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Executives

Kurt J. Abkemeier - Vice President Finance & Treasurer

James F. Geiger - Chairman of the Board, President and Chief Executive Officer

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

Analysts

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.

Cbeyond, Inc. (CBEY) Q2 2009 Earnings Call Transcript August 5, 2009 5:00 PM ET

Operator

Good day ladies and gentlemen and welcome to the Cbeyond second quarter 2009 earnings results conference call and webcast. Please note that today’s call is being recorded. At this time for opening remarks and introductions I would like to turn the conference over to Kurt Abkemeier. Please go ahead sir.

Kurt J. Abkemeier

Thank you, Operator and thank you to all participants for joining us today.

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 statement 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 upon 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 particularly affects our target market of small businesses, The risk that we may be unable to continue to experience revenue growth at historical or anticipated levels, the risk of unexpected increases in customer churn levels, changes in federal or state regulation or decisions 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 and estimates of taxable income or utilization of deferred tax assets which could significantly affect the Company’s effective tax rate, external events outside of our control including extreme weather, natural disasters, pandemics or terrorists attacks that could adversely affect our target markets and general economic in business conditions.

You are advised to consult any further disclosures we may make on the related subjects in the reports we file with the SEC, including the risk factors in our most recent annual report on Form 10-K together with updates that may incur in our quarterly reports on Form 10-Q and current reports on Form 8-K. Such disclosure 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 will turn it over to Jim Geiger.

James F. Geiger

Thank you, Kurt and thanks everyone for joining us today. As mentioned, today we were discussing the financial and operating results for the second quarter of 2009. But first, let me state that I am pleased with how low our business is performing in this difficult economic environment and remained confident in our continued success. Although the small business market has been impacted directly by the current recession, it is important to remember that this remains a very large and attractive market for Cbeyond. There are over 1.5 million small businesses with between 5 and 249 employees in the top 25 markets.

While we are continuing to grow very rapidly, today we are in only 12 of the top 25 markets and our customer base represents less than 5% of the addressable market in our cities but less than 3% of the top 25. So, we expect to see significant and profitable growth in the future as we continued to attract market share.

It is also important to remember that this is a difficult market segment to penetrate. It is our so focused and we have been successful with our distribution into it, but most of our competition is in the form of incumbent phone companies but do not focus on this customer and do not offer the smart solutions we deliver.

We are seeing some challenges in this economy but I believe our business model is intact and we are responding to the current challenges but the management flexibility that will position us to meet our goals.

Now, I will address the merits of our business in more detail. We start with gross sales and customer additions. Gross sales or new contracts in the quarter were our highest ever and were 5% greater than Q1 of this year, our next highest quarter production. Gross customer additions or those customers in sold were over 4100 in the quarter well above our highest previous figure in the first quarter of approximately 3800 and 8.3% sequential increase.

We had organic net customer and revenue growth of approximately 20% year-over-year. This is notable because we believe the kind of growth we continued to post is rare in this economic environment and the results are supported by the fact that our eighth average sales productivity per rep has remained stable throughout the recession, even as our sale staff has grown and our sale staff retention has improved year-over-year.

On a market-by-market basis, several of our cities recorded their best ever quarter for customer additions in Q2. As in the previous two quarters, Los Angeles led all markets in customer additions. Elsewhere, we saw a consistent result in older markets such as Atlanta and Dallas and improving performance in some of our smaller progressing markets such as Detroit and Minneapolis.

Although production increased in Chicago, we would like to see further games there. As most of you know, we gave a lot of transparency with our market segment reporting and we welcome the scrutiny that brings.

In the spirit of that transparency, I would like to say a few words about Denver. In Denver, the small business market seems to have suffered more than the average from the recession. In fact we saw our revenue decrease in Denver from Q1 to Q2 and this is due to several factors. First, we had a credit in the first quarter in Denver from customer promotional breakage of approximately $100,000 but we also have seen higher churn and slower growth in customer additions there than we would like to see. We are addressing the situation in Denver with steps to limit churn, reduce costs and push growth.

I will shift to keep things in context, in the current quarter our Denver posted annualized revenue of over $71 million with adjusted EBITDA margins of 50% or annualized adjusted EBITDA of $35.9 million and annualized free cash flow of $33.5 million but I guess you could say would love to have a dozen Denver’s.

In some of our established markets, we saw a slight margin declines in the prior quarter. EBITDA margins routinely fluctuate from quarter-to-quarter but I also want you to know that while we have a market blueprint that has served as well across our cities we will also deviate from that model where we feel it makes sense for our business.

For example, in recent quarters, we expanded our sale staff in Los Angeles to capitalize on the opportunity we saw there and that move has paid off handsomely in revenue gains.

In certain of other cities where the economy is causing a greater challenge for us, we are evaluating some incremental cost reductions that will help us to maintain margins and meet our short term EBITDA goals as a company.

As for new market launches, our Washington DC market is up to a strong start and we believe our service will be well received in Seattle where we expect to launch service in Q4.

Turning to customer churn, our churn rate of 1.5% in the quarter was stable from the prior quarter and in line with our expectation in light of the continuing economic recession. While unemployment rate declined and other pressures in small businesses have increased, our churn levels have remained in a relatively stable range during the recession.

One of the more reassuring facts within churn is at our controllable churn, the churn that arises from service, pricing, and other business reasons has remained stable since well before the recession at about 4/10 of 1%. This metric has remained at 40 basis points for 29 consecutive quarters and as a proxy to some degree for the satisfaction of our customers and a desirability of our product offering to sustaining businesses in our target market.

All of the increased churn that came about when the economy worsened over the last year and a half has been uncontrollable churn, from business closings and non-payment by customers and these uncontrollable churn now stands at about 1.1% of the 1.5% that we reported. Currently, our indications are the churn does not appear to getting any worse at this time but it is too early at this time to forecast any improvement.

So, for now, our short term outlook is if the churn should continue generally in the current range as long as the economic environment remains difficult. Overtime once the economy improves, we would expect our churn rate to decline as business closings in contractions which feed the controllable portion of our churn rate starts to decrease. In the meantime, we are focused on providing high quality customer experience while maintaining tight credit standards.

As you all know, our business is not just about adding and retaining customers, it is about providing the sweetest solutions that enable our small business customers to operate more efficiently and productively. Into that end, we have increased our application penetration to 7.3 apps used per customer, with the attached rate of mobile to new customers climbing above 50% and the overall mobile penetration reaching 37% of our customer base.

Many of our other key applications such as fax, the email, and secure backup, secure desktop and Hosted Microsoft Exchange continue to show solid growth and penetration.

Finally, Bob will address of these issues in greater depth but I would like to say a few words about business model in the economy.

As I look across our business I continue to see many reasons for optimism. Despite the recession, our growth in customers remained strong. Our product set is relevant and improving each year in each breadth and quality. The regulatory environment has likely only improved with the new administration and we believe there is broad support for policies to promote competition and I believe the core tenets of our business model are sound namely attracting new small business customers to our unique bundle of services, keeping our existing customers and selling more productivity and enhancing applications to both.

In terms of our financials, we believe we are on track to post the kind of inflection point in Q4 of this year that will lead to growth in EBITDA margins and positive free cash flow in 2010. Our continuing challenge in the short term remains the economy, which has led to higher customer churn levels than normal and to increase ARPU pressures more recently.

As the current economic conditions improve in time, we believe Cbeyond is on sound footing to take advantage of the upturn when it occurs. With that said, I will now turn the call over to Bob to provide more details on the numbers. Bob?

J. Robert Fugate

Thanks Jim. I will now go over the detailed operating metrics and financial results for the quarter ended June 30, 2009. Starting with our customers, we ended the quarter with 46,405 customers representing a growth rate of 20.3% year-over-year and 4.7% quarter-over-quarter. Net customer additions for the quarter were 2,063 versus 1,879 in Q1, an increase of 184 from the last quarter due to a healthy increase in gross additions and a stable churn rate.

Our revenue in the second quarter of 2009 was $101.8 million, a 19.7% year-over-year growth rate and 3.6% growth sequentially representing a $3.6 million increase in revenue from Q1.

Q1 ’09 included a $600,000 positive adjustment or true up relating to customer promotional liabilities recorded in the prior periods. Adjusting for that benefit in Q1, the sequential increase in revenue for Q2 over Q1 would have been $4.2 million.

ARPU or average revenue per customer location was $748 in Q2 ’09 compared to $755 in the Q1 ’09 and $754 in Q2 ’08. We experienced increase pressure on ARPU in the second quarter but I would like to put these figures in context and also address the question of why we do not currently expect ARPU to drop in the future quarters consistent with the decrease we saw from Q1 to Q2.

Our ARPU has been remarkably stable overtime; in fact for 19 of the last 22 quarters and for the last nine consecutive quarters, we have posted ARPU within 1% of the average across this period.

Just us our customer churn rate did not rise steadily after we saw an uptick due to the recession, neither do we expect ARPU to decline steadily at this point for three primary reasons, we avoid direct price comparisons by bundling our services and packages and combining mobile and landline minutes in the line. We do not sell our service standalone and avoid price per minute and price per line comparisons.

Second, we have very low variable revenue. Less than 5% of customer revenue is usage base and impacted by seasonality or reduced usage. And third, we provide a very comprehensive product offering. As customers use more and more of our 30 productivity enhancing applications, they assign increasing levels of value to the overall Cbeyond bundle and customer experience.

Quarter-to-quarter comparisons of ARPU can be difficult in large part due to the way we record promotional rebates to customers under generally accepted accounting principles.

In Q1 of 2009, we recorded a true up of $5 of ARPU from rebate breakage, while in Q2 we did not record any true up of breakage credits. Taking this $5 amount away from Q1 for comparative purposes, ARPU would have been $750 in Q1, dropping $2 to $748 in Q2 versus the apparent drop of $7 from $755 to $748. This represents a decrease in ARPU of 0.3% from Q1 to Q2.

Aside from the rebate breakage issue which was known and expected, we did experience some unexpected pressure on ARPU in the second quarter. This resulting reduction to ARPU is primarily from increasing pressure from customers for incentives to sign up for service or renewed contracts and decreasing levels of landline long distance voice usage that contribute to over its charges above our based packages. Both of which, we believe have resulted from the effect of the economic recession on customers.

The decreases to ARPU resulting from these customer incentives and from lower landline voice usage were offset by increases to ARPU from growth and mobile voice usage and applications use per customer as well as other factors.

We are aware of some factors that should support ARPU in near term such as positive rate changes relating to regulatory items and the historically higher usage patterns and greater number of business days in Q3.

In general, we continued to expect relatively stable ARPU with stable defined as being within the range of roughly 1% up or down per year. The short term bias is slightly more than the down side due to the continuing recession but longer term we believe there are many factors that can positively impact ARPU.

Moving on to expenses, our cost of revenue as a percentage of revenue was 33.8% during the second quarter compared to 32.4% in Q1 ’09 and 32% in Q2 ’08. Our cost of revenue in the second quarter was impacted by increased mobile expenses, recurring service costs and subsidies handset costs and a handful of smaller cost of service items.

As far our gross margin, it was 66.2% in Q2 compared to 67.6% in Q1 of this year. Gross margin declined impart due to the ARPU decline from Q1 discussed previously. We generally expect the gross margins to decline gradually overtime due to the success of our mobile offering and its growing impact on our business.

However, we are also constantly working to renegotiate costs with our principle suppliers and to implement various network efficiencies that were resulted in the lower operating costs in order to offset the impact of declining ARPU or the impact of mobile costs.

We have a number of projects underway to reduce our cost of service overtime, such as metro fiber deployments for transport and additional co-locations, circuit [re-grooms] and higher bandwidth Ethernet technology on the access side.

SG&A excluding non-cash share based compensation expense as a percentage of revenue was 52.6% during the second quarter compared to 52.3% in Q1 ‘09 and 52% in Q2 ’08.

A few comments regarding SG&A, changes in Q2 occurred in both salaries and wages and bad debt expense. Our annual pay rate increases took a fact April 1 of this year and that increased our SG&A by approximately $400,000 over Q1.

Bad debt expense increased by about 40 basis points during the quarter, increasing from 2% of revenue in Q1 to 2.4% of revenue in Q2 and is fluctuated over the last year and a half from our highest 2.7% to a low of 1.6%. So, the current level is well within our recent historical range. This difference accounted for an increase in SG&A of $450,000. The recording of bad debt expenses, a constant exercise of estimates for future customer non-payment and experience based adjustments to prior estimate.

Our receivables remained healthy as evidenced by our day sales outstanding of 17 days and the bad debt expense reflects our adherence to tight credit policies.

Getting to adjusted EBITDA, it was $13.8 million during the second quarter compared to $15 million in Q1 and $13.7 million in Q2 of ’08. Our EBITDA positive markets posted $41.7 million during the second quarter of $167 million on an annualized basis.

The negative adjusted EBITDA at corporate as a percentage of revenue was 22.5% during the second quarter, a decrease compared to 23% in Q1 ’09. We expect our corporate costs to continue to decline as a percentage of revenue throughout the year. Our other early stage markets created a $5 million drag on adjusted EBITDA in Q2 ’09 compared to a $4.8 million drag in Q1 ’09.

We anticipate that this amount of drag on adjusted EBITDA will remain in the range of about $4 million to $5 million per quarter as long as we add two to three new markets per year. While the drag on adjusted EBITDA of new market launches can be expected to hover in this range for the next few years as we launch new markets, we anticipate posting growth in total adjusted EBITDA largely as a result of progress from newer markets and we expect this increase in consolidated adjusted EBITDA to be most noticeable when we report Q4 numbers.

I will provide further discussion on this topic in a few minutes in the guidance portion of my remarks.

At this point, I will mention a question that has arisen from time-to-time.

Are the newer markets performing worse or in some way less attractive than the first set that we entered?

Well, first of all, our older cities were nurtured and brought the profitability in much stronger economic climates when the small business failure rate that contributes so highly to churn was substantially lower than in recent periods. Our newer cities have had to overcome this higher churn rate in their early stage formative period. So they have not been able to build as much momentum in revenue and ultimately EBITDA margins as the earlier cities which were enjoying much better economic climates in their comparable periods.

As a result, comparisons of the newer cities performance to that at the first set of markets is difficult given the real differences in the economy and its impact on customer failure in churn. In addition, each market has its own unique characteristics. Some have the potential for higher margins than others, simply because of differences in our circuit costs that we incur according to different regulatory rates set on a state-by-state basis.

We expect that all of the markets we have entered will be successful but on average, the newer ones are taking several months or longer to reach EBITDA breakeven than the 18 months of average target we set for our first six. In large part, due to the higher business failure rate prevailing during the current recession than we had in prior periods when the economy was healthy.

In time, we expect the economic conditions will improve and our market economics will improve again with them. We are managing the business for the long term and we believe the market model is flexible and robust to be successful for us.

Now, turning to net income, we posted the following.

A net loss of $2.2 million during the second quarter compared to net income of $100,000 in Q1 ’09 and $500,000 in Q2 ’08. The net loss in the current quarter was impacted by growth and depreciation and amortization, an increase reported net income taxes which are based on annual estimates rather than actual quarterly amount.

As we have stated previously, we have not been managing the net income but do expect to begin posting positive and growing net income beginning in Q4 of this year.

Now, a few words on capital expenditures, our capital expenditures were $16.9 million during the second quarter compared to $17.3 million in Q1 ’09 and $18.2 million in Q2 ’08.

Capital expenditures in the second quarter of 2009 decreased from the prior quarter because decreases in capital expenditures and certain of our markets and our corporate location were greater than the increase in pre-launch spending for Seattle. Capital expenditures normally fluctuate quarter-to-quarter but overall we are confident that we are on plan for spending in this area for the year.

Now, word about free cash flow, although, our consolidated free cash flow was negative $3.1 million. Our first market generated the following during the second quarter, $93.5 million of revenue, $41.7 million of adjusted EBITDA, foreign adjusted EBITDA margin of 44.6% and consumes only $5.3 million for the capital expenditures, resulting in $36.4 million of free cash flow or $146 million of annualized free cash flow. That is a 39% free cash flow margin unburdened by corporate costs.

After allocating corporate expenses and CapEx to these cities on a percentage of revenue basis, we generated $7.8 million of free cash flow in the quarter or 8.3% of revenue from these markets.

Note that these seven markets represent 91.8% of total revenues so the vast majority of corporate expenses in CapEx are captured in this free cash flow statistic. We are expecting to become free cash flow positive on a consolidated basis in the fourth quarter of this year and are aiming at free cash flow neutral for the year in total.

Regarding the balance sheet, we had a cash and cash equivalents position of $27.9 million at June 30 versus $31.3 million at March 31. The decrease in cash from March 31 was primarily due to decreases in cash flow from operations in the quarter.

But I would like to make a few points here about our cash balance and how we view it.

As I just mentioned in the discussion about free cash flow, having over $146 million in annualized free cash flow from our profitable markets allows us to manage our cash balance as we invest for growth. At this time, we are continuing to allow cash to gradually decrease consistent with our plan as we grow toward an inflection point in adjusted EBITDA, free cash flow, and our cash balance in the next couple of quarters.

As you know, we have no debt outstanding and a $25 million credit facility and reserve which we currently do not expect to borrow under.

Finally, I would like to discuss guidance for 2009. We built our original 2009 guidance nine months ago and now with the benefit of three more quarters of operating performance and experience with the economic environment. We believe we can narrow our range of guidance further.

A revised guidance for 2009 is revenues of approximately $420 million, adjusted EBITDA of $62 million to $66 million and capital expenditures of $62 million to $66 million.

A revised revenue guidance of approximately $420 million represents our best estimate based on a review of all factors and includes the assumptions that customer additions continue to grow steadily and churn is generally consistent with recent periods, while ARPU remains in a tight range of several dollars either side of the current level.

Regarding adjusted EBITDA, we have spoken previously about reaching an expected milestone in Q4 of this year where we post the level of consolidated EBITDA and EBITDA margin well above recent quarters.

Our current guidance range assumes that this inflection point is intact in Q4. This is of course anchored by our revenue expectation. But we are also factoring in the progress toward positive EBITDA of some of our newer markets over the next few quarters, which was to be on target as well as certain network related cost economies that we have already obtained but have not shown up yet in our financials and a number of SG&A related expense initiatives that will help ensure cost containment as we keep up our rapid phase of growth.

In addition, the guidance also assumes that the launch of the 13th market Seattle will occur in the fourth quarter of 2009 rather than late in the third quarter as previously projected. Guidance for capital expenditures matches our adjusted EBITDA figures reflecting our goal of being approximately free cash flow neutral for the year.

That concludes my remarks. At this time, I will turn the call over to the operator for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Colby Synesael - Kaufman Brothers.

Colby Synesael - Kaufman Brothers

The first question has to do with ARPU. I know you cited a variety of reasons why you do not think it is going to decline any further. But it seems like the experience is not on the Company that want to trend start, it does continue for a little bit. And just trying to get some understanding why you would think more customers were asked for rebates going forward or why more customers were not asked for pricing concessions when they were renewing or signing up going forward? Thanks.

James F. Geiger

Colby thank you. I guess I would still like to reiterate the points that Bob made to start the answer that unlike some of the wire line and wireless competitors that we have faced, we avoid those direct price comparisons by selling package products versus a la carte pricing.

We do have a very low usage component of about 5%, actually just under 5% of our customer revenue is variable and I would say probably that the element that is hardest for us to assign any kind of quantitative factor to you but customers assigned varying levels of value to the applications we provide them and uniquely we have about 30 different apps for our customers to choose from and they find that value equation as evidenced by to strength in our sales numbers. They find that value equation quite compelling, Bob maybe...

J. Robert Fugate

Yes. I will just add something to that Colby.

We look at a number of components of ARPU when we examine our financials and I can tell you that the ARPU that we derived from additional line from customers and applications has been steadily increasing overtime and that has been somewhat offset equally by ARPU decreases from the customer incentives that you asked about.

So, while those have cancelled each other out, we have had some remaining small differences lately related to usage and terminating access and some slight shifts in the package or mix but those are relatively small and we feel that the major movements within ARPU are contained in the increases we see in the application revenue, the additional lines and those being pretty much offset by the customer incentives.

So, the customer incentives are component of ARPU that we manage. They have always been part of our business. We have been doing this for years and we feel like this is something that we have got a pretty good handle on.

And then finally, I will just repeat that overtime. ARPU is fluctuated less than 1% around the mainline and that when I say overtime for years and so we do not really see that changing overtime. Quarter-to-quarter can be a few dollars up or down. It was the 2% after adjustments from Q1 to Q2.

Colby Synesael - Kaufman Brothers

The CBM product set is unique as it is and obviously you offer a lot of different applications that they can get with another telecom service provider. Why do you need to be so aggressive with your rebate program or with your pricing concessions when these contacts come up for renewals that there is really nowhere else that they can potentially go and get this type of services?

James F. Geiger

The best answer I have is the economy. I know that with our vendors, Colby, and I bet with the vendors that you interact with were being pressured by companies who are watching their bottom line and those promotions we had expected at this time when we thought about our regional forecasting that the additional applications that we would sell and the additional lines that they would offset or outweigh the promotional changes and usage changes, but they have not and the best answer I have is the economic environment.

Operator

Your next question comes from the line of James Breen - Thomas Weisel Partners.

James Breen - Thomas Weisel Partners

Just with respect with the guidance for the second half of the year, is there any seasonality to your current cost of revenue, any reason to expect that dip in service revenue in the second half? Thanks.

J. Robert Fugate

We would expect to see the cost of revenue, we have got some projects that I mentioned earlier in my remarks that we think will start to bear fruit in Q3 and then in Q4, so that, I think, will have a positive impact on cost of revenue but not really due to seasonality.

James Breen - Thomas Weisel Partners

Okay. Jim mentioned briefly the regulatory side of things; has it been in the indication with respect either to special access or some of the other things that are before the SEC right now that you may see pricing improve in the last month?

James F. Geiger

I do not think Jim that I can point to something that would suggest it will see pricing improve but I think tenor and tone would suggest that the environment is improved.

Operator

Your next question comes from the line of Jennifer Fritzsche - Wells Fargo Securities, LLC.

Jennifer Fritzsche - Wells Fargo Securities, LLC

Just a question on the middle tier market or I am not sure what your call them, Houston, Chicago, LA, and San Diego have revenue growth which was nicely in the north to 25% year-over-year but EBITDA seemed to be flat sequentially and margins dropped here by roughly 180 basis points to 33 unchanged and I know Jim has mentioned Chicago some pressure there. Is there anything else than we are seeing here that would contribute to this?

James F. Geiger

Yes. There are few factors that play there in those markets on the EBITDA margin. First of all, the bad debt expense increase that we reported cut across all the markets and that was a common factor. I do not really anticipate that you will continue to see that again in Q3 at this point. But in addition, in some of these markets, some one time cost and factors that affected some of the expenses that we think will not really be mirrored again.

On the mobile side, we had some increases in mobile costs that impacted EBITDA margins. And if you look at the history of these cities, I think you will see that there are up and down fluctuations quarter-by-quarter in the EBITDA margins that are not uncommon.

So, I think you will see that change a little bit overtime. Also, I will point out Los Angeles about a 25% growth. So, Los Angeles good growth and in EBITDA good growth in revenue, several of the markets you noted had good growth in revenue but I think we will also see short term, some pickup on the EBITDA margin side as well.

Jennifer Fritzsche - Wells Fargo Securities, LLC

Great. And just one follow up question, Jim, you had mentioned sales churn improved year-over-year. I know you do not disclose this number in absolute number basis but can you discuss or quantify the improvement in terms of the basis point?

James F. Geiger

Yes. You are talking about the retention of our sales organization.

Jennifer Fritzsche - Wells Fargo Securities, LLC

Right, right.

James F. Geiger

Let me see, it was immaterial, Jennifer. I think a safe estimate would be in the 20% range improvement of retention in 20% and we give that credit largely to implementing our Cbeyond University program where we are bringing all of our new hires in and we are spending a lot more time and of course money therefore educating our new hires and I have to give an assist to the economy.

I think probably that we are getting, kids are finding harder time to find a job and maybe their options if they find the word difficult or challenging in the first few months, their options are fewer so they are sticking around and being successful I think maybe a little bit more.

Operator

Your next question comes from the line of Timothy Horan - Oppenheimer.

Timothy Horan - Oppenheimer & Co.

A couple of questions did your guidance of just well done to a little bit more detail. Are basically astounding this level of ARPU and churn for the remainder of the year? I am not looking for exact guidance but, is that what you are contemplating with your guidance?

J. Robert Fugate

Yes. The guidance would assume that ARPU does not deviate greatly from the level of that now within a few dollars plus or minus of this number and the churn rate is generally expected to be stable.

Timothy Horan - Oppenheimer & Co.

Okay, great. And just to confirm that there was not any real seasonality in the quarter this EBITDA number that you were saying one time issues in there and historically you have not seen too much seasonality. I know you saw some last year but just wanted to comment. In prior years or second quarter, EBITDA seemed to be a bit lower than the second half of the year. Is there any reason for that historically or in this quarter?

James F. Geiger

Seasonality did not play a large role in Q2. For us, we often define seasonality in our business as having to do with the changing number of business days in the quarter and Q2 was not an outline in that respect.

So, typically what we see is Q3 has a few more business days and Q4 is on the lower end as far as the four quarters of a year ago.

Timothy Horan - Oppenheimer & Co.

Got it, and then lastly, it does seem like some of your larger markets, I know you are going to focus on Denver but Atlanta, Dallas, Chicago looks like we saw in the season slow down in revenue growth. Is that mostly due to churn and the economy and I guess it is some of worsening trend if that continues and I guess many margin business models historically have been hit by churn that has been typical to, but due to either up to a certain level and it really dampens, end up dampening growth quite a bit, just your thoughts on that. Thanks.

James F. Geiger

Yes. Well, I will just respond by saying that the churn that we have in the older cities cuts deeper than the same percentage of level of churn in the newer cities, specifically we have got a bigger base there.

So, we can be adding the same number of new customers in an older city and not get as much revenue benefit from it because of the bigger number of customer churn. So, that is always a factor and then as we mentioned before we are in a period of time where we have got this elevated churn due to recession. We think that at a point in the future we are not sure when. We are going to see some of that business failure or level that we have got in place now. It will reduce and that will provide us with a bigger lift in revenue growth from the older market.

So we do not really feel like we are reaching a top out point there and we are optimistic that you can see some further acceleration at a point in the future.

Operator

Your next question comes from the line of George Sutton - Craig-Hallum Capital.

Analyst for George Sutton - Craig-Hallum Capital

This is DJ calling for George Sutton. I have a couple of questions. I will start with the economy and the economy improves, where do you anticipate you will foresee it? Will it be in the churn or product sales or pricing?

James F. Geiger

Well, we often to get asked about our prognostics about the prognostications about the economy. If we look at customer sales, we would be already optimistic that the economy was starting to turn and that there was more optimism because we have posted record numbers there of new customer additions.

Probably the most visible place though, DJ, where we would see tangible number that the economy was turning is in the business failures within the churn number. The ARPU number as Bob said optically it looks like a large number but it really blows down to about $5 difference because of the promotional breakage in the first quarter and $3 of real difference, so it is less than 1%. So I do not think you will see it in ARPU. Churn would be the most visible metric.

Analyst for George Sutton - Craig-Hallum Capital

Okay, thanks. And my second question is any changes you will make in this environment to your sale structure or to your corporate overhead?

James F. Geiger

Absolutely, I think I opaquely referred to the fact that we will take necessary steps to deliver on that inflection point in the fourth quarter and that would include taking a hard look at some other markets and our SG&A spend there as well as at corporate.

Operator

Your next question comes from the line of Robert Dezego - Suntrust Robinson Humphrey.

Robert Dezego - Suntrust Robinson Humphrey

Just a couple of quick questions here, I would like you to talk on the ARPU pressure, just to go back that for one second. Are you seeing it more with the new customers or existing customers, kind of maybe ballpark of where you are seeing that pressure?

James F. Geiger

It would be promotions related to the acquisition of new customers, the numbers would be more weighted there.

Robert Dezego - Suntrust Robinson Humphrey

Okay. You have been doing very well obviously on the wireless; can you talk about maybe the churn differential and then the ARPU differential that you are seeing in the wireless customers versus the typical non-wireless customer?

James F. Geiger

No. The interesting thing about churn with wireless, I think it is true that as you add more applications inclusive certainly of the mobile application, ARPU was higher and the more applications that customer used as long as they are satisfied with those applications, churn generally is lower. But we have not really had a problem with controllable churn.

So, the increase in churn is solidly related to uncontrollable churn, business closings, contractions and the rest of those customers. So, we do not really see that environment really has not changed and I would tell you that it is a bit binary at times you may know with your own mobile usage if our product is not conducive to the places you visit. It is a bit binary. People are unhappy with that and that might contribute more churn.

Robert Dezego - Suntrust Robinson Humphrey

Right, okay. And on the ARPU pressure on the second quarter, as you went through the end of June and end of July, have you seen any kind of change, just give us a sneak peek in the third quarter?

James F. Geiger

I think it is a little too early to give you any color on Q3 ARPU at this point.

Robert Dezego - Suntrust Robinson Humphrey

Okay. And then the last question I have here is you win that program for customers for that point of purpose and it does leave. Has there been any change there and I guess I will say there has been any change in the competitor [win that] programs from the incumbents, from your customers that are leaving for non-economic reasons or customers that you takeover from the [belts]. Are you seeing the [belts] come back and fight a little harder to win these customers back?

James F. Geiger

We are not fighting any harder to keep them, I would say. I think that has already crested a bit but really negligible differences. But I do see the competitors, the incumbents particularly, trying a little harder to keep customers, not successfully frankly, not significant but they are trying harder. It is noticeable.

Robert Dezego - Suntrust Robinson Humphrey

And is there like a percentage of your near term wins that when they sign a contract usually they cannot really leave you right away, the one back up or they have touched before they sign the contract?

James F. Geiger

Well, all of that is lumping to that 4/10 of a point of controllable, so that is not under pressure.

Operator

Your next question comes from the line of Dave Coleman - RBC Capital Markets.

Dave Coleman - RBC Capital Markets

Just one point in the second quarter, did you guys start noticing that breakage trends started to deviate from your expectations and can you also quantify how promotions offered today compared to about three months ago or year ago? Thanks.

James F. Geiger

Yes. Just to clarify on the Q2 and the breakage, just to clarify what we are talking about there. We have an accounting led true up that we occasionally need to record according to US GAAP in a quarter and that true up is related to a historic set of periods for a particular promotion or incentive that we offer. So, we had a true up that occurred in Q1 of ’09 and we did not have a corresponding true up in Q2.

So that true up in Q1 ’09 contributed $5 to Q1’s ARPU. So Q1’s ARPU was $755. If you pull that true up out, the base ARPU was $750 versus the $748 of ARPU that we had in Q2. Hopefully that is a response to your question.

J. Robert Fugate

And $5 is a %7 of the ARPU pressure is due to the true up. The other $2 is due to increase promotional activity.

James F. Geiger

And lower usage and some other things.

Dave Coleman - RBC Capital Markets

Okay. That is great. Second question on renewals, I guess BeyondVoice I customers that renew, what is the take rate of BeyondMobile? And what is the BeyondMobile take rate overall currently? Thanks.

J. Robert Fugate

I do not have the number in front of me but my sense is it is lower than the attach rate for new customers but not appreciably and the attach rate for new customers on mobile is over 50%. That has been a consistent figure for over year.

Operator

Your next question comes from the line of Barry McCarver - Stephens.

Barry McCarver - Stephens, Inc.

I guess a couple of questions; first off, I want to make sure understand your comments on margin. If I understand what you are seeing, is that generally speaking, we should see gross margin trend down overtime but adjusted EBITDA margin trend up overtime not necessarily every quarter but in your suggesting that that gross margin maybe a little flatter in the second half of the year, is it out there?

James F. Geiger

Yes. I think that is true.

Barry McCarver - Stephens, Inc.

Okay. And then my second question, I am just wondering if you can just give us a little bit more detail on what was happening in Denver. That was a big surprise at least to me in the quarter and you talked about some things you will be doing there in the second half to help sure that market up. Can you give us a little more color there?

James F. Geiger

Well, customers are flat in Denver. It is the net effect of slight decrease in our production and a relatively significant increase in the first quarter in uncontrollable churn and when I say an increase from below average to about our overall average and we traditionally had a very low churn there.

In addition to that there was an increase in mobile adoption and handset subsidies, as well as an increase in SG&A. That was largely led by bad debt expense and that would cause the decline in EBITDA.

Barry McCarver - Stephens, Inc.

So are you attributing all that to the economy in that market or do you think there is anything short handed on headcount there or like that or just completely the economy?

James F. Geiger

The effect in the second quarter was largely, I think Bob explained that phenomena the increases in churn on a large base have a compounding effect on the net and revenue and that certainly is the case that happened in Denver in the second quarter.

Just for a little color. July gross ads were up and churn was down significantly and we are hoping to make that the new trend in Denver.

Operator

Your next question comes from the line of Frank Louthan - Raymond James.

Frank Louthan - Raymond James

Going back to the client in the usage and the overage business, at what percentage of your revenue comes from average on the minutes of use and can you be a little bit more specific on the changes to the pricing and how would regulatory changes affect your pricing? Wouldn’t that affect your cost more, just give a little more color on that?

James F. Geiger

Yes. I will speak to the usage first. Of our customer revenues, 5% are usage related. Knowing we say usage, we mean that these are overage minutes in, for most in the long distance voice area that are above the package minutes that we offer our customers. So, that contributes a small portion of our revenues about 5% customer revenues.

Then just under 2% of our total revenues are terminating access and that is the usage base but it is the usage of where customers of other carriers are terminating long distance call if under our network and so it is the usage of their customers.

So, that is not what we call non-customer usage. That is the terminating access. So, when you add those together, they are a little under 7% of our total revenues.

And you were asking about how regulatory changes are impacting our pricing or the pricing within our ARPU for that?

Frank Louthan - Raymond James

Yes.

James F. Geiger

I do not anticipate that. I think you are correct when you said that they were not pricing effecting. If I would say that I was mistaken, they are cost effecting.

Frank Louthan - Raymond James

Okay, great. Just a follow up on the overage, was that a materially different percentage to over 18 months ago or has that been pretty consistent?

James F. Geiger

It has been very consistent. I believe it was the same number. It might have been 8%, 12 to 18 months ago but it is within a point, Frank.

J. Robert Fugate

Yes. The terminating access piece has declined slightly overtime. So if you look back a couple of years, you would see it a little bit over 2% and now it is a little bit under 2%.

Frank Louthan - Raymond James

Okay, great. One last question, what percentage of your customers have seen their bills declined over the last 12 months from cutting back on services or lines?

James F. Geiger

I do not know the answer for that Frank. I would say the number of customers who have overage charges is the minority, a significant minority of our customers. I mean it represents only 5% of total revenue.

Frank Louthan - Raymond James

Well, I mean more broadly as the customers are pushing back on pricing or have been cutting down on number of lines in total to try and save some costs, are you seeing customers with bills that are consistently coming down over that time period whereas maybe in the past you saw customers had per year for sort of consistently grow their bills, does that stop or is that reversed at all?

James F. Geiger

I guess the best way to answer that is that going back to our ARPU discussion previously, the ARPU is really not fluctuated much. It has been within that 1% level that I have spoken about for nine consecutive quarters and so the difference is among some of the customers within the base have not amounted to a net large difference overall.

Just to give a little more color, we have about 10% in growing of our sales access if you will resource our focus on our existing customer base and we make a lot of contacts and we do a lot of education each month now and what we do rather than ride prices down as most of our competitors do, we add value through more applications that are included within the package price. So, we educate customers on their ability to utilize more and more of our applications.

So that is how we have tended to. Over our history, we have such stable ARPU, Frank, and a big piece of our strategy.

Kurt J. Abkemeier

Operator, this is Kurt. We got time for two more calls.

Operator

Your next question comes from the line of Jonathan Schildkraut - Jefferies.

Jonathan Schildkraut - Jefferies & Co.

Actually, most of my questions have been asked and answered. But as long as I am in the queue might spend a bit more time on this inflection that we should look forward in the fourth quarter, it sounds like it is just an EBITDA inflection not on a revenue growth inflection. Revenue growth in this quarter I guess was up 3.6% sequentially, which is a fairly low number by historical standards for the Company. I am just wondering if you can give us a view with what you are expecting in terms of sequential revenue growth as we head into the backend of the year. Thank you.

James F. Geiger

Revenue growth for us is it is hard to impact with predicting an inflection. So, you are right. We are not expecting a revenue inflection point in Q4. We were referring to EBITDA and free cash flow and that will lead to growth in our cash balance from the balance sheet and not revenue.

Our business is characterized in a baseball analogy by hitting a lot of singles. We are the kind of business that can land a big contract and impact revenue that way. If you look at the historical sequential growth in revenue, if you adjust out the breakage gain, I referred you in Q1 earlier; we had a sequential growth in revenue from Q1 of $4.2 million.

I think that is a pretty good example of the kind of sequential revenue growth. You should see on a quarterly basis. But really the story where we are referring to with discussion of an inflection is the story of the newer five or six markets and their progress toward breakeven EBITDA and I think we are seeing good progress as we look at them and I think you will continue to notice that and in the third quarter and I will give even more evidence that that fourth quarter inflection point will be met.

Jonathan Schildkraut - Jefferies & Co.

Are you still planning to launch two to three markets next year and should we assume by the push out at Seattle in the inflection that you are highlighting in the fourth quarter that potentially the first market launch of 2010 will be delayed relative to the timing of 2009?

James F. Geiger

We are still planning to launch two to three markets next year. This year we launched Washington DC in late Q1 and at this point we will probably be looking at early the mid-Q2 for the next market that we launch. Seattle, it is very little different from our original plan. It is sort of a difference between September launch for our Q4 launch and we have just push it out a little bit, but that is not going to have much of an impact on the numbers.

Operator

Your last question comes from the line of David Dixon - FBR Capital Markets.

David Dixon - FBR Capital Markets

I have got a question on your recent pricing promotions which checks are highlighting have become more aggressive. I wonder if you could talk of that to what extent there has been a change in your promotional activity of late? And perhaps some comments on the scale and scope of those promotions? I am thinking specifically about the, it looks like $100 rate on BeyondVoice I, $150 on II and $300 on BeyondVoice III as well as in discounted pricing for additional channels. Just curious how that has been different to what you have done in the past and where those perhaps result in any change in the mix of gross ads that you are seeing in July between those three categories? I am also hearing that you are now starting to combine those promotions, so just some general commentary around that would be terrific. Thanks.

J. Robert Fugate

Well, I will do the best I can here but David we have always had a variety of different types of promotions that we use with customers and we continue to try to explain in detail. The differences and how those have changed on this call I think would be difficult and probably not something that we would want it to do just for competitive reasons. Those are competitive tools that we use to close transactions, with customers on occasion and I would rather not describe those specifically but I do not think that there has been a tremendous change in any of those recently versus once we have used in the past.

James F. Geiger

I think what I would add David is that what we have been incentivizing is an increase in application adoption and as Bob mentioned in his discussion is a long discussion about ARPU.

The promotions are largely offsetting those corresponding increases in application usage. So, I think that is really the different nature of the promotion.

J. Robert Fugate

Yes. And the other part that you do not see, we really have a talked about much today is increased sales of applications into our customer base. That is happening. That is part of the contributing factor that goes to offset the promotions that maybe more visible to people if you do channel checks. So, it is hard to do channel checks on what we are doing with our sales into the base but that is healthy and a growing contribute to ARPU.

I am sorry, David. We have always been very disciplined, sales people themselves cannot discount or promote without the authority of their vice president and general manager. There were a certain number of promotions that are given out to each one of the offices and each one of the VP-GMs and so I would say that it is very disciplined as well.

David Dixon - FBR Capital Markets

I will just follow up to these checks are indicating there, winning deals now on price. You are no longer missing on that front which is very encouraging you. You have kept the headline price very discipline. It is just that this recent action, I was just curious as to whether whatever they are have been introduced from the scale respective across all franchises or whatever it has been limited to particular jurisdictions.

James F. Geiger

No. They are generally available in limited quantities to all of our jurisdictions.

David Dixon - FBR Capital Markets

Okay. And then just lastly, very quickly, on larger bandwidth deals, which I think is one area of concern, you may be missing out with some opportunities there. When do you expect that you will have a high bandwidth offering in the marketplace?

James F. Geiger

Well, today, we offer 1.53 and 4.5 megabits of some metric bandwidth which is very competitive depending on your bandwidth needs. Again, we had record sales this quarter so we find that to be very compelling and in our offering to cut.

Kurt J. Abkemeier

I want to thank everybody. That concludes our call and we are very proud of our performance and we are very proud of the people that made it all possible. So, we thank you for your investment and your time. Thank you, Operator.

Operator

Ladies and gentlemen that does conclude today’s conference. We thank you for your participation. You may now disconnect.

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