Capital Growth Systems (CGSY.OB) 10-Q 2011 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934

For the transition period from            to            

Commission File Number 0-30831

CAPITAL GROWTH SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Florida	65-0953505
(State of other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

200 S. Wacker Drive Suite 1650, Chicago, IL 60606

(Address of principal executive offices)

(312) 673-2400

(Registrant’s telephone number, including area code)

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  x    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    ¨  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. (Check one):

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

As of November 5, 2010, the issuer had outstanding 168,233,180 shares of its $0.0001 par value common stock.

Table of Contents

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

		Page No.
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements		1
	Condensed Consolidated Balance Sheets as of September 30, 2010 [Unaudited] and December 31, 2009		2
	Condensed Consolidated Statements of Operations for the three and nine-month periods ended September 30, 2010 and 2009 [Unaudited]		3
	Condensed Consolidated Statements of Shareholders’ Equity (Deficit) from January 1, 2010 to September 30, 2010 and January 1, 2009 to December 31, 2009 [Unaudited]		4
	Condensed Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2010 and 2009 [Unaudited]		5
	Notes to Condensed Consolidated Financial Statements (Unaudited)		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		34
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		43
Item 4.	Controls and Procedures		43
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		45
Item 1A.	Risk Factors		46
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		47
Item 3.	Defaults Upon Senior Securities		47
Item 4.	(Removed and Reserved)		47
Item 5.	Other Information		47
Item 6.	Exhibits		47
SIGNATURES AND CERTIFICATIONS			48

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements are contained principally in the sections entitled “Business” and “Management’s Discussion and Analysis and Plan of Operation.” These statements involve known and unknown risks, uncertainties, and other factors, which may cause our actual results, performance, or achievements to be materially different from any future results, performances, or achievements expressed or implied by the forward-looking statements.

In some cases, you can identify forward-looking statements by terms such as “may,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential,” and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We discuss many of these risks in this report in greater detail under Item 1A- “Risk Factors.” These forward-looking statements represent our estimates and assumptions only as of the date of this report and we do not assume any obligation to update any of these statements.

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share data)

(Unaudited)

	September 30, 2010			December 31, 2009
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	3,851		$	3,377
Accounts receivable, net		4,335			9,739
Prepaid expenses and other current assets		3,922			907
Total Current Assets		12,108			14,023
Property and equipment, net		791			980
Intangible assets, net		14,696			16,462
Goodwill		1,480			1,480
Other assets		374			1,434
TOTAL ASSETS	$	29,449		$	34,379
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
CURRENT LIABILITIES
Debtor-in-possession term loan	$	9,384		$	—
Debt		22			16,107
Accounts payable		2,277			13,119
Accrued expenses		5,126			5,839
Deferred revenue		3,531			4,095
Total Current Liabilities		20,340			39,160
Liabilities for warrants to purchase common stock		—			17,960
Embedded derivatives of convertible debt instruments		—			28,214
Deferred income taxes		67			40
Deferred revenue, Long-term portion		—			13
Liabilities Subject to Compromise		38,224			—
Total Liabilities		58,631			85,387
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY (DEFICIT)
Preferred stock, $.0001 par value; 5,000,000 authorized, none issued or outstanding as of September 30, 2010 and December 31, 2009
Common stock, $.0001 par value; 350,000,000 authorized, 168,233,180 issued and outstanding at September 30, 2010 and December 31, 2009, respectively		17			17
Additional paid-in capital		106,188			105,290
Accumulated deficit		(135,254	)		(156,260	)
Accumulated other comprehensive income (loss)		(133	)		(55	)
Total Shareholders’ Equity (Deficit)		(29,182	)		(51,008	)
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)	$	29,449		$	34,379

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share data)

(Unaudited)

	Three-month periods ended September 30,						Nine-month periods ended September 30,
	2010			2009			2010			2009
REVENUES	$	13,871		$	16,457		$	42,432		$	48,578
COST OF REVENUES		10,050			12,524			31,485			37,411
GROSS MARGIN		3,821			3,933			10,947			11,167
OPERATING EXPENSES
Compensation		2,258			2,747			8,194			9,459
Travel and entertainment		255			260			925			935
Occupancy		411			413			1,181			1,230
Professional services		942			1,658			3,672			5,001
Insurance		117			79			216			240
Depreciation and amortization		680			1,139			2,044			3,415
Bad debt expense		155			162			491			439
Other operating expenses		302			254			772			699
TOTAL OPERATING EXPENSES		5,120			6,712			17,495			21,418
OPERATING LOSS		(1,299	)		(2,779	)		(6,548	)		(10,251	)
Interest expense		(4,560	)		(4,322	)		(15,621	)		(10,511	)
Registration rights and failure to file recoveries		—			1,395			—			—
Gain (loss) on warrants and derivatives		26,055			7,565			46,173			(12,262	)
Gain (loss) on extinguishment of debt and conversion of debt to stock		(273	)		294			(273	)		(68	)
Reorganization items		(2,672	)		—			(2,672	)		—
Income tax (expense) benefit		9			(100	)		(53	)		(100	)
NET INCOME (LOSS)	$	17,260		$	2,053		$	21,006		$	(33,192	)
INCOME (LOSS) PER SHARE OF COMMON STOCK – BASIC
Net income (loss) per share of common stock – basic	$	0.10		$	0.01		$	0.12		$	(0.20	)
INCOME (LOSS) PER SHARE OF COMMON STOCK – DILUTED
Net income (loss) per share of common stock – diluted	$	0.07		$	0.01		$	0.08		$	(0.20	)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING – BASIC		168,233,180			165,492,875			168,233,180			162,807,688
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING – DILUTED		458,040,141			191,838,929			458,040,141			162,807,688

The accompanying notes are an integral part of these condensed consolidated financial statements.

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(DEBTOR-IN-POSSESSION)

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

(in thousands, except share data)

(Unaudited)

	Common Shares		Common Stock		Additional Paid-in Capital		Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity (Deficit)
Balance, January 1, 2009		154,281,018	$	16	$	101,606	$	(103,426	)	$	7		$	(1,797	)
Conversion of debt to common stock		13,952,162		1		1,981		—			—			1,982
Stock-based compensation expense		—		—		1,703		—			—			1,703
Foreign currency translation adjustment		—		—		—		—			(62	)		(62	)
Net loss for 2009		—		—		—		(52,834	)		—			(52,834	)
Balance, December 31, 2009		168,233,180	$	17	$	105,290	$	(156,260	)	$	(55	)	$	(51,008	)
Balance, January 1, 2010		168,233,180	$	17	$	105,290	$	(156,260	)	$	(55	)	$	(51,008	)
Stock-based compensation expense		—		—		898		—			—			898
Foreign currency translation adjustment		—		—		—		—			(78	)		(78	)
Net income for the nine-month period ended September 30, 2010		—		—		—		21,006			—			21,006
Balance, September 30, 2010		168,233,180	$	17	$	106,188	$	(135,254	)	$	(133	)	$	(29,182	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESION)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, except share data)

(Unaudited)

	Nine-months periods  ended September 30,
	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by (used in) operating activities	$	3,110		$	(7,721	)
Reorganization items		(1,184	)		—
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES		1,926			(7,721	)
CASH FLOWS FROM INVESTING ACTIVITIES
Change in long-term deposits		125			—
Purchase of property and equipment		(89	)		(170	)
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES		36			(170	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from debtor-in-possession term loan		9,250			—
Proceeds from the issuance of debt		—			5,600
Repayment of long-term debt		(9,591	)		(25	)
Payment of financing costs		(1,069	)		—
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES		(1,410	)		5,575
Effect of exchange rate on cash and cash equivalents		(78	)		(48	)
Change in cash and cash equivalents		474			(2,364	)
Cash and cash equivalents – beginning of period		3,377			4,598
Cash and cash equivalents – end of period	$	3,851		$	2,234
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest	$	1,762		$	1,053
Cash paid for income taxes		107			—
NON-CASH INVESTING AND FINANCING ACTIVITIES
Conversion of debt to common stock		—			2,931
Issuance of July debentures to satisfy debt obligations		1,802			400
Conversion of accounts payable to VPP debentures		—			1,207

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements

September 30, 2010 (Unaudited)

NOTE 1. Organization and Basis of Presentation.

Description of Business

Capital Growth Systems, Inc. (CGSI) and its subsidiaries (the “Company”) operate in one reportable segment as a single source telecom logistics provider in North America and the European Union. The Company helps customers improve efficiency, reduce cost, and simplify operations of their complex global networks – with a particular focus on access networks.

Basis of Presentation

The Company’s unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2010 and 2009, have been prepared in accordance with generally accepted accounting principles for interim information and the rules and regulations of the Securities and Exchange Commission for interim financial information. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of the Company’s management, all adjustments, consisting of normal, recurring adjustments, considered necessary for a fair statement have been included. The results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010. Refer to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009 for the most recent disclosure of the Company’s accounting policies.

The Company’s condensed consolidated financial statements include the accounts of Capital Growth Systems, Inc. (CGSI) and its wholly-owned operating subsidiaries: ²⁰/20 Technologies, Inc. ( ²⁰/20 ), Magenta netLogic Ltd. (Magenta) which operates in the United Kingdom, Centre Path, Inc. (Centre Path), Global Capacity Group, Inc. (GCG), Global Capacity Direct, LLC (GCD) and Global Capacity Holdco, LLC. Except where necessary to distinguish the entities, together they are referred to as the “Company.” Global Capacity Holdco, LLC was organized for the sole purpose of holding the FCC 214 licenses previously held by GCG and GCD.

All material intercompany transactions and balances have been eliminated in consolidation.

The foreign currency translation adjustments resulting from the consolidation of Magenta, the Company’s United Kingdom subsidiary, have not been significant.

Amounts, exclusive of shares and per share data, are shown in thousands of dollars unless otherwise noted.

Bankruptcy Filing and Going Concern

The accompanying condensed consolidated statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. As of September 30, 2010, the Company’s current liabilities and liabilities subject to compromise exceeded its current assets by $46.5 million. Included in the current liabilities and liabilities subject to compromise is $20.0 million of current maturities of long-term debt, net of $23.1 million of debt discount associated with the initial fair value of related warrants and embedded derivatives and $17.3 million associated with OID and imputed interest. Cash on hand at September 30, 2010 was $3.9 million (not including $0.3 million restricted for outstanding letters of credit and tax escrow).

On July 23, 2010, the Company and its United States (“U.S.”) subsidiaries (the “Debtors”) filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The Debtors’ Chapter 11 cases are being jointly-administered under Case No.10-12302 .The Debtors will continue to operate their business as “debtors-in-possession” under the supervision of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. The Company’s subsidiary in the United Kingdom, Magenta, was not included in the filing and will continue their business without supervision from the Bankruptcy Court and will not be subject to the requirements of the Bankruptcy Code.

The Company remains in possession of its assets and properties, and continues to operate its businesses. The Company has obtained and the Bankruptcy Court has approved debtor-in possession financing which will provide up to $10.25 million, of which $9.25 million was funded on August 2, 2010 (“DIP Financing”).

The financing will enable the Company to continue to operate its businesses in the ordinary course pending a proposed reorganization of the Company’s businesses. However, there can be no assurance that the Company will be successful in gaining approval of its plan for reorganization.

The Plan Support and Restructuring Agreement provides for among other things the right of the Junior Debenture Holders to credit bid for the purchase of the Debtors’ assets all or some of the liens and pre-petition amounts due under the Debentures including accrued OID and Tranche B amounts under the DIP Facility plus accrued interest.

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(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

On August 2, 2010, $9.25 million was advanced to the Company by the Lenders under the terms of the DIP Financing. In addition to paying critical vendors and utility deposits, the funds were used on August 3, 2010 to pay $5.2 million to the Senior Lender (Pivotal Global Capacity, LLC or “Pivotal”) which represents payment in full of the outstanding Senior Secured Loan. Pivotal closed, on May 3, 2010, on its purchase of all the rights and obligations of the previous Senior Lender (ACF CGS, L.L.C.) with respect to the Term Loan and Security Agreement dated November 19, 2008, as amended, with no changes in terms and conditions. Pivotal was assigned the same rights and obligations of the previous holder and stepped into the role as the new Senior Lender in the same capacity as ACF CGS, L.L.C.

As of August 31, 2010 and September 30, 2010, the Company was in default on the DIP Loan Agreement. The DIP Loan Agreement provided for certain financial covenants to be maintained. Among those covenants was the requirement to maintain EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization), as defined in the DIP Loan Agreement, of at least $0.1 million for the month ended August 31, 2010 and $0.2 million for the two months ended September 30, 2010. The Company did not meet this financial covenant test for the month of August and the two months ended September 30, 2010 and accordingly, was in default of the DIP Loan Agreement. The DIP Loan Agreement provides, in the event of an Event of Default, for a default interest rate at a rate per annum which is 2% above the rate in effect immediately before the Event of Default. This rate will continue in effect during the continuance of an Event of Default. The Default Rate of Interest on both the Tranche A and Tranche B Loans is 14% per annum.

The Company is currently operating pursuant to Chapter 11 under the Bankruptcy Code and continuation of the Company as a going concern is contingent upon, among other things, the Company’s ability (i) to comply with the terms and conditions of the DIP Financing Agreement described in Note 7, Debtor-in-Possession Term Loan; (ii) to develop a plan of reorganization and obtain confirmation under the Bankruptcy Code; (iii) to reduce unsustainable debt and other liabilities and simplify its complex and restrictive capital structure through the bankruptcy process; (iv) to return to profitability; (v) to generate sufficient cash flow from operations; and (vi) to obtain financing sources to meet its future obligations. These matters create uncertainty relating to the Company’s ability to continue as a going-concern. The accompanying condensed consolidated financial statements do not reflect any adjustments relating to the recoverability and classification of assets or liabilities that might result from the outcome of these uncertainties. In addition, any plan of reorganization could materially change amounts reported in the Company’s condensed consolidated financial statements, which do not give effect to any adjustments of the carrying value of assets and liabilities.

Financial Reporting in Reorganization

Accounting Standards Codification (“ASC”) 852Reorganizations (“ASC 852”),which is applicable to companies in Chapter 11, generally does not change the manner in which financial statements are prepared. However, it does require that the financial statements for periods subsequent to the filing of the Chapter 11 petition distinguish between transactions and events that are directly associated with the reorganization proceedings and the ongoing operations of the business as well as additional disclosures. Revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the reorganization and restructuring of the business must be reported separately as reorganization items in the statements of operations beginning in the quarter ending September 30, 2010. The balance sheet must distinguish pre-petition liabilities subject to compromise from both those pre-petition liabilities that are not subject to compromise and from post-petition liabilities. Liabilities that may be affected by a plan of reorganization must be reported at the amounts expected to be allowed, even if they may be settled for lesser amounts. In addition, cash provided by reorganization items must be disclosed separately in the statements of cash flows. The Company adopted ASC 852 effective on July 23, 2010 and will segregate those items as outlined above for all reporting periods subsequent to such date.

The Company cannot determine as of this date the manner of accounting that the Company will apply upon emergence from Chapter 11, until a Plan of Reorganization has been approved and confirmed by the Bankruptcy Court. One method of accounting that may be applied upon emergence from Chapter 11 is fresh-start accounting. Fresh-start accounting applies when the reorganization value of the assets of the emerging entity immediately before the date of confirmation is less than the total of all postpetition liabilities and allowed claims, and holders of existing voting shares immediately before confirmation receive less than 50% of the voting shares of the emerging entity.

Accounts Receivable

Accounts receivable represent amounts owed from billings to customers and are recorded at gross amounts owed less an allowance for potentially uncollectible accounts. The Company provides an allowance for potentially uncollectible accounts receivable based upon prior experience and management’s assessment of the collectability of existing specific accounts. The total reserve for uncollectible accounts was $0.8 million and $1.0 million as of September 30, 2010 and December 31, 2009, respectively. The Company’s policy is to write-off accounts receivable balances once management has deemed them to be uncollectible.

Fair Value Measurements

The Company has adopted a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. In this valuation, the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability at the measurement date and fair value is a market-based measurement and not an entity-specific measurement.

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Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

The Company utilizes the following hierarchy in fair value measurements:

• Level 1 – Inputs use quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

• Level 2 – Inputs use other inputs that are observable, either directly or indirectly. These inputs include quoted prices for similar assets and liabilities in active markets as well as other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

• Level 3 – Inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair measurements requires judgment and considers factors specific to each asset or liability.

The Company has embedded derivatives associated with its convertible debt instruments and warrants classified as liabilities which are measured at fair value on a recurring basis. The embedded derivatives and the warrants are measured at fair value using the Black-Scholes valuation model with pricing inputs that are observable in the market or that can be derived principally from or corroborated by observable market data. In selecting the appropriate fair value technique the Company considers the nature of the instrument, the market risks that it embodies, and the expected means of settlement.

Recurring Fair Value Measurements: Liabilities measured at fair value on a recurring basis at September 30, 2010 and December 31, 2009 are as follows, in millions:

	Quoted Prices in Active Markets for Identical Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at September  30, 2010
Derivative financial instruments		—	$	0.0		—	$	0.0
Warrant liability		—		0.0		—		0.0
	Quoted Prices in Active Markets for Identical Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at December  31, 2009
Derivative financial instruments		—	$	28.2		—	$	28.2
Warrant liability		—		18.0		—		18.0

Fair Value of Financial Instruments not measured at fair value on a recurring basis: The carrying amount of cash, accounts receivable, debt, and accounts payable are considered representative of their respective fair values because of the short-term nature of these financial instruments. Long-term debt approximates fair value due to the interest rates on the promissory notes approximating current rates.

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Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

Non-Recurring Fair Value Measurements: Assets measured at fair value on a non-recurring basis at December 31, 2009 are as follows, in millions:

	Quoted Prices In Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at December  31, 2009		Total Gains (Losses) For the Year Ended December 31, 2009
Long-lived assets – Intangibles		—		—	$	16.5	$	16.5	$	(5.9	)
Goodwill		—		—		1.5		1.5		(12.5	)

There were no assets or liabilities measured at fair value on a non-recurring basis at September 30, 2010.

Intangible assets and goodwill are tested annually, or more frequently, if a change in circumstances or the occurrence of events indicates that potential impairment exists. As a result of the Company continuing to incur operating losses and filing for Chapter 11 bankruptcy in July 2010, the Company evaluated its goodwill and other long-lived assets for impairment as of September 30, 2010. Based on the results of the impairment testing, no impairment was recorded on the Company’s goodwill and other long-lived assets as of September 30, 2010. The Company recorded an impairment charge during the fourth quarter of 2009, as detailed below.

In accordance with the provisions of the Impairment or Disposal of Long-Lived Assets Subsection of the FASB’s Accounting Standards Codification (ASC) Topic 360-10, intangible assets with a carrying amount of $22.4 million were written down to their fair value of $16.5 million, resulting in an impairment charge of $5.9 million, which was included in results of operations for the fourth quarter of 2009.

Pursuant to the provisions of ASC Topic 350,Intangibles – Goodwill and Other, goodwill with a carrying amount of $14.0 million was written down to its fair value of $1.5 million, resulting in an impairment charge of $12.5 million, which was included in results for the fourth quarter of 2009.

See the Intangible Assets and Goodwill note for a discussion of the valuation techniques and a description of the information used to determine fair value in 2009.

Comprehensive Income (Loss)

Comprehensive income (loss) is as follows:

	Three-month periods ended September 30,					Nine-month periods ended September 30,
	2010			2009		2010			2009
Net income (loss), as reported	$	17,260		$	2,053	$	21,006		$	(33,192	)
Foreign currency translation adjustment		(63	)		2		(78	)		(48	)
Comprehensive income (loss)	$	17,197		$	2,055	$	20,928		$	(33,240	)

Use of Estimates

The preparation of financial statements with accounting principles, generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Reclassifications

Due to the material activity in the allowance for doubtful accounts and bad debt expense, certain amounts previously reported have been reclassified to conform to the current period presentation.

9

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

NOTE 2- Reorganization under Chapter 11

Reorganization under Chapter 11 of the Bankruptcy Code

On July 22, 2010, the Company entered into a Plan Support Agreement (“PSA”) with certain holders of its debentures. Upon entering into the PSA, on July 23, 2010, the Debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. The Debtors excluded from the bankruptcy filing, its wholly owned United Kingdom subsidiary, Magenta net Logic, Ltd. The Debtors have operated their business as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of Chapter 11 and orders of the Bankruptcy Court and will continue to do so until they emerge from Chapter 11 bankruptcy proceedings, as described herein.

On July 27, 2010, the Bankruptcy Court approved certain first-day motions in the Chapter 11 Cases, including without limitation, approval of an interim order authorizing the use by the Debtor of their cash collateral, orders authorizing the payment of suppliers, wages, salaries and other benefits to employees and certain operating expenses, orders prohibiting utilities from altering, refusing or discontinuing services to Debtor, orders authorizing the continued use of the Company’s existing cash management system, orders authorizing payment of pre-petition sales, use, property and other taxes and orders authorizing debtors to continue to operate under and provide services pursuant to its Service Order with Excel Communications. On August 13, 2010, the Bankruptcy Court approved on a final basis the Debtors’ first-day motion relating to these and certain other matters.

Plan of Reorganization

On August 11, 2010, the Debtors filed a Plan of Reorganization (the “Plan”) and related Disclosure Statement with the Bankruptcy Court. On September 22, 2010, the Bankruptcy Court approved the adequacy of information contained in the Disclosure Statement and the Debtors subsequently commenced solicitation of the votes of its Lenders, Debenture Holders and other interest holders entitled to vote on the Plan.

Although the Bankruptcy Court approved the adequacy of information contained in the Disclosure Statement, the Debtors must obtain approval of the Plan from those interest holders entitled to vote on the Plan, obtain the Bankruptcy Court’s confirmation of the Plan, obtain an exit financing facility that repays the debtor-in-possession term loan in cash in full on the Plan’s Effective Date and provides working capital to the new entity upon emergence from bankruptcy and perform certain administrative actions in conjunction with the emergence from Chapter 11. There can be no assurance that the Debtors will satisfy these conditions, complete such required actions and emerge from Chapter 11 within the Debtors’ anticipated timeframe or at all.

Debtor-in-Possession Financing and Payoff of the Senior Term Loan

With the filing of voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code, the Company entered into a Debtor in Possession Loan and Security Agreement (the “DIP Loan Agreement”) with Downtown CP-CGSY, LLC (the “Tranche A Lender”), the holders of certain debentures issued by the Company (the “Pre-Petition Debenture Lenders”), and certain other investors that were approved by the Pre-Petition Debenture Lenders (collectively, the “Tranche B Lenders” and together with the Tranche A Lender, collectively, the “Lenders”). The DIP Loan Agreement was effective as of July 30, 2010 and was approved on an interim basis on that date (the “Interim Order”). On August 13, 2010, the Bankruptcy Court approved on a final basis the DIP Loan Agreement.

The DIP Loan Agreement provides for an aggregate financing of up to $10.25 million to be provided through a $3 million Tranche A Loan and a $7.25 million Tranche B Loan. See Note 7, Debtor-in-Possession Term Loan for the terms of the DIP Loan Agreement.

10

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

On August 2, 2010, $9.25 million was advanced by the Lenders to the Debtors under the terms of the DIP Financing. The remaining $1.0 million of the total financing will be funded by the Tranche B Lenders contingent upon entry of a final order by the Bankruptcy Court approving the Loan and satisfaction by the Debtors of certain affirmative and negative covenants. The funds were used to pay, on August 3, 2010, $5.1 million in full settlement of the Senior Secured Loan due to Pivotal Global Capacity, LLC (the “Senior Lender”); assurance deposits in the amount of $3.2 million to the Debtors’ carriers and the remaining $0.8 million for critical vendors and working capital.

The Loans bear interest at 12% per annum and require mandatory prepayments in the amount of 100% of the net sale proceeds from non-ordinary course assets sales and 100% of insurance and condemnation proceeds, and tax refunds. The Debtors paid commitment fees of $.06 million and a $.02 million structuring fee to the Tranche A Lender. If the Tranche A Loan is extended beyond the maturity date, an extension fee of 1% of the Tranche A Loan amount is due for up to two 60 day extensions. The Loans are secured by all the assets of the Debtors.

11

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

As of August 31, 2010 and September 30, 2010, the Company was in Default on the DIP Loan Agreement. The DIP Loan Agreement provided for certain financial covenants to be maintained. Among those covenants was the requirement to maintain EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization), as defined in the DIP Loan Agreement, of at least $0.1 million for the month ended August 31, 2010 and $0.2 million for the two months ended September 30, 2010. The Company did not meet this financial covenant test and accordingly, was in default of the DIP Loan Agreement as of August 31, 2010 and September 30, 2010. The DIP Loan Agreement provides, in the event of an Event of Default, for a default interest rate at a rate per annum which is 2% above the rate in effect immediately before the Event of Default. This rate will continue in effect during the continuance of an Event of Default. The Default Rate of Interest on both Tranche A and Tranche B Loans is 14% per annum.

Other Matters relating to Reorganization under Chapter 11 of the Bankruptcy Code

Bankruptcy Reporting Requirements

The Company has submitted monthly operating reports to the Bankruptcy Court during the Chapter 11 Cases. These monthly reports have been prepared according to requirements of federal bankruptcy law. While the Company believes that these reports provide then-current information required under federal bankruptcy law, they are nonetheless unconsolidated, unaudited, prepared in a format different from that used in the Company’s consolidated financial statements filed under the securities laws and are only prepared for the combined Debtor entities. Accordingly, the Company believes that the substance and format of the materials does not allow meaningful comparison with its regular publicly disclosed consolidated financial statements. Moreover, the materials filed with the Bankruptcy Court have not been prepared for the purpose of providing a basis for an investment decision relating to the Company’s securities or for comparison with other financial information filed with the Securities and Exchange Commission.

12

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

Liabilities Subject to Compromise

As described above, certain claims against the Debtors in existence prior to the Chapter 11 Cases (“pre-petition liabilities”) may be subject to compromise or other treatment under the Plan (see “Other Matters relating to Reorganization under Chapter 11 of the Bankruptcy Code”) and are reflected as liabilities subject to compromise in the accompanying condensed consolidated balance sheet. A summary of liabilities subject to compromise as of September 30, 2010 is shown below:

	September 30, 2010
Liabilities Subject to Compromise
Accounts payable	$	14,017
Accrued liabilities		4,204
Debt subject to compromise:
July Debentures		8,733
Amended March Debentures		4,918
November Debentures		2,404
VPP Debentures		1,006
Seller Debentures		2,942
Total liabilities subject to compromise	$	38,224

Reorganization Items

Reorganization items include expenses, gains and losses directly related to the Debtors’ reorganization proceedings. For the three and nine months ended September 30, 2010, the Company incurred $2.7 million of reorganization items. The reorganization items include attorney and financial advisor fees for the Company, debenture holders and unsecured creditors, and United States Trustee fees.

13

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

Condensed Combined Debtor-in-Possession Financial Information

The financial statements shown below represent the condensed combined statements of the Debtors only and are prepared on the same basis as the accompanying condensed consolidated financial statements. The Company’s non-Debtor subsidiary, Magenta, is reflected as non-consolidated subsidiary in these financial statements. Accordingly, the net assets of the non-Debtor subsidiary is reflected as “Accumulated losses of unconsolidated non-Debtor subsidiary in excess of investment” in the balance sheet shown below, and the net loss of the non-Debtor subsidiary is reflected as “Equity in net loss of non-Debtor subsidiary” in the statement of operations shown below. Intercompany transactions between the Debtors have been eliminated. Intercompany balances between the Debtors and non-Debtor subsidiary are reflected as “Amounts due from non-Debtor subsidiary, net” in the balance sheet shown below.

CONDENSED COMBINED DEBTOR-IN-POSSESSION

BALANCE SHEET

(Non-filed entities, principally non-US subsidiary excluded from Debtor group; unaudited)

	September 30, 2010
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	3,825
Accounts receivable, net		4,266
Prepaid expenses and other current assets		3,891
Total Current Assets		11,982
Property and equipment, net		791
Amounts due from non-Debtor subsidiary, net		3,000
Intangible assets, net		14,695
Goodwill		1,480
Other assets		375
TOTAL ASSETS	$	32,323
LIABILITIES AND DEFICIT
CURRENT LIABILITIES
Debtor-in-possession term loan	$	9,384
Accounts payable		2,213
Accrued expenses		5,056
Deferred Revenue		3,517
Total Current Liabilities		20,170
Accumulated losses of unconsolidated non-Debtor subsidiary in excess of investment		10,361
Deferred Income Taxes		67
Liabilities Subject to Compromise		38,224
Deficit Attributable to Debtors		(36,499	)
TOTAL LIABILITIES AND DEFICIT	$	32,323

14

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

CONDENSED COMBINED DEBTOR-IN-POSSESSION

STATEMENTS OF OPERATIONS

(Non-filed entities, principally non-US subsidiary excluded from Debtor group; unaudited)

	Three months ended September 30, 2010			Nine months ended September 30, 2010
Revenues	$	13,816		$	42,195
Cost of revenues		10,050			31,485
Gross margin		3,766			10,710
Operating expenses		4,894			16,365
Operating (loss)		(1,128	)		(5,655	)
Interest expense		4,560			15,619
Gain on warrants and derivatives		(26,055	)		(46,173	)
Loss on extinguishment of debt and conversion of debt to stock		273			273
Equity in net loss of non-Debtor subsidiary		171			895
Write off of non-Debtor receivable		221			924
Reorganization items		2,672			2,672
Income tax (benefit) expense		(9	)		53
Net income (loss) attributable to Debtors	$	17,039		$	20,082

15

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

CONDENSED COMBINED DEBTOR-IN-POSSESSION

STATEMENTS OF CASH FLOWS

(Non-filed entities, principally non-US subsidiary excluded from Debtor group; unaudited)

	Nine months ended September 30, 2010
Cash Flows from Operating Activities
Net cash provided by operating activities	$	3,185
Reorganization Items		(1,184	)
Net Cash Provided by Operating Activities		2,001
Cash Flows from Investing Activities
Purchase of property and equipment		(89	)
Change in long-term deposit and other assets		125
Net Cash Provided by Investing Activities		36
Cash Flows from Financing Activities
Proceeds from debtor-in-possession term loan		9,250
Repayment of long-term debt		(9,585	)
Payment for deferred financing cost		(1,069	)
Cash Flows (Used In) Financing Activities		(1,404	)
Effect of exchange rate on cash and cash equivalents		(78	)
Increase in cash and cash equivalents		555
Cash and cash equivalents-beginning of period		3,270
Cash and cash equivalents-end of period	$	3,825

16

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

NOTE 3. Recent Accounting Pronouncements.

Recently Adopted Accounting Pronouncements

In December 2009, the FASB issued ASU No. 2009-17,Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, which amends ASC 810,Consolidation to address the elimination of the concept of a qualifying special purpose entity. The standard also replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity. This standard also requires continuous reassessments of whether an enterprise is the primary beneficiary of a VIE whereas previous accounting guidance required reconsideration of whether an enterprise was the primary beneficiary of a VIE only when specific events had occurred. The standard provides more timely and useful information about an enterprise’s involvement with a variable interest entity and will be effective as of the beginning of interim and annual reporting periods that begin after November 15, 2009. The Company adopted the standard on January 1, 2010.

In January 2010, the FASB issued ASU No. 2010-6,Improving Disclosures About Fair Value Measurements, which provides amendments to ASC 820Fair Value Measurements and Disclosures, including requiring reporting entities to make more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements including information on purchases, sales, issuances, and settlements on a gross basis and (4) the transfers between Levels 1, 2, and 3. The standard is effective for annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures, which are effective for annual periods beginning after December 15, 2010. The Company adopted the standard for Levels 1 and 2 on January 1, 2010, and does not expect the adoption of the standard for Level 3, on January 1, 2011, to have a material impact on its consolidated financial statements.

The FASB updated ASC Topic 810,Consolidations, and ASC Topic 860,Transfers and Servicing, which significantly changed the accounting for transfers of financial assets and the criteria for determining whether to consolidate a variable interest entity (VIE). The update to ASC Topic 860 eliminates the qualifying special purpose entity (QSPE) concept, establishes conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies the financial asset de-recognition criteria, revises how interests retained by the transferor in a sale of financial assets initially are measured, and removes the guaranteed mortgage securitization re-characterization provisions. The update to ASC Topic 810 requires reporting entities to evaluate former QSPEs for consolidation, changes the approach to determining a VIE’s primary beneficiary from a mainly quantitative assessment to an exclusively qualitative assessment designed to identify a controlling financial interest, and increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a VIE. The Company adopted the provisions of these staff positions effective January 1, 2010.

The adoption of the pronouncements above did not have a material effect on the Company’s financial position or results of operations.

New Accounting Pronouncements Not Yet Effective

In October 2009, the FASB issued ASU 2009-13,Multiple-Deliverable Revenue Arrangements, (amendments to ASC Topic 605, Revenue Recognition) (ASU 2009-13) and ASU 2009-14,Certain Arrangements that Include Software Elements, (amendments to ASC Topic 985, Software) (ASU 2009-14). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted.

17

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

The Company is currently evaluating the impact of the adoption of these ASUs on its consolidated results of operations of financial condition. The Company will implement the standard effective January 1, 2011.

In April 2010, the FASB issued ASU 2010-13, Topic 718,Compensation—Stock Compensation, which addressed the classification of an employee share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. ASU 2010-13 specifies that a share-based payment awarded that contains a condition that is not a market, performance, or service condition is required to be classified as a liability unless it otherwise qualifies as equity. The amendment is effective for fiscal years, and interim periods beginning on or after December 15, 2010. The Company is currently evaluating the impact of the adoption of this ASU on its consolidated results of operations of financial condition. The Company will implement the standard effective January 1, 2011.

NOTE 4. Property and Equipment.

Property and equipment consists of the following:

	September 30, 2010			December 31, 2009
Furniture and fixtures	$	343		$	343
Computer equipment		979			972
Leasehold improvements		817			813
Machinery and equipment		1,670			1,630
		3,809			3,758
Accumulated depreciation		(3,018	)		(2,778	)
Net property and equipment	$	791		$	980

Depreciation of property and equipment was $ 0.1 million and $0.2 million for the three-months ended September 30, 2010 and September 30, 2009, and $0.3 million and $0.6 million for the nine-month periods ended September 30, 2010 and September 30, 2009, respectively.

NOTE 5. Intangible Assets and Goodwill.

Intangible assets were acquired in business combinations. The assets have no significant residual values. All intangible assets are subject to amortization. Gross carrying amounts, accumulated amortization, and amortization for the periods ending September 30, 2010 and December 31, 2009 for each major intangible asset class are as follows:

		September 30, 2010
	Amortization Period in  Years	Gross Carrying Amount		Accumulated Amortization			Net
Developed technology	15	$	8,546	$	(4,360	)	$	4,186
Customer base	15		14,256		(3,746	)		10,510
Total	13.2 weighted average years	$	22,802		(8,106	)	$	14,696

		December 31, 2009
	Amortization Period in Years	Gross Amount		Accumulated Amortization			Impairment Losses			Net Carrying Value
Developed technology	5 to 15	$	12,215	$	(3,581	)	$	(3,669	)	$	4,965
Customer relationships	6 to 15		16,510		(2,759	)		(2,254	)		11,497
Total	13.9 weighted average years	$	28,725	$	(6,340	)	$	(5,923	)	$	16,462

Amortization expense related to the intangible assets was $0.6 million and $0.9 million for the three-months ended September 30, 2010 and 2009, and $1.8 million and $2.8 million for the nine-month periods ended September 30, 2010 and 2009, respectively.

18

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

Estimated amortization expense for intangible assets is as follows for the years ending December 31:

Remaining 3 months of 2010	$	589
2011		2,141
2012		1,953
2013		1,767
2014		1,571
2015		1,392
Thereafter		5,283
Total	$	14,696

As a result of the Company continuing to incur operating losses and the filing for Chapter 11 bankruptcy in July 2010, the Company evaluated its specifically identifiable intangible assets for impairment as of September 30, 2010.

Based on the results of the impairment testing, the future expected undiscounted cash flows to be generated from the Company’s intangible assets exceeded its carrying value, therefore, no impairment was recorded as of September 30, 2010.

Goodwill

Management determined that the Company had only one reporting unit for the purposes of goodwill impairment testing in 2009. The results of the annual impairment test indicated that there was a $12.5 million impairment of goodwill recorded in the fourth quarter of 2009.

The value at acquisition and current carrying value of goodwill for the acquired companies are as follows:

	September 30, 2010							December 31, 2009
	Value at Acquisition		Accumulated Impairment Losses			Net Carrying Value		Value at Acquisition		Accumulated Impairment Losses			Net Carrying Value
Total	$	13,993	$	(12,513	)	$	1,480	$	13,993	$	(12,513	)	$	1,480

In 2009, the fair value of goodwill was determined using a discounted cash flow model from projections of the future operations of the business utilizing forecasts of operations, financial position, and cash flows provided by Management. The resultant fair value of the Company’s reporting unit was less than its carrying value at December 31, 2009, requiring step two of the goodwill impairment test to be performed.

As a result of the “step two” analysis, the Company assigned the fair value to the assets and liabilities and determined that the calculated implied fair value of goodwill was approximately $1.5 million, resulting in a $12.5 million impairment charge to write-down the carrying value of goodwill to the implied fair value.

Due to the impairment triggers noted above, the Company conducted an interim goodwill impairment test as of September 30, 2010. The fair value of the Company’s reporting unit, determined using a discounted cash flow model, was greater than its carrying value at September 30, 2010. Further, the Company has received a number of competitive bids from third parties during the bankruptcy process which are in excess of the current carrying value of the Company’s assets and accordingly no impairment of goodwill was recorded as of September 30, 2010.

Determining the fair value of a reporting unit is a matter of judgment and often involves the use of significant estimates and assumptions. The use of different assumptions could increase or decrease an impairment charge. An erosion of future business could create additional impairment in goodwill or other long-lived assets and require a significant charge in future periods.

19

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

NOTE 6. Accrued Expenses.

Accrued expenses consist of the following:

	September 30, 2010 Pre-petition Subject to Compromise		September 30, 2010 Post-petition		December 31, 2009
Accrued carrier disputes	$	627	$	—	$	1,661
Compensation and payroll taxes		905		866		1,067
Interest expense		—		55		620
Excise and sales taxes		—		1,833		858
Reorganization items		—		1,489		—
Professional services		—		265		997
Other expenses		2,672		618		636
Total accrued expenses	$	4,204	$	5,126	$	5,839

The accrued expenses pre-petition as of September 30, 2010 are included in Liabilities Subject to Compromise. See Note 2 –Reorganization under Chapter 11.

As a result of the Debtors’ filing voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code on July 23, 2010, the Company determined that it was most likely that the Company was not going to be able to pay in full the principal balances of the Debenture Debt and accordingly, suspended the accrual of interest on this Debt. The amount of interest that would have been accrued had the Company not suspended the accrual would have amounted to $0.2 million as of September 30, 2010.

NOTE 7. Debtor-in-Possession Term Loan.

	September 30, 2010		December 31, 2009
Tranche A	$	3,000	$	—
Tranche B		6,384		—
Debtor-in-possession term loan	$	9,384	$	—

With the filing of voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code, the Company entered into a Debtor in Possession Loan and Security Agreement (the “DIP Loan Agreement”) with Downtown CP-CGSY, LLC (the “Tranche A Lender”), the holders of certain debentures issued by the Company (the “Pre-Petition Debenture Lenders”), and certain other investors that were approved by the Pre-Petition Debenture Lenders (collectively, the “Tranche B Lenders” and together with the Tranche A Lender, collectively, the “Lenders”). The DIP Loan Agreement was effective as of July 30, 2010 and was approved on an interim basis on that date (the “Interim Order”), pending a final hearing on the matter.

The DIP Loan Agreement provides for an aggregate financing of up to $10.25 million to be provided through a $3 million Tranche A Loan and a $7.25 million Tranche B Loan.

The Terms of the DIP Financing are as follows:

a) DIP Facility/Availability: upon entry of the Interim Order, an initial advance of: (i) $9.25 million (consisting of a $3 million Tranche A Loan and $6.25 million Tranche B Loan), (ii) such additional amount as may be agreed to by Downtown Capital in writing, or (iii) such other sum as is approved by the Bankruptcy Court on an interim basis. Upon entry of a Final Order, up to $10.25 million outstanding at any time. As of September 30, 2010, $3.0 million was outstanding under the Tranche A Loan and $6.4 million was outstanding under the Tranche B Loan. For the three and nine month periods ended September 30, 2010, interest expense on the DIP Term Loan was $0.2 million.

b) Purpose: Principally short-term working capital, utility deposits, critical vendor payments, payment of pre-petition secured indebtedness of Secured Lien Lender.

20

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

c) Financial Terms: Interest on Tranche A Loan will be payable at the end of each month in arrears at 12% per annum. Interest on the Tranche B Loan, including PIK interest added to the principal amount of the Tranche B Loans, shall accrue at 12% payment in kind which shall accrue and be added to the principal monthly, but be paid in full upon the earlier of the Effective Date of a plan of reorganization, upon an Event of Default or the Maturity Date. As of September 30, 2010, the balance outstanding for the Tranche B Loan was $6.4 million which included $0.1 million of PIK interest which has been added to the principal balance.

d) Maturity: The Borrowers shall repay any outstanding advances and loans under the DIP Financing on the earliest of: (i)(a) the occurrence of an Event of Default and (b) the Effective Date of a Plan of Reorganization; provided that subject to the Lenders’ written consent the Borrowers may extend such date by up to two periods of sixty days each; (ii) the date of the acceleration of any outstanding extensions of credit under the DIP Financing; (iii) entry of an order reversing in any respect either of the DIP Financing Orders (unless waived in writing by DIP Lenders); (iv) the conversion of any of the Chapter 11 Cases to a case under Chapter 7 of the Bankruptcy Code; (v) the appointment of a trustee or an examiner with special powers; and (vi) the dismissal of any of the Chapter 11 Cases.

e) Fees:The Tranche A Lender has received a Structuring fee of $.02 million and a Commitment Fee of $.06 million. In addition, the Tranche A Lender shall receive an Extension Fee of 1% for each of the two sixty day extensions of the Maturity Date, which extensions must be consented to by the DIP Lenders in writing.

f) Mandatory Prepayment: (i) 100% of the net sale proceeds from non-ordinary course assets sales; (ii) 100% of insurance and condemnation proceeds and tax refunds, in each case received by the Borrowers or any of the Guarantors.

g) Financial Covenants:

a) EBITDA of at Least:

1-      Month Ended August 31, 2010	$	0.1 million
2-      Two Months Ended September 30, 2010	$	0.2 million
3-      Three Months Ended October 31, 2010	$	0.3 million
4-      Four Months Ended November 30, 2010	$	0.45 million

b) Monthly Recurring Circuit Revenue of at least $3.65 million for the months ended August 31, 2010, September 30, 2010, October 31, 2010 and November 30, 2010.

c) Monthly Recurring Circuit Margin Percentages of 19.5% each for August, September, October and November, 2010 and Cumulative Recurring Circuit Margin Percentage of 19.5 % for August and 20.0% for September, October and November 2010.

d) Shall not have on a consolidated basis outstanding Accounts Payable of more than $4.1 million as at August 31, September 30, October 31 and November 30, 2010.

On August 2, 2010, $9.25 million was advanced by the Lenders to the Debtors under the terms of the DIP Financing. The remaining $1.0 million of the total financing will be funded by the Tranche B Lenders contingent upon entry of a final order by the Bankruptcy Court approving the Loan and satisfaction by the Debtors of certain affirmative and negative covenants. The funds were used to pay, on August 3, 2010, $5.2 million in full settlement of the Senior Secured Loan due to Pivotal Global Capacity, LLC (the “Senior Lender”); assurance deposits in the amount of $3.2 million to the Debtors’ carriers and the remaining $0.8 million for critical vendors and working capital.

The Loans bear interest at 12% per annum and require mandatory prepayments in the amount of 100% of the net sale proceeds from non-ordinary course assets sales and 100% of insurance and condemnation proceeds, and tax refunds. The Debtors paid commitment fees of $.06 million and a $.02 million structuring fee to the Tranche A Lender. If the Tranche A Loan is extended beyond the maturity date, an extension fee of 1% of the Tranche A Loan amount is due for up to two 60 day extensions. The Loans are secured by all the assets of the Debtors.

As of August 31, 2010 and September 30, 2010, the Company was in default on the DIP Loan Agreement. The DIP Loan Agreement provided for certain financial covenants to be maintained. Among those covenants was the requirement to maintain EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization), as defined in the DIP Loan Agreement, of at least $0.1

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(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

million for the month ended August 31, 2010 and $0.2 million for the two months ended September 30, 2010. The Company did not meet this financial covenant test and accordingly, was in default of the DIP Loan Agreement as of August 31, 2010 and continued through September 30, 2010. The DIP Loan Agreement provides, in the event of an Event of Default, for a default interest rate at a rate per annum which is 2% above the rate in effect immediately before the Event of Default. This rate will continue in effect during the continuance of an Event of Default. The Default Rate of Interest on both Tranche A and Tranche B Loans is 14% per annum.

NOTE 8. Debt.

Debt consists of the following:

	September 30, 2010 Subject to Compromise		September 30, 2010 Post- petition		December 31, 2009
Term loan, interest at the higher of prime or 5%, plus a margin of 14% (5% paid-in-kind “PIK”), due November 2010, debt discount at issuance of $2.2 million, outstanding principal balance of $8.5 million. On August 3, 2010 the outstanding principal balance plus accrued interest was paid in full. The remaining unamortized debt discount of $0.3 million was written off as part of loss on extinguishment of debt. At December 31, 2009, the outstanding principal balance was $8.5 million, plus PIK of $0.8 million, net of unamortized debt discount of $1.0 million	$	—	$	—	$	8,314
July Debentures (1), $10.5 million, issued in July 2009 and August 2009, Original Issue Discount (OID) and Debt Discount at issuance of $4.5 million and $5.2 million, respectively, interest at the higher of prime or 5%, plus a margin of 14% (5% PIK), and due May 2011. At September 30, 2010, the net balance outstanding was subject to compromise. At December 31, 2009, the outstanding principal balance was $10.5 million plus $0.1 million PIK, net of unamortized OID and debt discount of $3.6 million and $4.1 million, respectively		8,733		—		2,931
Amended March Debentures (1), OID and debt discount at issuance of $12.4 million and $18.4 million, respectively, due March 2015, outstanding principal balance of $30.8 million at issue. At September 30, 2010, the net balance outstanding was subject to compromise. At December 31, 2009, the outstanding principal balance was $26.9 million, net of unamortized OID and debt discount of $11.0 million and $14.1 million, respectively.		4,918		—		1,764
November Debentures (1), OID and debt discount at issuance of $5.9 million and $9.0 million, respectively, due November 2015, outstanding principal balance of $14.9 million at issue. At September 30, 2010, the net balance outstanding was subject to compromise. At December 31, 2009, the outstanding principal balance was $14.9 million, net of unamortized OID and debt discount of $5.6 million and $8.5 million, respectively.		2,404		—		840
VPP Debentures (1), outstanding principal balance of $2.0 million issued in July 2009, OID and debt discount at issuance of $0.8 million and $1.2 million, respectively, and due November 2011. As at September 30, 2010 the net balance outstanding was subject to compromise. As of December 31, 2009, the outstanding principal balance was $2.0 million, net of unamortized OID and debt discount of $0.6 million and $1.0 million, respectively.		1,006		—		380
Seller Debenture (1), $4.0 million non-interest bearing, debt discount for imputed interest and conversion feature at issuance of $1.5 million and $2.0 million, respectively, due May 2011 and renewable monthly thereafter. At September 30, 2010, the net balance outstanding was subject to compromise. At December 31, 2009, the outstanding principal balance was $4.0 million, net of unamortized debt discount of $2.1 million.		2,942		—		1,851
Unsecured loans from certain employees of Magenta, interest at 8.43%, due upon demand		—		22		27
Total		20,003		22		16,107
Less: current maturities		20,003		22		16,107
Long-term portion	$	—	$	—	$	—

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(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

All long-term debts are presented as current obligations as a result of the Company being in default on certain reporting and administrative covenants. The long-term debt commitments including the maturity value of original issue discount securities are $60.5 million as of September 30, 2010 and $67.7 million as of December 31, 2009. This amount does not include minimum interest due on the term note per the default clause of the agreement. As part of the Company’s formal reorganization, the Company is currently negotiating alternatives to restructure its debt instruments.

The reporting and administrative covenants established under the term note and the other debt instruments issued in November 2008 were created assuming an ongoing relationship with a significant customer. As that relationship, effectively, ended in 2009, the Company received a number of default notices and entered into a number of amendments to the loan agreements and forbearance agreements. On May 3, 2010, Pivotal Global Capacity, LLC, an affiliate of the Pivotal Group of Companies, successfully closed on its purchase of rights and obligations of the Senior Lender (ACF CGS, L.L.C.) with respect to the Term Loan and Security Agreement dated November 19, 2008, as amended, with no changes in terms and conditions. During the three months ended September 30, 2010, the Company paid Pivotal fees of $0.8 million including $0.7 million for due diligence fees for a future investment of $3 million by Pivotal. The company expensed the due diligence fees as the $3 million investment was not made. Additionally, Capstone Investments was paid a fee of $0.2 million for their advice with respect to this transaction.

The July Debentures, Amended March Debentures, November Debentures, VPP Debentures and Seller Debentures are all subject to compromise and full recovery by the debenture holders has been impaired as a result of the Debtors filing voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code. The outstanding balances as of September 30, 2010 are listed under “Liabilities Subject to Compromise” in Note 2 “Reorganization under Chapter 11.” Because of the uncertainty that the principal balances of the Debentures may not be paid in full, the Company has suspended the accrual of interest on the debentures as of the date of the filing of the voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code on July 23, 2010. The amount of interest that would have been accrued had the Company not suspended interest accruals on the Debentures amounted to $0.2 million as of September 30, 2010.

Term Loan: The Term Loan Agreement provided for a senior secured term loan (Term Loan) of $8.5 million effective November 19, 2008. The Company, each of its subsidiaries and GCD (Borrowers) granted to ACF CGS, L.L.C. (Senior Lender or Agent) a security interest in substantially all of their assets and a collateral pledge of all of the common stock or limited liability company interests of its wholly-owned subsidiaries.

During the period ended September 30, 2010, $3.7 million received from a customer was used to reduce the Term Loan outstanding balance.

On May 3, 2010, Pivotal Global Capacity, LLC, an affiliate of the Pivotal Group of companies engaged in the private equity business (“Pivotal”), closed on its purchase of all rights and obligations of the Senior Lender (ACG CGS, L.L.C., as agent for itself and any other named lenders) with respect to the Term Loan and Security Agreement dated November 19, 2008, as amended between ACF CGS, L.L.C. on the one hand and the Company and all of its active 100% owned subsidiaries on the other hand. As part of the Loan Agreement assignment, Pivotal, ACF CGS, L.L.C. and the Company and its subsidiaries entered into a Resignation, Appointment and Amendment Agreement whereby Pivotal was substituted as the “Agent” and sole lender under the Loan Agreement with no changes in terms and conditions. The Company agreed to reimburse Pivotal for its third party expenses incurred in connection with the transactions leading to the assignment of the loan from ACF CGS, L.L.C. Pivotal has been assigned the same rights and obligations of the previous holder and has stepped into the role as the new Senior Lender in the same capacity as ACF CGS, L.L.C. Interest on the Term Loan is payable monthly at the higher of prime or 5% plus a margin of 14%, with 5% of that rate paid-in-kind. Paid-in-kind interest compounds monthly and is added to the outstanding principal balance of the Term Loan. The Company incurred debt issuance costs of $1.8 million in connection with the Term Loan Agreement, which included a Term Loan origination fee of 2.5%, financial advisory services, legal fees and other costs. The Term Loan matures November 2010.

On August 3, 2010, the Debtors paid Pivotal $5.1 million representing the outstanding principal balance plus accrued interest from the proceeds of the DIP Financing. The Debtors paid $0.1 million in fees.

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Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

July Debentures: Effective July 31, and August 24, 2009, the Company issued two tranches that totaled $10.5 million of principal amount of OID senior secured convertible debentures (July Debentures), representing the funding of $6.0 million of subscription amount (inclusive of $0.4 million of subscriptions credited to the holders of the March and November Debentures for entering into a waiver and amendment agreement which, among other things, consented to the issuance of the July Debentures, and inclusive of $0.1 million against liabilities of the Company to Aequitas Capital Management, Inc.) and $4.5 million of OID added to principal, coupled with warrants to purchase up to 18.8 million shares of common stock, all exercisable or convertible at $0.24 per share (the July Warrants and coupled with the July Debentures are collectively referred to as the Units). The transaction resulted in proceeds to the Company of $5.6 million, before $0.5 million of financing fees. The July Debentures are secured by a security interest in the assets of the Company and its subsidiaries, and Aequitas Capital Management, Inc. was appointed collateral agent for the July Debenture holders.

At issuance, the July Debentures are convertible into 43.8 million shares of common stock at $0.24 per share, based on the aggregate maturity value, at any time at the option of the holders, but not before the Company’s Authorized Share Increase. In addition, the Company issued to the purchasers of the July Debentures warrants to purchase an aggregate of 18.8 million shares of its common stock at an exercise price of $0.24 per share. The warrants are exercisable at any time prior to their expiration date, but not before the Authorized Share Increase and expire five years after the date of such share increase. The Company determined that the conversion feature of the July Debentures was an embedded derivative. As a result of a shortfall in the collection of certain designated receivables or contract amounts by August 31, 2009, the July Units purchase agreement required a reduction in the conversion price of the July Debentures and the exercise price of the warrants from $.24 per share to $.15 per share with respect to all July Debentures held by persons that funded a portion of the shortfall with respect to subsequently issued Debentures (August Debentures), and all of the July Debenture holders did fund their ratable shares of the shortfall.

The estimated fair value of the warrants and embedded derivative as of the issuance date of the July Debentures, adjusted for the probability of the timing of the Authorized Share Increase, was $2.0 million and $3.2 million, respectively, and was recorded as debt discount and an increase to liabilities for warrants to purchase common stock and embedded derivative liability, respectively. The Company determined the fair value of the warrants and embedded derivative using the Black-Scholes pricing model with these average assumptions: common stock fair value of $0.16 per share, expected volatility of 152.4% for warrants and 154.5% for embedded derivatives, risk-free interest rate of 2.6% for warrants and 1.0% for embedded derivatives, expected term of 5.3 years for warrants and 1.8 years for embedded derivatives and no dividends

In addition to the OID amount, the Cash Subscription Amount of the July Debentures bears interest in an amount equal to the “Cash Subscription Amount Interest,” comprised of the sum of: (i) the prime rate of interest as announced in the Wall Street Journal (subject to a floor of 5%); plus (ii) 14% per annum (the Applicable Margin). Basic Interest (comprised of the prime rate component plus 9% of the total 14% of the Applicable Margin) is payable monthly in arrears (twenty days following the end of each month), with the remaining 5% to be paid at the option of the Company in either cash or as paid-in-kind (PIK) Interest, whereby such amount can be accrued and added to principal (in which event an additional OID factor of 75% of such amount is also added to principal of the July Debenture).

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Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

As required by the debenture agreement, the amount due at maturity was increased by $1.4 million during the period ended March 31, 2010, representing unpaid monthly interest of $0.5 million and additional OID amounts due on the unpaid monthly interest and the unpaid quarterly redemption payment due of $0.9 million. During the three months ended June 30, 2010, the Company had not made the required redemption payment in the month following the quarter ended March 31, 2010. During the quarter ended September 30, 2010 no interest was paid and the company suspended the accrual of interest.

Amended March Debentures: Pursuant to the November 20, 2008 Waiver Agreement, the holders of $16 million of original principal amount of March Debentures exchanged their March Debentures due March, 2013 for $28.0 million of Amended March Debentures, convertible into common stock at $0.24 per share (the Tranche 1 Amended March Debentures). The principal amount of the Tranche 1 Amended March Debentures is comprised of the $16 million original principal amount of the March Debentures plus the sum of the following: (i) the remainder of the interest that would have accrued under the March Debentures, or $6.0 million; (ii) 25% of the original principal amount of the March Debentures, or $4.0 million; (iii) liquidated damages related to the Company’s failure to timely complete the registration of its common stock, as discussed below, equal to 12% of the original principal amount, or $1.9 million; and (iv) interest on the liquidated damages at 16% per annum, or $0.1 million (collectively, the Tranche 1 Add-on Amount).

The remaining March Debentures were held by two affiliated holders, who held a total of $3.0 million of original principal amount. The two affiliated holders subsequently reduced their original principal amount to an aggregate outstanding balance of $2.5 million through conversions of their principal to common stock. Pursuant to the November 20, 2008 Waiver Agreement, the Company exchanged their March Debentures for $2.9 million of Amended March Debentures (the Tranche 2 Amended March Debentures), which mirror the terms of the Tranche 1 Amended March Debentures.

The principal amount of the Tranche 2 Amended March Debentures is comprised of the $2.5 million outstanding balance of the March Debentures plus the sum of the following: (i) liquidated damages related to the Company’s failure to timely complete the registration of its common stock, as discussed below, equal to 12% of the original principal amount, or $0.4 million and (ii) legal fees incurred by the two affiliated holders in negotiation and documentation of the revised transactions (collectively, the Tranche 2 Add-on Amount). In addition, at the Financial Closing, the Company made a one-time payment to the two affiliated holders in the aggregate of $0.9 million, which was the sum of the interest accrued on the March Debentures up to the amendment date and the remainder of the interest that would have accrued under their March Debentures. At June 30, 2010 and December 31, 2009, the balances owed to these holders were not material.

The Amended March Debentures are due March 2015. The warrants originally issued with the March Debentures, discussed below, remain outstanding and the March 2013 expiration date of the warrants was unchanged. The Amended March Debentures are OID securities and do not call for the payment of interest over their term. The Company is required to make quarterly redemption payments of the Add-on Amounts beginning July 1, 2009 through the maturity date, at which time the remaining principal balance will also be due. The November 20, 2008 Senior Lender Intercreditor Agreement contains certain conditions to the cash payment of the quarterly redemption amounts. To the extent the Company fails to satisfy those conditions, the Amended March Debenture holders, at their election, can accept either payment of such amount with shares of common stock, provided the Company has completed the Authorized Share Increase and met certain other conditions as defined by the March Amended Debentures, or, alternatively, accrue the unpaid portion with interest until maturity.

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

In July 2009, in conjunction with the issuance of the July Debentures, Amended March Debenture holders were allowed the right to exercise up to the lesser of their Amended March Debenture balance or five times the subscription price of the July Debentures purchased by them, at $0.15 per share and the quarterly redemption payments due July 1, 2009 through April, 2012 were deferred until Maturity date, March 11, 2015.

The holders of the Amended March Debentures retain the right at any time to convert up to an aggregate of $14.4 million of the face amount into common stock of the Company at $0.24 per share or up to 60.0 million shares on an as converted basis and convert up to an aggregate of $3.2 million of the face amount into common stock of the Company at $0.15 per share or up to 21.0 million shares on an as converted basis. There were no debt conversions during the nine-month period ended September 30, 2010. During the year ended December 31, 2009, holders converted $2.9 million of the Amended March Debentures into 13.9 million shares of common stock

November Debentures: On November 20, 2008, pursuant to the November Securities Purchase Agreement (SPA), the Company completed the private placement of $9.0 million of November Debentures with a maturity value of $14.9 million and due November 2015. The Company incurred $2.0 million of debt issuance costs in connection with the SPA. The November Debentures are OID securities and do not call for the payment of interest over their term. In connection with the issuance of the November Debentures, the Company recorded original issue discount of $5.9 million based upon the difference between the principal amount due at maturity of $14.9 million and the subscription amount of $9.0 million. The Company is required to make quarterly redemption payments beginning July 1, 2009 through the maturity date, at which time the remaining principal balance will also be due. The Senior Lender Intercreditor Agreement contains certain conditions to the cash payment of the quarterly redemption amounts. To the extent the Company fails to satisfy those conditions, the November Debenture holders, at their election, can accept either payment of such amount with shares of common stock, provided the Company has completed the Authorized Share Increase and met certain other conditions as defined by the November Debentures, or, alternatively, accrue the unpaid portion until maturity.

The November Debentures are convertible into common stock at $0.24 per share, or 62.0 million shares based on the aggregate maturity value, at any time at the option of the holders, but not before the Company’s Authorized Share Increase. In addition, the Company issued to the purchasers of the November Debentures warrants to purchase an aggregate of 28.2 million shares of its common stock at an exercise price of $0.24 per share. The warrants are exercisable at any time prior to their expiration date, but not before the Authorized Share Increase and expire five years after the date of authorized share increase. The Company determined that the conversion feature of the November Debentures was an embedded derivative. The estimated fair value of the warrants and embedded derivative as of the issuance date of the November Debentures, adjusted for the probability of the timing of the Authorized Share Increase, was $4.2 million and $9.6 million, respectively, and was recorded as additional debt discount and an increase to liabilities for warrants to purchase common stock and embedded derivative liability, respectively.

The aggregate initial fair value of the warrants and embedded derivative of $13.8 million exceeded the $9.0 million original principal amount of the November Debentures by $4.8 million, which was recognized immediately as interest expense. The Company determined the fair value of the warrants and embedded derivative using the Black-Scholes pricing model with the following average assumptions: common stock fair value of $0.22 per share, expected volatility of 141.6%, risk-free interest rate of 1.0%, expected term of 7.0 years and no dividends.

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

VPP Debentures: The Company established a vendor payment plan (VPP) designed to reduce past due obligations to certain of its vendors over time. In conjunction with the Second Amendment to the Loan Agreement, the Company issued $1.2 million subscription value, equal to the amount of vendor obligations, with a 65% OID factor as Vendor Payment Plan Debentures, due November 2011. Participants in the VPP Debentures included Shefsky and Froelich, Ltd. ($0.6 million), Capstone Investments ($0.4 million), and Aequitas Capital Management, Inc., ($0.2 million) at subscription. The VPP Security Agreement is substantially a similar form of security agreement (the VPP Security Agreement) as applicable to the July Security Agreement, with Aequitas Capital Management, Inc. to serve as the Collateral Agent.

At issuance, the VPP Debentures are convertible into common stock at $0.24 per share, or 8.3 million shares based on the aggregate maturity value, at any time at the option of the holders, but not before the Company’s Authorized Share Increase. In addition, the Company issued to the VPP Debenture holders warrants to purchase an aggregate of 3.8 million shares of its common stock at an exercise price of $0.24 per share. The warrants are exercisable at any time prior to their expiration date, but not before the Authorized Share Increase and expire five years after the date of such share increase.

The Company determined that the conversion feature of the VPP Debentures was an embedded derivative. The estimated fair value of the warrants and embedded derivative as of the issuance date of the VPP Debentures, adjusted for the probability of the timing of the Authorized Share Increase, was $0.4 million and $0.7 million, respectively, and was recorded as debt discount and an increase to liabilities for warrants to purchase common stock and embedded derivative liability, respectively. The Company determined the fair value of the warrants and embedded derivative using the Black-Scholes pricing model with these average assumptions: common stock fair value of $0.17 per share, expected volatility of 152.5% for warrants and 145.8% for embedded derivatives, risk-free interest rate of 2.6% for warrants and 1.3% for embedded derivatives, expected term of 5.3 years for warrants and 2.3 years for embedded derivatives and no dividends.

Seller Debenture: The $4.0 million unsecured Seller Debenture, due May 2011, was issued as partial consideration in the November 2008 GCD acquisition. The Debenture is non-interest bearing so the Company discounted the note at a 19% imputed interest rate resulting in an initial carrying value of $2.5 million. Management determined the 19% rate was applicable based on the interest rate at which the Company obtained other financing at the date of Closing. The Seller Debenture is subject to the terms of the Senior Lender Intercreditor Agreement and the Junior Lender Intercreditor Agreement.

The Seller Debenture is convertible into shares of the Company’s common stock at a conversion rate of $0.24 per share, or 12.5 million shares. The Seller Debentures are convertible at any time at the option of the Seller, but not before the Company’s Authorized Share Increase. The Company determined that the conversion feature of the Seller Debenture was an embedded derivative. The estimated fair value of the embedded derivative as of the issuance date of the Seller Debenture, adjusted for the probability of the timing of the Authorized Share Increase, of $2.0 million was recorded as debt discount and an increase to embedded derivative liability. The Company determined the fair value of the embedded derivative using the Black-Scholes pricing model with the following assumptions: common stock fair value of $0.22 per share, expected volatility of 141.6%, risk-free interest rate of 1.0%, expected term of 2.5 years and no dividends.

NOTE 9. Liability for Embedded Derivatives and Warrants.

Embedded Derivatives

The conversion features of the debt are considered embedded derivatives requiring bifurcation from the debt host and are included on the balance sheet as a liability (embedded derivatives of convertible debt) at fair value. The embedded derivative is revalued at each balance sheet date and marked to fair value with the corresponding adjustment recognized as “gain or loss on warrants and derivatives” in the statements of operations.

As of September 30, 2010 and December 31, 2009, the fair value of the derivatives embedded in the convertible debt was $0.0 million and $28.2 million, respectively. The weighted average assumptions used to value the embedded derivative liability at September 30, 2010 were: exercise price of $.20, life of 3.4 years, volatility 0.0%, and risk free interest rate of 0.9%. As a result of the Company’s Chapter 11 filing and subsequent decline in stock price to $0.01 per share as of September 30, 2010, no future volatility was assumed as there is currently no expectation that the Company’s stock price will increase from the $0.01 per share price. At December 31, 2009, the weighted average assumptions used were: exercise price of $0.20, life of 4.1 years, volatility 155.3%, and risk free interest rate of 2.2%.

Warrants

The Company’s outstanding warrants also meet the definition of a liability based on the assessment above. The warrants are classified as a liability in the balance sheet (see “liabilities for warrants to purchase common stock”) at fair value. The warrant liability is revalued at each balance sheet date and marked to fair value with the corresponding adjustment recognized as “gain or loss on

27

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(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

warrants and derivatives” in the statements of operations. As of September 30, 2010 and December 31, 2009, the fair value of the warrants was $0.0 million and $18.0 million, respectively. The weighted average assumptions used to value the warrant liability at September 30, 2010 were: exercise price of $0.23, life of 3.6 years, volatility 0.0%, and risk free interest rate of 0.83%. As a result of the Company’s Chapter 11 filing and subsequent decline in stock price to $0.01 per share as of September 30, 2010, no future volatility was assumed as there is no expectation that the Company’s stock price will increase from the $0.01 per share price. At December 31, 2009, the weighted average assumptions used were: exercise price of $0.23, life of 4.4 years, volatility 149.8%, and risk free interest rate of 2.3%.

At September 30, 2010 and December 31, 2009, respectively, the Company had 181.3 million warrants outstanding to purchase its common stock. These warrants were issued in connection with debt and equity offerings and in lieu of cash payments for services provided and became exercisable when issued. The warrants expire two to five years from date of issuance.

The table below summarizes the warrant expiration dates as of September 30, 2010:

Expiration Date	Number of Warrants (in thousands)		Range of Exercise Prices	Weighted Average Exercise Price
2010		675	$0.27-$0.35		0.306
2011		7,846	$0.25-$0.70		0.416
2012		13,000	$0.15-$0.25		0.198
2013		60,452	$0.24		0.240
2014		—	-		—
2015		99,335	$0.15-$0.24		0.209
Total warrants outstanding		181,308			0.228

All outstanding warrants expire no later than June 30, 2015.

Warrant activity from December 31, 2009 through September 30, 2010 is as follows:

	Number of Warrants (in thousands)		Weighted Average Exercise Price		Weighted Average Remaining  Contractual Life (Years)		Aggregate Intrinsic Value ($000)
Outstanding at December 31, 2009		181,308	$	0.228
Outstanding at September 30, 2010		181,308		0.228		3.6	$	—

There was no warrant activity during the nine-month period ended September 30, 2010.

NOTE 10. Share-Based Compensation.

Long-Term Incentive Plans

The Company has adopted various long-term incentive plans. Shares under all plans generally vest 25% upon issuance and 25% on the grant anniversary date until fully vested for service grants. Performance options granted under the plans vest as objectives outlined are achieved. Vesting requirements include new revenue goals, creating value within the organization, and/or achieving performance targets. When performance objectives are not attained that portion of the award is cancelled.

Executive Stock Option Agreements

From time to time, the Company provides for the issuance of share-based compensation in conjunction with employment agreements or special arrangements with certain of its executives and directors. As of September 30, 2010, the Company has authorized up to 65.2 million shares to be issued under these arrangements.

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

Activity under the stock option plans and board approved stock grants with time based vesting for the nine-months ended September 30, 2010 is as follows:

	Shares (in  thousands)			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Aggregate Intrinsic Value
Outstanding at December 31, 2009		23,366		$	0.565
Granted		400			0.240
Exercised		—			—
Forfeited/cancelled		(283	)		0.660
Outstanding at September 30, 2010		23,483		$	0.558		5.9	$	—
Exercisable at September 30, 2010		21,448		$	0.567		5.9	$	—

Time based awards generally vest 25% upon issuance and 25% on the successive three anniversary dates of the award. The Company estimates the fair value of stock option grants using the Black-Scholes pricing model with the assumptions detailed below. The weighted average grant-date fair value of options with time based vesting granted during the nine-month periods ended September 30, 2010 and 2009 was $0.10 and $0.124, respectively. For the nine-month periods ended September 30, 2010 and 2009, respectively, the Company recognized compensation expense for stock option awards totaling $0.6 million and $ 1.5 million, respectively. In the three-month period ended September 30, 2010 and 2009, compensation expense was $0.1 million and $0.6 million, respectively. At September 30, 2010, unamortized compensation associated with time-based options totaled $0.6 million with a remaining weighted average amortization period of 0.6 years.

Activity under the stock option plans and board approved stock grants with performance-based vesting for the nine-months ended September 30, 2010 is as follows:

	Shares (in  thousands)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Aggregate Intrinsic Value
Outstanding at December 31, 2009		14,367	$	0.488
Granted		—		—
Exercised		—		—
Forfeited/cancelled		—		—
Outstanding at September 30, 2010		14,367		0.488		4.0	$	—
Exercisable at September 30, 2010		1,333	$	0.57		5.0	$	—

Performance based awards generally vest 33% to 50% upon attaining targeted revenue growth, gross profit margins and continued employment with the Company. The Company estimates the fair value of stock option grants using the Black-Scholes pricing model. There were no performance options issued during the nine-month period ended September 30, 2010. For the nine-month periods ended September 30, 2010 and 2009, respectively, the Company recognized compensation expense for performance-based stock option awards totaling $0.2 million and $0.1 million, respectively. For the three-month period ended September 30, 2010, the Company did not recognize any compensation expense for performance- based stock option awards and no shares were cancelled. During the three-months ended September 30, 2009, compensation expense was reduced by $0.1 million as performance criteria was not attained and 0.9 million shares were cancelled. At September 30, 2010, unamortized compensation associated with performance-based options totaled $4.9 million with a remaining weighted average amortization period of 1.2 years.

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

The assumptions used to calculate the fair value of stock option grants issued are as follows:

	Nine-month period  ended September 30, 2010
Expected volatility		148.6	%
Weighted-average expected volatility		148.6	%
Expected term (in years)		6.1
Weighted-average risk-free interest rate		2.77	%
Expected dividends		—

Expected volatility is based on the Company’s trading history over a three-year period. Weighted average volatility uses the volatility on the grant date and the number of options granted throughout the year. The expected term is the time Management estimates options will be outstanding. The weighted average risk free interest rate is taken from the US Treasury rate of similar lived instruments on the date of the option grant.

The Company does not anticipate issuing dividends for the foreseeable future. A forfeiture rate of 5.0% is currently being used.

No options were exercised during the nine-month period ended September 30, 2010. No tax benefit has been recorded related to stock-based compensation expense.

NOTE 11. Shareholders’ Equity (Deficit).

The Company’s authorized common stock entitles holders to one vote for each share held of record. As of September 30, 2010, the Company has authorized 350 million shares of the $.0001 par value common stock. During the three and nine-month periods ended September 30, 2010, the Company did not issue any shares of common stock.

During 2009, the Company issued 14.0 million shares of common stock upon the conversion of $2.9 million of outstanding debt.

From time to time, in lieu of, or in addition to cash, the Company issues shares of its common stock as a contract incentive or as payment for non-employee services. The amount recorded for such shares issued is based on the closing price of the Company’s common stock on the effective date of the stock issuance or the agreement and is included with professional services on the Company’s consolidated statements of operations.

The Company has previously entered into non-employee service agreements and as a contract incentive agreed to issue common stock of 2.3 million and 2.0 million shares, respectively. The shares were earned as of the effective date of the agreements and, except for a breach of contract, are non-forfeitable. Under the 2009 and 2008 contract incentive, although earned, shares are not issuable until the Authorized Share Increase expected in 2010. No additional non-employee service agreements requiring share issuance were entered into during the three and nine-month periods ended September 30, 2010.

NOTE 12. Income Taxes.

The Company did not identify any uncertain tax positions as of September 30, 2010 and December 31, 2009. The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision. The Company recorded no interest and penalties during the nine-month period ended September 30, 2010 and the year ended December 31, 2009 nor had any accrued interest or penalties as of these dates. The Company is no longer subject to U.S. Federal tax examinations by tax authorities for tax years before 2006. The Company is open to state tax audits until the applicable statutes of limitations expire.

The current tax expense for the three and nine months ended September 30, 2010 relates to state income taxes imposed primarily to GCD as a result of its profitability from a separate company tax perspective. The deferred tax expense relates to book and income tax basis difference in goodwill created in the GCD acquisition. For the three months ended September 30, 2010, the Company recognized an income tax benefit of $0.009 million and recognized income tax expense of $0.05 million for the nine months ended September 30, 2010. There was a $0.1 million tax provision recorded for the three and nine months ended September 30, 2009. The tax provision includes state income taxes but is primarily related to deferred tax expense arising from the book and income tax basis difference in goodwill from the GCD acquisition which occurred in November 2008.

Deferred tax assets and liabilities reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company has Federal net operating loss (NOL) carry forwards of $68.5 million in the United States (U.S.) and foreign (U.K.) NOL carry forwards of $10.0 million at

30

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

September 30, 2010 and December 31, 2009. The Federal NOL and credit carry forwards have been reduced to reflect approximate annual limitations under Internal Revenue Code Sections 382 and 383 as a result of the various subsidiary stock acquisitions in prior years. It is likely subsequent equity changes have since occurred to further limit the utilization of these NOLs and credit carry forwards.

Realization of the NOL carry forwards, tax credits, and other deferred tax temporary differences is contingent on future taxable earnings. The deferred tax asset was reviewed for expected utilization using a “more likely than not” approach by assessing the available positive and negative evidence surrounding its recoverability.

The Company has recorded a full valuation allowance against the net deferred tax assets (whether acquired or otherwise generated) due to the uncertainty of future taxable income, which is necessary to realize the benefits of the deferred tax assets.

NOTE 13. Income (Loss) per Share.

Basic net income (loss) per share is computed by dividing the net income (loss) applicable to common shareholders by the weighted-average number of shares of common stock outstanding for the period. Diluted net income (loss) per share reflects potential dilution of all applicable common stock equivalents. Such common stock equivalents would include shares issuable pursuant to common stock options and warrants using the treasury stock method and shares issuable pursuant to convertible debt and preferred stock using the if-converted method to the extent such inclusion would be dilutive. Because the Company’s warrants are accounted for as liabilities, the treasury stock method is supplemented by adjusting net income (loss) applicable to common shareholders to an amount that excludes any gains or losses related to the warrants otherwise reflected in net income (loss). Similarly, the if-converted method for convertible securities includes a similar adjustment to net income (loss) applicable to common shareholders. Because the Company has several potentially dilutive securities outstanding, its earning (loss) per share computations include appropriate consideration of the sequencing of potentially dilutive assumptions.

	Three-month periods ended September 30,						Nine-month periods ended September 30,
	2010			2009			2010			2009
Diluted EPS Computation
Net Income (Loss)	$	17,260		$	2,053		$	21,006		$	(33,192	)
Add back:
Unamortized debt discount and deferred financing costs		25,751			—			30,398			—
Interest on convertible debentures		3,836			336			11,440			—
Gain on embedded derivatives – convertible debt instruments		(15,381	)		(2,133	)		(28,214	)		—
Total add-backs		14,206			(1,797	)		13,624			—
Net income (loss), adjusted	$	31,466		$	256		$	34,630		$	(33,192	)
Net income (loss) applicable to common shareholders – Diluted	$	31,466		$	256		$	34,630		$	(33,192	)
Weighted average common shares outstanding – Basic		168,233,180			165,492,875			168,233,180			162,807,688
Dilutive effect of common stock equivalents – convertible debentures		289,806,961			26,346,054			289,806,961			—
Weighted average common shares outstanding and common stock equivalents		458,040,141			191,838,929			458,040,141			162,807,688
Earnings per share:
Basic	$	0.10		$	0.01		$	0.12		$	(0.20	)
Diluted	$	0.07		$	0.01		$	0.08		$	(0.20	)

The diluted earnings per share calculation includes the add-back of interest expense, unamortized debt discount and deferred financing costs and derivative/warrant gain, or (loss) on convertible debentures.

Potentially dilutive shares, which were excluded in computing diluted loss per share, as their inclusion would have had an anti-dilutive effect on the net income (loss) per share, are as follows:

	Three-month periods  ended September 30,				Nine-month periods  ended September 30,
	2010		2009		2010		2009
Stock options		37,991,199		62,623,702		37,991,199		62,623,702
Warrants		181,308,076		190,285,389		181,308,076		190,285,389
Convertible debentures		—		189,603,585		—		242,103,585
		219,299,275		442,512,676		219,299,275		495,012,676

NOTE 14. Commitments and Contingencies.

Operating and Capital Leases: The Company has entered into or assumed certain non-cancelable operating and capital lease agreements related to office and warehouse space, equipment, and vehicles. Total rent expense under operating leases, net of sublease income, was $0.2 million and $0.4 million for the three months ended September 30, 2010 and 2009, respectively and $0.7 million and $0.8 million for the nine-month periods ended September 30, 2010 and 2009, respectively.

Future contractual obligations are as follows for the years ending December 31:

	Operating Leases
Remaining 3 months of 2010	$	251
2011		999
2012		507
2013		179
Thereafter		—
Total	$	1,936

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CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

Subsequent to the filing of voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code, the Bankruptcy Court granted the Debtors’ Motions for the rejection of two office leases which on a combined basis amounted to $0.07 million of future rent. Accordingly, these future rent payments are not included in the future contractual obligations schedule stated above.

On February 1, 2010, the Company entered into a Separation and Transition Services Agreement with the former Chief Financial Officer (“CFO”) and committed to issue a warrant to purchase 5.0 million shares of the Company’s common stock at $0.24 per share. Under the Separation and Transition Services Agreement, the Company is prohibited from issuing the warrant until receiving the consent of the Subordinated Debenture holders or after all Subordinated Debentures have been satisfied by conversion to common stock or full payment has been made. Because the Company cannot determine if, and when, consent of the Subordinated Debenture holders will be obtained or the Subordinated Debenture balances will be satisfied, uncertainty exists concerning the warrant issuance date and term. As a result, no value has been assigned to this transaction in the financial statements.

Simultaneous with the execution of the Separation and Transition Services Agreement entered into by the Company with the former CFO, the Company entered into a Consulting Agreement (“Agreement”) with him. The Agreement provides for a total of $0.4 million to be paid to the former CFO in twenty-four equal semi-monthly installments. The Agreement commences on February 15, 2010 and will terminate on January 31, 2011 unless both parties agree to extend the Agreement beyond the termination date. As of September 30, 2010 the Company has paid $0.3 million to the former CFO in accordance with the terms of the Separation and Services Agreement. Further, the Company as of September 30, 2010 has paid $0.1 million to the former CFO under the Consulting Agreement. As of September 30, 2010, the balance due under the Separation and Service Agreement was $0.2 million.

The Company is also involved in various legal actions arising in the ordinary course of business and matters related to the Company’s bankruptcy filing which are under review of the bankruptcy court. In the opinion of management, the ultimate disposition of those matters will not have a material adverse effect on our consolidated financial position or the results of operations.

NOTE 15. Related Parties.

Certain of the Company’s significant shareholders, directors and executive officers perform financing and other services for the Company and have made loans to the Company or otherwise participated in financing transactions.

Aequitas Capital Management, Inc., together with its affiliates owned 13.4 million shares or approximately 8% of the Company’s outstanding common stock and held warrants to purchase 25.0 million shares of the Company’s common stock as of September 30, 2010. At September 30, 2010, the Company was indebted to Aequitas for debentures issued for a subscription amount of $5.7 million which at maturity have a face amount of $9.8 million. The Company also owed Aequitas $0.3 million of accounts payable at September 30, 2010.

During the nine-month period ended September 30, 2010, Aequitas was issued additional July Debentures with a face amount of $0.7 million as a result of the Company not making scheduled interest and OID payments on the July Debentures and Aequitas’ funding of the cash subscription amount for such additional July Debentures. Also during the nine months ended September 30, 2010 and September 30, 2009, in connection with advisory services provided, the Company incurred fees of $0.09 million and $0.03 million, and made cash payments of $0.06 million and $0.02 million, respectively.

In 2009, the Company designated Aequitas as Collateral Agent to administer the July Securities Purchase Agreement. Aequitas was entitled to a Collateral Agent Fee of $0.3 million. As of September 30, 2010, $0.2 million of the Collateral Agent Fee remains unpaid. The Company also incurred $0.05 million to Aequitas for expenses incurred in connection with the July Securities Purchase Agreement.

Also during 2009, the Company issued a VPP Debenture to Aequitas, as part of the July Securities Purchase Agreement, with a cash subscription amount of $0.2 million in exchange for an equal amount of trade accounts payable owed to Aequitas. The terms of the VPP Debenture include quarterly OID payments beginning October 1, 2009, with the balance due November 30, 2011. The Company did not make the OID payments due October 1, 2009 and January 1, 2010, as it was not permitted at that time under the provisions of the Senior Lender intercreditor agreement.

During the nine months ended September 30, 2010, a significant shareholder was issued additional July Debentures with a face amount of $0.1 million as a result of the Company not making scheduled interest and OID payments on the July Debentures.

NOTE 16. Business Concentration.

During the nine-month period ended September 30, 2010 and 2009, a major customer represented $12.1 million (29 %) of total revenues and $7.0 million (14 %) of total revenues, respectively.

At September 30, 2010 and December 31, 2009, a major customer represented $1.2 million (29%) and $1.0 million (11%) of accounts receivable, respectively. A different major customer represented $0.7 million (17%) and $1.1 million (11%) of accounts receivable at September 30, 2010 and December 31, 2009. At December 30, 2009, a third customer represented $3.7 million (38%) of accounts receivable.

32

CAPITAL GROWTH SYSTEMS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

Notes to Interim Condensed Consolidated Financial Statements—(Continued)

September 30, 2010 (Unaudited)

NOTE 17. Geographic and Other Information.

Revenues generated outside the United States for the three- month periods ended September 30, 2010 and 2009 totaled $0.4 million and $0.3 million, respectively, and for nine-month periods ended September 30, 2010 and 2009 totaled $1.1 million and $0.8 million, respectively. Substantially all of the Company’s international revenue was generated in the European Union, Canada and Central America. As of September 30, 2010 and December 31, 2009, the Company’s international identifiable assets outside the United States totaled approximately $0.1 million and $0.4 million, respectively. All of the Company’s international identifiable assets were located in the United Kingdom.

The Company’s management team views the operations of ²⁰/20, Magenta, CentrePath, GCG, CGSI, and GCD as a single operating segment, for which it prepares discrete financial statement information and is the basis for making decisions on how to allocate resources and assess performance. All of the Company’s products and services are part of an integrated suite of offerings within telecom logistics solutions. Customer offerings are grouped into two categories: Optimization Solutions and Connectivity Solutions. Customers may buy one or both of these product offerings.

NOTE 18. Subsequent Events.

On October 5, 2010, the Company filed notice with the Bankruptcy Court revising the bid procedures that govern the October 14, 2010 auction that was held to sell the assets of the Company. The revised bid procedures provide for an open auction with no stalking horse bid. The exclusivity period for making a stalking horse bid lapsed.

The Debtors entered into debtor-in-possession financing with a Tranche A Lender that funded $3.0 million of secured financing and a consortium of Tranche B Lenders (comprised of prior secured lenders to the Debtors) who advanced $6.25 million in the aggregate to the Debtors. An affiliate of the Tranche B Lenders, Global Acquisition Newco Corp. (“GAC”), was formed for the purpose of making a stalking horse bid to purchase the assets of the Debtors. With the lapsing of the exclusive period for making the stalking horse bid, GAC requested that the Debtors extend the dates for the critical steps toward the sale of the Debtors’ assets. In response to this request, the Debtors agreed to modify the Bidding Procedures to extend the dates for the following events associated with the upcoming auction of the Debtors’ assets.

Date	Event
October 18, 2010	Outside date for submission of bids to become qualified bidders
October 21, 2010	Auction for assets at offices of Shefsky & Froelich Ltd. In Chicago, Il.
October 28, 2010	Hearing for approval of auction bidders at Bankruptcy Court in Wilmington, De.
November 2, 2010	Confirmation hearing at Bankruptcy Court in Wilmington, De.

On October 21, 2010, the Debtors commenced the auction for the sale of the Debtors’ assets. The bidding process was commenced but not concluded. The auction was reconvened in New York City at the offices of Olshan Grundman Frome Rosenzweig & Wolosky LLP on Monday, October 25, 2010 and concluded on that date.

On November 2, 2010, the Bankruptcy Court deferred the selection of a winning bid until November 19, 2010.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements and related notes thereto.

Overview

Capital Growth Systems, Inc., doing business as Global Capacity (“CGSI,” “we,” “our,” “us,” or the “Company”), is a publicly traded corporation that delivers telecom information and logistics solutions to a global client set consisting of systems integrators, telecommunications companies, and enterprise customers. These solutions enable clients to address the inefficiencies inherent in access networks globally. The global market for access networks, estimated at over $200 billion annually, is highly inefficient, plagued by market fragmentation, regionalized rules and regulations, and lack of transparency related to pricing and supply. This creates an environment where clients pay unnecessarily inflated prices due to inefficient procurement practices and margin stacking. The market is characterized by a large number of suppliers that offer piece parts of a customer’s end-to-end network requirement that must be effectively combined with assets from other providers to deliver a complete network solution. This dynamic creates challenges for customers seeking to procure network connectivity globally. Lack of transparency relative to the supply and pricing of network assets creates inefficient procurement practices, and lack of expertise to effectively provision and manage these integrated services creates complex and costly operating environments.

Going to market as Global Capacity, the Company has integrated the core systems, processes, and personnel of its five operating subsidiaries and organized them into two lines of business: Optimization Solutions and Connectivity Solutions. These businesses leverage the core intellectual property, systems, processes and expertise of the Company to deliver a set of offerings comprising tariff quotation management software, custom pricing software, network optimization consulting, engineering services, remote management services, “One Marketplace” network services, network novation services, and off-net extension services. Utilizing its depth of global telecom supply and pricing data in an automated fashion with powerful tools and expert analysis, the Company helps bring transparency to the fragmented and inefficient global telecom market – resulting in dramatically reduced cost and improved efficiency for the Company’s clients, while producing revenue and margin for the Company.

To service its clients, CGSI has operating offices in several U.S. locations (Chicago, IL, Waltham, MA, New York, NY, Glastonbury, CT, and Houston, TX). It also has a presence in the European Union (Manchester, UK, and Lisbon, Portugal).

The Company is (and has been since its 2006 reorganization) investing its time, team resources, and capital in the development of its intellectual property and the scaling of its systems in order to meet the growing demand among its clients for its services. At the same time, expenses are managed closely and lower-cost outsource opportunities are given case-by-case consideration.

On July 23, 2010, the Company and its United States (“U.S.”) subsidiaries (the “Debtors”) filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The Debtors will continue to operate their business as “debtors-in-possession” under the supervision of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. The Company’s subsidiary in the United Kingdom was not included in the filing and will continue their business without supervision from the Bankruptcy Court and will not be subject to the requirements of the Bankruptcy Code. See Note 2, Reorganization under Chapter 11.

Optimization Solutions provides clients license access to Global Capacity’sautomated quotation management platform,CLM, enabling them to automatically generate accurate quotes for access circuits based on tariffs appropriate for the particular service.CLM acts as an electronic trading platform, allowing customers to match their demand against a global catalog of pricing and supply data, creating a level of market transparency not available elsewhere.CLM may also be customized using a customer’s specific infrastructure and contract data, creating an automated mechanism to generate customer pricing, reducing back office cost and accelerating sales.Optimization Solutions clients may also leverage theCLM platform, along with proprietary network optimization tools, to delivernetwork optimization consulting services, in which the Company assesses existing inventories of access networks, identifying opportunities to reduce cost through both financial and physical network grooming. Realized savings are typically between 10-40% of current spend.Optimization Solutions clients also leverage Global Capacity’sengineering and remote network management services on a professional services basis, selectively deploying these services against specific opportunities to implement and manage private network solutions that increase efficiency and reduce cost.

Connectivity Solutions clients utilize Global Capacity’s logistics expertise to implement access network solutions that improve efficiency and reduce cost. “One Marketplace,” the Company’s physical network trading platform, aggregates network capacity from multiple suppliers at strategically deployed pooling points, using Global Capacity switching equipment to efficiently deploy capacity against market demand. “One Marketplace” reduces network costs for clients, while delivering gross margin more similar to facilities-based providers than to resellers. Global Capacity’sNetwork Novation practice offers outsourced access network operations, including pricing, procurement, and provisioning and network management. These solutions deliver lower access network costs by aggregating customer demand, while also reducing client SG&A associated with managing access network operations.Off-net extension services enable Global Capacity to identify, price, procure, provision and support competitive off-net access services for large clients, providing access to a broad universe of providers with transparency and efficiency.

34

Services

Management believes organizing the Company and its offerings between Optimization Solutions and Connectivity Solutions provide the greatest opportunity to deliver targeted solutions that maximize value to the customer while simultaneously maximizing revenue and margin opportunities for the Company. Customers may buy Optimization Solutions only, Connectivity Solutions only, or they may buy both. Management believes there are significant opportunities to leverage offerings from one line of business to drive demand for the solutions of the other line of business. Furthermore, the mix of offerings and their different characteristics (non-recurring and monthly recurring revenue streams) provide diversity of revenue and protect the Company from being overly dependent or exposed by a single offering or line of business.

Optimization Solutions

The Optimization Business provides five offerings:

Automated quotation management software (an annual software license) enables customers to use Global Capacity’s CLM system to match customer demand against a global catalog of telecom supply and pricing data to generate an accurate, tariff-based quote for the selected services and locations. This automated process replaces the largely manual process most companies continue to rely on and dramatically reduces the amount of time it takes to generate an accurate quote, while increasing the accuracy of the quote. This serves as a baseline for the customer to obtain a competitive market price, which CLM supports through workflow management functionality. This results in a competitive sales advantage for our customers, while also reducing their operating costs.

Customized access network pricing software (an annual software license) uses the CLM automated quotation management system as a baseline capability, but customizes the system to include customer specific information such as customer points of presence, negotiated / contracted rates, interconnect points, and business rules. This customization enables the customer to quickly and accurately generate an automated price, using the customer’s contracts, infrastructure, and business rules, dramatically improving the speed and responsiveness to customer pricing requests. This capability reduces the cost of generating a customer price quote, automating the generation of customized pricing at a fraction of the cost of generating the same price manually.

Network optimization consulting uses the CLM pricing functionality, coupled with powerful optimization algorithms, in a well-defined methodology to work with clients to collect, cleanse, implement, and analyze network data – including inventory, cost, and design data – in order to produce a network optimization report that identifies opportunities to improve the efficiency and reduce the cost of complex global networks. Recommendations include: financial grooming, where costs are reduced through identification of overcharges; contractual strategies, including moving services to new tariff structures and novating existing network contracts to more favorable vehicles; and physical grooming, where networks are moved to more favorable suppliers, re-homed to different points of presence, or aggregated to achieve better cost points. The Company then employs its logistics capabilities to help customers implement and realize the identified savings. The optimization process typically identifies savings of 2-5% for financial grooming and 15-40% for physical grooming. These savings can total many millions of dollars in large, complex network environments. The Company contracts for Optimization Consulting engagements on a base service fee plus contingent fee basis, where the Company is paid a non-recurring fee based upon a percentage of the savings achieved from the engagement.

Engineering services help customers implement optimized network infrastructure through a suite of services that include the design, engineering, build out, testing and turn-up of complex networks. These services leverage well-developed processes, repeatable methodologies, and deep expertise of the Company to deliver targeted engagements. The Company has built or augmented hundreds of customer networks. These engagements are delivered as non-recurring revenue on a statement of work (SOW) basis.

Remote management services employ the Company’s highly-integrated Operations Support Systems (OSS) and state of the art Network Operations Center (NOC) to deliver network monitoring and management of customer networks. This service can be delivered as a stand-alone service for networks not provided by us or it can be bundled as part of a complete network solution delivered via the Connectivity Solutions business unit. Remote Management Services are proactive, 7X24 monitoring and management services that leverage automated fault and performance management systems, integrated trouble ticketing and reporting systems, and world-class network engineering and operations expertise to provide a premium level of service for a customer’s most critical networks. Remote Management Services are contracted on a monthly recurring basis.

Connectivity Solutions

The Connectivity Solutions Business provides three offerings:

“One Marketplace,” the Company’s physical network trading platform, aggregates network capacity from multiple suppliers at strategically deployed pooling points, using Global Capacity switching equipment to efficiently deploy capacity against market demand. “One Marketplace” reduces network costs for clients, while delivering gross margin more similar to facilities-based providers than to resellers.

35

The Company is continuously expanding “One Marketplace” by installing additional aggregation points, and creating interconnections with suppliers (national, regional, and local) to expand the reach and increase the capacity of the platform. Increased client demand, as evidenced by its 160% growth experienced during 2009, enables continued profitable expansion of the platform.

Network Novation practice offers outsourced access network operations, including pricing, procurement, provisioning and network management. These solutions deliver lower access network costs by aggregating customer demand, while also reducing client SG&A associated with managing access network operations solutions. Global Capacity’s Network Novation practice has developed proven processes to seamlessly assume the management of existing network contracts, freeing the client to focus on their core business, while reducing the overall cost of their access network.

Off-net extension services enable Global Capacity to identify, price, procure, provision and support competitive off-net access services for large clients, providing access to a broad universe of providers with transparency and efficiency. Using the Company’s pricing systems, we generate an automated, accurate price quote. We then manage that quote from initial pricing through ordering, procurement, provisioning, test and turn up, and operations hand-off, utilizing the Company’s proprietary Circuit Lifecycle Manager (CLM) system. Networks are then monitored and managed by our 7X24 Network Operations Center (NOC). By leveraging automated systems across the entire telecom supply chain, the Company is able to accelerate the delivery of an optimal network.

Significant progress in gaining customer acceptance of our offerings during 2010 underlies Management’s belief that our technology, systems, and logistics capabilities make the Company’s business offerings more efficient, faster, and less expensive for systems integrators, telecommunications companies, and enterprise customers to manage the telecom supply chain for their complex global networks. By purchasing our solutions to create market-pricing transparency and improve the efficiency of the entire telecom supply chain, our customers are able to improve the responsiveness of sales, reduce operating expense, improve margins, and deliver better service.

Markets and customers

The global market for access networks is estimated at over $200 billion annually and represents a significant percentage of the overall network cost that service providers and large systems integrators incur in delivering network solutions to their global customers. The global access market is served by over 900 primary suppliers, none of whom has a ubiquitous footprint. The market is further confused by varying business rules, customs, and regulations in different regions of the world. These factors, coupled with the rapid pace of technology change and advancement, result in an inefficient, fragmented market where cost structures are unnecessarily high – creating margin pressure on service providers and systems integrators. Because there is no market transparency relative to the supply and price of networks globally, most telecommunication companies and systems integrators have a lengthy, manual, inefficient process to design and price global networks. This results in extended sales cycles, high operating costs, and inefficient procurement of networks.

One of the fundamental challenges for corporations and other institutions with complex and/or geographically dispersed data communications networks is the number of service providers and pricing alternatives that must be pieced together in order to create an end-to-end data connectivity solution. Large multinational corporations are increasingly seeking to work with fewer vendors and a single network provider that they can look to for provisioning end-to-end network solutions fits that design. Additionally, service providers, particularly in regions where facilities-based competition has been introduced, actively market their services with price as the primary differentiator and network reach being the primary limiting factor. This price-based competition has stressed already challenged gross margins and, as a result, service providers are actively seeking means to reduce the costs associated with network quotation management and off-network procurement.

Beyond the telecommunication service providers, expanding enterprises, multi-national corporations, information service providers, and systems integrators are deploying and managing private network-based solutions that provide seamless connections in support of the ever-increasing demand for business continuity, disaster recovery, regulatory compliance, and collaboration capabilities. Because telecommunications is not the primary line of business for these private network operators, but rather a facilitator to their end business goals, inefficiencies in the procurement process result in most companies paying more than they should for connectivity. In a competitive environment, such a drain on profitability can be significant.

This confusion is increased by global deregulation, physical fragmentation of the network layer – whether copper, fiber, coaxial cable, or wireless spectrums – and geographic fragmentation. This market environment appears ideal for an information-driven logistics model focused on minimizing the confusion and inefficiency that plagues the telecom market. The Company believes that it has such a business model and operating capability, as well as a management team experienced in executing such an information-leveraged and technology-leveraged approach.

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We have assembled a vast global knowledge base of critical information with respect to tariffs, competitive pricing, physical locations of facilities, and carriers connected to such buildings and nearby points of presence. We also have combined this information with sophisticated software tools and algorithms to enable us to often obtain automated “best of breed” connectivity solutions in seconds, rather than weeks or months. This ability to automate the “supply chain” of connectivity provides the Company with a competitive advantage. This process also requires continuous refreshing, updating, and validation of data and is therefore a continually evolving process to stay current with changing information and new information. This requirement to constantly acquire and manage new and updated data sets, combined with the Company’s investment in systems, tools, and processes, provides the basis for the Company’s unique positioning as a telecom logistics company.

The Company believes its investment in market intelligence and efficiency tools, combined with the robust processes and deep expertise of its staff, make it uniquely positioned to capitalize on this market opportunity with its unique, telecom logistics business model.

Sales and marketing

Optimization Solutions

Target Markets. Optimization Solutions are targeted at global, national, and regional telecommunications carriers, systems integrators, and enterprise customers with large, complex global network requirements.

Sales Approach. We have an international sales team that uses a consultative approach to sell Optimization Solutions to a financial buyer highly placed within our target customers. We employ a combination of direct and channel sales to maximize market penetration and coverage and we offer limited scope “pilot” engagements to quickly demonstrate the value of the solution. We then use a high-touch, relationship-based approach to extend and expand our pilot engagements into more meaningful engagements that provide a steady stream of revenue and margin for the Company.

Connectivity Solutions

Target Markets. Connectivity Solutions are targeted at enterprise, system integrator, and telecommunications companies seeking a simplified, turnkey network connectivity solution.

Sales Approach. We have an international sales team that employs a combination of direct and channel sales to maximize market penetration and coverage. The sales team is tasked with identifying and closing new business, which is then transitioned to account managers to maintain the ongoing relationship, creating additional revenue and margin from the account. The sales teams work closely with the carrier management teams to insure the most robust, cost effective solutions are sold and delivered.

Competition

Management believes that the combination of capabilities and solutions which the Company has integrated and organized into the Optimization Solutions business and the Connectivity Solutions business is unique in the marketplace. However, there are competitors in the market for some of the individual solutions that the Company brings to market.

Optimization Solutions

Optimization Consulting: There are a number of consulting firms that purport to offer network optimization services. Most of these, however, are focused on a specific area of network optimization – typically overcharge analysis. This narrow focus misses the largest opportunity to identify and implement network savings available from financial and physical grooming. Furthermore, Management is not aware of any other company that owns or deploys a database of global supply and pricing data along with proprietary network optimization tools to deliver an automated network optimization solution.

Automated Pricing Software: Management is not aware of any other company that has an automated pricing system that leverages a similar global base of supply and pricing data along with robust pricing algorithms. The primary competition that we encounter is the legacy pricing system and related processes that are entrenched in existing suppliers.

Remote Management Services and Professional Services: There is a wide range of telecommunications carriers, hardware manufacturers, and services firms that offer NOC services and network implementation services. Management believes that the unusually high degree of integration and automation used in the delivery of the Company’s NOC services is a competitive differentiator in the marketplace. Further, the tight integration of the network management systems with the Company’s unique pricing and provisioning systems and technologies make these solutions very valuable in the highly integrated service delivery model employed by Global Capacity.

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Connectivity Solutions

The marketplace for connectivity solutions is highly competitive, including Facility-based Carriers, Virtual Network Operators (VNOs), and Systems Integrators. Despite this, the Company does provide services to carriers and VNOs and at times will collaborate with our competition to provide a seamless solution for their end users.

Financial Performance

The Company reported operating losses of $1.3 million and $2.8 million for the three months ended September 30, 2010 and 2009, respectively, and $6.5 million and $10.3 million for the nine-months ended September 30, 2010 and 2009, respectively. As of September 30, 2010, the Company’s current liabilities including liabilities subject to compromise exceeded its current assets (working capital deficiency) by $46.5 million. Included in the current liabilities is $9.4 million of current maturities of DIP financing. Cash on hand at September 30, 2010 was $3.9 million (not including $0.3 million restricted cash for outstanding letters of credit and tax escrow). Cash provided by (used in) operating activities was $1.9 million and $(7.7) million for the nine-month period ended September 30, 2010 and 2009, respectively. The Company’s net working capital deficiency, accumulated deficit and recurring operating losses raise substantial doubt about its ability to continue as a going concern.

Expenses are being managed closely and lower-cost outsource opportunities are given case-by-case consideration. On May 3, 2010, Pivotal Global Capacity, LLC, an affiliate of the Pivotal Group of Companies, successfully closed on its purchase of rights and obligations of the Senior Lender (ACF CGS, L.L.C.) with respect to the Term Loan and Security Agreement dated November 19, 2008, as amended, with no changes in terms and conditions.

On July 23, 2010, the Company and its domestic subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code. With these filings, the Debtors entered into and the Bankruptcy Court approved, a Debtor in Possession Financing Facility (“DIP Financing”) which will provide up to an aggregate of $10.25 million. On August 2, 2010 the Debtors received $9.25 million under the DIP Financing. On August 3, 2010, in accordance with the provisions of the DIP Financing, the Debtors paid $5.2 million to Pivotal representing payment in full of the outstanding Senior Secured Loan together with accrued interest.

As of August 31, 2010 and September 30, 2010, the Company was in default on the DIP Loan Agreement. The DIP Loan Agreement provided for certain financial covenants to be maintained. Among those covenants was the requirement to maintain EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization), as defined in the DIP Loan Agreement, of at least $0.1 million for the month ended August 31, 2010 and $0.2 million for the two months ended September 30, 2010. The Company did not meet this financial covenant test for the month of August and the two months ended September 30, 2010 and accordingly, was in default of the DIP Loan Agreement. The DIP Loan Agreement provides, in the event of an Event of Default, for a default interest rate at a rate per annum which is 2% above the rate in effect immediately before the Event of Default. This rate will continue in effect during the continuance of an Event of Default. The Default Rate of Interest on both the Tranche A and Tranche B Loans is 14% per annum.

Critical Accounting Policies and Estimates

The Company adopted Accounting Standard Codification (“ASC”) 852 Reorganizations (“ASC 852”),which is applicable to companies in Chapter 11, generally does not change the manner in which financial statements are prepared. However, it does require that the financial statements for periods subsequent to the filing of the Chapter 11 petition distinguish between transactions and events that are directly associated with the reorganization proceedings and the ongoing operations of the business as well as additional disclosures. Revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the reorganization and restructuring of the business must be reported separately as reorganization items in the statements of operations beginning in the quarter ending September 30, 2010. The balance sheet must distinguish pre-petition liabilities subject to compromise from both those pre-petition liabilities that are not subject to compromise and from post-petition liabilities. Liabilities that may be affected by a plan of reorganization must be reported at the amounts expected to be allowed, even if they may be settled for lesser amounts. In addition, cash provided by reorganization items must be disclosed separately in the statements of cash flows. The Company adopted ASC 852 effective on July 23, 2010 and will segregate those items as outlined above for all reporting periods subsequent to such date.

There has been no other changes to our critical accounting policies and estimates contained in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K filed for the year ended December 31, 2009.

Results for the three-month period ended September 30, 2010 compared to 2009

Total revenues for the three-month period ended September 30, 2010 were $13.9 million compared to $16.5 million for the same period in 2009, representing a 16 % decrease. This decrease is primarily due to disconnects from three major customers resulting from a shift in circuitry strategy.

Revenues generated from Optimization Solutions totaled $2.5 million for the three-month periods ended September 30, 2010 and 2009, which represents optimization consulting, automated pricing software, remote management services, and professional services. The Connectivity Solutions business recorded $11.4 million for the three-month period ended September 30, 2010 compared to $14 million for the same period in 2009, which is from the delivery of turn-key global networks and system management services.

The consolidated gross margin rate was 28% for the three-month period ended September 30, 2010 compared to 24% for the same period in 2009. This increase was driven primarily by an improvement in the Optimization Solutions margins from lower costs and partially offset by a decrease in the Connectivity Solutions margin. Optimization Solutions’ gross margin totaled $(0.1) million or (4%) for the three-month period ended September 30, 2010 as compared to $1.4 million or 57% for the same period in 2009. Connectivity Solutions’ margin totaled $3.9 million or 34 % compared to $2.5 million or 18% for the same period in 2009.

Operating expenses for the three-months ending September 30, 2010 and 2009 consist of the following:

	Three-month periods  ended September 30,
	(in thousands)
	2010		2009
Compensation	$	2,258	$	2,747
Professional services		942		1,658
Depreciation and amortization		680		1,139
Other operating expenses		1,240		1,168
Total operating expenses	$	5,120	$	6,712

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Compensation expense decreased $0.5 million (18%) for the three-month period ended September 30, 2010 as compared to 2009. Included in compensation expense for 2010 and 2009 are non-cash charges of $0.1 million and $0.8 million, respectively, related to stock-based compensation. The decrease in compensation expense was due primarily to the reduction of 16 staff positions since September 30, 2009 and the decrease of $0.7 million in non-cash charges related to the accounting treatment of stock option grants.

Professional services decreased $0.7 million (43%) for the three-month period ended September 30, 2010 as compared to 2009. The decrease was primarily the result of an in depth review of the requirement for all professional services and renegotiation of rates.

Depreciation and amortization expense relates primarily to the Network Operating Center in the suburbs of Boston and the fair value assigned to the Company’s intellectual property. Depreciation and amortization decreased by $0.5 million (40%) for the three-month period ended September 30, 2010 as compared to September 30, 2009. This decrease was due primarily to the write down of certain intangible assets in the fourth quarter of 2009.

Other operating expenses were essentially the same for the three-month period ended September 30, 2010 as compared to the same period for 2009. Any significant increase in future operating costs is expected to be a direct result of a corresponding increase in revenues, excluding any additional stock-based compensation expense. Any significant increase in revenues is anticipated to outpace the increase in related operating costs.

Any significant increase in future operating costs is expected to be a direct result of a corresponding increase in revenues, excluding any additional stock-based compensation expense. Any significant increase in revenues is anticipated to outpace the increase in related operating costs.

Results for the three-month period ended September 30, 2010 reflect interest expense of $4.6 million, an increase of $0.3 million from the three-month period ended September 30, 2009 amount of $4.3 million. Interest expense for the three-month periods ended September 30, 2010 and 2009 includes $3.9, related to the amortization of the fair value assigned to the warrants and embedded derivatives issued with debt. Interest expense for the three-month period ended September 30, 2010 also includes $0.7 million of accrued interest.

Results for the three-month period ended September 30, 2010 reflect a gain on warrants and derivatives of $26.1 million compared to a gain of $7.6 million for the comparable period in 2009. The current year’s gain was driven primarily by the $0.07 decrease in the period end price of the Company’s stock as of September 30, 2010 as compared to the June 30, 2010 closing price of the Company’s stock and the lack of expected future volatility of the Company’s stock price due to the Chapter 11 bankruptcy filing. The 2009 gain on warrants and derivatives was driven primarily by the $0.03 decrease in the per share closing price of the Company’s stock as of September 30, 2009 as compared to the June 30, 2009 closing price. The warrant and embedded derivatives liabilities are revalued at each balance sheet date and marked to fair value with the corresponding adjustment recognized as gain or loss on warrants and derivatives in the statement of operations.

Results for the three-month period ended September 30, 2010 reflect a loss on the extinguishment of debt of $(0.3) million as compared to a gain of $0.3 million for the comparable period in 2009. The loss was due to the write off of unamortized deferred financing costs related to the Senior Secured Term Loan which was paid in full on August 3, 2010 in advance of the Term Loan’s due date of November 10, 2010.

Reorganization items, net for the three-month period ended September 30, 2010 were $2.7 million. These expenses represent professional and other fees incurred in connection with the Company’s filing voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code on July 23, 2010.

Results for the nine-month period ended September 30, 2010 compared to 2009

Total revenues for the nine-month period ended September 30, 2010 were $42.4 million compared to $48.6 million for the same period in 2009, representing a 13 % decrease. This decrease is primarily due to disconnects from three major customers resulting from a shift in circuitry strategy.

Revenues generated from Optimization Solutions totaled $7.4 million for the nine-month period ended September 30, 2010 compared to $7.1 million for the same period in 2009, which represents optimization consulting, automated pricing software, remote management services, and professional services, representing a 4% increase. The Connectivity Solutions business recorded $35.0 million for the nine-month period ended September 30, 2010 compared to $41.5 million for the same period in 2009, which is from the delivery of turn-key global networks and system management services, representing a 16% decrease.

The consolidated gross margin rate was 26 % for the nine-month period ended September 30, 2010 compared to 23% for the same period in 2009. This increase was driven primarily by the improvement in the margins from Connectivity Solutions as a result of lower costs. Optimization Solutions’ gross margin totaled ($0.7) million or (9%) for the nine-month period ended September 30, 2010 as compared to $3.5 million or 49% for the same period in 2009. Connectivity Solutions’ margin totaled $11.6 million or 33 % compared to $7.7 million or 18% for the same period in 2009.

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Operating expenses for the nine-months ended September 30, 2010 and 2009 consist of the following:

	Nine-month periods  ended September 30,
	(in thousands)
	2010		2009
Compensation	$	8,194	$	9,459
Professional services		3,672		5,001
Depreciation and amortization		2,044		3,415
Other operating expenses		3,585		3,543
Total operating expenses	$	17,495	$	21,418

Compensation expense decreased $1.3 million 13% for the nine-month period ended September 30, 2010 as compared to 2009. Included in compensation expense for 2010 are non-cash charges of $0.9 million related to the accounting treatment of certain stock option grants as compared to $1.5 million for the same period in 2009. The decrease in compensation expense was due to the decrease of $0.7 million in non cash charges related to the treatment of stock option grants and by a reduction of 16 staff positions since September 30, 2009.

Professional services decreased $1.3 million (27%) for the nine-month period ended September 30, 2010 as compared to the nine-month period ended September 30, 2009, due to fewer advisory fees incurred and stronger controls over the utilization of outside services.

Depreciation and amortization expense relates primarily to the Network Operating Center in the suburbs of Boston and the fair value assigned to the Company’s intellectual property. Depreciation and amortization decreased by $1.4 million (40%) for the nine-month period ended September 30, 2010 as compared to September 30, 2009. This decrease was due primarily due to impairment of certain intangible assets in the fourth quarter of 2009.

Other operating expenses were essentially the same for the nine-month period ended September 30, 2010 as compared to the same period for 2009. Any significant increase in future operating costs is expected to be a direct result of a corresponding increase in revenues, excluding any additional stock-based compensation expense. Any significant increase in revenues is anticipated to outpace the increase in related operating costs.

Results for the nine-month period ended September 30, 2010 reflect interest expense of $15.6 million, an increase of $5.1 million from the nine-month period ended September 30, 2009 amount of $10.5 million. Interest expense for the nine-month periods ended September 30, 2010 and 2009 includes $11.7 million and $8.9 million, respectively, related to the amortization of the fair value assigned to the warrants and embedded derivatives issued with debt. Interest expense for the nine-month period ended September 30, 2010 also includes $2.2 million of accrued interest and $1.7 million of fees incurred with respect to debt financings and exploring additional financing options.

Results for the nine-month period ended September 30, 2010 reflect a gain on warrants and derivatives of $46.2 million compared to a loss of $12.3 million for the comparable period in 2009. The current year’s gain was driven primarily by the $0.11 decrease in the period end price of the Company’s stock as of September 30, 2010 as compared to the December 31, 2009 closing price of the Company’s stock and the lack of expected future volatility of the Company’s stock price due to the Chapter 11 bankruptcy filing. The 2009 loss on warrants and derivatives was driven primarily by the $0.04 increase in the period end closing price of the Company’s stock as compared to the December 31, 2008 closing price. The warrant and embedded derivatives liabilities are revalued at each balance sheet date and marked to fair value with the corresponding adjustment recognized as gain or loss on warrants and derivatives in the statement of operations.

Results for the nine-month period ended September 30, 2010 reflect a loss on extinguishment of debt of $(0.3) million as compared to a loss of $(0.07) million for the comparable period in 2009. The loss in 2010 was due to the write off of unamortized deferred financing costs related to the Senior Secured Term Loan which was paid in full on August 3, 2010 in advance of the Loan’s maturity date of November 10, 2010.

Reorganization items, net for the nine month period ended September 30, 2010 were $2.7 million. These expenses represent professional and other fees incurred in connection with the Company’s filing voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code on July 23, 2010.

Liquidity and Capital Resources

Cash provided by operating activities for the nine-month period ended September 30, 2010 was $1.9 million. The primary variance between the net income of $21.0 million and net cash provided by operating activities for the nine-month period ended September 30, 2010 was due to non-cash charges from amortization and depreciation of $2.0 million, amortization of debt discount, interest paid-in-kind, and OID of $11.7 million, stock-based compensation of $0.9 million, amortization of deferred financing costs of $1.7 million, and the addback of the gain due to the change in fair value of embedded derivatives and warrants of $46.2 million. There was a reduction in accounts receivable of $5.3 million, mainly due to the collection of the BT settlement proceeds during the first quarter.

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Cash (used in) operating activities in the amount of $(7.7) million for the nine-month period ended September 30, 2009 was due to a loss of $33.2 million. The variance between the loss and net cash used in operating activities during the nine-month period ended September 30, 2009 was primarily due to the non-cash charges of $1.5 million for stock-based compensation, $3.4 million of depreciation and amortization, a $1.5 million non-cash extinguishment of debt, $12.3 million from the change in fair value of embedded derivatives and warrants, and $5.1 million of amortization of debt discounts, interest paid-in-kind, and OID.

The cash provided by (used in) investing activities during the nine-month period ended September 30, 2010 and 2009 was $0.04 million and $(0.2) million, respectively. Capital expenditures in both 2010 and 2009 consisted primarily of computer-related equipment. Although we currently do not anticipate any significant capital expenditures in the near future, we may have a need to make similar additional capital expenditures related to the integration of our operations.

Net cash (used in) provided by financing activities during the nine-month period ended September 30, 2010 and 2009 was $(1.4) million and $5.6 million, respectively. During the nine-month period ended September 30, 2010 there was a $9.6 million repayment of debt to the Senior Lender and payment of $1.0 million for financing costs which were offset by proceeds of $9.3 million from DIP financing. During the nine month period ended September 30, 2009, the Company received proceeds from debenture offerings of $5.6 million.

The accompanying condensed consolidated statements have been prepared on a going concern basis, which contemplates the realization of its assets and the discharge of its liabilities in the normal course of business for the foreseeable future. As of September 30, 2010, the Company’s current liabilities and liabilities subject to compromise exceeded its current assets by $46.5 million. Included in the current liabilities is $9.4 million of current maturities of DIP financing. Cash on hand at September 30, 2010 was $3.9 million (not including $0.3 million restricted for outstanding letters of credit and tax escrow).

On May 3, 2010 Pivotal Global Capacity, LLC, an affiliate of the Pivotal Group of companies engaged in the private equity business and based in Phoenix, Arizona (“Pivotal”), successfully closed on its purchase of all the rights and obligations of the Senior Lender (ACF CGS, L.L.C.) with respect to the Term Loan and Security Agreement dated November 19, 2008, as amended, with no changes in the terms and conditions. Pivotal had been assigned the same rights and obligations of the previous holder and has stepped into the role as the new Senior Lender in the same capacity as ACF CGS, L.L.C. See below for details of this transaction which discusses the subsequent pay off of this Term Loan.

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On July 23, 2010, the Company and certain of its subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code. The Company remains in possession of its assets and properties and continues to operate its businesses. The Company has obtained and the Bankruptcy Court has approved debtor-in possession financing (“DIP Financing”).

The July Debentures, Amended March Debentures, November Debentures , VPP Debentures and Seller Debentures are all subject to compromise and full recovery by the debenture holders has been impaired as a result of the Debtors filing voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code. The outstanding balances as of September 30, 2010 are listed under “Liabilities Subject to Compromise” in Note 2 “Reorganization under Chapter 11”. Because of the uncertainty that the principal balances of the debentures may not be paid in full, the Company has suspended the accrual of interest on the debentures as of the date of the filing of the voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code on July 23, 2010. The amount of interest that would have been accrued had the Company not suspended interest accrual on the debentures amounted to $0.2 million as of September 30, 2010.

The DIP Financing has been entered into with Downtown CP-CGSY, LLC or its nominee (“Downtown Capital” or Tranche A Lender”) in the amount of $3 million (“Tranche A”) and with certain holders of Junior Convertible Debentures (“Junior Debentures”, and collectively with Downtown Capital, the “DIP Lenders”) in the amount of $7.25 million for a total aggregate amount not to exceed $10.25 million.

The Debtors have entered into a Debtor in Possession Loan and Security Agreement (“DIP Credit Agreement”) in order to provide funds to the Debtors to assist in the restructuring, to pay critical vendors and utility deposits, to prevent an immediate shutdown of the Company’s operations, and to pay off the pre-petition secured indebtedness of Pivotal Global Capacity, LLC (the “Senior Lender” or “Pivotal”). The Junior Debentures have voluntarily agreed to subordinate their pre-petition liens to the Tranche A Lender.

The DIP Financing provides for the following:

a) Borrowers: Global Capacity Group, Inc. and the other debtors, as debtors-in –possession.

b) DIP Lenders: Downtown Capital or its nominee, and the certain holders of the Junior Debentures.

c) DIP Facility/Availability: upon entry of the Interim Order, an initial advance of: (i) $9.25 million (consisting of a $3 million Tranche A Loan and $6.25 million Tranche B Loan), (ii) such additional amount as may be agreed to by Downtown Capital in writing, or (iii) such other sum as is approved by the Bankruptcy Court on an interim basis. Upon entry of a Final Order, up to $10.25 million outstanding at anytime.

d) Purpose: Principally short-term working capital, utility deposits, critical vendor payments, payment of pre-petition secured indebtedness of Secured Lien Lender.

e) Financial Terms: Interest on Tranche A Loan will be payable at the end of each month in arrears at 12% per annum. Interest on the Tranche B Loan, including PIK interest added to the principal amount of the Tranche B Loans, shall accrue at 12% payment in kind which shall accrue and be added to the principal monthly, but be paid in full upon the earlier of the Effective Date of a plan of reorganization, upon an Event of Default or the Maturity Date.

f) Maturity: The Borrowers shall repay ant outstanding advances and loans under the DIP Financing on the earliest of: (i)(a) the occurrence of an Event of Default and (b) the Effective Date of a Plan of Reorganization; provided that subject to the Lenders’ written consent the Borrowers may extend such date by up to two periods of sixty days each; (ii) the date of the acceleration of any outstanding extensions of credit under the DIP Financing; (iii) entry of an order reversing in any respect either of the DIP Financing Orders (unless waived in writing by DIP Lenders); (iv) the conversion of any of the Chapter 11 Cases to a case under Chapter 7 of the Bankruptcy Code; (v) the appointment of a trustee or an examiner with special powers; and (vi) the dismissal of any of the Chapter 11 Cases.

g) Fees: The Tranche A Lender has received a Structuring fee of $.02 million and a Commitment Fee of $.06 million. In addition, the Tranche A Lender shall receive an Extension Fee of 1% for each of the two sixty day extensions of the Maturity Date, which extensions must be consented to by the DIP Lenders in writing.

h) Mandatory Prepayment: (i) 100% of the net sale proceeds from non-ordinary course assets sales; (ii) 100% of insurance and condemnation proceeds and tax refunds, in each case received by the Borrowers or any of the Guarantors.

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i) Financial Covenants:

a) EBITDA of at Least:

1-      Month Ended August 31, 2010	$	0.1 million
2-      Two Months Ended September 30, 2010	$	0.2 million
3-      Three Months Ended October 31, 2010	$	0.3 million
4-      Four Months Ended November 30, 2010	$	0.45 million

b) Monthly Recurring Circuit Revenue of at least $3.65 million for the months ended August 31, 2010, September 30, 2010, October 31, 2010 and November 30, 2010.

c) Monthly Recurring Circuit Margin Percentages of 19.5% each for August, September, October and November, 2010 and Cumulative Recurring Circuit Margin Percentage of 19.5 % for August and 20.0% for September, October and November 2010.

d) Shall not have on a consolidated basis outstanding Accounts Payable of more than $4.1 million as at August 31, September 30, October 31 and November 30, 2010.

Prior to making the filings, the Debtors entered into a Plan Support and Restructuring Agreement (the “Plan”) with the Junior Debentures which provides a plan for the Debtors’ exit out of Bankruptcy. In accordance with the terms of the Plan, the holders of the Junior Debentures can credit bid to purchase the assets of the Debtors all or some of the liens and pre-petition amounts due under the Debentures including accrued OID and Tranche B amounts due under the DIP Facility plus accrued interest.

On August 2, 2010, $9.3 million was advanced to the Company by the Lenders under the terms of the DIP Financing. In addition to paying critical vendors and utility deposits, the funds were used to pay $5.2 million to the Senior Secured Lender (Pivotal Global Capacity, LLC or “Pivotal”) which represents payment in full of the outstanding Senior Secured Loan.

As of August 31, 2010 and September 30, 2010, the Company was in default on the DIP Loan Agreement. The DIP Loan Agreement provided for certain financial covenants to be maintained. Among those covenants was the requirement to maintain EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization), as defined in the DIP Loan Agreement, of at least $0.1 million for the month ended August 31, 2010 and $0.2 million for the two months ended September 30, 2010. The Company did not meet this financial covenant test for the month of August and the two months ended September 30, 2010 and accordingly, was in default of the DIP Loan Agreement. The DIP Loan Agreement provides, in the event of an Event of Default, for a default interest rate at a rate per annum which is 2% above the rate in effect immediately before the Event of Default. This rate will continue in effect during the continuance of an Event of Default. The Default Rate of Interest on both the Tranche A and Tranche B Loans is 14% per annum.

The Company is currently operating pursuant to Chapter 11 under the Bankruptcy Code and continuation of the Company as a going concern is contingent upon, among other things, the Company’s ability (i) to comply with the terms and conditions of the DIP Financing Agreement described above; (ii) to develop a plan of reorganization and obtain confirmation under the Bankruptcy Code; (iii) to reduce unsustainable debt and other liabilities and simplify the its complex and restrictive capital structure through the bankruptcy process; (iv) to return to profitability; (v) to generate sufficient cash flow from operations; and (vi) to obtain financing sources to meet its future obligations. These matters create uncertainty relating to the Company’s ability to continue as a going concern. The accompanying condensed consolidated financial statements do not reflect any adjustments relating to the recoverability and classification of assets or liabilities that might result from the outcome of these uncertainties. In addition, any plan of reorganization could materially change amounts reported in the Company’s condensed consolidated financial statements, which do not give effect to any adjustments of the carrying value of assets and liabilities.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements and their expected impact on our future consolidated results of operations or financial condition, see the Notes to Consolidated Financial Statements.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements in place as of September 30, 2010 or December 31, 2009.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

NOT APPLICABLE

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Interim Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report, have concluded that, based on the evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15, our disclosure controls and procedures were effective as of the end of the period covered by this report.

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Changes in Internal Control over Financial Reporting

There have been no changes in our internal controls over financial reporting that occurred during the Company’s third fiscal quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

From time to time, we are involved in various legal matters arising in the ordinary course of business. In the opinion of Management, the ultimate disposition of such matters will not have a material adverse effect on our consolidated financial position or the results of operations.

On July 23, 2010, Capital Growth Systems, Inc. (CGSIQ.OB) (the “Company”) and its domestic subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court in the District of Delaware. The Debtors will continue to operate their business as debtors-in-possession under the jurisdiction of the bankruptcy court and in accordance with the applicable provisions of the Bankruptcy Code. The bankruptcy court approved the Company’s motion to have the Chapter 11 cases jointly administered under Case No.10-12302. The Company’s subsidiary in the United Kingdom was not included in the filings and will continue to operate their business without supervision from the Bankruptcy Court and will not be subject to the requirements of the Bankruptcy Code.

Plan Support and Restructuring Agreement.

Prior to making these filings, we entered into a Plan Support and Restructuring Agreement (“Plan”) with the Junior Debentures which provides a plan for the Debtors’ exit out of bankruptcy. Pursuant to the Plan, the parties agreed to the terms of a pre-negotiated consensual plan of reorganization to be filed with the Bankruptcy Court. Pursuant to the Plan, the parties thereto have agreed to support a financial reorganization of the Debtors consistent with the terms and conditions set forth in the term sheets attached as Exhibit A to the Plan Support and Restructuring Agreement.

The Terms of the Plan Support and Restructuring Agreement include:

a) The Participating Debenture Holders will form a Newco with which to purchase the assets of the Company.

b) A $10.25 million DIP Facility will be provided for the purpose of;

1- Pay in full the Senior Secured Lender and

2- Pay critical vendors and utility deposits.

c) If Newco is winning bidder, Newco will purchase assets of the Company.

The DIP Financing provides for the following:

a) Borrowers: Global Capacity Group, Inc. and the other debtors, as debtors-in –possession.

b) DIP Lenders: Downtown Capital or its nominee, and the certain holders of Junior Debentures.

c) DIP Facility/Availability: upon entry of the Interim Order, an initial advance of: (i) $9.25 million (consisting of a $3 million Tranche A Loan and $6.25 million Tranche B Loan), (ii) such additional amount as may be agreed to by Downtown Capital in writing, or (iii) such other sum as is approved by the Bankruptcy Court on an interim basis. Upon entry of a Final Order, up to $10.25 million outstanding at any time.

d) Purpose: Principally short-term working capital, utility deposits, critical vendor payments, payment of pre-petition secured indebtedness of Secured Lien Lender.

e) Financial Terms: Interest on Tranche A Loan will be payable at the end of each month in arrears at 12% per annum. Interest on the Tranche B Loan, including PIK interest added to the principal amount of the Tranche B Loans, shall accrue at 12% payment in kind which shall accrue and be added to the principal monthly, but be paid in full upon the earlier of the Effective Date of a plan of reorganization, upon an Event of Default or the Maturity Date.

f) Maturity: The Borrowers shall repay ant outstanding advances and loans under the DIP Financing on the earliest of: (i)(a) the occurrence of an Event of Default and (b) the Effective Date of a Plan of Reorganization; provided that subject to the Lenders’ written consent the Borrowers may extend such date by up to two periods of sixty days each; (ii) the date of the acceleration of any outstanding extensions of credit under the DIP Financing; (iii) entry of an order reversing in any respect either of the DIP Financing Orders (unless waived in writing by DIP Lenders); (iv) the conversion of any of the Chapter 11 Cases to a case under Chapter 7 of the Bankruptcy Code; (v) the appointment of a trustee or an examiner with special powers; and (vi) the dismissal of any of the Chapter 11 Cases.

g) Fees: The Tranche A Lender has received a Structuring fee of $.02 million and a Commitment Fee of $.06 million. In addition, the Tranche A Lender shall receive an Extension Fee of 1% for each of the two sixty day extensions of the Maturity Date, which extensions must be consented to by the DIP Lenders in writing.

h) Mandatory Prepayment: (i) 100% of the net sale proceeds from non-ordinary course assets sales; (ii) 100% of insurance and condemnation proceeds and tax refunds, in each case received by the Borrowers or any of the Guarantors.

i) Financial Covenants:

a. EBITDA of at Least:

i.	Month Ended August 31, 2010	$	0.1 million
ii.	Two Months Ended September 30, 2010	$	0.2 million
iii.	Three Months Ended October 31, 2010	$	0.3 million
iv.	Four Months Ended November 30, 2010	$	0.45 million

b. Monthly Recurring Circuit Revenue of at least $3.65 million for the months ended August 31, 2010, September 30, 2010, October 31, 2010 and November 30, 2010.

c. Monthly Recurring Circuit Margin Percentages of 19.5% each for August, September, October and November, 2010 and Cumulative Recurring Circuit Margin Percentage of 19.5 % for August and 20.0% for September, October and November 2010.

d. Shall not have on a consolidated basis outstanding Accounts Payable of more than $4.1 million as at August 31, September 30, October 31 and November 30, 2010.

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The Plan Support and Restructuring Agreement contains customary terms, are subject to material conditions and may be terminated upon the occurrence of certain events.

ITEM 1A. RISK FACTORS.

The following updates the risk factors included in the Company’s Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2009, and the Quarterly Report on Form 10-Q for the Quarterly Period Ended June 30, 2010.

We face significant risks and uncertainties in connection with our bankruptcy reorganization Chapter 11 Filing.

We filed for protection under Chapter 11 of the Bankruptcy Code on July 23, 2010. During our Chapter 11 proceedings, our operations, including our ability to execute our business plan, are subject to the risks and uncertainties associated with bankruptcy. Risks and uncertainties associated with our Chapter 11 proceedings include the following:

• Actions and decisions of our creditors and other third parties with interests in our Chapter 11 proceedings may be inconsistent with our plans;

• Our ability to obtain court approval with respect to motions in the Chapter 11 proceedings prosecuted from time to time;

• Our ability to develop, prosecute, confirm and consummate a plan of reorganization or effect a structured settlement with respect to the Chapter 11 proceedings;

• Our ability to maintain contracts that are critical to our operations;

• Our ability to retain management and other key individuals; and

• Risks associated with third parties seeking and obtaining court approval to terminate or shorten the exclusivity period for us to propose and confirm a plan of reorganization, to appoint a Chapter 11 trustee or to convert the cases to Chapter 7 cases.

These risks and uncertainties could affect our business and operations in various ways. For example, negative events or publicity associated with our Chapter 11 proceedings could adversely affect our operations and financial condition, particularly if the Chapter 11 proceedings are protracted. Also, transactions outside the ordinary course of business are subject to the prior approval of the Bankruptcy Court, which may limit our ability to respond timely to certain events or take advantage of certain opportunities.

Because of the risk and uncertainties associated with our Chapter 11 proceedings, the ultimate impact of events that occur during these proceedings will have on our business, financial condition and results of operations cannot be accurately predicted or quantified, and there is substantial doubt about our ability to continue as a going concern. We cannot provide any assurance as to what values, if any, will be ascribed in our bankruptcy proceedings to our various pre-petition liabilities, common stock and securities. As a result of Chapter 11 proceedings, our currently outstanding common stock could have no value and may be canceled under any plan of reorganization we might propose and, therefore, we believe that the value of our various pre-petition liabilities and other securities is highly speculative. According, caution should be exercised with respect to existing and future investments in any of these liabilities or securities.

We may have insufficient liquidity to successfully operate our business.

The Company expects to incur significant costs as a result of the bankruptcy case. We are currently financing our operations during the reorganization using cash on hand and cash generated by operations. In the event that we do not have sufficient liquidity to fund our operations such that we need to obtain additional financing, there can be no assurance as to our ability to obtain sufficient financing on acceptable terms or at all. The challenges of obtaining financing, if necessary, would be exacerbated by adverse conditions in the general economy and the volatility and the tightness in the financial and credit markets. These conditions and our bankruptcy case would make it more difficult for us to obtain financing.

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We expect that the plan of reorganization will call for the successful bidder to fund our DIP Loan and all other needs of the Company from the date of confirmation as the successful bidder until the date of closing of the transfer of ownership of our operations to the successful bidder. We expect that one of the conditions to the closing of the transfer will be the obtaining of FCC and state regulatory authority for a change in control of our operations to the successful bidder, which approval could take 90 days or more. We further expect that during this interim period, the successful bidder would seek to be responsible for oversight and control of our operations, although we expect that day to day operations will continue to be run primarily by the current management team in place. There is a risk that the conditions precedent to the ultimate disposition of our operations may not be satisfied, or that the successful bidder will lack the funds to consummate the closing as consummated (which is anticipated to require the provision of additional financing to cover obligations to critical vendors and working capital needs), which could result in a failure to close the contemplated sale. In such event, we would be required to seek another buyer for our assets, and there can be no assurances that a subsequent successful buyer could be located on terms favorable to stakeholders, as well as a risk that our operations may not be successfully run during the interim period from turn over of managerial authority of the Company to the initial bidder, until ultimate disposition of our business.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

As a result of the Company being in default on certain reporting and administrative covenants related to the Senior Debt, all long-term debts are presented as current obligations.

As of August 31, 2010 and September 30, 2010, the Company was in Default on the DIP Loan Agreement. The DIP Loan Agreement provided for certain financial covenants to be maintained. Among those covenants was the requirement to maintain EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization), as defined in the DIP Loan Agreement, of at least $0.1 million for the month ended August 31, 2010 and $0.2 million for the two months ended September 30, 2010. The Company did not meet this financial covenant test and accordingly, was in default of the DIP Loan Agreement as of August 31, 2010 and September 30, 2010. The DIP Loan Agreement provides, in the event of an Event of Default, for a default interest rate at a rate per annum which is 2% above the rate in effect immediately before the Event of Default. This rate will continue in effect during the continuance of an Event of Default. The Default Rate of Interest on both Tranche A and Tranche B Loans is 14% per annum.

ITEM 4. (REMOVED AND RESERVED)

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.

Exhibits filed as a part of this quarterly report on Form 10-Q are listed in the Index to Exhibits located on page 40 of this Report.

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SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

CAPITAL GROWTH SYSTEMS, INC.
(DEBTOR-IN-POSSESSION)
By:	/S/    PATRICK C. SHUTT
	Patrick C. Shutt, Chief Executive Officer
	/S/    GEORGE A. KING
	George A. King, Interim Chief Financial Officer

Dated: November 15, 2010

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Exhibit Number	Description of Document
10.1	Debtor in Possession Loan and Security Agreement (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on August 5, 2010).
10.2	Joint Disclosure Statement of Capital Growth Systems, Inc. and Subsidiaries (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on August 17, 2010).
10.3	Plan of Reorganization of Capital Growth Systems, Inc. and Subsidiaries (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed on August 17, 2010).
10.4	Plan Support Agreement of Capital Growth Systems, Inc. and DIP Lenders (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K, filed on August 17, 2010).
31.1	Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2	Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

* Furnished herewith.

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