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Internet Telephony: August 13, 2008 eNewsLetter
August 13, 2008

PAETEC: Revenues Up, Profits Down

By Tim Gray, TMCnet Web Editor

After a turbulent week that saw their stock price take a major tumble and then stabilize,  PAETEC (News - Alert) Holding Corp. announced second quarter earnings today that fell far short of initial expectations.

The Fairport, NY-based telecommunications company announced the financial results after the close of regular stock market trading. Although revenues rose to $405 million from $275 million, a 47 percent increase over the same quarter in 2007, the company lost $14.7 million, compared with a $5.9 million profit a year earlier

The increase was principally due to the addition of a full quarter of McLeodUSA results.
PAETEC Chairman and CEO Arunas A. Chesonis said the company remained “Bullish” about PAETEC’s business and noted affects of a slumping macro economy had led to a slowing in customer growth that ultimately hit PAETEC’s bottom line.
"Second quarter results, while being up versus 2007 results, showed a slowing of the growth PAETEC has experienced over the past several years. The second quarter results were essentially flat versus the first quarter 2008,” said Chesonis.
Despite the disappointing results, Chesonis said there are several positive takeaways from second quarter 2008, most notably solid overall sales that should continue to generate substantial operating cash flows and that the achievement of anticipated synergies from the company’s acquisition of McLeodUSA continues to proceed well.

”We are also announcing a share repurchase program which reflects our positive outlook on the long-term business," said Chesonis. “PAETEC is pursuing a number of key initiatives which are designed to enhance PAETEC's operational efficiency going forward. We have recently eliminated 151 full-time equivalent positions, are aggressively pursuing a strategy to disconnect unused facilities, and are slowing capital expenditures to better align these costs with our current growth rate, while continuing to invest for long-term opportunities."
Earlier this month the company forecast second-quarter revenue would be below analysts' estimates and said it would not meet its 2008 outlook as pricing pressure increased, prompting stock prices to drop 38 percent to a 52-week low. Before the earnings call Standard & Poor's Rating Services revised its outlook to stable from positive after hearing the company would fall short of pervious guidance.
Long Term Growth
In an interview with TMCnet editors last week, Chesonis noted that this downturn appeared to be a longer rather than a shorter one, and said usually the first part of a downturn causes customers to start looking to save money; creating a soft market.

“It’s very tempting to crawl into a shell and be very scared and hesitant,” he said. “But the company still has significant free cash flow and expects a Q2 positive free cash flow.”
In the same meeting, Chief Operating Officer EJ Butler pointed to PAETEC’s positioning in is 82 of top100 markets in the country as a strength for future growth. The increased markets is partially  due to the past year’s acquisition of Mcleod USA. And although, he said, eventually PAETEC would reach the other top areas it wasn’t necessary in order to be a nationwide player in the industry. PAETEC has the cited becoming a Fortune 500 company as one of its long term goals.
“It is encouraging,” said Butler. “The national footprint opens up more avenues for our business. People are referring business to us.”
PAETEC Cuts Jobs
Although Butler and Chesonis both touted the company’s employees as the key strength to the company’s success moving forward ­– “We know it is the people that make the company, letting go of people could be a bad decision,” Butler told TMCnet at the time, noting that the decision could cost more in the short term but having an “A team” was best for the long haul – PAETEC was nonetheless forced to make cuts the day before the earnings call.
The company laid off 80 employees worldwide, 2 percent of its total workforce. PAETEC has 840 employees in New York and approximately four thousand nationwide.
The news came just more than a week after the company announced second quarter earnings would not meet expectations. The company's stock lost more than 50 percent  of its value during that period. However, it has since stabilized. On October 31, 2007 PAETEC stock was at $13.48 compared to $3.39 at closing Wednesday, up 33 cents from Tuesday.

“There are too many smart and engaged people here who care about this business,” Butler said. “We will be fine.”
In fact, Butler said the stock may not reflect it daily, but the culture still focused on people. “We want a different relationship with our customers than competitors do.”
Focusing on Strengths
During today’s call executives accentuated the positives; including Network services revenue, which accounted for 78.3 percent of second quarter 2008 total revenue, increased 39.3 percent year-over-year to $317.6 million. In addition to the inclusion of McLeodUSA's operations for the 2008 second quarter, network services revenue in the 2008 quarter benefited from growth in the Company's Dynamic IP, MPLS VPN, and network security products.

The growth of the network services business was constrained primarily by fewer than expected billable minutes of use, increased pricing pressure, and an increase in disconnects. PAETEC anticipates that these factors will affect its rate of growth for the remainder of 2008.

Carrier services represented 17.7 percent  of total revenue for second quarter 2008 and grew 91.0 percent year-over-year to $71.6 million, largely reflecting the addition for the entire 2008 quarter of McLeodUSA's carrier operations and associated fiber transactions, which historically have generated a higher percentage of McLeodUSA's total revenue than the percentage of total revenue generated by legacy PAETEC's carrier services business. PAETEC believes that the adverse economic environment may have contributed to usage-related pressure experienced by the carrier services business and related softness in access revenues. The carrier services business also experienced a loss of some wireless customers primarily due to consolidation in the wireless communications industry.
PAETEC announced a stock re-purchase program. Chesonis says this reflects the company's positive outlook on the long-term business.
Don’t forget to check out TMCnet’s White Paper Library, which provides a selection of in-depth information on relevant topics affecting the IP Communications industry. The library offers white papers, case studies and other documents which are free to registered users. Today’s featured white paper is Jim Cossetta, President, CEO, 4What Interactive, Creators of The VoIPTrainer, brought to you by 4What Interactive (News - Alert).

Tim Gray is a Web Editor for TMCnet, covering news in the IP communications, call center and customer relationship management industries. To read more of Tim’s articles, please visit his columnist page.


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