Cbeyond Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.31.13 | About: Cbeyond, Inc. (CBEY)

Cbeyond (NASDAQ:CBEY)

Q2 2013 Earnings Call

July 31, 2013 5:00 pm ET

Executives

Robert G. Clancy - Vice President of Investor Relations

James F. Geiger - Co-Founder, Chairman, Chief Executive Officer and President

J. Robert Fugate - Co-Founder, Chief Financial Officer, Executive Vice President and Secretary

Analysts

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Brett Feldman - Deutsche Bank AG, Research Division

Barry McCarver - Stephens Inc., Research Division

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Donna Jaegers - D.A. Davidson & Co., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Cbeyond Second Quarter 2013 Conference Call and Webcast. [Operator Instructions]

I would now like to introduce your host for today's program, Mr. Rob Clancy of Investor Relations. Please go ahead.

Robert G. Clancy

Thank you, operator, and thank you, call participants, for joining us today to discuss Cbeyond's operating and financial results for the second quarter of 2013.

I would like to begin today's call by reminding you that this call contains forward-looking statements that include words such as believe, expect, anticipate, intend, project and similar expressions. Actual results may differ from our forward-looking statements. For specific factors that might cause future results to differ, we refer you to the forward-looking statements discussion in our most recent press release and the risk factors and other disclosures in our periodic reports that we file with the SEC.

On the call today, we have Jim Geiger, Chairman, President and CEO; and Bob Fugate, Executive Vice President and CFO.

With that, I'll turn it over to Jim Geiger.

James F. Geiger

Thank you, Rob, and thanks for joining us on the call today. I'll start by providing a brief update on our second quarter results, then discuss our full year guidance and our ongoing transformation activities. Bob will then provide an update on our financial results.

First, in the second quarter, we achieved revenue $118.2 million, adjusted EBITDA of $21.9 million and free cash flow of $7.1 million. We're doing a good job of managing our profitability and free cash flow as we transition from a communication-centric company to the premier cloud solutions provider for the small and mid-sized business segment. On our last quarter call, I highlighted many aspects of our transformation that are working very well. We also discussed the main focus of improvement being sales productivity. When we developed our financial plan earlier this year, we set very ambitious sales productivity goals, which reflected significant increases in the second quarter and growing through the rest of the year. I am pleased that we continue to move many metrics in a positive direction, including sales productivity. We are not yet at the productivity levels we planned for at the beginning of the year.

As a result, we are lowering our revenue guidance for 2013. Our new revenue range now contemplates low-to-modest productivity increases through the balance of the year, together with relatively stable customer churn. Importantly, we are maintaining our adjusted EBITDA guidance, lowering cash CapEx expenditures and increasing our free cash flow guidance for the year, and Bob will discuss these items in greater detail.

Going through this transformation has required significant effort and I'm pleased with the progress we're making. We recognize that our sales productivity is still not at the level we want or expect, so let me spend some time discussing this in terms of what's working, what we're learning and how we plan to make further improvements in the context of products, prospects and people, all of which are integral to overall sales productivity.

So first, let me discuss products. We continue to believe that the convergence of cloud, network and security is the next enterprise wave making its way to the small and mid-sized business market.

To support this opportunity, in less than 2 years, we have developed a very comprehensive suite of services that provide us with a defensible long-term position in this fast-growing market. More specifically, as a cloud solutions provider, we offer the complete set of cloud services, as well as the solutions needed to enable the cloud, such as our MPLS network and IT professional services group.

Our total cloud family of services is resonating well in the market and we have evidence that our strategy is working. In the second quarter, 2.0 revenue represented 13.6% of total revenue, which has doubled the amount of 2.0 revenue in Q2 of last year and up over 200 basis points from just a quarter ago. 2.0 ARPU increased over the first quarter and has increased sequentially for the past 5 quarters. Exiting the month of June, 2.0 revenue is 14.2% of total revenue, coming from just 6.9% of our customer base.

One of the most successful 2.0 products to date has been our TotalCloud Phone System or TCPS as we have experienced 20% attach rates with our TCP offering year-to-date. And we expect our success with this product to grow even further with the introduction of our TCPS plus mobile, which we expect to launch this quarter. We believe that our wireless capability to our MVNO or mobile virtual network operator agreement provides us with a competitive advantage not available to other Cloud PBX providers, by allowing our customers to use their mobile phone as their primary handset while in the office or on the go with fully transferable features.

One of the important parts of our transformation has been our shift from predominately T-1 access to higher bandwidth Metro Ethernet, which we believe is foundational to our advanced services offerings, while also lowering our cost structure with our own fiber and Ethernet-over-copper.

As we mentioned last quarter, we believe we have one of the largest Metro Ethernet footprints in our 14 markets outside of the ILEC's as our total network offering provides 10 megabits or more of symmetric bandwidth to over 190,000 multi-tenant buildings, in which we can offer our powerful value proposition of network and cloud.

We are also making steady progress on our fiber plans and ended the quarter with 309 lit buildings, allowing us to reach 1,140 current customers and many more new prospects. We have converted over 875 customers, or said differently, of the 3.7 customers per lit building we serve, we have converted 2.8 customers to our fiber thus far.

It is our current expectation to end the year with more than 500 lit fiber buildings. This part of our transformation is also taking a little longer than we expected, but significant groundwork has been laid that will allow us to reach our initial goal of 1,000 lit buildings in 2014. So we feel good about the progress we've made on the product front.

Now let's discuss prospects. As we've said, one of the reasons our strategy is taking more time to develop is our customers and prospects do not fully understand the benefits of moving to the cloud.

One of the challenges we face is finding the right customer, both new and existing, with the right sales channel. We now have a much better understanding of determining the right customer profile, both new and existing, for our new products and this has been a learning process for us.

Traditionally, we were focused on the small business customer with 5 to 20 employees, while our new product set can now serve the more technology-dependent small and mid-sized businesses, often with 30 to 100 employees and including multi-location customers with advanced needs and the desire for a common experience across all locations.

Solution selling is by its nature more complex. It involves an educational dialogue and a problem-solving approach that requires more focused targeting of prospects, but ultimately leads to a deeper and more valuable relationship. To further enhance our prospecting this quarter, we improved the sales management practices and implemented a marketing platform, enabling us to better target potential 2.0 customers.

And last, let me discuss our people. Historically, we had a direct sales force that was exclusively focused on transaction-based selling of communication-centric services to our customers. And we are migrating to a company with multiple distribution channels centered on solution selling of cloud and other IT services. Over time, it is our belief that we will ultimately migrate from a primarily 100% transaction-based selling model to a primarily 100% solutions-based selling approach. Frankly, we underestimated the speed of change we could effect in our traditional sales force, and that has been a large factor in the pace of our productivity gains, particularly in our traditional direct sales channel.

One of the ways we intend to improve overall productivity is by shifting more resources to our more productive and efficient channels and away from less productive ones. Although we have historically been known primarily as a direct sales organization, we have consistently generated about 1/4 of our customers from our indirect channel partners. We believe the indirect channel represents an opportunity for growth as a percentage of our business, and we are adding resources to take advantage of the high productivity this channel has been recording, as well as the appeal our 2.0 offerings hold for many VARs in this channel, who are looking for network and cloud services partners.

We are also growing our inside channel, which focuses on upselling to our base, as well as working incoming leads for new business, often in partnership with our field sales reps. Inside sales is a relatively cost-effective and potentially highly productive channel that can help us deepen our relationships with our customers, while driving higher ARPU. We've also been making changes to our approach to direct sales. In particular, we've moved away from hiring entry level sales reps and now require a higher level of experience before a young person becomes a Cbeyond sales rep.

Over time, the plan is to continue to transition our direct sales reps away from lower-end transaction selling to an increasing comfort level with solution selling of our 2.0 products. Over time, we'll promote more successful direct sales reps into the ranks of our senior account executives group, focused on 2.0 sales to mid-size accounts. And our senior account executives are steadily gaining traction.

In fact, in the quarter, our sales to accounts generating over 1,000 per month increased by 28%, as compared to Q1. So again, we have some evidence that our strategy is working. In summary, we are evolving to a more efficient sales structure and shifting emphasis to the areas we see the best prospects for future success, and at the same time, effectively managing profitability and cash flows.

I'm proud of the progress we've made, and we are confident that we are on the track to establishing a sustainable platform for growth for the long run. We have a strong conviction about our strategic direction, encouraged by plenty of success metrics moving in the right direction. Our transformation is simply taking more time than we anticipated.

Part of the reason our revenue transition is taking more time is the result of decisions we are making not to chase the lower end 1.0 customers while rebalancing internal resources within the company to focus more on our higher value 2.0 customers and revenue streams. Our goal has been to grow our 2.0 revenue stream and, at the same time, stabilize our 1.0 revenue, while continuing to shift emphasis toward acquiring new 2.0 rather than 1.0 customers.

Let me now discuss our balance sheet for a moment. As we work through our transformation, we have maintained one of the strongest balance sheets in the industry and we continue to generate solid free cash flow and expect the same going forward. Our cash flow is more than sufficient to allow us to invest in our business for future growth. And the transformation path we are on is designed to reposition our company to create long-term value for our shareholders.

Because of our balance sheet strength and solid free cash flow generation, our board has approved a $20 million share repurchase program to be completed over the next 24 months, which at current levels represents more than 7% of total shares outstanding. This is a significant action and represents our conviction about our business model and our desire to create long-term shareholder value and return capital to our shareholders.

So let me summarize. We've made solid progress developing the product set, including network, cloud and security for the small and mid-sized business base. We have improved our bandwidth capabilities, allowing us to offer these advanced services. Our 2.0 metrics are moving in a positive direction. Sales productivity, while improving sequentially, remains an opportunity and main focus area going forward. We are allocating resources toward the most productive sales channels and opportunities and away from those with lower returns. Our strong balance sheet and solid free cash flow position allows us to return capital to shareholders.

And at this time, I'll turn the call over to Bob to provide more detail on the quarter. Bob?

J. Robert Fugate

Thanks, Jim. Today, I'll discuss our financial results for the second quarter and provide an update on our full year 2013 guidance.

Let me begin with the revenue. We posted total revenue of $118.2 million in Q2, a 4.5% decrease year-over-year and a 1.4% decrease sequentially; largely, the result of lower-than-expected sales productivity and declines in our 1.0 customer base.

ARPU in Q2 was $662, an increase of $6 from Q1 levels and a result of continued increases in our 2.0 ARPU, as well as increased cost recovery fees added in Q1.

Network, voice and data revenue declined 5.8% year-over-year due to declines in our 1.0 customer base and a reflection of our strategy to shift sales resources to 2.0 products and services.

Managed hosting and cloud revenue increased 20.9% year-over-year, reflecting the progress we're making at selling these services. In fact, the growth rate for this revenue stream continues to improve each quarter. Total 2.0 revenue in the quarter was $16.1 million or 13.6% of total revenue and more than double the 2.0 revenue in Q2 of last year.

Additionally, 2.0 revenue as a percent of total revenue is up to 220 basis points from last quarter, and we ended the quarter with 2.0 revenue being 14.2% of June's monthly revenue. We added over 600 2.0 customers during the quarter, a steady increase over prior quarters and our 2.0 customer base is now 6.9% of our total customer base.

Our 2.0 ARPU has increased each of the last 5 quarters. 2.0 ARPU is 70% higher than the ARPU of our total base and roughly 80% higher than our 1.0 ARPU.

Now I'd like to make a few comments about our customer churn. Our monthly customer churn for Q2 was 1.6%, which is consistent with our recent experience and expectations. Importantly, the revenue churn from these disconnected customers is less than the unit churn percent, reflecting the fact that we are primarily losing lower ARPU customers that are not ideal candidates for our 2.0 services. We continue to believe that 2.0 customer churn will be much lower than that of our traditional customers given the stickiness of our 2.0 services and the higher value they provide.

As we've mentioned on prior calls, over the last year, we have shifted our focus from a customer unit orientation to revenue and revenue quality. This shift meant that we would be posting fewer 1.0 customer additions while targeting higher spending accounts, and that is still the case today and one of the reasons for the revenue pressure.

Next, I'll cover our gross margins and adjusted EBITDA. Gross margins in the quarter decreased slightly by 110 basis points. Selling, general and administrative expenses, excluding noncash share-based compensation expense, decreased by $4 million sequentially, due in part to lower compensation expense. We're carrying fewer of our traditional sales staff as we continue to shift away from our less productive channels.

Our adjusted EBITDA for the quarter was $21.9 million, an increase of approximately $1.1 million from the first quarter due to lower SG&A cost. Our adjusted EBITDA margin was 18.6%, which is up over 100 basis points from the first quarter but down year-over-year as last year's adjusted EBITDA benefited from last year's sales force transition.

Moving to CapEx, total capital expenditures in the second quarter were $20.1 million, of which $14.8 million were cash capital expenditures. Our cash CapEx during the quarter increased by $2.4 million from the first quarter, in line with our expectations. Noncash CapEx during Q2 was $5.3 million, which consisted mostly of capital lease obligations related to our fiber assets and other equipment purchases.

Turning to our cash position, our cash balance at June 30 was approximately $27.5 million, an increase of $3.7 million sequentially. The increase in cash is a result of free cash flow of $7.1 million in the quarter, offset somewhat by working capital uses.

We currently have $2 million outstanding on our term loan, which is our loan we are currently using to pay one of our fiber partners. This is unchanged from last quarter. We expect to begin payments on this loan over a 3.5-year period beginning in early 2015. We have no borrowings outstanding under our $75 million revolving credit facility. We also have $13.7 million in outstanding capital lease obligations.

Next, I'd like to discuss free cash flow. Free cash flow, defined as adjusted EBITDA less our cash capital expenditures, was $7.1 million in Q2, which compares with $8.4 million last quarter. The sequential decline of $1.3 million was the result of higher cash CapEx, offset somewhat by an increase of $1.1 million this quarter in adjusted EBITDA.

To summarize, we believe that the company continues to maintain a healthy cash position, with a strong balance sheet that gives us a solid platform from which to pursue our strategic evolution. And as Jim stated, we believe our balance sheet and cash flows support our $20 million share repurchase program.

Lastly, I would like to provide an update on our full year 2013 guidance. While we experienced a slight increase to overall sales productivity in the quarter, the productivity levels were below the ambitious plans we set at the beginning of the year. We're modifying our plan on sales productivity to reflect more modest increases throughout the balance of 2013 based on recent experience and run rates. Thus, we are adjusting our revenue guidance for the full year and now expect revenue to be between $464 million and $471 million. Our revised revenue expectations are the result of several factors: Lower-than-planned productivity among our traditional sales force that has generally been focused on the 1.0 market; longer sales cycles and extended installation intervals for our new 2.0 customers due to more complex solutions being sold; and continued pricing pressure on our base of 1.0 accounts.

Despite the revenue change, we still expect to achieve adjusted EBITDA in the range of $76 million to $80 million due, in part, to lower expected sales expenses and other cost management efforts. We also now expect cash CapEx to be in the range of $56 million to $60 million, in large part due to lower revenues. And finally, as a result, we are raising our free cash flow outlook to $18 million to $22 million.

At this time, I'll turn the call over to the operator for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Frank Louthan from Raymond James.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Okay, great. Can you give us an idea of when you're looking at the customers and so forth, have any change in the trend of the customers that have been leaving and churning off, any change in the size? And what is sort of the rationale for customers that are leaving currently? And you said it was a little bit smaller, are they finding better bandwidth elsewhere or are you trying to push them towards 2.0 and they're leaving? Well, how should we think about that? And then the CapEx trending a little bit lower; are you guys are getting a little bit more efficient or is it just taking it a little longer to get the fiber builds done or both, or can you walk us through that?

James F. Geiger

Thanks, Frank. I'll take the first part of that. On churn, I would say that the focus that we have is on customers that we've identified that have the potential for 2.0 and less of a focus on the customers that don't. So I would say that the churn of customers is taking a natural course where the smaller ones are leaving and we think less valuable, and we're spending more time focused on higher revenue, higher opportunity existing customers, as well as new customers.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

So maybe in the past, you would have spent more time kind of cultivating and keeping those customers. And now you're spending less on that. So, therefore, they're naturally just leaving. Is that kind of how to think about it for us that aren't in the business?

J. Robert Fugate

Yes, I think that's right. I think that there are -- there is a subset of our base that is very price-focused. They're smaller. They don't have the technology needs of cloud services or enhanced services and they are leaving, primarily, I would say, for price purposes.

James F. Geiger

Yes, and on the CapEx question, Frank, basically the success-based CapEx will flex a bit. So as we took revenue down a little bit, we've been able to move CapEx estimates down slightly in proportion with that and, to a lesser degree, there's a little less spending on fiber this year than originally planned.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Okay, great. And can you give us a little more color on the TCPS mobile product and what sort of features that'll have and how ubiquitous that'll be throughout your customer base?

James F. Geiger

Yes, we mentioned that we've had great success. I mean, we haven't talked about attached rate on a product in a long time at this level, 20% attached rate new customers. So we're very excited about that. We think we can drive it higher. We've got an MVNO, as you know, and it gives us a costing advantage against our competitors. We can include the cost of your local line inside the mobile line. And you can have full-feature transparency as -- and functionality to allow your employees, remote workers, what have you, to have both a dual presence, sort of their phone extension at the office on their mobile, as well as their mobile that we call it dual persona. And so we believe likely that this is going to displace the sale of desktop telephones in many cases. And, of course, people can bring their own as well, but they won't get the cost advantage that we can offer up from being a MVNO and your TCBS provider.

Operator

Our next question comes from the line of Brett Feldman from Deutsche Bank.

Brett Feldman - Deutsche Bank AG, Research Division

I just wanted to ask a little bit more about the guidance, particularly with regards to EBITDA. I just want to maybe get a firmer understanding of why it is you've trimmed your revenue guidance but are still reasonably comfortable with the range you had before on EBITDA. I know it's not the identical range so the midpoint is pretty close. Is it simply lower sort of success-based sales compensation expense? Or is there something else where you're seeing some efficiency in savings?

J. Robert Fugate

It is both components of SG&A. So it certainly is the fact that we're -- we've got a lower level of selling expenses in place, but there are some other cost management items in the SG&A category that are -- we're able to move down in tandem as well.

Brett Feldman - Deutsche Bank AG, Research Division

Okay. And then I want to talk a little bit more about the sales productivity. You mentioned that you're assuming a more modest improvement in the back half of the year and you noted that both 1.0 and 2.0 fell a little bit short of what you'd anticipated in the second quarter. As you think about the back half of the year, are you differentiating the productivity assumptions, meaning are you saying, for example, and I'm just making this up, that maybe 1.0 struggles, but 2.0 gets better because it's newer and people are ramping or are you just sort of uniformly assuming everything's at a bit of a lower level? And then I'll follow up depending on how you answer that.

James F. Geiger

Certainly, the 1.0, we're actively managing that lower. And we are focusing on and repurposing resources in 2.0. So just more color, we had a very ambitious plan at the beginning of the year and expected significant increases in productivity. We achieved a quarter-over-quarter increase Q2 to Q1 of about 8%, but our goal was significantly higher.

It is true that there are longer sales cycles in 2.0. It is true that there are longer insulation cycles as well. So I think that probably what is at most fault is the ambitious plans that we had, and we do have markets that are performing at our expectation. So that gives us great promise, we believe, and hope that when applying those best practices and management across those markets that we can achieve the original estimates at some point in the future.

Brett Feldman - Deutsche Bank AG, Research Division

What do you think gets you there across the board? It was good to hear that you do have some markets where you're living up to expectations because I was just wondering if perhaps maybe your reps are being as productive as they possibly could be, it was just too much of a goal and therefore, you need more reps. But it sounds like maybe it's just taking longer to get everybody up to full run rate. So can you maybe help us understand what it is about the reps or the regions where you're hitting the productivity and what's the delta there versus places where you're not quite where you need to be?

James F. Geiger

Yes, what I'd say about that is that it is mostly a lack of uniformity. We are achieving it in certain markets. I think the thing that we really underestimated was the pace of change that our people could adapt to on average. And again, we think that there's great opportunity in sharing those best practices across all of our markets, and that's really what we're focused on right now for the rest of the year. But as far as guidance, I would say that the low end would assume higher churn and lower productivity. And, of course, it's the higher end we would have greater productivity in and lower churn so.

Brett Feldman - Deutsche Bank AG, Research Division

One last one, if you don't mind. You mentioned that 1.0 customers, to the extent they churn for a competitive offer, it's typically for price. Who are you finding as the price leader in the market right now for that segment?

James F. Geiger

Predominantly in that segment, in the lowest end of our market segment is cable.

Brett Feldman - Deutsche Bank AG, Research Division

Right. So -- and that may be a bit more different than as we've seen, or different from it's been in the past. I know cable's been always been there, but are you finding that they're really starting to come out as a much more formidable competitor in that segment?

James F. Geiger

Yes. I think that the percentage that would go to cable versus back to the ILEC, I think has increased toward cable.

Operator

Our next question comes from the line of Barry McCarver from Stephens Inc.

Barry McCarver - Stephens Inc., Research Division

So I guess back on guidance and thinking about where we were at the beginning of the year; you were anticipating a little stronger revenue and near year-end. Certainly, with this revised guidance, it suggests that there isn't a ramp in revenue here. And then I understand you're maintaining your adjusted EBITDA guidance for the year, but we saw gross margins slip in the quarter and if we're expecting cloud or Cbeyond 2.0 revenue to continue to build and managed hosting and cloud to continue to build, I'm a little surprised because the guidance suggests that's not going to be the case, with it reflecting higher gross margin. So help me understand how to think about what 3Q and 4Q are going to roll out and look like from revenue and EBITDA because at this point, it suggests further deterioration all around.

J. Robert Fugate

Well, Barry, I think that it definitely would imply that there's a continuing decrease in overall revenue in Q3 and Q4. And I don't think that that's different at least in Q3 than what was originally the plan and implied in our guidance from the beginning of the year. I think it is true that Q4 would look a little differently. What I think I would say is that we're looking for a gradual soft landing to this revenue decrease and the pace of that. And I think that's coming as we continue to build our success in the channels that are selling our 2.0 products. We see the evidence of that. We think that's going to be improving the quality of the revenue that we're delivering. And ultimately, it's going to reflect itself in the future and improve profitability in the business and a return to growth. Exactly when those events occur is not something I think we're in a position to state on today's call. But looking at -- your question was for the balance of this year, and I think for the balance of this year, we're getting more visibility and confidence around the guidance that we put out today. I would say that it certainly -- when you've got 2 quarters under your belt, you have a lot more confidence just because of the way the math works in our kind of business than you -- a lot more so than you did at the beginning of the year. As Jim said, we started out with ambitious goals. We've realized them in some respects, but they weren't -- they haven't uniformly realized them. And so I think that there remains opportunity for confidence in the business, but it's just taking a little bit longer to achieve the transition that we wanted.

Barry McCarver - Stephens Inc., Research Division

Well, I guess, asking the question a little differently is that if you look at the deterioration of your network, voice and data revenue, it appears to be accelerating. Is that a 3Q phenomenon and there's an inflection point there? Or should we assume that it's going to continue to move down at a rapid pace through at least the next 2 quarters? And then that begs a question, do you think there's an inflection point next year somewhere?

J. Robert Fugate

I would say that, that component, that network, voice and data component of revenue will continue to decrease on, let's say, a similar pace in dollar terms over the next quarter at least, and then perhaps softening as we go through the end of the year and into next. At that point, I would say it's -- we would be planning for more stable revenue and getting -- and reaching a platform that we can start to post increases from, and that would be probably end of this year, beginning of next year.

Barry McCarver - Stephens Inc., Research Division

And for managed hosting and cloud revenue, can you give us an idea of what the margin profile looks like? Because that ought to give us an idea of how big that line item needs to become before it has a meaningful influence on gross margins and EBITDA.

J. Robert Fugate

Well, we're not putting out separate sort of product line P&Ls in terms of disclosure at this point. But certainly, the hosting in cloud component of our business is definitely providing us with higher gross margins well above the traditional business that we've had over time. So that traditional business been in the, let's say, 65% to 70% gross margins over time and this managed hosting and cloud revenue component part of our -- a key part of our 2.0 effort, that's got margins several points well above that. And I would say gross margins for that part of the business, mid-70s, that sort of thing. So it's a part of the business that we intend to focus on increasingly and increasingly direct our sales efforts and resources toward that. It's more profitable. It creates more differentiation and value in the business.

James F. Geiger

And, Barry, the only thing I would add to that is, that is a subset of products that we sell under the 2.0 banner. And so I would say that they're often sold in concert with our total network products and that, I think, is also -- we talked about the ARPU of that, the 2.0 products. That is actually a very happy story. It continues to inch up each month, ARPU of our 2.0. And as we said, we exited June with about 14.2% of our revenue there.

Operator

Our next question comes from the line of Barry Sine from Drexel Hamilton.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

First question, your focus seems to be moving around into changing your sales model through different channels, but I also heard you say something to the effect that the customers are not yet understanding fully the benefit of moving to the cloud. So I'm wondering if the issue maybe more on your products, maybe you're too early, and what are you seeing customers buying? If they're not buying your 2.0 bundle, what are these customers that you're calling on buying in the market?

James F. Geiger

I think the reference was to maybe a traditional customer that we focused on that isn't adapting the cloud at a pace that we may have understood -- that we may have guessed. So we are moving -- within the -- we've always sold between 5 and 250 employees. It was -- about 85% of our traditional customers are based -- before we started our transformation, 85% of them fell in the sub-20 category. And I think we had an average of 12 employees in our customer base. So what we're finding is a slight shift upward in the 30 to 100 as being our sweet spot versus the 5 to 30. So that 30 to 100, our customers that largely have technology demands that we call them a tech dependent customer, they often have remote workers. They have high-bandwidth needs. They have knowledge workers; the somebody who sits behind a computer. They have some compliance needs. And multi-location again is also a very important aspect of that potential customer. So we're -- that now is more of a focus. We had about 15% to 20% of them in our base of customers and now, that is more of our focus with our new set of services.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Yes, but why aren't the customers adopting 2.0 product set to the extent that you would have thought? Is it on the customer side or the sell side or the product mix side?

J. Robert Fugate

At that lower end, what we're competing for are companies that have not embraced moving their service to the cloud. They have embraced moving their PBX. We talked about the attach rates of 20%, which I think is extraordinary, frankly. But we are competing with on-premise service in that lower end of that marketplace, and the customers that we are focused on are buying our services. I mean we had a 21% increase of our managed hosting and cloud services year-over-year. So that is moving. It isn't moving as fast as we wanted to, but we are finding good adoption there. And if I've given you the impression that customers, our prospects aren't buying our services, I've given you the wrong impression.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Okay. Let me shift gears and maybe a question for Bob in terms of the guidance. If I compare the full year revenue EBITDA guidance and calculate a margin versus what you've already reported for the first half of the year, it looks like a pretty significant step down in the adjusted EBITDA margin. Where should we look for that and what does that imply in terms of your ability to spend on SG&A and marketing expenditures?

J. Robert Fugate

Well, I think we have certainly -- we've outlined for you some discussion of how we are shifting resources among channels. We've got in place the plans to significantly grow our emphasis on some of the channels that we think are more productive and efficient than others. We talked in our prepared remarks about our investment in the indirect and inside sales efforts. We're continuing to work our other 2.0 channel, what we call our SA channel. So there's a significant emphasis and ongoing investment in those areas that is important to our positioning the business as we described previously with greater emphasis on selling 2.0 revenue. And I think we feel confident that we've got the resources we need to accomplish that, as well as hitting the EBITDA margins and levels that we've provided in our guidance, as well as the cash flow.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Okay. And my last question on the mobile product, if you could talk about, is that product available both on iOS and Android platforms? And to what extent you have available to you the latest models of the various handsets?

James F. Geiger

We've got good inventory on Android-based sets, but not -- we do not represent Apple products today. But you can bring your own device for our service. It just has a different cost point.

Robert G. Clancy

Jonathan, we have time for one more question.

Operator

Certainly. Our final question comes from the line of Donna Jaegers from D.A. Davidson.

Donna Jaegers - D.A. Davidson & Co., Research Division

Just 2 quick ones. On the ARPU of $662, Bob, I think you mentioned that there was some onetime benefit there. Can you sort of break that out a little more?

J. Robert Fugate

Yes. There were no onetime benefits to ARPU. What I was referring to is that the 2 principal positive drivers in that $6 increase in ARPU were the fact that we had a full -- we enjoyed a full quarter of the cost recovery increase we started in Q1; that's not a onetime event. That's essentially an increase to prices and that continues going forward. So that was one component. The other component of increasing ARPU in the quarter was simply selling more cloud applications to our customers. So that's a positive aspect of what Jim was referring to previously with our traction in selling 2.0 application.

Donna Jaegers - D.A. Davidson & Co., Research Division

Great. And then just to sort of get your definitions clear on some of these. You talk about Cbeyond 2.0, which includes higher bandwidth services, cloud PBX and cloud, so that's the all-inclusive term. And then later in the release, you break out cloud and that's sort of sitting flat at around $3.5 million in the quarter. So when you guys talk about cloud and managed services, what does the managed services include? Is that just the hosted -- that's just the cloud PBX?

J. Robert Fugate

Managed hosting and cloud revenue includes all of our cloud services. So it includes the cloud PBX plus the cloud server revenues. It also includes dedicated server revenues as well, which you would kind of place more under the managed hosting than the cloud part of that description. Our 2.0 revenues are also partly inside of that network, voice and data revenue component because that network, voice and data refers to both one -- both the T1-based accounts and the revenue they generate, as well as the higher bandwidth revenue that we get from that fiber and Ethernet-over-copper access.

Operator

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Jim Geiger for closing comments.

James F. Geiger

Thank you, operator, and thank you for joining us on the call. We continue to make significant progress transforming our business to become the premier cloud solutions provider to the small and mid-sized business market. Our transformation is working and the 2.0 metrics are moving in a positive direction and show evidence of a growing business opportunity. We have pockets of success that we need to replicate across the business. We recognize that we must improve sales productivity. Although the pace of transformation is a bit slower than expected, we're making the right changes to our business, and the underlying foundation remains healthy, as evidenced by our EBITDA and free cash flow performance. Our balance sheet strength and solid free cash flow generation allows us to return significant capital to our shareholders. And finally, we want to thank you, our investors, for their continued support in our company. Thanks again for joining the call and have a great night.

Operator

Thank you, ladies and gentlemen, for your anticipation in today's conference. This does conclude the program. You may now disconnect. Good day.

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