0001445305-12-003439.txt : 20121106 0001445305-12-003439.hdr.sgml : 20121106 20121105193038 ACCESSION NUMBER: 0001445305-12-003439 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 20120930 FILED AS OF DATE: 20121106 DATE AS OF CHANGE: 20121105 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CBEYOND, INC. CENTRAL INDEX KEY: 0001205727 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 000000000 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-51588 FILM NUMBER: 121181475 BUSINESS ADDRESS: STREET 1: 320 INTERSTATE NORTH PARKWAY SE STREET 2: SUITE 500 CITY: ATLANTA STATE: GA ZIP: 30339 BUSINESS PHONE: 678-424-2400 MAIL ADDRESS: STREET 1: 320 INTERSTATE NORTH PARKWAY SE STREET 2: SUITE 500 CITY: ATLANTA STATE: GA ZIP: 30339 FORMER COMPANY: FORMER CONFORMED NAME: CBEYOND INC DATE OF NAME CHANGE: 20060717 FORMER COMPANY: FORMER CONFORMED NAME: CBEYOND COMMUNICATIONS INC DATE OF NAME CHANGE: 20021113 10-Q 1 cbey-2012930x10q.htm 10-Q CBEY-2012.9.30-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 000-51588 
CBEYOND, INC.
(Exact name of registrant as specified in its charter) 
Delaware
 
59-3636526
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
320 Interstate North Parkway, Suite 500
Atlanta, GA
 
30339
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (678) 424-2400
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
¨

 
Accelerated filer
 
ý
 
 
 
 
 
 
 
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Title of Class
 
Number of Shares Outstanding on November 1, 2012
Common Stock, $0.01 par value
 
29,819,968

1


INDEX
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
In this document, Cbeyond, Inc. and its subsidiary are referred to as “we,” “our,” “us,” the “Company” or “Cbeyond.”
This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to, statements identified by words such as “expectation,” “guidance,” “believe,” “expect” “anticipate,” “estimate,” “intend,” “plan,” “target,” “project,” and similar expressions. Such statements are based upon the current beliefs and expectations of our 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: 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 increase in customer churn levels; changes in federal or state regulation or decisions by regulatory bodies that affect us; periods of economic downturn or unusual volatility in the capital markets or other negative macroeconomic conditions that could harm our business, including our access to capital markets and the impact on 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 retain experienced management and personnel; rapid technological change and the timing and amount of startup costs incurred in connection with the introduction of new services or the entrance into new markets; our ability to maintain or attract sufficient customers in existing or new markets; our ability to respond to increasing competition; our ability to manage the growth of our operations; changes in estimates of taxable income or utilization of deferred tax assets which could significantly affect our effective tax rate; pending regulatory action relating to our compliance with customer proprietary network information; the risk that the anticipated benefits, growth prospects and synergies expected from our acquisitions may not be fully realized or may take longer to realize than expected; the possibility that economic benefits of future opportunities in an emerging industry may never materialize, including unexpected variations in market growth and demand for the acquired products and technologies; delays, disruptions, costs and challenges associated with integrating acquired companies into our existing business, including changing relationships with customers, employees or suppliers; unfamiliarity with the economic characteristics of new geographic markets; ongoing personnel and logistical challenges of managing a larger organization; our ability to retain and motivate key employees from the acquired companies; external events outside of our control, including extreme weather, natural disasters, pandemics or terrorist attacks that could adversely affect our target markets; our ability to implement and execute successfully our new strategic focus; our ability to expand fiber availability; the extent to which small and medium sized businesses continue to spend on cloud, network and security services; our ability to recruit, maintain and grow a sales force focused exclusively on our technology-dependent customers; our ability to integrate new products into our existing infrastructure; the effects of realignment activities; the extent to which our customer mix becomes more technology-dependent; our ability to achieve future cost savings related to our capital expenditures and investment in Ethernet technology; and general economic and business conditions. You are advised to consult any further disclosures we make on related subjects in the reports we file with the Securities and Exchange Commission, or SEC, including our Annual Report on Form 10-K for the year ended December 31, 2011 and any updates that may occur in our quarterly reports on Form 10-Q and Current Reports on Form 8-K and this report in the sections titled “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part II, Item 1A. Risk Factors.” 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.


3


Part I. FINANCIAL INFORMATION
Item 1.    Financial Statements
CBEYOND, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
(Amounts in thousands, except per share amounts)
(Unaudited)
 
As of
 
September 30, 2012
 
December 31,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
23,876

 
$
8,521

Accounts receivable, gross
25,877

 
27,479

Less: Allowance for doubtful accounts
(2,346
)
 
(2,608
)
Accounts receivable, net
23,531

 
24,871

Prepaid expenses
11,042

 
7,447

Inventory, net
1,956

 
1,772

Restricted cash

 
1,295

Deferred tax asset, net
205

 
450

Other assets
1,457

 
562

Total current assets
62,067

 
44,918

Property and equipment, gross
527,289

 
486,273

Less: Accumulated depreciation and amortization
(370,789
)
 
(325,803
)
Property and equipment, net
156,500

 
160,470

Goodwill
19,814

 
19,814

Intangible assets, gross
9,609

 
9,609

Less: Accumulated amortization
(2,476
)
 
(1,507
)
Intangible assets, net
7,133

 
8,102

Non-current deferred tax asset, net
1,390

 
4,254

Other non-current assets
4,196

 
3,514

Total assets
$
251,100

 
$
241,072

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
16,462

 
$
14,467

Accrued telecommunications costs
15,557

 
16,548

Deferred customer revenue
11,372

 
11,360

Other accrued liabilities
24,216

 
20,925

Current portion of fiber debt
199

 

Contingent consideration

 
4,927

Total current liabilities
67,806

 
68,227

Non-current fiber debt
3,158

 

Other non-current liabilities
7,351

 
8,858

Stockholders’ equity:
 
 
 
Common stock, $0.01 par value; 50,000 shares authorized; 29,803 and 28,913 shares issued and outstanding, respectively
298

 
289

Preferred stock, $0.01 par value; 15,000 shares authorized; no shares issued and outstanding

 

Additional paid-in capital
318,709

 
311,370

Accumulated deficit
(146,222
)
 
(147,672
)
Total stockholders’ equity
172,785

 
163,987

Total liabilities and stockholders’ equity
$
251,100

 
$
241,072

See accompanying notes to Condensed Consolidated Financial Statements.

4


CBEYOND, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Operations
(Amounts in thousands, except per share amounts)
(Unaudited)
 
For the three months ended September 30,
 
For the nine months ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenue
121,491

 
122,529

 
369,096

 
362,101

Operating expenses:
 
 
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization of $10,304, $9,324, $30,882, and $28,252, respectively, shown separately below)
38,675

 
40,457

 
119,323

 
120,261

Selling, general and administrative (exclusive of depreciation and amortization of $7,868, $7,518, $24,536 and $22,548, respectively, shown separately below)
60,584

 
65,744

 
185,977

 
194,587

Depreciation and amortization
18,172

 
16,842

 
55,418

 
50,800

Total operating expenses
117,431

 
123,043

 
360,718

 
365,648

Operating income (loss)
4,060

 
(514
)
 
8,378

 
(3,547
)
Other (expense) income:
 
 
 
 
 
 
 
Interest expense
(138
)
 
(136
)
 
(409
)
 
(363
)
Other income, net

 

 

 
1,210

Income (loss) before income taxes
3,922

 
(650
)
 
7,969

 
(2,700
)
Income tax expense
(1,969
)
 
(491
)
 
(4,516
)
 
(258
)
Net income (loss)
$
1,953

 
$
(1,141
)
 
$
3,453

 
$
(2,958
)
Net income (loss) per common share:
 
 
 
 
 
 
 
Basic
$
0.07

 
$
(0.04
)
 
$
0.12

 
$
(0.10
)
Diluted
$
0.06

 
$
(0.04
)
 
$
0.12

 
$
(0.10
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
29,533

 
29,442

 
29,348

 
29,606

Diluted
30,267

 
29,442

 
29,971

 
29,606

See accompanying notes to Condensed Consolidated Financial Statements.

CBEYOND, INC. AND SUBSIDIARY
Condensed Consolidated Statement of Stockholders’ Equity
(Amounts in thousands)
(Unaudited)
 
Common Stock
 
Additional
 
 
 
Total
 
Shares
 
Par
Value
 
Paid-in
Capital
 
Accumulated
Deficit
 
Stockholders’
Equity
Balance at December 31, 2011
28,913

 
$
289

 
$
311,370

 
$
(147,672
)
 
$
163,987

Exercise of stock options
407

 
4

 
1,580

 

 
1,584

Issuance of employee benefit plan stock
313

 
3

 
131

 

 
134

Issuance of employee bonus plan stock
89

 
1

 
694

 

 
695

Share-based compensation from options to employees

 

 
1,137

 

 
1,137

Share-based compensation from restricted shares to employees

 

 
5,114

 

 
5,114

Share-based compensation for non-employees

 

 
75

 

 
75

Vesting of restricted shares
507

 
5

 
(5
)
 

 

Common stock withheld as payment for withholding taxes upon the vesting of restricted shares
(176
)
 
(2
)
 
(1,387
)
 

 
(1,389
)
Shares repurchased under our publicly announced share repurchase program
(250
)
 
(2
)
 

 
(2,003
)
 
(2,005
)
Net income

 

 

 
3,453

 
3,453

Balance at September 30, 2012
29,803

 
$
298

 
$
318,709

 
$
(146,222
)
 
$
172,785

See accompanying notes to Condensed Consolidated Financial Statements.

CBEYOND, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)
 
For the nine months ended September 30,
 
2012
 
2011
Operating Activities:
 
 
 
Net income (loss)
$
3,453

 
$
(2,958
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
55,418

 
50,800

Deferred taxes
3,109

 
(455
)
Provision for doubtful accounts
4,685

 
4,723

Other non-cash income, net

 
(1,210
)
Non-cash share-based compensation
9,697

 
10,551

Change in acquisition-related contingent consideration
23

 
(329
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(3,345
)
 
(5,909
)
Inventory
(184
)
 
156

Prepaid expenses and other current assets
(4,490
)
 
(1,067
)
Other assets
(497
)
 
301

Accounts payable
1,995

 
3,656

Other liabilities
(1,742
)
 
(3,187
)
Net cash provided by operating activities
68,122

 
55,072

Investing Activities:
 
 
 
Purchases of property and equipment
(47,117
)
 
(59,235
)
Additional acquisition consideration
(4,950
)
 
(780
)
Decrease in restricted cash
1,295

 

Net cash used in investing activities
(50,772
)
 
(60,015
)
Financing Activities:
 
 
 
Taxes paid on vested restricted shares
(1,389
)
 
(1,813
)
Proceeds from short-term borrowings
4,250

 

Repayment of short-term borrowings
(4,250
)
 

Financing issuance costs
(185
)
 
(343
)
Proceeds from exercise of stock options
1,584

 
315

Repurchase of common stock
(2,005
)
 
(11,094
)
Net cash used in financing activities
(1,995
)
 
(12,935
)
Net increase (decrease) in cash and cash equivalents
15,355

 
(17,878
)
Cash and cash equivalents at beginning of period
8,521

 
26,373

Cash and cash equivalents at end of period
$
23,876

 
$
8,495

Supplemental disclosure:
 
 
 
Interest paid
$
290

 
$
219

Income taxes paid, net of refunds
$
1,180

 
$
763

Non-cash purchases of property and equipment
$
3,357

 
$
87

See accompanying notes to Condensed Consolidated Financial Statements.


5


CBEYOND, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts)
(Unaudited)
Note 1. Description of Business, Basis of Presentation and Summary of Significant Accounting Policies
Cbeyond, Inc., a managed information technology (or “IT”) and communications service provider, incorporated on March 28, 2000 in Delaware. Our services include cloud applications such as Microsoft® Exchange, data center infrastructure as a service, cloud private branch exchange (or “PBX”) phone systems, Microsoft® SQL Server®; as well as networking and telecommunication services such as broadband Internet access, Multi-Protocol Label Switching (or “MPLS”), virtual private networking, mobile voice and data, information security, local and long distance voice services; and administration management and professional services to migrate and manage customer environments.
The majority of such services, other than cloud-based services purchased independent of network access, are delivered over our secure all-Internet Protocol network via dedicated connections, which allows us to control quality of service much better than services delivered over the best-efforts public Internet. We utilize various types of high-speed connections where available and economically feasible, such as Ethernet-over-copper and Fiber Optic Metro Ethernet (collectively referred to as “Metro Ethernet”), allowing for the rapid deployment of new products and services. Our network allows us to manage quality of service and achieve network reliability comparable to that of traditional communications networks.
Unaudited Interim Results
The accompanying unaudited interim Condensed Consolidated Financial Statements and information have been prepared in accordance with generally accepted accounting principles in the United States (or “GAAP”) and in accordance with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by GAAP for complete financial statements. In the opinion of management, these financial statements contain all normal and recurring adjustments considered necessary to present fairly the financial position, results of operations and cash flows for the periods presented. The results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results to be expected for the full year. These statements should be read in conjunction with our audited Consolidated Financial Statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011.
Reclassifications
Reclassifications have been made to the three and nine months ended September 30, 2011 Condensed Consolidated Statement of Operations to condense Customer revenue and Terminating access revenue and conform to our current presentation of Revenue for the three and nine months ended September 30, 2012.
Recently Adopted Accounting Standards
In May 2011, the Financial Accounting Standards Board (or “FASB”) issued amended guidance on fair value measurement and related disclosures. The new guidance clarifies the concepts applicable for fair value measurement of non-financial assets and requires the disclosure of quantitative information about the unobservable inputs used in a fair value measurement. This guidance is effective for reporting periods beginning after December 15, 2011, and is applied prospectively. The adoption of this amended guidance did not have any effect on our consolidated financial statements.
In June 2011, the FASB issued amended guidance on the presentation of comprehensive income. The amended guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. In addition, it gives an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance is effective for reporting periods beginning after December 15, 2011 and is applied retrospectively. As we do not currently have components of other comprehensive income, the adoption of this guidance did not have any effect on our consolidated financial statements.
Note 2. Earnings per Share
Basic and Diluted Net Income (Loss)
We calculate basic net income (loss) per share by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period. Our diluted net income (loss) per share is calculated in a similar manner, but includes the effect of dilutive common equivalent shares outstanding during the year. To the extent any common equivalent shares from stock options and other common stock equivalents are anti-dilutive, they are excluded from the computation of dilutive net loss per share. We were in a net loss position for the three and nine months ended September 30, 2011, resulting in no difference between basic net loss per share and diluted net loss per share.
The following table summarizes our basic and diluted net income (loss) per share calculations (in thousands, except per share amounts): 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2012
 
2011
 
2012
 
2011
Net income (loss)
$
1,953

 
$
(1,141
)
 
$
3,453

 
$
(2,958
)
Basic weighted average common shares outstanding
29,533

 
29,442

 
29,348

 
29,606

Effect of dilutive securities
734

 

 
623

 

Diluted weighted average common shares outstanding
30,267

 
29,442

 
29,971

 
29,606

Basic income (loss) per common share
$
0.07

 
$
(0.04
)
 
$
0.12

 
$
(0.10
)
Diluted income (loss) per common share
$
0.06

 
$
(0.04
)
 
$
0.12

 
$
(0.10
)
Securities that were not included in the diluted net income (loss) per share calculations because they were anti-dilutive, inclusive of unexercised stock options and unvested restricted stock (see Note 6 to the Condensed Consolidated Financial Statements), are as follows (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2012
 
2011
 
2012
 
2011
Anti-dilutive shares
3,512

 
5,122

 
3,693

 
5,141

Note 3. Acquisitions
On November 3, 2010, we acquired substantially all of the net assets of privately-held MaximumASP, LLC, MaximumCOLO, LLC, and Maximum Holdings, LLC (collectively known as “MaximumASP”). On October 29, 2010, we acquired 100% of the outstanding voting stock of privately-held Aretta Communications, Inc. (or “Aretta”).
The final acquisition-date fair value of the consideration transferred to the shareholders of MaximumASP totaled $33,400, which consisted of cash consideration of $28,791 (exclusive of $94 of cash acquired) and estimated contingent consideration of $4,609. During the second quarter of 2011, we amended the asset purchase agreement with MaximumASP to clarify certain terms of the agreement. The amendment revised the 2011 revenue achievement range of $10,800 to $11,400 to a range of $13,000 to $16,000, adding revenue components that were not considered in the original agreement. The amendment did not alter the total eligible contingent consideration of $5,400, nor did it alter the contingent consideration payment date. The effect of this amendment on our financial statements was not significant. Based on the revenue level that was actually achieved in 2011, we paid the shareholders of MaximumASP $4,150 in March 2012.
The final acquisition-date fair value of the consideration transferred to the sellers of Aretta totaled $4,027, which consisted of cash consideration of $2,465 (exclusive of $177 of cash acquired) and estimated contingent consideration of $1,562. During the second and fourth quarters of 2011, we made cash payments of $400 and $400, respectively, to the former shareholders of Aretta upon achievement of product development milestones. Based on the revenue level that was actually achieved in 2011, we paid the former shareholders of Aretta $800 in March 2012.
The following table summarizes changes to our total contingent consideration liability recorded from December 31, 2011 to September 30, 2012:
 
Contingent
consideration
liability
December 31, 2011
$
4,927

Fair value adjustments
23

Contingent consideration paid
(4,950
)
September 30, 2012
$


6


Note 4. Debt
Our debt is comprised of the following:
 
 
September 30,
2012
 
December 31,
2011
Fiber capital leases
$
199

 
$

Current portion of fiber debt
$
199

 
$

Fiber Loan
$
2,000

 
$

Fiber capital leases
1,158

 

Non-current fiber debt
$
3,158

 
$

Credit Facility
We are party to a credit agreement with Bank of America, which provides for a $75,000 revolving line of credit (or “Credit Facility”). On March 31, 2012, we entered into the sixth amendment of the Credit Facility to increase the allowable capital lease amounts under the agreement from $10,000 to $30,000. On May 2, 2012, we amended and restated our Credit Facility to provide a senior secured delayed draw term loan (or “Fiber Loan”) of $10,000. In general, funds available to us under the Fiber Loan may be drawn during an 18-month period and repayments are due in quarterly installments beginning in 2013 through the maturity date of May 2, 2017. The Credit Facility is secured by all of the assets of the Company.
Borrowings under the Credit Facility approximate fair value due to their variable interest rates and are based on Level 2 inputs. We value long-term debt using market and/or broker ask prices when available. When not available, we use a standard credit adjusted discounted cash flow model.
Under the terms of the amended and restated Credit Facility, we are subject to certain financial covenants and restrictive covenants, which limit, among other items, our ability to incur additional indebtedness, make investments, sell or acquire assets and grant security interests in our assets. Through the maturity date of the Credit Facility, we are required to maintain a consolidated leverage ratio less than or equal to 1.5 to 1.0. We are also required to maintain minimum levels of Adjusted EBITDA (on a rolling four quarter basis) and maximum levels of annual capital expenditures as presented below:
Year ending December 31,
Maximum
Capital
Expenditures
 
Minimum
Adjusted
EBITDA
2012
$
85,000

 
$
68,000

2013
90,000

 
75,000

2014
87,000

 
75,000

2015 through the maturity date
$
94,000

 
$
75,000

Other terms of the Credit Facility are further described in Note 9 to our Consolidated Financial Statements and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the year ended December 31, 2011. As of September 30, 2012, we are in compliance with all applicable covenants.
During the nine months ended September 30, 2012, we borrowed and repaid $4,250 of short term borrowings under our revolving line of credit, and as of September 30, 2012, we had no outstanding borrowings, utilized $1,345 for letters of credit and had $73,655 in remaining availability. As of September 30, 2012, we had $2,000 outstanding under the Fiber Loan at an annual interest rate of 2.0% and had remaining availability of $8,000.
Fiber Capital Leases
The amendments to our Credit Facility were made in connection with our strategic initiative to focus on technology-dependent customers while delivering higher network bandwidth at a lower overall cost. In March 2012, we executed agreements with Fiber Optic providers whereby we will acquire fiber network assets in multiple markets under 20-year capital leases, including an agreement for the indefeasible rights of use of certain fiber assets. Our contracts include commitments expected to be satisfied through monthly payments over the first five years, and commitments expected to be satisfied through lump sum payments as delivery milestones are met. All lump sum payments will be directly funded by our Fiber Loan, which will be repaid by us through the maturity date of May 2, 2017.
Upon execution of these agreements, we took delivery of fiber assets and incurred minimum capital lease obligations of $2,400, which were recorded to Property and equipment and Non-current fiber debt. This obligation was partially satisfied in

7


May 2012 through a $2,000 lump sum payment directly funded by our Fiber Loan. During the second quarter of 2012, we took delivery of additional fiber assets and recorded Property and equipment and capital lease obligations of $957, of which $199 were recorded to Current portion of fiber debt. No fiber assets were delivered during the third quarter of 2012.
Under these agreements, we have outstanding construction orders for fiber assets with future minimum lease payments of $2,450, for which we have obtained building access agreements (or "BAAs"). We enter into BAAs with building owners in order to locate equipment on-site that will be used to serve tenants and also access building risers and raceways for interior wiring. These commitments are not recognized on our balance sheet as of September 30, 2012 because they are contingent upon construction being completed and acceptance of the fiber assets. As of September 30, 2012, our commitments to Fiber Optic providers, based on estimated delivery dates of these fiber assets, will be payable as follows:
Year ending December 31,
Fiber lease commitments
2012
$
30

2013
490

2014
490

2015
490

2016
490

Thereafter
460

Total
$
2,450

As of September 30, 2012, we have placed additional construction orders that total $14,680 for which we have not yet obtained building access agreements. We do not expect to be able to obtain building access agreements for every order placed. Therefore, we expect a portion of these orders may never be constructed. Additional construction orders may be placed in the future. In addition, we have up to $5,600 of available fiber assets that we may order at our option and fund by our Fiber Loan.
Note 5. Strategic Realignment
In early 2012, we began a strategic shift to directly focus more of our selling and service delivery efforts toward the customers within our target market of technology-dependent small and mid-sized businesses that have complex IT needs. We announced this strategy during the first quarter of 2012 and accelerated efforts to realign our distribution channels by building a new direct sales group dedicated to managing both existing and new technology-dependent customers, reducing our traditional direct sales force, and consolidating certain offices.
This strategic realignment resulted in $2,606 of expense during the nine months ended September 30, 2012. During the first quarter of 2012, we recognized $682 of non-cash costs included in Depreciation and amortization. All other costs are included in Selling, general, and administrative expense.
The following table summarizes changes to the accrued liability associated with the strategic realignment during 2012: 
 
Employee
costs (1)
 
Facility exit
costs (2)
 
Other
costs
 
Total
Expense
$
1,119

 
$
696

 
$
109

 
$
1,924

Payments
(983
)
 
(222
)
 
(109
)
 
(1,314
)
Accrued liability at September 30, 2012
$
136

 
$
474

 
$

 
$
610

(1)
The remaining employee-related liability will be paid within 12 months and approximates fair value due to the short discount period.
(2)
Includes costs for consolidating certain leased offices. These charges were measured using fair value measurements with unobservable inputs (Level 3) and represent the present value of expected lease payments and direct costs to obtain a sublease, reduced by estimated sublease rental income. The timing and amount of estimated cash flows will continue to be evaluated each reporting period.
Note 6. Share-Based Compensation Plans
We maintain share-based compensation plans, governed under our 2005 Equity Incentive Award Plan, that permit the grant of nonqualified stock options, incentive stock options, restricted stock and stock purchase rights (collectively referred to as "share-based awards"). Although the Board of Directors may approve a different vesting period, share-based awards generally vest at a rate of 25% per year over four years or at the attainment of certain performance targets as of the determination date. Upon an exercise of options or a release of restricted stock, new shares are issued out of our approved stock plans. As of September 30, 2012, we had 247 share-based awards available for future grant. Compensation expense for share-based awards, including those related to our 401(k) Profit Sharing Plan and our corporate bonus plans, totaled $2,975 and $9,697 during the three and nine months ended September 30, 2012, respectively, and totaled $2,920 and $10,551 during the three and nine months ended September 30, 2011, respectively.
Consistent with the prior year, 50% of the share-based awards granted to our Chief Executive Officer in 2012 are based on achieving financial performance metrics, and beginning this year, 30% of the share-based awards granted in 2012 to certain other executive officers are based on these same metrics. The 2012 performance-based awards are earned based upon attaining a certain financial performance metric in 2012 with 25% of these awards contingent upon sustaining the metric in 2013. Under the terms of these awards granted to the Chief Executive Officer and other executive officers in 2012, 50% will vest in 2014 and 50% in 2015.
On September 23, 2012 the Board of Directors approved a grant of restricted shares to certain executive officers, excluding our Chief Executive Officer. The restricted shares include 375 shares that vest based on our share price performance compared to the Russell 2000 Index over a two year period beginning October 1, 2012. Each executive is granted a target number of shares and will ultimately earn between 0% and 150% of the target amount of shares based on a performance multiplier. The aggregate grant date fair value of the market restricted shares is $3,686, of which $34 was recognized during the three months ended September 30, 2012. The fair value of performance awards with a market condition are determined using a Monte Carlo simulation. The Monte Carlo valuation model simulates a range of possible future stock prices for the Company and the Russell 2000 Index to estimate the probability that a vesting condition will be achieved. Assumptions used in the Monte Carlo valuation model include a risk-free rate of return of 0.3% an expected term of 2.0 years, and volatility of 49.7%. We considered historic and observable market data when determining these assumptions. Expense is recognized ratably over the two-year vesting period.
The following table summarizes changes in outstanding share-based awards from December 31, 2011 to September 30, 2012: 
 
Stock options
 
Restricted stock
Outstanding, December 31, 2011
3,616

 
1,186

Granted
324

 
1,177

Stock options exercised (A)
(407
)
 

Restricted stock vested (B)

 
(596
)
Forfeited or canceled
(145
)
 
(116
)
Outstanding, September 30, 2012
3,388

 
1,651

Options exercisable, September 30, 2012
2,792

 
 
(A)
The total intrinsic value of options exercised during the nine months ended September 30, 2012 was $1,812 .
(B)
The fair value of restricted shares that vested during the nine months ended September 30, 2012 was $4,412.
The following table summarizes the weighted average grant date fair values and the trinomial option-pricing model assumptions that were used to estimate the grant date fair value of options granted during the nine months ended September 30, 2012 and 2011: 
 
Nine months ended September 30,
 
2012
 
2011
Grant date fair value
$
3.15

 
$
6.49

Expected dividend yield
%
 
%
Expected volatility
53.4
%
 
53.2
%
Risk-free interest rate
1.4
%
 
2.9
%
Expected multiple of share price to exercise price upon exercise
2.0

 
2.0

Post vest cancellation rate
2.9
%
 
1.1
%
As of September 30, 2012, we had $2,223 and $12,648 of unrecognized compensation expense related to unvested options and restricted stock, respectively, which are expected to be recognized over a weighted average period of 2.7 and 2.1 years, respectively.
During the first quarter of 2012, management approved a mandatory share-based compensation plan for employee participants that provides for the settlement of 20% of performance-based compensation under our 2012 corporate bonus plan with shares of common stock. The shares earned by the participants in this plan vest at various points in 2013. During the three and nine months ended September 30, 2012, we recognized $555 and $1,540, respectively of share-based compensation expense under our 2012 corporate bonus plan. Based on the September 30, 2012 share price, 157 shares would be required to satisfy the $1,540 obligation as of September 30, 2012.
We have a commitment to contribute shares to the 401(k) Profit Sharing Plan (or “Plan”) at the end of each Plan year which equates to a matching contribution value as a percentage of eligible employee compensation. We match up to 3.5% of eligible compensation contributed to the plan. We fund our matching contribution in Company stock and the number of shares we contribute is based on the share price on the last day of the Plan year. Throughout the year, the ultimate number of shares that settles relating to our matching contribution remains variable until the December 31 settlement date. The Plan does not limit the number of shares that can be issued to settle the matching contribution. During the three and nine months ended September 30, 2012, we recognized $654 and $1,934, respectively, of share-based compensation expense related to the Plan as compared to $646 and $1,802 for the three and nine months ended September 30, 2011, respectively. Based on the September 30, 2012 share price, 201 shares would be required to satisfy the $1,977 obligation as of September 30, 2012, assuming all participants were fully vested as of September 30, 2012.
Note 7. Income Taxes
The following table summarizes significant components of our income tax expense for the nine months ended September 30, 2012 and 2011: 
 
Nine months ended September 30,
 
2012
 
2011
Federal income tax expense (benefit) at statutory rate
$
2,789

 
$
(945
)
State income tax expense, net of federal effect
578

 
285

Nondeductible expenses
223

 
171

Write-off deferred tax assets for non-deductible share-based compensation
1,216

 
1,668

Change in valuation allowance
(276
)
 
(900
)
Other
(14
)
 
(21
)
Total
$
4,516

 
$
258

When a reliable estimate of the annual effective tax rate can be made, we recognize interim period income tax expense (benefit) by determining an estimated annual effective tax rate and then apply this rate to the pre-tax income (loss) for the year-to-date period. Our estimated annual tax rate fluctuates significantly from only slight variances in estimated full year income due to our proximity to break-even results. Our income tax expense (benefit) includes state income tax expense that results from Texas gross receipts-based tax, which is due regardless of profit levels. This tax is not dependent upon levels of pre-tax income (loss) and has a significant influence on our effective tax rate. Accordingly, we recognized interim period tax expense through September 30, 2012 based on our year-to-date effective tax rate. This methodology provides a more accurate portrayal of our year-to-date income tax expense, as well as reduces the impact that future income variances will have on the accuracy of this amount.
Our 2012 and 2011 income tax expense includes the effects of certain transactions that are not recognized through the year-to-date effective tax rate, but rather are recognized as discrete events during the quarter in which they occur. During the nine months ended September 30, 2012 and 2011, certain restricted shares vested where the market price on the vesting date was lower than the market price on the date the restricted shares were originally granted. This resulted in realizing a lower actual tax deduction than was deducted for financial reporting purposes. During the nine months ended September 30, 2012 and 2011 we wrote off deferred tax assets of $1,216 and $1,668, respectively, relating to the share-based compensation that had been recognized for these restricted shares for financial reporting purposes, with the charge going first to exhaust the Company’s accumulated additional-paid-in-capital pool, and the remainder charged to income tax expense. Additionally, a portion of our valuation allowance against the stock compensation deferred tax assets was no longer required and was reduced.
Our net deferred tax assets, after valuation allowance, totaled approximately $1,595 at September 30, 2012 and primarily relate to net operating loss carryforwards. In order to realize the benefits of the deferred tax asset recognized at September 30, 2012, we will need to generate approximately $4,200 in pre-tax income in the foreseeable future, which management currently believes is achievable. If we generate less taxable income, which is reasonably possible, we may have to increase our allowance against our net deferred tax assets with a corresponding increase to income tax expense.
Note 8. Other Liabilities
The following table summarizes significant components of other liabilities as of September 30, 2012 and December 31, 2011:
 
September 30,
2012
 
December 31,
2011
Accrued bonus
$
8,943

 
$
8,918

Accrued other compensation and benefits
5,493

 
1,962

Accrued other taxes
4,370

 
4,404

Accrued promotions
660

 
1,155

Deferred rent
2,466

 
1,991

Other accrued expenses
2,284

 
2,495

Other accrued liabilities
$
24,216

 
$
20,925

Non-current portion of deferred rent
$
6,107

 
$
7,348

Non-current other accrued expenses
1,244

 
1,510

Other non-current liabilities
$
7,351

 
$
8,858

Note 9. Segment Information
Through June 30, 2012, we were organized into three reportable segments: Core Managed Services Established Markets, Core Managed Services Emerging Markets, and Cloud Services. Our Chief Executive Officer is the Chief Operating Decision Maker (or “CODM”). Beginning in late 2011 and continuing into the third quarter of 2012, we integrated substantially all administrative and operating functions of our former Cloud Services segment into the administrative and operating functions of our former Core Managed Services segments. Sales and marketing functions have also been substantially combined as we focus on selling integrated service packages that include our cloud-based services. Due to the advanced stage of our integration, during the third quarter of 2012, our CODM began assessing performance on product-oriented basis rather than on a geographic basis by reviewing financial results on a consolidated basis accompanied by disaggregated revenue information by product line. Accordingly, we have revised our reportable segments to reflect the way our CODM is currently managing and viewing the business. As of September 30, 2012 we operate our business as one reportable segment.
Note 10. Share Repurchase Program
On May 2, 2011, Cbeyond’s Board of Directors authorized up to $15,000 in repurchases of Cbeyond common shares from time to time in open market purchases, privately negotiated transactions or otherwise. During the first quarter of 2012, we completed the program by repurchasing $2,005 in outstanding shares, representing 250 shares at an average price of $8.01 per share. Since the beginning of the program in May 2011, we repurchased 1,514 shares at an average price of $9.93. Repurchased shares are retired and are no longer issued and outstanding, but remain authorized shares.
Note 11. Contingencies
Triennial Review Remand Order
The Federal Communications Commission issued its Triennial Review Remand Order (or “TRRO”) and adopted new rules, effective in March 2005, governing the obligations of incumbent local exchange carriers (or “ILECs”), to afford access to certain of their network elements, if at all, and the cost of such facilities. Certain ILECs continue to invoice us at incorrect rates, resulting in an accrual for the estimated difference between the invoiced amounts and the appropriate TRRO pricing. These amounts are generally subject to either a two-year statutory back billing period limitation or a 12-month contractual back billing limitation and are reversed as telecommunication cost recoveries once they pass the applicable back billing period, or once a settlement agreement is reached that may relieve a previously recognized liability. As of September 30, 2012 and December 31, 2011, respectively, our accrual for TRRO totals $1,204 and $1,187.
Regulatory and Customer-based Taxation Contingencies
We operate in a highly regulated industry and are subject to regulation and oversight by telecommunications authorities at the federal, state and local levels. Decisions made by these agencies, including the various rulings made to date regarding interpretation and implementation of the TRRO, compliance with various federal and state rules and regulations and other administrative decisions are frequently challenged through both the regulatory process and through the court system. Challenges of this nature often are not resolved for long periods of time and occasionally include retroactive impacts. At any point in time, there are a number of similar matters before the various regulatory agencies that could be either beneficial or adverse to our operations. In addition, we are always at risk of non-compliance, which can result in fines and assessments. We regularly evaluate the potential impact of matters undergoing challenges and matters involving compliance with regulations to determine whether sufficient information exists to require either disclosure and/or accrual. However, due to the nature of the regulatory environment, reasonably estimating the range of possible outcomes and the probabilities of the possible outcomes is difficult since many matters could range from a gain contingency to a loss contingency.
We are required to bill taxes, fees and other amounts (collectively referred to as “taxes”) on behalf of government entities at the county, city, state and federal level (“taxing authorities”). Each taxing authority may have one or more taxes with unique rules as to which services are subject to each tax and how those services should be taxed, the application of which involves judgment and interpretation, and heightens the risk of non-compliance. At times, the statutes and related regulations are ambiguous or appear to conflict, which further complicates our efforts to remain in compliance. Because we sell many of our services on a bundled basis and assess different taxes on the individual components included within the bundle, there is also a risk that a taxing authority could disagree with the taxable value of a bundled component.
Taxing authorities periodically perform audits to verify compliance and include all periods that remain open under applicable statutes, which range from three to four years. At any point in time, we are undergoing audits that could result in significant assessments of past taxes, fines and interest if we were found to be non-compliant. During the course of an audit, a taxing authority may, as a matter of policy, question our interpretation and/or application of their rules in a manner that, if we were not successful in substantiating our position, could potentially result in a significant financial impact to us. In the course of preparing our financial statements and disclosures, we consider whether information exists which would warrant specific disclosure and/or accrual in such situations.
To date, we have been successful in satisfactorily demonstrating our compliance and have concluded audits with either no assessment or assessments that were not material to us. However, we cannot be assured that in every such audit in the future the merits of our position or the reasonableness of our interpretation and application of rules will prevail. During the quarter ended September 30, 2012, we identified conflicting statutes and regulations regarding the taxation of certain transactions in one taxing jurisdiction where we conduct business. We believe it is reasonably possible that the taxing authority will reach a conclusion that differs from ours, representing potential exposure of up to $1,000.
Legal Proceedings
From time to time, we are involved in legal proceedings arising in the ordinary course of business. We believe that we have adequately reserved for these liabilities and that as of September 30, 2012, there is no litigation pending that could have a material adverse effect on our results of operations and financial condition.
As of the date of this filing, we are involved in the preliminary stage of a lawsuit with IPVX Patent Holdings, Inc. (“IPVX”) (the current owner of patents previously owned by Klausner Technologies (“Klausner”)) that Klausner filed in the United States District Court for the Eastern District of Texas. Klausner sued us and a number of other technology companies on October 27, 2011, alleging that our service violates various patents they have for a technology known as visual voicemail, and Klausner subsequently sold the patent to IPVX. The term “visual voicemail” describes the ability to select voicemail messages for retrieval in any order, and it is not clear that we utilize any services to which the patents would apply. Although the patents expired in March 2012, the suit seeks past damages. Klausner has previously sued other parties in matters that were settled prior to trial. Our preliminary licensing discussions with IPVX have not yet clarified any dispute regarding the Cbeyond services to which the patents might arguably apply. Due to these discussions and other legal issues, including our pending Motion to Dismiss, we are currently unable to estimate any possible range of loss which may arise from the lawsuit.

8


Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion together with our Condensed Consolidated Financial Statements and the related notes and other financial information included elsewhere in this periodic report and our Annual Report on Form 10-K. The discussion in this periodic report contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this report should be read as applying to all related forward-looking statements wherever they appear in this report. Our actual results could differ materially from those discussed here. See “Cautionary Notice Regarding Forward-Looking Statements” elsewhere in this report. In this report, Cbeyond, Inc. and its subsidiary are referred to as “we,” “our,” “us,” the “Company” or “Cbeyond”.
Overview
We first launched communication services in Atlanta in April 2001 and have since expanded those services into 13 additional metropolitan markets. Our acquisitions of MaximumASP and Aretta in late 2010 expanded our IT services into cloud computing with virtual and dedicated cloud servers and cloud private branch exchange (or “PBX”).
In late 2011, we began to integrate the operations of MaximumASP and Aretta into our existing operations and under common functional leadership. We began this effort as part of a strategic shift to directly focus more of our selling and service delivery efforts toward the customers within our target market of small and mid-sized businesses that are more dependent on technology and have more complex IT needs. We performed research that enabled us to define and quantify a segment of the small-business customer market called the “technology-dependent” customer. Technology-dependent customers have the following characteristics:
The bulk of their employees use personal computers on the job;
They have knowledge workers who need to share data from a centralized source;
They have remote workers who need to access data on the go;
They need symmetric Metro Ethernet to run their business;
They are often multi-location businesses; and
They have a willingness to consider outsourcing their infrastructure as a way to preserve capital and increase both focus and productivity.
We announced this strategy in early 2012 and accelerated efforts to realign our distribution channels by building a new direct sales group dedicated to managing both existing and new technology-dependent customers, reducing our traditional direct sales force, and consolidating certain offices. This strategic realignment resulted in $2.6 million of expense during the nine months ended September 30, 2012.
In connection with our strategic shift to directly focus on technology-dependent customers, we have defined certain of our technology-dependent customers as “Cbeyond 2.0” customers. Cbeyond 2.0 customers are those customers that we provide network access at speeds in excess of 10 Mbps or certain cloud-based services, such as virtual server, dedicated server, or cloud PBX services. In addition, we designate customers using our MPLS service as Cbeyond 2.0 customers. We refer to all other customers as Cbeyond 1.0 customers. Although Cbeyond 1.0 customers also frequently purchase cloud-based services from us, we delineate between Cbeyond 1.0 and Cbeyond 2.0 based on how pervasive or significant we believe such services are to a customer’s operation. Specifically, we consider the cloud-based services that qualify a customer as Cbeyond 2.0 as infrastructure-as-a-service in nature. We believe the distinction is important because infrastructure services are generally longer-term in nature, generate higher revenues and provide a gateway for software-as-a-service products.
Our cloud-based services that do not qualify a customer as being designated Cbeyond 2.0 include products such as Virtual Receptionist, Microsoft® Exchange hosting, web hosting, and fax-to-email, among others. Depending on the product, we host these types of services for between 5% and 80% of our customers and have been hosting such services for most of our existence, which gives us significant experience in operating in a cloud-based services environment. These cloud-based services are typically included within our bundled service package, but customers purchase additional quantities to meet their specific needs. From the nine months ended September 30, 2011 to the same period in 2012, charges for additional services outside of our bundled package grew 20.0% from $4.4 million to $5.3 million.
We estimate that almost one-half of our customers qualify as technology-dependent, but are not currently considered Cbeyond 2.0 customers because either they do not currently utilize cloud-based solutions, advanced network services, or they utilize cloud-based solutions from other providers. We believe this makes them strong prospects to become Cbeyond 2.0 customers. We generated $24.3 million of revenue from Cbeyond 2.0 customers during the nine months ended September 30,

9


2012. We did not start tracking the comprehensive Cbeyond 2.0 customer base until 2012, and thus we do not have comparable and meaningful prior year Cbeyond 2.0 customer revenue data.
We currently include all revenue from customers who purchase network access from us (or "Network access customers") within our average monthly revenue per customer location (or “ARPU”) calculation. Thus, revenue from customers who purchase cloud-based services independent of network access is excluded from ARPU. After considering all cloud-based services, we believe that Cbeyond 2.0 customers currently provide approximately 50% higher ARPU than that of our Cbeyond 1.0 customers and that the percentage may grow in future periods. We have not yet determined the future revenue metrics that best represent the results of the consolidated business or the results from customers that purchase cloud-based services independent of network access.
 
Three months ended September 30,
 
Nine months ended September 30,
 
2012
 
2011
 
2012
 
2011
Calculation of ARPU
 
 
 
 
 
 
 
Total revenue
$
121,491

 
$
122,529

 
$
369,096

 
$
362,101

Cloud only revenue
(3,486
)
 
(3,326
)
 
(10,098
)
 
(9,607
)
(A) Network access customer revenue (1)
118,005

 
119,203

 
358,998

 
352,494

(B) Average Network access customers
61,446

 
60,395

 
61,523

 
59,049

ARPU (A / B / months)
$
640

 
$
658

 
$
648

 
$
663


(1)
During the third quarter of 2012 we began including revenue from certain cloud-based services provided to Network access customers within the ARPU calculation that were not previously included. We have recast all historical disclosures of ARPU for all periods presented in this Form 10-Q to conform to the current presentation.
As we accelerate sales of cloud-based services to both new and existing technology-dependent Network access customers, we expect our revenue to include an increasing proportion of higher ARPU Cbeyond 2.0 customers in the future. Our strategic shift is expected to result in little to no net growth in customers in the near term; however, we expect that in the longer-term our ARPU and customer additions will increase as our customer mix becomes more oriented to those who are technology-dependent and are using our services to satisfy their technology needs. In addition, we expect that our future capital expenditures and operating expenses will continue to be more focused on selling to these types of customers. Operating expenses will include the cost of revenue to support a higher bandwidth Metro Ethernet network and the selling expenses of a more focused and consultative sales force. Capital expenditures will include the costs of building out a higher bandwidth network and additional hosting infrastructure.
During the first quarter of 2012 we executed agreements to provide Fiber Optic access in multiple markets through long-term capital leases of fiber infrastructure assets, including agreements for the indefeasible rights of use of certain fiber network assets. Upon execution of these agreements, we took delivery of fiber assets and incurred minimum capital lease obligations of $2.4 million, which were recorded to Property and equipment and Non-current fiber debt. The obligation of $2.4 million recorded as of March 31, 2012 was partially satisfied in May 2012 through a $2.0 million lump sum payment directly funded by our Fiber Loan. During the second and third quarters, we took delivery of additional fiber assets with future minimum capital lease obligations of $1.0 million, of which $0.2 million were recorded to Current portion of fiber debt. The cash outlays for all obligations arising from our fiber assets will be either directly funded by our Fiber Loan or financed through fiber providers and will be payable by us through 2017 either as debt or capital lease obligations. Under these agreements, we have building access agreements and outstanding construction orders for fiber assets with expected future minimum lease payments of $2.5 million. These commitments are not recognized on the balance sheet as of September 30, 2012 because they are contingent upon completing construction and acceptance of the fiber assets. As of September 30, 2012, we have placed additional construction orders that total $14.7 million for which we have not yet obtained building access agreements. We do not expect to be able to obtain building access agreements for every order placed. Therefore, we expect a portion of these orders may never be constructed. Additional construction orders may be placed under these contracts in the future. In addition, we have up to $5.6 million of available fiber assets that we may order at our option and fund by our Fiber Loan.
Through June 30, 2012, we were organized into three reportable segments: Core Managed Services Established Markets, Core Managed Services Emerging Markets, and Cloud Services. Our Chief Executive Officer is the Chief Operating Decision Maker (or “CODM”). Beginning in late 2011 and continuing into the third quarter of 2012, we integrated substantially all administrative and operating functions of our former Cloud Services segment into the administrative and operating functions of our former Core Managed Services segments. Sales and marketing functions have also been substantially combined as we

10


focus on selling integrated service packages that include our cloud-based services. Due to the advanced stage of our integration, during the third quarter of 2012, our CODM shifted his focus towards a product-oriented structure rather than a geographic basis and began reviewing financial results on a consolidated basis accompanied by disaggregated revenue information by product line. Accordingly, we have revised our reportable segments to reflect the way our CODM is currently managing and viewing the business. As of September 30, 2012 we operate our business as one reportable segment.
Our CODM uses Adjusted EBITDA and Free Cash Flow to assess the financial performance of the business at a consolidated level. We believe these are important performance metrics for evaluating our ability to generate cash that can potentially be used by the business for capital investments, acquisitions, reduction of debt, or potential payment of dividends or share repurchases. We have also designed our corporate bonus compensation plan to include Free Cash Flow as a component.
Management believes that Adjusted EBITDA data should be available to investors so that investors have the same data that management employs in assessing operations. EBITDA is a non-GAAP financial measure commonly used by investors, financial analysts and ratings agencies. EBITDA is generally defined as net income (loss) before interest, income taxes, depreciation and amortization. However, we use Adjusted EBITDA, also a non-GAAP financial measure, to further exclude, when applicable, non-cash share-based compensation, public offering or acquisition-related transaction costs, purchase accounting adjustments, gain or loss on asset dispositions and non-operating income or expense. On a less frequent basis, Adjusted EBITDA may exclude charges for employee severances, asset or facility impairments, and other exit activity costs associated with a management directed plan (collectively referred to as realignment costs). Adjusted EBITDA is presented because this financial measure is an integral part of the internal reporting system used by our CODM to assess and evaluate the performance of the business at a consolidated level.
Historically, we have defined Free Cash Flow as Adjusted EBITDA less capital expenditures. During the first quarter of 2012, we refined our definition of capital expenditures for purposes of calculating Free Cash Flow to distinguish capital expenditures that require the up-front outlay of cash from those where payment is deferred on a longer-term basis. This distinction is driven by the significant investments we are making to lease fiber assets that have an expected useful life of 20 years, which is substantially longer than our typical asset lives. We believe this distinction is warranted and appropriate since these investments are expected to yield meaningful positive cash flows in future periods when the debt and lease payments occur. These favorable future cash flows will result from fiber infrastructure replacing a significant portion of the access and transport circuits we currently lease from incumbent local exchange carriers (or "ILECs"). We have recast all historical disclosures of capital expenditures as well as Free Cash Flow for all periods presented in this Form 10-Q to be consistent with this delineation between cash and non-cash capital expenditures. Prior year non-cash capital expenditures are comprised of landlord-paid improvements to leased office space. Free Cash Flow is not a measure of financial performance under GAAP and may not be comparable to similarly titled measures reported by other companies.
Adjusted EBITDA was $75.4 million during the nine months ended September 30, 2012, a 31% increase over the comparable period in 2011. Free Cash Flow was $28.3 million during the nine months ended September 30, 2012 compared to $(1.6) million during the comparable period in 2011. The growth in Adjusted EBITDA and Free Cash Flow is primarily attributable to revenue growth, a reduction in capital expenditure subsequent to our Ethernet-over-copper conversion efforts in 2011 and lower operating costs as a result of our strategic realignment.

11


 
Three months ended September 30,
 
Nine months ended September 30,
 
2012
 
2011
 
2012
 
2011
Reconciliation of Free Cash Flow and Adjusted EBITDA to Net income (loss) (Dollar amounts in thousands)
 
 
 
 
 
 
 
Free Cash Flow
$
7,691

 
$
(396
)
 
$
28,300

 
$
(1,631
)
Cash capital expenditures
17,516

 
19,273

 
47,117

 
59,235

Adjusted EBITDA
$
25,207

 
$
18,877

 
$
75,417

 
$
57,604

Depreciation and amortization
(18,172
)
 
(16,842
)
 
(55,418
)
 
(50,800
)
Non-cash share-based compensation
(2,975
)
 
(2,920
)
 
(9,697
)
 
(10,551
)
MaximumASP purchase accounting adjustments

 
418

 

 
354

Transaction costs

 
(47
)
 

 
(154
)
Realignment costs (1)

 

 
(1,924
)
 

Interest expense
(138
)
 
(136
)
 
(409
)
 
(363
)
Other income, net

 

 

 
1,210

Income (loss) before income taxes
3,922

 
(650
)
 
7,969

 
(2,700
)
Income tax expense
(1,969
)
 
(491
)
 
(4,516
)
 
(258
)
Net income (loss)
$
1,953

 
$
(1,141
)
 
$
3,453

 
$
(2,958
)
 
(1)
During the nine months ended September 30, 2012, $1,924 of realignment costs are included in Selling, general and administrative expense and $682 are included in Depreciation and amortization.
The nature of the primary components of our operating results – Revenue, Cost of revenue and Selling, general and administrative expenses – are described below.
Revenue
Our offerings range from a comprehensive catalog of discrete IT, network, communications, mobile services, security and professional services to a simple bundle of local and long distance voice communication services with broadband Internet access. Our offerings are classified as either Network, Voice and Data or Managed Hosting and Cloud.
Managed Hosting and Cloud includes virtual and physical servers and cloud PBX services to customers and distribution channels that are not limited by geographical location. We provide these services to Network access customers; however, certain customers purchase these cloud-based services independent of network access. Managed Hosting and Cloud also includes other services, such as Virtual Receptionist, Microsoft® Exchange hosting, web hosting, and fax-to-email, purchased by Network access customers in excess of the quantities included in their bundled service package.
We believe our product offerings allow us to greatly expand the breadth of services we can deliver to our customers via the web, thus further minimizing or eliminating the need for our customers to invest in complex IT infrastructure and resources while increasing our wallet share opportunity and improving our value proposition. As we continue to focus on and expand our cloud-based services, we expect to expand our addressable customer market and provide more innovative technology to new and existing customers, with a primary focus on the technology-dependent small business customer.
For businesses that desire basic communications services, we offer an array of competitively priced flexible packages, known as BeyondVoice packages, designed to address customers’ business needs rather than their size. Among other services, BeyondVoice packages include local, long distance, and mobile voice services; Broadband Internet Access; voicemail; and email. Network, Voice and Data includes revenue from BeyondVoice packages and incremental charges related to voice minutes, service lines, and data usage purchased by Network access customers in excess of the quantities included in their packages.
Our integrated service offering packages will continue to evolve as the needs of our customers and the market change, such as including more cloud-based services in our base integrated packages.
ARPU is impacted by a variety of factors including: introduction of new packages with different pricing, changes in customer demand for certain products or services, changes in customer usage patterns, the proportion of customers signing three-year contracts at lower package prices as compared to shorter term contracts, the distribution of customer installations during a period, the use of customer incentives employed when needed to be competitive, as well as fluctuations in terminating

12


access rates.
Network, Voice and Data revenue is generated under one, two, and three-year contracts. Therefore, customer churn rates have an impact on projected future revenue streams. We define customer churn rate for a given month as the number of Network access customers disconnected in that month divided by the total number of Network access customers at the beginning of that month. Due to differences in ARPU between Cbeyond 1.0 customers and Cbeyond 2.0 customers, we believe a unit-based churn metric is likely to become less meaningful than it has been historically. In the future, we intend to transition to a revenue-based churn metric that will be applicable to all revenue, including revenue from customers that purchase cloud-based services independent of network access.
Although not a significant source of our Network, Voice and Data revenue, we charge other communications companies for terminating calls to our customers on our network. Terminating access charges have historically grown at a slower rate than our customer base due to reductions in access rates on interstate calls as mandated by the Federal Communications Commission. These rate reductions are expected to continue in the future, so we expect terminating access revenue will be declining in the near term.
Cost of Revenue
Our cost of revenue represents costs directly related to the operation of our network, including payments to the ILECs and other communications carriers for access, interconnection and transport fees; customer circuit installation costs to the local telephone companies; fees paid to third-party providers for web hosting services; collocation rents and other facility costs; telecommunications-related taxes and fees; and the cost of mobile handsets. The primary component of cost of revenue consists of the access fees paid to local telephone companies for high capacity circuits we lease on a monthly basis to provide connectivity to our customers. These access circuits link our customers to our network equipment located in a collocation facility, which we lease from local telephone companies.
Historically, most of the high capacity circuits we leased have been T-1’s, which are the largest component of our circuit access fees. However, we are converting many of our existing customer T-1 circuits and have begun serving new customers using Metro Ethernet in place of T-1 circuits in a number of locations. Although not available to us on a ubiquitous basis in all areas, Ethernet technology provides us with the opportunity to offer a large percentage of our customers’ bandwidth at speeds well in excess of T-1 circuits while reducing our ongoing operating expenses. We have substantially completed our Ethernet-over-copper customer conversion project and have shifted focus to our Fiber Optic initiative. Future costs related to our fiber network expansion include maintenance costs for dark fiber (or fiber provided by third parties that will be operated by us) and access fees for lit fiber (or fiber that will be operated by third parties).
A rising component of cost of revenue is transport cost, which is primarily the cost we incur with ILECs for traffic between central offices where we have collocation equipment, traffic between wire centers without our presence and our collocations, and intercity traffic between our markets. These costs may increase in the near term as we have built additional collocations to support our Ethernet initiative; however, we expect that the increased transport costs will be offset by greater reductions in future access fees resulting from our investment in Ethernet technology, which provides significantly lower operating expenses than traditional T-1 technology.
Another significant component of our cost of revenue is the cost associated with our mobile offering. These costs include usage-based charges, monthly recurring base charges, or some combination thereof, depending on the type of mobile product in service, and the cost of mobile equipment sold to our customers to facilitate their use of our service. The cost of mobile equipment typically exceeds our selling price of such devices due to the competitive marketplace and pricing practices for mobile services. We believe these costs are offset over time by the long-term profitability of our service contracts.
We routinely receive telecommunication cost recoveries from various local telephone companies to adjust for prior errors in billing, including the effect of price decreases retroactively applied upon the adoption of new rates as mandated by regulatory bodies. These service credits are often the result of negotiated resolutions of bill disputes that we conduct with our vendors. We also receive payments from the local telephone companies in the form of performance penalties that are assessed by state regulatory commissions based on the local telephone companies’ performance in the delivery of circuits and other services that we use in our network. Because of the many factors as noted above that impact the amount and timing of telecommunication cost recoveries, estimating the ultimate outcome of these situations is uncertain. Accordingly, we generally recognize telecommunication cost recoveries as offsets to cost of revenue when the ultimate resolution and amount are known and verifiable. These items do not follow any predictable trends and often result in variances when comparing the amounts received over multiple periods. In the future, through systematic improvements in process applications, and after gaining further historical experience, we may be able to more reliably estimate the outcome of telecommunication cost recoveries prior to being known and verifiable, which could result in earlier recognition of these recoveries.

13


The primary costs of revenue associated with our cloud-based services include licensing fees for the required operating systems, broadband service and access fees, power for our data center facilities and other various costs.
Selling, General and Administrative Expense
Our selling, general and administrative expense consist of salaries and related costs for employees and other costs related to sales and marketing, engineering, information technology, billing, regulatory, administrative, collections, legal and accounting functions. In addition, bad debt expense and share-based compensation expense are included in selling, general and administrative expenses. Our selling, general and administrative expense includes both fixed and variable costs. Fixed selling costs include base salaries and office rent. Variable selling costs include commissions, bonuses and marketing materials. Fixed general and administrative costs include the cost of staffing certain corporate overhead functions such as IT, marketing, administrative, billing and engineering, and associated costs, such as office rent, legal and accounting fees, property taxes and recruiting costs. Variable general and administrative costs include the cost of provisioning and customer activation staff, which varies with the level of installation of new customers, and the cost of customer care and technical support staff, which varies with the level of total customers on our network and the complexity of our product offering.
Reclassifications
Reclassifications have been made to the three and nine months ended September 30, 2011 Revenue table within Item 2 herein to present our revenue on a product-line basis, separating Network, Voice and Data from Managed Hosting and Cloud. Reclassifications have also been made to ARPU within Item 2 herein to include revenue from certain cloud-based services provided to Network access customers within the calculation that were not previously included. Such reclassifications were made to conform to the current presentation for the three and nine months ended September 30, 2012.
Results of Operations
Revenue (Dollar amounts in thousands, except ARPU) 
 
For the three months ended September 30,
 
 
 
 
 
2012
 
2011
 
Change from Previous Periods
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
Percent
Revenue
 
 
 
 
 
 
 
 
 
 
 
Network, Voice and Data
$
115,164

 
94.8
%
 
$
117,061

 
95.5
%
 
$
(1,897
)
 
(1.6
)%
Managed Hosting and Cloud
6,327

 
5.2
%
 
5,468

 
4.5
%
 
859

 
15.7
 %
Total revenue
121,491

 
 
 
122,529

 
 
 
(1,038
)
 
(0.8
)%
Cost of revenue
38,675

 
31.8
%
 
$
40,457

 
33.0
%
 
$
(1,782
)
 
(4.4
)%
Gross margin (exclusive of depreciation and amortization):
$
82,816

 
68.2
%
 
$
82,072

 
67.0
%
 
$
744

 
0.9
 %
Network access customer data:
 
 
 
 
 
 
 
 
 
 
 
Customer locations at period end
60,876

 
 
 
61,125

 
 
 
(249
)
 
(0.4
)%
ARPU
$
640

 
 
 
$
658

 
 
 
$
(18
)
 
(2.7
)%
Average monthly churn rate
1.6
%
 
 
 
1.4
%
 
 
 
0.2
%
 
 
 

14


 
For the nine months ended September 30,
 
 
 
2012
 
2011
 
Change from Previous Periods
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
Percent
Revenue
 
 
 
 
 
 
 
 
 
 
 
Network, Voice and Data
$
350,925

 
95.1
%
 
$
346,957

 
95.8
%
 
$
3,968

 
1.1
 %
Managed Hosting and Cloud
18,171

 
4.9
%
 
15,144

 
4.2
%
 
3,027

 
20.0
 %
Total revenue
369,096

 
 
 
362,101

 
 
 
6,995

 
1.9
 %
Cost of revenue
119,323

 
32.3
%
 
120,261

 
33.2
%
 
(938
)
 
(0.8
)%
Gross margin (exclusive of depreciation and amortization):
$
249,773

 
67.7
%
 
$
241,840

 
66.8
%
 
$
7,933

 
3.3
 %
Network access customer data:
 
 
 
 
 
 
 
 
 
 
 
Customer locations at period end
60,876

 
 
 
61,125

 
 
 
(249
)
 
(0.4
)%
ARPU
$
648

 
 
 
$
663

 
 
 
$
(15
)
 
(2.3
)%
Average monthly churn rate
1.5
%
 
 
 
1.3
%
 
 
 
0.2
%
 
 
Revenue. Total revenue remained relatively flat during the three and nine months ended September 30, 2012 compared to the same periods in 2011 due to our efforts to realign our distribution channels by building a new direct sales group dedicated to technology-dependent customers and reducing our traditional direct sales force. Although ending Network access customers were lower, average customers during the period was 4.2% higher during the nine months ended September 30, 2012 compared to the comparable period in 2011. Our net reduction in Network access customers is attributable to the reduction in our traditional Cbeyond 1.0 sales force and the ongoing level of customer churn. As we continue to build our Cbeyond 2.0 sales force, introduce additional sophisticated products targeted to technology-dependent customers, and further expand our Metro Ethernet network, we expect revenue growth to return.
ARPU declined 2.7% and 2.3% during the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011. The decline in ARPU is primarily due to existing customers converting to lower priced packages, decreased charges for usage above levels of voice minutes included in our packages, customers reducing the number of additional lines and services with incremental charges, and decreased adoption of our mobile services. We believe the decline is also related to the economic conditions faced by our customers and continued competitive pressures from alternate communications providers, such as cable companies. These negative factors have been partially offset by the increased delivery of additional offerings, including our cloud-based services.
ARPU may continue to decline in the short-term for the reasons noted above; however, we also anticipate that our strategic shift toward selling sophisticated solutions to technology-dependent customers will decrease the rate of decline by increasing the proportion of new, higher ARPU, technology-dependent customers. Longer-term, we expect that our focus on technology-dependent customers, or Cbeyond 2.0 customers, and new product launches will increasingly benefit ARPU. During the third quarter of 2012, we launched our TotalCloud Phone System and TotalCloud Data Center managed service, which provides more secure and customized access to cloud services.
Our average customer churn rate was 1.6% and 1.5% for the three and nine months ended September 30, 2012, respectively, representing a slight increase over prior periods. The increase from 1.4% and 1.3% for the comparable periods in 2011, is primarily attributable to price competition for smaller communications centric customers.


15


Cost of Revenue (Dollar amounts in thousands)
 
For the three months ended September 30,
 
 
 
2012
 
2011
 
Change from Previous Periods
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
Percent
Cost of revenue (exclusive of depreciation and amortization):
 
 
 
 
 
 
 
 
 
 
 
Circuit access fees
$
18,135

 
14.9
 %
 
$
18,420

 
15.0
 %
 
$
(285
)
 
(1.5
)%
Other cost of revenue
10,932

 
9.0
 %
 
11,769

 
9.6
 %
 
(837
)
 
(7.1
)%
Transport cost
6,440

 
5.3
 %
 
6,172

 
5.0
 %
 
268

 
4.3
 %
Mobile cost
4,345

 
3.6
 %
 
5,620

 
4.6
 %
 
(1,275
)
 
(22.7
)%
Telecommunications cost recoveries
(1,177
)
 
(1.0
)%
 
(1,524
)
 
(1.2
)%
 
347

 
(22.8
)%
Total cost of revenue
$
38,675

 
31.8
 %
 
$
40,457

 
33.0
 %
 
$
(1,782
)
 
(4.4
)%
 
 
For the nine months ended September 30,
 
 
 
2012
 
2011
 
Change from Previous Periods
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
Percent
Cost of revenue (exclusive of depreciation and amortization):
 
 
 
 
 
 
 
 
 
 
 
Circuit access fees
$
54,410

 
14.7
 %
 
$
54,234

 
15.0
 %
 
$
176

 
0.3
 %
Other cost of revenue
33,849

 
9.2
 %
 
35,073

 
9.7
 %
 
(1,224
)
 
(3.5
)%
Transport cost
19,322

 
5.2
 %
 
17,803

 
4.9
 %
 
1,519

 
8.5
 %
Mobile cost
13,999

 
3.8
 %
 
16,615

 
4.6
 %
 
(2,616
)
 
(15.7
)%
Telecommunications cost recoveries
(2,257
)
 
(0.6
)%
 
(3,464
)
 
(1.0
)%
 
1,207

 
(34.8
)%
Total cost of revenue
$
119,323

 
32.3
 %
 
$
120,261

 
33.2
 %
 
$
(938
)
 
(0.8
)%
Cost of Revenue. The principal drivers of the overall decrease in cost of revenue as a percent of total revenue are the reduction in installation costs and reduced operating costs due to the Metro Ethernet-over-copper conversion project, which was substantially complete at the end of 2011, and the reduction in mobile-related costs.
Circuit access fees, or line charges, represent the largest single component of cost of revenue. These costs primarily relate to our lease of circuits connecting our equipment at network points of collocation to our equipment located at our customers’ premises. The increase in circuit access fees has historically correlated to the increase in the number of customers, and this trend has continued throughout 2012, after considering Metro Ethernet migration costs incurred. Circuit access fees includes conversion costs associated with migrating customers to Metro Ethernet technology. Direct and indirect conversion costs were $1.8 million and $1.4 million during the nine months ended September 30, 2011 compared with $0.4 million of direct conversion costs incurred during the nine months ended September 30, 2012. We expect circuit access fees as a percentage of revenue to stabilize over time as we continue to convert customers to Metro Ethernet technology, which we expect will further reduce operating costs, and as ARPU stabilizes.
Other cost of revenue includes components such as long distance charges, installation costs to connect new circuits, the cost of local interconnection with ILECs’ networks, Internet access costs, the cost of third-party service offerings we provide to our customers, costs to deliver our cloud-based services, and certain taxes and fees. Other cost of revenue decreased as a percentage of revenue in the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011, primarily due to lower installation costs related to the Ethernet-over-copper conversion project.
Transport cost is a rising component of cost of revenue and may continue to rise in the near term at a rate outpacing customer growth as we build additional collocations to support our Metro Ethernet initiative. Longer-term, we expect transport costs to stabilize and access costs to decrease on a per-customer basis given the cost savings of Ethernet access over traditional T-1 access.
As a percentage of revenue, mobile costs decreased during the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011. Primary drivers of this decrease include a reduction in

16


mobile service costs and mobile device costs as a result of lower volume. The reduction in shipments stems from a lower percentage of new customers electing mobile services primarily due to a reduction in our use of promotional incentives and the high level of competition in the mobile device market. Additionally, over time, we have been able to negotiate and achieve more efficient unit service costs. Though we do not currently anticipate significant changes in the percentage of customers using our mobile services in the future, we have been selling more recent model mobile devices. As such, we do not anticipate mobile costs will continue to decline from current levels in the long term.

Selling, General and Administrative and Other Operating Expenses (Dollar amounts in thousands, except monthly selling, general and administrative expenses per average customer location) 
 
For the three months ended September 30,
 
 
 
2012
 
2011
 
Change from Previous Periods
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
Percent
Selling, general and administrative (exclusive of depreciation and amortization)
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and benefits (excluding share-based compensation)
$
37,252

 
30.7
%
 
$
40,514

 
33.1
 %
 
$
(3,262
)
 
(8.1
)%
Share-based compensation
2,975

 
2.4
%
 
2,920

 
2.4
 %
 
55

 
1.9
 %
Marketing cost
340

 
0.3
%
 
1,012

 
0.8
 %
 
(672
)
 
(66.4
)%
Transaction expense

 

 
(371
)
 
(0.3
)%
 
371

 
nm

Other selling, general and administrative
20,017

 
16.5
%
 
21,669

 
17.7
 %
 
(1,652
)
 
(7.6
)%
Total SG&A
$
60,584

 
49.9
%
 
$
65,744

 
53.7
 %
 
$
(5,160
)
 
(7.8
)%
Other operating expenses:
 
 
 
 
 
 
 
 
 
 
 
    Depreciation and amortization
18,172

 
15.0
%
 
16,842

 
13.7
 %
 
1,330

 
7.9
 %
Total other operating expenses
$
18,172

 
15.0
%
 
$
16,842

 
13.7
 %
 
$
1,330

 
7.9
 %
Other data:
 
 
 
 
 
 
 
 
 
 
 
Monthly SG&A per average customer
$
283

 
 
 
$
349

 
 
 
$
(66
)
 
(18.9
)%
Average employees
1,617

 
 
 
2,010

 
 
 
(393
)
 
(19.6
)%
 

17


 
For the nine months ended September 30,
 
 
 
2012
 
2011
 
Change from Previous Periods
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
Percent
Selling, general and administrative (exclusive of depreciation and amortization)
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and benefits (excluding share-based compensation)
$
112,588

 
30.5
%
 
$
120,255

 
33.2
 %
 
$
(7,667
)
 
(6.4
)%
Share-based compensation
9,697

 
2.6
%
 
10,551

 
2.9
 %
 
(854
)
 
(8.1
)%
Marketing cost
1,724

 
0.5
%
 
2,223

 
0.6
 %
 
(499
)
 
(22.4
)%
Transaction expense

 
0

 
(264
)
 
(0.1
)%
 
264

 
nm

Realignment costs
1,924

 
0.5
%
 

 
0

 
1,924

 
nm

Other selling, general and administrative
60,044

 
16.3
%
 
61,822

 
17.1
 %
 
(1,778
)
 
(2.9
)%
Total SG&A
$
185,977

 
50.4
%
 
$
194,587

 
53.7
 %
 
$
(8,610
)
 
(4.4
)%
Other operating expenses:
 
 
 
 
 
 
 
 
 
 
 
    Depreciation and amortization
55,418

 
15.0
%
 
50,800

 
14.0
 %
 
4,618

 
9.1
 %
Total other operating expenses
$
55,418

 
15.0
%
 
$
50,800

 
14.0
 %
 
$
4,618

 
9.1
 %
Other data:
 
 
 
 
 
 
 
 
 
 
 
Monthly SG&A per average customer
$
321

 

 
$
354

 

 
$
(33
)
 
(9.3
)%
Average employees
1,675

 

 
1,949

 

 
(274
)
 
(14.1
)%
Selling, General and Administrative Expense and Other Operating Expenses. Selling, general and administrative expense decreased during the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011, primarily due to a lower number of average employees, partially offset by realignment costs.
Salaries, wages and benefits decreased during the three and nine months ended September 30, 2012 compared to that of the prior year, both in amount and as a percentage of revenue. During the three and nine months ended September 30, 2012, Salaries, wages and benefits decreased compared to the prior year due to a lower number of average employees as a result of our strategic realignment, which resulted in a reduced workforce during the first and second quarter of 2012. We expect the majority of the savings that resulted from our strategic realignment to largely be offset throughout the remainder of the year as we continue to invest in our Cbeyond 2.0 sales force and staffing of operations to support our increase in technology-dependent customers.
Share-based compensation expense decreased overall and as a percentage of revenue during the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to a decline in the fair value of awards granted based on lower share prices in recent periods. As our share price has declined, we have experienced decreases in our share-based compensation expense related to the full vesting of higher historical valued awards granted. This is partially offset by increased share-based compensation costs related to our 2012 corporate bonus plan as all employees now receive 20% of their bonus in shares.
Marketing costs decreased for the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011 due to lower advertising and promotional activity as we reduced costs while focusing on our strategic shift. This decline is not expected to continue as we focus on technology-dependent customers.
The strategic realignment, which was announced in early 2012, resulted in $1.9 million of selling, general and administrative expense for the nine months ended September 30, 2012. This expense primarily consisted of $1.1 million for employee severances and ongoing medical benefits, and $0.7 million for expected losses under non-cancelable office leases for the nine months ended September 30, 2012.
Other selling, general and administrative expenses primarily include professional fees, outsourced services, rent and other facilities costs, maintenance, recruiting fees, travel and entertainment costs, property taxes and bad debt expense. The decrease in this category of costs is primarily due to scaling back operations as part of our strategic realignment effort and stronger overall cost controls as we scale back overhead growth due to slowing revenue growth.

18


Bad debt expense was $1.5 million, or 1.2% of total revenue for the three months ended September 30, 2012 and 2011. During the nine months ended September 30, 2012 and 2011 bad debt expense was $4.7 million or 1.3% of revenue.
The increase in depreciation and amortization for the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011 relates primarily to a 10.1% increase in depreciable fixed assets over the prior period. In addition, we recognized $0.7 million of accelerated depreciation during the nine months ended September 30, 2012 on certain long-lived assets at offices which were consolidated as part of the strategic realignment.
Excluding depreciation and amortization, our selling, general and administrative cost per average Network access customer location for the three and nine months ended September 30, 2012 were 18.9% and 9.3% lower than in the same respective periods in 2011 primarily due to our strategic realignment efforts. These efficiency gains were partially offset by declining ARPU. In the future, as we grow our sales channels and operations to support our technology-dependent Cbeyond 2.0 customers, we expect selling, general and administrative expenses to increase.
Other Income (Expense) and Income Taxes (Dollar amounts in thousands) 
 
For the three months ended September 30,
 
 
 
2012
 
2011
 
Change from Previous Periods
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
Percent
Interest expense
(138
)
 
(0.1
)%
 
(136
)
 
(0.1
)%
 
(2
)
 
1.5
%
Income tax expense
(1,969
)
 
(1.6
)%
 
(491
)
 
(0.4
)%
 
(1,478
)
 
301.0
%
Total
$
(2,107
)
 
(1.7
)%
 
$
(627
)
 
(0.5
)%
 
$
(1,480
)
 
236.0
%
 
 
For the nine months ended September 30,
 
 
 
2012
 
2011
 
Change from Previous Periods
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
Percent
Interest expense
$
(409
)
 
(0.1
)%
 
$
(363
)
 
(0.1
)%
 
$
(46
)
 
12.7
 %
Other income, net

 
 %
 
1,210

 
0.3
 %
 
(1,210
)
 
(100.0
)%
Income tax expense
(4,516
)
 
(1.2
)%
 
(258
)
 
(0.1
)%
 
(4,258
)
 
1,650.4
 %
Total
$
(4,925
)
 
(1.3
)%
 
$
589

 
0.2
 %
 
$
(5,514
)
 
nm

Interest expense. The majority of our interest expenses for the three and nine months ended September 30, 2012 and 2011 relate to commitment fees under our Credit Facility, and are slightly higher in 2012 due to an increase in our Credit Facility from $40.0 million to $75.0 million. As we continue to draw on our Fiber Loan and incur capital lease obligations, we expect to incur increased interest expense.
Other income, net. During the nine months ended September 30, 2011, we recognized other income of $1.2 million, which primarily relates to adjusting liabilities of our former captive leasing subsidiaries upon the expiration of various statutory periods.
Income tax expense. We recognized our 2012 interim period income tax expense based on our year-to-date effective tax rate because our estimated annual tax rate fluctuates significantly from only slight variances in estimated annual income. The three and nine months ended September 30, 2012 income tax expense primarily relates to the utilization of net operating losses due to our increase in pretax income, as well as state income tax expense in markets in which we do not have net operating losses. The income tax expense also includes state income tax expense levied by Texas, which imposes a gross receipts based tax due regardless of profit levels. This tax is not dependent upon levels of pre-tax income and has a significant influence on our effective tax rate. Additionally, income tax expense reflects amounts associated with share-based transactions, which are described in Note 7 to the Condensed Consolidated Financial Statements. The amounts recorded in 2012 and 2011, also benefited from reductions in the deferred tax asset valuation allowance of approximately $0.3 million and $0.9 million, respectively.
Our net deferred tax assets, after valuation allowance, totaled approximately $1.6 million at September 30, 2012 and primarily relate to net operating loss carryforwards. In order to realize the benefits of the deferred tax asset recognized at September 30, 2012, we will need to generate approximately $4.2 million in pre-tax income in the foreseeable future, which management currently believes is achievable. If we generate less taxable income, which is reasonably possible, we may have to increase our allowance against our net deferred tax assets with a corresponding increase to income tax expense.

19


Liquidity and Capital Resources (Dollar amounts in thousands):
 
For the nine months ended September 30,
 
Change from Previous Period
 
2012
 
2011
 
Dollars
 
Percent
Cash Flows:
 
 
 
 
 
 
 
Net cash provided by operating activities
$
68,122

 
$
55,072

 
$
13,050

 
23.7
 %
Net cash used in investing activities
(50,772
)
 
(60,015
)
 
9,243

 
(15.4
)%
Net cash used in financing activities
(1,995
)
 
(12,935
)
 
10,940

 
(84.6
)%
Net increase (decrease) in cash and cash equivalents
$
15,355

 
$
(17,878
)
 
$
33,233

 
nm

At September 30, 2012, we had cash and cash equivalents of $23.9 million held primarily in our operating bank accounts.
Cash Flows from Operating Activities. Our operating cash flows result primarily from cash received from our customers, offset by cash payments for circuit access fees, employee compensation (less amounts capitalized related to internal use software that are reflected as cash used in investing activities), and operating leases. Cash received from our customers generally corresponds to our revenue. Because our credit terms are typically less than one month, our receivables settle quickly. Changes to our operating cash flows have historically been driven primarily by changes in operating income and changes to the components of working capital, including changes to receivable and payable days. Operating cash flows may fluctuate favorably or unfavorably depending on the timing of significant vendor payments.
Operating cash flows increased by $13.1 million in 2012 primarily due to higher net income and working capital, resulting from lower selling, general and administrative expense arising from the reduction in our traditional Cbeyond 1.0 sales force in connection with our strategic realignment efforts.
Cash Flows from Investing Activities. Our principal cash investments are purchases of property and equipment, which fluctuate depending on the growth in customers in our existing markets, the timing and number of facility and network additions needed to expand existing markets and upgrade our network, enhancements and development costs related to our operational support systems in order to offer additional applications and services to our customers, and increases to the capacity of our data centers as our customer base and the breadth of our product portfolio expand.
Cash flows used in investing activities decreased during the current year primarily due to a reduction in capital expenditures as we substantially completed the Ethernet-over-copper initiative in 2011 and we ceased market expansion to focus on our strategic transformation. During the nine months ended September 30, 2012, we paid $5.0 million in deferred acquisition consideration related to our Cloud Services acquisitions. We also transferred $1.3 million of cash formerly classified as restricted cash into our operating account.
Cash Flows from Financing Activities. Cash flows from financing activities relate to activity associated with employee stock option exercises, vesting of restricted shares, financing costs associated with the amendments to our Credit Facility, and the repurchase of common stock. We repurchased 0.3 million shares for $2.0 million during the nine months ended September 30, 2012 under the $15.0 million repurchase program authorized by our Board of Directors in May 2011. We also received $1.6 million related to proceeds from exercise of stock options.
Overall. We believe that cash on hand, cash generated from operating activities, and cash available under our Credit Facility will be sufficient to fund capital expenditures, capital lease obligations, operating expenses and other operating cash requirements associated with future growth. Significant cash payments were made during the nine months ended September 30, 2012 that occur on an infrequent basis, such as share repurchases and acquisition-related consideration. In addition, during 2012, we reduced our communications-centric, or Cbeyond 1.0, sales force in order to reinvest in teams focused on delivering services to technology-dependent customers, which resulted in cash payments of $1.0 million for employee severances and ongoing medical benefits and $0.2 million of other exit activity costs. These reductions in personnel have temporarily resulted in a significant increase in Free Cash Flow during the three and nine months ended September 30, 2012. Although we anticipate that Free Cash Flow will remain positive in the foreseeable future, we expect that the expense savings arising from these reductions in personnel will be partially offset by the growth in staffing for our new Cbeyond 2.0 sales channels.
The settlement of acquisition-related contingent consideration necessitated funding beyond our cash on hand and cash flow from operations, therefore requiring us to draw $4.0 million against our Credit Facility during the first quarter of 2012. We repaid this borrowing during the second quarter of 2012 and have no amounts outstanding as of September 30, 2012. We currently have no plans to draw against the Credit Facility for short-term needs. In addition, the Fiber Loan secured under our amended and restated Credit Facility will provide us up to $10.0 million to finance the purchase of fiber assets from a third

20


party. We have $2.0 million outstanding under the Fiber Loan as of September 30, 2012. Further, while we do not anticipate a need for additional access to capital or new financing aside from our Credit Facility in the near term, we monitor the capital markets and may access those markets if our business prospects or plans change resulting in a need for additional capital, or if additional capital required can be obtained on favorable terms.
Contractual Obligations and Commitments
We have new commitments in connection with our strategic initiative to build our fiber network through capital lease arrangements. See Note 4 to our Condensed Consolidated Financial Statements for more details.
There have been no other material changes with respect to the contractual obligations and commitments disclosed in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2011.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies
We prepare consolidated financial statements in accordance with GAAP in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue and expenses, and related disclosures in our consolidated financial statements and accompanying notes. We believe that of our significant accounting policies, which are described in Note 2 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2011, we consider those that involve a higher degree of judgment and complexity as critical. While we have used our best estimates based on the facts and circumstances available to us at the time, different estimates reasonably could have been used in the current period, or changes in the accounting estimates that we used are reasonably likely to occur from period to period which may have a material impact on the presentation of our financial condition and results of operations. Although we believe that our estimates, assumptions and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions, judgments or conditions. A description of accounting policies that are considered critical may be found in our 2011 Annual Report on Form 10-K, filed on March 7, 2012, in the “Critical Accounting Policies” section of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 

21


Item 3.    Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our variable-rate borrowings under our Credit Facility are subject to fluctuations in interest expense and cash flows. Management actively monitors this exposure when present. At September 30, 2012, we had no borrowings outstanding under our Credit Facility. In May 2012, we amended and restated our Credit Facility to provide for our Fiber Loan of $10 million, with applicable interest rates similar to our pre-existing Credit Facility. In May 2012 we utilized $2.0 million of our Fiber Loan. A 100 basis point increase in market interest rates would have resulted in an increase in pre-tax interest expense of less than $0.1 million. As we continue to draw on our Fiber Loan, our sensitivity to interest rate risk will increase. As of September 30, 2012, our cash and cash equivalents were held in non-interest bearing bank accounts.
Item 4.    Controls and Procedures
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

22


PART II. OTHER INFORMATION
Item 1.    Legal Proceedings
From time to time, we are involved in legal proceedings arising in the ordinary course of business. We believe that we have adequately reserved for these liabilities and that as of September 30, 2012, there is no litigation pending that could have a material adverse effect on our results of operations and financial condition. The information within Note 11 to the Condensed Consolidated Financial Statements under the caption “Legal Proceedings” is incorporated herein by reference.
Item 1A.     Risk Factors
Investors should carefully consider the risk factors in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011, in addition to the other information contained in our Annual Report and in this quarterly report on Form 10-Q. There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3.    Defaults upon Senior Securities
None.
Item 4.    Mine Safety Disclosures
None.
Item 5.    Other Information
None.
Item 6.    Exhibits
Exhibit
No
  
Description of Exhibit
 
 
 
10.1*
 
At-Will Employment Agreement by and between Cbeyond and James Geiger.
 
 
 
10.2*
 
At-Will Employment Agreement by and between Cbeyond and J. Robert Fugate.
 
 
 
10.3*
 
Form of At-Will Employment Agreement by and between Cbeyond and Robert R. Morrice, Joseph A. Oesterling and N. Brent Cobb
 
 
 
31.1*
  
Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2*
  
Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1†
  
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
32.2†
  
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101††
  
The following financial information from the Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statement of Stockholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) the Unaudited Notes to Condensed Consolidated Financial Statements.
*
Filed herewith.
Furnished herewith.
††
Furnished electronically herewith.

23


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
CBEYOND, INC.
 
 
 
 
By:
 
/s/ James F. Geiger
 
Name:
 
James F. Geiger
 
Title:
 
Chairman, President and Chief Executive Officer
 
 
 
 
By:
 
/s/ J. Robert Fugate
 
Name:
 
J. Robert Fugate
 
Title:
 
Executive Vice President and Chief Financial Officer
Date: November 5, 2012
Exhibit Index
 
Exhibit
No
  
Description of Exhibit
 
 
 
10.1*
 
At-Will Employment Agreement by and between Cbeyond and James Geiger.
 
 
 
10.2*
 
At-Will Employment Agreement by and between Cbeyond and J. Robert Fugate.
 
 
 
10.3*
 
Form of At-Will Employment Agreement by and between Cbeyond and Robert R. Morrice, Joseph A. Oesterling and N. Brent Cobb.
 
 
 
31.1*
  
Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2*
  
Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1†
  
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
32.2†
  
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101††
  
The following financial information from the Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statement of Stockholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) the Unaudited Notes to Condensed Consolidated Financial Statements.
 
*
Filed herewith.
Furnished herewith.
††
Furnished electronically herewith.


24
EX-10.1 2 cbey-2012930x10qxex101.htm EXHIBIT 10.1 CBEY-2012.9.30-10Q-Ex.10.1
Exhibit 10.1


AT-WILL EMPLOYMENT AGREEMENT

THIS AT-WILL EMPLOYMENT AGREEMENT (this “Agreement”) is made as of November 5, 2012 (the “Effective Date”), by and between Cbeyond, Inc., a Delaware corporation (the “Company”), and James F. Geiger (“Executive”). Capitalized terms used but not otherwise defined have the meanings given to them in Section 3.

In consideration of the mutual promises made in this Agreement and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Executive and the Company (collectively the “Parties”), intending to be legally bound, agree as follows:

1.
At-Will Employment. Executive acknowledges and agrees that no agreement or arrangement between Executive and the Company (including the execution and delivery of this Agreement) shall entitle Executive to become or remain in the employment of the Company or affect the right of the Company to terminate Executive’s employment at any time and for any reason.

2.
Termination.

(a)    Severance.

(i)
Non-Change in Control Severance. Subject to Section 2(d) below, in the event of a Specified Termination of Executive’s employment, the Company shall in accordance with its customary payroll practices, during the period beginning the day after the date of Executive’s Separation from Service with the Company and ending on the first anniversary of such date, pay Executive severance payments on the Company’s normal pay dates at a rate equal to 100% of the annual base salary rate in effect immediately prior to Executive’s termination of employment. If Executive’s Specified Termination occurs following a Change in Control, the severance provisions of paragraph 2(a)(ii) shall control rather than the provisions of this paragraph.

(ii)
Post Change in Control Severance. Subject to Section 2(d) below, in the event of a Specified Termination of Executive’s employment following a Change in Control, in lieu of the severance described in paragraph 2(a)(i), above, the Company shall in accordance with its customary payroll practices, during the period beginning the day after the date of Executive’s Separation from Service and ending on the first anniversary of such date, pay Executive severance payments on the Company’s normal pay dates at a rate equal to 100% of the annual base salary rate in effect immediately prior to Executive’s termination of employment. In addition, Company shall, within three business days of the date six months following the date of Executive’s Separation from Service, pay Executive a lump sum equal to the average monetary value of the bonus paid to the Executive by the Company over the previous three years plus, at Executive’s election, either (A) an additional lump sum equal to one and one-half times the annual base salary of the Executive in effect on the date of his Specified Termination or (B) an

1



Exhibit 10.1


additional lump sum equal to 50% of the annual base salary of the Executive in effect on the date of his Specified Termination. If Executive chooses option (A), above, the Noncompete Period described in paragraph 3(d) below, shall be modified for all purposes under this Agreement to be equal to the period beginning on the date of Executive’s Specified Termination and ending thirty months later.

(iii)
Effect of Voluntary Reductions in Bonus or Accepting Equity in Lieu of Cash for Bonus on Post Change in Control Severance. If Executive chooses in one or more years, for any reason whatsoever, to voluntarily accept a lower bonus payment than would otherwise have been due, the payment to Executive described in in Section 2(a)(ii), above, which is based on the payment of bonuses for previous years shall be calculated as if Executive had received the full bonus earned in each of the preceding three years. If, for any reason whatsoever, the Company provides the Executive all or a portion of Executive’s bonus in equity in one or more years, the payment to Executive described in in Section 2(a)(ii), above, which is based on the payment of bonuses for previous years shall be calculated by combining, for each of the years on which the calculation is based, the value of the cash bonus provided to Executive with the value of the equity provided in lieu of cash using the cash value of the equity at the time of issuance.

(b)
Continuation of Medical Benefits via the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA). Subject to Section 2(d) below, in the event of a Specified Termination of Executive’s employment, the Company shall pay COBRA benefits for Executive and any dependants covered by Executive’s Company-provided health insurance on the date of his/her Specified Termination. In the event that Executive had no Company-provided health insurance upon the date of his/her Specified Termination, he/she shall not be eligible for any benefits otherwise available under this paragraph.

(c)    Stock Awards.

(i)
In the event of a Specified Termination of Executive’s employment following the effective date of a Change in Control, the vesting and/or exercisability of each of Executive’s outstanding Stock Awards shall be automatically accelerated on the date of termination.

(ii)
In the event of a Specified Termination of Executive’s employment prior to the effective date of a Change in Control, (A) the vesting and/or exercisability of twenty percent (20%) of each of Executive’s outstanding non-performance-based Stock Awards shall be automatically accelerated on the date of termination (i.e., if forty percent (40%) of each Stock Award is vested as of the date of termination, then after such termination sixty percent (60%) of such Stock Award shall be vested and forty percent (40%) shall be unvested); and (B) if Executive has a performance-based Stock Award pending on the date of the Specified Termination, the performance period

2



Exhibit 10.1


ends in the one year following the Specified Termination and the performance goals of the Stock Award are met, Executive shall be provided, after the performance goals are met, with 60% of the shares Executive would have received had Executive been employed by the Company at the time the performance period ended. Performance-based Stock Awards with a performance period that does not end in the year following Executive’s Specified Termination are forfeited. Notwithstanding anything to the contrary in this sub-paragraph, if a performance-based Stock Award Agreement specifies how vesting shall occur for a particular performance-based Stock Award following a Specified Termination of Executive’s employment prior to the effective date of a Change in Control, such Stock Award Agreement shall control in place of this sub-paragraph.

(iii)
In the event of a termination of Executive’s employment by reason of Executive’s death, the vesting and/or exercisability of each of Executive’s outstanding Stock Awards shall be automatically accelerated on the date of death.

(iv)
In the event of a termination of Executive’s employment by reason of Executive’s Disability, the vesting and/or exercisability of each of Executive’s outstanding Stock Awards shall be automatically accelerated on the date of termination so that sixty percent (60%) of each such Stock Award shall be vested and/or exercisable (i.e., to the extent, but only to the extent, that less than sixty percent (60%) of an outstanding Stock Award has not already vested upon such termination of employment, such Stock Award will vest as of the date of such termination so that sixty percent (60%) of such Stock Award shall be vested.

(v)
With respect to all Stock Awards granted to Executive on or after September 30, 2005, in the event of a Specified Termination of Executive’s employment, such Stock Awards shall remain exercisable for a period of two (2) years following the date of Executive’s termination. With respect to all Stock Awards granted to Executive prior to September 30, 2005, such Stock Awards shall remain exercisable following Executive’s termination of employment as set forth in the award agreements pursuant to which such Stock Awards were granted.

(vi)
Except as specifically provided in Section 2(c)(v) above, this Section 2(c) shall supersede any other agreement with respect to the acceleration of Executive’s Stock Awards as a result of a termination of Executive’s employment, death, Disability and/or a Change in Control, including, without limitation, the applicable provisions of any award agreements pursuant to which such Stock Awards were granted. Such award agreements will continue to govern Executive’s Stock Awards to the extent not expressly superseded by this Agreement.


3



Exhibit 10.1


(d)
Release; First Payment Date; Separate Payments. On or after the date of Executive’s Separation from Service and on or before the date that is 45 days after the date of Executive’s Separation from Service, Executive shall execute a release (the “Release”) in the form attached hereto and incorporated herein as Exhibit A or Exhibit B, as applicable. Such Release shall specifically relate to all of Executive’s rights and claims in existence at the time of such execution and shall confirm Executive’s obligations under Section 3 of this Agreement. It is understood that, if specified in the applicable Release, Executive has a certain number of calendar days to consider whether to execute such Release, and Executive may revoke such Release within seven (7) calendar days after execution. In the event Executive does not execute such Release within the period specified in the first sentence of this Section 2(d), or if Executive revokes such Release within the subsequent seven (7) day period, no benefits shall be payable under this Agreement. Notwithstanding anything to the contrary in this Agreement, any severance payments or benefits that would otherwise be payable or provided under this Agreement before the first normal payroll payment date falling on or after the sixtieth (60th) day after the date on which the Executive incurs a Separation from Service (the “First Payment Date”) shall be made on the First Payment Date. Each separate severance installment payment and each other payment that Executive may be eligible to receive under this Agreement shall be a separate payment under this Agreement for all purposes.

3.    Confidentiality, Noncompete, and Nonsolicitation.

(a)
Nondisclosure and Nonuse of Confidential Information. Executive shall not disclose or use at any time, either during Executive’s employment with the Company or thereafter, any Confidential Information (as defined below) of which Executive is or becomes aware, whether or not such information is developed by Executive, except to the extent that such disclosure or use is directly related to and required by Executive’s performance of duties assigned to Executive by the Company; provided that nothing herein shall restrict Executive from disseminating personal knowledge gained during the course of Executive’s employment with the Company after the second anniversary of the termination of Executive’s employment with the Company to the extent such personal knowledge is not the property of the Company. Executive shall take all appropriate steps to safeguard Confidential Information and to protect it against disclosure, misuse, espionage, loss and theft. As used in this Agreement, the term “Confidential Information” is defined by O.C.G.A. §13-8-51(3) and means information that is not generally known to the public and that is used, developed or obtained by the Company in connection with its business, including but not limited to (i) products or services, (ii) fees, costs and pricing structures, (iii) designs, (iv) analysis, (v) drawings, photographs and reports, (vi) computer software, including operating systems, applications and program listings, (vii) flow charts, manuals and documentation, (viii) data bases, (ix) accounting and business methods, (x) inventions, devices, new developments, methods and processes, whether patentable or unpatentable and whether or not reduced to practice, (xi) customers and clients and customer or client lists, (xii) copyrightable works, (xiv) all technology and trade secrets, (xv) business plans and financial models, and (xvi) all similar and related information in whatever form. Confidential Information shall