •
              A
                  settlement with a major ILEC on disputes that resulted in a $1.0
                  million
                  reduction of cost of operating revenue in the year ended December
                  31,
                  2005.•
              A
                  decrease of $0.7 million for operator and directory assistance
                  expense.
                  During 2005 we moved our service to a lower cost vendor resulting
                  in a
                  reduction in the rates we are charged for this service.•
              Decrease
                  in our POTS expense of $0.1 million resulting from a decrease in
                  the
                  number of loops for the year ended December 31, 2005 compared to
                  the year
                  ended December 31, 2004. This is a result of POTS customers discontinuing
                  our services as we focus our business more on our T1
                  platform.
 **45**
 ***Selling,
        General and Administrative.*** For the
        year ended December 31, 2005, selling, general and administrative expenses
        (excluding depreciation and amortization) totaled $89.3 million, a 22% or
        $16.2
        million increase compared to the $73.1 million for the year ended December
        31,
        2004. The increase is primarily due to:
 
 •
              An
                  $8.4 million increase in salary, wages and benefit related expenses.
                  This
                  is primarily the result of an increase in average headcount from
                  approximately 720 employees for the year ended December 31, 2004
                  to
                  approximately 800 employees for the year ended December 31, 2005,
                  due to
                  the growth of our business and the impact of the ICG California
                  acquisition.•
              A
                  $2.4 million increase in agent commissions as a result of significant
                  revenue growth for the independent agent sales channel and changes
                  made to
                  our agent commission structure for competitive reasons.•
              Additional
                  expenses of $2.1 million for incremental transition expenses related
                  to
                  the integration of assets as a result of the ICG California acquisition
                  on
                  January 1, 2005. We do not expect to incur additional incremental
                  transition expenses during 2006.•
              A
                  $1.4 million increase in property tax related expense primarily
                  due to the
                  ICG California acquisition in January 2005 and reversal of certain
                  accrued
                  property taxes during the year ended December 31, 2004 resulting
                  from the
                  resolution of property tax audits in California and adjustments
                  in
                  estimated audit exposure in other states.•
              Additional
                  expenses of $1.3 million pursuant to our transition services agreement
                  with ICG under which certain services related to the acquired operations
                  of ICG California were performed for us by ICG. These services
                  primarily
                  related to accounting, billing, collections, provisioning, call
                  center and
                  network support. A significantly reduced amount of these transition
                  services are expected to be provided through the first quarter
                  of 2006.
                  Therefore, we anticipate incurring minimal additional expenses
                  for this
                  item in the future.•
              A
                  $0.8 million increase in engineering equipment and network maintenance
                  expense driven by our network expansion as a result of the ICG
                  California
                  acquisition.•
              A
                  $0.7 million increase in bad debt expense primarily a result of
                  the
                  recently acquired ICG California wholesale revenue streams.•
              A
                  $0.6 million increase in severance obligations incurred during
                  the year
                  ended December 31, 2005 in connection with the resignation of two
                  executive officers.•
              A
                  $0.5 million increase in outside services expenses resulting from
                  higher
                  expenses relating to contract services and timing of professional
                  fees for
                  Sarbanes-Oxley compliance and audit
                  expenses.
 
 The
        increased expenses were partially offset by:
 
 •
              A
                  $1.6 million decrease in additional benefits which was primarily
                  the
                  result of lower management bonuses for the year ended December
                  31, 2005 as
                  a result of not achieving certain predetermined financial
                  goals.•
              A
                  $1.1 million decrease in expense related to a paid time off policy
                  change
                  for certain of our employees effective September 1, 2005. This
                  is a one
                  time reduction. Therefore, no future expense reduction is
                  anticipated.•
              A
                  $0.6 million decrease resulting from a favorable settlement reached
                  on an
                  equipment lease dispute during the year ended December 31, 2005.
                  See Note
                  10 to the financial statements for additional information related
                  to this
                  settlement.
 
 We
        have
        increased headcount over the past 24 months primarily as a result of the
        acquisition of ICG California and customer initiatives. During 2006, we
        anticipate increasing our headcount a small amount which will result in higher
        selling, general and administrative expense in 2006 than 2005. These planned
        headcount increases are for our VOIP initiatives, an increased focus on growing
        and managing our existing customer base and productivity and gross margin
        enhancing activities. In addition, effective January 1, 2006, we are required
        to
        recognize compensation expense for all share-based payments, which will increase
        our selling, general and administrative expense in 2006 and beyond.
   ***Network
        Optimization.*** For the
        year ended December 31, 2005, we recognized $0.1 million of income related
        to
        the release of our accrued network optimization reserve for rent expense.
        This
        release in the network optimization reserve was a direct result of a final
        decree issued by the US Bankruptcy Court on December 29, 2005.
 
 ***Depreciation
        and Amortization.*** For the
        year ended December 31, 2005, depreciation and amortization was $21.7 million
        as
        compared to $15.5 million for the year ended December 31, 2004. The additional
        depreciation and amortization was primarily attributable to the $32.3 million
        of
        property and equipment and $3.1 million of intangibles acquired from ICG
        in
        January 2005.
 
 ***Interest
        Income.*** Interest
        income was $0.9 million for the year ended December 31, 2005, compared to
        $0.4
        million for the year ended December 31, 2004. Interest income is derived
        primarily from the investment of cash and cash equivalents, investments
        available-for-sale and restricted cash and cash equivalents. The increase
        is
        largely due to increases in our rates of return on investments.
 **46**
 ***Interest
        Expense.*** Gross
        interest expense for the year ended December 31, 2005 totaled $3.8 million,
        as
        compared to $0.2 million for the year ended December 31, 2004. Interest expense
        includes interest on capital lease commitments and commitment fees and interest
        paid relating to our line of credit. The increase is primarily a result of
        our
        assumption of capital leases in the ICG California acquisition.
  ***Other
        Income.*** For
        the
        year ended December 31, 2005, we recorded $7.7 million of other income, which
        was primarily comprised of $7.2 million related to early termination of our
        Las
        Vegas, Nevada switch site lease, which is net of exit expenses. This was
        a
        one-time transaction and is not expected to occur again. We are spending
        a
        portion of the cash received on the construction of a replacement switch
        facility in Las Vegas during the first quarter of 2006. For the year ended
        December 31, 2004, we recorded a minimal amount of other income primarily
        related to the gain on asset sales. These gains primarily resulted from the
        sale
        of network equipment.
 
 *Year
        Ended December 31, 2004 vs. 2003*
 
 ***Operating
        Revenues.*** Total
        operating revenues increased to $151.0 million for the year ended December
        31,
        2004 as compared to $148.2 million for the year ended December 31, 2003.
        The 2%
        increase in revenue was primarily the result of:
 
 •
              A
                  $12.9 million or 40% increase in revenue related to our T1 based
                  products
                  and services as we had an increase in the number of business customers
                  receiving those services, offset by:•
              A
                  $7.0 million or 8% decline in our plain old telephone service (“POTS”)
                  revenue as we focus more of our business and new revenue on our
                  T1 based
                  products and services; and•
              A
                  $3.2 million or 17% decrease in our switched access revenue. This
                  decrease
                  in switched access revenue was primarily a result of 1) a decrease
                  in
                  revenue of $1.5 million related to the reduction in rates we negotiated
                  with our major carriers and a decrease in rates mandated by the
                  FCC; 2) a
                  decrease in revenue of $2.9 million related to a decrease in rates
                  related
                  to intralata toll charges for one of the ILECs and a dispute with
                  another
                  ILEC regarding intralata toll usage; and 3) an increase in revenue
                  of $1.2
                  million related to one-time resolution of disputes over presubscribed
                  interexchange carrier charges, a switched access
                  element.
 
 ***Cost
        of Operating Revenues.*** Cost of
        operating revenues (excluding depreciation and amortization) for the year
        ended
        December 31, 2004, was $69.3 million as compared to $75.4 million for the
        year
        ended December 31, 2003. The 8% or $6.1 million decrease in the cost of
        operating revenues is primarily due to:
 
 •
              A
                  $3.0 million or 10% decrease in the recurring expense related to
                  our POTS
                  resulting from a 10% decrease in average POTS lines in service
                  for the
                  year ended December 31, 2004, versus the year ended December 31,
                  2003, as
                  we continued to move more of our revenue toward data services.•
              A
                  $3.1 million or 84% increase in the cost of T1 and trunk services
                  for the
                  year ended December 31, 2004, compared to the year ended December
                  31,
                  2003. This increase is the result  of revenue growth of 46% for
                  these services for the year ended December 31, 2004, compared to
                  the year
                  ended December 31, 2003.•
              A
                  $2.0 million or 36% decrease in the cost of providing long-distance
                  services for the year ended December 31, 2004, compared to the
                  year ended
                  December 31, 2003. This decrease is a result of a decrease in the
                  average
                  cost per minute partially offset by an increase in minutes of use
                  for the
                  year ended December 31, 2004, compared to the year ended December
                  31,
                  2003.•
              A
                  $4.3 million or 26% decrease in the cost of our network infrastructure
                  for
                  the year ended December 31, 2004, compared to the year ended December
                  31,
                  2003. Cost savings have been achieved through grooming the network
                  of
                  unneeded capacity, routing traffic by a more cost effective means,
                  and the
                  effect of a capital project focused on replacing higher cost circuits
                  with
                  lower cost circuits.
 **47**
  ***Selling,
        General and Administrative.*** For the
        year ended December 31, 2004, selling, general and administrative expenses
        (excluding depreciation and amortization) totaled $73.1 million, a 6% or
        $4.5
        million decrease compared to the $77.6 million for the year ended December
        31,
        2003. The decrease is primarily due to:
 
 •
              A
                  $2.6 million reduction in bad debt expense as a result of higher
                  credit
                  standards for new customers and continued effective collection
                  efforts. In
                  addition, during 2003, we reached resolution of several disputes
                  with our
                  switched access customers resulting in the need for higher bad
                  debt
                  expense in that period.•
              A
                  reduction in salary, wages and benefit related expense of $2.3
                  million.
                  This decrease primarily results from severance obligations incurred
                  during
                  the year ended December 31, 2003, and reduced employee commission
                  expense
                  as a result of a comprehensive reshaping of our sales
                  organization.•
              A
                  $1.1 million reduction in occupancy expense, which is primarily
                  the result
                  of office space reductions in our Las Vegas, Nevada and Chicago,
                  Illinois
                  markets.•
              A
                  $0.9 million reduction in insurance expense primarily driven by
                  more
                  competitive insurance rates available during 2004 than during 2003,
                  as
                  well as our lower asset-value base in 2004 resulting from the Asset
                  Sales
                  which contributed to the overall lower insurance
                  expenses.•
              A
                  $0.8 million reduction in property tax related expense primarily
                  due to a
                  reversal of accrued property tax resulting from the resolution
                  of property
                  tax audits in California and ongoing adjustments in estimated liability
                  in
                  other states.
 
 The
        reduced expenses were partially offset by:
 
 •
              A
                  $1.4 million increase in equipment related expense due to a favorable
                  settlement with a vendor during the year ended December 31, 2003,
                  and a
                  $1.0 million increase in agent commissions as a result of significant
                  growth within the independent agent channel.•
              Additional
                  expenses of $0.5 million for incremental transition expenses related
                  to
                  preparation for the integration of the ICG acquisition. We completed
                  the
                  acquisition of ICG’s California retail and wholesale customers and
                  statewide fiber network on January 1, 2005.•
              Costs
                  related to our required compliance with Section 404 provisions
                  of the
                  Sarbanes-Oxley Act during the year ended December 31, 2004. In
                  2004, we
                  spent $0.5 million in these compliance efforts. This amount excludes
                  any
                  allocation of our personnel who spent time during 2004 on
                  Sarbanes-Oxley.
 
 ***Network
        Optimization.*** For
        the
        year ended December 31, 2003, we recognized a $1.0 million reduction to our
        previously recognized network optimization costs primarily resulting from
        a
        final settlement with one of our network carriers. ****** With
        respect to the network optimization charges, the total actual charges have
        been
        based on ultimate settlements with the incumbent local exchange carriers,
        recovery of costs from subleases, our ability to sell or re-deploy network
        equipment for growth in our existing network and other factors. The closing
        down
        of these markets as part of the network optimization charges have contributed
        materially to our improved operating performance and is expected to materially
        benefit our future operating results. There are no remaining liabilities
        attributable to our network optimization charges that will have a material
        future impact on our liquidity or results from operations.
 
 ***Depreciation
        and Amortization.*** For the
        year ended December 31, 2004, depreciation and amortization was $15.5 million
        as
        compared to $16.4 million for the year ended December 31, 2003. The decrease
        was
        a result of a reduction in the depreciable base of assets.
 
 ***Interest
        Income.*** Interest
        income was $0.4 million for the year ended December 31, 2004, compared to
        $0.2
        million for the year ended December 31, 2003. Interest income is derived
        primarily from the investment of cash and cash equivalents, investments
        available-for-sale and restricted cash and cash equivalents. The increase
        in
        interest income results from higher average cash and investments, primarily
        the
        result of additional cash we raised from the issuance of common stock in
        September 2003, as well as continued reductions to our operating
        losses.
 
 ***Interest
        Expense.*** Gross
        interest expense for the year ended December 31, 2004 totaled $0.2 million,
        as
        compared to $0.5 million for the year ended December 31, 2003. Interest expense
        includes commitment fees and interest paid relating to our line of credit
        and
        interest on capital lease obligations. The decrease in interest expense is
        primarily related to a reduction in average borrowings under our line of
        credit
        and the fulfillment of capital lease obligations during 2004.
 
 ***Other
        Income*** *.* ****** For
        the
        year ended December 31, 2004, we reported $0.4 million of other income as
        compared to $1.9 million for the year ended December 31, 2003. Other income
        recognized during 2003 resulted primarily from the reversal of a sales tax
        contingency reserve deemed no longer needed.
 
 **Discontinued
        Operations**
 
 In
        January 2003, we announced a series of strategic and financial transactions
        to
        further strengthen us financially and focus our operations on our California,
        Nevada and Illinois markets. We brought geographic concentration to our business
        by selling our customers and assets in Florida, Georgia, Ohio, Michigan and
        Texas to other service providers (the “Asset Sales”).
 
 In
        March
        2003, we completed the sale of our assets in our Ohio and Michigan markets
        to
        LDMI Telecommunications, Inc. ("LDMI") pursuant to Asset Purchase Agreements
        dated as of February 6, 2003 and January 8, 2003. The purchase price for
        the
        assets in Ohio and Michigan was $3.3 million and $3.8 million, respectively.
        As
        of December 31, 2003, the total purchase price had been received. In addition,
        LDMI agreed to assume certain liabilities from us with respect to the Ohio
        and
        Michigan assets.
 **48**
 In
        March
        2003, we completed a transaction with Xspedius Equipment Leasing, LLC ("XE"),
        a
        subsidiary of Xspedius Communications, LLC ("Xspedius") pursuant to an Asset
        Contribution Agreement effective as of December 31, 2002. Under the terms
        of the
        Asset Contribution Agreement, we contributed the assets in our Texas market
        to
        XE in exchange for a 14% interest in XE. In April 2003, we sold 92.85% of
        our
        interest in XE (13% of XE) to a current member of XE for $0.5 million. In
        addition, XE agreed to assume certain liabilities from us with respect to
        the
        Texas assets. In
        April
        2003, we completed the sale of our assets in our Florida and Georgia markets
        to
        Florida Digital Networks, Inc. (“FDN”), pursuant to an Asset Purchase Agreement
        dated as of January 8, 2003. The purchase price for the assets in Florida
        and
        Georgia was $12.4 million. In addition, FDN agreed to assume certain of our
        liabilities with respect to the Florida and Georgia assets. As of December
        31,
        2005, $12.0 million of the purchase price has been received and the remaining
        $0.4 million was being held in escrow.
 
 Each
        of
        the transactions described above involved transition services and/or management
        agreements that were sufficient to transfer the operations of these businesses.
        We were reimbursed for the cost of specific services provided on behalf of
        the
        buyer. For the year ended December 31, 2003, we recognized $3.7 million of
        reimbursements for transition services and management agreement fees. The
        amounts recognized from the transition services and management agreements
        have
        been included as an offset to the operating expenses component of income
        (loss)
        from discontinued operations in our consolidated statements of operations.
        We
        ceased providing transition services as of December 31, 2003.
 
 As
        of
        December 31, 2005, we have recorded a $0.4 million receivable related to
        asset
        sales from discontinued markets. This receivable has been included in other
        receivables in our consolidated balance sheets and the balance is being held
        in
        escrow by a third party escrow agent. We expect to receive the remaining
        $0.4
        million, net of expenses chargeable to us of $0.3 million included in accrued
        other expenses on the consolidated balance sheet, before June 2006. Subsequent
        to December 31, 2005, an additional $0.1 million of the remaining escrow
        was
        received.
 
 The
        operating revenues and expenses of our discontinued markets have been classified
        as discontinued operations under
        SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”
for all periods presented. (Loss) income related
        to these discontinued markets was as follows for the years ended December
        31,
        2005, 2004 and 2003 (in thousands):
  **Year
                  Ended December 31,****2005**
              
              
              **2004**
              
              
              **2003**Operating
                  revenues
              
              $
              33
              
              $
              4
              
              $
              6,150Operating
                  (income) expenses
              
              
              81
              
              
              (584
              )
              
              7,995(Gain)
                  loss on disposal
              
              
              —
              
              
              (320
              )
              
              523(Loss)
                  income from discontinued operations
              
              $
              (48
              )
              $
              908
              
              $
              (2,368
              )
 
 During
        2005, we recorded $0.1 million in operating expenses primarily driven by
        rent
        expense of $0.2 million for a leased switch location not assigned as part
        of the
        market sales, offset by reversals of use and property tax liabilities of
        $0.1
        million. During 2004, we recorded $0.6 million of operating income from
        discontinued operations, primarily related to the reversal of sales and property
        tax liabilities resulting from the resolution of tax audits and ongoing
        estimates of audit exposure in other states, as well as the resolution of
        certain disputes with several carriers. During 2003, we recorded $8.0 million
        in
        operating expenses from discontinued operations, primarily related to the
        ongoing operation of the discontinued markets through the date of sale.
        Operating expense for the year ended December 31, 2003 included exit costs
        of
        $2.4 million, primarily related to facility and lease contract termination
        costs
        of $1.8 million and one-time severance termination benefits of $0.6
        million.
 
 For
        the
        year ended December 31, 2004, we recorded a gain on disposal of $0.3 million
        to
        account for an adjustment in the costs to sell the assets. For the year ended
        December 31, 2003, we recorded a loss on disposal of $0.5 million, which
        was
        comprised of a $1.2 million loss on disposal to account for the resolution
        of
        purchase price adjustments and additional costs to sell the assets, partially
        offset by a $0.7 million gain resulting from the reversal of pre-bankruptcy
        sales tax contingency due to a favorable resolution regarding this
        matter.
 
 These
        amounts are reflected in income (loss) from discontinued operations in our
        consolidated statements of operations.
 **49**
 **Application
        of Critical Accounting Estimates**
 
 The
        discussion and analysis of our financial condition and results of operations
        is
        based upon our consolidated financial statements, which have been prepared
        in
        accordance with accounting principles generally accepted in the United States
        of
        America. The preparation of these financial statements requires us to make
        estimates and judgments that affect the reported amounts of assets, liabilities,
        revenues and expenses, and related disclosure of contingent assets and
        liabilities. Management believes that the following accounting policies fall
        within the Securities and Exchange Commission’s definition of “critical
        accounting policies,” or involve a “critical accounting estimate” because they
        are particularly dependent upon estimates and assumptions made by management
        about matters that are highly uncertain at the time the accounting estimates
        are
        made. In addition, while we have used our best estimates based on facts and
        circumstances available to us at the time, different estimates reasonably
        could
        have been used in the current period, and changes in the accounting estimates
        we
        used are reasonably likely to occur from period to period which may have
        a
        material impact on the presentation of our financial condition and results
        of
        operations. We review these estimates and assumptions periodically and reflect
        the effects of revisions in the period that they are determined to be necessary.
        We have reviewed our critical accounting policies with our audit
        committee.
 
 On
        an
        on-going basis, we evaluate our estimates, including those related to revenue
        recognition, allowance for doubtful accounts, billing from network carriers,
        sales and property taxes, deferred income taxes, impairment of goodwill,
        other
        intangible and long-lived assets, business combinations and capital lease
        obligations. We base our estimates on historical experience and on various
        other
        assumptions that are believed to be reasonable under the circumstances, the
        results of which form the basis for making judgments about the carrying values
        of assets and liabilities that are not readily apparent from other sources.
        Actual results may differ from these estimates under different assumptions
        or
        conditions. We believe the following critical accounting policies reflect
        our
        more significant judgments and estimates used in the preparation of our
        consolidated financial statements.
  *Revenue
        Recognition* :
        We
        recognize operating revenues as services are rendered to customers in accordance
        with the Securities and Exchange Commission’s (“SEC”) Staff Accounting Bulletin
        (“SAB”) No. 104, “Revenue Recognition.” We recognize revenue from monthly
        recurring charges, enhanced features and usage in the period in which service
        is
        provided. Advance billings for services not yet provided are deferred and
        recognized as revenue in the period in which service is provided. We bill
        the
        transactional elements of usage-based services in arrears. Estimates are
        used
        for these services to recognize revenue in the period earned. Nonrefundable
        activation fees are also deferred and recognized as revenue over the expected
        term of the customer relationship.
 
 We
        recognize revenue from switched access in the period in which service is
        provided, when the price is fixed, the earnings process is complete and the
        collectability is reasonably assured. In circumstances when these criteria
        are
        not met, revenue recognition is deferred until these criteria are met.
        Consequently, under such circumstances, although we continue to bill the
        customer for all services provided, we do not recognize revenue until cash
        is
        received. As
        part
        of the revenue recognition process for switched access, we evaluate whether
        receivables are reasonably assured of collection based on certain factors,
        including past credit history, financial condition of the customer, industry
        norms, past payment history of the customer and the likelihood of billings
        being
        disputed by customers. If
        the
        amount we collect, in the future, from our switched access charges varies
        significantly from our estimates, our revenue may be negatively
        affected.
 
 Judgments
        in recognizing revenue may affect our results and cause our revenue to be
        difficult to predict. Any changes in recognizing revenue could cause our
        operating results to vary significantly.
 
 *Allowance
        For Doubtful Accounts* :
        We
        maintain allowances for doubtful accounts for estimated losses resulting
        from
        our inability to collect all amounts owed by our customers for our services.
        We
        have recorded both specific and general reserves for bad debt to reduce the
        related receivables to the amount we ultimately expect to collect from
        customers. In order to estimate the appropriate level of this allowance,
        we
        analyze 1) historical bad debts, 2) disputes, 3) current economic, industry
        and
        competitive trends, 4) specific information we obtain on the financial condition
        or changes in the credit worthiness of our customers, and 5) changes in our
        customer payment patterns and other relevant factors. If the financial condition
        of our customers were to deteriorate and impact their ability to make payments,
        or certain carriers dispute amounts we have billed, additional allowances
        may be
        required. In establishing the allowance for doubtful accounts, we have taken
        into consideration the aggregate risk of our receivables. If actual results
        differ from our estimates, we may need to adjust our allowance for doubtful
        accounts in the future.
 
 *Billing
        From Network Carriers* :
        Various
        long distance carriers and incumbent carriers lease loop, transport and network
        facilities to us. The pricing of such facilities is governed by either a
        tariff
        or an interconnection agreement. These carriers bill us for our use of such
        facilities. From time to time, the carriers present inaccurate bills to us,
        which we dispute. As a result of such billing inaccuracies, we record an
        estimate of our liability based on our measurement of services received.
        When
        disputes are ultimately resolved, our cost of operating revenues (excluding
        depreciation and amortization) may increase or be reduced in the period the
        dispute is settled depending upon the final resolution. As the period of
        time
        required to resolve these types of disputes often extends over several quarters,
        the effect of the ultimate resolution of such disputes is normally realized
        in
        periods subsequent to the period in which the dispute is initiated.
 
 As
        of
        December 31, 2005, we had $4.6 million of invoices disputed with carriers.
        We
        have recorded a reserve of $0.3 million related to the disputed balances.
        Based
        on the nature and history of disputes with the carriers, we believe this
        amount
        to be adequate. Any significant changes as a result of the resolution of
        these
        disputes may require us to adjust our reserves in the future and would affect
        our operating results accordingly.
 **50**
 *Sales
        and Property Taxes:* We
        maintain reserves for estimated exposure for various sales and use taxes
        that
        taxing jurisdictions may claim as being owed due to interpretations of state
        and
        local regulations. In addition, we maintain reserves for positions taken
        related
        to the underlying taxable base of capital expenditures made in past years
        by
        Mpower Lease Corporation, a wholly owned subsidiary of Communications prior
        to
        June 30, 2005, when it was liquidated into Communications. Similarly, reserves
        are maintained for positions taken on the assessment basis used to pay certain
        property taxes to various state and local taxing jurisdictions. These tax
        matters can be complex in nature and uncertain as to the ultimate outcome.
        Although we believe our positions are fully supportable, we consider the
        likelihood of potential challenges and the sustainability of such challenges
        upon examination. Changes in our tax reserves have occurred and are likely
        to
        continue to occur as our assessments change based on current facts and
        circumstances, such as further developments and progress of tax examinations
        in
        various jurisdictions.
 
 We
        continually review the facts and circumstances of each of these reserves
        in
        accordance with the requirements of Statement of Financial Accounting Standards
        (“SFAS”) No. 5, “Accounting for Contingencies”, and believe that each reserve
        recorded is appropriate at December 31, 2005. Any significant results from
        audits, other triggering events, or the passage of time, may require us to
        adjust our reserves in the future and would affect our operating results
        at that
        time.
 
 *Deferred
        Income Taxes* :
        We
        record deferred income tax assets and liabilities on our balance sheet related
        to events that impact our financial statements and income tax returns in
        different periods. To compute these deferred income tax balances, we first
        analyze the differences between the book bases and tax bases of our assets
        and
        liabilities (referred to as “temporary differences”). These temporary
        differences are then multiplied by current tax rates to arrive at the balances
        for the deferred income tax assets and liabilities. We then must estimate
        whether deferred income tax asset amounts will be realized in the future.
        A
        valuation allowance is provided for the deferred income tax asset amounts
        that
        are not likely to be realized. At this time, our judgment is that it is more
        likely than not that no benefit from net deferred income tax assets will
        be
        recognized and therefore a full valuation allowance has been provided for
        against these net deferred income tax assets as of December 31, 2005. Future
        changes in this judgment could result in a material impact to our net
        income.
 
 *Goodwill
        and Intangible Assets:* Goodwill
        results from the ICG California acquisition, which was determined based on
        purchase accounting standards as the excess of the purchase price including
        liabilities assumed over the fair value of identifiable assets acquired.
        Intangibles consist primarily of customer relationships and trademark. SFAS
        No.
        142, “Goodwill and Other Intangible Assets” (SFAS No. 142) provides that
        goodwill and other separately recognized intangible assets with indefinite
        lives
        are not amortized, but are subject to at least an annual assessment for
        impairment through the application of a fair-value-based test. We utilize
        November 30 as our annual impairment test measurement date. Intangible assets
        that do have finite lives are amortized over their estimated useful lives
        and
        reviewed for possible impairment in accordance with SFAS No. 144 “Accounting for
        the Impairment or Disposal of Long-Lived Assets,” as discussed within the
“Impairment of Long-Lived Assets” section below.
 
 The
        identification and measurement of goodwill impairment involves a comparison
        of
        the estimated fair value of a reporting unit with the carrying value of the
        reporting unit. We estimate the fair value of our reporting unit based on
        the
        market capitalization of our common stock as of our annual impairment test
        measurement date. Our impairment review for indefinite lived intangible assets
        is based on a combination of a market based approach and a relief from royalty
        approach. The market based approach estimates the fair value of an asset
        based
        on a comparison of the asset to comparable publicly traded assets in our
        industry or transactions involving similar assets. The relief from royalty
        approach estimates the fair value of an asset based on the value of the cash
        flows that we expect to generate in the future, which requires significant
        judgment with respect to future volume, revenue and expense growth rates,
        and
        the selection of an appropriate discount rate. We use estimates based on
        expected trends in making these assumptions. An impairment charge is recorded
        for the difference between the carrying value of the asset and the estimated
        fair value of the asset. We use judgment in assessing whether assets may
        have
        become impaired between annual valuations. Indicators such as unexpected
        adverse
        economic factors, unanticipated technological change or competitive activities,
        or acts by governments and courts, may signal that an asset has become impaired.
        No impairment charges were recorded on goodwill or indefinite lived intangibles
        in 2005, 2004 or 2003.
 
 *Impairment
        of Long-Lived Assets:* Property
        and equipment, finite lived intangible assets, and other long-lived assets
        are
        reviewed for possible impairment in accordance with SFAS No. 144. We conduct
        annual reviews for idle and underutilized equipment, and review business
        plans
        for possible impairment implications. If an event or change in circumstance
        arises that indicates the carrying amount of the asset may not be recoverable,
        an impairment review is performed by us. Our impairment review is based on
        an
        undiscounted cash flow analysis at the lowest level for which identifiable
        cash
        flows exist. The analysis requires management judgment with respect to changes
        in technology, the continued success of product and service offerings, and
        future volume, revenue and expense growth rates. Impairment occurs when the
        carrying value of the asset exceeds the future undiscounted cash flows. When
        an
        impairment is indicated, the estimated future cash flows are then discounted,
        or
        another appropriate fair value methodology is utilized, to determine the
        estimated fair value of the asset and an impairment charge, if any, is recorded
        for the difference between the carrying value and the fair value of the asset.
        No impairment charges were recorded on long-lived assets in 2005, 2004 or
        2003.
 
 *Business
        Combinations:* On
        January 1, 2005, we acquired title to the ICG California business. We retained
        an independent appraiser to assist in determining the fair value of certain
        assets acquired and liabilities assumed as required under SFAS No. 141. See
        the
        section titled “ *ICG
        California Acquisition* ”
for
        a
        summary of the fair value of assets acquired and liabilities
        assumed. Although
        we believe the values assigned to the assets acquired and liabilities assumed
        to
        be reasonable, differences in valuation of these assets or liabilities would
        have resulted in a change in the value of our intangible
        assets.
 **51**
 *Capital
        Lease Obligations:* Pursuant
        to the acquisition of ICG California in January 2005, we assumed certain
        capital
        leases of ICG, including certain long-term leases for its fiber network,
        which
        had a fair value of $26.0 million as of January 1, 2005 utilizing an implicit
        interest rate of 15%. The capital lease obligations have terms that range
        from 2
        to 16 years. See Note (8) to our financial statements for a table showing
        the
        future minimum lease payments for our capital leases. Although we believe
        the
        values assigned to the capital leases to be reasonable, differences in the
        assumptions of the implicit interest rate of the capital leases would have
        the
        effect of increasing or decreasing the value of the capital leases.
  **Effects
        of New Accounting Standards**
 
 *Accounting
        for Conditional Asset Retirement Obligations - an interpretation of FASB
        Statement No. 143*
 
 In
        March
        2005, the Financial Accounting Standards Board (“FASB”) issued FASB
        Interpretation No. (“FIN”) 47, "Accounting for Conditional Asset Retirement
        Obligations - an interpretation of FASB Statement No. 143, " which clarifies
        the
        term "conditional asset retirement obligation" used in FASB No. 143 "Accounting
        for Asset Retirement Obligations" and specifically when an entity would have
        sufficient information to reasonably estimate the fair value of an asset
        retirement obligation. The provisions of FIN 47 were effective as of December
        31, 2005. The adoption of FIN 47 did not have a material impact on our
        consolidated results of operations or financial condition.
 
 *Share-Based
        Payment*
 
 In
        December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment" (FAS
        123R)
        which requires us to measure and recognize compensation expense for all
        share-based payments at fair value. In addition, the FASB has issued a number
        of
        supplements to FAS 123R to guide the implementation of this new accounting
        pronouncement. Share-based payments include stock option grants and other
        equity-based awards granted under our long-term incentive and stock option
        plans. FAS 123R will be effective beginning January 1, 2006. We will use
        the
        Black-Scholes valuation model as the method for determining the fair value
        of
        our equity awards that we issue after January 1, 2006. We will use the modified
        prospective transition method, which requires that compensation cost be
        recognized in our financial statements for all awards granted after the date
        of
        adoption as well as for existing awards for which the requisite service has
        not
        been rendered as of the date of adoption (the “Existing Awards”) and requires
        that prior periods not be restated. We estimate that we will recognize
        compensation expense related to Existing Awards of $1.4 million and $0.6
        million
        over the remaining requisite service periods during the years ending December
        31, 2006 and 2007, respectively. The impact of Existing Awards for the year
        ending December 31, 2008 is minimal. We cannot yet estimate what the
        compensation expense impact will be on our financial statements for the awards
        that we issue after January 1, 2006. FAS 123R also requires us to calculate
        the
        pool of excess tax benefits available to absorb tax deficiencies recognized
        subsequent to adopting FAS 123R (the “APIC Pool”). We are currently evaluating
        acceptable methods for calculating our APIC Pool.
 
 *Accounting
        Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB
        Statement No. 3*
 
 In
        May
        2005, the FASB issued SFAS No. 154 "Accounting Changes and Error Corrections,
        a
        replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS No. 154
        requires that all voluntary changes in accounting principles be recognized
        as a
        retroactive restatement of all periods presented except when retroactive
        restatement is impracticable. In addition, SFAS No. 154 also requires that
        a
        change in depreciation method be accounted for as a change in accounting
        estimate that is affected by a change in accounting principle, which would
        be
        accounted for in the period of change if the change affects that period and
        also
        in future periods if the change affects both the period of change and future
        periods. SFAS No. 154 also eliminates paragraph 4 of APB 20, which specifies
        that APB 20 does not apply to changes made to comply with new pronouncements.
        This Statement will require that any change in an accounting principle made
        as a
        result of a new pronouncement be reported following the same guidance as
        that
        for voluntary changes in accounting principles unless the new pronouncement's
        transition provisions require another method. SFAS No. 154 is effective for
        years beginning after December 15, 2005. We do not expect the adoption of
        SFAS
        No. 154 to have a material impact on our consolidated results of operations
        or
        financial condition.
 
 *Minimum
        Revenue Guarantees Granted to a Business or Its Owners*
 
 In
        November 2005, the FASB issued FASB Staff Position (“FSP”) No. FIN
        45-3, *“* Application
        of FASB Interpretation No. 45 to Minimum Revenue Guarantees Granted to a
        Business or Its Owners,” which amends paragraph 3 of FIN 45, “Guarantor's
        Accounting and Disclosure Requirements for Guarantees, Including Indirect
        Guarantees of Indebtedness of Others,” to include minimum revenue guarantees.
        FSP No. FIN 45-3 requires that a liability be recognized at inception for
        the
        fair value of the obligation to stand ready to perform under the guarantee,
        even
        if it is not probable that the contingent events that would cause payment
        will
        occur. FSP No. FIN 45-3 is effective for new minimum revenue guarantees issued
        or modified on or after the beginning of the first fiscal quarter following
        November 10, 2005, with disclosure requirements effective for any minimum
        revenue guarantee issued prior to the initial application of the FSP. We
        are
        currently evaluating the potential effect of the adoption of FSP No. FIN
        45-3
        and do not believe that it will have a material impact on our consolidated
        results of operations or financial condition.
 **52**
 **Forward
        Looking Statements**
 
 Under
        the
        safe harbor provisions of the Private Securities Litigation Reform Act of
        1995,
        we caution the reader that certain statements contained in this report regarding
        our and/or management’s intentions, hopes, beliefs, expectations or predictions
        of the future are forward-looking statements. We wish to caution the reader
        these forward-looking statements are not historical facts and are only estimates
        or predictions. Actual results, including projections with respect to our
        future
        operating performance, may differ materially from those projected as a result
        of
        risks and uncertainties including future sales growth, changes in federal
        or
        state telecommunications regulations, market acceptance of our product and
        service offerings, the liquidity of our common stock, our ability to secure
        adequate financing or equity capital to fund our operations and network
        expansion, our ability to manage growth and maintain a high level of customer
        service, the performance of our network and equipment, our ability to enter
        into
        strategic alliances or transactions, the cooperation of incumbent local exchange
        carriers in provisioning lines and interconnecting our equipment, regulatory
        approval processes, the effect of regulatory decisions on our access charges
        and
        operating costs, changes in technology, price competition and other market
        conditions and risks detailed in Item 1A - “Risk Factors.” We undertake no
        obligation to update publicly any forward-looking statements, whether as
        a
        result of future events, new information, or otherwise.
 
 **Item
        7A.** ***Quantitative
        and Qualitative Disclosures about Market Risk***
 
 We
        do not
        use interest rate derivative instruments to manage our exposure to interest
        rate
        changes. The interest rate under our line of credit floats with the prime
        rate
        and therefore we do have exposure to interest rate changes as a result of
        our
        line of credit agreement. As of December 31, 2005, we did not have any
        outstanding borrowings under the line of credit.
 
 As
        a
        result of the ICG California acquisition in January 2005, we acquired certain
        capital leases that have fixed interest rates and as a result we do not have
        exposure to interest rate changes for those obligations.
 
 **Item
        8.** ***Financial
        Statements and Supplementary Data***
 
 The
        response to this item is submitted as a separate section of this
        report.
 
 **Item
        9.** ***Changes
        in and Disagreements with Accountants on Accounting and Financial
        Disclosure***
 
 Not
        applicable.
 
 **Item
        9A.** ***Controls and Procedures***
 
 *Disclosure
        Controls*
 
 As
        of the
        end of the period covered by this report, which period includes the operating
        results of ICG California acquired on January 1, 2005, under the supervision
        and
        with the participation of our management, including our chief executive officer
        ("CEO") and chief financial officer ("CFO"), we evaluated the design and
        operation of our disclosure controls and procedures (as defined in Rules
        13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 as amended,
        or
        the "Exchange Act"). Based on this evaluation, our management, including
        our CEO
        and CFO, has concluded that our disclosure controls and procedures are designed,
        and are effective, to give reasonable assurance that the information we are
        required to disclose is recorded, processed, summarized and reported within
        the
        time periods specified in the SEC’s rules and forms. Based upon this evaluation,
        the CEO and CFO concluded that our disclosure controls and procedures are
        effective in providing reasonable assurance that information required to
        be
        disclosed in our reports filed with or submitted to the SEC under the Exchange
        Act is accumulated and communicated to management, including the CEO and
        CFO, as
        appropriate to allow timely decisions regarding required
        disclosure.
 
 *Changes
        in Internal Control Over Financial Reporting*
 
 There
        were no changes in our internal control over financial reporting during the
        quarter ended December 31, 2005, that have materially affected, or are
        reasonably likely to materially affect, our internal control over financial
        reporting.
 
 *Management's
        Annual Report on Internal Control over Financial Reporting*
 
 Our
        management is responsible for establishing and maintaining adequate internal
        control over financial reporting (as defined in Rule 13a-15(f) under the
        Exchange Act). Our management assessed the effectiveness of our internal
        control
        over financial reporting as of December 31, 2005. In making this assessment,
        our
        management used the criteria set forth by the Committee of Sponsoring
        Organizations of the Treadway Commission ("COSO") in “Internal
        Control-Integrated Framework”. Our management has concluded that, as of December
        31, 2005, our internal control over financial reporting is effective based
        on
        these criteria. Our independent registered public accounting firm, Deloitte
        & Touche LLP, has issued an audit report on our assessment of our internal
        control over financial reporting, which is included herein.
 **53**
 The
        effectiveness of our or any system of controls and procedures is subject
        to
        certain limitations, including the exercise of judgment in designing,
        implementing and evaluating the controls and procedures, the assumptions
        used in
        identifying the likelihood of future events, and the inability to eliminate
        misconduct completely. Our management, including our CEO and CFO, does not
        expect that our disclosure controls and procedures or our internal controls
        will
        prevent all errors and all fraud. A control system, no matter how well designed
        and operated, can provide only reasonable, not absolute, assurance that the
        objectives of the control system are met. Further, the design of a control
        system must reflect the fact that there are resource constraints, and the
        benefits of controls must be considered relative to their costs. Because
        of the
        inherent limitations in all control systems, no evaluation of controls can
        provide absolute assurance that all control issues and instances of fraud,
        if
        any, within our company have been detected.
  **54**
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 Board
        of
        Directors and Stockholders
 Mpower
        Holding Corporation
 Rochester,
        New York
 
 We
        have
        audited management’s assessment, included in the accompanying Management’s
        Annual Report on Internal Controls over Financial Reporting, that Mpower
        Holding
        Corporation and subsidiaries (the “Company”) maintained effective internal
        control over financial reporting as of December 31, 2005, based on criteria
        established in *Internal
        Control—Integrated Framework* issued
        by
        the Committee of Sponsoring Organizations of the Treadway Commission. The
        Company’s management is responsible for maintaining effective internal control
        over financial reporting and for its assessment of the effectiveness of internal
        control over financial reporting. Our responsibility is to express an opinion
        on
        management’s assessment and an opinion on the effectiveness of the Company’s
        internal control over financial reporting based on our audit.
 
 We
        conducted our audit in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether effective
        internal control over financial reporting was maintained in all material
        respects. Our audit included obtaining an understanding of internal control
        over
        financial reporting, evaluating management’s assessment, testing and evaluating
        the design and operating effectiveness of internal control, and performing
        such
        other procedures as we considered necessary in the circumstances. We believe
        that our audit provides a reasonable basis for our opinions.
 
 A
        company’s internal control over financial reporting is a process designed by, or
        under the supervision of, the company’s principal executive and principal
        financial officers, or persons performing similar functions, and effected
        by the
        company’s board of directors, management, and other personnel to provide
        reasonable assurance regarding the reliability of financial reporting and
        the
        preparation of financial statements for external purposes in accordance with
        generally accepted accounting principles. A company’s internal control over
        financial reporting includes those policies and procedures that (1) pertain
        to
        the maintenance of records that, in reasonable detail, accurately and fairly
        reflect the transactions and dispositions of the assets of the company; (2)
        provide reasonable assurance that transactions are recorded as necessary
        to
        permit preparation of financial statements in accordance with generally accepted
        accounting principles, and that receipts and expenditures of the company
        are
        being made only in accordance with authorizations of management and directors
        of
        the company; and (3) provide reasonable assurance regarding prevention or
        timely
        detection of unauthorized acquisition, use, or disposition of the company’s
        assets that could have a material effect on the financial
        statements.
 
 Because
        of the inherent limitations of internal control over financial reporting,
        including the possibility of collusion or improper management override of
        controls, material misstatements due to error or fraud may not be prevented
        or
        detected on a timely basis. Also, projections of any evaluation of the
        effectiveness of the internal control over financial reporting to future
        periods
        are subject to the risk that the controls may become inadequate because of
        changes in conditions, or that the degree of compliance with the policies
        or
        procedures may deteriorate.
 
 In
        our
        opinion, management’s assessment that the Company maintained effective internal
        control over financial reporting as of December 31, 2005, is fairly stated,
        in
        all material respects, based on the criteria established in *Internal
        Control—Integrated Framework* issued
        by
        the Committee of Sponsoring Organizations of the Treadway Commission. Also
        in
        our opinion, the Company maintained, in all material respects, effective
        internal control over financial reporting as of December 31, 2005, based
        on the
        criteria established in *Internal
        Control—Integrated Framework* issued
        by
        the Committee of Sponsoring Organizations of the Treadway
        Commission.
 
 We
        have
        also audited, in accordance with the standards of the Public Company Accounting
        Oversight Board (United States), the consolidated financial statements and
        financial statement schedule of the Company as of and for the year ended
        December 31, 2005 and our report dated March 1, 2006 expressed an unqualified
        opinion on those consolidated financial statements and financial statement
        schedule.
  Date: March
                1, 2006
              
              /s/ Deloitte
                & Touche LLPDeloitte
&
Touche
                LLPRochester,
                New
                York
 **55**
 
 
 **Item
        9B.** ***Other
        Information***
 
 Not
        applicable.
 
  **56**
  **PART
        III**
 
 **Item
        10.** ***Directors
        and Executive Officers of the Registrant***
 
 Our
        executive officers and directors, and their respective ages as of February
        22,
        2006, are as follows:
 
 **Name**
              
              **Age**
              
              **Position**Rolla
                  P. Huff
              
              49
              
              Chief
                  Executive Officer and Chairman of the BoardMichael
                  E. Cahr
              
              65
              
              DirectorAnthony
                  J. Cassara
              
              50
              
              DirectorPeter
                  H.O. Claudy
              
              44
              
              DirectorMichael
                  M. Earley
              
              50
              
              DirectorAndrew
                  D. Lipman
              
              54
              
              DirectorRobert
                  M. Pomeroy
              
              43
              
              DirectorJoseph
                  M. Wetzel
              
              50
              
              President
                  and Chief Operating OfficerS.
                  Gregory Clevenger
              
              42
              
              Executive
                  Vice President and Chief Financial OfficerRussell
                  I. Zuckerman
              
              58
              
              Senior
                  Vice President, General Counsel and Corporate SecretaryJames
                  G. Dole
              
              47
              
              Senior
                  Vice President, Strategic ImplementationJames
                  E. Ferguson
              
              51
              
              President,
                  Sales and MarketingAnthony
                  M. Marion, Jr.
              
              54
              
              Vice
                  President, Information TechnologyMichele
                  D. Sadwick
              
              39
              
              Vice
                  President, Customer Base ManagementRussell
                  A. Shipley
              
              43
              
              President,
                  Wholesale and Network ServicesMichael
                  J. Tschiderer
              
              46
              
              Senior
                  Vice President of Finance, Controller and
                  Treasurer
 
 *Rolla
        P. Huff* currently serves as our chief executive officer and has been chairman of
        our
        board of directors since July 2001. Mr. Huff was elected to our board of
        directors pursuant to the terms of his employment agreement. In addition,
        the
        terms of our reorganization plan implemented upon the completion of our
        bankruptcy proceeding in 2002 provides for our chief executive officer to
        serve
        on our board of directors. Mr. Huff’s current term as a director will expire in
        2006. Mr. Huff was elected as our chief executive officer and president and
        as a
        member of our board of directors in November 1999. From March 1999 to September
        1999, Mr. Huff served as president and chief operating officer of Frontier
        Corporation and served as executive vice president and chief financial officer
        of that corporation from May 1998 to March 1999. From July 1997 to May 1998,
        Mr.
        Huff was president of AT&T Wireless for the Central U.S. region and Mr. Huff
        served as senior vice president and chief financial officer of that company
        from
        1995 to 1997. From 1994 to 1995, Mr. Huff was financial vice president of
        mergers and acquisitions for AT&T.
 
 *Michael
        E. Cahr* has
        served on our board of directors since July 30, 2002. Mr. Cahr’s current term as
        a director will expire in 2008. Since April 1999, Mr. Cahr has been president
        and chief executive officer of Saxony Consultants. He also served as president
        of that company from 1980 to 1987. During the interim, from 1994 to March
        1999,
        Mr. Cahr served as chairman, president and chief executive officer of
        Allscripts, a medication management solutions company. From 1987 to 1994,
        Mr.
        Cahr was venture group manager for Allstate Venture Capital. Mr. Cahr was
        president, chief executive officer and owner of Abbey Fishing Company from
        1973
        to 1980. From 1963 to 1973 Mr. Cahr held various positions at Sun Chemical
        Corporation. Mr. Cahr also serves as a director of Lifecell Corporation and
        PacificHealth Laboratories, Inc.
 
 *Anthony
        J. Cassara* has
        served on our board of directors since May 2003. Mr.
        Cassara’s current term as a director will expire in 2006. Since
        January 2001, Mr. Cassara has been president of Cassara Management Group,
        Inc.,
        a privately-held business consulting practice focusing on the telecommunications
        industry. Prior to founding this firm, Mr. Cassara was president of the carrier
        services division of Frontier Corporation from April 1996 to September 1999,
        and
        after Frontier was acquired by Global Crossing continued in that position
        until
        December 2000. During his sixteen years with Frontier and Global Crossing
        from
        1984 until December 2000, Mr. Cassara held many executive positions in various
        domestic and international business units. Mr. Cassara also served as chief
        executive officer of Pangea, a telecommunications company, from February
        2001
        until June 2001. Mr. Cassara serves as a director of American Communications
        Network Inc. and TeleGlobe International Holdings, Inc.
 
 *Peter
        H.O. Claudy* was
        selected to serve on our board of directors in February 2005. Mr. Claudy's
        current term as a director will expire in 2007. Mr. Claudy was designated
        to
        serve on the board of directors by MCCC ICG Holdings, LLC ("MCCC") under
        the
        terms of an investor rights agreement entered into with MCCC and ICG
        Communications, Inc. ("ICG"). The investor rights agreement was entered into
        in
        connection with our purchase of ICG's customer base and certain network assets
        in California and an investment by MCCC in our common stock in January 2005.
        Mr.
        Claudy is a director of ICG and a member of the managing board of MCCC. Since
        1991, Mr. Claudy has been employed by M/C Venture Partners, a venture capital
        firm specializing in communications and information technology companies.
        He
        currently serves as general partner. Mr. Claudy also serves on the boards
        of
        directors of Atlantis Bidding Corp., Florida Digital Network, New Global
        Telecom, Site Excell Tower Partners, Supra Telecom and the New England Venture
        Capital Association, the latter of which he is also president.
 **57**
 *Michael
        M. Earley* has
        served on our board of directors since July 30, 2002. ** Mr.
        Earley’s current term as a director will expire in 2007. Mr.
        Earley has been an advisor to a number of businesses, acting in a variety
        of
        management roles since 1997. He has served as chief executive officer of
        Metropolitan Health Networks, Inc., a provider of healthcare services, since
        March 2003 and he was elected chairman of the board in September 2004. From
        January 2001 until March 2003, Mr. Earley was self-employed as a business
        advisor. During 2000 and 2001, Mr. Earley was a consultant to and acting
        chief
        executive officer of Collins Associates, an institutional money management
        firm.
        From 1998 to 1999, Mr. Earley served as principal and owner of Triton Group
        Management Inc, a business advisory concern. From 1994 to 1997, Mr. Earley
        served as president of Triton Group Ltd., a public diversified holding company.
        From 1991 to 1993, Mr. Earley was senior vice president, chief financial
        officer
        and director of Intermark, Inc. and Triton Group Ltd., during which time
        the two
        companies were restructured and consolidated through a pre-arranged Chapter
        11
        proceeding. From 1986 to 1990, Mr. Earley held the positions of chief financial
        officer of Triton Group Ltd. and vice president, corporate development for
        Triton Group Ltd. and Intermark, Inc. Mr. Earley was controller for
        International Robomation/Intelligence from 1983 to 1985 and an audit and
        tax
        member of the Ernst & Whinney accounting firm from 1978 to
        1983.
 
 *Andrew
        D. Lipman* was
        selected to serve on our board of directors in April 2004. Mr. Lipman’s current
        term as director will expire in 2006. Since 1988, Mr. Lipman has been a partner
        in the Washington, D.C. law firm of Swidler Berlin LLP, where he heads the
        firm’s telecommunications practice. He is currently vice chairman of the firm.
        Mr. Lipman also served from 1988 until 1997 as senior vice president legal
        and
        regulatory affairs for MFS Communications, at the time, a large local
        competitive telecommunications carrier. Mr. Lipman also serves as director
        of
        NuSkin Corporation (a cosmetic and nutritional supply company), The Management
        Network Group (a consulting firm), Sutron Corporation (a manufacturer of
        weather
        monitoring devices), World Cell (a cell phone retailer) and Last Mile (a
        facilitator of building access).
 
 *Robert
        M. Pomeroy* has
        served on our board of directors since July 30, 2002. Mr. Pomeroy’s current term
        as a director will expire in 2007. Since January 2004, Mr. Pomeroy has been
        the
        chief executive officer of Gotham Donutz LLC, an owner/operator of quick
        service
        restaurants. From August 2001 until January 2004, Mr. Pomeroy was a
        self-employed financial consultant. From September 2000 to August 2001, Mr.
        Pomeroy was the chief financial officer of Graphnet, Inc., a multinational
        data
        communications carrier. From June 1999 to August 2000, Mr. Pomeroy was a
        vice
        president and equity research analyst for Goldman, Sachs & Co. where he
        covered the telecommunications industry. Prior to Goldman Sachs, Mr. Pomeroy
        was
        a vice president and equity research analyst with Credit Suisse First Boston
        from May 1998 to June 1999. Additionally, Mr. Pomeroy is a certified public
        accountant with substantial auditing experience with multinational public
        accounting firms.
 
 *Joseph
        M. Wetzel* currently serves as our president and chief operating officer. Mr. Wetzel
        joined
        our company as president of operations in August 2000, and served in that
        role
        from August 2000 through July 2001, at which time he assumed his current
        position. He also served on our board of directors from March 2002 until
        April
        2003. From 1997 to 2000, Mr. Wetzel was vice president of technology with
        MediaOne Group and from 1993 to 1997 was vice president of technology with
        MediaOne's multimedia group. From 1977 to 1993, Mr. Wetzel served in a number
        of
        technology and operational leadership positions within US West
        Companies.
 
 *S.
        Gregory Clevenger* has
        served as our executive vice president and chief financial officer since
        April
        2002. Mr. Clevenger joined our company as senior vice president - corporate
        development in January 2000 and served from May 2001 to April 2002 as our
        executive vice president - chief strategic and planning officer. He also
        served
        on our board of directors from March 2002 until April 2003. From 1997 to
        December 1999, Mr. Clevenger was vice president of investment banking at
        Goldman, Sachs & Co. in the communications, media and entertainment group in
        Singapore and New York. From 1992 to 1997, Mr. Clevenger was an associate
        and
        vice president in the investment banking division of Morgan Stanley & Co.
        Incorporated in New York, Hong Kong and Singapore in a variety of groups
        including the global telecommunications group and the global project finance
        and
        leasing group.
 
 *Russell
        I. Zuckerman* joined
        our company in January 2000 as director of national legal affairs and has
        served
        as our secretary since April 2000. Since December 2000, he has served as
        senior
        vice president, general counsel and secretary. Prior to December 2000, Mr.
        Zuckerman had been in private practice of law since 1973 with Underberg &
Kessler, LLP, and served as managing partner and chairman of the firm’s
        litigation department.
 **58**
 *James
        G. Dole* joined
        our company as senior vice president of strategic implementation in February
        2005. From September 2004 until February 2005, Mr. Dole worked for us as
        a
        consultant focusing on the acquisition and integration of our acquisition
        of
        ICG. Mr. Dole worked as an independent consultant providing services to both
        startups and established companies from January 2002 until February 2005.
        Mr.
        Dole served as senior vice president of global access management for Global
        Crossing North America from February 2000 until January 2002. Mr. Dole was
        chief
        financial officer of the business services division of Frontier Corporation
        from
        March 1999 until January 2000. Between 1986 and 1999, Mr. Dole held numerous
        management positions at Frontier, and its predecessor Rochester Telephone.
        From
        1981 to 1986, Mr. Dole worked in various positions at Marine Midland
        Bank.
 
 *James
        E. Ferguson* joined
        our company as president of sales and marketing in July 2003. Prior to joining
        our company, Mr. Ferguson held senior sales leadership positions with Frontier
        Corporation from September 1996 until September 1999, and then with Global
        Crossing after its acquisition of Frontier in September 1999 until July 2003
        except during the period from August 2001 until June 2002, during which he
        served as executive vice president - sales for Myrient, a managed hosting
        company. During his seven years with Frontier and Global Crossing, Mr. Ferguson
        served as Frontier’s president of the western division and Global Crossing’s
        vice president of the west region, vice president of multi-national accounts
        and
        vice president of nextgen markets. Prior to Frontier/Global Crossing, Mr.
        Ferguson held sales management positions at Cable and Wireless, Sprint, Racal
        Skynetworks and GTE.
 
 *Anthony
        M. Marion, Jr.* joined
        our company in June 2000 as vice president of operations support systems
        planning and development. Since February 2002, he has served as vice president,
        information technology. Prior to joining our company, Mr. Marion was the
        executive vice president and chief information officer for Concentrix
        Corporation, an integrated customer management services business, from September
        1999 to June 2000. From March 1998 to September 1999, Mr. Marion was the
        director of information technology for CTGT Global where he was responsible
        for
        Maxcom Telecommunications, a startup competitive local exchange carrier (“CLEC”)
        in Mexico City, Mexico. Mr. Marion served as the director of applications
        maintenance management for Computer Task Group, an information technology
        services business, from September 1996 to March 1998. From 1991 through 1996,
        Mr. Marion held various technical management and director-level positions
        with
        ACC Corp, a telecommunications business, ultimately serving as the corporate
        vice president of information technology. Since 1973, Mr. Marion has held
        various progressive information technology and management positions in
        education, financial services, health care, telecommunications and consulting
        services.
 
 *Michele
        D. Sadwick* is our
        vice president of customer base management, serving in that role since October
        2002. Ms. Sadwick joined our company in November 1999 as vice president of
        corporate communications. Ms. Sadwick previously served as director of internal
        and external communications for Global Crossing, joining that firm through
        its
        acquisition of Frontier Corporation where she held communications management
        positions since 1994.
 
 *Russell
        A. Shipley* is our
        president of wholesale services and chief network services executive. Mr.
        Shipley joined our company in June 2003 as new technology officer. In February
        2005, Mr. Shipley was named as president, wholesale division, a newly formed
        division started in conjunction with our acquisition of certain ICG assets
        in
        January 2005 and he also assumed responsibility for our network services
        in
        January 2006. Prior to joining our company, Mr. Shipley served as vice president
        of operations for Global Name Registry from September 2002 to June 2003.
        Mr.
        Shipley provided individual consulting services for startups and telecom
        investment firms from March 2002 to September 2002. Mr. Shipley served as
        senior
        vice president of global network transport operations for Global Crossing
        from
        January 2002 to March 2002, vice president of data engineering and operations
        from June 2000 to December 2001 and as vice president of network services
        from
        September 1999 until June 2000. Mr. Shipley joined Global Crossing in September
        1999 when it acquired Frontier Corporation, where he had been vice president
        of
        network services since June 1999, and was vice president of network planning
        and
        development from September 1995 to May 1999. Mr. Shipley held numerous
        management positions between 1985 and 1994 for Rochester Telephone, the
        predecessor of Frontier.
 
 *Michael
        J. Tschiderer* joined
        our company in May 2000 and as of February 2005 serves as our senior vice
        president of finance, controller and treasurer. He had previously served
        as our
        vice president of finance and controller from March 2001. He has served as
        treasurer since April 2003. Mr. Tschiderer served as our vice president,
        finance
        and administration from May 2000 to March 2001. Before joining us, Mr.
        Tschiderer had been a partner in the accounting firm of Bonadio & Co. in
        Rochester, New York from 1995 to April 2000. He is a certified public accountant
        in the state of New York.
 
 Messrs.
        Huff, Wetzel, Clevenger, Zuckerman, Marion and Tschiderer and Ms. Sadwick
        all
        served as officers at the time we initiated our voluntary pre-negotiated
        petition in bankruptcy in February 2002.
 
 Robert
        M.
        Pomeroy, Michael E. Cahr, Richard L. Shorten, Jr. and Michael M. Earley were
        selected as directors effective July 30, 2002 as designees of the holders
        of our
        senior notes due 2010 in accordance with the terms of our reorganization
        plan
        implemented upon the completion of our bankruptcy proceeding.
 
 Our
        board
        of directors has also determined that Robert M. Pomeroy has been designated
        as
        our “audit committee financial expert” and is independent within the meaning of
        the rules of the Securities and Exchange Commission.
 
 On
        February 15, 2006, Richard L. Shorten, Jr. resigned from our board of directors
        after forming a new business relationship with a Connecticut-based hedge
        fund.
        Mr. Shorten, who joined our board in 2002, had no conflicts with our management
        or other board members.
 **59**
 **Code
        of Ethics**
 
 We have
        adopted a Corporate Code of Conduct and Ethics (the "Code of Ethics") that
        applies to our principal executive officer, principal financial officer,
        principal accounting officer or controller, or persons performing similar
        functions, as well as to other directors, officers and employees of our company.
        The Code of Ethics is posted on our website ( www.mpowercom.com )
        and is
        available in print free of charge to any stockholder who requests a copy.
        Interested parties may address a written request for a printed copy of the
        Code
        of Ethics to: General Counsel, Mpower Holding Corporation, 175 Sully's Trail,
        Suite 300, Pittsford, New York 14534. We intend to satisfy the disclosure
        requirement regarding any amendment to, or a waiver of, a provision of the
        Code
        of Ethics for our principal executive officer, principal financial officer,
        principal accounting officer or controller, or persons performing similar
        functions by posting such information on our website.
 
 **Section
        16(a) Beneficial Ownership Reporting Compliance**
 
 Section
        16(a) of the Exchange Act requires our directors and executive officers and
        persons who own more than 10% of our equity securities to file initial reports
        of ownership and reports of changes in ownership with the Securities and
        Exchange Commission. Such persons are required by the Exchange Act to furnish
        us
        with copies of all Section 16(a) forms they file.
 
 Based
        solely on our review of the copies of such forms received by us with respect
        to
        transactions during 2005, or written representations from certain reporting
        persons, we believe that all filing requirements applicable to our directors,
        executive officers and persons who own more than 10% of our equity securities
        have been complied with.
 
 **Item
        11.** ***Executive
        Compensation***
 
 **Summary
        of Cash and Certain Other Compensation**
 
 The
        following table shows, for the fiscal years ended December 31, 2005, 2004
        and
        2003, the cash compensation paid by us, as well as certain other compensation
        paid or accrued for such year, for our chief executive officer and the four
        most
        highly compensated executive officers other than the chief executive officer
        employed by us as of December 31, 2005. This table also indicates the principal
        capacities in which they served during 2005.
 
 **Summary
                  Compensation Table****Long-Term****Annual
                  Compensation**
              **Compensation****Other
                  Annual**
              **Awards**
              **All
                    Other****Name
                  and Principal Position**
              **Year**
              **Salary
                  ($)**
              **Bonus
                  ($)**
              **Compensation
                  ($) (1)**
              **Options
                  (#)**
              **Compensation** ($)Rolla
                  P. Huff,
              2005
              536,000
              133,760(2)
              —
              323,145
              —Chairman
                  and chief executive officer
              2004
              453,539
              430,858(3)
              —
              562,800
              —2003
              440,654
              455,554(4)
              —
              824,100
              —Joseph
                  M. Wetzel,
              2005
              318,000
              56,660(2)
              —
              140,671
              —President
                  and chief operating officer
              2004
              306,923
              187,561(3)
              —
              281,250
              —2003
              300,000
              191,231(4)
              71,561(5)
              202,500
              —S.
                  Gregory Clevenger,
              2005
              300,000
              53,500(2)
              —
              135,678
              —Executive
                  vice president and chief financial officer
              2004
              269,231
              180,864(3)
              —
              281,250
              —2003
              264,423
              191,231(4)
              —
              335,625
              —James
                  E. Ferguson,
              2005
              233,394
              35,984(2)
              —
              93,418
              —President
                  - sales and marketing
              2004
              225,077
              124,557(3)
              —
              150,000
              —2003
              104,923
              82,500(6)
              —
              350,000
              —Steven
                  A. Reimer,
              2005
              217,422
              39,364(2)
              —
              90,464
              219,420(7)Senior
                  vice president - customer operations
              2004
              204,615
              120,619(3)
              —
              187,500
              —2003
              200,000
              127,487(4)
              —
              135,000
              66,670(8)
 **60**
 (1)
              The
                  amounts of perquisites received by executive officers have not
                  been
                  disclosed unless they exceed the lesser of $50,000 or 10% of salary
                  and
                  bonus for a particular year.(2)
              Includes
                  the cash component of the 2005 annual bonus paid in
                  2006.(3)
              Includes
                  the cash component of the 2004 annual bonus paid in
                  2005.(4)
              Includes
                  the cash component of the 2003 annual bonus paid in
                  2004.(5)
              Mr.
                  Wetzel’s other annual compensation for 2003 includes perquisites received
                  by him, which were comprised of approximately $51,000 related to
                  the use
                  of a townhouse in Las Vegas and approximately $21,000 of various
                  other
                  perquisites.(6)
              Represents
                  third quarter and fourth quarter 2003 management bonus. The amount
                  earned
                  for the fourth quarter bonus was paid in 2004.(7)
              Represents
                  severance benefit accrued in 2005 in connection with Mr. Reimer’s
                  resignation.(8)
              Represents
                  retention payments paid in 2003.
 
 **Compensation
        Committee Interlocks and Insider Participation**
 
 Our
        compensation committee consists of Michael E. Cahr, Anthony J. Cassara and
        Andrew D. Lipman. None of the members of the compensation committee ever
        served
        as officers or employees of our company.
 
 **Employment
        Agreements**
 
 *Rolla
        P. Huff.* Our
        employment agreement with Mr. Huff provides for a base salary of $536,000
        per
        year and an annual bonus of up to the greater of (i) $536,000; or (ii) his
        base
        salary based on our achievement of certain annual targets to be established
        by
        our board of directors in conjunction with our annual operating budget or
        in the
        discretion of our board of directors. Mr. Huff is required to devote his
        full
        time and efforts to the business of our company during the term of his
        employment agreement, which expires on September 18, 2006. Mr. Huff’s employment
        may be terminated by either us or Mr. Huff at any time. Mr. Huff has agreed
        not
        to participate in a competitive business during the term of his employment
        and
        for a period of twelve months following termination. In the event Mr. Huff’s
        employment ceases, Mr. Huff will be entitled to severance pay equal to the
        greater of (a) $1.5 million or (b) two times his base salary preceding his
        cessation of employment (or $536,000 if higher), and the highest bonus paid
        to
        him during any 12 month period between November 1, 1999 and the termination
        date, with payment to be made in a lump-sum.
 
 *Joseph
        M. Wetzel.* Our
        employment agreement with Mr. Wetzel provides for a base salary of $318,000
        per
        year and an annual bonus of up to 75% of his base salary based upon achieving
        established corporate, functional and individual goals. Mr. Wetzel is required
        to devote his full time and efforts to the business of our company during
        the
        term of his employment agreement. Mr. Wetzel’s employment may be terminated by
        either us or Mr. Wetzel at any time. Mr. Wetzel has agreed not to participate
        in
        a competitive business during the term of his employment and for a period
        of
        twelve months following termination. If Mr. Wetzel’s employment is terminated by
        us without cause or due to a change of control or there is a material change
        in
        Mr. Wetzel’s responsibilities or salary or a relocation of more than 35 miles
        from his present place of business, Mr. Wetzel will receive severance pay
        equal
        to two times the higher of his fixed salary immediately preceding the
        termination date or $300,000 and two times the highest bonus paid to him
        during
        any 12 month period between September 20, 2002 and the termination date,
        with
        payment to be made in a lump-sum.
 
 *S.
        Gregory Clevenger.* Our
        employment agreement with Mr. Clevenger provides for a base salary of $300,000
        per year and an annual bonus of up to 75% of the greater of (i) $300,000;
        or
        (ii) his base salary based upon achieving established corporate, functional
        and
        individual goals. Mr. Clevenger is required to devote his full time and efforts
        to the business of our company during the term of his employment agreement.
        Mr.
        Clevenger’s employment may be terminated by either us or Mr. Clevenger at any
        time. Mr. Clevenger has agreed not to participate in a competitive business
        during the term of his employment and for a period of twelve months following
        termination. If Mr. Clevenger’s employment is terminated by us without cause or
        due to a change of control or there is a material change in Mr. Clevenger’s
        responsibilities or salary or a relocation of more than 35 miles from his
        present place of business, Mr. Clevenger will receive severance pay equal
        to two
        times the higher of his fixed salary immediately preceding the termination
        date
        or $300,000 and two times the highest bonus paid to him during any 12 month
        period between April 25, 2002 and the termination date, with payment to be
        made
        in a lump-sum.
 
 **61**
 *James
        E. Ferguson.* Our
        employment agreement with Mr. Ferguson provides for a base salary of $233,200
        per year and an annual bonus of up to 75% of his base salary based upon
        achieving established corporate, functional and individual goals. Mr. Ferguson
        is required to devote his full time and efforts to the business of our company
        during the term of his employment agreement. Mr. Ferguson’s employment may be
        terminated by either us or Mr. Ferguson at any time. Mr. Ferguson has agreed
        not
        to participate in a competitive business during the term of his employment
        and
        for a period of twelve months following termination. If Mr. Ferguson’s
        employment is terminated by us without cause or by him for good reason, Mr.
        Ferguson will receive severance pay equal to two times his fixed salary
        immediately preceding the termination date or the fixed salary on June 18,
        2003,
        and two times the highest bonus paid by us through the termination date,
        with
        payment to be made in a lump sum.
 
 *Steven
        A. Reimer.* Our
        retention and severance agreement with Mr. Reimer provides for a severance
        benefit equal to one times his salary immediately preceding his termination
        date, if terminated by us without cause or voluntarily by the officer for
        good
        reason. Mr. Reimer’s employment with us terminated in January 2006 and he will
        receive the severance benefit specified in his agreement. Mr. Reimer has
        agreed
        not to participate in a competitive business during the severance period.
 
 **Option
        Grants in Last Fiscal Year**
 
 The
        table
        below sets forth information regarding all stock options granted in the 2005
        fiscal year under our Stock Option Plans to those executive officers named
        in
        the Compensation Table above.
 
 **Name**
              
              **Number
                  of Securities Underlying Options Granted in****2005**
              
              **%
                  of Total Options Granted to Employees in Fiscal****Year**
              
              **Exercise****Price**
              
              **Market
                  Price or Fair Value on Date of****Grant**
              
              **Expiration****Date**
              
              **Potential
                  Realized Assumed Annual Rates****of
                  Stock Price****Appreciation
                  (1)****5%**
              
              
              **10%**Rolla
                  P. Huff
              
              
              323,145
              
              
              14.4
              %
              $
              1.63
              
              $
              1.63
              
              
              2/9/15
              
              $
              331,255
              
              $
              839,466Joseph
                  M. Wetzel
              
              
              140,671
              
              
              6.3
              %
              $
              1.63
              
              $
              1.63
              
              
              2/9/15
              
              $
              144,202
              
              $
              365,435S.
                  Gregory Clevenger
              
              
              135,648
              
              
              6.0
              %
              $
              1.63
              
              $
              1.63
              
              
              2/9/15
              
              $
              139,053
              
              $
              352,386James
                  E. Ferguson
              
              
              93,418
              
              
              4.2
              %
              $
              1.63
              
              $
              1.63
              
              
              2/9/15
              
              $
              95,763
              
              $
              242,681Steven
                  A. Reimer
              
              
              90,464
              
              
              4.0
              %
              $
              1.63
              
              $
              1.63
              
              
              2/9/15
              
              $
              92,734
              
              $
              235,007
 
 (1)
              The
                  dollar amounts under these columns are the result of calculations
                  at the
                  5% and 10% rates set by the Securities and Exchange Commission
                  and
                  therefore are not intended to forecast possible future appreciation,
                  if
                  any, of the price of our common
                  stock.
 
 **Aggregated
        Option Exercises in Last Fiscal Year and Fiscal Year End Option
        Values**
 
 The
        following table shows aggregate exercises of options during 2005 and the
        values
        of options held as of December 31, 2005 by those executive officers named
        in the
        Compensation Table above.
 **Name**
              
              **Number
                  of Shares Acquired****on
                  Exercise**
              
              **Value****Realized**
              
              **Number
                  of Unexercised Options**
                **December
                  31, 2005**
                **Exercisable(E)/****Unexercisable(U)**
              
              **Value
                  of Unexercised In-The-Money Options**
                **December
                  31, 2005 (1)**
                **Exercisable(E)/****Unexercisable(U)**Rolla
                  P. Huff
              
              
              —
              
              
              —
              
              
              3,701,895(E
              )
              $
              3,119,656(E
              )Rolla
                  P. Huff
              
              
              —
              
              
              —
              
              
              214,400(U
              )
              $
              27,872(U
              )Joseph
                  M. Wetzel
              
              
              —
              
              
              —
              
              
              1,960,671(E
              )
              $
              1,753,175(E
              )Joseph
                  M. Wetzel
              
              
              —
              
              
              —
              
              
              120,000(U
              )
              $
              15,600(U
              )S.
                  Gregory Clevenger
              
              
              —
              
              
              —
              
              
              2,060,648(E
              )
              $
              1,897,362(E
              )S.
                  Gregory Clevenger
              
              
              —
              
              
              —
              
              
              120,000(U
              )
              $
              15,600(U
              )James
                  E. Ferguson
              
              
              —
              
              
              —
              
              
              376,751(E
              )
              $
              118,499(E
              )James
                  E. Ferguson
              
              
              —
              
              
              —
              
              
              216,667(U
              )
              $
              69,000(U
              )Steven
                  A. Reimer
              
              
              —
              
              
              —
              
              
              557,964(E
              )
              $
              281,950(E
              )Steven
                  A. Reimer
              
              
              —
              
              
              —
              
              
              80,000(U
              )
              $
              10,400(U
              )
 **62**
 (1)
              Amounts
                  shown are based upon the closing sale price for our common stock
                  on
                  December 31, 2005, which was $1.38 per common
                  share.
  **Director
        Compensation**
 
 Our
        outside directors, with the exception of Mr. Claudy, will each receive quarterly
        payments, in advance, of $12,000, paid on January 1, April 1, July 1, and
        October 1, 2006, as compensation for their services as board members for
        2006.
        No options were granted to outside directors in 2005.
 
 **Item
        12.** ***Security
        Ownership of Certain Beneficial Owners and Management and Related Stockholder
        Matters***
 
 The
        following table shows information known to us with respect to beneficial
        ownership of common stock as of February 22, 2006, by (A) each director,
        (B)
        each of the executive officers named in the Summary Compensation Table beginning
        on page 60, (C) all executive officers and directors as a group and (D) each
        person known by us to be a beneficial owner of more than 5% of our outstanding
        common stock.
 
 **Name
                  of Beneficial Owner**
              **Number
                  of Shares**
                **Beneficially****Owned
                  (1)**
              **Percentage
                  of**
                **Ownership
                  (2)**MCCC
                  ICG Holdings LLC (3)
              14,728,924
              15.7%Peter
                  H.O. Claudy, director (4)
              14,728,924
              15.7%Aspen
                  Advisors, LLC (5)
              10,490,000
              11.4%West
                  Highland Capital, Inc. (6)
              7,338,435
              8.0%Kingdon
                  Capital Management, LLC (7)
              5,958,730
              6.5%Rolla
                  P. Huff, chief executive officer and chairman of the board
                  (8)
              3,827,017
              4.0%S.
                  Gregory Clevenger, executive vice president and chief financial
                  officer
                  (9)
              2,227,635
              2.4%Joseph
                  M. Wetzel, president and chief operating officer (10)
              2,118,171
              2.3%Steven
                  A. Reimer, senior vice president customer operations (11)
              587,964
              *James
                  E. Ferguson, president sales and marketing (12)
              473,918
              *Michael
                  E. Cahr, director (13)
              325,000
              *Robert
                  M. Pomeroy, director (14)
              280,000
              *Michael
                  M. Earley, director (15)
              255,000
              *Anthony
                  J. Cassara, director (16)
              250,000
              *Andrew
                  D. Lipman, director (17)
              100,000
              *All
                  executive officers and directors as a group (16 persons)
                  (4)(8)(9)(10)(12)(13)(14)(15)(16)(17)(18)
              27,491,705
              26.1%
 
 *
                  Less than 1% of total.
 
 **63**
 (1)
              In
                  accordance with the Securities and Exchange Commission’s rules, each
                  beneficial owner’s holdings have been calculated assuming the full
                  exercise of options held by the holder which are currently exercisable
                  or
                  which will become exercisable within 60 days after the date indicated
                  and
                  no exercise of options held by any other person.(2)
              Applicable
                  percentage of ownership for each holder is based on 91,609,999
                  shares of
                  common stock outstanding on February 22, 2006, plus any common
                  stock
                  equivalents and presently exercisable stock options held by each
                  such
                  holder, and options held by each such holder which will become
                  exercisable
                  within 60 days after March 1, 2006.(3)
              Information
                  is based on a Schedule 13D filed with the Securities and Exchange
                  Commission on January 7, 2005. Of these shares 12,740,030 are owned
                  by ICG
                  Communications, Inc. (“ICG”) and 1,988,894 of these shares are owned by
                  MCCC ICG Holdings LLC (“MCCC”) which owns 100% of ICG. Also includes
                  warrants to purchase 2,000,000 shares owned by MCCC. Based upon
                  MCCC’s
                  ownership of ICG, MCCC and ICG may be deemed to have shared power
                  to
                  direct the vote and shared power to direct the disposition of these
                  securities.(4)
              As
                  a member of the board of managers of MCCC and as a director of
                  ICG, Mr.
                  Claudy may be deemed to beneficially own the shares owned by ICG
                  and MCCC.
                  Mr. Claudy disclaims beneficial ownership of the shares of common
                  stock
                  and warrants held by ICG and MCCC except to the extent of any pecuniary
                  interest therein.(5)
              Information
                  is based on a Schedule 13G/A filed with the Securities and Exchange
                  Commission on July 15, 2005, by Aspen Partners, Series A, Aspen
                  Capital
                  LLC (general partner of Aspen Partners), Aspen Advisors LLC (investment
                  advisor to Aspen Partners) and Nikos Hecht (managing member of
                  Aspen
                  Capital LLC and Aspen Advisors LLC). Aspen Partners LLC directly
                  owns
                  7,356,346 shares (including 200,000 shares issuable upon exercise
                  of
                  presently exercisable warrants). Aspen Partners, Aspen Capital,
                  Aspen
                  Advisors and Hecht each share the power to vote and dispose of
                  7,356,346
                  shares. Aspen Advisors and Hecht share the power to vote and dispose
                  of an
                  additional 3,133,654 shares owned by private clients of Aspen Advisors.
                  The address of Aspen Advisors and its affiliates is 152 West
                  57thStreet, New York, New York 10019.(6)
              Information
                  is based on a Schedule 13G/A filed with the Securities and Exchange
                  Commission on January 19, 2006. West Highland Capital, Inc. (“WHC”) is a
                  registered investment adviser whose clients have the right to receive
                  or
                  the power to direct the receipt of dividends from, or the proceeds
                  from
                  the sale of, the shares owned by them. Lang H. Gerhard is the sole
                  shareholder of WHC and the manager of Estero Partners, LLC (“Estero”).
                  Gerhard, Estero and WHC are the general partners of West Highland
                  Partners, LP, an investment limited partnership (“WHPLP”). Each of the
                  foregoing is identified on the Schedule 13G as having shared dispositive
                  power of the shares owned by WHC. WHC, Estero and Gerhard are identified
                  in the Schedule 13G as a group, and WHPLP disclaims membership
                  in the
                  group. The Schedule 13G indicates that WHC, Estero and WHPLP each
                  share
                  the power to vote and dispose of 6,838,435 shares. The Schedule
                  13G
                  indicates that Gerhard has the sole power to vote and dispose of
                  an
                  additional 500,000 shares for a total of 7,338,435 shares. The
                  address of
                  West Highland Capital, Inc. is 300 Drake’s Landing Road, Suite 290,
                  Greenbrae, CA 94904.(7)
              Information
                  is based on a Schedule 13G filed with the Securities and Exchange
                  Commission on January 25, 2006. The address of this beneficial
                  owner is
                  152 West 57thStreet, 50thFloor, New York, New York, 10019.(8)
              Mr.
                  Huff’s ownership includes options to purchase 3,701,895 shares which
                  are
                  presently exercisable. Excludes 10,024 shares owned by Mr. Huff’s wife and
                  minor children, with respect to which shares Mr. Huff disclaims
                  beneficial
                  ownership.(9)
              Mr.
                  Clevenger’s ownership includes options to purchase 2,060,648 shares which
                  are presently exercisable. Also includes 6,000 shares owned by
                  Mr.
                  Clevenger’s minor children and 125,741 shares of restricted stock which
                  will vest in four annual installments beginning on February 20,
                  2007.(10)
              Mr.
                  Wetzel’s ownership includes options to purchase 1,960,671 shares which
                  are
                  presently exercisable and 132,500 shares of restricted stock which
                  will
                  vest in four annual installments beginning on February 20,
                  2007.(11)
              Mr.
                  Reimer’s ownership includes options to purchase 557,964 shares which are
                  presently exercisable.(12)
              Mr.
                  Ferguson’s ownership includes options to purchase 376,751 shares which are
                  presently exercisable and 97,167 shares of restricted stock which
                  will
                  vest in four annual installments beginning on February 20,
                  2007.(13)
              Mr.
                  Cahr’s ownership includes options to purchase 255,000 shares which are
                  presently exercisable.(14)
              Mr.
                  Pomeroy’s ownership includes options to purchase 255,000 shares which are
                  presently exercisable.(15)
              Mr.
                  Earley’s ownership includes options to purchase 255,000 shares which are
                  presently exercisable.(16)
              Mr.
                  Cassara’s ownership includes options to purchase 250,000 shares which are
                  presently exercisable or which will become exercisable within 60
                  days
                  after the date of this report.(17)
              Mr.
                  Lipman’s ownership includes options to purchase 100,000 shares which are
                  presently exercisable or which will become exercisable within 60
                  days
                  after the date of this report.(18)
              Includes
                  options to purchase 2,571,349 shares, which are held by executive
                  officers
                  not named above and which are presently exercisable or which will
                  become
                  exercisable within 60 days after the date of this report. Also
                  includes
                  306,668 shares of restricted stock held by executive officers not
                  named
                  above which will vest in four annual installments beginning on
                  February
                  20, 2007.
 **64**
 **Securities
        Authorized for Issuance under Equity Compensation Plans**
 
 The
        following table provides information regarding options, warrants or other
        rights
        to acquire equity securities under our equity compensation plans as of December
        31, 2005:
 
 **Number
                  of securities to be issued upon exercise of outstanding
                  options,****warrants and rights**
              
              **Weighted-average
                  exercise price of outstanding options,****warrants and rights**
              
              **Number
                  of securities remaining available**
                **for
                  future issuance under equity**
                ******compensation
                  plans**Equity
                  compensation plans approved by security holders
              
              
              9,375
              
              $
              1.28
              
              
              7,490,625(1
              )Equity
                  compensation plans not approved by security holders
              
              
              21,669,637
              
              $
              0.95
              
              
              116,120(2
              )Total
              
              
              21,679,012
              
              $
              0.95
              
              
              7,606,745
 
 (1)
              We
                  have reserved an additional 4,000,000 shares of common stock that
                  may be
                  issued under the 2005 Plan as a result of expirations, forfeitures
                  or
                  cancellations under the Prior Plans.(2)
              Includes
                  warrants that may be earned by Shemano Group, Inc. in connection
                  with the
                  transaction discussed in Note 12 to the financial
                  statements.
 
 **Item
        13.** ***Certain
        Relationships and Related Transactions***
 
 Andrew
        D.
        Lipman, who serves on our board of directors, is a partner and vice chairman
        of
        the Swidler Berlin LLP law firm in Washington, D.C. We retained that law
        firm
        for legal regulatory counsel in 2005 and intend to do so in the
        future.
 
 On
        January 1, 2005, we acquired ICG Communications, Inc.’s customer base and
        certain network assets in California pursuant to an asset purchase agreement,
        dated October 22, 2004 (the “Agreement”). Under the terms of the Agreement, we
        acquired ICG’s California retail and wholesale customer segments, its state-wide
        self-healing SONET fiber network with fully survivable metropolitan fiber
        rings
        in six major metropolitan markets, which connect 128 on-net fiber-lit commercial
        buildings. We purchased these assets for $16.6 million in the form of (i)
        $14.1
        million in the form of 10,740,030 shares of our common stock, (ii) $1.2 million
        in the form of warrants dated January 1, 2005, to purchase another 2,000,000
        shares of our common stock exercisable on or prior to the fifth anniversary
        of
        the date of issuance at an exercise price of $1.38 per share and (iii) $1.3
        million of direct acquisition costs. In connection with the acquisition,
        MCCC
        ICG Holdings, LLC purchased 1,988,894 shares of our common stock for an
        aggregate purchase price of $2.5 million on January 5, 2005. Our director
        Peter
        H.O. Claudy is a director of ICG and a member of the managing board of MCCC.
 
 Mr.
        Claudy is also a director of an entity that is more than 10% owner of Florida
        Digital Networks, Inc. (“FDN”). In April 2003, we completed the sale of our
        assets in its Florida and Georgia markets to FDN. The purchase price for
        the
        assets in Florida and Georgia was $12.4 million. At December 31, 2005, we
        have
        recorded $0.4 million of receivables remaining from the sale to FDN, with
        the
        entire balance owed being held in escrow by a third party escrow agent. During
        2005, we received approximately $1.1 million from FDN related to these
        receivables. Subsequent to December 31, 2005, an additional $0.1 million
        was
        received by us from escrow. During 2005, we received approximately $0.6 million
        from BellSouth that was due to FDN. All amounts received were promptly remitted
        to FDN in the normal course of business.
 
 Mr.
        Claudy did not serve as a director of ours until after the completion of
        the ICG
        California acquisition and the sale of assets to FDN. He does not receive
        compensation for his services as a member of our board of
        directors.
  **Item
        14.** ***Principal
        Accountant Fees and Services***
 
 *Audit
        Fees*
 
 The
        aggregate fees billed by Deloitte & Touche LLP for the audit of our annual
        financial statements, the reviews of our financial statements included in
        our
        quarterly reports on Form 10-Q, services relating to the audit of our internal
        controls over financial reporting in connection with Section 404 of the
        Sarbanes-Oxley Act of 2002, as well as services that are normally provided
        by
        the accounting firm in connection with statutory and regulatory filings were
        approximately $0.5 million for each of the years ended December 31, 2005
        and
        2004.
 **65**
 *Audit-Related
        Fees*
 
 There
        were no aggregate fees billed by Deloitte & Touche LLP for assurance and
        related services that were reasonably related to the performance of the audit
        and reviews referred to above for the year ended December 31, 2005. These
        fees
        were less than $0.1 million for the year ended December 31, 2004.
 
 *Tax
        Fees*
 
 The
        aggregate fees billed for tax compliance, tax advice and tax planning rendered
        by Deloitte & Touche LLP to us were less than $0.1 million for the years
        ended December 31, 2005 and 2004. The fees were related to the preparation
        of
        our income tax returns and tax consulting.
 
 *All
        Other Fees*
 
 The
        aggregate fees billed for all other non-audit services rendered by Deloitte
        & Touche LLP to us were less than $0.1 million for the years ended December
        31, 2005 and 2004.
 
 All
        non-audit services require an engagement letter to be signed prior to commencing
        any services. The engagement letter must detail the fee estimates and the
        scope
        of services to be provided. The current policy of our audit committee is
        that
        the audit committee must approve of the non-audit services in advance of
        the
        engagement and the audit committee’s responsibilities in this regard may not be
        delegated to management. No non-audit services were rendered that were not
        in
        compliance with this policy.
  **66**
  **PART
        IV**
 
 **Item
        15.** ***Exhibits
        and Financial Statement Schedules***
 
 (a)
 
 (1)
              The
                  response to this portion of Item 15 is submitted as a separate
                  section of
                  this report.(2)
              The
                  response to this portion of Item 15 is submitted as a separate
                  section of
                  this report.(3)
              Filing
                  of Exhibits:
 
 Exhibit
                  10.19
              —
              Employment/Stock
                  Repurchase Letter Agreement dated October 13, 1999, between Mpower
                  Communications Corp. and Rolla P. HuffExhibit
                  10.42
              —
              Separation
                  of Employment Letter Agreement dated January 5, 2006, between Mpower
                  Communications Corp. and Steven ReimerExhibit
                  10.43
              —
              Separation
                  of Employment Agreement dated January 5, 2006, between Mpower
                  Communications Corp. and Roger PachutaExhibit
                  21
              —
              Subsidiaries
                  of the RegistrantExhibit
                  23
              —
              Consent
                  of Deloitte & Touche LLPExhibit
                  24
              —
              Power
                  of Attorney (on signature page)Exhibit
                  31.1
              —
              Rule
                  13a-14(a)/15d-14(a) Certification of Chief Executive
                  OfficerExhibit
                  31.2
              —
              Rule
                  13a-14(a)/15d-14(a) Certification of Chief Financial
                  OfficerExhibit
                  32
              —
              Section
                  1350 Certifications
 
 **67**
 (b)
              The
                  following exhibits are filed herewith or incorporated by reference
                  as
                  indicated. Exhibit numbers refer to Item 60l of Regulation
                  S-K.
 
 2.1
              Findings
                  of Fact, Conclusions of Law, and Order Under Section 1129 of the
                  Bankruptcy Code and Rule 3020 of the Bankruptcy Rules Confirming
                  Debtors’
                  First Amended Joint Plan of Reorganization, dated July 17, 2002.
                  (2)2.2
              Debtors’
                  First Amended Joint Plan of Reorganization dated May 20, 2002.
                  (2)2.3
              Debtors’
                  First Amended Disclosure Statement dated May 20, 2002.
                  (2)2.4
              Asset
                  Purchase Agreement, dated as of January 8, 2003, between Mpower
                  and LDMI
                  Telecommunications, Inc. (3)2.5
              Amendment
                  No. 1 to Asset Purchase Agreement, dated as of February 6, 2003,
                  between
                  Mpower and LDMI Telecommunications, Inc. (3)2.6
              Asset
                  Contribution Agreement, effective as of December 31, 2002, between
                  Mpower
                  and Xspedius Equipment Leasing, LLC. (3)2.7
              Asset
                  Purchase Agreement, dated as of January 8, 2003, between Mpower,
                  Florida
                  Digital Network, Inc. and Southern Digital Network, Inc.
                  (3)2.8
              Acknowledgment
                  and Amendment No. 1 to Asset Purchase Agreement, dated as of April
                  7,
                  2003, between Mpower, Florida Digital Network, Inc. and Southern
                  Digital
                  Network, Inc. (3)2.9
              Asset
                  Purchase Agreement, dated as of February 6, 2003, between Mpower
                  and LDMI
                  Telecommunications, Inc. (3)2.10
              Asset
                  Purchase Agreement dated October 22, 2004, by and among MCCC ICG
                  Holdings,
                  LLC, ICG Communications, Inc., Mpower Holding Corporation and Mpower
                  Communications Corp. (14)3.1
              Second
                  Amended and Restated Certificate of Incorporation filed with the
                  Secretary
                  of State of the State of Delaware on July 30, 2002. (4)3.2
              Second
                  Amended and Restated By-laws. (4)3.3
              Rights
                  Agreement between Mpower Holding Corporation and Continental Stock
                  Transfer & Trust Company as Rights Agent, including Certificate of
                  Designation for the Series A Preferred Stock. (5)3.4
              Amendment
                  of Rights Agreement and Certification of Compliance with Section
                  26 dated
                  March 14, 2005, between Mpower Holding Corporation and Continental
                  Stock
                  Transfer & Trust Company (16).4.1
              See
                  the Second Amended and Restated Certificate of Incorporation filed
                  as
                  Exhibit 3.1 and the Second Amended and Restated By-laws filed as
                  Exhibit
                  3.2.9.1
              Investor
                  Rights Agreement listed in Item 10.32 below.10.1
              Amendment
                  To Employment/Stock Repurchase Agreement dated August 1, 2001,
                  between
                  Mpower Holding Corporation and Rolla P. Huff. (1) (7)10.2
              Amendment
                  To Employment/Stock Repurchase Agreement dated September 20, 2002
                  between
                  Mpower Communications Corp. and Rolla P. Huff. (1) (8)10.3
              Amendment
                  to Employment Agreement dated September 18, 2002 between Mpower
                  Communications Corp. and Joseph M. Wetzel.(1) (8)10.4
              Amendment
                  to Employment Agreement dated September 20, 2002 between Mpower
                  Communications Corp. and S. Gregory Clevenger. (1) (8)10.5
              Amended
                  Employment Agreement dated September 20, 2002 between Mpower
                  Communications Corp. and Russell I. Zuckerman.(1) (14)10.6
              Retention
                  and Severance Agreement dated October 24, 2001 between Mpower
                  Communications Corp. and Michele Sadwick. (1) (9)10.7
              Severance
                  Agreement dated October 18, 2001 between Mpower Communications
                  Corp. and
                  Roger Pachuta. (1) (9)10.8
              Retention
                  and Severance Agreement dated October 28, 2001 between Mpower
                  Communications Corp. and Steve Reimer. (1) (9)10.9
              Employment
                  Letter dated August 8, 2000 between Mpower Communications Corp.
                  and Joseph
                  M. Wetzel. (1) (10)10.10
              RFC
                  Capital Corporation Receivables Sale Agreement dated as of January
                  23,
                  2003. (9)10.11
              Mpower
                  Communications Corp. Employee Benefit Trust Agreement II. (1)
                  (9)10.12
              Mpower
                  Holding Corporation’s Directors and Officers Insurance Premium Trust
                  Agreement dated November 15, 2002. (9)10.13
              Mpower
                  Holding Corporation 2002 Stock Option Plan I. (1) (6)10.14
              Mpower
                  Holding Corporation 2002 Stock Option Plan II. (1) (6)10.15
              Employment
                  Agreement dated June 2, 2003 between Mpower Communications Corp.
                  and
                  Russell A. Shipley. (1) (11)10.16
              Employment
                  Agreement dated June 18, 2003 between Mpower Communications Corp.
                  and Jim
                  Ferguson. (1) (11)10.17
              Form
                  of Registration Rights Agreement dated September 25, 2003.
                  (12)10.18
              Form
                  of Warrant dated September 25, 2003. (12)10.19
              Employment/Stock
                  Repurchase Agreement dated October 13, 1999, between Mpower Communications
                  Corp. and Rolla P. Huff. (1)10.20
              Employment
                  Agreement dated April 25, 2002, between Mpower Communications Corp.
                  and S.
                  Gregory Clevenger. (1) (14)10.21
              Third
                  Amendment to Employment Agreement dated March 19, 2003, between
                  Mpower
                  Communications Corp. and Rolla P. Huff. (1) (14)10.22
              Second
                  Amendment to Employment Agreement dated March 19, 2003, between
                  Mpower
                  Communications Corp. and S. Gregory Clevenger. (1) (14)10.23
              Second
                  Amendment to Employment Agreement dated March 19, 2003, between
                  Mpower
                  Communications Corp. and Joseph M. Wetzel. (1) (14)10.24
              Third
                  Amendment to Employment Agreement dated June 2003 between Mpower
                  Communications Corp. and S. Gregory Clevenger. (1) (14)10.25
              Third
                  Amendment to Employment Agreement dated June 2003 between Mpower
                  Communications Corp. and Joseph M. Wetzel. (1) (14)10.26
              Fourth
                  Amendment to Employment Agreement dated December 31, 2003, between
                  Mpower
                  Communications Corp. and Joseph M. Wetzel. (1) (14)10.27
              Retention
                  and Severance Agreement dated October 11, 2001, between Mpower
                  Communications Corp. and Anthony M. Marion, Jr. (1)
                  (14)10.28
              First
                  Amendment to Employment Agreement dated March 19, 2003, between
                  Mpower
                  Communications Corp. and Russell I. Zuckerman. (1) (14)10.29
              Second
                  Amendment to Employment Agreement dated June 2003 between Mpower
                  Communications Corp. and Russell I. Zuckerman. (1) (14)10.30
              Employee
                  Benefit Trust Agreement dated October 23, 2001, between HSBC Bank
                  USA and
                  Mpower Communications Corp. (1) (14)10.31
              Subscription
                  Agreement dated January 1, 2005, between MCCC ICG Holdings LLC
                  and Mpower
                  Holding Corporation. (15)10.32
              Investor
                  Rights Agreement dated January 1, 2005, by and among MCCC ICG Holdings
                  LLC, ICG Communications, Inc. and Mpower Holding Corporation.
                  (15)10.33
              First
                  Amendment to Employment Agreement dated February 3, 2005, between
                  Mpower
                  Communications Corp. and Russell A. Shipley. (1) (16)10.34
              Employment
                  Agreement dated February 2, 2005, between Mpower Communications
                  Corp. and
                  Michael Tschiderer. (1) (16)10.35
              Amendment
                  to Retention and Severance Agreement dated January 25, 2005, between
                  Mpower Communications Corp. and Steven Reimer. (1) (16)10.36
              Amendment
                  to Retention and Severance Agreement dated February 4, 2005, between
                  Mpower Communications Corp. and Roger Pachuta. (1) (16)10.37
              Employment
                  Agreement dated February 15, 2005, between Mpower Communications
                  Corp. and
                  James Dole. (1) (16)10.38
              Third
                  Amendment to Lease dated February 10, 2005, between Mpower Communications
                  Corp. and Vista Holdings, LLC. (16)10.39
              Consulting
                  Agreement dated February 18, 2005, between Mpower Communications
                  Corp. and
                  Cassara Management Group, Inc. (16)10.40
              First
                  Amendment to Employment Agreement dated July 28, 2004, between
                  Mpower
                  Communications Corp. and James Ferguson. (1) (16)10.41
              Mpower
                  Holding Corporation 2005 Long-Term Incentive Plan (1)
                  (17)10.42
              Separation
                  of Employment Agreement dated January 5, 2006, between Mpower
                  Communications Corp. and Steven Reimer10.43
              Separation
                  of Employment Agreement dated January 5, 2006, between Mpower
                  Communications Corp. and Roger Pachuta21
              Subsidiaries
                  of the Registrant23
              Consent
                  of Deloitte & Touche LLP31.1
              Rule
                  13a-14(a)/15d-14(a) Certification of Chief Executive
                  Officer.31.2
              Rule
                  13a-14(a)/15d-14(a) Certification of Chief Financial
                  Officer.32
              Section
                  1350 Certifications.
 **68**
 (1)
              Management
                  contract or compensation plan or agreement required to be filed
                  as an
                  Exhibit to this Report on Form 10-K pursuant to Item 15(a) (3)
                  of Form
                  10-K.(2)
              Incorporated
                  by reference to Mpower Holding Corporation’s Current Report on Form 8-K
                  filed with the Commission on July 30, 2002.(3)
              Incorporated
                  by reference to Mpower Holding Corporation’s Current Report on Form 8-K
                  filed with the Commission on April 22, 2003.(4)
              Incorporated
                  by reference to Mpower Holding Corporation’s Registration Statement of
                  Form 8-A filed with the Commission on July 30, 2002.(5)
              Incorporated
                  by reference to Mpower Holding Corporation’s Current Report on Form 8-K
                  filed with the Commission on July 16, 2003.(6)
              Incorporated
                  by reference to Mpower Holding Corporation’s Registration Statement on
                  Form S-8 filed with the Commission on June 19, 2003.(7)
              Incorporated
                  by reference to Mpower Holding Corporation’s Quarterly Report on Form 10-Q
                  for the quarter ended September 30, 2001.(8)
              Incorporated
                  by reference to Mpower Holding Corporation’s Quarterly Report on Form 10-Q
                  for the quarter ended September 30, 2002.(9)
              Incorporated
                  by reference to Mpower Holding Corporation’s Annual Report on Form 10-K
                  for the year ended December 31, 2002.(10)
              Incorporated
                  by reference to Mpower Holding Corporation’s Annual Report on Form 10-K
                  for the year ended December 31, 2000.(11)
              Incorporated
                  by reference to Mpower Holding Corporation’s Quarterly Report on Form 10-Q
                  for the quarter ended June 30, 2003.(12)
              Incorporated
                  by reference to Mpower Holding Corporation’s Current Report on Form 8-K
                  filed with the Commission on September 30, 2003.(13)
              Incorporated
                  by reference to Mpower Holding Corporation’s Current Report on Form 8-K
                  filed with the Commission on October 27, 2004.(14)
              Incorporated
                  by reference to Mpower Holding Corporation’s Annual Report on Form 10-K
                  for the year ended December 31, 2003.(15)
              Incorporated
                  by reference to Mpower Holding Corporation’s Current Report on Form 8-K
                  filed with the Commission on January 6, 2005.(16)
              Incorporated
                  by reference to Mpower Holding Corporation’s Annual Report on Form 10-K
                  for the year ended December 31, 2004.(17)
              Incorporated
                  by reference to Mpower Holding Corporation’s definitive proxy statement
                  filed with the Commission on June 27, 2005.(c)
              Schedule
                  II - Valuation and Qualifying Accounts and Reserves is included
                  below. All
                  other schedules have been omitted as they are not required under
                  the
                  related instructions, are inapplicable, or because the information
                  required is included in the consolidated financial statements or
                  related
                  notes thereto.
  **69**
  
 **MPOWER
        HOLDING CORPORATION**
 
 **SCHEDULE
        II — VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR
        ENDED**
 **DECEMBER
        31, 2005**
 
 **Additions****Description**
              
              **Balance
                  at Beginning****of
                  Year**
              
              **Charged
                  to costs and****expenses**
              
              **Deductions**
              
              **Balance
                  at**
                **End
                  of Year**Allowance
                  for doubtful accounts
              
              $
              1,375
              
              $
              2,219
              
              $
              2,063
              
              $
              1,531Accrued
                  network optimization costs
              
              $
              233
              
              $
              (133
              )
              $
              —
              
              $
              100
 
 
 **MPOWER
        HOLDING CORPORATION**
 
 **SCHEDULE
        II — VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR
        ENDED**
 **DECEMBER
        31, 2004**
 
 **Additions****Description**
              
              **Balance
                  at Beginning****of
                  Year**
              
              **Charged
                  to costs and****expenses**
              
              **Deductions**
              
              **Balance
                  at**
                ******End
                  of Year**Allowance
                  for doubtful accounts
              
              $
              2,292
              
              $
              1,509
              
              $
              2,426
              
              $
              1,375Accrued
                  network optimization costs
              
              $
              243
              
              $
              —
              
              $
              10
              
              $
              233
 
 
 **MPOWER
        HOLDING CORPORATION**
 
 **SCHEDULE
        II — VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR
        ENDED**
 **DECEMBER
        31, 2003**
 
 **Additions****Description**
              
              **Balance
                  at Beginning****of
                  Year**
              
              **Charged
                  to costs and****expenses**
              
              **Deductions**
              
              **Balance
                  at**
                **End
                  of Year**Allowance
                  for doubtful accounts
              
              $
              3,151
              
              $
              4,743
              
              $
              5,602
              
              $
              2,292Accrued
                  network optimization costs
              
              $
              1,480
              
              $
              (591
              )
              $
              646
              
              $
              243
  **70**
 **SIGNATURES**
 
 Pursuant
        to the requirements of Section 13 or 15(d) of the Securities Exchange Act
        of
        1934, the registrant has duly caused this Report to be signed on its behalf
        by
        the undersigned, thereunto duly authorized.
 MPOWER
                  HOLDING CORPORATIONDate: March
                1, 2006
              
              /s/ Rolla
                P.
                HuffRolla
                P. Huff*Chief
                  Executive Officer and Chairman of the
                  Board*
 
 **POWER
        OF ATTORNEY**
 
 KNOW
        ALL
        MEN BY THESE PRESENTS that each person whose signature to this Annual Report
        on
        Form 10-K appears below hereby constitutes and appoints each of Rolla P.
        Huff,
        S. Gregory Clevenger and Russell I. Zuckerman and any of them as such person’s
        true and lawful attorney-in-fact and agent, with full power of substitution
        and
        resubstitution, for such person and in such person’s name, place and stead, in
        any and all capacities, to sign any and all amendments to this Annual Report
        on
        Form 10-K, and to file the same, with all exhibits thereto, and other documents
        in connection therewith, with the Commission, and does hereby grant unto
        each
        said attorney-in-fact and agent full power and authority to do and perform
        each
        and every act and thing requisite and necessary to be done in and about the
        premises, as fully to all intents and purposes as such person might or could
        do
        in person, hereby ratifying and confirming all that each said attorney-in-fact
        and agent, or any substitute therefore, may lawfully do or cause to be done
        by
        virtue hereof.
 
 Pursuant
        to the requirements of the Securities Exchange Act of 1934, this report has
        been
        signed below by the following persons on behalf of the registrant and in
        the
        capacities and on the dates indicated:
 /s/ ROLLA
                P.
                HUFF
              
              
              /s/ S.
                GREGORY CLEVENGERRolla
                  P. Huff
                Chief
                  Executive Officer and Chairman of the Board
                March
                  1, 2006
              
              
              S.
                  Gregory Clevenger
                Executive
                  Vice President - Chief Financial Officer
                March
                  1, 2006
  /s/ MICHAEL
                J. TSCHIDERER
              
              
              /s/ MICHAEL
                E. CAHRMichael
                  J. Tschiderer
                Senior
                  Vice President of Finance, Controller and Treasurer
                March
                  1, 2006
              
              
              Michael
                  E. Cahr
                Director
                March
                  1, 2006
  /s/ ANTHONY
                J. CASSARA
              
              
              /s/ PETER
                H.O. CLAUDYAnthony
                  J. Cassara
                Director
                March
                  1, 2006
              
              
              Peter
                    H.O. Claudy
                Director
                March
                  1, 2006
  /s/ MICHAEL
                M. EARLEY
              
              
              /s/ ANDREW
                D.
                LIPMANMichael
                  M. Earley
                  Director
                  March
                    1, 2006
              
              
              Andrew
                  D. Lipman
                  Director
                  March
                    1, 2006
  /s/ ROBERT
                M.
                POMEROYRobert
                M. Pomeroy
                Director
                March
                  1, 2006
 **71**
  
 **MPOWER
        HOLDING CORPORATION**
 
 **INDEX
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 
 **Page**Report
                  of Independent Registered Public Accounting Firm
              73Consolidated
                  Balance Sheets as of December 31, 2005 and 2004
              74Consolidated
                  Statements of Operations for the years ended December 31, 2005,
                  2004 and
                  2003
              75Consolidated
                  Statements of Stockholders’ Equity for the years ended December 31, 2005,
                  2004 and 2003
              76Consolidated
                  Statements of Cash Flows for the years ended December 31, 2005,
                  2004 and
                  2003
              77Notes
                  to Consolidated Financial Statements
              79
  **72**
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 Board
        of
        Directors and Stockholders
 Mpower
        Holding Corporation
 Rochester,
        New York
 
 We
        have
        audited the accompanying consolidated balance sheets of Mpower Holding
        Corporation and subsidiaries (the “Company”) as of December 31, 2005 and 2004,
        and the related consolidated statements of operations, stockholders’ equity, and
        cash flows for each of the three years in the period ended December 31, 2005.
        Our audits also included the financial statement schedule listed in the Index
        at
        Item 15. These financial statements and financial statement schedule are
        the
        responsibility of the Company’s management. Our responsibility is to express an
        opinion on the financial statements and financial statement schedule based
        on
        our audits.
 
 We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audits provide a
        reasonable basis for our opinion.
 
 In
        our
        opinion, such consolidated financial statements present fairly, in all material
        respects, the financial position of the ** Company
        as of December 31, 2005 and 2004, and the results of its operations and its
        cash
        flows for each of the three years in the period ended December 31, 2005,
        in
        conformity with accounting principles generally accepted in the United States
        of
        America. Also, in our opinion, the financial statement schedule referred
        to
        above, when considered in relation to the basic consolidated financial
        statements taken as a whole, presents fairly, in all material respects, the
        information set forth therein.
 
 We
        have
        also audited, in accordance with the standards of the Public Company Accounting
        Oversight Board (United States), the effectiveness of the Company’s internal
        control over financial reporting as of December 31, 2005, based on the criteria
        established in *Internal
        Control—Integrated Framework* issued
        by the Committee of Sponsoring Organizations of the Treadway Commission and
        our
        report dated March 1, 2006, expressed an unqualified opinion on management’s
        assessment of the effectiveness of the Company’s internal control over financial
        reporting and an unqualified opinion on the effectiveness of the Company’s
        internal control over financial reporting.
 Date: March
                  1, 2006
                
                /s/ Deloitte
                  & Touche LLPDeloitte
&
Touche
                  LLPRochester,
                  New
                  York
 **73**
 **MPOWER
        HOLDING CORPORATION**
 **CONSOLIDATED
        BALANCE SHEETS**
 **(IN
        THOUSANDS, EXCEPT PREFERRED AND COMMON SHARE AND PER COMMON SHARE
        AMOUNTS)**
 
 
 **December
                  31,**
              
              **December
                  31,****2005**
              
              
              **2004****ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              18,278
              
              $
              27,327Investments
                  available-for-sale
              
              
              8,845
              
              
              8,064Accounts
                  receivable, less allowance for doubtful accounts of $1,531 and
                  $1,375 at
                  December 31, 2005 and 2004, respectively
              
              
              13,828
              
              
              10,140Other
                  receivables
              
              
              890
              
              
              3,164Prepaid
                  expenses and other current assets
              
              
              3,075
              
              
              3,060Total
                  current assets
              
              
              44,916
              
              
              51,755Property
                  and equipment, net
              
              
              65,492
              
              
              33,012Long-term
                  restricted cash and cash equivalents
              
              
              9,237
              
              
              9,515Long-term
                  investments available-for-sale
              
              
              1,317
              
              
              2,041Goodwill
              
              
              8,861
              
              
              —Intangibles,
                  net of accumulated amortization of $14,750 and $11,072 at December
                  31,
                  2005 and 2004, respectively
              
              
              3,785
              
              
              4,367Other
                  long-term assets
              
              
              4,396
              
              
              4,274Total
                  assets
              
              $
              138,004
              
              $
              104,964**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  liabilities:Current
                  maturities of capital lease obligations
              
              $
              540
              
              $
              —Accounts
                  payable
              
              
              12,545
              
              
              20,462Accrued
                  sales tax payable
              
              
              1,841
              
              
              2,190Accrued
                  bonus
              
              
              904
              
              
              2,508Deferred
                  revenue
              
              
              5,141
              
              
              5,059Accrued
                  other expenses
              
              
              13,741
              
              
              11,756Total
                  current liabilities
              
              
              34,712
              
              
              41,975Long-term
                  capital lease obligations
              
              
              23,120
              
              
              —Other
                  long-term liabilities
              
              
              2,415
              
              
              1,833Total
                  liabilities
              
              
              60,247
              
              
              43,808Commitments
                  and contingenciesStockholders’
                  equity:Preferred
                  stock, 49,900,000 shares authorized but unissued at December 31,
                  2005 and
                  2004
              
              
              —
              
              
              —Series
                  A preferred stock, 100,000 shares authorized but unissued at December
                  31,
                  2005 and 2004
              
              
              —
              
              
              —Common
                  stock, $0.001 par value, 1,000,000,000 shares authorized, 91,506,765
                  and
                  78,570,772 shares issued and outstanding at December 31, 2005 and
                  2004,
                  respectively
              
              
              92
              
              
              79Additional
                  paid-in capital
              
              
              121,991
              
              
              104,054Accumulated
                  deficit
              
              
              (44,326
              )
              
              (42,977
              )Total
                  stockholders' equity
              
              
              77,757
              
              
              61,156Total
                  liabilities and stockholders' equity
              
              $
              138,004
              
              $
              104,964
 
 See
        accompanying notes to consolidated financial statements.
  **74**
  **MPOWER
        HOLDING CORPORATION**
 **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
 **(IN
        THOUSANDS, EXCEPT COMMON SHARE AND PER COMMON SHARE
        AMOUNTS)**
   **Year
                  Ended December 31,****2005**
              
              
              **2004**
              
              
              **2003**Operating
                  revenues:Telecommunication
                  services
              
              $
              193,017
              
              $
              151,010
              
              $
              148,172Costs,
                  expenses and other:Cost
                  of operating revenues
                (exclusive
                  of depreciation and amortization shown separately below of $15,611,
                  $8,006
                  and $7,697 for the years ended December 31, 2005, 2004 and 2003,
                  respectively)
              
              
              88,222
              
              
              69,279
              
              
              75,445Selling,
                  general and administrative
                (exclusive
                  of depreciation and amortization shown separately below of $6,042,
                  $7,527
                  and $8,672 for the years ended December 31, 2005, 2004 and 2003,
                  respectively)
              
              
              89,303
              
              
              73,111
              
              
              77,609Network
                  optimization
              
              
              (122
              )
              
              —
              
              
              (954
              )Depreciation
                  and amortization
              
              
              21,653
              
              
              15,533
              
              
              16,369Interest
                  income
              
              
              (869
              )
              
              (430
              )
              
              (199
              )Interest
                  expense
              
              
              3,817
              
              
              248
              
              
              526Other
                  income, net
              
              
              (7,686
              )
              
              (418
              )
              
              (1,859
              )Loss
                  from continuing operations
              
              
              (1,301
              )
              
              (6,313
              )
              
              (18,765
              )Discontinued
                  operations:(Loss)
                  income from discontinued operations
              
              
              (48
              )
              
              908
              
              
              (2,368
              )Net
                  loss
              
              $
              (1,349
              )
              $
              (5,405
              )
              $
              (21,133
              )Basic
                  and diluted (loss) income per common share:Loss
                  from continuing operations
              
              $
              (0.01
              )
              $
              (0.08
              )
              $
              (0.27
              )(Loss)
                  income from discontinued operations
              
              
              (0.00
              )
              
              0.01
              
              
              (0.04
              )Net
                  loss
              
              $
              (0.01
              )
              $
              (0.07
              )
              $
              (0.31
              )Basic
                  and diluted weighted average common shares outstanding
              
              
              91,437,180
              
              
              78,438,470
              
              
              68,515,811
 
 See
        accompanying notes to consolidated financial statements.
  **75**
   **MPOWER
        HOLDING CORPORATION**
 **CONSOLIDATED
        STATEMENTS OF STOCKHOLDERS’ EQUITY**
 **(IN
        THOUSANDS, EXCEPT COMMON SHARE AMOUNTS)**
 
 
 **Common
                  Stock****Shares**
              
              
              **Amount**
              
              
              **Additional**
                  **Paid-In**Capital
              
              
              **Accumulated**Deficit
              
              
              **Total
                  Stockholders’ Equity****Balance
                  at January 1, 2003**
              
              
              64,999,025
              
              $
              65
              
              $
              87,511
              
              $
              (16,439
              )
              $
              71,137Options
                  exercised for common stock
              
              
              292,976
              
              
              —
              
              
              64
              
              
              —
              
              
              64Stock-based
                  compensation
              
              
              —
              
              
              —
              
              
              175
              
              
              —
              
              
              175Private
                  placement of common stock
              
              
              12,940,741
              
              
              13
              
              
              15,985
              
              
              —
              
              
              15,998Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              (21,133
              )
              
              (21,133
              )**Balance
                  at December 31, 2003**
              
              
              78,232,742
              
              
              78
              
              
              103,735
              
              
              (37,572
              )
              
              66,241Options
                  exercised for common stock
              
              
              338,030
              
              
              1
              
              
              80
              
              
              —
              
              
              81Stock-based
                  compensation
              
              
              —
              
              
              —
              
              
              91
              
              
              —
              
              
              91Agent
                  selling expense - warrants
              
              
              —
              
              
              —
              
              
              148
              
              
              —
              
              
              148Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              (5,405
              )
              
              (5,405
              )**Balance
                  at December 31, 2004**
              
              
              78,570,772
              
              
              79
              
              
              104,054
              
              
              (42,977
              )
              
              61,156Common
                  stock issued in business acquisition
              
              
              10,740,030
              
              
              11
              
              
              14,059
              
              
              —
              
              
              14,070Warrants
                  issued in business acquisition
              
              
              —
              
              
              —
              
              
              1,246
              
              
              —
              
              
              1,246Common
                  stock issued for cash, net of costs
              
              
              1,988,894
              
              
              2
              
              
              2,161
              
              
              —
              
              
              2,163Options
                  exercised for common stock
              
              
              207,069
              
              
              —
              
              
              61
              
              
              —
              
              
              61Agent
                  selling expense - warrants
              
              
              —
              
              
              —
              
              
              410
              
              
              —
              
              
              410Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              (1,349
              )
              
              (1,349
              )**Balance
                  at December 31, 2005**
              
              
              91,506,765
              
              $
              92
              
              $
              121,991
              
              $
              (44,326
              )
              $
              77,757
 
 See
        accompanying notes to consolidated financial statements.
 
  **76**
 **MPOWER
        HOLDING CORPORATION**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **(IN
        THOUSANDS)**
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Cash
                  flows from operating activities:Net
                  loss
              
              $
              (1,349
              )
              $
              (5,405
              )
              $
              (21,133
              )Adjustments
                  to reconcile net loss to net cash provided by (used in) operating
                  activities:Depreciation
                  and amortization
              
              
              21,653
              
              
              15,533
              
              
              16,369Bad
                  debt expense
              
              
              2,219
              
              
              1,509
              
              
              4,743(Gain)
                  loss on disposal of assets from discontinued operations
              
              
              —
              
              
              (320
              )
              
              523Loss
                  on discharge of debt
              
              
              —
              
              
              —
              
              
              102Network
                  optimization
              
              
              (122
              )
              
              —
              
              
              (954
              )Gain
                  on sale of assets, net
              
              
              (71
              )
              
              (388
              )
              
              (534
              )Loss
                  on sale of investments, net
              
              
              —
              
              
              11
              
              
              —Amortization
                  of investment premiums
              
              
              128
              
              
              27
              
              
              —Amortization
                  of deferred debt financing costs
              
              
              131
              
              
              131
              
              
              131Stock-based
                  compensation expense
              
              
              —
              
              
              91
              
              
              175Agent
                  selling expense - warrants
              
              
              410
              
              
              148
              
              
              —Changes
                  in assets and liabilities:(Increase)
                  decrease in accounts receivable
              
              
              (4,357
              )
              
              2,427
              
              
              (3,695
              )(Increase)
                  decrease in other receivables
              
              
              (198
              )
              
              3,492
              
              
              (3,491
              )Decrease
                  in prepaid expenses and other current assets
              
              
              457
              
              
              1,427
              
              
              1,327Decrease
                  in other long-term assets
              
              
              203
              
              
              617
              
              
              6,987Decrease
                  in accounts payable
              
              
              (5,059
              )
              
              (75
              )
              
              (5,346
              )Decrease
                  in accrued sales tax payable
              
              
              (960
              )
              
              (1,457
              )
              
              (1,427
              )(Decrease)
                  increase in accrued bonus
              
              
              (1,604
              )
              
              120
              
              
              1,854(Decrease)
                  increase in deferred revenue
              
              
              (1,617
              )
              
              (15
              )
              
              2,227Decrease
                  in accrued other expenses
              
              
              (1,208
              )
              
              (3,531
              )
              
              (7,302
              )Net
                  cash provided by (used in) operating activities
              
              
              8,656
              
              
              14,342
              
              
              (9,444
              )Cash
                  flows from investing activities:Purchase
                  of property and equipment, net of payables
              
              
              (16,754
              )
              
              (5,623
              )
              
              (7,229
              )Deposits
                  on property and equipment purchase commitments
              
              
              (1,349
              )
              
              —
              
              
              —Proceeds
                  from sale of assets from continuing operations
              
              
              218
              
              
              407
              
              
              872Proceeds
                  from sale of assets from discontinued operations
              
              
              1,093
              
              
              63
              
              
              19,364Costs
                  associated with sale of assets from discontinued
                  operations
              
              
              —
              
              
              —
              
              
              (1,239
              )Purchase
                  of investments available-for-sale, net
              
              
              (2,578
              )
              
              (10,505
              )
              
              —Sale
                  of investments available-for-sale, net
              
              
              2,393
              
              
              362
              
              
              —(Purchase)
                  sale of restricted investments, net
              
              
              (134
              )
              
              114
              
              
              4,002Other
              
              
              (379
              )
              
              —
              
              
              —Net
                  cash (used in) provided by investing activities
              
              
              (17,490
              )
              
              (15,182
              )
              
              15,770Cash
                  flows from financing activities:Payments
                  on capital lease obligations
              
              
              (2,504
              )
              
              (256
              )
              
              (1,569
              )Payment
                  of deferred debt financing costs
              
              
              (262
              )
              
              —
              
              
              (131
              )Proceeds
                  from issuance of common stock, net of costs
              
              
              2,551
              
              
              81
              
              
              16,062Repurchase
                  of Senior Notes
              
              
              —
              
              
              —
              
              
              (2,154
              )Other
              
              
              —
              
              
              (965
              )
              
              —Net
                  cash (used in) provided by financing activities
              
              
              (215
              )
              
              (1,140
              )
              
              12,208Net
                  (decrease) increase in cash and cash equivalents
              
              
              (9,049
              )
              
              (1,980
              )
              
              18,534Cash
                  and cash equivalents at beginning of year
              
              
              27,327
              
              
              29,307
              
              
              10,773Cash
                  and cash equivalents at end of year
              
              $
              18,278
              
              $
              27,327
              
              $
              29,307
 
 **77**
 Supplemental
                  schedule of non-cash investing and financing activities:Fair
                  value of assets acquired in business acquisition
              
              $
              46,393
              
              $
              —
              
              $
              —Liabilities
                  assumed in business acquisition
              
              $
              (29,752
              )
              $
              —
              
              $
              —Common
                  stock issued in business acquisition
              
              $
              14,070
              
              $
              —
              
              $
              —Warrants
                  issued in business acquisition
              
              $
              1,246
              
              $
              —
              
              $
              —Property
                  and equipment purchased under capital leases
              
              $
              162
              
              $
              —
              
              $
              —Net
                  payable related to purchase of property and equipment
              
              $
              2,962
              
              $
              3,503
              
              $
              35Net
                  payable related to costs associated with business
                  acquisition
              
              $
              —
              
              $
              145
              
              $
              —Net
                  proceeds receivable from sale of assets from discontinued
                  operations
              
              $
              —
              
              $
              —
              
              $
              826Supplemental
                  cash flow information:Cash
                  paid for interest
              
              $
              2,006
              
              $
              117
              
              $
              525
 
 See
        accompanying notes to consolidated financial statements.
  **78**
  **MPOWER
        HOLDING CORPORATION**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **Years
        Ended December 31, 2005, 2004 and 2003**
 
 **(1)
        Description of Business and Significant Accounting
        Policies**
 
 **Description
        of Business**
 
 The
        accompanying consolidated financial statements of Mpower Holding Corporation
        (“Holding"), a Delaware corporation, include the accounts of Holding and its
        wholly-owned subsidiary, Mpower Communications Corp. ("Communications") and
        other subsidiaries of Communications (collectively the “Company”). All
        intercompany balances and transactions have been eliminated.
 
 The
        Company was one of the first facilities-based competitive local telephone
        companies founded after the inception of the Telecommunications Act of 1996,
        which opened up the local telephone market to competition. The Company offers
        local and long distance voice services as well as high-speed Internet access
        and
        voice over internet protocol (“VOIP”) by way of a variety of broadband product
        and service offerings over its network of collocations, switches and fiber
        network. The Company’s services have historically been offered through
        Communications primarily to small and medium-sized business customers in
        all of
        its markets and residential customers primarily in the Las Vegas, Nevada
        market.
        The Company’s markets include Los Angeles, California, San Diego, California,
        Northern California (the San Francisco Bay area and Sacramento), Las Vegas,
        Nevada and Chicago, Illinois. The Company also bills a number of major local
        and
        long distance carriers for the costs of originating and terminating traffic
        on
        the Company’s network for the Company’s local service customers. The Company
        does not have any unbundled network element platform (“UNE-P”) revenues although
        it is actively pursuing opportunities to provide network-based alternatives
        to
        UNE-P carriers on a wholesale basis in light of recent regulatory
        changes.
 
 On
        January 1, 2005, the Company acquired certain assets and assumed certain
        liabilities of ICG Communications, Inc. (“ICG”). The assets acquired include
        ICG’s customer base and certain network assets in California. See Note 2 for
        additional discussion of this acquisition.
 
 **Significant
        Accounting Policies**
 
 ***Revenue
        Recognition***
 
 The
        Company recognizes operating revenues as services are rendered to customers
        in
        accordance with the Securities and Exchange Commission’s (“SEC”) Staff
        Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition.” The Company
        recognizes revenue from monthly recurring charges, enhanced features and
        usage
        in the period in which service is provided. Advance billings for services
        not
        yet provided are deferred and recognized as revenue in the period in which
        service is provided. The Company bills the transactional elements of usage-based
        services in arrears. Estimates are used for these services to recognize revenue
        in the period earned. Nonrefundable activation fees are also deferred and
        recognized as revenue over the expected term of the customer relationship.
        The
        Company recognizes revenue from switched access in the period in which service
        is provided, when the price is fixed, the earnings process is complete and
        the
        collectability is reasonably assured. In circumstances when these criteria
        are
        not met, revenue recognition is deferred until these criteria are met.
        Consequently, under such circumstances, although the Company continues to
        bill
        the customer for all services provided, it does not recognize revenue until
        cash
        is received. As
        part
        of the revenue recognition process for switched access, the Company evaluates
        whether receivables are reasonably assured of collection based on certain
        factors, including past credit history, financial condition of the customer,
        industry norms, past payment history of the customer, the likelihood of billings
        being disputed by customers, and recognizes a small amount of these revenues
        on
        a cash basis.
 
 The
        Company maintains allowances for doubtful accounts for estimated losses
        resulting from its inability to collect all amounts owed by its customers
        for
        its services. In order to estimate the appropriate level of this allowance,
        the
        Company analyzes historical bad debts, current economic and competitive trends,
        changes in the credit worthiness of its customers, changes in its customer
        payment patterns and other relevant factors. In establishing the allowance
        for
        doubtful accounts, the Company has taken into consideration the aggregate
        risk
        of its receivables.
 **79**
 ***Cost
        of Operating Revenues***
 
 Cost
        of
        operating revenues include the cost of leasing copper loops from the incumbent
        local exchange carriers (“ILECs”), the cost to change over new customers onto
        the Company’s network, the cost of accessing and transporting voice and data
        traffic over the Company's network, long distance charges from service providers
        related to the traffic generated by the Company’s customers, the cost of leasing
        collocation space from the ILECs and the related utilities to operate the
        Company's equipment at those sites, the leased space related to the Company's
        switch sites and the related utilities needed to operate the Company’s switches
        and other related services. Cost of operating revenues does not include internal
        labor costs or an allocation of depreciation and amortization
        expense.
 
 The
        Company leases its loop, transport and network facilities from various long
        distance carriers and ILECs. The pricing of such facilities are governed
        by
        either a tariff or an interconnection agreement. These carriers bill the
        Company
        for the use of such facilities and other services. From time to time, the
        carriers present inaccurate bills, which the Company invoices disputed. As
        a
        result of such billing inaccuracies, the Company records an estimate of its
        liability based on its measurement of services received. As of December 31,
        2005
        and 2004, the Company had $4.6 million and $6.5 million, respectively, of
        disputes with carriers and recorded reserves of $0.3 million and $2.8 million,
        respectively, related to the disputed balances in accounts payable on the
        consolidated balance sheets.
 
 ***Selling,
        General and Administrative Expenses***
 
 Selling
        expenses consist primarily of salaries, commissions and related personnel
        costs
        attributable to the Company’s sales personnel, marketing costs and facilities
        costs. General and administrative expenses consist primarily of all other
        salaries and related personnel costs, the cost of maintaining the hardware
        and
        software in our network and back office systems, provision for bad debts,
        professional fees, insurance, property taxes, customer care and billing expense,
        facilities expense and agent selling expense.
 
 ***Other
        Income***
 
 During
        2005, the Company recognized other income of $7.7 million, which was primarily
        comprised of $7.2 million related to early termination of our Las Vegas,
        Nevada
        switch site lease, as discussed in Note 10. The Company recognized $0.4 million
        of other income during 2004, which was primarily related to the gain on asset
        sales. During 2003, the Company reported other income of $1.9 million primarily
        resulting from the reversal of a sales tax contingency reserve deemed to
        no
        longer be needed.
 
 ***Comprehensive
        Loss***
 
 The
        Company reports comprehensive loss in accordance with Statement of Financial
        Accounting Standards (“SFAS”) No. 130, "Reporting Comprehensive Income." SFAS
        No. 130 establishes rules for the reporting of comprehensive loss and its
        components. For the years ended December 31, 2005, 2004 and 2003, comprehensive
        loss consisted solely of the Company’s net loss.
 
 ***Concentration
        of Credit Risk***
 
 Financial
        instruments that potentially subject the Company to concentrations of credit
        risk consist principally of cash and cash equivalents and accounts receivable.
        The Company places its cash and cash equivalents in financial institutions
        considered by management to be high quality and limit the amount of credit
        exposure to any one institution. The Company has not experienced any losses
        in
        these accounts and believes that it is not exposed to any significant credit
        risk on cash balances.
 
 The
        Company conducts business with a large base of customers. Concentrations
        of
        credit risk with respect to accounts receivable are limited due to the large
        number of customers comprising the Company's customer base. The Company performs
        ongoing credit evaluations of its customers' financial condition. Additionally,
        a significant portion of the Company's accounts receivable related to switched
        access is concentrated in a limited number of carriers. The Company has reached
        access rate agreements with its three largest carriers. Allowances are
        maintained for potential credit issues and such losses to date have been
        within
        management's expectations.
 
 ***Cash
        and Cash Equivalents***
 
 The
        Company considers short-term investments with an original maturity of three
        months or less at the date of purchase to be cash equivalents. The fair value
        of
        the Company's cash and cash equivalents approximates carrying amounts due
        to the
        relatively short maturities and variable interest rates of the instruments,
        which approximate current market rates.
 
 **80**
 ***Investments***
 
 The
        Company’s short-term and long-term investments consist of investment-grade debt
        securities which are recorded at fair value and classified as available-for-sale
        in accordance with the provisions of SFAS No. 115, “Accounting for Certain
        Investments in Debt and Equity Securities.” During
        2005 and 2004, net unrealized holding gains and losses were not significant
        and
        accordingly the amortized cost of these investments approximated fair value
        as
        of December 31, 2005 and 2004. The Company classifies its available-for-sale
        debt securities maturing within twelve months of the balance sheet date as
        short-term and all others as long-term. Interest
        and amortization of premiums for available-for-sale securities are included
        in
        interest income, and realized gains and losses on available-for-sale investments
        sold were determined based on the specific identification method and included
        in
        other income, net in the Company’s consolidated statements of operations. The
        Company does not hold these investments for speculative or trading purposes.
        As
        of December 31, 2005 and 2004, no securities were impaired.
 
 ***Restricted
        Cash and Cash Equivalents***
 
 The
        Company has committed to pay severance benefits to certain employees in the
        event they are terminated involuntarily, without cause or resign voluntarily
        for
        good reason. The Company maintains two irrevocable grantor trusts, which
        have
        been funded at a level sufficient to pay a portion of the severance benefit
        obligations pursuant to employment agreements. The Company restricted $7.5
        million of cash and cash equivalents for these severance benefits as of December
        31, 2005 and 2004. As of December 31, 2005, $0.3 million of restricted cash
        and
        cash equivalents, representing severance obligations to be paid during the
        next
        twelve months, were included in prepaid expenses and other current assets
        on the
        consolidated balance sheet. For the years ended December 31, 2005, 2004 and
        2003, the Company paid out $0.1 million, $0.1 million and $2.1 million,
        respectively, relating to these severance commitments.
 
 In
        addition, the Company maintains a trust for the future purchase, if needed,
        of
        run-off insurance for its directors and officers. As of December 31, 2005
        and
        2004, the Company restricted $2.0 million of cash and cash equivalents for
        the
        purchase of run-off insurance.
 
 The
        trusts referred to above were all established prior to filing bankruptcy
        by the
        Company in 2002 to reassure key employees and members of the board of directors
        that the Company’s obligations to pay severance benefit obligations and to
        obtain run-off insurance coverage could be met in any event. This was essential
        to the success of the Company’s business plan, in that without the retention of
        key employees and members of the board of directors, the ability to successfully
        carry out the Company’s business plan would be greatly hampered. Key employees
        and members of the board of directors needed the assurance that the severance
        benefits they were relying on were funded and could be paid in any event,
        and
        that they would have been protected with run-off insurance in the event of
        a
        merger, acquisition or other event requiring such insurance
        coverage.
 
 The
        trusts established to cover commitments for severance payments will terminate
        when all employees have been paid all amounts due them pursuant to the terms
        and
        conditions of those trust agreements. The trust to purchase run-off insurance
        will terminate when the funds in the trust have been used to purchase run-off
        insurance in the event of a merger, acquisition or other event requiring
        such
        insurance.
 
 ***Prepaid
        Expenses and Other Current Assets***
 
 Prepaid
        expenses and other current assets consist primarily of prepaid rent, prepaid
        insurance, prepaid maintenance agreements and the current portion of deferred
        customer installation costs, deposits held by vendors and restricted cash
        and
        cash equivalents. Prepaid expenses are expensed on a straight-line basis
        over
        the corresponding life of the underlying agreements. Deferred customer
        installation costs are expensed on a straight-line basis over the estimated
        customer life, consistent with the corresponding deferred revenue.
 
 ***Property
        and Equipment***
 
 Property
        and equipment that is in use or being held for future use are carried at
        cost,
        less accumulated depreciation and amortization. Direct and indirect costs
        of
        construction are capitalized.
 
 Depreciation
        is computed using the straight-line method over estimated useful lives beginning
        in the month an asset is placed into service. Estimated useful lives of property
        and equipment are as follows:
 Buildings
              39
                  yearsTelecommunication
                  and switching equipment
              3-10
                  yearsFiber
                  optic network
              the
                  lesser of the estimated useful lives or term of leaseComputer
                  hardware and software
              3-5
                  yearsOffice
                  equipment and other
              3-10
                  yearsLeasehold
                  improvements
              the
                  lesser of the estimated useful lives or term of
                  lease
 
 The
        Company capitalizes costs associated with the design, deployment and expansion
        of the Company's network and operating support systems, including internally
        and
        externally developed software. Capitalized external software costs include
        the
        actual costs to purchase software from vendors. Capitalized internal software
        costs generally include personnel and related costs incurred in the enhancement
        and implementation of purchased software packages. Repair and maintenance
        costs
        are expensed as incurred.
 **81**
  Capitalized
        internal labor costs were as follows (in thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Capitalized
                  internal labor costs
              
              $
              1,599
              
              $
              1,130
              
              $
              1,330
 
 ***Goodwill
        and Intangible Assets***
 
 The
        Company accounts for goodwill and other intangible assets under the provisions
        of SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 provides
        that goodwill and other separately recognized intangible assets with indefinite
        lives are not amortized, but are subject to at least an annual assessment
        for
        impairment through the application of a fair-value-based test. The Company
        utilizes November 30 as its annual impairment test measurement date. Intangible
        assets that do have finite lives are amortized over their estimated useful
        lives
        and reviewed for possible impairment in accordance with SFAS No. 144 “Accounting
        for the Impairment or Disposal of Long-Lived Assets,” as discussed within the
“Impairment of Long-Lived Assets” section below. Additional information
        concerning the Company’s goodwill and intangible assets is provided in Note
        5.
 
 The
        identification and measurement of goodwill impairment involves a comparison
        of
        the estimated fair value of the Company’s reporting unit with the carrying value
        of the reporting unit. The Company estimates the fair value of its reporting
        unit based on the market capitalization of the Company’s common stock as of the
        annual impairment test measurement date. The Company’s impairment review for
        indefinite lived intangible assets is based on a combination of a market
        based
        approach and a relief from royalty approach. The market based approach estimates
        the fair value of an asset based on a comparison of the asset to comparable
        publicly traded assets in its industry or transactions involving similar
        assets.
        The relief from royalty approach estimates the fair value of an asset based
        on
        the value of the cash flows that the business can be expected to generate
        in the
        future, which requires significant judgment with respect to future volume,
        revenue and expense growth rates, and the selection of an appropriate discount
        rate. Management uses estimates based on expected trends in making these
        assumptions. An impairment charge is recorded for the difference between
        the
        carrying value of the asset and the estimated fair value of the asset. The
        Company uses its judgment in assessing whether assets may have become impaired
        between annual valuations. Indicators such as unexpected adverse economic
        factors, unanticipated technological change or competitive activities, or
        acts
        by governments and courts, may signal that an asset has become impaired.
        No
        impairment charges were recorded on goodwill or indefinite lived intangibles
        in
        2005, 2004 or 2003.
 
 ***Impairment
        of Long-Lived Assets***
 
 Property
        and equipment, finite lived intangible assets, and other long-lived assets
        are
        reviewed for possible impairment in accordance with SFAS No. 144, “Accounting
        for the Impairment or Disposal of Long-Lived Assets.” The Company conducts
        annual reviews for idle and underutilized equipment, and reviews business
        plans
        for possible impairment implications. If an event or change in circumstance
        arises that indicates the carrying amount of the asset may not be recoverable,
        an impairment review is performed by the Company. The Company’s impairment
        review is based on an undiscounted cash flow analysis at the lowest level
        for
        which identifiable cash flows exist. The analysis requires management judgment
        with respect to changes in technology, the continued success of product and
        service offerings, and future volume, revenue and expense growth rates.
        Impairment occurs when the carrying value of the asset exceeds the future
        undiscounted cash flows. When an impairment is indicated, the estimated future
        cash flows are then discounted, or another appropriate fair value methodology
        is
        utilized, to determine the estimated fair value of the asset and an impairment
        charge, if any, is recorded for the difference between the carrying value
        and
        the fair value of the asset.
 
 No
        impairment charges were recorded on long-lived assets in 2005, 2004 or
        2003.
 
 ***Other
        Long-Term Assets***
 
 Other
        long-term assets consist primarily of deposits on property and equipment
        purchase commitments, deposits on operating leases and the long-term portion
        of
        deferred customer installation costs and prepaid insurance. The deposits
        on
        property and equipment purchase commitments are held until construction of
        the
        asset is completed and accepted, at which point the deposit will be applied
        to
        the cost of the constructed asset. The deposits on operating leases are held
        for
        various periods of time by the respective lessors and are expected to be
        returned to the Company based on the specific conditions of the individual
        operating leases. Deferred customer installation costs are expensed on a
        straight-line basis over the estimated customer life, consistent with the
        corresponding deferred revenue. Prepaid expenses are expensed on a straight-line
        basis over the corresponding life of the underlying agreements.
 
 As
        of
        December 31, 2004, other long-term assets included direct acquisition costs
        related to the Company’s ICG California acquisition (See Note 2). Direct
        acquisition costs represented direct costs incurred by the Company in
        preparation for the ICG California acquisition that closed in January 2005
        such
        as professional fees, and amounts payable under a management services agreement
        and a transition services agreement and were subsequently included in the
        Company’s purchase price for the acquisition in 2005.
 
 **82**
 ***Income
        Taxes***
 
 The
        Company applies the provisions of SFAS No. 109, "Accounting for Income Taxes,"
        which requires the recognition of deferred income tax assets and liabilities
        for
        the consequences of temporary differences between amounts reported for financial
        reporting and income tax purposes, including net operating loss carryforwards.
        SFAS No. 109 requires recognition of a future tax benefit of net operating
        loss
        carryforwards and certain other temporary differences to the extent that
        realization of such benefit is more likely than not; otherwise, a valuation
        allowance is applied. The Company maintains a full valuation allowance on
        its
        net deferred income taxes, as further discussed in Note 16.
 
 ***Fair
        Value of Financial Instruments***
 
 SFAS
        No.
        107, "Disclosure About Fair Value of Financial Instruments," requires entities
        to disclose the fair value of financial instruments, both assets and liabilities
        recognized and not recognized on the consolidated balance sheet, for which
        it is
        practicable to estimate fair value. SFAS No. 107 defines fair value of a
        financial instrument as the amount at which the instrument could be exchanged
        in
        a current transaction between willing parties. At December 31, 2005 and 2004,
        the carrying value of financial instruments (primarily capital lease obligations
        at December 31, 2005) approximated fair value due to the implied interest
        rates
        of the leases, which are comparable with estimated current rates.
 
 ***Asset
        Retirement Obligations***
 
 The
        Company accounts for its asset retirement obligations under the provisions
        of
        SFAS No. 143, “Accounting for Asset Retirement Obligations” and Financial
        Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 47, “Accounting
        for Conditional Asset Retirement Obligations - an interpretation of FASB
        Statement No. 143.” An asset retirement obligation represents a legal obligation
        associated with the retirement of a tangible long-lived asset that is incurred
        upon the acquisition, construction, development or normal operation of that
        long-lived asset. The Company is required to recognize asset retirement
        obligations in the period in which they are incurred, if a reasonable estimate
        of fair value can be made. The asset retirement obligation is subsequently
        adjusted for changes in fair value. The associated estimated asset retirement
        costs are capitalized as part of the carrying amount of the long-lived asset
        and
        depreciated over its useful life. The Company’s asset retirement obligations are
        primarily associated with telecommunications and switching equipment the
        Company
        acquired from ICG located in various leased facilities in which the Company
        has
        contractual obligations to remove certain assets associated with the lease
        agreements upon termination of the agreements.
 
 ***Concentration
        of Suppliers***
 
 The
        Company currently leases its transport capacity from a limited number of
        suppliers and is dependent upon the availability of collocation space and
        transmission facilities owned by the suppliers. The Company is vulnerable
        to the
        risk of renewing favorable supplier contracts, timeliness of the supplier
        in
        processing the Company's orders for customers and is at risk related to
        regulatory agreements that govern the rates to be charged to the
        Company.
 
 ***Use
        of Estimates***
 
 The
        preparation of the financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        estimates and assumptions that affect the reported amounts of assets and
        liabilities and disclosure of contingent assets and liabilities at the date
        of
        the financial statements and the reported amounts of revenues and expenses
        during the reporting period. Actual results could differ from these
        estimates.
 
 ***Reclassifications***
 
 Certain
        reclassifications, which have no effect on net loss, have been made in the
        prior
        period financial statements to conform to the current presentation. The Company
        eliminated presentation of income (loss) from operations from its consolidated
        statements of operations effective for the year ended December 31,
        2005.
 **83**
 ***Stock-based
        Compensation***
 
 The
        Company measures the compensation cost of its stock option plan under the
        provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting
        for Stock Issued to Employees,” as permitted under SFAS No. 123, “Accounting for
        Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for
        Stock-Based Compensation - Transition and Disclosure.” Under the provisions of
        APB No. 25, compensation cost is measured based on the intrinsic value of
        the
        equity instrument awarded. Under the provisions of SFAS No. 123, compensation
        cost is measured based on the fair value of the equity instrument
        awarded.
 
 Had
        compensation cost for the employee stock options been determined consistent
        with
        SFAS No. 123, the Company’s results from operations would approximate the
        following pro forma amounts (in thousands, except per common share
        amounts):
  **Year
                    Ended December 31,****2005**
                
                **2004**
                
                **2003**Net
                    loss, as reported
                
                $
                (1,349
                )
                $
                (5,405
                )
                $
                (21,133
                )Add:
                    Stock-based compensation expense included in reported net loss,
                    net of
                    related income tax effects
                
                
                —
                
                
                91
                
                
                175Deduct:
                    Total stock-based compensation expense to be determined under
                    a fair value
                    based method for all awards, net of related income tax
                    effects
                
                
                (3,357
                )
                
                (3,853
                )
                
                (4,603
                )Pro
                    forma net loss
                
                $
                (4,706
                )
                $
                (9,167
                )
                $
                (25,561
                )Basic
                    and diluted net loss per common share, as reported
                
                $
                (0.01
                )
                $
                (0.07
                )
                $
                (0.31
                )Basic
                    and diluted net loss per common share, pro forma
                
                $
                (0.05
                )
                $
                (0.12
                )
                $
                (0.37
                )
 The
          Company utilizes the
          Black-Scholes method for determining the fair value of its options for
          purposes
          of the pro forma disclosures required by SFAS No. 123. The assumptions
          used for
          the Black-Scholes method were reviewed during 2004. Based on the review
          and
          consideration of the Company’s current financial position subsequent to its
          emergence from bankruptcy and the disposal of certain markets, it was determined
          that the unadjusted historical stock prices used to calculate its expected
          volatility were no longer reflective of future performance. Based on the
          review,
          the Company changed its methodology of determining the expected volatility
          and
          modified its calculation to place more reliance on recent periods in order
          to
          provide a more accurate projection of the future expected volatility of
          the
          Company’s common stock.
 
 For
        options granted during the year ended December 31, 2005, the weighted average
        fair value of options on the date of grant, estimated using the Black-Scholes
        option pricing model, was $0.90, using the following assumptions: dividend
        yield
        of 0%; expected option life of 6.0 years; risk free interest rate ranging
        from
        3.82% to 4.36% and an expected volatility ranging from 52% to 56%.
 
 For
        options granted during the year ended December 31, 2004, the weighted average
        fair value of options on the date of grant, estimated using the Black-Scholes
        option pricing model, was $1.27, using the following assumptions: dividend
        yield
        of 0%; expected option life of 6.0 years; risk free interest rate ranging
        from
        3.05% to 4.14% and an expected volatility ranging from 56% to 201%.
 
 For
        options granted during the year ended December 31, 2003, the weighted average
        fair value of options on the date of grant, estimated using the Black-Scholes
        option pricing model, was $1.02, using the following assumptions: dividend
        yield
        of 0%; expected option life of 6.0 years; risk free interest rate of 3.06%
        and
        an expected volatility of 200%.
 
 ***Income
        (Loss) Per Common Share***
 
 SFAS
        No.
        128, “Earnings Per Share,” requires the Company to calculate its income (loss)
        per common share based on basic and diluted income (loss) per common share.
        Basic earnings per common share excludes the effect of potential common stock
        and is computed by dividing income (loss) applicable to common stockholders
        by
        the weighted average number of shares of common stock outstanding during
        the
        period. Diluted earnings per common share reflects the potential dilution
        that
        could result if securities or other contracts to issue common stock were
        exercised or converted into common stock. Diluted earnings per common share
        assumes the exercise of stock options using the treasury stock method and
        assumes the conversion of preferred stock using the “if converted”
method.
 **84**
 **Effects
        of New Accounting Standards**
 
 *Accounting
        for Conditional Asset Retirement Obligations - an interpretation of FASB
        Statement No. 143*
 
 In
        March
        2005, the FASB issued FIN 47 which clarifies the term "conditional asset
        retirement obligation" used in FASB No. 143 "Accounting for Asset Retirement
        Obligations" and specifically when an entity would have sufficient information
        to reasonably estimate the fair value of an asset retirement obligation.
        The
        provisions of FIN 47 were effective as of December 31, 2005. The adoption
        of FIN
        47 did not have a material effect on the Company’s consolidated results of
        operations or financial condition.
 
 *Share-Based
        Payment*
 
 In
        December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment" (FAS
        123R)
        which requires companies to measure and recognize compensation expense for
        all
        share-based payments at fair value. In addition, the FASB has issued a number
        of
        supplements to FAS 123R to guide the implementation of this new accounting
        pronouncement. Share-based payments include stock option grants and other
        equity-based awards granted under the Company’s long-term incentive and stock
        option plans. FAS 123R will be effective for the Company beginning January
        1,
        2006. The Company will use the Black-Scholes valuation model as the method
        for
        determining the fair value of its equity awards that are issued after January
        1,
        2006. The Company will use the modified prospective transition method, which
        requires that compensation cost be recognized in the financial statements
        for
        all awards granted after the date of adoption as well as for existing awards
        for
        which the requisite service has not been rendered as of the date of adoption
        (the “Existing Awards”) and requires that prior periods not be restated. The
        Company estimates that it will recognize compensation expense related to
        Existing Awards of $1.4 million and $0.6 million over the remaining requisite
        service periods during the years ending December 31, 2006 and 2007,
        respectively. The impact of Existing Awards for the year ending December
        31,
        2008 is minimal. The Company can not yet estimate what the compensation expense
        impact will be on the financial statements for the awards that are issued
        after
        January 1, 2006. FAS 123R also requires an entity to calculate the pool of
        excess tax benefits available to absorb tax deficiencies recognized subsequent
        to adopting FAS 123R (the “APIC Pool”). The Company is currently evaluating
        acceptable methods for calculating its APIC Pool.
 
 *Accounting
        Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB
        Statement No. 3*
 
 In
        May
        2005, the FASB issued SFAS No. 154 "Accounting Changes and Error Corrections,
        a
        replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS No. 154
        requires that all voluntary changes in accounting principles be recognized
        as a
        retroactive restatement of all periods presented except when retroactive
        restatement is impracticable. In addition, SFAS No. 154 also requires that
        a
        change in depreciation method be accounted for as a change in accounting
        estimate that is affected by a change in accounting principle, which would
        be
        accounted for in the period of change if the change affects that period and
        also
        in future periods if the change affects both the period of change and future
        periods. SFAS No. 154 also eliminates paragraph 4 of APB 20, which specifies
        that APB 20 does not apply to changes made to comply with new pronouncements.
        This Statement will require that any change in an accounting principle made
        as a
        result of a new pronouncement be reported following the same guidance as
        that
        for voluntary changes in accounting principles unless the new pronouncement's
        transition provisions require another method. SFAS No. 154 is effective for
        years beginning after December 15, 2005. The Company does not expect the
        adoption of SFAS No. 154 to have a material impact on the Company’s consolidated
        results of operations or financial condition.
 
 *Minimum
        Revenue Guarantees Granted to a Business or Its Owners*
 
 In
        November 2005, the FASB issued FASB Staff Position (“FSP”) No. FIN
        45-3, *“* Application
        of FASB Interpretation No. 45 to Minimum Revenue Guarantees Granted to a
        Business or Its Owners,” which amends paragraph 3 of FIN 45, “Guarantor's
        Accounting and Disclosure Requirements for Guarantees, Including Indirect
        Guarantees of Indebtedness of Others,” to include minimum revenue guarantees.
        FSP No. FIN 45-3 requires that a liability be recognized at inception for
        the
        fair value of the obligation to stand ready to perform under the guarantee,
        even
        if it is not probable that the contingent events that would cause payment
        will
        occur. FSP No. FIN 45-3 is effective for new minimum revenue guarantees issued
        or modified on or after the beginning of the first fiscal quarter following
        November 10, 2005, with disclosure requirements effective for any minimum
        revenue guarantee issued prior to the initial application of the FSP. The
        Company is currently evaluating the potential effect of the adoption of FSP
        No.
        FIN 45-3 and does not believe that it will have a material impact on the
        Company’s consolidated results of operations or financial
        condition.
 
 **85**
 **(2)
        Acquisition**
 
 On
        January 1, 2005, the Company completed the acquisition of ICG’s retail and
        wholesale customers in California; a 1,412 route mile intrastate fiber ring
        and
        915 route miles of metropolitan fiber rings which connect 128 commercial
        buildings across major cities in California, along with certain network assets
        and assumed certain liabilities related to those assets (“ICG California”)
        pursuant to an Asset Purchase Agreement (“Agreement”) dated October 22, 2004 by
        and among MCCC ICG Holdings, LLC (“MCCC”), ICG and the Company. MCCC is a joint
        venture between Columbia Capital and M/C Venture Partners. ICG is a Denver-based
        nationwide communications provider focused on delivering data and voice services
        to corporate customers, internet service providers and telecommunication
        carriers using a network that it owned and operated. It was a publicly held
        company until October 18, 2004 when it became a private entity through a
        merger
        transaction. As a result of this merger, MCCC owns 100% of the voting stock
        of
        ICG.
 
 The
        Company purchased these assets for $16.6 million excluding liabilities assumed,
        comprised of (i) $14.1 million in the form of 10,740,030 shares of the Company’s
        common stock, (ii) $1.2 million in the form of warrants dated January 1,
        2005,
        to purchase another 2,000,000 shares of the Company’s common stock exercisable
        on or prior to the fifth anniversary of the date of issuance at an exercise
        price of $1.38 per share and (iii) $1.3 million of direct acquisition costs
        (described below). The Company also assumed certain of ICG’s capital lease
        obligations in California, including its long-term leases for its fiber network,
        which had a fair value of $26.0 million as of January 1, 2005. The $14.1
        million
        value of 10,740,030 shares of common stock was determined using an average
        stock
        price of $1.31 during the three days before and three days after the date
        the
        acquisition was announced. The fair value of the warrants was determined
        using
        the Black-Scholes method, with the following assumptions: dividend yield
        of 0%;
        expected warrant life of 5 years; risk free interest rate of 3.35%; and an
        expected volatility of 57%.
 
 MCCC
        received one seat on the Company’s board of directors as a result of this
        transaction. In connection with the acquisition, Columbia Capital and M/C
        Venture Partners, through their ownership of MCCC, invested $2.5 million
        in cash
        for an additional 1,988,894 shares of the Company’s common stock on January 5,
        2005.
 
 The
        ICG
        transaction described above involved a management services agreement and
        a
        transition services agreement that maintained the continuity of the ICG
        operations in California and prepared for the transfer of required business
        functions to the Company. Under the management services agreement, the Company
        reimbursed ICG for the cost of specific services provided by ICG on the
        Company’s behalf between the date the definitive agreement was signed (October
        22, 2004) and final closing (January 1, 2005). The Company recognized gross
        direct acquisition costs of $0.5 million for services and fees incurred under
        the management services agreement. The management services agreement also
        provided that the operating results of ICG’s California operations accrued to
        the benefit of the Company during the period of the agreement. During this
        period, ICG’s California operations generated operating income of $0.3 million,
        which has been recorded as an offset to the gross direct acquisition costs
        the
        Company incurred under the management services agreement. The Company recorded
        additional direct acquisition costs of $1.1 million primarily for legal and
        consulting fees incurred in connection with the ICG California acquisition.
        The
        $1.3 million of net direct acquisition costs described above was included
        as a
        component of the purchase price in accordance with SFAS No. 141, “Business
        Combinations.”
 
 Commencing
        on the transaction closing date, January 1, 2005, certain services were provided
        by ICG to the Company under a transition services agreement providing for
        services through December 31, 2005. For the year ended December 31, 2005,
        the
        Company incurred $1.3 million of expense under the transition services
        agreement, primarily related to accounting, billing, collections, provisioning,
        call center and network support services performed by ICG on the Company’s
        behalf, which are included in selling, general and administrative expenses
        in
        the Company’s consolidated statements of operations.
 
 At
        December 31, 2005, approximately $0.2 million of cash has been received by
        ICG
        from customer payments on behalf of the Company, which amounts are to be
        remitted to the Company under the terms of the transition services agreement.
        This amount is recorded on the accompanying consolidated balance sheets in
        other
        receivables and is expected to be received by the Company in the first quarter
        of 2006, net of amounts due to ICG under the transition services agreement
        and
        other operating expenses paid on behalf of the Company by ICG. At December
        31,
        2005, approximately $1.0 million of vendor invoices have been paid on the
        Company’s behalf by ICG, which amounts are to be remitted to ICG under the terms
        of the transition services agreement. This amount is recorded in the
        accompanying consolidated balance sheet in accounts payable. In January 2006,
        $0.8 million of this amount was paid.
 
 **86**
 The
        Company retained independent appraisers to assist in determining the fair
        value
        of certain assets acquired and liabilities assumed as required under SFAS
        No.
        141. The following table summarizes the final purchase price allocation for
        the
        ICG California acquisition (in thousands):
 
 **Assets
                  Acquired**
              
              **January
                  1,****2005**Accounts
                  receivable
              
              $
              1,526Other
                  receivables
              
              
              301Prepaid
                  expenses and other current assets
              
              
              60Property
                  and equipment
              
              
              32,299Goodwill
              
              
              8,861Intangibles
              
              
              3,096Other
                  long-term assets
              
              
              250Total
                  assets acquired
              
              
              46,393**Liabilities
                  Assumed**Current
                  maturities of capital lease obligations
              
              
              2,476Deferred
                  revenue
              
              
              1,613Accrued
                  other expenses
              
              
              1,723Long-term
                  capital lease obligations
              
              
              23,526Long-term
                  deferred revenue
              
              
              78Asset
                  retirement obligations
              
              
              336Total
                  liabilities assumed
              
              
              29,752Total
                  purchase price (exclusive of liabilities assumed)
              
              $
              16,641
 
 Commencing
        on January 1, 2005, the results of operations for ICG California have been
        included as part of the accompanying consolidated financial statements of
        the
        Company. The following unaudited pro forma financial information represents
        the
        combined results of operations for the Company and ICG California for the
        year
        ended December 31, 2004, assuming that the ICG California acquisition had
        occurred as of January 1, 2004, after giving effect to certain adjustments
        including depreciation and amortization expense, interest expense and the
        issuance of common stock and warrants. These pro forma results of operations
        have been prepared for comparative purposes only and are not necessarily
        indicative of the results that may occur in the future or that would have
        occurred had the acquisition occurred during the prior year (in thousands,
        except common share and per common share amounts):
 **Year
                  Ended****December
                  31,****2004****(pro
                  forma)**Operating
                  revenue
              
              $
              192,701Net
                  loss
              
              $
              (17,146
              )Basic
                  and diluted net loss per common share
              
              $
              (0.19
              )Basic
                  and diluted weighted average common shares outstanding
              
              
              89,149,155
 **87**
 **(3)
        Investments**
 
 The
        fair
        value of investments available-for-sale were as follows (in
        thousands):
 
 **December
                  31,****2005**
              
              **2004**Short-term
                  investments:Auction
                  rate securities
              
              $
              5,850
              
              $
              6,150Certificates
                  of deposit
              
              
              255
              
              
              —Corporate
                  bonds
              
              
              1,737
              
              
              1,396U.S.
                  government agency notes
              
              
              1,003
              
              
              518Total
                  short-term investments
              
              $
              8,845
              
              $
              8,064Long-term
                  investments:U.S.
                  government agency notes
              
              $
              461
              
              $
              1,032Certificates
                  of deposit
              
              
              190
              
              
              —Corporate
                  bonds
              
              
              666
              
              
              1,009Total
                  long-term investments
              
              $
              1,317
              
              $
              2,041
 
 Proceeds
        from the sale of investments available-for-sale were as follows (in
        thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Proceeds
                  from the sale of investments available-for-sale
              
              $
              2,393
              
              $
              362
              
              $
              —
 
 The
        realized losses from sales of investments were as follows (in
        thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Gross
                  realized losses
              
              $
              —
              
              $
              11
              
              $
              —
 
 **88**
 **(4)
        Property and Equipment**
 
 Property
        and equipment consist of the following (in thousands):
 
 **December
                  31,****2005**
              
              **2004**Buildings
                  and property
              
              $
              1,712
              
              $
              1,716Telecommunication
                  and switching equipment
              
              
              67,217
              
              
              33,968Leasehold
                  improvements
              
              
              7,397
              
              
              6,892Fiber
                  optic network
              
              
              12,033
              
              
              —Computer
                  hardware and software
              
              
              9,408
              
              
              7,638Office
                  equipment and other
              
              
              3,874
              
              
              2,722Assets
                  held for future use
              
              
              3,530
              
              
              3,296105,171
              
              
              56,232Accumulated
                  depreciation and amortization
              
              
              (44,975
              )
              
              (27,206
              )60,196
              
              
              29,026Construction
                  in progress
              
              
              5,296
              
              
              3,986Net
                  property and equipment
              
              $
              65,492
              
              $
              33,012
 
 Included
        in the table above is $32.3 million of property and equipment acquired as
        a
        result of the ICG California acquisition, discussed in Note 2 and $2.1 million
        related to the integration of assets acquired from ICG. As of December 31,
        2004,
        construction in progress included capital investments of $2.4 million in
        preparation for the integration of the assets acquired from ICG.
 
 Depreciation
        expense was as follows (in thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Depreciation
                  expense
              
              $
              17,913
              
              $
              10,952
              
              $
              11,787
 
 Assets
        held for future use are directly related to the recovery of switch and
        collocation equipment from markets cancelled or exited, primarily during
        2002
        and 2001, and continued network enhancements which are expected to be
        re-deployed throughout the Company's remaining operating markets. These assets
        continue to be depreciated and the net book value at December 31, 2005 and
        2004
        was $1.1 million and $1.4 million, respectively.
 
 As
        of
        December 31, 2005 construction in progress included capital investments of
        $2.6
        million in preparation for the relocation of the Las Vegas switch, as discussed
        in Note 10.
 
 **(5)
        Goodwill and Intangible Assets**
 
 As
        of
        December 31, 2005, the Company has goodwill of $ 8.9
        million resulting from the ICG California acquisition as discussed in Note
        2,
        which was determined based on purchase accounting standards as the excess
        of the
        purchase price including liabilities assumed over the fair value of identifiable
        assets acquired.
 
 **89**
 Intangible
        assets consist of the following (in thousands):
 
 **December
                  31,****2005**
              
              **2004**Amortized
                  intangible assets:Customer
                  relationships
              
              $
              16,301
              
              $
              13,745Internally
                  developed software
              
              
              340
              
              
              —Product
                  licensing agreement
              
              
              200
              
              
              —16,841
              
              
              13,745Less
                  accumulated amortization:Customer
                  relationships
              
              
              (14,597
              )
              
              (11,072
              )Internally
                  developed software
              
              
              (113
              )
              
              —Product
                  licensing agreement
              
              
              (40
              )
              
              —(14,750
              )
              
              (11,072
              )Amortized
                  intangible assets, net
              
              
              2,091
              
              
              2,673Trademark
              
              
              1,694
              
              
              1,694Intangibles,
                  net
              
              $
              3,785
              
              $
              4,367
 
 Included
        in the table above are $3.1 million of intangible assets acquired as a result
        of
        the ICG California acquisition, as discussed in Note 2. Approximately $2.6
        million of the acquired intangible assets was assigned to customer
        relationships, which have an estimated useful life of 3 years, Approximately
        $0.3 million was assigned to software and $0.2 million was assigned to a
        product
        licensing agreement, which have estimated useful lives of 3 years and 5 years,
        respectively.
 
 Amortization
        expense related to customer relationships, software and the product licensing
        agreement was as follows (in thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Amortization
                  expense
              
              $
              3,678
              
              $
              4,581
              
              $
              4,582
 
 **90**
 Estimated
        amortization expense for each of the next five years ending December 31,
        consists of the following (in thousands):
  2006
              
              $
              1,0062007
              
              
              1,0052008
              
              
              402009
              
              
              402010
              
              
              —$
              2,091
 
 The
        trademark was determined to have an indefinite life and is not subject to
        amortization.
 
 **(6)
        Other Long-Term Assets**
 
 Other
        long-term assets consist of the following (in thousands):
 
 **December
                  31,****2005**
              
              **2004**Deposits
                  on property and equipment purchase commitments
              
              $
              1,349
              
              $
              —Deposits
                  on operating leases
              
              
              1,277
              
              
              1,095Deferred
                  customer installation costs
              
              
              1,105
              
              
              1,101Prepaid
                  insurance
              
              
              351
              
              
              572Other
              
              
              314
              
              
              396Direct
                  acquisition costs
              
              
              —
              
              
              1,110Other
                  long-term assets
              
              $
              4,396
              
              $
              4,274
 
 During
        June 2005, the Company entered into an asset purchase agreement with IDACOMM,
        a
        subsidiary of IDACORP, Inc., to acquire four strands of dark fiber within
        a
        fiber network that IDACOMM is currently constructing in Las Vegas, Nevada.
        The
        total purchase commitment for this fiber network is $2.5 million, of which
        $1.3
        million was paid to IDACOMM as a deposit in June 2005. IDACOMM may transfer
        individual segments of the fiber network to the Company as each identifiable
        segment is completed and accepted. As of December 31, 2005, the Company has
        not
        accepted any individual segments of the fiber network. Accordingly, the $1.3
        million deposit has been included within “Deposits on property and equipment
        purchase commitments” in the above table of other long-term assets. All segments
        of the fiber network are expected to be completed and accepted in the first
        quarter of 2006.
 
 As
        of
        December 31, 2004, other long-term assets included $1.1 million of direct
        acquisition costs incurred by the Company in preparation for the ICG
        acquisition. In January 2005, the direct acquisition costs were included
        as a
        component of the purchase price for the ICG acquisition, as discussed in
        Note
        2.
 
 **(7)
        Line of Credit**
 
 The
        Company’s agreement with a lending institution provides the Company with a
        revolving line of credit facility of up to $7.5 million, secured by certain
        customer accounts receivable. The agreement was due to expire on January
        24,
        2006 before it was extended to April 24, 2006. This credit facility bears
        an
        interest rate equal to the prime lending rate plus two percent (2%) per annum.
        At December 31, 2005, the Company had $7.5 million in availability under
        this
        agreement. Interest expense related to the line of credit (consisting of
        the
        allocable portion of the annual commitment fee) was $0.2 million, $0.2 million
        and $0.5 million for the years ended December 31, 2005, 2004 and 2003,
        respectively. The Company has not borrowed under the line of credit during
        2005
        or 2004 and has no outstanding balance as of December 31, 2005.
 
 **91**
 **(8)
        Capital Lease Obligations**
 
 Capital
        lease obligations consist of the following (in thousands):
 
 **December
                  31,****2005**Capital
                  lease obligations
              
              $
              23,660Less:
                  current portion
              
              
              (540
              )$
              23,120
 
 The
        following is the leased property under capital leases by major classes (in
        thousands):
 
 **December
                  31,****2005**Fiber
                  optic network
              
              $
              8,033Office
                  equipment and other
              
              
              1628,195Less:
                  accumulated amortization
              
              
              (577
              )$
              7,618
 
 Pursuant
        to the acquisition of ICG California in January 2005, discussed in Note 2,
        the
        Company assumed certain capital leases of ICG, including certain long-term
        leases for its fiber network, which had a fair value of $26.0 million as
        of
        January 1, 2005 utilizing an implicit interest rate of 15%. The capital lease
        obligations have terms that range from 2 to 16 years. The following table
        shows
        the future minimum lease payments under capital leases for each of the next
        five
        years ending December 31 and periods thereafter (in thousands):
 
 2006
              
              $
              4,0622007
              
              
              4,0312008
              
              
              4,0312009
              
              
              3,9972010
              
              
              3,986Thereafter
              
              
              39,805Total
                  minimum lease payments
              
              
              59,912Less:
                  amounts representing interest
              
              
              (36,252
              )Net
                  present value of capital lease obligations
              
              $
              23,660
 **92**
 **(9)
        Asset Retirement Obligations**
 
 The
        telecommunications and switching equipment the Company acquired from ICG
        is
        located in various leased facilities. In some cases, the Company has contractual
        obligations to remove certain of the assets associated with these lease
        agreements upon termination of the agreements. As part of the opening balance
        sheet for the ICG California acquisition, the Company has recorded a liability
        and asset for the present value of the estimated future exit costs associated
        with the related asset retirement obligations, which have been recorded within
        other long-term liabilities and property and equipment, respectively, in
        the
        consolidated balance sheet. The liability was established by calculating
        the
        present value of the asset retirement obligation using a discount rate of
        19.60%
        over a period that is representative of the estimated useful life of the
        related
        assets. Changes in the asset retirement obligation resulting from the passage
        of
        time are recognized as an increase in the carrying amount of the liability
        and
        as accretion expense, which is a component of depreciation and amortization
        on
        the consolidated statements of operations.
 
 The
        following table is a reconciliation of the beginning and ending asset retirement
        obligations (in thousands):
 
 Balance
                  as of December 31, 2004
              
              $
              —Recognition
                  of liability at January 1, 2005
              
              
              336Accretion
              
              
              62Balance
                  as of December 31, 2005
              
              $
              398
 
 The
        asset
        retirement obligations and associated assets are estimated based on several
        assumptions. If information becomes known that is different than the assumptions
        in use, revisions will be made using the more precise information. If actual
        costs differ from the assumptions used, the amount of the obligations will
        differ, perhaps significantly, from the amounts reflected in the accompanying
        consolidated financial statements.
 
 **(10)
        Commitments and Contingencies**
 
 ***Lease
        Obligations and Purchase Commitments***
 
 The
        Company has entered into various operating lease agreements with expirations
        through 2015, for its switching facilities and offices (the “Operating Lease
        Obligations”). Rent expense included in continuing operations was as follows (in
        thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Rent
                  expense
              
              $
              8,587
              
              $
              4,977
              
              $
              6,446
 
 On
        February 10, 2005, the Company entered into an amendment to its Las Vegas,
        Nevada switch site lease. In consideration for the Company’s agreement to
        accelerate the expiration date of the lease to an earlier date, the landlord
        paid the Company $7.7 million in cash and agreed to $0.3 million in rent
        abatement from February 1, 2005 through the new lease expiration at June
        30,
        2006. The cash was received in February 2005. This $8.0 million settlement,
        net
        of $0.8 million of estimated costs to exit the facility, has been included
        in
        other income in the consolidated statement of operations for the year ended
        December 31, 2005. The impact of this early termination of the existing lease
        as
        of December 31, 2005, reduced the Company’s lease obligations by approximately
        $0.9 million and changed the lease expiration date from August 2011 to June
        2006. The Company entered into a lease for a new switch site with a third
        party
        during the second quarter of 2005. A portion of the $7.7 million one-time
        payment is being used to construct a new switch facility in the Las Vegas
        market
        and to cover exit costs related to the existing switch site.
 
 The
        Company also has various agreements with certain carriers for transport,
        long
        distance and other network services (the “Circuit Lease Obligations”). At
        December 31, 2005, the Company's minimum commitment under these agreements
        is
        $15.7 million, which expires through December 2026. Circuit lease expenses
        for
        the periods ended in 2005, 2004 and 2003 are included in cost of operating
        revenues in the consolidated statements of operations.
 
 In
        the
        ordinary course of business, the Company enters into purchase agreements
        with
        its vendors. As of December 31, 2005, the Company had total unfulfilled
        commitments with vendors of $2.9 million. Included in this amount is the
        remaining $1.2 million purchase commitment with IDACOMM, as discussed in
        Note
        6.
 **93**
 As
        of
        December 31, 2005, the Company is obligated to make cash payments in connection
        with various lease obligations and purchase commitments. All of these
        obligations require cash payments to be made by the Company over varying
        periods
        of time. Certain of these arrangements are cancelable on short notice and
        others
        require payments upon early termination, if any. Included in the table below
        are
        obligations for continuing operations as of December 31, 2005 (in
        thousands):
 
 **2006**
              
              **2007**
              
              **2008**
              
              **2009**
              
              **2010**
              
              **Thereafter**Operating
                  Lease Obligations
              
              $
              7,710
              
              $
              6,656
              
              $
              4,931
              
              $
              3,652
              
              $
              1,831
              
              $
              1,739Circuit
                  Lease Obligations
              
              
              7,406
              
              
              3,501
              
              
              773
              
              
              461
              
              
              426
              
              
              3,157Purchase
                  Commitments
              
              
              2,918
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Total
              
              $
              18,034
              
              $
              10,157
              
              $
              5,704
              
              $
              4,113
              
              $
              2,257
              
              $
              4,896
 
 As
        provided in the asset sale agreements for the Company’s discontinued markets
        sold to third parties in 2003, the purchasers of these assets assumed the
        liabilities associated with the markets acquired. However, the Company remains
        contingently liable for several of the obligations in these markets. The
        Company is guarantor of future lease obligations with expirations through
        2015.
        The guarantees arose from the assignment of leases as a part of the asset
        sales.
        The Company is fully liable for all obligations under the terms of the leases
        in
        the event that the assignee fails to pay any sums due under the lease. The
        remaining maximum potential amount of future payments the Company could be
        required to make under the guarantees at December 31, 2005 was $7.6 million.
        No
        payments have been made to date and none are expected to be required to be
        made
        in the future. In accordance with FIN 45, “Guarantor’s Accounting and Disclosure
        Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
        to
        Others,” no liability has been recorded on the Company’s consolidated balance
        sheet at December 31, 2005 or 2004 as those guarantees are not subject to
        the
        recognition provisions.
 
 ***Litigation***
 
 From
        time
        to time, the Company is involved in legal proceedings arising in the ordinary
        course of business, including some claims asserted by the Company against
        others, in which monetary damages are sought. The result of any current or
        future litigation is inherently unpredictable; however, management believes
        there is no litigation asserted or pending against the Company that could
        have,
        individually or in the aggregate, a material adverse effect on its financial
        position, results of operations or cash flows.
 
 On
        February 17, 2005, a class action lawsuit was commenced against the Company,
        alleging violations of California Labor Code Sections 2802 and 2804. The
        group
        of plaintiffs attempting to be formed and certified as a class would include
        the
        Company’s sales representatives in California for the past four years. The
        plaintiffs are seeking to recover what they claim to be unreimbursed expenses
        incurred in the performance of their duties, including additional mileage
        reimbursement. The action is pending in Superior Court of the State of
        California for the County of Los Angeles. The Company denies any liability,
        intends to vigorously defend the action, and believes that ultimate damages
        awarded, if any, will not have a material adverse effect on its financial
        position, results of operations or cash flows.
 
 The
        Company was party to an equipment lease dispute that resulted in claims being
        made against the Company and certain of its subsidiaries. In July 2005, a
        settlement was reached for all legal actions and the $0.6 million favorable
        difference between the estimated liability previously recorded and the
        settlement amount was reflected as a reduction of selling, general and
        administrative expenses on the consolidated statements of operations for
        the
        year ended December 31, 2005. In October 2005, $0.8 million was paid by the
        Company to complete the settlement.
 
 ***Interconnection
        Agreements***
 
 In
        the
        ordinary course of business, the Company has negotiated interconnection
        agreements with SBC Corp. (now known as AT&T) including its California and
        Illinois subsidiaries, Sprint Nevada and Verizon California. These agreements
        specify the terms and conditions under which the Company leases unbundled
        network elements (“UNEs”) including type of UNE, price, delivery schedule, and
        maintenance and service levels. The term of these agreements is generally
        two
        years. While the initial terms have expired, the agreements provide for
        continued enforceability while the parties negotiate and, if necessary,
        arbitrate the terms and conditions of a new agreement or amendments to existing
        agreements. Although the Company is not currently negotiating new agreements,
        the Company is in the process of amending its interconnection agreements
        to
        conform to the Triennial Review Order and Triennial Review Remand Order
        (“TRO/TRRO”).
 **94**
 The
        Company has no minimum purchase obligations and pays for only those UNEs
        it
        orders and receives. While the Company has no performance requirements imposed
        upon it, the incumbent carriers must perform at specified levels, generally
        at a
        parity level with the same services provided to the incumbent's retail
        customers. To the extent the services of the local exchange carriers are
        used,
        the Company and its customers are subject to the quality of service, equipment
        failures and service interruptions of the local exchange carriers.
 
 The
        Company is dependent on the cooperation of the incumbent local exchange carriers
        to provide service for the origination and termination of its local and long
        distance traffic. Historically, charges for these services have made up a
        significant percentage of the overall cost of providing these services. The
        Company incurs costs through the use of services agreed to in the
        interconnection agreements. The costs are recognized in the period in which
        the
        service is delivered and are included as items within cost of operating
        revenues. From time to time the carriers present inaccurate bills which the
        Company disputes and ultimately settles in the normal course of
        business.
 
 ***Sales
        Tax and Property Tax Reserves***
 
 The
        Company maintains reserves for estimated exposure for various sales and use
        taxes that taxing jurisdictions may claim as being owed due to interpretations
        of state and local regulations as well as for positions taken related to
        the
        underlying taxable base of capital expenditures made in the past by the Company.
        Similarly, reserves are maintained for positions taken on the assessment
        basis
        used to pay certain property taxes to various state and local taxing
        jurisdictions. The Company believes that all such reserves are appropriately
        recorded in accordance with the provisions of SFAS No. 5, “Accounting for
        Contingencies,” at December 31, 2005 and 2004.
 
 **(11)
        Risks and Uncertainties**
 
 The
        Company’s services are subject to varying degrees of federal, state and local
        regulation. These regulations are subject to change by federal and state
        administrative agencies, judicial proceedings, and proposals that could change,
        in varying degrees, the manner in which the Company operates. The Company
        cannot
        predict the outcome of these proceedings or their impact upon the Company’s
        industry generally or upon the Company specifically.
 
 **(12)
        Stockholders' Equity**
 
 ***Common
        Stock***
 
 During
        May 2005, the Company filed with the SEC a registration statement on Form
        S-3
        for the benefit of ICG and MCCC as the selling stockholders under the
        registration statement. The registration statement was declared effective
        by the
        SEC on May 13, 2005. The registration statement was required to be filed
        by the
        terms of the asset purchase agreement and related agreement entered into
        as a
        part of the ICG California acquisition, as discussed in Note 2. The selling
        stockholders may offer the shares of the Company’s common stock registered by
        the prospectus. The registration statement covers the possible resale of
        (A)
        1,988,894 shares of common stock issued pursuant to the terms of a Subscription
        Agreement, dated as of January 1, 2005, by and between the Company and MCCC,
        (B)
        10,740,030 shares of common stock issued pursuant to the terms of the asset
        purchase agreement, dated as of October 22, 2004, by and among the Company,
        MCCC
        and ICG and (C) 2,000,000 shares of common stock issuable upon exercise of
        warrants issued pursuant to the asset purchase agreement. The Company will
        not
        receive any of the proceeds from the sale of the common shares pursuant to
        the
        registration statement.
 
 During
        May 2004, the SEC declared the Company’s shelf registration statement on Form
        S-3 effective, registering $250 million of new securities, which could include
        shares of the Company’s common stock, preferred stock, warrants to purchase
        common stock, or debt securities. The filing of this shelf registration
        statement could facilitate the Company’s ability to raise capital, should the
        Company decide to do so, in the future. The amounts, prices and other terms
        of
        any new securities will be determined at the time of any particular
        transaction.
 
 During
        January 2004, the Company adopted a warrant program under which up to 1,000,000
        shares of the Company’s common stock are authorized for issuance. The shares
        issuable under the warrant program are covered by the Company’s shelf
        registration statement on Form S-3 filed in 2004. The intent of the warrant
        program is to make available to independent sales agents engaged by the Company
        warrants to purchase shares of the Company’s common stock, with the number of
        warrants to be granted based on the increase in baseline sales performance
        achieved by these independent sales agents. These warrants are exercisable
        at
        any time and expire three years from the issuance date. Agent selling expense
        is
        included as a component of selling, general and administrative expenses in
        the
        consolidated statements of operations.
 
 **95**
 For
        the
        year ended December 31, 2005, the Company issued warrants to purchase 728,508
        shares of common stock and recognized $0.4 million of agent selling expense.
        The
        weighted average fair value of warrants on the date of grant, estimated using
        the Black-Scholes model, was $0.57 per common share, using the following
        assumptions: dividend yield of 0%; expected warrant life of 3.0 years; risk
        free
        interest rate ranging from 3.39% to 4.43% and an expected volatility ranging
        from 52% to 55%.
 
 For
        the
        year ended December 31, 2004, the Company issued warrants to purchase 260,430
        shares of common stock and recognized $0.1 million of agent selling expense.
        The
        weighted average fair value of warrants on the date of grant, estimated using
        the Black-Scholes model, was $0.57 per common share, using the following
        assumptions: dividend yield of 0%; expected warrant life of 3.0 years; risk
        free
        interest rate ranging from 2.83% to 3.26% and an expected volatility ranging
        from 56% to 63%.
 
 During
        September 2003, the Company raised approximately $16.0 million, net of selling
        costs, through the private placement of 12,940,741 shares of common stock
        at
        $1.35 per common share. The Company also issued warrants to the investors
        who
        participated in the private placement to purchase 2,588,148 shares of common
        stock at a price of $1.62 per common share in connection with the transaction.
        In addition, pursuant to an exclusive finders agreement between the Company
        and
        the Shemano Group, Inc. (“Shemano”), the Company issued warrants to Shemano and
        its affiliates to purchase 349,400 shares of common stock at a price of $1.62
        per common share as partial consideration for services rendered in connection
        with the private placement. These warrants are exercisable at any time and
        expire five years from the issuance date. Additional warrants to purchase
        up to
        83,856 shares of common stock will be issued to Shemano and its affiliates
        in
        the event the warrants held by the investors are exercised. The warrants
        were
        recorded in stockholders’ equity at fair market value using the Black-Scholes
        method to calculate the fair market value, with the following assumptions:
        dividend yield of 0%; expected warrant life of 5 years; risk free interest
        rate
        of 3.18% and an expected volatility of 175%.
 
 ***Preferred
        Stock***
 
 The
        Company maintains a Stockholder Rights Plan (the “Rights Plan”) which is
        designed to guard against partial tender offers and other abusive tactics
        that
        might be used in an attempt to gain control of the Company without paying
        all
        stockholders a fair price for their shares.
 
 Pursuant
        to the Rights Plan, preferred stock purchase rights were distributed as a
        dividend at the rate of one Right for each share of common stock held at
        the
        close of business on July 11, 2003. Each right entitles stockholders to buy
        one
        one-thousandth of a share of Series A Preferred Stock of the Company at an
        exercise price of $6.00. The Rights will be exercisable only if a person
        or
        group acquires beneficial ownership of 15% or more of the Company's outstanding
        common stock or commences a tender or exchange offer which, upon consummation,
        would result in such person or group being the beneficial owner of 15% or
        more
        of the Company's outstanding common stock. A description of the terms of
        the
        Rights are set forth in a Rights Agreement between the Company and the Rights
        Agent (the “Rights Agreement”).
 
 If
        any
        person becomes the beneficial owner of 15% or more of the Company’s common
        stock, or if a holder of 15% or more of the Company’s common stock engages in
        certain self-dealing transactions or a merger transaction in which the Company
        is the surviving corporation and its common stock remains outstanding, then
        each
        Right not owned by such person (or certain related parties) will entitle
        its
        holder to purchase, at the Right’s then current exercise price, units of the
        Company’s Series A Preferred Stock (or in certain circumstances, Company common
        stock, cash, property or other securities of the Company) having a market
        value
        equal to twice the then current exercise price of the Right. In addition,
        if the
        Company is involved in a merger or other business combination transactions
        with
        another person after which its common stock does not remain outstanding,
        or
        sells 50% or more of its assets or earning power to another person, each
        Right
        will entitle its holder to purchase, at the Right’s then current exercise price,
        shares of common stock of the ultimate parent of such other person having
        a
        market value equal to twice the then current exercise price of the
        Right.
 
 The
        Company will generally be entitled to redeem the Rights at $0.0001 per Right
        at
        any time until the 10th business day following public announcement that a
        person
        or group has acquired 15% or more of the Company's common stock.
 
 On
        March
        14, 2005, the Company and Continental Stock Transfer & Trust Company (the
“Rights Agent”), the rights agent under the Company’s Rights Agreement dated
        July 10, 2003 between the Company and the Rights Agent, agreed and acknowledged
        an amendment to the Rights Agreement dated as of December 31, 2004, to provide
        that MCCC ICG Holdings, LLC (“MCCC”) would not be deemed an “Acquiring Person”
under the Rights Agreement until such time as MCCC became the beneficial
        owner
        of 17% or more of the Company’s common stock.
 **96**
 **(13)
        Stock Option Plans**
 
 In
        August
        2005, the Company adopted the 2005 Long-Term Incentive Plan (the “2005 Plan”) to
        provide for grants of options to purchase shares of common stock, stock
        appreciation rights, restricted stock, restricted stock units and other
        equity-based awards to employees and non-employee directors of the Company
        and
        consultants who are eligible to participate in the 2005 Plan. The 2005 Plan
        does
        not permit the repricing of stock options or the granting of discounted options.
        During September 2005, the Company filed with the SEC a registration statement
        on Form S-8 to register 11,500,000 shares of the Company’s common stock issuable
        by the Company upon the exercise of options and other stock-based awards
        that
        have been granted or may be granted under the 2005 Plan. The 2005 Plan replaces
        the Company’s previous non-stockholder approved plans, the Mpower Holding
        Corporation Stock Option Plan I (“Stock Option Plan I”) and Mpower Holding
        Corporation Stock Option Plan II (“Stock Option Plan II”), together, referred to
        as the “Prior Plans”, and became effective upon approval of the stockholders on
        August 16, 2005 at the Company’s annual stockholders meeting. Additionally
        during September 2005, the Company filed Post-Effective Amendment No. 1 to
        a
        previously filed Form S-8 to deregister a total of 2,460,954 unissued shares
        of
        the Company’s common stock that had been available for issuance under the Prior
        Plans since no further options may be granted under the Prior Plans. The
        prior
        registration statement remains in effect for outstanding options under the
        Prior
        Plans. Options granted under the 2005 Plan can be non-qualified or incentive
        stock options and have a term of 10 years. Options granted under this plan
        are
        granted at a price equal to the fair market value of the Company’s common stock
        at the date of grant. Generally, options are granted for general retention
        purposes and vest evenly over three years. All of the options granted to
        date
        under the 2005 Plan would fully vest upon the employee’s termination without
        cause or a resignation with good cause and upon a change of control unrelated
        to
        any equity investment in the Company. All of the options issued under this
        plan
        have been accounted for as fixed awards. As of December 31, 2005, the Company
        has reserved 7,500,000 shares of common stock for issuance pursuant to equity
        based awards granted or to be granted under the 2005 Plan plus an additional
        4,000,000 shares of common stock that may be issued under the 2005 Plan as
        a
        result of expirations, forfeitures or cancellations under the Prior Plans;
        however, the number of shares of common stock issued under the 2005 Plan
        with
        respect to incentive stock options may not exceed 2,000,000.
 
 Stock
        Option Plan I provided for grants of options to purchase shares of common
        stock
        to employees and non-employee directors of the Company who were eligible
        to
        participate in the Stock Option Plan I. Options granted under the Stock Option
        Plan I were non-qualified, have a term of ten years from the date of grant
        and
        were generally granted at a price equal to the fair market value of the
        Company’s common stock at the date of the grant. Pursuant to the Company’s Plan
        of Reorganization in 2002, employees received an initial grant of options
        under
        the Stock Option Plan I (the “New Options”) to replace their cancelled options,
        on a one-for-one basis. The New Options were subject to the same terms and
        conditions as the corresponding cancelled outstanding Employee Options,
        including such provisions as exercise price, termination of employment and
        vesting. The outstanding New Options vested over a three year period, with
        one
        third of the options vested September 29, 2002, 2003 and 2004. All of the
        New
        Options were considered to be a new grant of options from a new reporting
        entity, and have been accounted for as fixed awards. Options granted for
        incentive bonuses vested immediately upon grant, whereas options granted
        for
        retention purposes vest evenly over three years. As of December 31, 2005,
        the
        Company has reserved 6,705,498 shares of common stock for issuance pursuant
        to
        options granted under the Stock Option Plan I.
 
 Stock
        Option Plan II provided for grants to employees of options to purchase shares
        of
        common stock. Options granted under the Stock Option Plan II were non-qualified,
        have a term of ten years and were granted at a price equal to the fair market
        value of the Company’s common stock at the date of grant. Options were granted
        for special retention arrangements under Stock Option Plan II and vested
        one-third immediately upon grant, one-third after one year and the remaining
        one-third vested after two years. Options were also granted under Stock Option
        Plan II during 2003 for a salary reduction program in which options were
        granted
        in exchange for a reduction in salary. These options vested over a six-month
        period. Generally, all other options were granted for general retention purposes
        and vest evenly over three years. Options under Stock Option Plan II were
        also
        available for the Company’s incentive bonus plan and retention purposes. Options
        granted for incentive bonuses vest immediately upon grant, whereas options
        granted for retention purposes generally vested evenly over three years.
        All of
        the options granted under the Stock Option Plan II would fully vest upon
        the
        employee’s termination without cause or a resignation with good cause and upon a
        change of control unrelated to any equity investment in the Company. All
        of the
        options issued under this plan have been accounted for as fixed awards. As
        of
        December 31, 2005, the Company has reserved 13,647,003 shares of common stock
        for issuance pursuant to options granted under the Stock Option Plan
        II.
 
 **97**
 Stock
        option transactions were as follows:
  **Number
                  of****Shares**
              
              **Weighted
                  Average Exercise****Price**Outstanding
                  at January 1, 2003
              
              
              11,103,832
              
              $
              0.49Granted
              
              
              4,608,981
              
              $
              1.05Exercised
              
              
              (292,976
              )
              $
              0.22Cancelled
              
              
              (815,921
              )
              $
              1.03Outstanding
                  at December 31, 2003
              
              
              14,603,916
              
              $
              0.64Granted
              
              
              4,529,939
              
              $
              1.43Exercised
              
              
              (338,030
              )
              $
              0.24Cancelled
              
              
              (199,235
              )
              $
              1.40Outstanding
                  at December 31, 2004
              
              
              18,596,590
              
              $
              0.83Granted
              
              
              2,244,050
              
              $
              1.63Exercised
              
              
              (207,069
              )
              $
              0.30Cancelled
              
              
              (271,695
              )
              $
              1.55Outstanding
                  at December 31, 2005
              
              
              20,361,876
              
              $
              0.92Exercisable
                  at December 31, 2003
              
              
              10,324,577
              
              $
              0.71Exercisable
                  at December 31, 2004
              
              
              14,505,115
              
              $
              0.71Exercisable
                  at December 31, 2005
              
              
              17,687,827
              
              $
              0.85
 
 The
        following table summarizes information about stock options outstanding and
        exercisable at December 31, 2005:
 
 **Range
                  of****Exercise Price**
              **Shares
                  Outstanding at December 31,****2005**
              **Weighted
                  Average Remaining Contractual****Life**
              **Weighted
                  Average Exercise****Price**
              **Number
                  Exercisable at December 31,****2005**
              **Weighted
                  Average****Exercise****Price**$0.03
                  to $0.25
              10,217,278
              6.7
                  years
              $0.19
              10,209,108
              $0.19$0.26
                  to $0.50
              225,667
              6.7
                  years
              $0.34
              224,096
              $0.34$0.51
                  to $1.00
              534,091
              7.3
                  years
              $0.85
              362,881
              $0.85$1.01
                  to $1.50
              4,390,414
              8.1
                  years
              $1.32
              2,227,002
              $1.30$1.51
                  to $2.00
              4,590,058
              8.3
                  years
              $1.68
              4,260,372
              $1.68$2.01
                  to $10.00
              386,278
              5.1
                  years
              $5.92
              386,278
              $5.92$10.01
                  to $47.67
              18,090
              3.7
                  years
              $19.59
              18,090
              $19.59$0.03
                  to $47.67
              20,361,876
              7.3
                  years
              $0.92
              17,687,827
              $0.85
 
 The
        Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
        in accounting for its option plans and has elected to adopt the
“disclosure-only” provision of SFAS No. 123, “Accounting for Stock Based
        Compensation,” as amended by SFAS No. 148 “Accounting for Stock Based
        Compensation - Transition and Disclosure.” Accordingly, no compensation expense
        has been recognized for its stock-based compensation plans other than for
        stock
        options issued with an exercise price below fair market value. For the year
        ended December 31, 2005, no stock-based compensation expense was recognized.
        For
        the years ended December 31, 2004 and 2003, the Company recognized stock-based
        compensation expense of $0.1 million and $0.2 million, respectively, related
        to
        in-the-money options granted under the Stock Option Plan I. Stock-based
        compensation expense is included as a component of selling, general and
        administrative expenses in the consolidated statements of
        operations.
 **98**
 **(14)
        Discontinued Operations**
 
 In
        January 2003, the Company announced a series of strategic transactions to
        further strengthen the Company financially and focus its operations on its
        California, Nevada and Illinois markets. The Company has brought geographic
        concentration to its business by selling its customers and assets in Florida,
        Georgia, Ohio, Michigan and Texas to other service providers.
 
 In
        March
        2003, the Company completed the sale of the assets in its Ohio and Michigan
        markets to LDMI Telecommunications, Inc. ("LDMI"), pursuant to Asset Purchase
        Agreements dated as of February 6, 2003 and January 8, 2003. The purchase
        price
        for the assets in Ohio and Michigan was $3.3 million and $3.8 million,
        respectively. As of December 31, 2003, the total purchase price had been
        received. In addition, LDMI agreed to assume certain liabilities of the Company
        with respect to the Ohio and Michigan assets.
 
 In
        March
        2003, the Company completed a transaction with Xspedius Equipment Leasing,
        LLC
        ("XE"), a subsidiary of Xspedius Communications, LLC ("Xspedius"), pursuant
        to
        an Asset Contribution Agreement effective as of December 31, 2002. Under
        the
        terms of the Asset Contribution Agreement, the Company contributed the assets
        in
        its Texas market to XE in exchange for a 14% interest in XE. In April 2003,
        the
        Company sold 92.85% of its interest in XE (13% of XE) to a current member
        of XE
        for $0.5 million. In addition, XE agreed to assume certain liabilities of
        the
        Company with respect to the Texas assets.
 
 In
        April
        2003, the Company completed the sale of the assets in its Florida and Georgia
        markets to Florida Digital Networks, Inc. (“FDN”), pursuant to an Asset Purchase
        Agreement dated as of January 8, 2003. The purchase price for the assets
        in
        Florida and Georgia was $12.4 million. In addition, FDN agreed to assume
        certain
        liabilities of the Company with respect to the Florida and Georgia assets.
        As of
        December 31, 2005, $12.0 million of the purchase price has been received
        and the
        remaining $0.4 million has been included in other receivables in the
        consolidated balance sheets and this amount is being held in escrow by a
        third
        party escrow agent. The Company expects to receive the remaining $0.4 million,
        net of expenses chargeable to the Company of $0.3 million included in accrued
        other expenses on the consolidated balance sheet, before June 30, 2006.
        Subsequent to December 31, 2005, an additional $0.1 million was received
        by the
        Company out of escrow.
 
 Each
        of
        the transactions described above involved transition services and/or management
        agreements that were sufficient to transfer the operations of these businesses.
        The Company was reimbursed for the cost of specific services provided on
        behalf
        of the buyer. For the year ended December 31, 2003, the Company recognized
        $3.7
        million of reimbursements for transition services and management agreement
        fees.
        The amounts recognized from the transition services and management agreements
        have been included as an offset to the operating expenses component of (loss)
        income from discontinued operations in the consolidated statements of
        operations. The Company ceased providing transition services as of December
        31,
        2003.
 
 The
        operating revenues and expenses of the Company’s discontinued markets have been
        classified as discontinued operations under
        SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”
for all periods presented. ( Loss)
        income related to these discontinued markets was as follows (in
        thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Operating
                  revenues
              
              $
              33
              
              $
              4
              
              $
              6,150Operating
                  expenses (income)
              
              
              81
              
              
              (584
              )
              
              7,995(Gain)
                  loss on disposal
              
              
              —
              
              
              (320
              )
              
              523(Loss)
                  income from discontinued operations
              
              
              ($48
              )
              $
              908
              
              $
              (2,368
              )
 
 **99**
 During
        2005, the Company recorded $0.1 million in operating expenses primarily driven
        by rent expense of $0.2 million for a leased switch location not assigned
        as
        part of the market sales, offset by reversals of use and property tax
        liabilities of $0.1 million. During 2004, the Company recorded $0.6 million
        of
        operating income from discontinued operations, primarily related to the reversal
        of sales and property tax liabilities resulting from the resolution of tax
        audits and ongoing estimates of audit exposure in other states, as well as
        the
        resolution of certain disputes with several carriers. During 2003, the Company
        recorded $8.0 million in operating expenses from discontinued operations,
        primarily related to the ongoing operation of the discontinued markets through
        the date of sale. Operating expenses for the year ended December 31, 2003,
        included exit costs of $2.4 million, primarily comprised of facility and
        lease
        contract termination costs of $1.8 million and one-time severance termination
        benefits of $0.6 million.
 
 For
        the
        year ended December 31, 2004, the Company recorded a gain on disposal of
        $0.3
        million to account for an adjustment in the costs to sell the assets. For
        the
        year ended December 31, 2003, the Company recorded a loss on disposal of
        $0.5
        million, which was comprised of a $1.2 million loss on disposal to account
        for
        the resolution of purchase price adjustments and additional costs to sell
        the
        assets, partially offset by a $0.7 million gain resulting from the reversal
        of
        pre-bankruptcy sales tax contingency due to a favorable resolution regarding
        this matter.
 
 These
        amounts are reflected in (loss) income from discontinued operations in the
        Company’s consolidated statements of operations.
 
 **(15)
        Loss Per Common Share**
 
 SFAS
        No.
        128, "Earnings Per Share," requires the Company to calculate its income (loss)
        per common share based on basic and diluted income (loss) per common share,
        as
        defined. Basic and diluted loss per common share for the years ended December
        31, 2005, 2004 and 2003, were computed by dividing the loss applicable to
        common
        stockholders by the weighted average number of shares of common stock
        outstanding during the period.
 
 For
        the
        years ended December 31, 2005, 2004 and 2003, the Company incurred losses
        from
        continuing operations. As a result of the losses, as of December 31, 2005,
        2004
        and 2003, the Company had outstanding 26,267,160, 21,794,568 and 17,541,464
        options and warrants, respectively, which were convertible into common shares
        that were not included in the calculation of diluted loss per common share
        because the effect would be antidilutive.
 
 The
        following table summarizes the calculation of basic and diluted loss per
        common
        share (in thousands, except common share and per common share
        amounts):
 
 **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003****Basic
                  and diluted loss per common share**Loss
                  from continuing operations
              
              $
              (1,301
              )
              $
              (6,313
              )
              $
              (18,765
              )(Loss)
                  income from discontinued operations
              
              
              (48
              )
              
              908
              
              
              (2,368
              )Net
                  loss
              
              $
              (1,349
              )
              $
              (5,405
              )
              $
              (21,133
              )Weighted
                  average common shares outstanding
              
              
              91,437,180
              
              
              78,438,470
              
              
              68,515,811Basic
                  and diluted loss from continuing operations per common
                  share
              
              $
              (0.01
              )
              $
              (0.08
              )
              $
              (0.27
              )Basic
                  and diluted (loss) income from discontinued operations per common
                  share
              
              
              (0.00
              )
              
              0.01
              
              
              (0.04
              )Basic
                  and diluted net loss per common share
              
              $
              (0.01
              )
              $
              (0.07
              )
              $
              (0.31
              )
 
 **100**
 **(16)
        Income Taxes**
 
 The
        Company has had no current federal or state income tax expense in any period
        presented in the accompanying consolidated statements of operations. Any
        state
        taxes paid have been properly recorded as part of selling, general, and
        administrative expenses. Any deferred income tax benefit has been offset
        by a
        valuation allowance.
 
 A
        reconciliation of income taxes computed at the federal statutory rate to
        income
        tax expense recorded in the Company’s consolidated statements of operations is
        as follows (in thousands):
 
 **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Federal
                  benefit at statutory rate
              
              $
              (472
              )
              $
              (1,892
              )
              $
              (7,397
              )Change
                  in valuation allowance, net of state tax and rate changes
              
              
              (364
              )
              
              435
              
              
              5,759Amortization
                  expense for customer relationships
              
              
              935
              
              
              1,604
              
              
              1,604Other
              
              
              (99
              )
              
              (147
              )
              
              34Income
                  tax expense
              
              $
              —
              
              $
              —
              
              $
              —
 
 Deferred
        income taxes reflect the net tax effect of temporary differences between
        the
        carrying amounts of assets and liabilities for financial reporting purposes
        and
        amounts used for income tax purposes. Significant components of the Company’s
        deferred income tax assets and liabilities for federal and state income taxes
        are as follows (in thousands):
 
 **December
                  31,****2005**
              
              **2004**Deferred
                  income tax asset:Net
                  operating loss carryforward
              
              $
              41,223
              
              $
              42,186Depreciation
                  and amortization
              
              
              461
              
              
              —Other
              
              
              4,176
              
              
              5,29345,860
              
              
              47,479Less:
                  valuation allowance
              
              
              (44,712
              )
              
              (45,075
              )Net
                  deferred income tax asset
              
              
              1,148
              
              
              2,404Deferred
                  income tax liability:Depreciation
                  and amortization
              
              
              —
              
              
              (1,092
              )Other
              
              
              (1,148
              )
              
              (1,312
              )Net
                  deferred income tax liability
              
              
              (1,148
              )
              
              (2,404
              )Net
                  deferred income taxes
              
              $
              —
              
              $
              —
 
 **101**
 The
        realization of deferred tax assets depends upon the existence of sufficient
        taxable income within the carry back or carry forward periods under the tax
        law
        for each tax jurisdiction. The Company has considered the following possible
        sources of taxable income when assessing the realization of deferred tax
        assets:
 
 •
              Future
                  taxable income exclusive of reversing temporary differences and
                  carry
                  forwards•
              Future
                  reversals of existing taxable temporary differences•
              Taxable
                  income in prior carry back years•
              Tax
                  planning strategies
 
 As
        a
        result of this review, the Company concluded that there was not sufficient
        positive evidence to enable it to conclude that it was more likely than not
        that
        the net deferred income tax assets would be realized. Therefore, the Company
        has
        maintained a full valuation allowance on its net deferred income tax assets
        at
        December 31, 2005. This assessment will continue to be undertaken in the
        future.
        The Company’s results of operations might be favorably impacted in the future by
        reversals of valuation allowances if the Company is able to demonstrate
        sufficient positive evidence that its deferred income tax assets will be
        realized.
 
 As
        of
        December 31, 2005, the Company had net operating loss (“NOL”) carryforwards for
        federal income tax purposes of approximately $110.0 million, which will expire
        at various times through 2025, if not utilized. As a result of the
        implementation of a bankruptcy plan in 2002, the Company has determined that
        it
        experienced an ownership change under Section 382 of the Internal Revenue
        Code.
        An ownership change generally occurs when certain persons or groups increase
        their aggregate ownership percentage in a corporation’s stock by more than 50
        percentage points during a measurement period. As a result of this ownership
        change, Section 382 will apply to limit the Company’s ability to utilize any
        remaining NOLs generated before the ownership change as well as certain
        subsequently recognized “built-in losses” and deductions existing as of the date
        of the ownership change to $4.4 million per year. The Company’s ability to
        utilize new NOLs arising after the ownership change will not be affected
        by the
        Section 382 ownership change that resulted from implementation of the bankruptcy
        plan . Of the $110.0 million NOLs existing at December 31, 2005, $72.5 million
        are subject to the Section 382 limit and $37.5 million are not.
 
 **(17)
        401(k) Plan**
 
 The
        Company maintains a defined contribution 401(k) plan (the “401(k) Plan”)
        pursuant to Section 401(k) of the Internal Revenue Code (“IRC”). The 401(k) Plan
        covers substantially all employees that meet certain service requirements.
        Under
        the 401(k) Plan, eligible employees may voluntarily contribute a percentage
        of
        their compensation, subject to limits under the IRC. The 401(k) Plan provides
        for discretionary matching contributions by the Company which were as follows
        (in thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**401(k)
                  contributions
              
              $
              162
              
              $
              59
              
              $
              184
 
 **(18)
        Related Party Transactions**
 
 Andrew
        D.
        Lipman, who serves on the Company’s board of directors, is a partner and vice
        chairman of the Swidler Berlin LLP law firm in Washington, D.C. The Company
        retained that law firm for legal regulatory counsel in 2005 and 2004, and
        intends to do so in the future. Total payments to this firm for legal regulatory
        counsel was $0.2 million and $0.5 million for the years ended December 31,
        2005
        and 2004, respectively.
 
 Peter
        H.O. Claudy, who serves on the Company’s board of directors, is a director of
        ICG and a member of the managing board of MCCC. On January 1, 2005, the Company
        acquired ICG Communications, Inc.'s customer base and certain network assets
        in
        California, as discussed in Note 2. Mr. Claudy is also a director of an entity
        that is more than 10% owner of Florida Digital Networks, Inc. ("FDN"). In
        April
        2003, the Company completed the sale of its assets in its Florida and Georgia
        markets to FDN as discussed in Note 14. Mr. Claudy did not serve as a director
        of the Company until after the completion of the ICG California acquisition
        and
        the sale of assets to FDN. He does not receive compensation for his services
        as
        a Company director.
 
 **102**
 **(19)
        Subsequent Events**
 
 *Stock
        Repurchase Program*
 
 On
        January 18, 2006, the Company announced that its Board of Directors has approved
        a stock repurchase program under which the Company is authorized to acquire
        up
        to $10 million of its outstanding common stock in the open market over the
        next
        12 months. The
        Company also announced it intends to adopt a prearranged 10b5-1 stock trading
        plan and use a portion of the $10 million to repurchase the Company’s stock
        pursuant to that plan. That 10b5-1 plan will be implemented when permitted
        under
        Company-imposed blackout periods and insider trading law
        restrictions.
 
 The
        Company’s stock repurchase program allows the Company to make share purchases
        from time to time during its normal trading windows, depending on market
        conditions, share price and other factors. The 10b5-1
        trading plan, when adopted, will allow the Company to
        also
        repurchase shares at times when it otherwise might be prevented from doing
        so
        under the insider trading laws or because of self-imposed trading blackout
        periods. The repurchased shares will be held in treasury.
 
 *Restricted
        Shares*
 
 On
        January 31, 2006, the Company’s compensation committee of the board of directors
        approved forms of restricted stock award agreements under the Company’s 2005
        Plan. During 2006, the Company has awarded 1,674,076 shares of restricted
        stock
        and granted options to purchase 540,000 shares of common stock under the
        2005
        Plan.
 
 *Warrant
        Program*
 
 During
        January 2006, the Company adopted a second warrant program (“Warrant Program
        II”), under which certain shares of the Company’s common stock are authorized
        for issuance. The shares issuable under Warrant Program II will be covered
        by
        Amendment No. 4 to the Company’s shelf registration statement on Form S-3. The
        implementation of the plan is contingent upon the effectiveness of Amendment
        No.
        4 to the Company’s shelf registration. The intent of Warrant Program II is
        identical to the intent of the warrant program initially adopted in January
        2004; to make available to independent sales agents engaged by the Company
        warrants to purchase shares of the Company’s common stock, with the number of
        warrants to be granted based on the increase in baseline sales performance
        achieved by these independent sales agents.
 
 **(20)
        Operating Segments**
 
 *Reportable
        Segments*
 
 The
        Company operates its business as one segment and as a consolidated entity
        managed at a national level. The Company’s products and services have similar
        network operations, back-office support and technology requirements. Therefore,
        the Company manages these services as a single segment that are sold in
        geographic areas, or markets, within the United States, or that are sold
        to
        customers with a presence across geographical markets. The Company regularly
        evaluates the makeup of its business to determine whether more than a single
        segment exists as its business evolves and develops.
 
 **103**
 *Products
        and Services*
 
 The
        Company classifies its products and services into various revenue categories
        as
        shown in the following table (in thousands):
  **Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003**Plain
                  old telephone service (“POTS”)/DSL
              
              $
              82,214
              
              $
              85,866
              
              $
              93,561T1
                  based products and services
              
              
              60,726
              
              
              34,856
              
              
              21,253Private
                  lines
              
              
              17,487
              
              
              —
              
              
              —Long
                  distance and other usage
              
              
              19,519
              
              
              14,925
              
              
              14,748Switched
                  access
              
              
              13,071
              
              
              15,363
              
              
              18,610Total
                  operating revenue
              
              $
              193,017
              
              $
              151,010
              
              $
              148,172
 
 Included
        in the Company’s presentation of prior years is a reclassification of DSL
        revenues from the “T1 based products and services” to “Plain old telephone
        service” (“POTS”) / DSL.
 
 **(21)
        Supplemental Quarterly Financial Data (Unaudited)** (in
        thousands except per common share amounts):
 
 **First**
                **Quarter**
              
              **Second
                  Quarter**
              
              **Third
                  Quarter**
              
              **Fourth****Quarter**Year
                  Ended December 31, 2005:Operating
                  revenues
              
              $
              47,726
              
              $
              47,262
              
              $
              49,149
              
              $
              48,880Income
                  (loss) from continuing operations
              
              
              3,877
              
              
              (4,296
              )
              
              (2,279
              )
              
              1,397Net
                  income (loss)
              
              
              3,845
              
              
              (4,299
              )
              
              (2,311
              )
              
              1,416Basic
                  income (loss) per common share:Income
                  (loss) from continuing operations
              
              
              0.04
              
              
              (0.05
              )
              
              (0.03
              )
              
              0.02Net
                  income (loss)
              
              
              0.04
              
              
              (0.05
              )
              
              (0.03
              )
              
              0.02Diluted
                  income (loss) per common share:Income
                  (loss) from continuing operations
              
              
              0.04
              
              
              (0.05
              )
              
              (0.03
              )
              
              0.01Net
                  income (loss)
              
              
              0.04
              
              
              (0.05
              )
              
              (0.03
              )
              
              0.01
 
 
 **First**
                **Quarter**
              
              **Second
                  Quarter**
              
              **Third
                  Quarter**
              
              **Fourth****Quarter**Year
                  Ended December 31, 2004:Operating
                  revenues
              
              $
              37,153
              
              $
              38,496
              
              $
              37,593
              
              $
              37,768Loss
                  from continuing operations
              
              
              (504
              )
              
              (1,397
              )
              
              (1,854
              )
              
              (2,558
              )Net
                  loss
              
              
              (263
              )
              
              (1,404
              )
              
              (1,346
              )
              
              (2,392
              )Basic
                  and diluted loss per common share:Loss
                  from continuing operations
              
              
              (0.01
              )
              
              (0.02
              )
              
              (0.02
              )
              
              (0.03
              )Net
                  loss
              
              
              (0.00
              )
              
              (0.02
              )
              
              (0.02
              )
              
              (0.03
              )
 
 **104**