PAETEC Holding Corp. Q1 2009 Earnings Call Transcript

PAETEC Holding Corp. (PAET)

Q1 2009 Earnings Call

May 6, 2009 5:00 pm ET

Executives

Chris Muller - IR

Arunas Chesonis - Chairman and CEO

Keith Wilson - CFO

Analysts

David Dixon - FBR Capital Markets

Simon Flannery - Morgan Stanley

Colby Synesael - Kaufman Brothers

Tim Horan - Oppenheimer

Frank Louthan - Raymond James

Donna Jaegers - D.A. Davidson

Robert Dezego - SunTrust Robinson Humphrey

Michael Rollins - Citigroup

Todd Morgan - Oppenheimer

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the 2009 First Quarter PAETEC Holding Corp. Earnings Call. My name is Becky and I will be your coordinator for today. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Mr. Chris Mueller. Please proceed.

Chris Muller

Thanks, Becky. Good morning, everyone, and welcome to PAETEC's first quarter 2009 earnings call.

With me on today's call are Chairman and CEO, Arunas Chesonis; Chief Financial Officer, Keith Wilson; and Chief Operating Officer, E. J. Butler. Following our prepared remarks, we will then conduct the Q&A session.

Before we get started, I need to remind everyone that in our remarks today, we'll be making some forward-looking statements about our expected operating results and financial position, our business strategy, our integration of acquired companies and other matters relating to our business.

These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual operating results, financial position or performance to be materially different from those we express or imply in our forward-looking statements.

We have highlighted some of our more important risks and uncertainties in our earnings release. For a more detailed discussion, please refer to PAETEC's 10-K for 2008 fiscal year and other filings with the SEC. We disclaim any obligation to update any of our forward-looking statements.

Please note that in today's call, we will be referring to certain non-GAAP financial measures. These measures are reconciled to the most comparable GAAP measures in our press release and supplemental information, which has been posted on the Investor Relations portion of our website at paetec.com.

Finally, now that we've done the Safe Harbor formalities all the way, please note that we have posted on the Investor Relations portion of our website, a new supplemental presentation that will be discussed on this call regarding PAETEC's operating metrics.

With that, I'd like to now turn the call over to PAETEC's Chairman and CEO, Arunas Chesonis.

Arunas Chesonis

Thanks, Chris. Today, we are very pleased to share with you our first quarter 2009 results. In a difficult economic environment, we are able to achieve our 25th consecutive quarter of free cash flow generation.

Several of the cost reduction activities that we began last year have now been realized. Although we have chosen not to give firm guidance for 2009, we are comfortable with how our business has been responding to the economic challenges.

Our solid financial position has continued to provide our employees, partners, and shareholders, with the confidence in our team to navigate through these uncertain times.

Since our last earnings call 69 days ago, I have visited over 25 markets and that with hundred of partners, customers, employees, and prospects. I can assure you from firsthand knowledge that PAETEC's value proposition has never been better received or appreciated.

Keith and I have been on the West Coast trip this week with several other officers, and are speaking to you from our first sales office in the San Francisco region. We just held our ribbon cutting ceremony two hours ago, and are actively selling in the bay area. This expansion brings our total coverage to 83 out of the top 100 US markets.

We are still integrating last year's McLeodUSA acquisition and sales force has continued to perform well. During the first quarter, we achieved 101% of our nationwide sales protocol. We expect to have more sales people in the organization by the end of 2009, and are investing in additional sales and technical training for all employees.

A significant portion for our new sales for the first quarter were IP related products and services. To support our rapidly IP-centric customer base, we installed four new IP soft-switch Gateways in Tampa, Boston, [Mobile] and Oakland. Our SIP trunking product has created enthusiasm among many industry veterans and we look forward to detailing our entire product portfolio in more depth during our Investor Day.

As we mentioned, during our earnings call, we have an Investor Day scheduled for Monday, May 18, at the NASDAQ market site in New York City. We will be spending five hours with 10 senior executives from PAETEC to provide an insight into our go-to-market strategies, network design and configuration, product specs and their competitive advantages, and our information technology automation activities.

For those of you who are unable to attend these types of company events, we will continue to provide information in our supplemental presentations located on our website under Investor Relations. Keith will take you through some of this quarter's highlights during his remarks.

One of the most important differentiating factors for PAETEC has always been the level of personalized service we provide to our enterprise customers, compared to the larger incumbent providers. However, that strategy is depended upon an enthusiastic and hard working employee group. Even in today's economic climate, I am pleased to report that our employee morale and productivity remain high.

Last month, we were ranked in the top 10 places to work in all of New York State and we were the only telecom company ranked in the large company category of over 250 employees.

There are over 500,000 businesses located in New York State, and this award sponsored by the Society of Human Resources Management is a great deal when you're recruiting top talent from any industry.

However, when I meet with prospective customers, employees and partners, the conversation does eventually migrate to the financial sustainability of the company. I always hope they steer me towards this topic, because I can then describe our solid cash position, strong free cash flow generation history of over six years, long debt maturity runway and significant cushion with respect to our one bank facility covenant.

When I also explain our ongoing stock repurchases and debt reductions utilizing our free cash flow, the conversations move on to how we can work together.

As each quarter goes by, I become more excited about PAETEC's overall ability to increase our future market share in the industry, and we also remain opportunistic this year when investigating methods of improving our balance sheet using our excess free cash flow.

Now, let's turn the call over to Keith who will step you through our detailed financial. Keith?

Keith Wilson

Thanks, Arunas. Good afternoon, everyone. We appreciate everybody's attendance on the call today. We know it's been a busy earnings release day and I think you're going to find that the information that we're going to share with you today is going to provide some really good insight on the company.

To start off, let's turn to the new first quarter '09 supplemental presentation that we posted on the Investor Relations portion of our website. I think you'll find if you download the presentation on your hard drive that it will move a little bit quicker. I'm going to go through a couple of highlights inside that presentation before I go through the overall financial performance of the company for the quarter.

The goal of creating this supplemental presentation really is to provide the public greater insight into PAETEC business. We believe this will allow all of those sufficiently interested in PAETEC to have a deeper understanding of the various moving pieces of the business. The supplement incorporates operating data for a six quarter of trailing period.

Now, let's discuss the information we've included in this supplement. On page 4, the network profile information. We have provided information on access line equivalents, fiber assets broken down by long-haul and fiber route miles and metro fiber-route miles, network switching infrastructure broken down by traditional TDM and soft switches. Lastly, we detail the number of collocation facilities that we maintain throughout the nationwide network.

Now, an item of note in the network profile is the commitment that PAETEC has had to network expansion, as metro route miles were increased by approximately 168 miles and long-haul was increased by 59 miles over the last year. Investments in the past 12 months in Atlanta, Colorado Springs, Des Moines, Indianapolis, and Dallas, all contributed to the expanded network.

Turning to page 5, the sales force profile. Initially, we have provided overall headcount. Then, we provided sales force headcount and detail the breaks down by direct channel, carrier and account development. Lastly, we provide information on the markets that we serve at the end of the quarter.

As Arunas has talked about, with the launch of the Bay area today, we will have 83 markets, you'll see 80 at the end of the period first quarter '09 as the switch was not officially opened at the end of the quarter.

Another item to note on this slide is the decline in direct sales reps is primarily due to the expected turnover in some of PAETEC's newer markets. We've talked to many of you and talked on these calls about expectations that will continue to look up to our sales force.

So, as we continue to strengthen the quality of that overall team. We are actively looking to recruit outstanding talent and looked to increase the overall sales force during the year. Our expectation is that we'll continue to backfill those positions, and we're very excited about the talent we're seeing in the market.

You turn to page six, we do a detailed revenue mix and I think that this is one of the most important slides for us in breaking out the different moving pieces of the company. We've segmented our total revenue into core network services, core carrier services, and total access fees, which we break down by networking carrier. We've also broken out total POTS, which we also breakdown by networking carrier. And lastly, integrated services.

We believe this breakout will better assist our stakeholders in appreciating the composition and trends of the various segments of our total revenue.

With the additional breakout, trends of the stability in PAETEC's core services become more evident. Top-line pressures have been heavily weighted towards access fees and POTS revenue attrition over the last year.

Turning to page 7, core network services. This slide drills down into the core network services line items in slide six. By doing so, we believe these new operating metrics should enable stakeholders to better model the business. Specifically, within network services, we detail revenue churn, customers, customer turn, average revenue per customer, average revenue for T1 and average T1 for customer.

The operating metrics give good insight to the businesses is evidenced by the steadily increasing average T1s for customer to 3.3 for first quarter of '09 and sequentially stable average revenue per customer of just over $2,000 and $2,032.

Moving on to page 9, core carrier services. This is a consistent approach with what we've done for the core network services slide in slide 7. This slide drills down on core carrier services. The core carrier services line item in slide 6. Specifically within core carrier services, we've detailed revenue churn, customers, customer churn, average revenue per customer, average revenue for T1 and average T1 per customer.

Taken together, the breakdown detail slide 7 and 10 that is core network and carrier services provide solid detail for approximately 84% of our total revenue.

One of our metrics detailed is average T1 for customer. This was done for consistency in reporting between the two different segments. From a bandwidth standpoint, it's more accurate to think about average carrier customer as using over 100 megabits of capacity within the PAETEC network.

Turning to page 11 and 12; we provide summary information on our free cash flow generation as well as our debt maturities profile. Lastly, on page 13, we provide detail on our share count information to better assist our stakeholders in valuation and computations.

Please note in the appendix, we have provided definitions that correlate with the various operating metrics throughout the supplemental.

Now, let's turn to the operating results. As Arunas indicted, despite continued economic turbulence, we're pleased to announce solid operating results. As we've been doing for the past year, I will first discuss the actual results of PAETEC Holding for the first quarter of 2009, as it compares to PAETEC's first quarter of 2008.

I will then discuss results for first quarter 2009 versus pro forma results for the first quarter of 2008, given effect of PAETEC's merger with McLeodUSA, as if it had occurred on January 1, 2008. The pro forma information is not necessarily indicative of what the combined companies results of operations, actually would had been if the merger had been completed on the date indicated, so first the actual performance.

First quarter 2009 was marked by similar trends that marked fiscal year 2008 for PAETEC and resulted in revenue growth quarter-over-quarter of 11.3% to $399.3 million from $358.8 million in the first quarter of 2008. The primary driver was the contribution of the McLeodUSA revenues following the closing of the acquisition on February 8, 2008.

Offsetting trends within network services resulted in 11% increase to $317.1 million over the first quarter 2008 revenues. Network services accounted for 79.4% of total revenues for the first quarter of 2009 and that was a marginal decrease in contribution from the first quarter in 2008.

Core network services performed well with an increase of 12.8% in the first quarter of 2009 over the first quarter of 2008. The increase was driven by the contribution of the McLeodUSA revenues associated with the acquisition, but more specifically by the strong contribution coming from PAETEC's success in multi-site MPLS revenues. Data revenues grew 23.8% for the first quarter of 2009 compared to the first quarter of 2008 as the national platform finalized by McLeodUSA acquisition provided an attractive value proposition for our core MPLS VPN product offering.

Consistent with the acquisition thesis, many new logos are being drawn to PAETEC's nationwide footprint and our ability to serve their broader networks as a single source provider.

While the broader data product portfolio performed well, a 23.8% increase during the first quarter of 2009 over the first quarter of 2008. These gains were muted by counter balancing forces in PAETEC's TDM customer base, including write-downs on renewals, pressure on usage from existing customers and increased churn from the smaller end of our customer base.

While monthly revenue churn in network services segment was still healthy at 7/10 of a percent, monthly customer churn kicked up to 1.6% as PAETEC is working less profitable, smaller customers through the system.

Network services revenue growth was also slowed by continued attrition in the non-strategic POTS portion of the business that was acquired as part of the McLeodUSA transaction.

POTS revenue related to network services related to network service decreased by 26.6% during the first quarter of 2009 from the same prior year period, despite slowing attrition rates during the first quarter of 2009. Revenue churn in the network services POTS segment was very respectable in the 2% range for the first quarter of 2009.

Finally, network services access revenues grew 26.1%, primarily due to the McLeodUSA acquisition for the first quarter 2009 from the same prior year period, which more than offset the decline in the POTS segment. While PAETEC has experienced some volatility in overall access revenues, during the first quarter of 2009, this revenue held up relatively well.

With an increased percentage of revenue coming from carrier services, the contribution McLeodUSA carrier revenues' drove an 18.4% increase in overall carrier services revenue for the first quarter of 2009 from the same prior year period. The reseller channel, which is other small and medium sized carriers that use portions PAETEC's network to provide underlying services was a solid driver for the business, due to the expanded network footprint offered by the McLeodUSA. The core carrier revenues were up 29% for the first quarter of 2009 from the first quarter of 2008.

Additionally, carrier POTS was up 48.6% for the first quarter, as compared to the same prior year period. Despite the strong growth in carrier POTS due to its relatively small contribution to overall carrier services, the POTS strength was more than offset by the pressure on access revenues during the quarter.

Access fees related to carrier revenues for the first quarter of 2009 were down 11.7% from the same prior year period. As a reminder, PAETEC had a mobile/wireless carrier customer who migrate the traffic off the PAETEC network during the first quarter of 2008 that accounted for the majority of the declines in access related revenues between the quarters.

During 2008, PAETEC had further migration of another mobile/wireless carrier's traffic that will result in pressured versus comparable period during 2009. Despite these headwinds, the core carrier business continues to be a solid contributor to the overall revenue stream for PAETEC.

In response to the overall economic slowdown, PAETEC did see capital spending pullback during the first quarter of 2009, and this had a negative impact on our ISG operations. ISG revenues for the quarter decreased 11.2% over the same prior year period, primarily due to the aforementioned pullback on spending.

While software sales were relatively stable during the first quarter of 2009 as opposed to the same prior year period, equipment sales of CISCO, Avaya, and Allworx were off 13.8%, collectively for the first quarter of 2009 as compared to the first quarter of 2008.

Due to contributed McLeodUSA revenues as well as consistency of core service offerings, adjusted EBITDA for the first quarter of 2009 increased 7.5% to 63.9 million, over adjusted EBITDA of 59.5 million for the first quarter 2008. Because McLeodUSA maintained lower adjusted lower EBITDA margins prior to the merger, the four quarter contribution resulted in a decline in overall PAETEC adjusted EBITDA margin, which represented adjusted EBITDA as a percentage of total revenue to 16.0% for the first quarter of 2009, compared to an adjusted EBITDA margin of 16.6% for the first quarter of 2008.

Net loss for the first quarter of 2009 was $3.3 million compared to net loss of $3 million for the first quarter of 2008. Interest expense for the first quarter of 2009 decreased to $17.2 million from $18.3 million for the first quarter of 2008, due to significantly lower interest rates on PAETEC's credit facility loans in the first quarter of 2009, which were more than offset increased debt levels resulting from the McLeodUSA acquisition and the 50 million revolver drawdown in the fourth quarter of 2008.

Provision for income taxes increased $4.7 million from a $3.9 million tax benefit in the first quarter of 2008 to $800,000 of income tax expense in the first quarter of 2009. PAETEC did not record a benefit for income taxes in the first quarter of 2009. The provision for income taxes for first quarter 2009 reflects only current state taxes and income taxes in certain jurisdiction where net operating losses are not available.

Now, to the pro forma results. There were a number of factors that affected first quarter of 2009, impacted first quarter 2009 revenue, including anticipated customer attrition in the non-core sub T1 business, reduced focus on fiber IRU sales not associated with more holistic solutions. The wireless carrier traffic migrations, lower usage base volume both from PAETEC customers and associated excess minutes, pricing concessions and increased churn.

So, the first quarter of 2009 revenue of $399.3 million represented a decrease of 3.4% from the same prior year period. While all the factors sited above had an impact on the quarter, the non-core sub T1 churn and the reduced focus on fiber IRUs combined resulted in it approximately $13.3 million of the decrease period-over-period.

Although first quarter 2009 cost of sales decreased 2.5% compared to the first quarter of 2008 pro forma cost of sales, gross margins declined from 50.6% in the pro forma basis in first quarter of 2008 to 50.2% in first quarter 2009.

SG&A expenses as a percentage of total revenue declined to 34.1% in the first quarter of 2009 from 34.8% on a pro forma basis in the first quarter of 2008, primarily as a result of headcount reductions.

Primarily driven by the decreases in revenues as I've just detailed, the adjusted EBITDA of $63.9 million for the first quarter 2009 represented a decrease of 1.7% from pro forma adjusted EBITDA of $65 million for the first quarter of 2008.

Despite the lower adjusted EBITDA period-over-period, the adjusted EBITDA margin improved to 16% for the first quarter of 2009, compared to the pro forma adjusted EBITDA margin of 15.7% for the first quarter of 2008. The positive effects of network cost reductions, expense management and achievement of synergies more than offset the reduction in pro forma revenues.

Net loss for the first quarter of 2009 declined to $3.3 million from a pro forma net loss of $11.1 million for the first quarter of 2008. The smaller net loss for first quarter of 2009 compared to 2008 pro forma results, primarily reflected lower SG&A and depreciation expenses and network costs.

In addition, pro forma net loss for the first quarter of 2008 included $19.1 million of one-time integration and restructuring expenses and sales tax and used charges, which were partially offset by $15.7 million of income tax benefits.

Interest expense of $17.2 million for the first quarter of 2009, represented a decrease of 7.4% from pro forma interest expense of $18.6 million for the first quarter of 2008.

Now on the capital expenditures. PAETEC continues to make disciplined investments in our deep asset rich network and invested approximately $30 million during the first quarter of 2009. Specific investments in switch, switch growth and expansion was a primary driver in addition to information technology purchases as we continue to enhance our system's infrastructure.

Other investments and that were made in our mid-Atlantic data center, as PAETEC continues to expand on those locations due to high demand for collocation space in the region.

Overall capital expenditures for the first quarter of 2009 were 7.5% of total revenue, up from $21.4 million, or 6% of total revenue for the first quarter of 2008. On the same quarterly pro forma basis described above, capital expenditures increased 23.4% from $24.3 million, or 5.9% of total revenue for PAETEC and McLeodUSA in the first quarter of 2008 to $30 million, or 7.5% of total revenue.

Now, we will go to cash flow and liquidity. PAETEC had a quarter end cash balance of $144 million, compared to the year end 2008 level of $164.5 million, primarily as a result of changes in working capital. Cash flow provided by operations was $11.2 million in the first quarter of 2009, while cash flow provided by operations was $2.6 million in the first quarter of 2008.

As indicated above, PAETEC achieved first quarter 2009 free cash flow of $33.9 million. As of March 31, 2009, PAETEC had $928.2 million in debt under its revolver term loan credit facility and senior notes.

On March 31, 2009, $578.2 million was outstanding under PAETEC senior credit facility term loans, which have a maturity date of February 28, 2013. Before their maturity, PAETEC is required to make scheduled principal payments of $6 million annually on the term loans.

At the end of the first quarter 2009, PAETEC was well within the sole financial maintenance covenant in its credit facility, which provides for a maximum permissible ratio of consolidated debt, defined as consolidated debtless cash on hand in excess of $20 million to consolidated EBITDA as defined of 5 to 1.

During the first quarter 2009, PAETEC made a scheduled principal payment of $1.5 million on its terms loans. At the beginning of the second quarter of 2009, PAETEC made $5.6 million in excess cash flow payments in reduction of the principle amount of its credit facility term loans.

PAETEC grew down its $50 million revolver inflow on October 15, 2008, and the revolver has a maturity date of February 28, 2012. And on March 31, 2009, PAETEC had outstanding $300 million principal amount of 9.5% senior notes due 2015. The senior notes have no financial maintenance covenants. PAETEC repurchased a total of 623,200 shares of common stock for an aggregate price of $764,853 or $1.23 average cost per share in the first quarter of 2009.

Since the inception of its previously announced program to repurchase up to 30 million of common stock through August 2009, PAETEC has repurchased approximately 6.5 million shares of common stock for an aggregate price of approximately $13.8 million. As of March 31, 2009, PAETEC had 140.8 million shares outstanding.

That concludes our prepared remarks. And I would now like to ask the operator to open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of David Dixon of FBR Capital Markets. Please proceed.

David Dixon - FBR Capital Markets

Thanks very much and congratulations on the quarter, and a great job on the EBITDA momentum Keith. I wanted to just focus now on the next catalyst going forward, which is the revenue stability.

Looking ahead to the second quarter, as we look at the first quarter, you mentioned it on the call, there was essentially 5 million plus of IIU sales in the first quarter of '08, for a call in the second quarter of '08 too we had some sequential usage declines there. So how should we be thinking about the prospects for revenue stability on the year-over-year basis in the second quarter of '09?

Keith Wilson

Yes. It's a really good question, David. If you go to page six of the supplemental, and you look at kind of the trending of the key movers of the business, you have seen pretty stable progression on the network services line on the core. And you continued to seek relatively stable performance on the carrier core as well, a little more volatility in our quarter. And, where the biggest pressure points have been have been a combination of, both the POTS and the access-related fees.

So there is usage-driven pieces there and there are also usage base-driven components of the network services pieces inside the core as well. And so, I think as Arunas talked about, new sales continue to be strong, so we are seeing that. We anticipate that we are going to continue to see attrition on the POT side.

And, I think what we need to do is be able to continue to sell and get some stability inside of those usage components of our existing customer base and realize the benefit of some of the success that we have had over the last six, eight months in terms of the selling proposition. So may I kind of throw it over to Arunas and have him apply a little bit as well.

Arunas Chesonis

David, that's the key question for all of us. One is that that revenue trajectory is going to start increasing. If you are out in the field with myself and the team, what you will find is the pressure that we saw on our ISG business where the Cisco, Avaya, Allworx, equipment sales were a bit down. That's entirely the reason so many partners and agents are excited about working with PAETEC.

Our equipment for service program to help them fund these capital purchases for their clients is really starting to get more momentum here. But one that actually turns into the top line growth, it's going to be a combination of not just our sales productivity, but also how the economy bounces back a bit over the next several quarters.

David Dixon - FBR Capital Markets

Right, so should we not be drawing too much of a conclusion from the sequential stability in revenues then, Arunas and Keith? Obviously, there is a change in the business days, some differences there that could drive that.

But I just don't want to get too far out in front of it. And just a quick follow-up , as you draw larger enterprise logos under the PAETEC platform, how should we think about the financial impacts, in terms of the EBITDA and cash flow of some of these larger, single-point deals that you are experiencing?

Keith Wilson

Yes, David, I would that, again, we want to be careful, because we haven't gone out there with guidance this year. We've given kind of thoughts as where we think the trajectory is. And if you look at the stability sequentially in the quarter, I think that you can expect similar type dynamics going on throughout the year. Right? Because you had fairly stable pieces now for roughly four quarters.

And as Arunas said, I think that the big question is when are we going to see a shift in stabilization and some of that is going to be economic -driven, some of it's going to be the impact of a lot of the good things that we are seeing out in the field today. But to your point, what do we expect to see with some of these larger opportunities? Arunas, do you want to take that?

Arunas Chesonis

Yes. I mean that's one of the areas, David, the whole senior team has been focusing on. We are seeing more up market opportunities where we are encouraging our sales force to go up market. And when you do that, what we are finding is you're competing most of the time against AT&T and Verizon, and not so much the smaller regional carriers and the folks that compete on price at the low end of the enterprise space.

So what we are finding is the margins are as high or higher than what you would see at the low end because you are actually comparing yourself against the larger incumbents.

Operator

Your next question comes from the line of Simon Flannery of Morgan Stanley. Please proceed.

Simon Flannery - Morgan Stanley

Okay. Thanks a lot, good afternoon. Just a minute ago you were talking about competing against AT&T and Verizon. Can you talk about the pricing dynamics in that marketplace?

How is pricing holding up, you mentioned and customers are starting to looking for a better deal for renewing new contracts, but how does that segment of the marketplace look and what sort of value are you offering versus where AT&T and Verizon would price how much of a discount if any is there?

And then on the buybacks, you obviously got a pretty good average price in the first quarter, stocks moved up a lot here. Is it still interesting to you to continue to deploy some of your free cash towards stock repurchases at decent levels? Thanks.

Arunas Chesonis

Okay. Thanks, Simon. I think I'll take the first question, Keith, if you want to handle the second. I think what we are finding out there is a range of pricing strategies from the larger incumbents, when they're actively pursuing new business versus trying to protect their new customer base.

But what we are also finding is, although the customers are very interested in price, what's been happening recently just in the last 3 or 4 months being out there in the field is the service quality issues.

The ability to reach someone to work out a billing resolution, the ability to get someone from the larger companies to actually provide a competitive bid against something we're offering, access to the network operation centers and switching center employees.

All those service issues are combining to make it more difficult for those enterprise customers to resolve their cost saving initiatives. So, again, I think now it's turned into a combination of saving money for people, but providing that higher level of service. That's been a bit of a change in the last quarter that I've seen out there.

Simon Flannery - Morgan Stanley

Is that because of layoffs at the big carriers?

Arunas Chesonis

It's tough to understand where it's really coming from. I do think layoffs are a bit of the situation out there. I think some of the carriers may have been worried a little bit about some of the union discussions and issues in preparing for things like that.

But frankly, I just think that they are focused in other areas. That sort of $5 to $50,000 month enterprise customer is much more in our sweet spot as a provider than for some of the other organizations out there that are focused in other ventures.

I think, again, on the stock repurchase and debts repurchase side, Keith, we both have certain opinions about this you want to go first.

Keith Wilson

Yes. Simon, I want to be careful about getting ahead of ourselves on specific pricing issues. I think the comment that, I'll leave you with on the stock buyback is we have plenty of room underneath the 30 million program that’s available to us.

I don't want to comment about specific strategies there. But as you've seen us do, we have been buyers. We are very interested in balance sheet management. I know, you've known us for a long time and we've always been very keen in terms of being good stewards of the balance sheet.

When we see an opportunity to take advantage of dislocation in the market, obviously we're going to do it. So I'm going to defer on the specific question that you asked. But we're very keenly aware of the opportunities that are out there.

Simon Flannery - Morgan Stanley

Understood.

Arunas Chesonis

Simon, I would just add to Keith, I will be just equally as vague at the same time.

Operator

Your next question comes from the line of Colby Synesael with Kaufman Brothers. Please proceed.

Colby Synesael - Kaufman Brothers

Just two questions. One, I think you mentioned early on, Arunas that your sales team did about 101% of quota for the quarter. I was wondering if you could compare that to the fourth quarter, just we can have an idea of how things are trending?

Then my next question has to do with fiber swaps. Obviously, now that you guys have the McLeod assets and had that for some time. I assume that you're going and talking to other providers about swapping some of your excess capacity for areas where you don't have capacity. I wondered if you could talk a little bit about that and what that's doing to margins as well as maybe some other opportunities? Thanks.

Arunas Chesonis

Sure. Great questions, Colby. I would tell you that, the trending for the sales force is still plus or minus a percent here or there. So, there wasn't anything substantially different about the first quarter from the fourth quarter or the third quarter sales results. We're rather on the same zone as the percentage to quota.

I think, again, the opportunity for us is to move the lower end of the sales force that's been used to only selling in a 1,000, 2,000 almost customers to get a moving up market. That's again, where we're focusing a lot of our training and hiring efforts for the next couple of quarters.

So I think we have chances to move that number a little bit higher than where we sit today.

On the fiber swaps, we've done about three fiber swaps in multiple markets and they're not just metro swaps, they're also long-haul swaps. We've got a couple more in the hopper. I think we're going to probably defer that question Colby to our investor days in about 12 days when we're down at in New York City.

We're going to spend a little bit of time sort of talking an example of what that does to margin and what that does to metro opportunity. But at this point, it hasn't substantially changed our margins because it's still such a small number on the whole base.

Operator

Your next question comes from the line of Tim Horan of Oppenheimer. Please proceed.

Tim Horan - Oppenheimer

The 13.3 million decrease you cited on the IRUs and T1s, what is your revenue in the quarter on those items? I know that decreases, just wondering what the run rate is now?

Keith Wilson

Let me make sure I have that right, Tim. The decreases were from 2008. Those were the fiber sales or the lack of focus on fiber sales today versus where it was kind of pre-close McLeod and effectively the churn in the POTS business. So, give me one second to pull up my pro forma from last year, but I want to say it was in the 413 range, 413.1 in 2008 on a pro forma basis.

Tim Horan - Oppenheimer

Okay. So the 13.3 was in the quarter, right?

Arunas Chesonis

That was in that quarter 2008, correct.

Tim Horan - Oppenheimer

Okay. Sorry for that clarification. Can you talk about the former McLeod territories where you have the sales force there, I think there was some opportunity maybe to hire new sales people and they were trained and get a little more focus on there? I know there is a lot going on with your sales force, maybe you can talk about the churn trends in the sales force, maybe where you would like to leave the year out in total sales head count. Because I think there is going to be very high correlation if you're hitting quarter between the number of sales people that you have and your ability to grow revenues, if churn stay stable and if you increase your sales force by 20%, all things being equal, you think you would get a proportion of increase in revenue growth?

Arunas Chesonis

Those are all good questions, Tim. I think for us, if we could hire right now a 100 solid major account sales executives across the country, especially in the old McLeod territories, we would do that tomorrow and issue those offer letters. But it's very difficult to find those kinds of folks and get them up to speed quickly overnight.

We gave a lot of legacy McLeod employees a chance to move up market. One of the areas we you saw the decrease in the actual sales executives where, we made a call after a year which folks we thought could make the move going up market versus those that we didn’t think could make it.

Some of those folks have stayed on in account management roles and some other supporters in the company. But, we decided to open up some new positions in some other territories.

There are some markets in Legacy McLeod territories that are doing very well. I was just in Detroit last week and you would be surprised. You would think people in Detroit would be completely depressed about what is going on in their universe, but actually the Detroit team is doing very well. We have a lot of opportunities not just there but in Western Michigan. Surprisingly, we're getting some nice traction in places like Portland, Oregon and other places that just have a new sales team over the last six to seven months.

So, again, our focus is not just in the McLeod territories, but in other parts of the countries, especially the Bay area here. We have nine employees here now in the San Francisco region and we are looking to add about 10 or 11 people in the sales side of the house, which we now needed here but I think you're absolutely right.

Our ability to not just get the existing sales force more efficient, but also bring more people on board is one of the priorities for the company in the next couple quarters. I think we'll be able to share with you a little more in detail on the Investor Day. We're going to spend some time with some of the sales executives. I think that's when we're going to spend some additional hours with you there.

Tim Horan - Oppenheimer

Then just one last clarification for Keith. Keith, is there anything in your radar that's going to drive up the cost of sales up and down and (inaudible) for SG&A in the next couple of quarters or is this good run rate? I guess you did a lot of downsizing. Is that all in the quarter or is there more affects on the expense line all the way? Thanks.

Keith Wilson

Yes, Tim. Good question. I think that at this stage of the game, we think that we're at a pretty good run rate on both of those. I mean, from a network cost standpoint, we've talked about this over the past six quarters or so.

There occasionally is volatility there, depending on dispute dynamics that we may run into with some of our carrier partners. So, is there a chance for quarterly spikes in a year with some of that dynamic? Yes. But generally, what kind of a four quarter run rate, I think it's a pretty good stable level.

Operator

Your next question comes from the line of Frank Louthan of Raymond James. Please proceed.

Frank Louthan - Raymond James

You talked about some of the customer churn at the smaller end. Can you give us an idea, when you see that or what percent is that coming from, maybe the really small customers at McLeod? Were there any particular customer verticals or maybe markets where you saw that was more concentrated? How are you defining a smaller customer, say, in terms of monthly recurring? Thanks.

Arunas Chesonis

Yes, Frank. When we talk about the smaller customers churning out, we're seeing them -- to be fair, it's nationwide. But there is a little bit of a heavier concentration in the southeast and in the central regions. That's really being driven by single T type customers, who have had to down size their operations, who were fairly aggressively priced initially with the expectations that there were some growth opportunity there.

And the growth opportunity, since they signed our contract didn't really show up because the adverse economic impact. And it's hard for us to justify the economics of that customer, especially in lieu of them wanting to lower their prices because they're having a challenging time. So, that's kind of your profile. As the smaller end customer single T, usually a company that is doing okay, that probably hasn't experienced the growth that they would like. So that's kind of the broader dynamic.

When you look at specific sector pressure in industries, if you look throughout the country, they're right where you would expect them to be. And so, this doesn't necessarily correlates specifically to that smaller group. Right because that smaller group ranges across from maybe could be a small hotel to a small engineering firm. It just depends. But where we've seen the biggest pressure is on things like real estate focus, hospitality focus, things of that nature, our real estate finance, some of mortgage companies, title companies, heavily concentrated kind of in those places. Whereas correspondingly, the places where we've seen the best pickup have been larger companies, we're seeing great momentum in financial services, great momentum in healthcare and very good momentum as you're starting to creep into the 41,000.

Frank Louthan - Raymond James

Okay, great. Thank you. And as far as sort of on network connections to buildings, you picked obviously a few of those with McLeod, how much of that, is that increased over the last 12 months. I apologize you already covered that, but if you go over that. And you made an announcement a couple months ago regarding continued increased uses in wireless connection for customers. Give us an update on that? Is that a meaningful percentage or is that becoming a meaningful percentage of contract customers.

Arunas Chesonis

I think, Frank. We've been working for our various methodologies both in legacy McLeod and legacy PAETEC to come up with numbers that are more meaningful for you. We were hoping to have those numbers in our supplemental this quarter. We just didn't quite get there. I think over the several next quarters, we're going to be excited about sharing that with you on an ongoing basis so you can see those increases.

There are some marginal increases, but it hasn't been substantial over the last three to six months. The wireless program, we've been training the engineering and sales support teams throughout the country on how to identify opportunities and bring them to the table.

Our funnel has never been larger in the wireless that’s not, everything from 10 Megabit all the way to Gigabit Ethernet opportunities. And that's something we're going to spend a little bit of time on in New York City in two weeks. We'll have the business unit sort of leader for wireless. And I'll actually be able to step you through some of the financials and why it's such a compelling opportunity for some people.

Operator

Your next question comes from the line of Donna Jaegers of D.A. Davidson. Please proceed.

Donna Jaegers - D.A. Davidson

Hi, guys. You guys, congratulations on a good quarter. And it looks like you manage to dodge a bullet in the carrier sales area, where everyone else like western global crossing has been singing the blues. Can you talk a little about, what's going on there with margins in your carrier services?

Arunas Chesonis

Sure. I think the interesting phenomenon for us is we're continuing to focus on the private labeling of wholesale services, where people are really reselling the PAETEC enterprise business under their own flag. And that's where we're trying to continue to spend a lot of time. The arbitrage opportunities are some areas where we can do shy away from, most of the time in the wholesale business.

We did see some of our customers in the wholesale side, who were focused on very short duration calls and were part of a broadcast system, especially focused on the elections during the fourth quarter. Some of those folks, we tend to shy away from as well and they move them off the network.

So, I think the team has done a pretty good job, balancing long-term relationships with those folks to try to take advantage of carriers on a monthly or weekly basis. So, I don't know if it's anything different that we've done in the last five years. It's just sort of more of the same, very conservative approach to wholesale.

Keith Wilson

Donna, this is Keith. The margins continue to be pretty consistent with where they've been in the past. As you know in our financials, we don't break out specific gross margins by segment, but I can tell you that there is been good stability there.

I think we do see opportunity to leveraging the fiber base network, a little bit more in the future. Today, it's been pretty consistent in terms of the products, as we've kind of been getting out there and getting to know some folks, expanding the product offering. So, we are dealing with a lot of type one customers on that side of the house. And we do think that being able to leverage our fiber network will be able to enhance those margins. But that's kind of another chapter. It's not happening in the past quarter or two.

Donna Jaegers - D.A. Davidson

Great. Just two other quick follow-ups. Though, you mentioned you had some fiber swaps. Was there any significant revenue from those in the quarter?

Keith Wilson

No revenue, Donna. It's accounted. If you look in the adjusted EBITDA, there is a gain on a non-monetary transaction of $141,000. That is actually -- that's a gain out of fiber swap that we did. It's very nominal. As Arunas said, if you look at the increase in both the metro and the long haul miles that we talked about earlier, there is some of that increase is swap capacity and some of it is physical build out inside of the existing network. So it's kind of a combination as we go through that.

Donna Jaegers - D.A. Davidson

Okay, great. And then on access cost, are you guys seeing any changes from [RBOX] as far as the cost that you pay for last mile access?

Arunas Chesonis

Donna, not significantly on special access side or the uni side, I think good news is with the new administration SEC. We've got some people who do believe in the balance approach for competitive telecom providers. The area that's it may be interesting for you is that we did see an uptick a little bit in the wholesale prices that people are being charged for voice services on an interesting basis around the country. But for folks like Quest and MCI, Verizon. So, I'm not sure that Quest increase was related to anything going on at the corporate level, but these are sort of interesting fact to put in the back of your mind.

Donna Jaegers - D.A. Davidson

And that was on wholesale voice termination?

Arunas Chesonis

Wholesale voice termination, so the other providers are taking advantage of that opportunity now with those increases.

Operator

Your next question comes from the line of Robert Dezego from SunTrust, Roberts & Humphrey.

Robert Dezego - SunTrust Robinson Humphrey

Hi, good evening, guys. Thanks for taking the call. Sort of a quick follow-up on cost side. You did a pretty good job cutting cost in the quarter. And I'm wondering, you'd mentioned in the past taking $30 million in cost out of the business for 2009. So, are you guys through that cost saving project at this point now and the second part of that question is, I know you answered on the cost of service side, the earlier question, but could you talk about the SG&A side, what we should think about for run rate going forward.

Keith Wilson

Sure, Rob. This is Keith. The moves that we’ve made with personnel headcount at the end of the year last year, that's done, at least, for that initial component that we talked about. The variability inside the SG&A side is really going to be kind of bad debt performance, and things of that nature. We did accrue for a higher bad debt level in this quarter.

As we've talked about on previous calls, we've seen that creeping up a little bit. We do expect that that’s going to continue to be an expense piece that we're going to have to keep an eye on. But I think generally, where our cost sits today on the SG&A side, I think is at a pretty good level.

Well, we do have open heads on the sales side and on the customer service side. Generally, I think our expectation is to be pretty modest in terms of that hiring and make sure that we continue to remain pretty efficient in that cost structure.

We've absorbed a lot of the increases that we typically take on things like CAM charges on the infrastructure and those sorts of costs. So, I mean those typically hit you at the beginning of the year.

So right now, the run rate that we're at, I think is a pretty good level. From the cost of service side, I think there is potential opportunity there. We've got a project clean sweep, where we've been working some access capacity through the network. And, turning down some circuits and we do think that we talked about that in the second half of last year, where we thought that had opportunity to bring some benefit to the cost to service side.

Robert Dezego - SunTrust Robinson Humphrey

Can we get some of those bad debt numbers, or is that something you're willing to release?

Keith Wilson

We accrued for 1.2%.

Robert Dezego - SunTrust Robinson Humphrey

How is that versus last quarter?

Keith Wilson

That was versus about 80 basis points in the fourth quarter of last year.

Robert Dezego - SunTrust Robinson Humphrey

And a year ago?

Keith Wilson

Probably about 70.

Robert Dezego - SunTrust Robinson Humphrey

Okay. And then the last question, I had for you guys is. Is there anything out there on the M&A front that you could speak to as far as assets that you still might find attractive now that you're getting through the McLeod assets and has there been potential interest from larger carriers that may be looking at you guys?

Arunas Chesonis

Well, as you know, Rob, we don't comment on M&A. So that probably ends that question real quick. But I think look, we still have plenty of things to do in front of us. We think we have got a wonderful network. We cover 83 of the top 100 MSAs today. We have some work on getting the sales force up and running the way we would like it in, both the central and western regions.

And the products have been incredibly well received. So I think with that in light, I think we are very excited about what we have under management today. But we will continue to be good stewards of capital for our shareholders.

Keith Wilson

Rob, you and I don't know each other that well over the last 10 or 15 years. But I can tell you the first nine years of PAETEC, we grew that company to 600 million in sales, 90% organically through our own sales organization and hard work.

And now that we have got the platform with the US LEC and McLeod networks combined, and we can truly compete on a nationwide basis against the larger players. I do think the best value creation for our shareholders is to get that top line growing in a nice healthy clip over the next several years, and people will really respond to that.

So I think, that's sort of job one for us. It normally takes a good two three years to get through an integration with any large company that you are doing something. And that I'm not worried about as much as far as it's just a process you have to go through.

But there is such a huge opportunity on that top line with that nationwide platform. I think we are all best served by just putting our heads down and focusing on that the next year and a half.

Robert Dezago - SunTrust Robinson Humphrey

Okay, great. And if I can have one last question, I apologize for asking three. But, did you guys give a mix of fixed revenue versus usage-based revenue in the quarter, or percentage of ARPU and any progress on how that's been changing?

Keith Wilson

We didn't break it out in the revenue mix, Rob, but it has been fairly consistent across the last couple of quarters. So it's in the kind of 30% range, which is inclusive of the access, long distance and local usage pieces.

Robert Dezago - SunTrust Robinson Humphrey

On new businesses, has that been improving from that ratio or changing, I guess you could say?

Arunas Chesonis

Yes, I was going to say I think that they are fundamentally, I'm not sure we would say that was necessarily bad even though.

Robert Dezago - SunTrust Robinson Humphrey

Right.

Arunas Chesonis

That's been pressure point for us. But as we continue to sell more IP-centric services, yes. That does continue to shift, so we continue to do a very nice job in selling kind of broad and robust IP networks, and those tend to be more fixed in nature.

I do believe because IT is still a relatively small piece of our business in the 20% range, we do think if that continues to grow, you are going to see a real shift. On the TDM side, we are encouraging folks to capture a little bit more fixed component as opposed to a variable piece. But again, we have never been advocates of totally eliminating the variable pieces of it. So it's incremental, it's not going to be radical.

Operator

Your next question comes from the line of Michael Rollins of Citigroup. Please proceed.

Michael Rollins - Citigroup

Hi, good afternoon. I was wondering if you could talk a little bit, in the release and I think in your comments, you commented a bit about some of the revenue that was the sub-T1 business.

I was wondering if you could size that total exposure within the revenue, so we could just understand what the risk of churn is in that piece as your deemphasizing the sales in that segment.

And the second question I had for you is I was wondering if you could talk a little bit more as you look at the integration process, you briefly talked about on the call with McLeod and you think about the major steps, where does billing fit into that, and what are the next big items of this underlying integration for the different acquisitions that you have done. Thanks.

Keith Wilson

Hey, Michael, thanks for the questions. Those are great. If you go to page six on the supplemental, in the first quarter it was the total POTS were kind of that non-strategic T1 business, or sub-T1 business was $17.8 million for the quarter, and is roughly about 4.5% of total revenues.

Michael Rollins - Citigroup

Okay, thank you.

Keith Wilson

Yep, and I'll have Arunas to talk about the integration.

Arunas Chesonis

Yes. And on the integration, Mike, I think every month, we are knocking off other smaller items. There is not just one big integration project. There's hundreds of little things you have to do. As an example, first quarter got the Lucent Voice Activation Manager installed. So now we got single view for 5E switches across the country.

We finished up some of the physical assets having [singling] links on the network. There is a lot of engineering areas that maybe don't sound too exciting, but they are very important to running your business better.

We actually got the TDM, TRI's working on our soft switch platform. So now we are with two switching centers, we don't have any legacy class 5, class 4 switching equipment. We are activating all TDM and all IP services just on the IP systems, both in Northern California and in Boston switch side too.

So a lot of that activity just keeps getting shipped away. The ones, I think you may be questioning is on the billing side. We have been billing outside of the legacy PAETEC footprint in the Southeast and other areas for national accounts on web chain platform for many quarters now. So, that continues to go forward, so everyone in the country is getting experience with the long-term billing platform for PAETEC.

We told you, I think at the last quarterly earnings call that first quarter 2010, is when we have scheduled the conversion from the Kenan system, which is the last piece that's left for US LEC conversion. That's looking very solid. I'm not here to tell you that we are moving it up a quarter, but we are feeling really good about the first quarter milestone.

And the people and the systems that we inherited from McLeod on the billing side were actually very strong. And I think sometimes they got a bum wrap on some of their OSS systems in there, and how much they were able to automate area.

So I think that will even go more smoothly than any kind of US LEC conversion, so that's pretty straightforward. I don't see any big stumbling block or hurdle right now in anything less than integration. It's just normal course of business right now.

Michael Rollins - Citigroup

Thank you for the incremental color. Thank you.

Arunas Chesonis

Sure.

Operator

And your next question comes from the line of Todd Morgan of Oppenheimer. Please proceed.

Todd Morgan - Oppenheimer

My question was answered. Thank you.

Arunas Chesonis

Thanks, Todd.

Operator

There are no further questions at this time. I would now like to turn the call back over to Arunas Chesonis for closing remarks.

Arunas Chesonis

Well, once again thanks everyone for joining us on the call. We are pleased with the first quarter and we will see you next quarter. Take care.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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