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. In this report, Cbeyond, Inc. and its subsidiary are referred to as "we", "our", "us", the "Company" or "Cbeyond".

Overview

We provide managed IP-based communications services to our target market of small businesses in select large metropolitan areas across the United States. We provide these services through bundled packages of local and long distance voice services, broadband Internet access and mobile voice and data, together with additional applications and services, for an affordable fixed monthly fee under fixed-length contracts.

We sell three integrated packages of services, which are primarily delineated by the number of local voice lines, long distance minutes and T-1 connections provided to the customer. Each of our BeyondVoice packages includes local and long distance voice services, broadband Internet access and mobile voice and data plus additional value-added applications, such as email, voicemail, web hosting, secure backup and file sharing, fax-to-email, virtual private network, and other communications and IT services. Customers may also choose to add extra features or lines for an additional fee. During 2008 we began offering secure desktop services and web-based services to customers in all of our current markets.

Our voice services (other than our mobile voice services) are delivered using Voice over Internet Protocol technology, and all such services are delivered over our secure all-IP network, which we believe affords greater service flexibility and significantly lower network costs than traditional service providers using circuit-switch technologies. We offer our mobile voice and data services via our mobile virtual network operator relationship with a nationwide wireless network provider.

We sell our services primarily through a direct sales force in each market, each of which is supplemented by sales agents. These sales agents often have other business relationships with the customer and, in many cases, perform equipment installations for us at our customers' sites. A significant portion of our new customers are generated by referrals from existing customers and partners. We offer financial incentives to our customers and other sources for referrals, which are charged to selling expenses.

We compete primarily against incumbent local exchange carriers, or ILECs, and, to a lesser extent, against competitive local exchange carriers, both of which are local telephone companies. Local telephone companies generally do not have the same focus on our target market and principally concentrate on medium or large enterprises or residential customers. In addition, cable television providers have begun serving the small and medium business market with telephone service in addition to high speed Internet access and video. To date, we have not experienced significant competition from cable television providers and do not believe that they intend to offer the breadth of services and applications that our customers purchase from us. We compete primarily based on our high-value bundled services that bring many of the same managed services to our customers that have historically been available only to large businesses, as well as based on our customer care, network reliability and operational efficiencies.

We formed Cbeyond and began the development of our network and business processes following our first significant funding in early 2000. We launched our first market, Atlanta, in early 2001 and have since expanded operations into twelve additional markets. Our current market expansion plan is to open two to three new markets per year depending on economic conditions and to establish operations in the largest 25 U.S. markets. We officially launched our thirteenth market, Seattle, early in the fourth quarter of 2009. The following comprises the service launch dates for current markets and the anticipated launch date of our announced future markets:

                Current Markets                Service Launch Date
                Atlanta                          2 nd Quarter 2001
                Dallas                           4 th Quarter 2001
                Denver                           1 st Quarter 2002
                Houston                          1 st Quarter 2004
                Chicago                          1 st Quarter 2005
                Los Angeles                      1 st Quarter 2006
                San Diego                        1 st Quarter 2007
                Detroit                          3 rd Quarter 2007
                San Francisco Bay Area           4 th Quarter 2007
                Miami                            1 st Quarter 2008
                Minneapolis                      2 nd Quarter 2008
                Greater Washington D.C. Area     1 st Quarter 2009
                Seattle                           4th Quarter 2009

We focus on adjusted EBITDA as a principal indicator of the operating performance of our business. EBITDA represents net income (loss) before interest, income taxes, depreciation and amortization. We define adjusted EBITDA as net income (loss) before interest, income taxes, depreciation and amortization expenses, excluding, when applicable, non-cash share-based compensation, public offering expenses, gain or loss on disposal of property and equipment and other non-operating income or expense. In our presentation of segment financial results, adjusted EBITDA for a geographic segment does not include corporate overhead expense and other centralized operating costs. We believe that adjusted EBITDA trends are a valuable indicator of our operating segments' relative performance and of whether our operating segments are able to produce sufficient operating cash flow to fund working capital needs, to service debt obligations and to fund capital expenditures.

We believe our business approach requires significantly less capital to launch operations compared to traditional communications companies using legacy technologies. Based on our historical experience, over time a substantial majority of our market-specific capital expenditures, such as integrated access devices installed at our customers' locations, are success-based, incurred primarily as our customer base grows. We believe the success-based nature of our capital expenditures mitigates the risk of unprofitable expansion. We have a relatively low fixed-cost component in our budgeted capital expenditures associated with each new market we enter, particularly in comparison to service providers employing time-division multiplexing, which is a technique for transmitting multiple channels of separate data, voice and/or video signals simultaneously over a single communication medium, or circuit-switch technology, which is a switch that establishes a dedicated circuit for the entire duration of a call.

The nature of the primary components of our operating results - revenues, cost of revenue and selling, general and administrative expenses - are described below:

Revenue

Our customers may subscribe to any one of our BeyondVoice I, BeyondVoice II and BeyondVoice III packages. Each BeyondVoice I customer receives all our services over a dedicated broadband T-1 connection providing a maximum symmetric bandwidth of 1.5 Mbps (megabits per second). BeyondVoice II customers receive their services over two dedicated T-1 connections offering a maximum symmetric bandwidth of 3.0 Mbps. BeyondVoice III customers receive their services over three dedicated T-1 connections offering a maximum symmetric bandwidth of 4.5 Mbps. We believe that our customers highly value the level of symmetric bandwidth offered with our services. For certain customers who may need additional bandwidth, we have begun offering increased bandwidth using Ethernet technology and may offer increased bandwidth via other means in the future. As of September 30, 2009, approximately 84.0% of our customer base had BeyondVoice I, 14.7% had BeyondVoice II and 1.3% had BeyondVoice III.

We offer customer promotions in the form of rebates and reimbursements. These rebates and reimbursements, or promotional obligations, may not ultimately be earned and claimed by customers. We refer to these unclaimed amounts as "breakage." Prior to recording breakage, our promotional obligations are recorded as a reduction of revenue at their maximum amounts due to the lack of sufficient historical experience required to estimate the amount that would ultimately be earned and claimed by customers. We recognize the benefit of changes to these estimated customer promotional obligations once such amounts are reasonably estimable, which periodically results in a significant change in estimate.

Average monthly revenue per customer location, or ARPU, is impacted by a variety of factors, including customers primarily signing three-year contracts at lower package prices as compared to shorter term contracts, the distribution of customer installations during a period, the adoption by customers of applications for which incremental fees are paid, the amount of long distance or mobile call volumes that generate overage charges above the basic amount of minutes included in customers' packages, customer promotions, as well as additional terminating access charges and customer usage and purchase patterns. Customer revenues represented approximately 98.2% of total revenues for the three and nine months ended September 30, 2009 as compared to 98.1% and 98.0% for the comparable periods in 2008. Access charges paid to us by other communications companies to terminate calls to our customers represented the remainder of total revenues.

Customer revenues are generated under contracts that run up to three-year terms. Therefore, customer churn rates have an impact on projected future revenue streams. Through mid-2007, we maintained average monthly churn rates of approximately 1.0% (we define average monthly churn rate as the average of monthly churn, which is defined for a given month as the number of customer locations disconnected in that month divided by the total number of customer locations on our network at the beginning of that month). Since that time, however, we have experienced elevated churn rates that we believe are attributable primarily to the inability of certain of our customers to meet their payment obligations as a result of deteriorated economic conditions. We cannot predict the duration or magnitude of the currently deteriorated economic conditions, but we expect our monthly churn rate will continue to be more than 1.0% for at least as long as the current economic environment persists.

Cost of Revenue

Our cost of revenue represents costs directly related to the operation of our network, including payments to the local telephone companies and other communications carriers such as long distance providers and our mobile provider, for access, interconnection and transport fees for voice and Internet traffic, customer circuit installation expenses paid to the local telephone companies, fees paid to third-party providers of certain applications such as 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 the T-1 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. The access fees for these circuits vary by state and are the primary reason for differences in cost of revenue across our markets.

As a result of the FCC's 2005 TRRO, we are required to lease circuits under special access, or retail, rates in locations that are deemed to offer competitive facilities as outlined in the FCC's regulations and interpreted by the state regulatory agencies.

Where permitted by regulation, we lease our access circuits on a wholesale basis as UNE loops or enhanced extended links (EELs) as provided for under the FCC's Telecommunications Elemental Long Run Incremental Cost rate structure. Where UNE pricing is not available, we pay special access rates, which may be significantly higher than UNE pricing. We lease loops when the customer's T-1 circuit is located where it can be connected to a local telephone company's central office where we have a collocation, and we use EELs when we do not have a central office collocation available to serve a customer's T-1 circuit. Historically, approximately half of our circuits are provisioned using loops and half using EELs, although the impact of the TRRO has reduced our usage of the T-1 transport portion of EELs and resulted in the conversion and consolidation of a majority of the previously installed T-1 transports to high capacity DS-3 transport. Our monthly expenses are significantly less when using loops rather than EELs, but loops require us to incur the capital expenditures of central office collocation equipment. We install central office collocation equipment in those central offices having the densest concentration of small businesses.

We usually launch operations in a new market with several collocations and add additional collocation facilities over time as we confirm the most advantageous locations in which to deploy the equipment. We believe our discipline of leasing these T-1 access circuits on a wholesale basis rather than on the basis of special access rates from the local telephone companies is an important component of our operating cost structure.

Another significant component of our cost of revenue is the cost associated with our mobile offering. These costs, which represent our fastest growing cost of revenue, include monthly base charges or usage-based charges, 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 market place and pricing practices for mobile services. We believe these costs are offset over time by the long-term profitability of our service contracts. Primarily as a result of the loss on the sale of mobile equipment recorded in full at the time of the sale, increased volumes of mobile sales decrease our gross margin percentages, although the growth of this service offering is expected to result in greater gross profits over time.

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 recognize telecommunication cost recoveries as offsets to cost of revenue when the ultimate resolution and amount are known. These items do not follow any predictable trends and often result in variances when comparing the amounts received over multiple periods.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses consist of salaries and related costs for employees and other expenses related to sales and marketing, engineering, information technology, billing, regulatory, administrative, collections and legal and accounting functions. In addition, share-based compensation expense is included in selling, general and administrative expenses. Our selling, general and administrative expenses include both fixed and variable costs. Fixed selling expenses include salaries and office rents. Variable selling costs include commissions 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 grows with the level of installation of new customers, and the cost of customer care and technical support staff, which grows with the level of total customers on our network. As we expand into new markets, certain fixed costs are likely to increase; however, these increases are intermittent and not proportional with the growth of customers.

Results of Operations

Revenue and Cost of Revenue (Dollar amounts in thousands, except ARPU)



                                                    For the Three Months Ended
                                        September 30, 2009             September 30, 2008              Change from Previous Period
                                                       % of                           % of
                                       Dollars        Revenue         Dollars        Revenue           Dollars              Percent
Revenue:
Customer revenue                      $ 104,018          98.2 %      $  88,500          98.1 %      $      15,518                 17.5 %
Terminating access revenue                1,937           1.8 %          1,743           1.9 %                194                 11.1 %

Total revenue                           105,955                         90,243                             15,712                 17.4 %

Cost of revenue (exclusive of
depreciation and amortization):
Circuit access fees                      13,805          13.0 %         11,640          12.9 %              2,165                 18.6 %
Other cost of revenue                    13,354          12.6 %         11,639          12.9 %              1,715                 14.7 %
Mobile cost                               9,576           9.0 %          7,222           8.0 %              2,354                 32.6 %
Telecommunications cost recoveries         (711 )        (0.7 )%        (3,478 )        (3.9 )%             2,767                (79.6 )%

Total cost of revenue                    36,024          34.0 %         27,023          29.9 %              9,001                 33.3 %


Gross margin (exclusive of
depreciation and amortization):       $  69,931          66.0 %      $  63,220          70.1 %      $       6,711                 10.6 %


Customer data:
Customer locations at period end         48,580                         40,569                              8,011                 19.7 %

ARPU                                  $     744                      $     760                      $         (16 )               (2.1 )%

Average monthly churn rate                  1.4 %                          1.3 %                              0.1 %


                                                    For the Nine Months Ended
                                        September 30, 2009             September 30, 2008              Change from Previous Period
                                                       % of                           % of
                                       Dollars        Revenue         Dollars        Revenue           Dollars              Percent
Revenue:
Customer revenue                      $ 300,531          98.2 %      $ 250,688          98.0 %      $      49,843                 19.9 %
Terminating access revenue                5,521           1.8 %          5,140           2.0 %                381                  7.4 %

Total revenue                           306,052                        255,828                             50,224                 19.6 %

Cost of revenue (exclusive of
depreciation and amortization):
Circuit access fees                      39,588          12.9 %         33,149          13.0 %              6,439                 19.4 %
Other cost of revenue                    38,226          12.5 %         32,710          12.8 %              5,516                 16.9 %
Mobile cost                              27,231           8.9 %         19,371           7.6 %              7,860                 40.6 %
Telecommunications cost recoveries       (2,677 )        (0.9 )%        (5,967 )        (2.3 )%             3,290                (55.1 )%

Total cost of revenue                   102,368          33.4 %         79,263          31.0 %             23,105                 29.1 %


Gross margin (exclusive of
depreciation and amortization):       $ 203,684          66.6 %      $ 176,565          69.0 %      $      27,119                 15.4 %


Customer data:
Customer locations at period end         48,580                         40,569                              8,011                 19.7 %

ARPU                                  $     747                      $     752                      $          (5 )               (0.7 )%

Average monthly churn rate                  1.5 %                          1.3 %                              0.2 %

Revenue. Total revenue increased for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008 primarily in proportion to the increase in the average number of customers. However in comparison to the same quarter in the prior year, revenue for the three months ended September 30, 2009 has increased at a slower rate than average customer growth primarily due to a decline in ARPU over this period. The decline in ARPU for the three months ended September 30, 2009 compared to the same period in 2008 is primarily due to increases in the impact of credits and promotional incentives issued to customers, contract renewals at lower base prices and decreased levels of voice usage that contribute to overage charges above our base package. We believe these declines are related to the effects of the economic recession on customers and increased competitive pressures. This downward pressure has been partially offset by an increase in the average applications used per customer to 7.4 in the period ended September 30, 2009 from 6.8 in the period ended September 30, 2008. In addition, we recognized benefits related to reductions to promotional obligations of $0.6 million in the nine months ended September 30, 2009 and $0.4

million in the three and nine months ended September 30, 2008 related to certain customer promotional liabilities recorded in prior periods. There were no comparable benefits recognized in the three months ended September 30, 2009. The increase in ARPU from these reductions to promotional obligations for the nine months ended September 30, 2009 was $2, compared to $4 and $1 for the three and nine months ended September 30, 2008, respectively. At this time, we anticipate ARPU to continue to be relatively stable in future periods based on the expectation that our customers will continue to increase the average number of applications they use; however, a variety of factors influence ARPU, including the duration and depth of the current economic recession, which could have a greater negative impact on future ARPU than we currently anticipate.

Revenues from access charges paid to us by other communications companies to terminate calls to our customers have increased for the three and nine month comparison periods due to our customer growth but have declined as a percentage of ARPU. These terminating access charges have historically grown at a slower rate than our customer base due to our customers' increased use of mobile services and reductions in access rates on interstate calls as mandated by the FCC. These rate reductions are expected to continue in the future, so we expect terminating access revenue will continue to grow at a rate slower than our customer growth.

The following comprises the segment contributions to the increase in revenue in the three and nine months ended September 30, 2009 as compared to the three and nine months ended September 30, 2008:

(Dollar amounts in thousands):

                                            For the Three Months Ended
                                  September 30, 2009         September 30, 2008           Change from Previous Period
                                                % of                       % of
                                   Dollars     Revenue        Dollars     Revenue         Dollars              Percent
Atlanta                          $    21,539      20.3 %    $    20,641      22.9 %    $         898                  4.4 %
Dallas                                19,010      17.9 %         17,733      19.7 %            1,277                  7.2 %
Denver                                17,733      16.7 %         17,999      19.9 %             (266 )               (1.5 )%
Houston                               12,692      12.0 %         11,963      13.3 %              729                  6.1 %
Chicago                                9,943       9.4 %          9,410      10.4 %              533                  5.7 %
Los Angeles                            9,861       9.3 %          6,250       6.9 %            3,611                 57.8 %
San Diego                              4,805       4.5 %          3,030       3.4 %            1,775                 58.6 %
Detroit                                2,546       2.4 %          1,567       1.7 %              979                 62.5 %
San Francisco Bay Area                 3,544       3.3 %          1,045       1.2 %            2,499                   nm
Miami                                  2,545       2.4 %            407       0.5 %            2,138                   nm
Minneapolis                            1,188       1.1 %            198        nm                990                   nm
Greater Washington, D.C. Area            539       0.5 %             -         nm                539                   nm
Seattle                                   10        nm               -         nm                 10                   nm

Total Revenue                    $   105,955                $    90,243                $      15,712

nm - not meaningful

                                               For the Nine Months Ended
                                     September 30, 2009         September 30, 2008          Change from Previous Period
. . .