PAETEC Holding Corp. Q2 2009 Earnings Call Transcript

PAETEC Holding Corp. (PAET)

Q2 2009 Earnings Call

August 05, 2009; 8.30 am ET

Executives

Arunas Chesonis - Chairman & Chief Executive Officer

Keith Wilson - Chief Financial Officer

E. J. Butler - Chief Operating Officer

Chris Muller - Vice President of Investor Relations

Analysts

Simon Flannery - Morgan Stanley

Frank Louthan - Raymond James

Tim Horan - Oppenheimer

Donna Jaegers - D.A. Davidson

Michael Funk - Banc of America

Colby Synesael - Kaufman Brothers

Robert Dezego - SunTrust Robinson Humphrey

Michael Rollins - Citi Investment Research

Presentation

Operator

Good day ladies and gentlemen, and welcome to the second quarter 2009 PAETEC Holding Corp. earnings conference call. My name is Ann, and I will be your coordinator for today’s call. (Operator Instructions) At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session following the presentation.

I would now like to turn the presentation over to Mr. Chris Muller. Please proceed.

Chris Muller

Thanks Ann. Good morning, everyone, and welcome to PAETEC’s second 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-and-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 www.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 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, good morning everyone and welcome to PAETEC’s second quarter 2009 earnings call. Today we are pleased to share with you our second quarter results. Despite the difficult economic realities we were able to achieve our 26 consecutive quarter of free cash flow generation.

We were also able to maintain our enterprise revenue stream essentially flat year-over-year and sequentially. Many of our network optimization expense saving initiatives have continued to provide stable operating cash flows, so we may continue to invest in new markets, new products, and new IT automation projects.

Our most noteworthy accomplishment during the second quarter was the repayment of $330 million in term loans due 2013 by issuing $350 million 8 and 7/8 secured notes. We took advantage of a small window of opportunity to insure that PAETEC virtually eliminated any refinancing risk during the upcoming 2012 to 2014 timeframe.

Management made its recommendations as Board of Director on June 9 and was able to price the transaction eight days later with support of our team of employees, bankers, alternatives and accounts. Even if our economy does not improve the next four years we believe we can amortize our remaining senior bank debt and revolver utilizing our operating free cash flows and cash on hand.

During previous earnings calls you promise to share more information about our company and today we are releasing additional data about our last mile fiber and wireless network. As of June 30, we have 1912 Facilities-Fed Buildings in our network, over 90% are fiber fed small connections while the remaining are over the fixed wireless links. We will continue to invest our network directly, and also investigate additional capacity swaps.

Another area of current and future investment in our infrastructure will be in the data center and hosting space. We just announced a 6,500 to our Bethlehem data center complex and we are in final planning stages of a multiyear program of data center expansion throughout the US.

We plan on leveraging much of our existing, central office footprint, especially some under used McLeodUSA facilities by building 7 to 10 additional regional data centers over the next two to three years. We believe that we can absorb these capital costs with minimal impact to our traditional CapEx program. We have seen the industry trend accelerate for outsourcing and managed IT services.

Early in our company’s history in 1999 we acquired the managed services company Campuslink and then in 2000, the software company Pinnacle both of which how differentiate our network services offerings. Now by expanding and data center hosting Colocation capabilities we will continue to enhance our data services security and business continuity product portfolio.

When I travel around the countries speaking to employees, customers and partners about our company and especially our financial results I have found it very helpful to use our supplemental quarterly information. If you would turn to page six of this quarter’s supplemental data, you’ll know what I mean. I’m pulling it upright now here.

Approximately, 75% of our overall revenues come from our enterprise customer base, which is illustrated in two of the five segments shown ton slide titled ‘Revenue Mix.’ When you add the network services core and integrated services components, you can see we have been holding at approximately $300 million in revenues in 2Q ‘08, first quarter ‘09 and second quarter ‘09.

If I point it to page six, I can show you how to get to those numbers, first line item network services core, look at second quarter ‘08 and you’ve $283.8 million, dropdown a couple of lines to the integrated services and you see $16.1 million you add those together you get $299.9 million in revenues for that quarter.

That’s really the invoices that we send out to our enterprise customers. Again, you go to Q1 ‘09 and do the $286.3 million plus the $13.4 million, gets you about $299.7 million, and then you do the second quarter year essentially at $300 million, so just to help people get through those numbers.

Now the new sales have kept pace can customer churn, revenue compression, economic impacts such as lower usage revenues, contract renegotiation and location eliminations and technology substitution. As we have said during previous calls a major priority for PAETEC to achieve our growth objectives, will be to increase the number and the productivity of our sales professionals in our newer markets such as Dallas, Houston, Phoenix, Seattle, bay areas and others.

Our carrier services core revenues have also essentially stayed flat during the same period. However, our revenue pressure has come from the two expected segments: Access Fees and POTS. These areas will continue to trend downward, but at some point, we’ll be surpassed by our enterprise growth. As in the overall economy, there are some early signals that we are making progress in some of the McLeod territories.

For example, our revenues from Houston, Phoenix and Cleveland are up when comparing both year-over-year and sequential growth. We’ll continue to invest in any markets that we feel have the local leadership to take advantage of our opportunity. That is the benefit of operating a stable, free cash flow generating service provider.

Now on different note, our integration activities continue to on track. During the second quarter, when we completed our launch of dynamic IP, into the remaining legacy U.S. LEC cities including Memphis, Mobile, New Orleans, Pennsylvania and Daytona beach.

We collapsed all three IP domain name service to our DNS into one geographically diverse platform with a single management tool that we inherited this time from legacy PAETEC. We collapsed all cross company IP traffic statistics reporting into a single platform and this one we inherited legacy McLeodUSA.

We migrated all calling card customers from various platforms onto one single legacy McLeodUSA SCP. We expanded our OC48 backbone to Milwaukee, Cedar Rapids in Detroit. We enabled Charlotte 4 Gigabit Ethernet services. We continued progress toward carrier access building and intermediation platform consolidation at the end of 2009.

We began parallel testing already for again interrupting billing conversion schedule to be completed year end. That’s the conversion from the U.S. flat billing system to the core PAETEC billing system and we enhanced our agent management tools and prepared for the agent property system online launch next week, which gives enhanced capability to agents to personalize solutions and set pricing for those enterprise customers.

On the M&A front, we are continuing to see opportunities both large and small, but I’ve not yet found the right fit. We are very focused on the remaining integration tasks and completed our transformation of the McLeod territories. There are several exciting new product and service offerings that we are contemplating for launch of the next 12 to 18 months organically, which maybe an even better return to our shareholders from one estimates the up sale potential alone to our 46,000 plus enterprise customers.

Our company has weathered the economic downturn, if continued to generate free cash flow and we’re well positioned to take market share now and in the future. I am just as optimistic today about PAETEC as I ever have been. Thank you for your support and attention

Now, I’ll hand the call over to our CFO, Keith Wilson.

Keith Wilson

Thank, Arunas. Good morning, everyone. As a reminder, we’ve posted a supplement to our quarterly earnings release and it can be found on the Investor Relations section of our corporate website at www.paetec.com if you haven’t already pulled it up. The goal of creating the supplemental presentation is to provide investors greater insight into the PAETEC business.

We believe this will allow all those interested in PAETEC to have a deeper understanding of the various living pieces of the business. The supplement incorporates operating data for a six quarter trailing period. Before I get started, I wanted to point out a few new elements that we’ve added to our earnings release information.

First our earnings release, we have included a new sequential analysis section, which discusses our operating results in the second quarter 2009 versus the first quarter of 2009. Second, in our Q2 ‘09 supplemental presentation, we have included new elements that include Facilities-Fed buildings, as Arunas discussed and it’s found in the network profile section.

We have included a new POTS section, which details revenue churn, customers, customer churn along with the average revenue per customer for this business component and lastly, we have now included a section detailing our T1 churn for our core network services. Providing this information will allow investors to better understand our churn dynamics from a customer, revenue and T1 churn perspective.

PAETEC continue to grow the access lines that it serves. On a year-over-year our access line equivalents increased by 5.7% from $5.5 million in Q2 ‘08 to $5.8 million in Q2 ‘09. During the second quarter of 2009, we invested in continued network expansion by adding approximately 572 miles during the second quarter of 2009.

The primary addition was a long-haul route between Omaha, Nebraska and Denver, Colorado gained through a fiber swap. This will enable us to improve our transport cost between our Front Range network and the broader Midwest network.

We will continue to look at transactions like this to further augment our fiber network to supplement our organic build initiatives. Lastly, at the end of the second quarter, PAETEC had 1912 Facilities-Fed buildings on this network, which includes both wireless and Fiber-Fed buildings. This is a newly released metric that we will update quarterly.

PAETEC continue to drive its sales force towards nationwide optimization by seeking the best talent in the highest value-added positions. For the quarter we reduced overall sales headcount by 16, we redeployed headcount to our highly successful channel sales group, while reducing sales teams in two markets that we believe we are exceeding optimal levels of personnel. Each of these markets had three teams prior to the reduction.

We are planning to redeploy the headcount to other markets that are currently under optimized based on demand and current levels of success. As we continue to strengthen the quality of the overall sales force, we actively look to recruit outstanding talent and to increase personnel during the year.

As a reminder, we have dissected our total revenue into core network services, core carrier service, total access fees, which we breakdown by network and carrier, total POTS which we also breakdown by network and carrier, and lastly integrated solutions. Management believes this breakout will better assist our stakeholders and appreciating the composition and trends of the various segments of our total revenue.

We will first walk through our results on the same period year-over-year basis discussing our full income statement and then circle back to do the same on a sequential quarter-over-quarter basis. So, let’s start in the same period or year-over-year analysis.

Total revenue decreased 2.5% or $10.1 million in Q2 ‘09 from Q2 ‘08, primarily due to decline in usage based revenues associated with long distance, access and POTS. Total network service revenue decreased 1.5% or $4.6 million year-over-year, primarily due to a $4.6 million decrease in non-core POTS revenue and an $800,000 decrease in access revenue.

Core network services revenue grew slightly by 3/10 of a percent or 800,000 year-over-year primarily due to an 11.7% data revenue growth. Growth in data revenues offset continued pressure from long distance usage based revenues and increased revenue churn, which increased to 1.1% from 7/10 of a percent a year ago, as we continue to churn many smaller customers. Overall Q2 ‘09 revenue per customer remained relatively flat from a year ago.

Carrier services revenue declined 6.7% or $4.8 million year-over-year primarily due to a $3.9 million decrease in access revenue and a $1.4 million decrease in non-core POTS revenue. Core carrier services revenue grew 1% or 500,000 in the second quarter 2009 over second quarter 2008.

If we look at the table on the bottom right corner of page six, the same page that Arunas referenced earlier. We can see one of the longer term trends in our business becoming more evident. Our core network and core carrier services are becoming an increasingly larger part of the revenue generation, as both access fees and POTS become a smaller part of our revenue composition.

Year-over-year access revenues declined by 90 basis points to generate 7.8% of our total revenue, while POTS declined by a 140 basis points, so now that generates only 4.1% of our total revenue. Accordingly, core network and core carrier services comprise over 84% of our revenue base today, and lastly integrated solutions revenue accounted for the remaining 3.9% of second quarter 2009 total revenue.

The integrated solutions revenue decreased 4.4% largely due to a 14.2% decrease from hardware and related revenue. Cost of goods sold for the second quarter of 2009 decreased 2.6% as a result of the impact of network optimization and network cost controls.

As a result, gross margin for the second quarter of 2009 remains stable at 50.2% compared to the prior year period due in part to attrition of customers purchasing lower margin products and to the positive effects of network grooming.

In term of operating costs, we believe many of the initiatives we implemented over the past nine months to better align our cost structure to the tougher economic environment have gained solid traction and have manifested in improved operating margin.

As a result of these initiatives, SG&A expenses excluding stock based compensation decreased 5.6% in the second quarter 2009 from the second quarter 2008. So as a percentage of total revenue, SG&A expenses were 34.1% in the second quarter of 2009, compared to 35.2% in second quarter of 2008.

Largely as a result of this improvement, adjusted EBITDA for second quarter of 2009 increased 5.6% to 63.5%. Over adjusted EBITDA of $60.2 million for second quarter of 2008. Adjusted EBITDA margin, which represents adjusted EBITDA as a percentage of total revenue was 16.1% for the second quarter of 2009, compared to an adjusted EBITDA margin of 14.9% for the second quarter of 2008.

Net loss for the second quarter of 2009 was $16.5 million compared to net loss of $14.7 million for second quarter of 2008. For second quarter of 2009, lower costs and depreciation expense were offset by lower revenue and a one-time $10.3 million non-cash loss on extinguishment of debt due in part to a $4.5 million of swap termination costs associated with the unwinding of $135 million in LIBOR swaps and other costs associated with the partial repayment of the company’s term loans with proceeds from our senior secured notes sale in June of 2009.

Additionally, second quarter of 2008 net income was bolstered by a tax benefit $2.7 million, which contributed to the period-over-period variance. When we consider our second quarter of 2009 operating results versus second quarter of 2008, we have the following takeaways.

One, economic headwinds continue to put pressure on revenue, as we saw 2.5% revenue decline year-over-year. Stability in our core network services was not enough to keep total revenue flat in this environment, as access fees and POTS related to network services experienced continued pressure.

Two, stability in gross margin, despite a total revenue decline, our gross margin was flat year-over-year due the attrition of lower margin customers along with the positive effects of grooming projects by our network operations team.

Three, the cost initiative that our management team put in place over the past few quarters have gained solid traction. Recognition of the challenging economic environment, we worked hard to better align our cost structure.

Lastly, modest EBITDA growth was the ultimate result of the combination of a revenue decline and a stable gross margin along with solid cost alignment in this economic environment.

Now let’s turn to the sequential analysis of Q2 ‘09 versus Q1 ‘09. Total revenue decreased 1% or $4.1 million in Q2 ‘09 from Q1 ‘09, primarily due to a decline in usage based revenues associated with long distance access in non-core basic telephone service or PODS.

Total network services revenue decreased 1.3% or $4.1 million quarter-over-quarter, as the pressure on usage along with the attrition in access fees POTS outpaced growth in our data service revenue. Specifically, core network services declined 6/10s per percent or $1.7 million, as pressure on usage-based revenue outpaced growth in our data and GPN revenue quarter-over-quarter.

Q2 ‘09 revenue churn of 1.1% did increase from 7/10s per percent in Q1 ‘09, with the continued churning of smaller customers; carrier services declined 2.9% or $2 million quarter-over-quarter, primarily due to $1 million or 2% decrease in core carrier services along with 900,000 decrease in access revenue. The decrease in core carrier services revenue was largely as a result of pressure on usage-based revenue streams, resulting in a 1.7% decrease in revenue per customer. As churn and customers remained relatively flat quarter-over-quarter.

Lastly, integrated solutions revenue which accounted for 3.9% of Q2 ‘09 total revenues, increased 15% largely due to a better performance on our hardware and software sales. Cost of goods sold for the second quarter of 2009 decreased 1.1% from Q1 ‘09 due to continual efforts to reduce network costs.

As a result, gross margin for Q2 ‘09 was flat at 50.2% compared to the prior quarter. SG&A expenses excluding stock-based compensation decreased 1.1% from Q1 ‘09. However as a percentage of total revenue, SG&A expenses were unchanged from the first quarter of 2009 at 34.1%.

Adjusted EBITDA of $63.5 million for the second quarter 2009 represented a marginal decrease of 6/10 of a percent or 400,000 from adjusted EBITDA of $63.9 million for the first quarter of 2009. Adjusted EBITDA margin improved to 16.1% for second quarter of 2009, compared to 16% for the first quarter of 2009.

Net loss for Q2 ‘09 increased to $16.5 million from a net loss of $3.3 million in the previous quarter as Q2 ‘09 net income primarily reflected the charges associated with the loss on extinguishment of debt. Interest expenses of $17.3 million for Q2 ‘09 was essentially unchanged from Q1 ‘09.

Capital expenditures for the quarter in 2009 were $27.2 million or 6.9% of total revenues down from $34.7 million or 8.6% of total revenue for second quarter 2008. The decline year-over-year was largely due to timing of investments in the network after the close of McLeodUSA acquisition in 2008. For Q2 ‘09 free cash flow which we define as adjusted EBITDA less capital expenditures was $36.3 million up from $25.5 million in Q2 ‘08.

This increase was due to efficient capital investment along with a higher adjusted EBITDA year-over-year. PAETEC posted the 26 consecutive quarter of free cash flow. PAETEC had a quarter end cash balance of $139.7 million compared to the first quarter of 2009 quarter ending balance of $144 million primarily as a result of expenses paid in conjunction with the debt financing activity along with the required debt reduction of $6.2 million during the quarter.

On balance sheet management initiatives, PAETEC was quite active in Q2 ‘09 as we were able to accomplish the following. One, PAETEC amended it credit facility to allow for a repurchase about to $100 million in cash of its term loans and it discount through November 30, 2010. As well as the ability to issue senior secured notes and apply the net proceeds to repay the term loans of par.

Two after the announcement PAETEC proactively issued $350 million in new senior secured notes and used the net proceeds to repay approximately $330.5 million principle amount of the outstanding term loans. As a result, the remaining balance of our term loan due in 2013 was $241.5 million at quarter end. We are very approach of the continued support we receive from the debt investor community allowing us to close this transaction in a challenging economic environment.

We’re please to have an appropriate debt maturity timeline of term loans maturing in 2013 that we believe we can comfortable amortize before maturity via cash flow generation and cash on hand coupled with the appropriate longer term notes that mature in 2015 and 2017.

As a reminder, at the end of Q2 ‘09 PAETEC was well within the sole financial covenant in its credit facility, which provides for a maximum permissible ratio of consolidated debt defined as consolidated debt less cash on hand and excess of $20 to consolidated EBITDA as defined in our credit agreement of 5 to 1.

Now I’d like to make a note of another balance sheet item. In June of 2009, approximately $6.1 million shares of restricted stock units granted in 2006 to some of the company’s current and former senior officers were eligible for issuance. This plan was originally provided in connection with PAETEC’s balance sheet recapitalization, in June of 2006 following the buy out of numerous private equity investors.

Through arrangements with the grantees, the company retained approximately 2 million shares to satisfy the individual tax obligations, to with holding of the share mean the company’s consideration to pay the tax obligations and cash unless the company only issues 4.1 million shares of common stock, in connection with those brands.

The company executed this transaction in lieu of additional share repurchases under our previously announced stock buyback plan. At June 30th, 2009 PAETEC had 145,267,884 common shares outstanding. That concludes our prepared remarks and I would now like to ask and open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Simon Flannery - Morgan Stanley.

Simon Flannery - Morgan Stanley

Wanted to follow up on the data center comment if I could, give us a little bit more color on what you’re thinking in terms of timing? How much these data centers are going cost? The sort of square footage, some of the details around that and a pretty very good cash flow and CapEx performance in Q2, we’ve seen it come down to the sort of 6% of revenues. Is that sort of more timing issues, or give us a sense of color, what we might expect for the second half of the year?

Arunas Chesonis

On data center side, one way to think about it is probably two to three centers built out every year. We’ve got two very large centers in Pennsylvania that conserves the Northeast and Mid-Atlantic area. We’d like to for the next 12 months place one in the Midwest, one in the Southwest, actually one in New England. New England is one of our fastest growing marketplaces especially on data side and we’ve got a sales organization that really I know as case so I think you take advantage of it.

So I think once you look at the timeframe of the investment, now you can start thinking about how much it would cost to build out. Again every location is unique, because of the variety of infrastructure we already have in some of these places. If you look in a place like Phoenix, lets say if that tends to be a great place for data center expansion just based on the stability of the environment down there, and we do have a large enterprise based in Southern California as well Arizona.

We’ve 10,000 square feet of extra space that we’re paying for that came to us as the part McLeodUSA merger. We’ve got environmentals, we’ve got power, we’ve generation, we have very little costs associated we’re trying to bill that out. I think you go to a place like Houston or Dallas, we’ve got extra space, very similar situation to Phoenix.

If you look at a place like New England or some places in west of downtown Boston, where we put our second switching center, there is space on that same floor to just blow through some walls and build an extra 3,000 to 10,000 square feet business space. There we just sold out all our collo space there recently in about six months, almost 30 Cabinet and owe just a very small amount, but it goes very quickly.

Again it’s very unique to the situation. You should think of it anywhere from $400,000 to $1.5 million per say. Again we think we can easily do that without too much impact within the typical CapEx intensity we have as a company.

Simon Flannery - Morgan Stanley

Then the CapEx for the second half of the year?

E. J. Butler

We think that a more normalized run rate is kind of in the seven to eight range so as you think about the overall year, you may see it be a little higher in the second half to catch up. That being said, I mean one of the trends we’re seeing is continued attractive purchasing terms from a lot of the vendors.

So we’re not going to rush to spend the dollars, if we can get the same amount of things that we’re looking for cheaper. So while there has been some timing benefit to what we’ve seen in the first half of the year, there’s also been concession benefit that we seen across the board from various vendors.

Simon Flannery - Morgan Stanley

That’s helpful. Thank you.

Keith Wilson

Just to add on to your data senor, this is something we want to spend a lot more time with people on the investor day, next May when we do that sure again in New York City.

What has gotten us excited about the data center business and the hosting business in general, is the pull through on network data provides you on the longer term, the stickiness of the relationship. We’re finding that for someone who ends up spending 2,000 to 3,000 a month with you on actual data center product itself, you’re typically pulling through another $3,000, $4,000, $5,000 a month in network services.

As long as you stay flexibility and for people that need a little bit of diversity with the Verizon on AT&T and you give them that option. You’ll tend to get your fair share of the network service as well. So, that’s one thing we want to spend more time with you and just really explain the pull through for folks like us.

Operator

Your next question comes from Frank Louthan - Raymond James.

Frank Louthan - Raymond James

Can you give us an idea of where you see the POTS and the access revenue starting to go and where is that function? Where is that sort of going to bottom out and stabilize? Can you give us an idea of what the current mix of new sales looks like today? So I think you’re trying to diversify away from some of that, but give us an idea of going forward, how much more exposure you are building up to those more variable levels of revenue?

E. J. Butler

Sure, Frank. On the POTS and access, when we originally closed the transaction with McLeod, I think that we had talked to you all about what we believed was going to be kind of a three to four year attrition timeframe for that business with some of that revenue stream kind of lingering on long-term, with kind of single DS-0’s that aren’t associated with T1 based customers, because we will always have some smaller location that will have specific POTS line or advantage business line circuits that are associated with predominantly T1 customers.

What we have seen on the churn rates is that it looks like that POTS life will kind of linger at least through the four year timeframe. That from the time we close the transaction, it’s turning at about 2.5 per month, so that gets you about 25% a year.

So, we still think that will continue to be a trend line, but as Arunas talked about in his comments, while there’s pressure there. We are going to see some improvement over the enterprise productivity and some of the pressure points in the enterprise side that will surpass that and should, just create that as background noise.

On the access part, that continues to be a volatile area as well, and look we all get that; right. I mean that was a piece that really hurt, a lot of [Inaudible] in the early days because they got too heavy on access. I mean, right now, we are at just over 7.5% of our revenues on the access side.

I think our expectations are that there will continue to be pressure there. Now, there is two kinds of pressure, there is the change, the technology shift and the revenue mix shift that we will see, which will reduce the impact of access, but there’s also the usage component.

So, when you look at guys like AT&T and Verizon and Quest, who are all showing double digit access lines declines and pressure on their wireline business. Those are components of less people, using their facilities and calling into our customers and subsequently generating access.

So, we do believe a fair amount of the pressure on access today is coming from economic base driven dynamics. Again, unemployment is increased by 100%. So, there are less people using business phones today and that subsequently is impacting us on the revenue side, but I think long term we would continue to see that drop and I think normalize probably in the 5% to 6% range.

Keith Wilson

Frank, the two things I’d ask you to watch out for the next, year or two on both those area, on the POTS side, we do have a lot of partners of ours, who are their own independent sales agents for, not just PAETEC, but for other folks in the country.

What they’re looking for is a national provider, not just to take the off-net locations, but they’d like someone to also take the smaller locations under sort of the former UNP regime or the resell regime, so they could do, one relationship with someone like PAETEC and make it much easier for the customer, for themselves or administration purpose. So, that’s the one unknown.

Will we decide over the next year or two to allow our partners to bundle those off-net locations into a full national footprint for their enterprise customers. So, that may end up slowing down the POTS, just the trend downward and actually in the long run may actually help us grow that POTS business. So, I want you to watch out for that announcement if we do something.

The second thing is on the access side. I do think with this current SEC and the commissions we have in place, compared to the last SEC, I think there will be a thoughtful longer term approach to access reform and the carrier compensation reform than maybe was previously contemplated doing it much quicker. So, I think you got to stay in touch with that and see where that goes the next year or two.

On the products side question, mix of new sales, I know that the majority of our new sales Frank, are coming from IP based services, whether its our dynamic IP product, whether its MPLS, which is IP data, Citron King.

The one area where we are training the organization, how to think through this and the reporting that we get back is sometimes when people will sell a traditional PRI service and instead of deploying it on the TDM network will deploy it on the soft switches and the newer technology and be able to quickly migrate those folks without additional CapEx needs, when they’re ready on their time schedule, and in ways that’s almost selling it on your IP network versus not.

So we’re getting through those sort of definitional. “What’s the best way to say it?” We’re just trying to make sure we’re all using the same language throughout the country. I think we will be able to give you better information in the next six month or so. My guess is that’s closer to 75% to 80% of new sales on the IP network.

Frank Louthan - Raymond James

Just one follow-up on the data center side, are you leading with sales for network or are you leading with sales for services on that side? I assume you’re doing, hosting. Its managed services up from just straight cohort as well, but give us an idea of how you are selling into those data centers?

Arunas Chesonis

Again it’s all over the place. It really depends on the need of the customer. Some people have been hurt pretty severely with layoffs in their IT stuff. So they just don’t have the internal hedge to run the second data center, put into diverse side. Many people are looking at this business continuity, opportunities. It ranges all over the place.

Network tends to be one way where we can help, make the data center choice less expensive, because we’ve already got our network if those locations. We can be fairly aggressive on the pricing and still hold pretty strong margins there. Because we don’t have any last mile costs associated with much of those services. That’s where the real benefit comes from. So it’s usually people interested in the data center or the business continuity and then the network comes along to help subsidize it.

Keith Wilson

One of the key factors to broadening the portfolio through more expensive data center solutions is that ultimately, we’re a solutions based selling company. So when you’re going out there, whether it’s a circle customer, who is in their need of telecom expense management services, physical equipment like Cisco gear by all works gear or data centers.

We’re looking at it’s a holistic solution for folks. We’re trying to look at the easiest entry point into the customer and if certain customer happens to be data center that’s great, if it happens to be network that’s great too. I think we really approach it as, there’s a broader solution set as opposed to specifically trying to push a product just because it happens to be the latest in the portfolio. So it just provides an easier point of entry for our sales folks to provide a broader product set.

Arunas Chesonis

It also gives you great synergy on the employee side as well. When you have those people that are 24/7 managing the centers and therefore support to the customers. They’ve got, I don’t say a ton of extra time on their hands, but they have significant time on their hands that they can provide other functions for the company.

So just as an example our managed router service, when someone has got $50 million MPLS a network, a lot of times they’ll subcontract that management of those routers at $50, $75, $150 bucks a month to us. We’ve got now those people during C shifts that can do all of that work without putting extra pressure on the network operation center folks.

Operator

Your next question comes from Tim Horan - Oppenheimer.

Tim Horan - Oppenheimer

Really, you’ve should been around the industry obviously a long time. I’m curious what you think of the sector relative to the economy. I guess prior to the economy slowing down, you guys were kind of growing revenues $3 million, $4 million per quarter sequentially now, you kind of declining $2 million, $3 million.

I think the change, there is almost entirely due to the economy, but it could be curious on your perspective. If the economy is bottoming out now, it’s hard to know where it’s going into the next two to three years.

What do you think the lag is with your business and the overall economy? Is it a one year lag and we might continue to see revenues declining $2 million, $3 million per quarter for the next year? Do you think it could be a six month lag? At that point, we’ll bottom and it should theoretically start to grow again?

Just curious, how do you think the industry is relative to the overall economy? Maybe you can also comment, are you seeing real pricing pressures or is that really just volumes at this point that’s pressuring above in this things.

Arunas Chesonis

On your second question, first, we’re seeing just as you’d expect more pricing pressures. We have looked back over the last three, four years and looked at our happy customers who renegotiated their contract and stayed with us and what those write down tend to be as well as customers that leave you and they give you, a reason for leaving PAETEC, when they give you price is the answer.

Those numbers over the last six months have tended to be reasonably higher. So whether its, 20%, 30%, 40% greater from where it was several years ago, there is a measurable impact to the economy on pricing right now.

Tim Horan - Oppenheimer

Who is driving that pricing pressure?

Arunas Chesonis

It’s the nature of the environments that our customers are going through on running their own businesses. They’re much more aggressive now, that willing to take technology risk, inconvenience of cutovers, inconvenience of going through the fiscal cutover of new networks much more than they would have been say a couple of years ago.

Again if you take a typical enterprise customer, what was one of the reasons we weren’t getting the business from AT&T and Verizon, because they can still save a little money, by continue wouldn’t have to go you the bother and headache of doing the transition.

Now, if they don’t get the price point they want from one of the income providers they are going to go through the bother. Their job is at risk if had they don’t save money for the company. So it’s almost being driven, primarily from the customers as opposed to a price war between the carriers.

Keith Wilson

Yes, Tim, some of it is product mix shift and if you at kind apples-to-apples products, take whether it is usage based products or certain kind of flat rates stuff, the general pressure points across each of those are less than you would think. The greater than they used to be but less than what you would think. So I mean long distance pricing for us on a minute basis is down very modestly year-over-year even though our volume is down pretty significantly.

What you are seeing is, as we are seeing technology shift if you are seeing someone with a classic integrated T1 moving to IP based services you are seeing pressure on the overall average revenue pretty. So, for us year-over-year if you look at our enterprise segment core network our average revenue per T was down about 6.3% year-over-year.

That’s a little bit faster than what we have seen in previous year, some of that it is product shift and some of that is usage based, but the specific unit based stuff tends to be, I mean declining at kind of historical rates of kind 2% to 3%.

Tim Horan - Oppenheimer

Which carriers were the customers going to they have to save money even if it is technology shift they’re going to somebody else.

Keith Wilson

Well, they can be staying with us. So, they could moving from a six or seven year old customer PAETEC could moving from integrated circuit to IP based circuit moving the moderate, or other network.

Tim Horan - Oppenheimer

The correlation with the economy, Arunas.

Arunas Chesonis

Well, I think the way we have been explaining it to our employees and partners and what we gave them guidance last summer still thing holds for today. We toll them we thought it would be a two to three year downturn.

That’s the way we have been looking at everything from our capital program to our capital structure, and how to best prepare for it. I do think there’s going to be probably difficulties from, for our customer base on the kind of enterprise customers we deal with for another good year and a half before we see, some up tick.

You think about it they went through all their issues the last half of last year and first quarter of this year, and it takes, three, six, nine months to shut down offices. You can lay people off much more quickly but it is very difficult to eliminate locations and disconnect network.

Many of the carriers not just ourselves are in that process right now where we are seeing customers staying with you and not just renegotiating, but actually reducing locations. So, it is almost a location churn not just revenue churn and we see, another year, year and a half of that.

Keith Wilson

Probably the most difficult part of answering that question is what is the type of recovery, and we are not trying to be cute, but a jobless recovery with GDP growth pushed by efficiencies is one type, and more of a classic improvement in employment and static productivity is a different kind of improvement.

I think the dynamics in term of where the business responds to that are going be different. That being said, I still think we believe that our ability to capture share as we continue to do will allow us to pick a momentum maybe a little bit quicker than some of the other wire line guys who aren’t.

So as you look at again the declines that you’ve seen in some of the more traditional carriers versus at least the access line growth from us. We do believe that, one is kind of our base settles down again some of those usage pressures and things of those nature that we should start to stabilize and see some growth out of that. So really, I hate giving you the depends answer, but it kind of depends.

Arunas Chesonis

In term not all of the news is bad news. Our equipment for service program has got more interest than ever has before not just from customers, but agents and other partners.

I would say probably a third of our new sales right now has come components partial or full subsidy of our capital equipment as part of the financing program, which differentiates us from many of the folks out in the fields that go through sort of traditional financing programs. So, not all news is bad in this kind of environment for us.

Operator

Your next question comes from Donna Jaegers - D.A. Davidson.

Donna Jaegers - D.A. Davidson

Good job in holding your own under a tough economy. I’ve got two questions you talked about data revenues up 11.7% year-over-year. Can you give us sort of ballpark size of what are those revenues as a percentage of total revenues?

Arunas Chesonis

Yes. Data revenues today, Donna are running in the low 20s.

Donna Jaegers - D.A. Davidson

Low 20s as a percent.

Arunas Chesonis

Low 20s as a percent.

Donna Jaegers - D.A. Davidson

On slide eight, you talk about core network services the churn and we’re starting to see an up tick in both customer churn and revenue churn, which it would seem like that must to happened sort of late in the quarter. So it didn’t really impact revenues too much in Q2. Can you talk a little more about that?

Keith Wilson

I don’t know that I would agree that it didn’t, that it happened late in the quarter. I think it was pretty consistent throughout the quarter. I think that one of the things, there’s an interesting dynamic there. Run through the numbers, its smaller customers that are churning off.

Part of that dynamic as Arunas said earlier, those tend to be the most price sensitive. Those were the folks who are willing to move for very little in term of a price concession and at the same time, they are the less sophisticated customers that don’t necessarily demand the broadest product from someone like us.

Additionally, because of the pricing discipline that we have if there’s not an ability to overlay our SG&A, across a larger revenue stream it’s hard for us to really drive down the price for those guys. That’s why we’re seeing churn be a little bit higher there. That being said, our new bookings and our new sales continue to be pretty robust. So I mean, that’s one of the things that we talk about, maybe we don’t emphasize enough.

I mean, we’re bringing on a lot of customers every quarter, and these are very attractive customers and they are as, it’s as an attractive set of customers we’ve ever had access to largely because of our broad product set and our nationwide footprint. So yes, the churn dynamics are up and that’s frustrating for us.

I think the reality has had those stayed kind stated inline you probably, you would have seen a much better strength out of this quarter. That was really part of the frustration for us is because new bookings continue to be very good. We’re putting a lot of new people on the network, but we are getting pressure off of that stuff in addition to usage based revenues from customers who are staying with us.

Donna Jaegers - D.A. Davidson

Just as a quick follow up, the average installed time, since you’re doing more MPLS kind of networks. Is the installed time increasing or what is average installed time? So when should we expect those new bookings to really fall into sales?

Keith Wilson

Yes, it stayed fairly stable, Donna. Once we get the order into the back office, you’re look at about 60 days, so we’re seeing a little bit. There’s a little bit of briefcase time that comes through in front of that, but you are looking at, if you start to think about the MPLS orders, think about that kind of in 90 day range is pretty safe, because you’ve got to have a month of billing behind that. So, call it three months.

Donna Jaegers - D.A. Davidson

Then just one other quick question if I could. On McLeod given the sort of grooming that you are doing or the pruning that you are doing on your sales force.

It sounds like you’re certainly where you’re seeing success in the new McLeod markets. You are trying to fall that on quickly with more sales force, but where you are not seeing effective sales people then you are sort of grooming those people out. Is that sort of a fair radon? What we should expect with your sales effort?

Keith Wilson

We’ve gone through the first cycle. The folks that we hired either via the legacy PAETEC management or the McLeod management that we wanted to stay on. So, that’s happened. Now, we are going to start the second phase.

If you go to one of the slides here on sales force, on the supplemental, just to give you a little bit of sense of there, slide five. You go to direct sales associates, the direct sales number is 319 in the end of second quarter. We like to get that number closer to 350 range by the end of the year, sort of net incremental about 30 people. That would be a good target for us. We haven’t finalized the budget for next year, but we would like to get that up closer to the 400 range by end of next year.

There’s some other markets, we think we have some untapped potential that we’ve got great middle and higher level leadership. I could see putting second teams in places like New York City, Philadelphia, and Atlanta. We’ve got some real momentum in some of those markets with the folk. So, I don’t think its going to be just purely McLeod sales growth. It will be in older PAETEC markets as well.

Operator

Your next question comes from Michael Funk - Banc of America.

Michael Funk - Banc of America

If we can just focus for one more second on the sales force productivity and if you can comment on what you are seeing for productivity and even gross additions in some of the newer markets? Transitioning that to the enterprise strength that we are seeing in your business relative to some of the peers in the industry as a whole, your enterprise revenues are relatively flat sequentially and we’re still seeing pressure over to AT&T and Verizon.

Maybe a few comments on differences in some of the verticals, geography as well as customer size that are allowing you to keep that revenue stability relative to the industry?

Arunas Chesonis

That’s a 12 hour question there, Michael. We spend a lot of time as a management team going through that. I think to be fair I think it is a little too early for us to give you a lot of trends there. There are so many different moving pieces. We are trying to transition the sales force to go up market.

So, even where we were at a reasonably high level; we are trying to move up a larger percentage of our sales force from account executives to senior or major account executives. We are trying to build more specialists in for the vertical markets and assign those verticals.

We are trying to build a larger national account sales force. Right now, we have a handful of people working on Fortune 500 customers. We think we can expand that by two or three times over the next couple of years. We are adding specialists on the product side, whether it’s the equipment reps, who are able to bundle the network.

We are looking to add additional sort of datacenter and hosting experts in the sales force. The move is up market. So I think it is difficult for us right now to give you a lot of metrics that you are looking for.

Keith Wilson

But I would say, Michael in terms of general trending, things like our, but what we think is best in industry agent channel. That’s got an off to a very good start and kind of the broader footprint.

I think our strong SLAs in the quality of our MPLS network has allowed us to really find a lot of success in multi-location customers in each of the respective footprints, that have guarded some pretty significant wins. In the verticals, we’ve been able to leverage relationships in certain verticals.

Again, financial services, government, higher Ed, have all been very strong for us, regardless of that the point footprint. So, I mean all of those things that I think we looked at, when we originally did the McLeod are coming to fruition, and maybe now as fastest as we’d like. We are seeing some very good momentum in some of those places where PAETEC has had long term straight than encourages us.

Michael Funk - Banc of America

Then just on the gross side question. Clearly churn is one component of customer count, but gross side growth and what you are seeing some of the newer markets?

Keith Wilson

You mean in term of specific revenues or…?

Michael Funk - Banc of America

In terms of it is just gross sides or new customers come in online relative to the disconnects and some of the sales force productivity increases that you’ve seen as well as expect?

Keith Wilson

Michael that’s information that we haven’t release consistently, so I’d be a little bit reluctant to do that now. I think, what I can tell you is, our new bookings across the country have been pretty consistent and kind of the low $2 million per month range, but I’d be reluctant to kind of start breaking down, because when we put out that Analyst Day presentation to look at productivity and market share data. We really said that we’re going do that annually not quarterly. So I appreciate that you ask, but I think I’d like to defer that to be an annual release on the specific numbers.

E. J. Butler

I’ll just give you a little anecdotal color. If you look at markets like Houston, Dallas, Phoenix, some of what we consider to be new or restarted markets that we acquired through the McLeod integration. Those sales are up. New sales are up pretty significant to offset some of the churn of the lower revenue customers. Seattle, San Francisco, San Jose, Portland, I mean those sales month-over-month continue to contribute more to the overall sales volume.

A lot of that is fueled just by headcount growth. Where we virtually taken those markets from zero headcount in the Bay area and very nominal in the Pacific Northwest and we tripled the size of the sales force.

So there’s an educational process and going from putting together three regional carriers that were offered great service and very competitive pricing to a national carrier that really offers a true alternative to the, [I lack,] one source service provider that’s offering services to generally multi-location companies.

As Keith said, I think in the coming months or when we do the next investor presentation, we can give you another snapshot of market share by all of the markets including legacy PAETEC and McLeod, but I can tell you anecdotally we are getting more traction as we add sales personnel and really the unify product portfolio is out there and the legacy McLeod markets.

Operator

Your next question comes from Colby Synesael - Kaufman Brothers.

Colby Synesael - Kaufman Brothers

Just on the cost side of thing, we saw that cogs and SG&A were both down I think sequentially. Just curious, how much more cost saving are available not necessarily seeing an improvement in revenue? Also I was wondering as it relates to color, if you could break that out as a percentage of revenue since that’s obviously an area of focus for you guys and potentially give us the growth rates on that?

Then just my last question, just looking at the new products, you talked about I think 12 new products you’re looking at expanding in the next year or so. Just give some color on what those are and are those necessarily different than traditional telecom services type products, more managed hosting? A little bit color there will be helpful.

Keith Wilson

Colby, I’ll take one or two of these and then I’ll let Arunas to get the rest. From a cost structure standpoint, we think that there continues to be opportunity for us to be able to manage the cost structure.

Again it depends on the success we have in terms of driving down overall network, cost in network optimization. I’d only give you number now, but we do think that there’s an ability to continue to drive that. I think it depends on the type of revenue pressure that we see.

From an SG&A costs standpoint today, again I think there’s opportunity. The question is, what kind of decisions do we need/want to make as part of the business and trying to balance out long term growth dynamics that we believe still sit in the underlying business versus kind of cutting a little bit too deep into the cost structure.

So I’m going to dance around the answer, but I will tell you that we do believe there’s more cost to remove from the business and what we’re trying to do as be thoughtful in terms of how we balance managing the cost structure with what we still believe this is underlying solid fundamentals in terms of new customer acquisition and value proposition that PAETEC brings to there.

Colby Synesael - Kaufman Bros

It certainly sounds like these from on the SG&A side of things there’s certainly opportunities, but nothing that you have already started to implement already in the process of that we could potentially see in the third quarter?

Keith Wilson

That’s correct. I mean I would say do we have a couple of envelopes sealed with, kind different ideas that we think can be effective, yes, we do and it depends on the direction of where the business goes, but I mean we have been very thoughtful in looking at the opportunity set and we’ll do what we need to do continue to drive the business on the cash flow line.

In term of the specific Colocation stuff, I think we give you a lot of breakout of information today. I will tell you that the data center business is solid business, but still very small relative to the overall business. I don’t want to break that out as a specific line item today.

Arunas Chesonis

Keith brings up a great point. We have been doing this kind of data center type of business since we started the company. The amount of customer that is have some type of Colocation with us most every one of our central offices qualifies either as a tier 2 or tier 3 data center when you look at the characteristics of the infrastructure and the only reason not tier 4 many cases because 24/7 on site coverage.

So, when you try to extract that information from systems that weren’t built that way and for multiple merge companies we’re going to need a good six or nine months to go through that data just like we did on the fiber facilities on that buildings Colby.

We are very much trying to get that information timely to manage it better, but we want to breakout not just the pure data center stuff that’s traditional branded, but also all of the Colocation revenues with generate and all those COs around the country and with the pull through on the network, that’s going to take a little time because we never really insured billing it that way with that MRC associated with that.

That’s when it is going to be difficult to pull through and that’s why we’re not dodging your question. We want to have more information ourselves about that but we do feel really good about that business with. I think on the new product side, I said 12 months to 18 months, not sure I said 12 new products, we’re trying to be very focused I have new employees asking me what’s the next big thing for PAETEC.

The next big thing is like in the middle, CDM to IP revolution and you coming to my office and pitch me like a sales engineer and other chemical aspects and dynamic IP and then go ask me about what’s next. Is that’s what is really next over the next three, four years, but having said that you have to plan the seeds for the future. We have been talking for ten years about wireless resale, hand held device, and I think there’s a possibility that you can see us launch that kind of product offering next year.

Our customers are interested in just more things that we can do for them they like the service relationship, they like the personalize solution they want us to do more. I do think you will see us edge into more managed services, more hosting capabilities.

I think you will see us potentially go down market with some of our telecom expense management, both from the wireless and wire line we could help small enterprises manage there cost not just pay their but the overall cost in the US as well as overseas because many people need some help with locations in India, China just to manage the cost structures for the what they’re employees are doing other there.

So, I think there is a number of things that you can see from us, Colby, and the last one is put out there as we did purchase a little while ago a small electricity and natural gas brokerage company that now we have a couple hundred relationships in up state New York. Again I don’t want you to get all excited thinking we are going be become an energy company in the next 12 months, but we are planning the seeds for the future.

We’re learning the business we think there are similarities between telecom and IT and energy, just like ten years ago where we thought that the IT Directors and CIOs would become more in charge of telecom purchasing decisions, we do think the next ten years more CIOs will have responsibility for facilities will have more traditional back up power generation energy they need in data centers, energy conservation, the green initiatives, a lot of those issues they’re being pulled more and more into that we see from our customer base.

We think having as a portfolio that includes energy in the overall telecom and IT universe will really help differentiate us five, ten years in the future with CIOS throughout the country. So, again, a long way to answer, but stay tuned and we will share that with you as soon as anyone else.

Operator

Your next question comes from Robert Dezego - SunTrust Robinson Humphrey.

Robert Dezego - SunTrust Robinson Humphrey

Quick question on the churn, do you have a sense for how much of that churn is from customers that are actually going out of business or versus customers that are leaving you?

Arunas Chesonis

We have a pretty good sense, Robert. We track probably around 18 to 22 reason quotes for people leaving us whether it’s forced or voluntary. We’ve been going through that a lot as you can imagine the last nine months. I will tell you whether it’s going out of business, shutting down locations, non-payment, something where it’s more economic times related.

We think it’s somewhere in the 50% range of our churn is being impacted by the economy versus, a person really just doesn’t like our rates, not because the economy, but because we are priced too high or our service isn’t good or we just can’t do something that someone else can. We just messed up, I mean just sort of the some of the normal reasons you go through. I think it’s about 50% right now.

Keith Wilson

If you look at that, that would calibrate pretty closely to where kind of our historical churn rates are going to be.

Robert Dezego - SunTrust Robinson Humphrey

Was there any change in bad debt? Can you give us that number?

Keith Wilson

The accrual that we had for bad debt was up in the 1.3, 1.4 range. So, it continues to track a little bit higher for the year. It’s running at about 1.25, Rob, and that was kind of about what we expected. So, significantly higher than last year, but trending about where we thought it would.

Robert Dezego - SunTrust Robinson Humphrey

Just last question on the datacenter, I know you are getting a lot of questions on this, but the decision that you guys made to do here, is this decision being driven by your current customers coming to you and telling you this is what they want or is this really more of an opportunity for you to get new customers in the door?

Arunas Chesonis

It’s both, but I think you have to go back a little bit historically because US LEC had acquired FASTNET several years before. We went through the merger. So, they’ve had this product set. They did not invest as much as maybe they could have over those years, because they were trying to do other things.

I think we looked at it for the first year, really spent sometime with the Philadelphia to New York City that quarter, that customer base, existing customers as well as new prospects. Our sales teams found that it’s very much a differentiator and helped improve their closing ratios.

If you look at, two of the top five teams, sales teams in the country last year. When we went to Gentlemen’s Club, we virtually had the entire New Jersey, and Philadelphia sales teams on Gentlemen’s Club and it’s not just because they’re all great folks.

One of the reasons was they had the two major datacenters in their backyard in Southeastern Pennsylvania and they were using the very successfully. So, I think it’s a combination of going to get new logos as well as people coming to us asking for that support.

E. J. Butler

Just real quickly, just to back-up, what Arunas said. We probably have half a dozen, data hosting subject matter experts from the company and they basically act as overlays and the data hosting experts that help augment the network sales people. So, our people are generally out hunting network and what they’re increasingly getting brought into are hosting opportunities, because people are aware of the fact now that we operate, hosting business.

We also get plugged into RFPs now that are leading with hosting. That traditionally, we wouldn’t get considered for. So, I think hosting is enabling network, but its really network that is out there bringing in hosted opportunities and that will probably be the case until we really have a national hosting footprint and reputation.

Keith Wilson

Just to point on what E. J. said and he brand the national customer advisory board for us in Chicago last week with several executives and customers from around the country took their own time several days to speak with us. We are running with right now over 1,000 customers are on these active advisory boards and they meet on a regular basis with executives throughout the US.

I think we are up to 53 or 54 cities now. Our goal is to get that number up from a 1,000 to 2,000 or 3,000 in the next several years. I can tell you virtually 80% to 90% of our product introductions and our new launches come with a great deal of in put from those customers.

We are just not deciding what we want to do on our own, because what trends we see we’re get a lot of feedback from customers and not just on the general product but the physical design, the way the portal looks, all the detail associate with it roll out schedule. So, I think you can feel comfortable that we’re tapping into what customers are really looking for as helping them fix their pain points internally.

Robert Dezego - SunTrust Robinson Humphrey

On the building attached to your facilities based buildings in the quarter, is there any expectation to actually increase the number of buildings as we go forward?

Arunas Chesonis

We have active proposals throughout the country right now both wireless and fiber. Again it is something that we are allowing the newly acquired employees at McLeod to stretch a little bit. They were trying to conserve a little more cash the last couple of years before the merger.

So they’re trying to get used to the fact they go on pitch these kind of combination fiber build and network deals and we’ll keep you up to speed on that but the goal is to keep about $10 million to $15 million a year of capital reserved that we can do these internal projects throughout the US.

Robert Dezego - SunTrust Robinson Humphrey

What a customer actually signs a contract.

Arunas Chesonis

We don’t do specks, we never have. It has to have, a revenue term contract, minimum pay and sometimes they pay a little more up front to help with freight cost but we don’t believe in the building on speck there, Robert.

Operator

Your last question comes from Michael Rollins - Citi Investment Research.

Michael Rollins - Citi Investment Research

I wanted to just follow up on the Facilities-Fed buildings disclosure in the quarters. Is there a way to think about how many total customers are in those buildings to think about your market opportunity and what share of those customers you currently have today?

Keith Wilson

That’s, you are playing right to what we are thinking about there, Michael. That’s what we’re spending our time internally going through. I think we will be able to share that with you at some point in the future we are just not ready to do it right now.

Michael Rollins - Citi Investment Research

Presumably a high proportion of those buildings be in the McLeod territories versus your old heritage territories.

Keith Wilson

Yes.

E. J. Butler

A lot of the wireless, Michael would be in across the country in various locations so probably heavily concentrated in the PAETEC and on the fiber side obviously going to be more concentrated in the McLeod territory.

Chris Muller

Again, thank you everyone for joining us on the call. Appreciate your time and we look forward to speaking with you again next quarter. Bye-bye.

Operator

Ladies and gentlemen, 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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