Cbeyond, Inc. Q4 2008 Earnings Call Transcript

| About: Cbeyond, Inc. (CBEY)

Cbeyond, Inc. (NASDAQ:CBEY)

Q4 2008 Earnings Call

February 26, 2009 5:00 pm ET


Kurt J. Abkemeier – Vice President Finance & Treasurer

James F. Geiger – Chairman of the Board, President & Chief Executive Officer

J. Robert Fugate – Chief Financial Officer & Executive Vice President


Robert Dezego – Suntrust Robinson Humphrey

George Sutton – Craig-Hallum Capital

James Breen – Thomas Weisel Partners

Frank Louthan – Raymond James

Eric Kainer – Thinkequity LLC

Dave Coleman – RBC Capital Markets

Barry McCarver – Stephens, Inc.

Jonathan Schildkraut – Jefferies & Co.


Welcome to today’s Cbeyond fourth quarter 2008 results conference call and webcast. This call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to the Vice President of Finance and Treasurer, Mr. Kurt Abkemeier.

Kurt J. Abkemeier

I would like to begin today’s call by reminding you that this call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include but are not limited to statements identified by words such as expectations, guidance, believes, expects, anticipates, estimates, intends, plans, targets, projects and similar expressions.

Such statements are based on the current beliefs and expectations of Cbeyond’s management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. Factors that might cause future results to differ include but are not limited to the following: finalization of operating data, the significant reduction in economic activity which particular affects our target market of small businesses, the affects of natural disasters or extreme weather, the risk that we may be unable to continue experience revenue growth at historical or anticipated levels, the risk of unexpected increases in customer churn levels, changes in federal or state legislation or decision by regulatory bodies that affect Cbeyond.

Periods of economic downturn or unusual volatility in the capital markets or other negative macroeconomic conditions that can harm our business including the resulting inability of certain of our customers to meet their payment obligations, the timing of the initiation, progress or cancellation of significant contracts or arrangements, the mix and timing of services sold in a particular period, our ability to recruit and maintain experienced management and personnel, rapid technological change and the timing and amount of start up costs incurred in connection with the introduction of new services or the entrance in to new markets, our ability to maintain or attractive sufficient customers in existing or new markets, our ability to respond to increasing competition, our ability to manage the growth of our operations, changes in estimates of taxable income or utilization of deferred tax assets which could significant affect the company’s effective tax rate, external events outside our control including extreme weather, natural disasters or terrorists acts that could adversely affect our target markets and general economic business conditions.

You are advised to consult any further disclosure we may make on the related subject in the reports we file with the SEC including the risk factors in our most recent annual report on Form 10K together with updates that may incur in our quarterly reports on Form 10Q and current reports on Form 8K. Such disclosures covers certain risks, uncertainties and possibly inaccurate assumptions that could cause our actual results to differ materially from expected and historical results.

We undertake no obligation to correct or update any forward-looking statements whether as a result of new information, future events or otherwise. On the call today we have Jim Geiger, Chairman, President and CEO and Bob Fugate, Executive Vice President and CFO. With that said, I’ll turn it over to Jim Geiger.

James F. Geiger

As Kurt mentioned and the operator too we’re discussing the financial and operation results for the fourth quarter 2008. But, before I discuss the highlights for Q4 and what we’re currently seeing, I’d like to say a few words about the overall economic environment and our perspective in that. In preparing our remarks for today’s call we realized that the facts of Cbeyond’s business seems almost out of step with the broader news that describes one of the toughest economies since the Great Depression.

We read about the dire economic situation facing the world today and the serious situations that many businesses find themselves in. Cbeyond is certainly impacted as well but so far not nearly as much as many other businesses. We’ll try to explain why we think that’s the case but the important thing is that we’re reporting historical facts and trying to interpret them for you as best a we can. When we provide guidance about future results we’re tempering that guidance with the assumption that some of our business conditions will worsen in the short term.

Yet, for all of this Cbeyond’s business and prospects appear to us to be strong and we have no indications that will change. So, having said all that we are pleased to report another solid quarter of significant operational and financial achievements. In the fourth quarter we achieved record quarterly growth additions of customers of approximately 3,600 slightly higher than Q3 and our highest ever despite the fewer number of business days in Q4.

Net customer growth of approximately 21% year-over-year, revenue growth of approximately 22% year-over-year, growth in adjusted EBITDA of approximately 11% year-over-year and a relatively stable monthly customer churn rate of 1.4% in the quarter. And, all of this was achieved in a worsening economy. So, how is Cbeyond able to continue attracting and retaining customers in this economy?

I think the answer really goes to the heart of what makes Cbeyond different and special; our customers, our products, our sales channel and our team overall. First, let’s talk about our customers. On past calls we’ve often discussed the quality of our small business customer base. Our customers are entrepreneurs who are looking for tools to help them work smarter and more efficiently especially in this economy. They appreciate the productivity enhancing applications we offer and they continue to use more of our applications.

Because they don’t often have their own IT or telcom professional on staff, they like our package approach that makes big business tools available and affordable in a single predictable bill. Our target customers and customer base are stable and successful businesses. At December 31st, 70% of our customer base has been in business more than seven years and 57% have been in business 11 years or more.

Surprisingly, even in this economy the credit quality of our customers is holding up well. Based on the credit analysis of the customers provided by Experian, our percentage of high risk accounts slightly decreased from September 30th to December 31st ’08 while our percentage of low risk accounts slightly increased for that same period.

We’ve occasionally been asked if our small business market is shrinking or even going away in this economy. Our customer churn rate is a good indicator there. A year ago some investors expected our churn rate to climb rapidly as the economy worsened but this hasn’t been the case. We work hard to keep our churn rate as low as possible while maintaining tight credit standards. The increase in our customer churn rate from the 1% figure we enjoyed before the economy turned to the current 1.4% has been due to payment problems experienced by some of our customers.

We also feel price pressure from cheaper competitive offerings that provide basic communication services without the value added applications we include. But, as Bob will tell you later our guidance assumes increased churn levels over 2009 while still retaining a high level of overall revenue growth. Certainly, all sectors of American business are feeling the effects of the troubled economy, our customers included but we believe the entrepreneurs we market to are resilient and stable. They’ve weathered storms before and they’ll be around for a long time to come.

It should perhaps be noted that according to the Small Business Research Board, although consumer confidence is down, small business confidence actually improved somewhat in Q4 over Q3. The small business confidence index rose from 30 in Q3 to 36 in Q4 while 40% of small business owners expected the economy improve, an increase of 12 points over Q3.

Now, I recall reporting impacts to our business from the economy to you at a time in late 2007 and early 2008 when many CEOs and CFOs were banging their podiums at conferences proclaiming no ill effects to their business from the worsening economy. So, while it’s too early to predict a change for the positive, it’s quite possible that our small businesses were the first to enter this recession and may also be the first to exit.

We’ve discussed how the quality of our customers that we market to is one reason for our relative success in this economy. Now, let me talk about how our product offering fits in. you’ve heard us discuss our 30 plus applications and the way we make complex business solutions convenient and simple for our customers. The majority of Cbeyond’s new customers join us from the traditional telcom companies that offer basic communication services at a cheap price and on a large scale.

In contrast, we aim to provide all the communications and IT services that a small business requires and our unique platform simplifies and integrates the management of those applications. Our average customer uses seven of our applications, a figure that has been growing steadily. As Cbeyond continues to expand its application portfolio we become more important to our customer, embedded in to their business processes and integrated in to their office platforms.

Three years ago we began offering mobile services integrated with landline in a unique approach with shared minutes, shared voicemail and combined billing. I’m pleased to note that we now have a third of our customer base using our mobile services with a high percentage on the more profitable Smartphones. Later we added fax to email and remote backup and storage. The adoption rate for these has even been more rapid, over two thirds of our customers use fax to email and over half use remote backup and storage.

Last year we began hosting Microsoft Exchange and Secure Desktop each which are growing rapidly. In 2009 we’ve already introduced Mobile Workforce Manager and soon we’ll offer a virtual receptionist product both of which we believe will have wide appeal to our customers. Using GPS Mobile Workforce Manager provides a web enabled mobile worker tracking and reporting to enhance the productivity and efficiency of a business with mobile workers. For us, it reinforces customer stickiness and drives Smartphone adoption.

By summer we expect to launch virtual receptionist which will combine the benefits of automated answering, call routing, integrated voicemail and unified messaging thereby increasing office efficiency. Applications, additional lines and usage paid for above the core package now comprise more than 20% of our revenue per customer while the applications we’ve bundled in to the core package protect our revenue from price competition.

We’re excited about our product strategy, about where it has brought us over the last nine years and where it will take us going forward. We believe our sales growth and customer retention figures continue to prove that our broad package of applications is as valuable and as compelling to small businesses in today’s hard times as ever before.

We’ve talked about how the quality of the customer we attract and the differentiation and value of our product help ensure our continued success in this difficult economy. The third reason we believe we are performing well over the last year is our sales force. The personalized and consultative approach of our direct sales force may be old school but it works. Our customers want to contract with their vendors face-to-face. That’s how they conduct their business and they find the approach of our primary competitors to be remote and impersonal.

As I mentioned in the beginning of the call in our fourth quarter we recorded our highest level of gross customer additions ever at approximately 3,600 just above Q3s numbers. Of course, we’re adding sales reps each quarter with our geographical expansion so we should have more productive resources in the field each period but the fourth quarter had 5% fewer business days than the third quarter in which to sell and install new customers and we’ve never operated in an economy this negative and uncertain. So, we’re very pleased with our sales levels and are planning for them to continue to increase going forward.

At this point, I’d like to introduce a guest we have in the room with us, each month Cbeyond rewards the top sales manager based on a ranking of sales, operations support and community involvement. We call this the CEO challenge. The competition across the company is fierce, we have a lot of very talented and hardworking people in our sales leadership vying for the top position. In 2008 [Erin Plotkin] was our top sales manager and a person I’m very proud to have in our company.

We have invited [Erin] to our corporate office in Atlanta to listen in on our call today and celebrate his team’s success. [Erin] has been with Cbeyond for about two and a half years and in that time rose from sales consultant to team lead to sales activity manager, a role in which he currently leads a group of 10 sales consultants in the Los Angeles area. [Erin] is a great example of the opportunity that Cbeyond provides many young people that are entering the business world looking to build a career while making a difference in their communities. [Erin], thanks for your contribution and your continuing success.

That brings me to the final key to our success in this environment. Last year we made the commitment internally to redouble our focus on our most important resources, our team. We launched Cbeyond University, a training initiatives who’s initial focus is on newly hired sales reps. This effort is being led by Bob Morris the original architect of our unique sales culture and Mary Ford formally a leader in our product and marketing group. Both are long term colleagues and passionate Cbeyonders having been here since our founding.

We are seeing Cbeyond University starting to have an impact in terms of making our reps more productive sooner and in improving their retention. Recently the effort has also focused on sales management and overtime we expect to expand the university to other areas of the business. As I think about our fundamental tasks of attracting and retaining new customers, there are a number of things that come to mind.

A unique and broad set of business tools delivered via our Internet protocol based network with quality, superior service and a high level of integration and support and the convenience of a single provider. But, it’s clear that at the base of all this is a great set of people who care about our customer, are experts in finding solutions for their technology needs, and believe in what we are doing.

In summary, I believe that many of the key things that make Cbeyond different as a company are also what allow us to prosper during these difficult economic times. At this time I’d like to update you on our geographic expansion. First, as you will recall, we’re launching the Greater Washington DC market this quarter.

The network is up and running and our first group of sales people is in place. The DC market is our first exclusively Verizon market and it’s also different in that we will operate in three local regulatory jurisdictions: Virginia; Maryland; and the District of Columbia. This is a large market for small business with over 100,000 in our target market. And, at this time we’re also announcing that our 13th market will be Seattle which is scheduled for launch late in Q3 of this year.

Seattle is a vibrant market with approximately 43,000 small businesses in our target segment. We believe Seattle shares many of the same characteristics of Denver, one of our most successful markets including a large proportion of tech savvy entrepreneurs and other early adopters of technology who appreciate the kind of applications that Cbeyond offers. And, like Denver, Seattle is predominately a Quest market.

Seattle enjoys a favorable state regulatory climate that promotes competition which translates in to reasonable costs for broadband access to our customers and supports attractive margins for us. Finally, Seattle is the home of a significant marketing partner of ours Microsoft. As you know, one of our fast growing applications is hosted Microsoft Exchange and we hope to broaden that relationship to include more joint opportunities in the future.

In addition to our expansion in to DC and Seattle this year, our success in California has prompted further expansion there as well. For the last two quarters, our top three markets for net additions were our three California markets: Los Angeles; San Francisco; and San Diego. It’s often assumed that California is experiencing a disproportionate share of problems in this economy.

While that may be true, our results there are giving us confidence to increase our presence there. Last year our Los Angeles operation gained strength. As it gained strength we added a satellite office Orange County which we’ve now staffed with three sales teams and later this year we will open up a portion of Los Angeles that is served by Verizon which will allow us to fully address the largest small business market in the US.

Elsewhere, San Diego went adjusted EBITDA positive during the third quarter of 2008 in the month of September and posted its first full quarter of positive adjusted EBITDA in the fourth quarter. The San Francisco bay area continues to grow on schedule. Looking at our performance across our markets, we see a lot of reasons for confidence. The only areas of concern have been in our Chicago and Detroit markets, yet we’re seeing some early signs of improvement there as well.

Next, I’d like to say a few words on the regulatory environment. Although the previous administration was not particularly friendly to competition in our sector, we believe Cbeyond fair well in the regulatory arena as demonstrated by, among other things, the FCC’s blanket rejection of the Verizon and Quest forbearance petitions. We believe that democratic administration in congress will be more supportive of competition and will inhibit the monopolistic tendencies of the incumbents.

While as always, there remains some regulatory risk at both the federal and state level, we believe that the level playing field for open competition exists today should continue for the foreseeable future. In the past investors have seen the regulatory arena as posing notable future risk to Cbeyond long term. It’s our belief that the results of recent elections make it clear that those risk have been substantially reduced.

Before turning it over to Bob, I’d like to make a few final comments. I think we proved repeatedly through the past year that we can continue to grow despite the economy. In fact, we were recently cited by Forbes Magazines as number six on their fastest growing technology companies in the US. Second, we have a great business model even in this economy. While many in the technology sector are expecting flat or declining annual revenue, our anticipated growth rate this year implied eve at the low end of our guidance range is 20% year-over-year.

Third, we have a strong set of markets that generate the cash flows we need to cover all of our costs and to finance continued rapid growth. Fourth, the new administration should lessen some of the regulatory concerns investors have had over the last few years. Fifth, we’re going to keep prudently opening up new markets while obtaining and increasing free cash flow.

With that said I’ll turn it over to Bob for more details.

J. Robert Fugate

I’ll now go over the detailed operating metrics and financial results for the quarter ended December 31, 2008. Starting with our customers, we ended the quarter with 42,463 customers compared to 35,041 customers in last year’s period representing a growth rate of 21.2% year-over-year and 4.7% quarter-over-quarter compared to Q3’s customer count of 40,569. Net customer additions for the quarter were 1,894 versus 1,993 in Q3 noting that Q4 had 5% fewer business days than Q3.

Moving on to revenues, we recorded $93.9 million in the fourth quarter of 2008 versus $76.9 million in the fourth quarter of last year and $90.2 million in the third quarter of 2008. Our revenue growth rate was 22.1% year-over-year and 4% sequentially representing a $3.6 million increase in revenue from Q3. ARPU or average revenue per customer location was $754 during the quarter compared to $760 in Q3 ’08 and $750 in Q4 ’07.

Within the components of ARPU we continued our solid increased penetration of additional mobile lines and other applications. While these gains were offset by seasonally lower additional minute usage. As we noted last quarter our business model provides for stable and predictable ARPU due to the fact that it is predominately derived from fixed price packages, contains no wholesale element an includes only 7% from usage based components. Said another way, 93% of our revenue is predictable each quarter and subject to contract.

Overall, we continue to see the general trend in ARPU as stable to moderately increasing as we increase the value of what we include in our bundle and increase our application penetration with our customers.

Moving on to expenses, our cost of revenue as percentage of revenue was 32.4% during the fourth quarter compared to 29.9% in Q3 ’08 and 30.9% in Q4 ’07. Our higher cost of revenue in Q4 ’08 relative to Q3 was primarily impacted by recoveries of costs previously billed in error by our access providers that were substantially higher in Q3 ’08 than we typically receive. These recoveries are an ongoing operating activity in each period but fluctuate in volume from quarter-to-quarter.

The cost recoveries were $1.1 million in the fourth quarter of 2008 as compared to $3.5 million in the third quarter of 2008. The cost recoveries realized in the fourth quarter of ’08 of about $1 million are in line with the average level of recoveries we’ve realized in recent years. Going forward, we generally expect to record these costs more in the $500,000 to $1 million range per quarter.

Cost of revenue was also impacted by increased mobile costs from both usage and increased handset subsidies as well as the impact of lower margins from early stage markets. As we stated in the past and aside from the effect of these fluctuations and access cost recoveries, we generally expect that the gross margin percentage will decline modestly over time primarily due to the success of our mobile offering and its growing impact on the business.

SG&A as a percentage of revenue was 54.9% in Q4 ’08 compared to 55.25 in Q3 and 54.4% in Q4 ’07. The recent market launches of Minneapolis, Miami, San Francisco and Detroit have had a significant yet fully expected negative impact on SG&A margins during 2008. But, we’ve seen an improvement in this statistic since the second quarter of 2008 which has been the recent peak. We anticipate that as the proportion of new markets to the total number of markets decline we will see further SG&A leverage.

During the fourth quarter we recorded bad debt expense as percent of revenue at 2.2%. This is up from 1.7% in Q3 ’08 and has increased modestly due to the continues rigorous application of our credit policies. The slight uptick in the customer churn rate and our desire to maintain clean receivables on the balance sheet with ample reserves to cover future customer bad debt. We believe that we continue to be running credit and collection policies for our customers that are tight and appropriate for today’s environment.

As noted on prior calls, we believe we have a generally high quality small business customer base, one that can better withstand the vagaries of the economy than a customer base that is more representative than the overall average in terms of longevity and credit quality.

Now, I’ll speak briefly about non-cash share-based compensation expense. Non-cash share-based compensation expense was $3.6 million in the fourth quarter of ’08 versus $3.5 million in Q3 and $2.7 million in Q4 ’07. Although we exclude non-cash stock compensation expense from our reported adjusted EBITDA, we record this item as part of our SG&A expenses. Excluding the effect of non-cash compensation as a percent of revenue, SG&A was 51.1% in Q4 ’08 compared to 51.3% in Q3 ’08 and 51.0% in Q4 ’07.

Our consolidated adjusted EBITDA was $15.5 million in the fourth quarter versus $16.9 million in the third quarter of ’08 and $14 million in the fourth quarter of ’07. Our seven EBITDA positive markets posted $41 million in adjusted EBITDA in the fourth quarter or $164 million on an annualized basis. Q4 was the first quarter of positive adjusted EBITDA for San Diego and our negative adjusted EBITDA at corporate continued to show improvement declining as a percent of revenue from 22.8% of revenue in Q3 ’08 to 21.9% in Q4 ’08.

We expect that the negative corporate adjusted EBITDA margin will increase from Q4 ’08 to Q1 ’09 as is typical at the beginning of each year then continue its improvement in subsequent quarters. In considering adjusted EBITDA performance, it’s worth noting that we’re currently carrying five early stage negative EBITDA markets. These five early stage markets created a $4.9 million drag on adjusted EBITDA in Q4 ’08.

Keep in mind that new market launches can always be expected to generate some level of negative adjusted EBITDA. We would expect this amount of drag on adjusted EBITDA to remain within a range of $4 to $5 million per quarter as long as we add two to three new markets per year. While the drag on adjusted EBITDA new market launches can be expected to hover in this range for the next few years as we launch new markets.

What we believe you will soon be able to appreciate is the rapid growth in adjusted EBITDA in the adjusted EBITDA positive markets. Throughout 2009 we expect to see the investments we made in new market launches in 2007 and 2008 start to generate positive adjusted EBITDA. We opened there new markets in 2007: San Diego; Detroit; and the Bay Area, and two new markets in 2008: Miami; and Minneapolis. San Diego has already turned positive and we would expect several of these other markets to turn positive during 2009.

So the layering of all of our growing cash generating markets of Atlanta through Los Angeles plus the soon to be positive adjusted EBITDA in 2009 markets that layer in with even higher growth throughout we believe equals a compelling growth engine that will be better appreciated as one sees the number of positive adjusted EBITDA markets clearly exceeds the number of negative adjusted EBITDA markets by a large margin.

Moving to depreciation and amortization expense. This figure came in at $11 million in Q4 ’08 compared to $10.6 million in Q3 ’08 and $8.7 million in Q4 ’07. The increase during the fourth quarter is due to the continued capital investments associated with our growth and expansion. I would also like to note here that loss on disposals of property and equipment which we have previously shown as a non-operating expense below the operating income line has been collapsed in to depreciation and amortization both historically and in Q4 ’08.

We recorded an income tax expense of $300,000 in the fourth quarter versus $1.4 million in the third quarter of ’08 and a $9.3 million benefit to income tax in the fourth quarter of 2007. Prior to the fourth quarter of 2007, under SFAS 109 Cbeyond fully reserved for its potential future tax benefit relating primarily to net operating loss carry forwards. Although we are now recording income taxes based on the full corporate rate, we estimate that because of our remaining NOLs we will not be paying substantial cash taxes until at least 2012.

As we have stated before, although we’re not currently managing to net income we have posted positive net income in each quarter since we went public in November of 2005. We posted net income for $500,000 in the fourth quarter compared to $1.7 million in the third quarter of ’08 and $12.5 in the fourth quarter of ’07. The higher level of net income in the third quarter of 2008 was due to our recognizing a higher level of operating income in the third quarter in large part driven by the $3.5 million in cost recoveries that improved cost of revenue.

Next, capital expenditures; our capital expenditures were $22.4 million in the fourth quarter compared to $13.8 million in Q3 of ’08 and $18.1 million in Q4 of ’07. Although our Q4 capital expenditures increased by $8.7 million over the Q3 level this increase was largely due to the timing of expenditures and does not represent a fundamental increase in our ongoing level of capital expenditures. In fact, the average quarterly capital expenditures in Q3 and Q4 is equal to the level we posted in Q2 of 2008 and the amount of capital expenditures in Q4 implied by our annual guidance is exactly the amount we booked for that quarter.

In terms of the details, market related capital expenditures grew by $3.7 million over the Q3 number due to the timing of purchases to support customer growth, start up costs in Seattle and due to additional network infrastructure costs in Atlanta and Denver which should improve future EBITDA in those markets. As noted in the past, once our markets have been in operation over three years we target cap ex to be at 5% to 10% of revenue. For our first six markets our cap ex in the fourth quarter was 7.8% of revenue.

Our corporate capital expenditures were $11.1 million in the fourth quarter compared to $6.3 million in the third quarter ’08 and $7.6 million in the fourth quarter of ’07. The increase of $4.7 million in corporate capital expenditures in Q4 ’08 over Q3 was largely due to the timing of expenditures and relates primarily to ongoing data center expansion to support customer growth and the cost of development and integration related to our operating support systems.

Now, a word about free cash flow; for some time we’ve posted alternating quarters of positive or negative free cash flow which is netted to annual figures of less than $10 million negative over the last four years. As I’ll discuss further in the guidance section of my remarks, obtaining and increasing positive free cash flow is an important near term goals for Cbeyond. But, let’s not lose sight of some important current statistics.

Our first six markets generated over $34 million in free cash flow during Q4 or over $136 million on an annualized basis. This is a direct free cash flow margin of 39.8%. If we fully burdened these six markets by allocating negative adjusted EBITDA and cap ex from our corporate segment to these six markets, the result would be $8.8 million in fully burdened free cash flow in the quarter or $35.1 million of free cash flow on an annualized basis. A 10.2% fully burdened free cash flow margin.

Regarding the balance sheet, we had a cash and cash equivalent position of $37 million at December 31 versus $42.7 million at September 30. Currently we anticipated that Q1 of 2009 will be our low point of cash this year with cash balances building in the later part of the year. As you know, we have no debt outstanding and a $25 million credit facility in reserve which we currently do not expect to borrow under.

Lastly, we are reiterating our guidance for 2009. The guidance for 2009 is revenues of $420 to $440 million, adjusted EBITDA of $62 to $70 million and capital expenditures of $65 to $70 million. Our 2009 guidance assumes the continued challenging economy which is expected to impact our sales results and customer churn rate. Our revenue guidance assumptions include increased sales volumes due to the increasing number of sales representatives as we expand in to new markets overtime with flat to declining levels of sales productivity.

Our revenue guidance also assumes that ARPU grows slightly in line with the past year. In addition, we’re assuming that the customer churn rate will be similar to 2008 levels at the high end of the revenue range and slightly higher than currently levels at the low end of the range.

I’d like to say a few words about how our adjusted EBITDA will roll out on a quarterly basis. The first and second quarters of 2009 will be burdened by the launch of the Washington DC market and the typical increase in staffing related cost at the beginning of the year which are noticeable in our corporate segment. As we move through the year you should expect to see adjusted EBITDA rise on a quarterly basis with pronounced strengthens towards the end of the year. This is largely the result of the planned improving profitability we anticipate on a market-by-market basis over time.

To illustrate what I mean, we have begun using the terms advancers and decliners to describe our markets. Advancers are markets that have positive adjusted EBITDA or have negative adjusted EBITDA that is improving towards breakeven. Decliners are early stage markets that have negative adjusted EBITDA and are still deepening their losses towards their negative EBITDA trough.

In Q1 we will have 12 markets. Of those 12, nine should be advancers and three should be decliners. By Q4 of 2009 we will have 13 markets of which we project that 12 will be advancers and only one, Seattle will be a decliner. We provide our market level detail to investors not only because this is the way we measure ourselves internally but also because investors need this detail in order to understand both the underlying profitability in our model while we’re growing rapidly and to better predict inflection points in the life of our company.

Investors who don’t analysis this detailed information are probably not able to really understand the business and where it is headed. As we move towards late 2009 and in to 2010 we expect that we’ll be experiencing an inflection point in adjusted EBITDA and in adjusted EBITDA margins as illustrated by the advancers and decliners construct.

Regarding capital expenditures, we anticipate that our quarterly levels in 2009 will be lower than what we experienced in the fourth quarter of 2008 and more evenly incurred through the year although capital expenditures can be lumpy at times and don’t always tract smoothly through the year. I would like to note that while we project revenues to grow by over 20% in 2009 we do not anticipate growth in the level of capital expenditures this year.

Thinking about adjusted EBITDA and capital expenditures together, our goal is to achieve breakeven free cash flow or close to it for the year. And, with the inflection point that we expect in terms of adjusted EBITDA, this will set us up to show solid growth in free cash flow in 2010. Finally, we expect to continue holding significant excess cash balances without the need for outside capital or borrowing under our credit facility.

At this time I’ll turn the call over to Jim for a few final remarks before Q&A.

James F. Geiger

Operator, in the interest of time I’d just like to say thank you both for being on the call and we really appreciate your investment in Cbeyond. With that, we’ll take questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Robert Dezego – Suntrust Robinson Humphrey.

Robert Dezego – Suntrust Robinson Humphrey

I just had two quick questions for you, the first is can you talk a little bit and I know you talked a lot about your customer trends but I’d like to hear what you’re seeing from the customers that are potentially shrinking in size. These are customers that are laying off people and maybe they’re 20% to 30% the size they use to be. I’d like to know what these customers are asking for from you and are you seeing any ARPU pressure as they simply just have smaller businesses than they might have when they started?

The follow up to that would be the Small Business Association put out a press release last week expressing a lot of pleasure with the stimulus bill. While, it’s still pretty early and we’re not there yet I’m wondering if some of the tax incentives and credit availability for small businesses if you had any comment on how you think the stimulus package could help some of your customers out, that would be helpful.

James F. Geiger

We do see customers shrinking in size and for Cbeyond we don’t see that pressure necessarily manifesting itself in ARPU. You see that in our churn number because we’ve got a really tight range, we’ve got a minimum $495 product and an average of $750 so the shrinkage of customers is occurring and its manifesting it in our churn rates.

I guess we also do see some pressure that comes from customers who are having difficulty that do stay with us. But, what we try and do there primarily is try and make sure we take other things they are using, other things like mobile services, other things like storage and security products and we try and keep that customer on our service and we do a pretty good job of that. The stimulus package, boy I just simply don’t know how that may affect our small business customers, that may be part of what they see as an increase in their confidence in this economy but I just simply can’t answer that one. Bob, do you want to take a whack at that or not?

J. Robert Fugate

No, other than that it can’t hurt.


Your next question comes from George Sutton – Craig-Hallum Capital.

George Sutton – Craig-Hallum Capital

Two questions, when you originally provided guidance that was late October, obviously the world’s gotten materially more difficult by most views and here we are at February 26th and you seem even more confident in my opinion in your ability to hit those numbers than you did in October. Can you just discus that change? Then secondly, you mentioned early signs of improvement in the Midwest markets which honestly is a little surprising to me so I just wondered if you could give us some more specificity there?

James F. Geiger

I think that Bob and we were sufficient conservative in our guidance. We assumed churn rates that were in excess of what we were experiencing, what we are experiencing, within the range. As we mentioned on the call George, we’re still seeing heavy demand for our products and maybe especially in this environment where people are trying to consolidate a lot of their applications and economize that way. I think some of our customers are seeing an efficiency in that.

Again, it’s a simple business, attracting new customers and keeping the ones you’ve got. We’ve been fairly pleased with how we’ve been attracting customers in this environment. We mentioned a couple of soft spots but retaining them is where we’re not happy. We’re seeing an increase from our traditional 1% or 1.1% before the economy turned and now that extra amount that we’re experiencing is all related to a tougher economy. But, as we mentioned we’re still pretty happy with our strategy and our execution results.

Your second part of your question, we’re starting to see more improvement in Chicago as a market than we are in the Detroit area. So, Detroit is still lagging behind our expectations and Chicago is moving towards them.

George Sutton – Craig-Hallum Capital

Just as a follow up to that, you had mentioned Chicago was more of a management issue you believed than a market issue, is that proving to be the case?

James F. Geiger

Well, we’re tough on ourselves, we’re our own worse critics and we generally as we have said in the past look at environment and execution. We think the environment in the Midwest is different than other places and we do see some recovery though in execution. We believe that there’s probably two parts execution recovery and one part environment being more stable.


Your next question comes from James Breen – Thomas Weisel Partners.

James Breen – Thomas Weisel Partners

I just had a couple of questions on the new market, can you just give us an idea of what you think the total addressable market is in Seattle? Then, given where loop rates are there where do you feel you can settle out in terms of EBITDA margins relative to some of your older markets?

James F. Geiger

The target market in Seattle and the greater Seattle area is 43,000 businesses which makes it roughly equivalent to the Denver marketplace. We’ve talked before about three sort of groupings of opportunities in markets and those in the sort of 50% EBITDA, those in the mid 40s to the low 50s and those in the low 40 to 45% EBITDA range and we’re probably in the B category there in Seattle as far as the opportunity and margins.


Your next question comes from Frank Louthan – Raymond James.

Frank Louthan – Raymond James

Can you give us an idea of what a profile of a new customer looks like today versus maybe 12 or 18 months ago? Are these generally beyond voice one type of customers or are you getting some larger customers in the mix right off the bat? I mean, looking at a new market with a new customer how should we be thinking about those types of customers? Then, give a little more detail on the bad debt, most other carriers not seeing much change there. Should we model that running at north of 2% going forward?

James F. Geiger

The customer profile is surprisingly consistent across markets and new customers as well as the embedded base. We haven’t seen a change in the number of lines they use, the employees per customer. It’s really shocking to me, ARPU is incredibly consistent among all markets, the range between the top and the bottom is within single digits. So, the customer really hasn’t changed. What has changed is the applications that we sell to them that we are now able to market to once we develop and that’s really the I guess secret sauce to us not only having stable but increasing ARPU within this customer base.

They’re using more of the stuff we’re making. [BB] mix, the [BB1] through [BB3] mix has stayed stable and we think it represents the universe as a whole. We have enough statistically valid sample of customers. People are using more mobile and what is also an interesting trend that we think plays to our strength is that there are more customers that are buying SIP customer premise enabled equipment which allows us to sell a fairly unique product we have called our SIP Connect.

J. Robert Fugate

The other part of the question related to bad debt expense, it was just slightly above 2% in the quarter and I would say to your question, yes probably it’s going to be in the 2% to 2.5% range versus revenue short term. It’s going to be what it is. We haven’t made any changes to our credit policies and don’t expect to and think they’re appropriate.

Frank Louthan – Raymond James

Then one question on wireless, is there anything – are you facing any sort of contract reset currently? Is there anything to think about there? Maybe give us an idea of how many more years you may have on that contract? On the one hand probably difficult to change carriers, on the other hand you’re probably more important to them than they may have ever assumed. But, can you give us an idea is there anything to be concerned about there?

James F. Geiger

No concerns there Frank. We have a long term multiyear contract and we’re a darn good customer.


Your next question comes from Eric Kainer – Thinkequity LLC.

Eric Kainer – Thinkequity LLC

A couple of quick questions, first when we look at your guidance towards flat or declining sales productivity can I assume that is simply a factor of the economy and that as the economy turns up, whenever that happens to be, we should get flat or increasing sales productivity more in line with what we’ve historically seen?

James F. Geiger

Yes. I think that’s a reasonable expectation and probably within that one of the most significant factors would be our assumptions on churn.

Eric Kainer – Thinkequity LLC

So churn then factors in to your views on sales productivity?

James F. Geiger

I’m sorry Eric no but certainly on the revenue.

Eric Kainer – Thinkequity LLC

On the ARPU side where you saw lower minute usage in the fourth quarter, I assume part of that was the economy, part of it was seasonal impact. If not for the lower minute usage where would ARPU have come out? Would it have been 760 or higher?

J. Robert Fugate

We have only businesses so they’re really sensitive to business days so there were 5% fewer business days so we saw a comparable not actually a comparable, we saw a reduction in ARPU that we generally see in the fourth quarter.

James F. Geiger

It was about flat. Optically it seems like a big number if we say $3 which as a percentage is, is a fraction of 1%.


Your next question comes from Dave Coleman – RBC Capital Markets.

Dave Coleman – RBC Capital Markets

A couple of questions, I’m just wondering if you’re seeing any dislocation by weaker competitors and if that’s giving you opportunity to pick up some market share? Then, for the operating margins or gross margins if you could talk about how you expect those to trend in ’09 given your expectations of additional sales of Beyond Mobile? Then, just as far as the number of employees that you had at the end of the year?

James F. Geiger

Let me start with weaker competitors, we have seen the number of competitors each year we’ve been in business decline. That’s certainly a helpful phenomena for us. There has been in the past couple of years mergers and acquisitions so that it decreased the number of competitors we have. Generally larger companies are acquiring companies that may have affectively competed with us in a smaller customer arena and we see that stop. It has been a good climate competitively for us and we continue to see the cable companies focus on a customer that is smaller than our target. So, we aren’t seeing any impacts there.

Certainly, there is we think a good competitive environment also aided by the fact that we don’t really have a competitor that has our product portfolio or our focus or certainly the platform that we’ve built to deliver it so that’s a good story.

J. Robert Fugate

The other question was the gross margin trend for 2009?

Dave Coleman – RBC Capital Markets

Yes, the gross margins given the increased sales of Beyond Mobile.

J. Robert Fugate

Well, as we noted we would expect gross margin percentages will continue to decline very gradually throughout 2009. You won’t see a rapid change in those figures. It will be similar to recent quarters but slightly declining over time.

James F. Geiger

And the number of employees at year end was approximately 1,500.


Your next question comes from Barry McCarver – Stephens, Inc.

Barry McCarver – Stephens, Inc.

I think you’ve got most of my questions. I was wondering if you could walk through free cash flow for the quarter. I was off in my calculation there a little bit?

J. Robert Fugate

Well, free cash flow as defined by adjusted EBITDA less cap ex is simply the way we were describing it on the call. You may have been looking at from more of an accounting standpoint than that. That’s the way we were looking at it. So, if it was $15.5 million of adjusted EBITDA and $22 million of cap ex, it was approximately -$7 million of free cash flow in the quarter.

Barry McCarver – Stephens, Inc.

So what were your cash taxes in the quarter, zero?

J. Robert Fugate

They were approximately zero. We have a very small amount of state taxes that are paid but it would round to zero on a million dollar basis.


Your final question comes from Jonathan Schildkraut – Jefferies & Co.

Jonathan Schildkraut – Jefferies & Co.

I had a couple of question on market specific stuff and then I had a question on net adds. Market specific, it looked like Denver revenues were flat and there were some interesting movements in margins in Dallas. I’m just wondering if that just has to do with some of the unusual recoveries that you had in the third quarter?

The second question is on net adds as we look in to 2009 I think you said that with expanding markets an incremental sales team you felt that gross adds would continue to scale. This year was an interesting year obviously churn moved due to the economy and net adds were actually down just a little bit on a year-over-year basis despite the growth in gross adds. With the view that churn is going to be somewhat flat, would it be fair to then assume that net adds would again begin to scale up?

James F. Geiger

Let me start with your three questions in order. We’ll talk about Denver revenue for a minute first, Denver revenue was slightly down by about $40,000 from Q3 to Q4. It’s an interesting situation there in Q4. We had in terms of the several factors that would comprise the change, we had pretty stable gross customer additions from Q3 to Q4 but we had softer net customer additions in the latter half of the year and that was really because starting in Q3 Denver saw higher customer churn rate than it had experienced in Q1 and Q2.

That churn rate was still less than our overall average as a company but you take this sort of stable gross add, the higher churn rate and then the seasonally lower ARPU in Denver and then it all sort of combined to have that situation of flat revenue from Q3 to Q4. I would expect that the quarterly revenue in Denver will start to grow again as we move in to 2009. So, I don’t think this is a trend but more of just a one quarter kind of phenomena.

Your second question was about the Dallas EBITDA margins and why those changed the way they did. If you look at Q4 EBITDA margins and you see that the EBITDA margin there was 50.6% it’s pretty similar to the levels of EBITDA margins in Dallas of Q4 ’07, Q1 and Q2 of ’08. Q3 was an anomaly because of the really high concentration of access cost recoveries that we benefited from in that quarter in Dallas very disproportionately that won’t be recurring.

We often talk about how markets reach a certain level of adjusted EBITDA margin and that’s sort of their potential level and they maintain those margins over time and that’s what Dallas has done. So, we reverted back to the mean in Q4. Dallas is a healthy market. Then, the third question was the net adds moving in to 2009.

J. Robert Fugate

2009 in the first quarter what we generally see is about flat and we expect to see that again in the first quarter. But then as we continue to add markets, add productive sales people throughout the system we’ll see that continue to increase in quarters two through four.

James F. Geiger

With that we’d like to thank everyone for joining us on the call. That concludes it. We really do appreciate your trust and confidence in Cbeyond and its management team.


Once again ladies and gentlemen that does conclude our call for today. We thank you for your participation and wish you a wonderful day.

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