Eschelon Telecom (ESCH) 10-Q/A 2006 Q1 Quarterly report (amended)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-0001

FORM 10-Q/A

AMENDMENT NO. 1

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

ESCHELON TELECOM, INC.

(Exact name of registrant as specified in its charter)

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

Registrant’s telephone number, including area code: (612) 376-4400

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 the filing requirements for the past 90 days. Yes  x    No  o

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

Large accelerated filer o Accelerated filer o Non-accelerated filer x

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

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

EXPLANATORY NOTE

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

ESCHELON TELECOM, INC.

INDEX TO FORM 10-Q

PART I. FINANCIAL INFORMATION		3
Item 1.	Financial Statements:	3
	Consolidated Balance Sheets – December 31, 2005 and March 31, 2006 (Unaudited)	3
	Unaudited Consolidated Statements of Operations – Three months ended March 31, 2005 and 2006	4
	Unaudited Consolidated Statements of Cash Flows – Three months ended March 31, 2005 and 2006	5
	Notes to Consolidated Financial Statements	6
PART II. OTHER INFORMATION
Item 6.	Exhibits
Signature

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Eschelon Telecom, Inc.

Consolidated Balance Sheets

(In Thousands, Except Share and Per Share Amounts)

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

See accompanying notes.

3

Eschelon Telecom, Inc.

Unaudited Consolidated Statements of Operations

(In Thousands, Except Share and Per Share Amounts)

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

See accompanying notes.

4

Eschelon Telecom, Inc.

Unaudited Consolidated Statements of Cash Flows

(In Thousands)

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

See accompanying notes.

5

Eschelon Telecom, Inc.

Notes to Consolidated Financial Statements

(In Thousands, Except Share and Per Share Amounts)

(Unaudited)

1.)   Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements of Eschelon Telecom, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the United States Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal and recurring adjustments and accruals) considered necessary for a fair presentation for the periods indicated have been included. Operating results for the three month period ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The consolidated balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These financial statements should be read in conjunction with the Company’s audited financial statements and related notes thereto for the year ended December 31, 2005 included in the Eschelon Telecom, Inc. Form 10-K filed with the SEC on March 17, 2006.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Available-for-Sale Securities

Short-term investments are comprised of municipal and United States government debt securities with maturities of more than three months but less than one year. In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, and based on the Company’s intentions regarding these instruments, all investments in debt securities are classified as available-for-sale and accounted for at fair value. Fair value is determined by quoted market prices, with unrealized gains and losses reported as a separate component of stockholders’ equity. The Company uses the specific identification of securities sold method to recognize realized gains and losses in earnings.

The cost basis, unrealized holding gains and fair value of the investment securities available-for-sale as of March 31, 2006 and December 31, 2005, are as follows:

			Unrealized
			Holding
	Cost Basis		Gains		Fair Value
Available-for-sale securities as of March 31, 2006	$	782	$	13	$	795
Available-for-sale securities as of December 31, 2005	$	4,704	$	56	$	4,760

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

Property and Equipment

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

6

All internal costs directly related to the construction of the switches and operating and support systems, including compensation of certain employees, are capitalized.

Property and equipment consist of the following:

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

Goodwill and Other Intangible Assets

Goodwill represents the excess of cost over the fair value of net assets acquired.

Intangibles consist of customer installation costs, debt issuance costs, customer relationships, non-compete agreements and developed technology. The customer installation costs are being amortized over a period of 48 months, which approximates the average life of a customer contract. Debt issuance costs are being amortized over the term of the respective debt obligation. Non-compete agreement costs represent costs associated with a non-compete agreement with a former employee. These costs are being amortized over the term of the agreement. Customer relationships and developed technology are being amortized over four and three years, respectively.

Intangible assets consist of the following:

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

7

Stock-Based Compensation

Stock Option Plan

A total of 1,632,414 shares of the Company’s common stock have been authorized for issuance under the Eschelon Telecom, Inc. Stock Option Plan of 2002 (the “2002 Plan”). The 2002 Plan provides for grants of incentive stock options, non-statutory stock options, stock appreciation rights, restricted or unrestricted stock awards, phantom stock, performance awards and other stock-based awards to our employees, former employees, officers, directors and consultants. The 2002 Plan is administered by the Compensation Committee of the Board of Directors, which has sole discretion and authority, consistent with the provisions of the 2002 Plan, to determine which eligible participants will receive awards, when awards will be granted, the terms of awards, and the number of shares that will be subject to awards. The purpose of the 2002 Plan is to enable the Company to attract, retain and reward the best-available persons, to provide participants with incentives to improve stockholder value and to contribute to the growth and financial success of the Company through their future services of the Company. All of the Company’s employees, former employees, officers and directors are eligible to participate in the 2002 Plan.

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

Stock Options

Effective January 1, 2006, the Company adopted the provisions of SFAS No. 123R (SFAS 123R), Share-Based Payment: an amendment of FASB Statement No. 123 and FASB Statement No. 95, which requires the measurement and recognition of compensation expense for all share-based payment awards to employees and directors based on estimated fair values. Prior to the adoption of SFAS 123R, the Company accounted for its stock-based compensation under the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, and related interpretations. The Company recorded $336 of stock-based compensation expense under SFAS 123R for the three months ended March 31, 2006 for stock option awards. Under APB 25, $139 of stock-based compensation expense would have been recorded for the same period. For the three months ended March 31, 2006, $10 was recorded for vested restricted awards. At March 31, 2006, there is $1,064 of total unrecognized compensation expense related to unvested shares granted under the Company’s share-based payment plans, of which $1,053 relates to service-based option awards and $11 relates to restricted stock awards. The expense is expected to be recognized over a weighted-average period of 1.1 years.

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

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

8

The following table summarizes the assumptions used to estimate the fair value of options granted during the three month periods ended March 31, 2005 and 2006 using the Black-Scholes option-pricing model:

	Three months ended March 31,
	2005		2006
Expected dividend yield	—		—
Expected stock price volatility	25	%	26	%
Risk-free interest rate	3.71	%	4.56	%
Expected life of options	5 years		6 – 6.5 years

Pro forma information regarding net loss and net loss per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS 123. The following table illustrates the effect on net loss per share for the three months ended March 31, 2005, if the Company had applied the fair value recognition provision of SFAS 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:

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

The following table summarizes the option activity under the 2002 Plan:

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

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

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

9

Restricted and Unrestricted Common Stock

In 2003, the Company granted 183,399 shares of restricted common stock to certain of its directors and members of management. The Company records compensation expense as the restrictions are removed from the stock. In 2005, the Company granted 9,350 shares of unrestricted common stock to certain directors. Total compensation expense related to restricted and unrestricted common stock for the three months ended March 31, 2006 and 2005, is $10 and $36, respectively.

The following table summarizes the activity of the Company’s unvested restricted common shares for the three months ended March 31, 2006:

	Number of Shares		Weighted Average Grant- Date Fair Value
Unvested at December 31, 2005	31,686		$	0.68
Granted	—		—
Vested	(15,842	)	0.68
Forfeited	—		—
Unvested at March 31, 2006	15,844		$	0.68

Net Income (Loss) Per Share

Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based on the weighted average number of common shares outstanding adjusted by the number of additional shares that would have been outstanding had potentially dilutive common shares been issued. Potentially dilutive shares of common stock include unexercised stock options and unvested restricted stock grants. The Company does not have any potentially dilutive shares because net losses were reported in all periods presented.

2.)   Acquisitions

Advanced TelCom, Inc.

In connection with the acquisition of Advanced TelCom, Inc. on December 31, 2004, the Company accrued $2,531 in acquisition related expenses, which included severance benefits, relocation costs and contract termination fees. During the fourth quarter of 2005 the Company finalized its liabilities incurred in connection with the acquisition and recorded an adjustment to decrease the recorded liabilities by $403, which was recorded as a reduction to goodwill. As of March 31, 2006, $93 of the acquisition related expenses have yet to be paid.

3.)   Notes Payable

On March 29, 2006, the Company completed an offering of $48,000 of 8 3/8% senior second secured notes (“notes”) due 2010 at a discount resulting in a 9.92% yield. The notes were entered into under a fourth supplemental indenture to the original indenture dated March 17, 2004, and have the same terms and conditions of the original indenture. The Company received net proceeds of approximately $44,604 after deducting fees and expenses associated with the offering. The Company’s acquisition of Oregon Telecom, Inc. on April 1, 2006, was financed with approximately $20,000 of the proceeds from the offering. The remaining proceeds will be used for general corporate purposes and potential future acquisitions.

4.)   Benefit Contribution Plan

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

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5.)   Capital Stock

Preferred Stock

As a result of the Company’s initial public offering of common stock in August 2005, all of the Company’s then-outstanding shares of convertible preferred stock and accumulated dividends were automatically converted to common stock.

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

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

6.)   Reverse Stock Split

The Company completed a 0.0738-for-one reverse stock split affecting all outstanding shares of common stock on August 2, 2005. All share and per share data have been adjusted to reflect the stock split.

7.)   Condensed Consolidating Financial Information

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

The following tables present condensed consolidating balance sheets at December 31, 2005 and March 31, 2006 and condensed consolidating statements of operations and cash flows for the three-month periods ended March 31, 2005 and 2006.

11

Unaudited Condensed Consolidating Balance Sheets
As of December 31, 2005
(In Thousands)

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

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Unaudited Condensed Consolidating Balance Sheets

As of March 31, 2006
(In Thousands)

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

13

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

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

14

Unaudited Condensed Consolidating Statement of Operations
For the Three Months Ended March 31, 2006
(In Thousands)

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

15

Unaudited Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2005
(In Thousands)

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

16

Unaudited Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2006
(In Thousands)

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

17

8.)           Subsequent Event

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

18

Item 6. Exhibits

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

*  Filed herewith.

†  Furnished herewith.

19

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Eschelon Telecom, Inc.
Date: November 13, 2006	By:	/S/ Geoffrey M. Boyd
	Name:	Geoffrey M. Boyd
	Title:	Chief Financial Officer
		(Principal Financial and Accounting Officer and Duly Authorized Officer)

20