Executives
Chris Muller - VP, IR
Arunas Chesonis - Chairman and CEO
Keith Wilson - CFO
Analysts
Jason Fraser - Raymond James
Simon Flannery - Morgan Stanley
Tim Horan - Oppenheimer
Thomas Egan - JPMorgan
Mike Funk - Bank of America
David Dixon - FBR Capital Markets
Romeo Reyes - Jefferies
Donna Jaegers - D.A. Davidson
Todd Morgan - Oppenheimer
Presentation
PAETEC Holding Corp. (PAET) Q3 2009 Earnings Call November 5, 2009 8:30 AM ET
Operator
Good day ladies and gentlemen and welcome to the third quarter 2009 PAETEC Holding Corporation earnings conference call. My name is [Bimali] and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Chris Muller. You may proceed.
Chris Muller
Thanks Bimali. Good morning everyone and welcome to PAETEC's third 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'll 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 positions, 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 the 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'll 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 we've gotten the Safe Harbor formalities out of 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
Thank you, Chris. Good morning and welcome to PAETEC's third quarter 2009 earnings call. Today, we are very pleased to report a return to top-line revenue growth for our company. Even though we are still experiencing a difficult economic environment, we grow enterprise business over 1% from the second quarter to third quarter of this year. In addition, both our adjusted EBITDA and overall gross margin improve sequentially and we achieved our 27th consecutive quarter of positive free cash flow generation.
With our excess free cash flow, we continue to strengthen our balance sheet by voluntarily paying down an additional $10 million on our revolver. PAETEC's value proposition is truly starting to resonate through out our nationwide foot print. As we discussed, longer sales cycles are required for our more sophisticated customer relationships and momentum is clearly picking up.
I'd like to spend some time to share with you several of our representative sales wins in the enterprise space. Multi-site data centric networks have become our more typical customer over the few years. Some recent deals include a national health and fitness corporation found the right match in PAETEC's data service offering, contracting for a 27 site MPLS VPN network over a three year term with monthly recurring fees of over $16,000 for a total contract value of $576,000.
Our Midwest based publisher of traditional and digital content appreciated the value of combining PAETEC IT services and our widely acclaimed Aura solution. The service component of the offering was a three year 19,000 opt-per-month contract with a value of $684,000. PAETEC solution will significantly enhance the productivity of the publisher's staff and allow for more efficient movement of information for its digital offerings.
A mortgage servicing company, facing increased demand for its services to the foreclosure market was impressed with PAETEC's MPLS offering and signed on for a 36 month contract covering 35 sites at a deal value at approximately $2 million during the term. And finally, a new relationship to PAETEC is a 45 site industrial manufacturing firm that purchased MPLS Dynamic IP and traditional PRIs. This hybrid technology solution will span an initial contract length of five years and is worth over $2.8 million during the term. PAETEC's innovative combination of integrating various technologies and our nationwide reach were key to securing this field.
Now these four examples illustrate our growing confidence as one of the best competitive alternatives to AT&T and Verizon for enterprise clients. And while one quarter's results do not yet establish a new trend regarding revenue growth, we are enthusiastic about the depth of our sales funnel, the improvement in our churn metrics and the progress our customers have made in responding to their own economic challenges. Therefore, we are also pleased to reaffirm our 2009 guidance for both revenue and adjusted EBITDA and we'll be giving our 2010 guidance during the year-end earnings call early next year.
At our Board of Directors' meeting last week in Charlotte, North Carolina, we approved our new strategic plan for PAETEC. With the McLeodUSA merger we had essentially fulfilled the last strategic plans goals that we had established several years earlier. Our primary objectives at that time were to achieve greater scale within the competitive communication sector, become a national provider and significantly increase the network and fiber assets of the company.
And although the recent economic downturn has served our company's short-term valuation goals, we believe we have established a strong foundation for future growth and stock appreciation.
Our new strategic plan calls for solid organic revenue growth over the next five years, by investing in high quality people, expanding our network reach and continued innovation in our product offerings. Additionally, PAETEC is well positioned with management debt, financial strength and deep M&A experience to increase shareholder value by also being a disciplined and opportunistic buyer of other companies.
Increasing our customer's fiber densities, enhancing our product portfolio and adding skilled employees with all big goals of an active, long term M&A program. With the national footprint, we can take advantage of virtually any opportunity, while ensuring that no individual region or department is unable to handle its respective integration duties.
And before I hand you over to Keith Wilson, our CFO for more details on the financial results, I would like to impress upon all of you that the company has maintained a high level of operational excellence during this economic downturn. We have continued to receive awards and recognitions from various analysts and industry forums, in areas such as billing, new products and customer care.
And during the third quarter we even returned to the Deloitte Technology Fast 500 list. We are one of only 22 companies on the entire list that generate more than $1 billion in annual sales joining firms like Google and Apple. We are very excited to continue our march as a growth company. I will not only stretch to increase its revenues and free cash flow, but future share price as well.
Now, I'd like to turn the call over to Keith. Keith?
Keith Wilson
Thanks Arunas and good morning everyone. We are pleased to share our third quarter operating results with you as many of the financial and operational initiatives that management put in place over the past several quarters have manifested themselves in improved operating results, before we get started with the review of our financial results, I would like to point out some of the third quarter highlights. We generated revenue growth on a sequential basis, despite the naturally higher level of attrition from our non-core POTS business.
Our Enterprise business inclusive of core network services and the integrated solutions group which accounts for approximately 77% of our total revenue, demonstrated improvements among several important benchmarks, specifically core network services revenue is up both on a year-over-year and sequential basis, given a strong receptivity to our overall value proposition along with growth in our data and MPLS products. We saw improvement in our churn metrics both core network service revenue and customer churn decreased on a sequential basis.
A sequential increase of 5.3% in integrated solutions revenues as our bundled solutions continues to provide an attractive option for technology upgrades. We saw continued migration to our larger core enterprise customer, as we churn smaller customers from our base, specifically core network services revenue per customer increased 2.3% on a sequential basis; we generated gross margin improvements of 90 basis year-over-year, as a result of solid network grooming efforts along with continued churn of smaller customers.
We continued to see the benefit of our cost alignment efforts as our SG&A expense, exclusive of stock based compensation was down a 100 basis points year-over-year. All of these improvements taken together, allowed us to generate adjusted EBITDA growth of 11.2% on a year-over-year basis.
Now let's turn to the financial analysis, we will first walk through our income statement results on a same period year-over-year. Then circle back into the same on a sequential over quarter basis.
So let's start with the same period year-over-year analysis. Total revenue decreased 2.6% or 10.4 million in Q3 '09 from Q3 '08 primarily due to a decline in usage based revenues as well as access in POTS revenue.
Core network services revenue grew by 50 basis points or $1.3 million year-over-year largely due to 10.1% data revenue growth. Third quarter 2009 revenue churn was elevated at 90 basis points versus 60 basis points a year ago, as we continue to churn many smaller customers. As a result, our third quarter 2009 core network revenue for customer increased to $2100 versus $2032 a year ago.
Core carrier services revenue decreased 3.1% or $1.5 million in the third quarter of 2009 over third quarter 2008, primarily due to lower usage based revenue.
Lastly, Integrated Solutions revenue accounted for the remaining 4.1% of the third quarter 2009 total revenue. The Integrated Solutions revenue increased 1% due to modest growth in hardware and software revenues. If we look at the table on the bottom right corner of page six in the earnings supplement, we can see one of the longer term trends in our business is becoming more evident.
Our enterprise revenues and core carrier services continues to become an increasingly larger part of our revenue generation as both access fees and non-core POTS become a smaller part of our revenue composition. Enterprise and core carrier services comprise over 88.1% of our revenue base versus 85.9% a year ago.
Cost of goods sold for the third quarter of 2009 decreased 4.3% or $8.8 million. As we have progressed through much of the heavy lifting and integrating our networks from our recent acquisition, this has naturally created some increased bandwidth for our network teams to continue their ongoing network grooming efforts.
As a result, gross margin for the third quarter 2009 improved 90 basis points to 50.8% compared to 49.9% a year ago. Due impart to attrition of customers purchasing lower margin products and the positive effects of the network grooming efforts.
We are especially proud of the network cost team. Their excellent work has enabled us to capture cost savings opportunities as we continue to streamline our network cost profile.
In terms of operating costs, many of our initiatives we enacted over the past several quarters to better align our cost structure to the economic environment have manifested themselves in improved operating margins.
As a result of these initiatives, SG&A expenses excluding stock based compensation decreased 5.3% in third quarter 2009 from third quarter 2008. So as percentage of total revenue SG&A expenses were 34.6% in the third quarter of 2009, compared to 35.6% in third quarter of 2008.
Largely, as a result of this improvement, adjusted EBITDA for the third quarter of 2009 increased 11.2% to $64.2 million over adjusted EBITDA of $57.8 million for the third quarter in 2008. Adjusted EBITDA margin, which represents adjusted EBITDA as a percentage of total revenue increased 200 basis points to 16.2% for the third quarter of 2009, compared to 14.2% for the third quarter of 2008.
Net loss for the third quarter of 2009 was $6.5 million, compared to a net loss of $355.8 million for the third quarter in 2008. Net loss for Q3 '08 reflected a $340 million goodwill impairment charge and a $3.8 million in integration and separation costs.
Interest expense for the third quarter in 2009 increased to $19.8 million from $18.2 million for the third quarter of 2008. The increase in interest expense was primarily due to the higher weighted average interest rates following our issuance in June 2009 of our [8.78%] Senior Secured Notes and the application of no proceeds to repair outstanding credit facility term loans.
Now let's turn to the sequential analysis of Q3, '09 versus Q2, '09. Core network services increased 90 basis points or 2.5 million as growth in our data and VPN revenue outpaced pressure on usage-based revenue. It is worthy to note, to know Q3, '09 revenue churn of 90 basis points decreased from 1.1% in Q2, '09. Carrier services revenue declined 4.9% or 3.2 million quarter-over-quarter.
And lastly integrated solutions revenue increased 5.3% due to better performance in our hardware and software sales. Cost of goods sold for Q3, '09 decreased 1.2% or 2.3 million from Q2,' 09. Gross margin for Q3, '09 improved 60 basis points to 50.8% compared to the previous quarter due to continued network grooming efforts.
SG&A expenses excluding stock based compensation increased 1.6% from the second quarter 2009 primarily due to commissions and salary related expenses. As a percentage of total revenue, SG&A expenses were increased in the third quarter of 2009 to 34.6% from 34.1% in the second quarter of 2009.
Adjusted EBITDA of 64.2 million for the third quarter in 2009 represented a 1.1% increase from adjusted EBITDA of 63.5 million for the second quarter of 2009. Adjusted EBITDA margin improved to 16.2% for the third quarter of 2009 compared to 16.1% for the second quarter of 2009.
Net loss for the third quarter 2009 decreased to 6.5 million from a net loss of 16.5 million for the second quarter of 2009. The net loss for second quarter 2009 primarily reflected the one time debt extinguishment and related cost of 10.3 million. Again the interest expense increased from 17.3 million in the second quarter of 2009 to 19.8 million for the third quarter of 2009.
The increase in interest expense is primarily related to the higher weighted average interest rates, following our issuance of our Senior Secured Notes and the application that note proceeds to repay our outstanding credit facility term loans.
On the capital expenditure front, for the third quarter of 2009, we spend $27.7 million or 7% of total revenue, down from $31.3 million or 7.7% of total revenue for the third quarter of 2008.
Capital expenditures for the third quarter of 2009 were largely applied to investment enhancements to PAETEC's network and IT efforts. Compared, to the second quarter of 2009, capital expenditures for the third quarter of 2009, increased 2% from $27.2 million.
Capital expenditures as a percentage of total revenue for the second quarter 2009 were 6.9%.
Our cash flow and liquidity, PAETEC had a quarter end cash balance of $141.5 million compared to a second quarter 2009 quarter end cash balance of $139.7 million, primarily as a result of higher operating cash flows that were partially offset by our voluntary repayment of $10 million in loans outstanding under PAETEC's revolving credit facility and a $9 million pre-payment for fourth quarter networks services in which we negotiated an attractive discount for the pre-payment.
Cash flow provided by operations increased to $40.8 million in third quarter 2009 from $38.2 million in second quarter of 2009. In free cash flow for the third quarter in 2009 was $36.5 million which represented a 50 basis point increase from the second quarter of 2009 and was the 27th consecutive quarter of free cash flow generation.
At September 30, 2009 PAETEC had $930.9 million in debt under its term long credit facility revolver and Senior Notes. At September 30, 2009 $240.9 million was outstanding under PAETEC's senior credit facility term loans which have a maturity date of February 28, 2013. In the third quarter, PAETEC made a scheduled quarterly principal payment of $600,000 on its term loan.
On September 30, 2009 PAETEC used its free cash flow generation to repay $10 million of its revolver. Currently $40 million of the PAETEC's revolver remains drawn. On September 30, 2009, PAETEC had outstanding $350 million principal amount of [8.78%] Senior Secured Notes due 2017 and $300 million principal amount of 9.5% senior unsecured notes due 2015. Under our repurchase program, PAETEC repurchased a total of 299,900 shares of common stock for an aggregate cost of $780,628 or $2.60 average cost per share in the third quarter of 2009.
Since the inception of its August 2008 program, PAETEC has repurchased approximately 6.8 million shares of common stock for an aggregate price of approximately $14.5 million.
Lastly, in September of 2009, PAETEC announced a new $25 million share repurchase program through December 31, 2010 and with that, that will conclude our prepared remarks and I now would like to ask the operator to open up the call for questions.
Question-and-Answer Session
Operator
Your first question comes from the line of Jason Fraser with Raymond James. You may proceed.
Jason Fraser - Raymond James
Just given your nationwide network I wondered if you could talk a little bit about what kind of impact you are seeing from the economy on a regional basis and second question, just any fiber swaps or fiber sales in the quarter? That will be great thanks.
Arunas Chesonis
On the regional impacts, it's really very similar to where you see the unemployment trends and some of the vertical market issues, in some areas like real estate. You can expect that in locations like California, Florida, it still tends to get harder and hit. Michigan although, automotive got hit pretty hard. We're actually seeing some good sales results because of the offerings in the Midwest. So, again, it's very consistent with anything else you'd be seeing out there.
On the fiber swap side; there hasn't really been anything that happened over the last three months that we hadn't already reported on last quarter.
Operator
Your next question comes from the line of Simon Flannery with Morgan Stanley. You may proceed.
Simon Flannery - Morgan Stanley
Arunas wanted to talk about the new strategy that the board approved. Is the real message here that you've got the green light in effect to go ahead and be more opportunistic on the acquisition front and perhaps, you could just talk about what you see out there. We just saw Windstream buy NuVox, we've seen Comcast make a purchase in Chicago. Seems like M&A activity is picking up.
So, comment on what you're looking for and do you have target metrics in terms where you want to keep the leverage or cash flow accretive within a year or two. Give us some sense of how we should be thinking about what might be attractive to you? And then just on the economy, great to see that churn reduction number. It was a big drop sequentially. Do you think that's a good run rate going forward? Do you think there is more improvement to come? Thank you.
Keith Wilson
Sure, Simon. I think this just sort of set the background and really what the board approved is continuation of what we've done in the last five years. We have been fairly acquisitive since 2004 not just with some large (inaudible) targets but also with smaller companies that increased our customer density or improved our product portfolio.
I think the management team wanted to take a bit of a pause and just make sure that we had the McLeod integration under control and felt solid about that before we started up again looking at other opportunities. And so I think the management team and the board are very much in sync right now.
So, we've gotten sort of a green light internally to start looking a little bit more aggressively. But again, we're going to continue that disciplined conservative approach we've always taken. We always told people, steady state leverage for us is about 2.5 to 3.5 times EBITDA. We're willing go up as high as may be 4 times EBITDA in a very short period of time as long as we can see network cost and expense synergies quickly bringing that back down 3.5 just like we did with US LEC with McLeod.
We don't really bank on revenue synergies to make up that sort of a leverage difference very quickly, that's just upside for all of us. I think if you look at the types of companies that we would be looking at, again, they'll fall into very similar categories that we've looked at in the past. There are nice smaller companies that we can add very technical skilled employees to enhance products, improved performance in certain regions. We've told you in the past Texas is as a market is a real, great opportunity for the company having the required network there, but we'd like more density of employees and customers so you could potentially see us so look to states like Texas where we would want to make some smaller acquisitions.
On the (inaudible) side, there are some companies that I would categorize at this stage in evolution more as fixed rubbers versus more solidly run companies. And I think we would tend to shy away from fixed rubbers in the next few years just because we think we can do the same type of business with some better run companies. On the insurance side, is there anything you want to mention Keith.
Keith Wilson
Simon I think on the insurance side, we are pleased with the trajectory. We think that long term we would like the numbers to tighten even more than this, but I think based on where the economy sits right now, I think real significant improvement over the next quarter or two. We don't think it's going to be a real dramatic. So, I would say the long term we definitely have a goal of bringing this down more than where it is today. But you are probably at a decent spot right now for the next quarter or two.
Operator
Your next question comes from the line of Tim Horan with Oppenheimer. You may proceed.
Tim Horan - Oppenheimer
Good quarter. Is there any seasonality in the third quarter I know you did a little bit better last year in the third quarter. May be touching some of the stuff and just get a little bit more color on the expenses, it sounds like you have a very much increased confidence in being able to manage the margins at this point may be you've got quite a little flat for it with economies and the old data a year ago but how confident are you to kind of be able to at least maintain margins where we are right now given your increased control on the expense front? And then last you just talk about may be usage volumes and revenues how they kind of trended sequentially and may be what you saw within the quarter? Thanks.
Keith Wilson
Sure Tim this is Keith on seasonality typically the first and third quarters tend to be a little bit better, the second and fourth tend to be a little bit softer but historically it hasn't been overly dramatic from a specific seasonality standpoint. So, we thought that the quarter trended well, but we don't think it's a real outlier, largely because you had [assured] in September this year with a late holiday so you kind of had a soft first week of September and that kind of muted what typically would have been a much stronger month. But I think generally we still feel good about where the overall trending is.
From a margin standpoint I think we felt good about where the margins were, we didn't see a real significant one timers that kind of hit inside the margins for the quarter, so I think we feel pretty good I mean obviously there may be some movement in the margins on a fairly minor basis, but we think north of 16% at least is a good kind of baseline for now and hopefully we can drive it up from there.
Tim Horan - Oppenheimer
And on the used volumes may be what's going on with the sequence trends in this percentage of revenue and kind of what are you expecting there?
Keith Wilson
The usage volume stayed fairly stable in terms of overall I mean consistent Cohort analysis what we have talked to you guys about before, we continue to see year-over-year pressure on specific usage volumes I mean rate per unit continues to be pretty for us. So, we definitely did have overall pressure on usage. So, we definitely saw that, we brought some new usage into the portfolio, but as the percentage of revenue it's hovering just below 28% today inclusive of long distance LMS and access.
Arunas Chesonis
And Tim, its Arunas I think when you asked that question about comfort level of margins you always had to ask yourself is there any sort of unforeseen action on the regulatory front that could happen that could hurt you over the next, couple of years that's something we always keep a pretty tight hand along, we are very much engaged in Washington and with other state PUCs out there. But there is nothing really on the horizon we see at least over the next year or two that's going to significantly change margins for us whether its on the UNE forbearance side or special access, we feel pretty comfortable those would be sort of steady state places for us.
Operator
Your next question comes from the line of Thomas Egan with JPMorgan. You may proceed.
Thomas Egan - JPMorgan
Good morning, thanks for taking my question. Another margin question if you would. You mentioned that network grooming efforts were continuing, so I was wondering if you view that as a continuing opportunity, it sounded like you had more to do. So, I was wondering if we could expect additional improvement to the gross margin going forward if there is more network grooming to do.
Keith Wilson
It is an ongoing process and I think what we are very excited about is as you build customer density in some of the markets that were typically built out very strongly by McLeod but didn't have as much customer base there. You are going to see margin improvement in those locations specifically. So as you just continue to grow the customer base you are going to have continuing grooming opportunities, and we are still going to have that in some of the current areas. So, that will be something we'll do as long as we are in business. So that process won't stop.
Thomas Egan - JPMorgan
Would you say generally speaking, I mean just out of the gross margin improvement that we saw this quarter, because it went from like you said 49.9 to 50.8, would you say the bulk of that was due to grooming or was the bulk of that due to the lower margin customers leaving.
Keith Wilson
I would say it's a pretty reasonable mix between the two.
Operator
Your next question comes from the line of Mike Funk with Bank of America. You may proceed.
Mike Funk - Bank of America
If we can just go back to the new strategic plan and you mentioned that you had evaluated your organic growth projections going forward. If you can just comment on may be how your target markets, your strategy for addressing those markets and even projected growth are different after this strategic plan relative to your former one? And then as a second question, just looking at the results to date, and then the guidance you have out there and reiterated this morning. It appears as if the guidance as a mid point is easily achievable with even a step down in 4Q. Is [anything] we should be thinking about that could potentially pressure 4Q either seasonally kind of one time or if you want to be call out?
Keith Wilson
No Michael, this is Keith. I think we just debated as to whether or not to move guidance and the fact that we had just issued it couple of months ago, we just felt that we would keep it steady. We are not trying to signal that. We expect significant softness in the fourth quarter, so I think it's a fair question, but I think what we are trending you can link pretty easily up to kind of north of the mid point here, so I think that's a fair question.
Arunas Chesonis
On the strategic plan, Michael again, if you remember the first nine years of our life we were just a pretty strong organically grown type company, 90% of our revenues up to 600 million we did ourselves without acquisition, so we are very comfortable in that kind of world. I don't know if it's a significant change, I think its more of a continuation, but we are talking about more than doubling the sales organization over the next five years. And its going to take us several years to ramp up to that place, but those are the kinds of numbers that the assumptions in the organic part of the strategic plan. And again if you do some of that work, and we'll work with the investment community over the next couple of quarters to help you understand that, but that's going to be a very solid growth plan for the company just organically.
Keith Wilson
This is Keith I mean the two probably major things that we had to take in to consideration as we looked at the revised strategic plan, was one the economic situation that we are sitting in today, which was not necessarily the case on kind of the last plan that we are working within. And so there are clearly some different business dynamics that you have got to manage within that context. And the second really is the achievement of that past plan, and a significantly larger scale than where we were, back in kind of '03 - '04.
So taking a look at that scale, having the opportunity to provide a much more robust and innovative products at dealing with larger customers, provides incredible opportunity for us, but definitely we focus as the company in terms of how we were doing business five years ago, versus how we are going to be doing business over the next five years.
Arunas Chesonis
And Michael, I just want to caution you. I mean as part of the plan, we were very careful. We spend a lot of time debating in these both as a management team and as a board. We are not looking to significantly impact in a negative way the free cash flow dynamics of the company. We are not looking to ramp up too significantly the CapEx needs of the company. We think with the current platform and the assets that we have acquired over the past couple of years, we really do have that good foundation we can build off and that'll be incremental, its not going to be major shifts anything you have seen in the past.
Operator
Your next question comes from the line of David Dixon with FBR Capital Markets. You may proceed.
David Dixon - FBR Capital Markets
Thanks and good morning, Arunas. Congratulations on the quarter. So, we danced around a little bit on the question that I have here and what I wanted to put aside was the M&A focus and just comeback to the organic opportunity, the franchise from here. I wanted to get a sense Arunas to what extent today with the sales force where it is now to what extent we position that's the revenue growth in 2010? I am hearing that we are looking to really significantly move the sales organization and up over the next five years, that's been the real challenge typically to do that in this market in particular.
So, I am trying to get a sense of just where we are today with respect to revenue opportunity in 2010? With right-size for the current environment and then just some insights into what's your key focal areas are in terms of augmenting the product portfolio from this point?
Arunas Chesonis
Sure. Well, I think David those are all great questions I think, some we are ready to talk about right now, some we are not and we are going to take a little bit more time. I think on the sales force, we have been fairly consistent; we'd like to see it grow by another 15% to 20% by the end of next year. We're adding additional teams as we speak and we're out on the hiring front right now in some of our more successful major tier one markets like New York, Boston, Atlanta, elsewhere and we think there is a great opportunity for us to improve the target market share there.
When you look at sort of the type of sales organization that we're going to have in five years, that's where the conversation gets very interesting. Typically in our business, a senior or major account executive was more of a relationship manager and didn't have as much of a technical background necessarily in our industry.
When you look at what got us all to this point, I think going forward, someone who has a profile of a sales engineer or a technical data consultant is going to be more of the skill set required at the relationship level and that's going to be the same for any company that's really focusing on that, that medium to large enterprise space.
If you want to sell to $300 a month accounts single T customers, one side locations, you can do that with the sales force of the past but not the future. So, there's going to be an increased emphasis on training especially on more the technical products. When you ask a question on the growth trajectory for next year, a lot of it depends in our minds on the forecast that we all have on the general economic conditions.
So right now, we're going to wait a little bit before we give you that kind of guidance for next year. We do feel optimistic about where the trends are headed, as far as how the company can play within even an environment that doesn't get much better than where it is today.
On the product side, there are some areas where we're looking to do some pilot programs. We spoke last time about potential, not the fixed wireless piece, but the wireless piece as more handheld device. We think after looking at it every year for 10 years, there's going to be an opportunity for us to introduce an offering like that and test the waters sometime next summer.
We do think that more and more of our customers are looking for security solutions, data center support. And we announced that last quarter; we're going to be able to tell you through the next earnings call, where we're going to be putting those regional data centers next year. We're probably going to launch at least three in 2010.
So again, it's just creating a nice portfolio surrounding that office of the CIO is where we're going to spend our time investing in additional products. But we really have quite a robust product portfolio right now.
I think what you'll see David, and this isn't sort of a very glamorous thing to say, but we just need to get more effective in selling all of the products in all of the markets with the same level of consistency throughout the US and really train that sales organizations in those newer markets of ours, because in places like Boston, where we have been there for 11 years.
That team in New England is very good on all the data centric products and that's why they are going to be getting one the new data centers in that region. We just need a little bit more time training that sales force to be comfortable with all those products and that's going to be serve the goal for the 2010. I hope it gives you a little bit background there.
David Dixon - FBR Capital Markets
It does. Just two very quick follow ups if I could, in terms of the different skill sets that we're looking for. Where do you see that talent pool coming from going forward and then do I infer from the focus on wireless that will, from an access standpoint be looking more in terms of wireless based access versus cyber based access as we scout for franchise from here
Arunas Chesonis
Two good questions. I think on technical talent and the sales talent. We're finding a lot of people from the actual IT industry. They are more comfortable. Where you see people on the data integrators or the value-added resellers. People, who are comfortable in the IT world, are very comfortable at selling our new products and services. So, I think that tends to be a stronger focus for hiring practices.
On the wireless side, I wouldn't tell you David to think about potential acquisitions on last mile being more focused on wireless. I still think it will be more focused on the fiber base providers. We do a lot of internal fixed wireless projects for people, and that's going to be a capability we can continue with, without any kind of significant acquisitions.
We use licensed spectrum on a as needed basis depending upon what the customer needs are. So, there is really no great pressure for us to try to acquire wireless spectrum on the last mile or so.
Operator
(Operator Instructions). Your next question comes from the line of Romeo Reyes with Jefferies. You may proceed. Romeo your line is open.
Arunas Chesonis
We must have answered all the questions for him.
Operator
Your line is mute. Please unmute your line.
Romeo Reyes - Jefferies
Just a couple of quick questions, I think you guys did a great job on churn and also on maintaining your output here. Can you give a sense of when you look at re-pricings, what percentage of your customers are re-pricing every quarter. And then, if you could, as an add-on to that is, the average concession that you guys are seeing here. And then more importantly though, as we look at re-pricings, what's the incremental margin on your gross Q1 additions? Is it less or about the same as your average EBITDA margin? Thanks.
Arunas Chesonis
I guess I can get started and we'll ask the other folks to chime in. For most of the people that have gone through these difficult economic times, they've already asked us and pinged us for extra help in renegotiating contracts. So, what we're seeing now is more of a traditional re-pricing of contracts just because a typical contract is about 36 months in length. You can do the back-of-the-envelope analysis on how many times we have to go to people. A certain percentage of our contracts come up for renewal every year, and it's very similar to what we've been seeing the last four or five years. So, I don't think there is any huge change there for you. On the upper side, I think Keith, from your perspective?
Keith Wilson
Romeo, what's the question on the ARPU side again?
Romeo Reyes - Jefferies
I'm trying to figure out basically, when you look at gross margins, we obviously were looking at ARPUs and we're looking at incremental contribution, then we are looking at re-prices and there are a lot of variables going into this. But one of the highlights from what I can tell is that you guys have been able to sell more to existing customers. Your ARPU has gone from 2032 to 2104 in the last year, in the face of obviously a very tough economy.
So, I think that's obviously commendable. But what I am trying to figure out is, when you look at T1s, T1s have gone from 639 to 597, which basically implies that the margin on T1s are getting priced at substantially less than 597. So what I am trying to figure out is, as you look at your gross T1 additions, what's kind of the margin on those incremental growth ads that are coming in. Is it about the same as kind of your EBITDA margin or is it higher or is it lower? Is it going to dilute your EBITDA margins or is it going to be neutral?
Keith Wilson
Yeah its age old question Romeo. I think the place that I would really direct you to is that the pressure that you're seeing on the overall average revenue for T1 is really coming from a product shift mix. So, as we've talked about fairly often over the last year or so. Much more MPLS data centric transactions coming into play that have less usage component associated with them.
Typically, so that doing really two things for you. One is, its bringing a larger customer and your average revenue per customer statistically is coming up significantly and I think a lot of you have seen in conferences where we've shown this shift mix of folks who are spending $10000 a month or greater with PAETEC is growing pretty rapidly, but on a per unit basis, the circuits tend to come in a little tighter.
So, what we're seeing is on the gross margin side, typically those circuits are coming in at a better gross margin even though they are coming in at a lower revenue per unit, but they are coming in at a larger revenue grouping per customer and that's helping us leverage our SG&A.
So, even though you may be seeing stable or lower gross margin dollars, we're getting some of that pickup on the SG&A benefit because when you're servicing a customer that's $10,000 - $20,000 a month, you can do it more efficiently than you can with a customer who might be spending a thousand dollars a month. And so, yeah we continue to have this interplay of dynamics as you pointed out, but generally, what you're seeing is a product shift mix. You are seeing consistent or better gross margins coming from the data centric sales and you're getting leverage off of your SG&A piece down the road.
Arunas Chesonis
And Romeo, the thing that I'd like to reinforce a few, as you're modeling these trends longer term. These types of data centric sales are much stickier relationships with the customer. It's not easy to convert. I won't say it's painful. It's just inconvenient with all the other pressures people have going on, and that's why you saw such a reluctance in the past three or four years for people to get off frame in ATM and they'd rather just re-price that existing network versus going to brand new infrastructure.
So, you're going to see better churn dynamics with these types of customers, longer term. You're also going to see some better up sales, not just on the other products and services, but in areas like just the bandwidth on those circuits because not every T1 is being activated for the full bandwidth capabilities at the time of initial installation.
So, as people's broadband needs go up naturally with the way they do business, we're going those existing circuits be able to generate more revenues overtime, as you open up the rest of the capacity on those circuits. So, again, not something that's going to hit you next quarter, but over several years it should really improve your modeling for us.
Romeo Reyes - Jefferies
And then a quick follow-up on margins again. With that way we're looking at McLeod, I think the margins were I would so far probably in the high-single digits. Have you been able to bring up those margins for McLeod or is there additional upside there?
Keith Wilson
Again, Romeo we don't report McLeod separately because it's not separate, its part of the same company, but I can tell you that we are seeing very healthy gross margins coming out of the territories that have a richer network and so we are extremely pleased with the transaction, we are extremely pleased with the markets that we picked up as part of it and I think for sure as you have seen the overall corporate margin move up that is clearly part of some of those legacy markets that we acquired.
Romeo Reyes - Jefferies
And I apologize but this is going to be the last question. On the capital structure, as you look at embarking perhaps on one or two acquisitions, are you looking to, do you consider a requirement to take out the bank debt.
Keith Wilson
No.
Operator
Your next question comes from the line of Donna Jaegers with D.A. Davidson. You may proceed.
Donna Jaegers - D.A. Davidson
Most of my questions have been answered already, but I was just wondering if you could give us a little more color on I think NuVox was very aggressive competitor in the Southeast, and if you are seeing any different tone from them over the last quarter and expect any difference in the future?
Keith Wilson
Thanks Donna. As far as NuVox they've been an aggressive competitor, but they tend to focus on a very small end customer for us. They are not sort of in the large multi, national kind of customer base, so we haven't seen anything different from them in the past six months. And we don't expect to see too much difference over the next couple of quarters. They are good competitors, but they tend to play in a different space than we do.
Donna Jaegers - D.A. Davidson
And really it's going to smaller customers so do the one T1 or less or even smaller?
Keith Wilson
No. I think there one T1, two T1 again, the markets in the southeast and several of their markets tend to be smaller metropolitan areas anyway. But again that's I think it's very more of the same with NuVox with the wind stream combination.
Operator
Your last question comes from the line Todd Morgan with Oppenheimer. You may proceed.
Todd Morgan - Oppenheimer
Two quick things can you talk any further about your sale force recruitment efforts I know that's been a big part of your growth strategy, specially in some of your newer markets. Is it going to be easier? Are you ahead or behind budgeted plans as far as that goes. And I guess the second thing, you just mentioned a little bit, I'm talking about the competitive environment. I don't know if you are seeing any other markets or any the (inaudible) competitors perhaps using the prices as a tool, I think just coming what you have seen in the past?
Arunas Chesonis
Keith do you want to like chime in on the sales side?
Keith Wilson
Sure I mean one of the things I can tell on our sales force recruitment I mean we have certainly over the course of last year beefed up our internal recruiting efforts, we have added more resources within our HR department. We are doing kind of deeper profiling both on the interview and the people that we are going out to look to source.
As Arunas mentioned, its not so much of focus on people that had traditional competitive telecom industry experience, but its people that can come in and really speak to the office of the CIO, that have a data background, that are familiar with more of a national account profile, rather than just the traditional relationship managers. So I do think we are putting much more of a conservative effort on people that we believe can get us into that quarter off us.
We are also using various recruiters throughout the country that have expertise in that area. So, there is still a place for people coming in at kind of that entry level account executive position. And we are just using all of our traditional tools for that, but we have put a much more conservative effort on making sure that we are going up market a little bit.
And we have also been able to like I mentioned wide footprint, we are getting people that have applied here for showing an interest in working at PAETEC, that five years ago really wouldn't have considered us. Just because of our more regional focus and we were more of a transactional business then. So we are able to attract on the national accounts side and the major side, who previous to the US LEC and McLeod mergers really we probably would have been their third or fourth choice, as our place to work.
Arunas Chesonis
And I think to just of sort address your second question on using prices like competitive tool or strategy. I don't think it's so much any kind of industry trend we can talk about. It tends to be very specific to the company you are talking about and where we see people change their strategy with regard to prices when they tend to be a little bit more desperate in the short term.
Someone who may have had it for a little bit of a restructuring or little bit of pressure on some of their own internal goals, try to generate quick set of customers and may price a little bit too low on the short term. But again, its really company specific and there is nothing really across the industry I would try to tell you is going on any different than it has the last five years.
Arunas Chesonis
Well, thanks again everyone for joining us on the call. We are pleased with the third quarter results and getting ourselves back to that sequential revenue growth program and we look forward to talking to you next year by the fourth quarter and year end. So take care.
Operator
Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect.
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