Eschelon Telecom, Inc.

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Eschelon Telecom, Inc.

730 2nd Avenue South, Suite 1200
Minneapolis, Minnesota 55402
U.S.A.
Telephone: (612) 376-4400
Fax: (612) 376-4411
Web site: http://www.eschelon.com

Private Company
Incorporated: 1996 as Advanced Telecommunications, Inc.
Employees: 890
Sales: $141 million (2003)
NAIC: 517110 Wired Telecommunications Carriers; 517910 Other Telecommunications; 518210 Data Processing, Hosting and Related Services; 519190 All Other Information Services; 561420 Telephone Call Carriers

Eschelon Telecom, Inc., is a rapidly growing provider of integrated voice, data, and Internet services. Headquartered in Minneapolis, Minnesota, the company offers small and medium-sized businesses a comprehensive range of telecommunications and Internet products, including local lines, long distance, business telephone systems, DSL, Dedicated T-1 access, network solutions, and Web hosting. With almost 900 telecommunications and Internet professionals, Eschelon operates more than 210,000 access lines in service throughout its markets in the Midwest and the Western United States.

Origins

The company that would become known as Eschelon Telecom, Inc. was founded in 1996 as Advanced Telecommunications, Inc. by Clifford D. Williams, a long time executive in the cable television and communications industries. From 1971 to 1991, Williams served in various senior executive positions at Rogers Communications Inc., a cable television company. From 1992 to 1995, he was president and chief executive officer of Enhanced Telemanagement Incorporated, an integrated communications company that provided a full range of services and products to small businesses in Minnesota, Washington, Oregon, Illinois, and Ohio. Eager to start his own communications venture and capitalize on the burgeoning telecommunications market, Williams raised enough venture capital to form Advanced Telecommunications, Inc. (ATI) as a holding and management services company for telecommunications-related enterprises. With venture capital funding, he moved quickly to make a series of acquisitions of small telecommunications firms, including Cady Communications of Plymouth, Minnesota, in 1996, and American Telephone Technology, Inc. of Seattle, Washington, and American Telephone Technology, Inc. of Portland, Oregon, and Electro-Tel, Inc. of Denver, Colorado in 1997. Like many small telecommunications firms of the time, Williams believed the acquisitions had tremendous potential but needed infusions of capital and management expertise to maximize growth and enter new industry segments.

Growth Through Acquisitions in the Late 1990s

In 1998, Williams acquired One Call Telecom, Inc., a competitive local exchange carrier serving the Minneapolis/St. Paul market. The company was merged with Cady Communications, ATI's existing local exchange subsidiary serving the Twin Cities to position it as the leading provider of integrated telecommunications services in the Minneapolis/St. Paul market. In the same year, ATI acquired Seattle-based Tele-Contracting Services, Inc., merging it with American Telephone Technology, its subsidiary serving the Seattle and Portland markets. The combined company made it the Pacific Northwest's leading provider of integrated telecommunications services, including key systems, PBX systems, local dial tone, long-distance, WAN/LAN equipment and services, and other data and voice transmission products and services. In 1999, ATI also acquired Infinite Voice Mail of Boulder, Colorado, and Intellecom, Inc of Reno, Nevada. With these acquisitions, ATI was well underway in establishing a national presence in the western United States as a reseller of U.S. West and Sprint local and long-distance lines and a provider of Internet and digital subscriber lines to small to medium-sized businesses. In 1998, ATI had 330 employees and $29 million in sales.

In November 1999, ATI landed $45.6 million in venture capital with a promise of $30 million more to come from a consortium that included Boston-based Bain Capital, J.P. Morgan& Cos. in New York, and Stolberg Equity Partners in Denver. The funding was the largest single venture capital investment in the state of Minnesota in five years. For ATI, the investment was part of $140 million in debt and equity financing raised by the company in the third quarter of 1999. The funds were earmarked for building the company's sales force, installing large switching platforms in existing markets, and gaining ATI a foothold in new markets. With operations in Seattle, Denver, Reno, and Portland, ATI planned on expanding into Salt Lake City and Phoenix the following year. The sizeable investment in ATI mirrored the red hot investment interest in telecommunications firms, which in 1999 received fully 30 percent of all venture dollars nationwide.

A Name Change and Continued Expansion

In April 2000, ATI announced that it was changing its name to Eschelon Telecom, Inc. to unify the growing firm's integrated telecommunications operating units under one name. The rapidly growing and privately held company also said the name change was important to reduce confusion among regulators, vendors, customers, and the financial community. In the same month, the company expanded its full range telecommunications services to small and medium-sized businesses in Phoenix, Arizona with plans to expand into many other cities by the end of 2001. In order to finance its multi-city expansion, in April Eschelon filed for an initial public offering (IPO) of $172.5 million in common shares but delayed the offering due to the shaky stock market. The company's expansion plans nevertheless received a boost by new quality of service guarantees from US West concerning the installation, repair, and billing of the leased US West phone lines used by Eschelon to provide customer service. In return for these guarantees, Eschelon agreed to drop a filing with the Minnesota Public Utilities Commission opposing the pending acquisition of US West by long-distance provider Qwest Communications.

In May 2000, Eschelon completed a $135 million senior secured debt facility to help fund expansion of its integrated voice and data services network in Minnesota, Washington, Oregon, Utah, Arizona, Nevada, Idaho, Colorado, Montana, New Mexico, Nebraska, and North Dakota. The financing was led by GE Capital Corporation, FleetBoston Financial, and Fistar Bank. In August, the company landed another $35 million in venture capital to pay for switching equipment in Albuquerque, New Mexico; Boise, Idaho; and Reno, Nevada. With this venture funding, Eschelon aimed to become more facilities based as an operator of its own telephone switching equipment and some of the lines used to provide service, which was more profitable than leasing and reselling lines from the major telephone carriers.

In August 2001, Eschelon appointed Richard A. Smith, the company's president and chief operating officer, to its Board of Directors. Smith joined the company in 1998 as its executive vice-president and chief financial officer. He was promoted to president and chief operating officer in March 2000, signaling a vote of confidence in his abilities to lead the company's transformation to become a facilities-based telecommunications firm. Under Smith's direction, Eschelon had raised more than $260 million in private equity and debt financing while overseeing a 50 percent growth rate over the previous two years.

Eschelon Weathers the Telecom Bust

Despite this success, in November the company withdrew its $172.5 million IPO due to worsening conditions in the stock market. Until the stock market improved, the company planned to rely on the private financing markets in which it was having success in contrast to the public markets where the stocks of once high-flying telecom companies had collapsed more than 75 percent. In the past few months, Eschelon had raised approximately $50 million in funding from several sources. The most recent investment of $5 million came from Bermuda-based Global Crossing. The investment stemmed from a larger agreement providing for Eschelon to purchase $100 million in long-distance services over ten years from Global Crossing, which was then building an international fiber network. The deal followed other private agreements with Nortel Networks Corp. providing $10 million and another $35 million in equity investments from Windpoint Partners of Chicago and Bain Capital of Boston. Eschelon also signed an agreement in November 2000 with Qwest Communications International providing Qwest $150 million in revenue over five years in exchange for favorable resale rates for using Qwest's network. With the downturn in the markets and the pulling of its IPO, the agreement would allow Eschelon to more profitably sell Qwest's telephone network services at a time when it could not rapidly expand into a facilities-based telecommunications form.

Nevertheless, Eschelon continued to pursue growth through strategic acquisitions. As a result, in February 2001, as part of its multi-city expansion efforts, Eschelon acquired Rocky Mountain Telephone Company of Salt Lake City, a provider and installer of office telecommunications systems with $2 million in annual revenues. The deal came as the company continued its success in raising private capital, boosting its debt financing by $10 million and looking to raise another $50 million in equity investments by the spring. Eschelon's strategy was to have a company in each of the cities in which it was selling business-telephone services. At the same time, with the severe economic downturn that began in spring 2000 forcing Eschelon to curb its expansion plans, the company pursued a conservative build out of facilities that would leave it less vulnerable to capital markets. As a result, the company began focusing on selling to more businesses in the markets in which they had existing voice and data switching facilities. With this strategy, buying local telecom firms with an established customer base was a natural tactic to penetrate new markets.

Company Perspectives:

Our mission is to be a premiere telecommunications enterprise by delivering superior products and services to our customers, valuing and respecting our employees, and providing outstanding returns to our shareholders.

In April 2002, Eschelon's agreement with Qwest Communications giving it a discount on services in return for dropping opposition to Qwest's purchase of US West, Inc., came under regulatory scrutiny. This was the result of regulators in several states investigating Qwest for striking secret deals with competitors who agreed not to oppose its efforts to expand its long-distance business. The primary thrust of the investigations was whether and to what extent Qwest had tried to buy the silence of competitors in the beleaguered telecommunications industry. Because Qwest did not publicize the contracts, it allegedly prevented rivals from getting equal treatment. Eschelon's attorney said parts of the company's agreement should have been disclosed by Qwest to regulators, but the agreement never worked out as hoped. In addition to favorable resale rates, the agreement provided for a meeting between Eschelon executives and Qwest Chief Executive Officer Joseph P. Nacchio if problems arose with using Qwest's network. When Eschelon ran into difficulties getting Qwest to provide data it needed, the company requested the meeting to resolve the issue but was rebuffed.

In July 2002, in the midst of the brutal telecom downturn, Eschelon successfully raised an additional $35 million in new capital. Despite the grim state of the private and public equity markets, the new deal partnered the company's three largest stakeholders—Bain Capital, Stolberg Partners, and Windpoint Ventures—with un unidentified university pension fund as a first-time investor. The agreement was premised on a major restructuring of the company's debt load. In the restructuring, some of the participating banks had their positions in the company bought out, while others converted their loans into equity. As a result, the banks assumed a 13 percent equity stake in the company and reduced Eschelon's total debt load from approximately $139 million to $59 million. The investment community viewed Eschelon's ability to secure funding as impressive in an industry in which the vast majority of telecom companies, including such major players as NorthPoint communications, Covad Communications Group, Inc., Rhythms NetConnections, and ExciteAtHome all had sought bankruptcy protection. With many telecom companies going out of business, investors held out hope that Eschelon would survive the attrition among competitors, gain market share, and be well positioned to reach profitability in 2004.

Eschelon Positions Itself for Future Growth

In September 2003, Eschelon achieved its first month of free cash flow, one of the few Competitive Local Exchange Carriers (CLECs) to reach this financial milestone. The achievement meant the company was generating more cash from operations than it was expending to fund operating costs, capital spending, working capital, and debt obligations. At a time when other telecom firms had been filing for bankruptcy, downsizing, or cutting back on their future capital plans, Eschelon had continued to invest in systems and capabilities to expand its services and customer base. The company announced another milestone in December when it crossed the 200,000 mark for access lines in service, a doubling of its capacity in two years. As a result of this expansion, Eschelon became the number one CLEC in terms of market share in the twelve markets it served.

Eschelon moved into 2004 with strong first quarter results, reporting revenues of $38.2 million, an increase of $6.3 million from the first quarter of 2003. With the worst of the telecom downturn behind it, Eschelon's prospects looked increasingly promising. In October 2004, Eschelon announced it was acquiring Advanced Telecom Inc. (ATI), an independent Santa Rosa, California, company born during the telecom boom of the late 1990s, from General Electric Corp. for $45.5 million in cash. Eschelon's offer for ATI came as an unsolicited bid which marked its continuing strategy to grow through acquisitions and would enable it to enter the California market. ATI was founded in 1999 as Advanced TelCom Group in Santa Rosa during the rapid expansion of the telecommunications industry fueled by the deregulation of the telephone industry. The company, which primarily served business and government institutions, went bankrupt in 2002 with debts of $208 million and was purchased by General Electric Capital in bankruptcy court for $9.5 million. Eschelon saw value in acquiring ATI because of its 18,000 customers in California, Nevada, Oregon, and Washington utilizing 116,000 access lines. With the acquisition, Eschelon gained a leading market position among CLECs in the Pacific Northwest with revenues more than $215 million and over 350,000 access lines in service. After completing the acquisition in January 2005, Eschelon president and CEO Richard A. Smith said the combined companies would create the premier super-regional CLEC operating in key states in the western part of the country and would position the company for future growth.

Principal Competitors

Qwest; SBC Communications.

Key Dates:

1996:: Clifford D. Williams founds Advanced Telecommunications, Inc.; the company acquires Cady Communications of Minneapolis/St. Paul, Minnesota.
1997:: The company acquires American Telephone Technology, Inc. of Seattle, Washington, and Electro-Tel, Inc. of Denver, Colorado.
1998:: One Call Telecom of Minneapolis/St. Paul, Minnesota, and Tele-Contracting Specialists, Inc. of Seattle, Washington, are acquired.
1999:: The company acquires Infinite Voice Mail of Boulder, Colorado.
2000:: Fishnet.com of Minneapolis/St. Paul, Minnesota, is acquired.
2001:: The company acquires Rocky Mountain Telephone Company of Salt Lake City, Utah.