Except for statements that present historical facts, this management's discussion and analysis contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. In some cases, you can identify these statements by such forward-looking words as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "potential," "should," "will" and "would," or similar expressions. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual operating results, financial position, levels of activity or performance to be materially different from those expressed or implied by such forward-looking statements. Some of these risks, uncertainties and factors are discussed under the caption "Item 1A. Risk Factors" in our Annual Report on Form 10-K for our 2008 fiscal year and in our subsequently filed SEC reports.

You should read the following management's discussion and analysis in conjunction with our Annual Report on Form 10-K for our 2008 fiscal year and together with the condensed consolidated financial statements and related notes and the other financial information that appear elsewhere in this report.

Unless the context indicates otherwise, references in this management's discussion and analysis to "we," "us," "our," "PAETEC Holding" and "PAETEC" mean PAETEC Holding Corp. and its subsidiaries.

Overview

PAETEC is a competitive communications services and solutions provider guided by the principle that delivering superior customer service is the key to competing successfully with other communications services providers. PAETEC's primary business is providing large, medium-sized and, to a lesser extent, small business end-user customers in metropolitan areas with a package of integrated communications services that includes local and long distance voice, data, and broadband Internet access services. PAETEC had approximately 3,663 employees as of September 30, 2009. As of September 30, 2009, PAETEC Holding had in service 225,675 digital T1 transmission lines, which represented the equivalent of 5,416,200 access lines, for over 46,000 business customers in a service area encompassing 84 of the country's top 100 metropolitan statistical areas.

Revenue. PAETEC derives revenue from sales of its network services, carrier services and integrated solutions services. PAETEC derives most of its revenue from monthly recurring fees and usage-based fees that are generated principally by sales of its network services.

Monthly recurring fees include the fees paid by PAETEC's customers for lines in service and additional features on those lines. PAETEC primarily bills monthly recurring fees in advance.

Usage-based fees consist of fees paid by PAETEC's network services customers for each call made, fees paid by the incumbent carriers in PAETEC's markets as "reciprocal compensation" when PAETEC terminates local calls made by their customers, and access fees paid by other carriers for long distance calls PAETEC originates or terminates for those carriers.

The monthly recurring fees and usage-based fees generated by sales of PAETEC's network services to end users and carrier services to any customer tend to be relatively consistent from month to month, subject to changes in the calling patterns of the customer's business. These fees generally are based on the number of digital T1 transmission lines used by the customer. Because PAETEC believes that the cumulative number of digital T1 transmission lines in service provides accurate information with respect to its future revenue, the company uses data with respect to the cumulative number of digital T1 transmission lines PAETEC has in service from period to period to assist it in evaluating revenue trends related to its network services and carrier services businesses.

Network Services. PAETEC delivers integrated communications services, including local services, long distance services and data and Internet services, to end users on a retail basis, which the company refers to as its "network services." PAETEC's core network services are those that generate revenue from retail enterprise customers to which PAETEC delivers such integrated communications services on primarily T1 or larger access lines, which excludes access fee and reciprocal compensation fee revenue related to network services and revenue from the company's non-core "plain old telephone service," or "POTS," operations involving the provision basic telephone services supplying standard single line telephones, telephone lines and access to the public switched network.

PAETEC's network services revenue consists primarily of monthly recurring fees and usage-based fees. In addition to usage-based fees invoiced directly to the end-user customers, usage-based fees for PAETEC's network services include the interstate and intrastate access fees the company receives from other communications providers when it originates or terminates long-distance calls for those other providers to or from PAETEC's network services customers, and the reciprocal compensation fees PAETEC receives from some other local carriers when it terminates local calls made by the customers of the other local carriers. PAETEC recognizes revenue during the period in which the revenue is earned. PAETEC's network services also generate non-recurring service activation and installation fee revenues, which it receives upon initiation of service. PAETEC defers recognition of these revenues and amortizes them over the average contractual life, primarily three years.

Carrier Services. PAETEC generates revenue from wholesale sales of communications services to other communications businesses, which the company refers to as its "carrier services." PAETEC's core carrier services are those that generate revenue from other communications providers, which excludes access fee revenue related to carrier services and revenue from the company's non-core POTS operations.

PAETEC's carrier services revenue consists primarily of monthly recurring fees and usage-based fees. Usage-based fees for PAETEC's carrier services consist primarily of the interstate and intrastate access fees the company receives from other communications providers when it originates or terminates long distance calls for those other providers to or from PAETEC's carrier services customers, and the reciprocal compensation fees PAETEC receives from some other local carriers when it terminates to its carrier services customers local calls made by customers of other local carriers.

Integrated Solutions. PAETEC derives revenue from sales to retail end-user customers of telecommunications equipment and software and related services, which the company refers to as its "integrated solutions."

A portion of PAETEC's integrated solutions revenue consists of fees its customers pay for equipment and for PAETEC's system design and installation services. PAETEC recognizes revenue for equipment sales and system design and installation services upon delivery and acceptance of the underlying equipment.

PAETEC derives an additional component of its integrated solutions revenue by selling and supporting its proprietary telecommunications software. PAETEC recognizes revenue related to software sales upon delivery of the software. Support fees include fees for maintenance of PAETEC's telecommunications software and fees for training the end user in the proper use of that software. PAETEC recognizes maintenance fees on a pro rata basis over the length of the underlying maintenance contract and training fees after it fulfills the training obligation.

Cost of Sales. PAETEC provides its network services and carrier services by using electronic network components that it owns and telephone and data transmission lines that it leases from other telecommunications carriers. PAETEC's cost of sales for these services consists primarily of leased transport charges and usage costs for local and long distance calls. PAETEC's leased transport charges are the payments it makes to lease the telephone and data transmission lines, which the company uses to connect its customers to its network and to connect its network to the networks of other carriers. Usage costs for local and long distance are the costs that PAETEC incurs for calls made by its customers. Cost of sales for PAETEC's integrated solutions includes the costs it incurs in designing systems and purchasing and installing equipment.

Selling, General and Administrative Expenses. PAETEC's selling, general and administrative expenses include selling and marketing, customer service, billing, corporate administration, engineering personnel and other personnel costs.

Depreciation and Amortization. Depreciation and amortization include depreciation of PAETEC's telecommunications network and equipment, computer hardware and purchased software, office equipment, furniture and fixtures, and buildings, as well as amortization of intangible assets.

Debt Extinguishment and Related Costs.PAETEC's debt extinguishment and related costs include expenses related to the repayment of outstanding term loans under PAETEC's senior secured credit facilities and costs incurred related to the reduction of the notional amount of its swap agreement in effect as of June 30, 2009.

Interest Expense. Interest expense includes interest due on borrowings under PAETEC's senior secured credit facilities, senior notes and senior secured notes, amortization of debt issuance costs, debt discounts, and interest due on PAETEC's capital lease obligations and other debt.

Other Income, Net. Other income, net includes non-monetary gains on the sale of reciprocal indefeasible rights of use, or "IRUs," investment income, and other financing income.

Accounting for Income Taxes. PAETEC recognizes deferred income tax assets and liabilities for the expected future tax consequences of transactions and events. Under this method, PAETEC determines deferred income tax assets and liabilities based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which it expects the differences to reverse. If necessary, PAETEC reduces deferred income tax assets by a valuation allowance to an amount that it determines is more likely than not to be recoverable. PAETEC makes significant estimates and assumptions about future taxable income and future tax consequences to determine the amount of the valuation allowance.

Stock-Based Compensation. PAETEC's employees participate in a variety of equity incentive plans. Stock-based compensation expense for all stock-based compensation awards is based on the grant date fair value estimated in accordance with the Financial Accounting Standards Board, or "FASB," Accounting Standards Codification, or "ASC," Topic 718, Compensation. PAETEC recognizes these compensation costs, net of an estimated forfeiture rate, ratably over the requisite service period of the award.

Impairment Charge. PAETEC assesses the carrying value of its goodwill annually or as events or circumstances change. In accordance with its impairment assessment process, PAETEC recorded a non-cash impairment charge of $340.0 million in the third quarter of 2008 based on a preliminary assessment in that quarter, and recorded an additional non-cash charge of $15.0 million in the fourth quarter of 2008 based on the finalization of that preliminary assessment. The goodwill impairment charges were attributable to weaker economic conditions in PAETEC's markets. For more information about PAETEC's impairment review policies and its 2008 impairment charges, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies" in PAETEC's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2009. There was no change in goodwill during the nine months ended September 30, 2009.

Results of Operations

The following table presents selected operating data for the three and nine months ended September 30, 2009 and September 30, 2008. The comparison of PAETEC's operating results for the nine months ended September 30, 2009, which we refer to as our "2009 nine-month period," to our operating results for the nine months ended September 30, 2008, which we refer to as our "2008 nine-month period," is materially affected by the acquisition of McLeodUSA Incorporated, or "McLeodUSA," on February 8, 2008. McLeodUSA's operating results are included in PAETEC's operating results beginning on February 9, 2008. Because of the significance of this transaction, PAETEC's operating results for the 2009 nine-month period and 2008 nine-month period are not directly comparable. PAETEC's operating results for the three and nine months ended September 30, 2009 and 2008 were as follows:

                                    Three Months Ended              Three Months Ended               Nine Months Ended                 Nine Months Ended
                                    September 30, 2009              September 30, 2008              September 30, 2009              September 30, 2008 (1)
                                                                                    (dollars in thousands)
                                                   % of                            % of                             % of                               % of
                                      $           Revenue            $            Revenue             $            Revenue              $             Revenue
Revenue:

Network services revenue          $ 315,859            80 %      $  319,668            79 %      $   945,881            79 %      $     922,853            79 %
Carrier services revenue             63,536            16 %          70,305            17 %          199,066            17 %            199,928            17 %
Integrated solutions revenue         16,257             4 %          16,100             4 %           45,116             4 %             47,360             4 %

Total revenue                       395,652           100 %         406,073           100 %        1,190,063           100 %          1,170,141           100 %
Cost of sales (2)                   194,532            49 %         203,352            50 %          590,374            50 %            581,443            50 %
Selling, general and
administrative expenses (3)         140,894            36 %         149,703            37 %          422,471            35 %            428,337            37 %
Sales and use tax settlement             -              *                -              *             (1,200 )           *                   -              *
Impairment charge                        -              *           340,000            84 %               -              *              340,000            29 %
Integration and separation
costs                                    -              *             3,800             1 %               -              *                7,225             1 %
Depreciation and amortization        46,374            12 %          53,357            13 %          138,746            12 %            145,543            12 %

Income (loss) from operations        13,852             4 %        (344,139 )         (85 )%          39,672             3 %           (332,407 )         (28 )%
Debt extinguishment and
related costs                            -              *                -              *             10,348             1 %                 -              *
Other (income) expense, net            (156 )           *               259             *               (928 )           *                 (265 )           *
Interest expense                     19,776             5 %          18,243             4 %           54,300             5 %             54,783             5 %

Loss before income taxes             (5,768 )          (2 )%       (362,641 )         (89 )%         (24,048 )          (2 )%          (386,925 )         (33 )%
Provision for (benefit from)
income taxes                            757             *            (6,853 )          (2 )%           2,270             *              (13,463 )          (1 )%

Net loss                          $  (6,525 )          (2 )%     $ (355,788 )         (88 )%     $   (26,318 )          (2 )%     $    (373,462 )         (32 )%

Adjusted EBITDA (4)               $  64,238                      $   57,788                      $   191,686                      $     177,432

* Less than one percent

(1) Includes results of McLeodUSA subsequent to the McLeodUSA merger closing date of February 8, 2008.

(2) Exclusive of operating items shown separately below.

(3) Exclusive of operating items shown separately below and inclusive of stock-based compensation.

(4) Adjusted EBITDA, as defined by PAETEC for the periods presented, represents net loss before depreciation and amortization, interest expense, provision for (benefit from) income taxes, stock-based compensation, debt extinguishment and related costs, impairment charge, sales and use tax settlement, integration and separation costs, and gain on non-monetary transaction. Adjusted EBITDA is not a financial measurement prepared in accordance with GAAP. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Overview-Adjusted EBITDA Presentation" in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2009 for our reasons for including adjusted EBITDA data in this report and for material limitations with respect to the usefulness of this measurement. The following table sets forth, for the periods indicated, a reconciliation of adjusted EBITDA to net loss, as net loss is calculated in accordance with GAAP (in thousands):

                                     Three Months Ended           Three Months Ended            Nine Months Ended               Nine Months Ended
                                     September 30, 2009           September 30, 2008            September 30, 2009            September 30, 2008 (1)
                                                                                 (dollars in thousands)
Net loss                            $             (6,525 )        $          (355,788 )        $            (26,318 )        $               (373,462 )
Add back non-EBITDA items
included in net loss:
Depreciation and amortization                     46,374                       53,357                       138,746                           145,543
Interest expense, net of
interest income                                   19,628                       18,147                        53,499                            53,751
Provision for (benefit from)
income taxes                                         757                       (6,853 )                       2,270                           (13,463 )

EBITDA                                            60,234                     (291,137 )                     168,197                          (187,631 )
Stock-based compensation                           4,022                        5,125                        14,583                            17,838
Debt extinguishment and
related costs                                         -                            -                         10,348                                -
Impairment charge                                     -                       340,000                            -                            340,000
Sales and use tax settlement                          -                            -                         (1,200 )                              -
Integration and separation
costs                                                 -                         3,800                            -                              7,225
Gain on non-monetary
transaction                                          (18 )                         -                           (242 )                              -

Adjusted EBITDA                     $             64,238          $            57,788          $            191,686          $                177,432

Three Months Ended September 30, 2009 Compared With Three Months Ended September 30, 2008

Revenue. Total revenue decreased $10.4 million, or 2.6%, to $395.7 million for the 2009 quarter from $406.1 million for the 2008 quarter. The decrease in total revenue was primarily attributable to customer attrition in the non-strategic POTS portion of the business obtained as part of the McLeodUSA acquisition, which attrition accounted for approximately $5.6 million of the decrease, and to a decline in access fee revenue and reciprocal compensation of approximately $4.8 million. Of total revenue for the 2009 quarter, revenue from network services, carrier services and integrated solutions accounted for 79.8%, 16.1% and 4.1%, respectively, compared to 78.7%, 17.3% and 4.0%, respectively, for the 2008 quarter.

Revenue from network services decreased $3.8 million, or 1.2%, to $315.9 million for the 2009 quarter from $319.7 million for the 2008 quarter. The decrease in network services revenue primarily resulted from customer attrition in the non-strategic POTS portion of the business, which accounted for approximately $4.2 million of the decrease, and a decrease in access fee revenue and reciprocal compensation of approximately $0.9 million. For the 2009 quarter, revenue from monthly recurring fees and usage-based fees accounted for 72.3% and 26.6%, respectively, of revenue from network services, compared to 71.6% and 28.0%, respectively, of such revenue for the 2008 quarter. Revenue from core network services accounted for 72.6% of total revenue for the 2009 quarter, compared to 70.4% for the 2008 quarter. Revenue from core network services increased $1.3 million, or 0.5%, to $287.1 million for the 2009 quarter from $285.8 million for the 2008 quarter. The increase in core network services revenue primarily resulted from an increase in the number of digital T1 transmission lines in service and from increased revenue from dynamic internet protocol and multi-site virtual private network sales. Results of the network services business were affected by lower billable minutes of use, increased pricing pressure, and continued customer attrition, particularly in the non-strategic POTS portion of the business. PAETEC anticipates that these factors will adversely affect the performance of its network services business for the remainder of 2009.

Revenue from carrier services decreased $6.8 million, or 9.6%, to $63.5 million for the 2009 quarter from $70.3 million for the 2008 quarter. The decrease in carrier services revenue primarily resulted from a decrease in access fee revenue and reciprocal compensation of approximately $3.9 million and customer attrition in the non-strategic POTS portion of the business obtained as part of the McLeodUSA acquisition, which accounted for approximately $1.4 million of the decrease. Revenue from core carrier services accounted for 11.5% of total revenue for the 2009 and 2008 quarter. Revenue from core carrier services decreased $1.5 million, or 3.1%, to $45.3 million for the 2009 quarter from $46.8 million for the 2008 quarter. The decrease in core carrier services revenue primarily resulted from lower long distance usage. For the 2009 quarter, these operating trends affected the relative contribution to revenue of monthly recurring fees and usage-based fees, which accounted for 48.5% and 41.9%, respectively, of revenue from carrier services for the 2009 quarter, compared to 43.1% and 49.8%, respectively, of such revenue for the 2008 quarter.

Access fee revenue and reciprocal compensation included in network services revenue and access fee revenue and reciprocal compensation included in carrier services revenue together accounted for 8.1% of total revenue for the 2009 quarter, compared to 9.1% for the 2008 quarter. Reciprocal compensation revenue included in network services revenue and reciprocal compensation

revenue included in carrier services revenue together accounted for 1.3% of total revenue for the 2009 quarter, compared to 1.7% for the 2008 quarter. Access fee revenue as a percentage of network services usage-based fees increased to 19.4% for the 2009 quarter from 19.1% and for the 2008 quarter, while reciprocal compensation as a percentage of network services usage-based fees remained constant at 2.2% for the 2009 and 2008 quarters. Network access fee revenue as a percentage of network services usage-based fees increased primarily due to a lesser decline in minutes of use. Access fee revenue as a percentage of carrier services usage-based fees increased to 39.8% for the 2009 quarter from 37.5% for the 2008 quarter. Reciprocal compensation as a percentage of carrier services usage-based fees decreased to 12.6% for the 2009 quarter from 13.5% for the 2008 quarter. The decrease in reciprocal compensation as a percentage of carrier services usage-based fees was principally attributable to a shift in product mix toward Internet protocol-based services and other services that do not generate as much or any reciprocal compensation for PAETEC. PAETEC believes that the decrease in reciprocal compensation also reflected in part adverse economic conditions in PAETEC's markets that have contributed to usage-related pressure experienced by the carrier services business. The carrier services business also experienced a loss of some wireless customers, which PAETEC believes is primarily due to continuing consolidation in the wireless communications industry.

Revenue from integrated solutions services increased $0.2 million, or 1.0%, to $16.3 million for the 2009 quarter from $16.1 million for the 2008 quarter. The increase in revenue generated by the integrated solutions business was a result of modest growth in both telecommunications equipment and software sales.

Cost of Sales. Cost of sales decreased to $194.5 million for the 2009 quarter from $203.4 million for the 2008 quarter, in part because of a decline in minutes of use as the company's product mix continues to evolve away from more usage-sensitive products.

Leased transport charges increased to $153.5 million, or 78.9% of cost of sales, for the 2009 quarter from $153.0 million, or 75.2% of cost of sales, for the 2008 quarter. The increase of leased transport charges as a percentage of cost of sales was primarily attributable to the cost associated with the increased number of digital T1 transmission lines in service and to a decline in minutes of use.

Usage costs for local and long distance calls decreased to $30.7 million, or 15.8% of cost of sales, for the 2009 quarter from $39.6 million, or 19.5% of cost of sales, for the 2008 quarter. The decrease was attributable in part to a decline in the average usage rates PAETEC is charged by network providers, as well as to a decline in minutes of use.

Cost of sales as a percentage of total revenue decreased to 49.2% for the 2009 quarter from 50.1% for the 2008 quarter. The decrease was primarily attributable to continued network optimization and network cost control efforts.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $140.9 million for the 2009 quarter from $149.7 million for the 2008 quarter. Salaries, wages and benefits decreased by $6.7 million, primarily due to a decrease in the number of employees from . . .