Tableof Contents

 

###### *** ***

 

**UNITED STATESSECURITIES 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 30,2009**

 

**OR**

** **
| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

** **

**For the transition period from           to          .**

** **

**Commission File Number: 001-15605**

 

**EARTHLINK, INC.**

(Exact name of registrant asspecified in its charter)

* *

| **Delaware**                                                   | ** ** | **58-2511877**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization) |       | (I.R.S. Employer Identification No.) |

* *

| **1375 Peachtree St., Atlanta, Georgia** | ** ** | **30309**  |
|------------------------------------------|------------|------------|
| (Address of principal executive offices) |       | (Zip Code) |

* *

**(404) 815-0770**

(Registrant’s telephone number,including area code)

 

----

 

 

 (Former name, former address and former fiscalyear, if changed since last report date)

 

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Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x No o

 

Indicate by check mark whether theregistrant has submitted electronically and posted on its corporate Web site,if any, every Interactive Data File required to be submitted and postedpursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).  Yes o No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer x | ** ** | Accelerated filer o         |
|---------------------------|------------|-----------------------------|
| ** **                | ** ** | ** **                  |
| Non-accelerated filer o   | ** ** | Smaller reporting company o |

 

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

 

As of October 29, 2009, 107,018,656 shares of common stock, $.01 parvalue per share, were outstanding.

 

 

** **

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Table of Contents

** **

**EARTHLINK, INC.**

**Quarterly Report on Form 10-Q**

**For the Quarterly Period Ended September 30,2009**

** **

**TABLE OF CONTENTS**

** **
| **Part I**                                                                                     |
|-----------------------------------------------------------------------------------------------------|
| ** **                                                                                          | ** ** |
| Item  1. Financial Statements                                                                       | 1 |
|                                                                                                |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 24 |
|                                                                                                |   |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 | 47 |
|                                                                                                |   |
| Item 4. Controls and Procedures                                                                     | 47 |
|                                                                                                |   |
| **Part II**                                                                                    |
|                                                                                                |   |
| Item  1. Legal Proceedings                                                                          | 47 |
|                                                                                                |   |
| Item  1A. Risk Factors                                                                              | 47 |
|                                                                                                |   |
| Item  5. Other Information                                                                          | 48 |
|                                                                                                |   |
| Item 6.  Exhibits                                                                                   | 48 |
|                                                                                                |   |
| Signatures                                                                                          | 49 |

 

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Table of Contents

** **

**PART I**

 

**Item 1. Financial Statements.**

 

**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands, except per share data)**

 
| ** **                                                                                                                                                                                                                                                                                | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                | ** ** | **2008**              | ** ** | **2009**               | ** ** |
| ** **                                                                                                                                                                                                                                                                                | ** ** | ** **            | ** ** | **(unaudited)**        | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                |       |
| Current  assets:                                                                                                                                                                                                                                                                          |       |                  |       |                   |       |
| Cash  and cash equivalents                                                                                                                                                                                                                                                                |       | $                     | 486,564    |                   | $          | 562,274 |   |
| Accounts  receivable, net of allowance of $4,048 and $1,920 as of December 31,  2008 and September 30, 2009, respectively                                                                                                                                                       |       | 30,569                |       | 21,610                 |       |
| Marketable  securities                                                                                                                                                                                                                                                                    |       | —                |       | 90,791                 |       |
| Prepaid  expenses                                                                                                                                                                                                                                                                         |       | 6,445                 |       | 6,170                  |       |
| Deferred  income taxes, net                                                                                                                                                                                                                                                               |       | 20,254                |       | 4,543                  |       |
| Other  current assets                                                                                                                                                                                                                                                                     |       | 15,452                |       | 17,201                 |       |
| Total  current assets                                                                                                                                                                                                                                                                     |       | 559,284               |       | 702,589                |       |
| Long-term  marketable securities                                                                                                                                                                                                                                                          |       | 47,809                |       | 1,807                  |       |
| Long-term  investments                                                                                                                                                                                                                                                                    |       | 20,708                |       | 19,089                 |       |
| Property  and equipment, net                                                                                                                                                                                                                                                              |       | 37,246                |       | 34,759                 |       |
| Deferred  income taxes, net                                                                                                                                                                                                                                                               |       | 43,757                |       | 9,815                  |       |
| Purchased  intangible assets, net                                                                                                                                                                                                                                                         |       | 19,552                |       | 13,328                 |       |
| Goodwill                                                                                                                                                                                                                                                                                  |       | 112,812               |       | 112,812                |       |
| Other  long-term assets                                                                                                                                                                                                                                                                   |       | 4,698                 |       | 3,772                  |       |
| Total  assets                                                                                                                                                                                                                                                                             |       | $                     | 845,866    |                   | $          | 897,971 |   |
|                                                                                                                                                                                                                                                                                      |       |                  |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                             |       |
| Current  liabilities:                                                                                                                                                                                                                                                                     |       |                  |       |                   |       |
| Accounts  payable                                                                                                                                                                                                                                                                         |       | $                     | 13,109     |                   | $          | 8,061 |   |
| Accrued  payroll and related expenses                                                                                                                                                                                                                                                     |       | 37,470                |       | 20,656                 |       |
| Other  accrued liabilities                                                                                                                                                                                                                                                                |       | 39,415                |       | 35,070                 |       |
| Deferred  revenue                                                                                                                                                                                                                                                                         |       | 33,649                |       | 27,145                 |       |
| Convertible  senior notes, net of discount of $29,743 as of September 30, 2009                                                                                                                                                                                                       |       | —                |       | 229,007                |       |
| Total  current liabilities                                                                                                                                                                                                                                                                |       | 123,643               |       | 319,939                |       |
|                                                                                                                                                                                                                                                                                      |       |                  |       |                   |       |
| Convertible  senior notes, net of discount of $39,017 as of December 31, 2008                                                                                                                                                                                                        |       | 219,733               |       | —                 |       |
| Other  long-term liabilities                                                                                                                                                                                                                                                              |       | 16,015                |       | 16,492                 |       |
| Total  liabilities                                                                                                                                                                                                                                                                        |       | 359,391               |       | 336,431                |       |
|                                                                                                                                                                                                                                                                                      |       |                  |       |                   |       |
| Stockholders’  equity:                                                                                                                                                                                                                                                               |       |                  |       |                   |       |
| Convertible  preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued  and outstanding as of December 31, 2008 and September 30, 2009                                                                                                                       |       | —                |       | —                 |       |
| Common  stock, $0.01 par value, 300,000 shares authorized, 188,264 and 190,332 shares  issued as of December 31, 2008 and September 30, 2009,  respectively, and 108,516 and 106,992 shares outstanding as of December 31,  2008 and September 30, 2009, respectively |       | 1,883                 |       | 1,903                  |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                               |       | 2,135,887             |       | 2,131,130              |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                      |       | (1,016,833            | )          | (922,984               | )          |
| Treasury  stock, at cost, 79,748 and 83,340 shares as of December 31, 2008 and  September 30, 2009, respectively                                                                                                                                                                |       | (634,420              | )          | (656,760               | )          |
| Unrealized  (losses) gains on investments                                                                                                                                                                                                                                                 |       | (42                   | )          | 8,251                  |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                                          |       | 486,475               |       | 561,540                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                                          |       | $                     | 845,866    |                   | $          | 897,971 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

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**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

 
| ** **                                             | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                  | ** ** | **2009**                                 | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                                             | ** ** | **(in thousands, except per share data)** | ** ** |
| ** **                                             | ** ** | **(unaudited)**                           | ** ** |
|                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Revenues                                               |       | $                                         | 230,831    |                                     | $          | 174,521 |   | $ | 739,508 |   | $ | 559,181 |   |
|                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Operating  costs and expenses:                         |       |                                      |       |                                     |       |   |   |   |   |
| Cost  of revenues                                      |       | 87,616                                    |       | 66,885                                   |       | 277,655 |   | 211,720 |   |
| Sales  and marketing                                   |       | 22,191                                    |       | 13,840                                   |       | 78,913 |   | 45,405 |   |
| Operations  and customer support                       |       | 34,048                                    |       | 23,569                                   |       | 106,914 |   | 75,255 |   |
| General  and administrative                            |       | 23,316                                    |       | 16,472                                   |       | 72,010 |   | 51,503 |   |
| Amortization  of intangible assets                     |       | 3,153                                     |       | 2,039                                    |       | 11,153 |   | 6,224 |   |
| Facility  exit and restructuring costs                 |       | 1,078                                     |       | (97                                      | )          | 4,169 |   | 5,318 |   |
| Total  operating costs and expenses                    |       | 171,402                                   |       | 122,708                                  |       | 550,814 |   | 395,425 |   |
|                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Income  from operations                                |       | 59,429                                    |       | 51,813                                   |       | 188,694 |   | 163,756 |   |
| Gain  on investments, net                              |       | 4,352                                     |       | 35                                       |       | 5,677 |   | 305 |   |
| Interest  expense and other, net                       |       | (3,281                                    | )          | (5,067                                   | )          | (7,804 | ) | (14,458 | ) |
| Income  from continuing operations before income taxes |       | 60,500                                    |       | 46,781                                   |       | 186,567 |   | 149,603 |   |
| Income  tax provision                                  |       | (7,924                                    | )          | (16,914                                  | )          | (23,923 | ) | (55,754 | ) |
| Income  from continuing operations                     |       | 52,576                                    |       | 29,867                                   |       | 162,644 |   | 93,849 |   |
| Loss  from discontinued operations                     |       | (681                                      | )          | —                                   |       | (8,438 | ) | — |   |
| Net  income                                            |       | $                                         | 51,895     |                                     | $          | 29,867 |   | $ | 154,206 |   | $ | 93,849 |   |
|                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Basic  net income per share                            |       |                                      |       |                                     |       |   |   |   |   |
| Continuing  operations                                 |       | $                                         | 0.48       |                                     | $          | 0.28 |   | $ | 1.48 |   | $ | 0.88 |   |
| Discontinued  operations                               |       | (0.01                                     | )          | —                                   |       | (0.08 | ) | — |   |
| Basic  net income per share                            |       | $                                         | 0.47       |                                     | $          | 0.28 |   | $ | 1.40 |   | $ | 0.88 |   |
| Basic  weighted average common shares outstanding      |       | 110,153                                   |       | 106,615                                  |       | 109,895 |   | 106,853 |   |
|                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Diluted  net income per share                          |       |                                      |       |                                     |       |   |   |   |   |
| Continuing  operations                                 |       | $                                         | 0.47       |                                     | $          | 0.28 |   | $ | 1.46 |   | $ | 0.87 |   |
| Discontinued  operations                               |       | (0.01                                     | )          | —                                   |       | (0.08 | ) | — |   |
| Diluted  net income per share                          |       | $                                         | 0.46       |                                     | $          | 0.28 |   | $ | 1.38 |   | $ | 0.87 |   |
| Diluted  weighted average common shares outstanding    |       | 112,039                                   |       | 107,943                                  |       | 111,534 |   | 108,052 |   |
|                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Dividends  declared per share                          |       | $                                         | —     |                                     | $          | 0.14 |   | $ | — |   | $ | 0.14 |   |

 

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

 

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**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

 
| ** **                                                                         | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **September 30,** | ** ** |
| ** **                                                                         | ** ** | **2008**               | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**     | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**        | ** ** |
| Cash  flows from operating activities:                                             |       |                   |       |   |   |
| Net  income                                                                        |       | $                      | 154,206    |   | $ | 93,849 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                   |       |   |   |
| Depreciation  and amortization                                                     |       | 29,388                 |       | 18,610 |   |
| Loss  on disposals and impairments of fixed assets                                 |       | 6,255                  |       | 289 |   |
| Stock-based  compensation                                                          |       | 14,319                 |       | 10,552 |   |
| Deferred  income taxes                                                             |       | 15,968                 |       | 49,050 |   |
| Accretion  of debt discount and amortization of debt issuance costs                |       | 8,170                  |       | 10,121 |   |
| Gain  on investments, net                                                          |       | (5,677                 | )          | (305 | ) |
| Decrease  in accounts receivable, net                                              |       | 13,269                 |       | 8,959 |   |
| (Increase)  decrease in prepaid expenses and other assets                          |       | (6,466                 | )          | 4,466 |   |
| Decrease  in accounts payable and accrued and other liabilities                    |       | (45,491                | )          | (30,527 | ) |
| Decrease  in deferred revenue                                                      |       | (9,364                 | )          | (6,625 | ) |
| Net  cash provided by operating activities                                         |       | 174,577                |       | 158,439 |   |
|                                                                               |       |                   |       |   |   |
| Cash  flows from investing activities:                                             |       |                   |       |   |   |
| Purchases  of property and equipment                                               |       | (3,877                 | )          | (10,648 | ) |
| Purchases  of subscriber bases                                                     |       | (880                   | )          | — |   |
| Purchases  of marketable securities                                                |       | (53,027                | )          | (52,502 | ) |
| Sales  and maturities of marketable securities                                     |       | 109,929                |       | 12,473 |   |
| Proceeds  received from investments in other companies                             |       | 57,070                 |       | 200 |   |
| Other  investing activities                                                        |       | 65                     |       | — |   |
| Net  cash provided by (used in) investing activities                               |       | 109,280                |       | (50,477 | ) |
|                                                                               |       |                   |       |   |   |
| Cash  flows from financing activities:                                             |       |                   |       |   |   |
| Principal  payments under capital lease obligations                                |       | (2,698                 | )          | (25 | ) |
| Proceeds  from exercises of stock options                                          |       | 7,985                  |       | 5,073 |   |
| Repurchases  of common stock                                                       |       | (31,857                | )          | (22,340 | ) |
| Payment  of dividends                                                              |       | —                 |       | (14,960 | ) |
| Other  financing activities                                                        |       | 1,425                  |       | — |   |
| Net  cash used in financing activities                                             |       | (25,145                | )          | (32,252 | ) |
|                                                                               |       |                   |       |   |   |
| Net  increase in cash and cash equivalents                                         |       | 258,712                |       | 75,710 |   |
| Cash  and cash equivalents, beginning of period                                    |       | 173,827                |       | 486,564 |   |
| Cash  and cash equivalents, end of period                                          |       | $                      | 432,539    |   | $ | 562,274 |   |

 

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

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED**

** **

**1.  Organization**

** **

EarthLink, Inc.(“EarthLink” or the “Company”) is an Internet service provider (“ISP”),providing nationwide Internet access and related value-added services to individualand business customers. The Company’s primary service offerings are dial-up andhigh-speed Internet access services and related value-added services, such asancillary services sold as add-on features to the Company’s Internet accessservices, search and advertising. In addition, through the Company’swholly-owned subsidiary, New Edge Networks (“New Edge”), the Company builds andmanages private IP-based wide area networks for businesses and communicationscarriers.

 

TheCompany operates two reportable segments, Consumer Services and BusinessServices. The Company’s Consumer Services segment provides Internet access andrelated value-added services to individual customers. These services includedial-up and high-speed Internet access and voice-over-Internet protocol (“VoIP”)services, among others. The Company’s Business Services segment providesintegrated communications services and related value-added services tobusinesses and communications carriers. These services include managed privateIP-based wide area networks, dedicated Internet access and web hosting, amongothers. For further information concerning the Company’s business segments, seeNote 13, “Segment Information.”

 

**2. ****Summaryof Significant Accounting Policies**

 

*Basis ofPresentation*

* *

Thecondensed consolidated financial statements of EarthLink, which include theaccounts of its wholly-owned subsidiaries, for the three and nine months ended September 30,2008 and 2009 and the related footnote information are unaudited and have beenprepared on a basis consistent with the Company’s audited consolidatedfinancial statements as of December 31, 2008 contained in the Company’sAnnual Report on Form 10-K as filed with the Securities and ExchangeCommission (the “Annual Report”).  Allsignificant intercompany transactions have been eliminated.  In connection with the preparation of thecondensed consolidated financial statements the Company evaluated subsequentevents after the balance sheet date of September 30, 2009 through October 30,2009, the date of issuance of the Company’s condensed consolidated financialstatements.

 

Thesefinancial statements should be read in conjunction with the auditedconsolidated financial statements and the related notes thereto contained inthe Company’s Annual Report.  In theopinion of management, the accompanying unaudited financial statements containall adjustments (consisting of normal recurring adjustments), which managementconsiders necessary to present fairly the Company’s financial position, resultsof operations and cash flows for the interim periods presented.  The results of operations for the three andnine months ended September 30, 2009 are not necessarily indicative of theresults anticipated for the entire year ending December 31, 2009.

 

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the amounts reported in the financial statements.  Actual results may differ from those estimates.

 

*Discontinued Operations*

* *

TheCompany reflected its municipal wireless broadband results of operations asdiscontinued operations for the three and nine months ended September 30,2008. See Note 5, “Discontinued Operations,” for further discussion.

 

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* *

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED- (Continued)**

* *

*Fair Value ofFinancial Instruments*

* *

Thecarrying amounts of the Company’s cash, cash equivalents, trade receivables andtrade payables approximate their fair values because of their nature andrespective durations. The Company’s short- and long-term marketable securitiesconsist of available-for-sale and trading securities that are carried at marketvalue. The Company’s equity investments in publicly-held companies are statedat fair value, which is based on quoted market prices, with unrealized gainsand losses included in stockholders’ equity. The Company’s investments inprivately-held companies are stated at cost, net of other-than-temporaryimpairments, because it is impracticable to estimate fair value.

 

*Reclassifications*

* *

Certain amounts in the prior periodfinancial statements have been reclassified to conform to the current periodpresentation.

 

*Recently Issued Accounting Pronouncement*

* *

In September 2009,the Financial Accounting Standards Board (“FASB”) issued new guidance onrevenue recognition. The new guidance addresses the accounting formultiple-deliverable arrangements to enable vendors to account for products orservices (deliverables) separately rather than as a combined unit and to modifythe manner in which the transaction consideration is allocated across theseparately identifiable deliverables and how revenue is recognized. The newguidance also significantly expands the disclosure requirements formultiple-element arrangements. The new guidance is effective prospectively forrevenue arrangements entered into or materially modified in fiscal yearsbeginning on or after June 15, 2010. The Company does not expect theadoption of the new guidance to have a material impact on its financialstatements.

 

*Adoption of Recent Accounting Pronouncements*

* *

*Codification*. In the third quarter of 2009, the Company adopted theFASB Accounting Standards Codification (“ASC”). The ASC became the singleofficial source of authoritative U.S. generally accepted accounting principles(“GAAP”) recognized by the FASB, other than guidance issued by the Securitiesand Exchange Commission. The adoption of the ASC did not have a material impacton the Company’s financial statements. However, the adoption of the ASC changedthe Company’s references to GAAP in its consolidated financial statements.

 

*Convertible Debt*. On January 1, 2009, the Company adopted newaccounting guidance related to accounting for convertible debt instruments thatmay be settled in cash upon conversion, which was codified in ASC Subtopic470-20, “Debt With Conversion and Other Options.” The new accounting guidancerequires that the liability and equity components of convertible debtinstruments that may be settled in cash upon conversion (including partial cashsettlement) be separately accounted for in a manner that reflects an issuer’snon-convertible debt borrowing rate. The resulting debt discount is accretedover the period the convertible debt is expected to be outstanding asadditional non-cash interest expense. Retrospective application to all periodspresented is required. The adoption of this new guidance on January 1,2009 affected the accounting for the Company’s Convertible Senior Notes due November 15,2026 (the “Notes”), which were issued in November 2006. Upon adoption, theCompany recorded an adjustment to increase additional paid-in capital as of theNovember 2006 issuance date by approximately $62.1 million. The Company isaccreting the resulting debt discount to interest expense over the estimatedfive-year life of the Notes, which represents the first redemption date of November 2011.The Company recorded a pre-tax adjustment of approximately $22.3 million toretained earnings that represents the debt discount accretion during the yearsended December 31, 2006, 2007 and 2008 and will recognize additionalnon-cash interest expense of $12.2 million, $13.4 million and $12.4 millionduring the years ending December 31, 2009, 2010 and 2011, respectively,for accretion of the debt discount. As a result of the adoption of this newguidance, the Company reduced income from continuing operations and net incomefor the three months ended September 30, 2009 by $3.1 million and reducedbasic and diluted earnings per share by $0.03 per share, and reduced incomefrom continuing operations and net income for the nine months ended 

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED- (Continued)**

 

September 30,2009 by $9.0 million and reduced basic and diluted earnings per share by $0.08per share. The Company also recorded a deferred tax liability for temporary taxdifferences. However, this was offset by a corresponding decrease in thevaluation allowance for deferred tax assets.

 

The following tables present theeffect of the adoption of this new guidance on the Company’s affected financialstatement line items for the three and nine months ended September 30,2008 and as of December 31, 2008:

 
| ** **                                | ** ** | **Three Months Ended September 30,  2008** | ** ** | **Nine Months Ended September 30,  2008** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                | ** ** | **As Originally**                               | ** ** | **As**                                         | ** ** | **Effect of** | ** ** | **As Originally** | ** ** | **As** | ** ** | **Effect of** | ** ** |
| ** **                                | ** ** | **Reported**                                    | ** ** | **Adjusted**                                   | ** ** | **Change** | ** ** | **Reported** | ** ** | **Adjusted** | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **(in thousands, except per share data)**       | ** ** |
| Statement  of Operations:                 |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Interest  (expense) income and other, net |       | $                                               | (490       | )                                              | $          | (3,281 | ) | $ | (2,791 | ) | $ | 366 |   | $ | (7,804 | ) | $ | (8,170 | ) |
| Income  from continuing operations        |       | 55,367                                          |       | 52,576                                         |       | (2,791 | ) | 170,814 |   | 162,644 |   | (8,170 | ) |
| Net  income                               |       | 54,686                                          |       | 51,895                                         |       | (2,791 | ) | 162,376 |   | 154,206 |   | (8,170 | ) |
|                                      |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Basic  net income per share               |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Continuing  operations                    |       | $                                               | 0.50       |                                           | $          | 0.48 |   | $ | (0.03 | ) | $ | 1.55 |   | $ | 1.48 |   | $ | (0.07 | ) |
| Basic  net income per share               |       | 0.50                                            |       | 0.47                                           |       | (0.03 | ) | 1.48 |   | 1.40 |   | (0.07 | ) |
|                                      |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Diluted  net income per share             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Continuing  operations                    |       | $                                               | 0.49       |                                           | $          | 0.47 |   | $ | (0.02 | ) | $ | 1.53 |   | $ | 1.46 |   | $ | (0.07 | ) |
| Diluted  net income per share             |       | 0.49                                            |       | 0.46                                           |       | (0.02 | ) | 1.46 |   | 1.38 |   | (0.07 | ) |

 
| ** **                  | ** ** | **As of December 31, 2008** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **As Originally**                | ** ** | **As** | ** ** | **Effect of** | ** ** |
| ** **                  | ** ** | **Reported**                     | ** ** | **Adjusted** | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **(in thousands)**               | ** ** |
| Balance  Sheet:             |       |                             |       |   |   |   |   |
| Other  long-term assets     |       | $                                | 5,725      |   | $ | 4,698 |   | $ | (1,027 | ) |
| Long-term  debt             |       | 258,750                          |       | 219,733 |   | (39,017 | ) |
| Additional  paid-in capital |       | 2,075,571                        |       | 2,135,887 |   | 60,316 |   |
| Accumulated  deficit        |       | (994,507                         | )          | (1,016,833 | ) | (22,326 | ) |
|                             |            |                                  |            |  |  |  |  |  |  |  |

** **

**3.  Earnings per Share**

* *

TheCompany presents a dual presentation of basic and diluted earnings per share (“EPS”).Basic EPS represents net income divided by the weighted average number ofcommon shares outstanding during a reported period. Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock, including stock options, restricted stock units, phantom shareunits and convertible debt (collectively “Common Stock Equivalents”), wereexercised or converted into common stock. The dilutive effect of outstandingstock options, restricted stock units and convertible debt is reflected indiluted earnings per share by application of the treasury stock method. Phantomshare units are reflected on an if-converted basis. In applying the treasurystock method for stock-based compensation arrangements, the assumed proceedsare computed as the sum of the amount the employee must pay upon exerciseand the amounts of average unrecognized compensation cost attributed tofuture services.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED- (Continued)**

** **

Thefollowing table sets forth the computation for basic and diluted net income pershare for the three and nine months ended September 30, 2008 and 2009:

 
| ** **                                          | ** ** | **Three Months Ended**                    | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------|------------|------------------------|------------|
| ** **                                          | ** ** | **September 30,**                    | ** ** | **September 30,** | ** ** |
| ** **                                          | ** ** | **2008**                                  | ** ** | **2009**               | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                                          | ** ** | **(in thousands, except per share data)** | ** ** |
| **Numerator**                                       | ** ** | ** **                                | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income  from continuing operations                  |       | $                                         | 52,576     |                   | $          | 29,867 |   | $ | 162,644 |   | $ | 93,849 |   |
| Loss  from discontinued operations                  |       | (681                                      | )          | —                 |       | (8,438 | ) | — |   |
| Net  income                                         |       | $                                         | 51,895     |                   | $          | 29,867 |   | $ | 154,206 |   | $ | 93,849 |   |
|                                                |       |                                      |       |                   |       |   |   |   |   |
| **Denominator**                                     |       |                                      |       |                   |       |   |   |   |   |
| Basic  weighted average common shares outstanding   |       | 110,153                                   |       | 106,615                |       | 109,895 |   | 106,853 |   |
| Dilutive  effect of Common Stock Equivalents        |       | 1,886                                     |       | 1,328                  |       | 1,639 |   | 1,199 |   |
| Diluted  weighted average common shares outstanding |       | 112,039                                   |       | 107,943                |       | 111,534 |   | 108,052 |   |
|                                                |       |                                      |       |                   |       |   |   |   |   |
| **Basic net income per share**                      |       |                                      |       |                   |       |   |   |   |   |
| Continuing  operations                              |       | $                                         | 0.48       |                   | $          | 0.28 |   | $ | 1.48 |   | $ | 0.88 |   |
| Discontinued  operations                            |       | (0.01                                     | )          | —                 |       | (0.08 | ) | — |   |
| Basic  net income per share                         |       | $                                         | 0.47       |                   | $          | 0.28 |   | $ | 1.40 |   | $ | 0.88 |   |
|                                                |       |                                      |       |                   |       |   |   |   |   |
| **Diluted net income per share**                    |       |                                      |       |                   |       |   |   |   |   |
| Continuing  operations                              |       | $                                         | 0.47       |                   | $          | 0.28 |   | $ | 1.46 |   | $ | 0.87 |   |
| Discontinued  operations                            |       | (0.01                                     | )          | —                 |       | (0.08 | ) | — |   |
| Diluted  net income per share                       |       | $                                         | 0.46       |                   | $          | 0.28 |   | $ | 1.38 |   | $ | 0.87 |   |

 

Duringthe three months ended September 30, 2008 and 2009, approximately 8.0million and 4.1 million, respectively, stock options and restricted stock unitswere excluded from the calculation of diluted EPS because the exercise pricesplus the amount of unrecognized compensation cost attributed to futureservices exceeded the Company’s average stock price during the respectiveperiods. During the nine months ended September 30, 2008 and 2009,approximately 8.7 million and 5.2 million, respectively, stock options andrestricted stock units were excluded from the calculations of diluted EPS.Approximately 28.4 million and 28.9 million shares as of September 30,2008 and 2009, respectively, that underlie the Company’s convertible debtinstruments were also excluded from the calculations of diluted EPS because theexercise price exceeded the Company’s average stock price during the periods.These securities could be dilutive in future periods.

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

** **

**4.  Facility Exit and Restructuring****Costs**

** **

Facility exit and restructuringcosts consisted of the following during the three and nine months ended September 30,2008 and 2009:

 
| ** **                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                  | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**     | ** ** |
|                        |       |                   |       |                   |       |   |   |   |   |
| 2007  Restructuring Plan    |       | $                      | 1,159      |                   | $          | 31 |   | $ | 4,421 |   | $ | 5,446 |   |
| Legacy  Restructuring Plans |       | (81                    | )          | (128                   | )          | (252 | ) | (128 | ) |
|                        |       | $                      | 1,078      |                   | $          | (97 | ) | $ | 4,169 |   | $ | 5,318 |   |

 

*2007 Restructuring Plan*

* *

In August 2007, EarthLinkadopted a restructuring plan (the “2007 Plan”) to reduce costs and improve theefficiency of the Company’s operations. The 2007 Plan was the result of acomprehensive review of operations within and across the Company’s functionsand businesses. Under the 2007 Plan, the Company reduced its workforce byapproximately 900 employees, closed office facilities in Orlando, Florida;Knoxville, Tennessee; Harrisburg, Pennsylvania; and San Francisco, Californiaand consolidated its office facilities in Atlanta, Georgia and Pasadena,California. The 2007 Plan was primarily implemented during the latter half of2007 and during the year ended December 31, 2008. However, sincemanagement continues to evaluate EarthLink’s businesses, there have been andmay continue to be supplemental provisions for new cost savings initiatives aswell as changes in estimates to amounts previously recorded.

 

The Company recorded $5.4 millionof facility exit and restructuring costs during the nine months ended September 30,2009 as a result of changes to sublease estimates in its Atlanta, Georgia andPasadena, California facilities and further consolidation in its Atlanta, GAfacility. The following table summarizes facility exit and restructuring costsduring the nine months ended September 30, 2008 and 2009 and thecumulative costs incurred to date as a result of the 2007 Plan. Such costs havebeen classified as facility exit and restructuring costs in the CondensedConsolidated Statements of Operations.

 
| ** **                                      | ** ** | ** **                               | ** ** | ** **   | ** ** | **Cumulative** | ** ** |
|-------------------------------------------------|------------|------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                      | ** ** | ** **                               | ** ** | ** **   | ** ** | **Costs**      | ** ** |
| ** **                                      | ** ** | **Nine Months Ended September 30,** | ** ** | **Incurred** | ** ** |
| ** **                                      | ** ** | **2008**                                 | ** ** | **2009**     | ** ** | **To Date**    | ** ** |
|                                            | ** ** | **(in thousands)**                       |       |
|                                            | ** ** |                                     |       |         |       |           |       |
| Severance  and personnel-related costs          |       | $                                        | 474        |         | $          | —         |       | $ | 30,764 |   |
| Lease  termination and facilities-related costs |       | 3,352                                    |       | 5,400        |       | 22,424         |       |
| Non-cash  asset impairments                     |       | 514                                      |       | 46           |       | 24,792         |       |
| Other  associated costs                         |       | 81                                       |       | —       |       | 1,131          |       |
|                                            |       | $                                        | 4,421      |         | $          | 5,446          |       | $ | 79,111 |   |

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

Thefollowing table summarizes activity for the liability balances associated withthe 2007 Plan for the years ended December 31, 2007 and 2008 and for thenine months ended September 30, 2009, including changes during the yearsattributable to costs incurred and charged to expense and costs paid orotherwise settled:

 
| ** **                             | ** ** | **Severance**      | ** ** | ** **     | ** ** | **Asset**       | ** ** | **Other** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|--------------------|------------|----------------|------------|-----------------|------------|-----------|------------|------------|------------|
| ** **                             | ** ** | **and Benefits**   | ** ** | **Facilities** | ** ** | **Impairments** | ** ** | **Costs** | ** ** | **Total**  | ** ** |
| ** **                             | ** ** | **(in thousands)** | ** ** |
| Balance  as of December 31, 2006  |       | $                  | —     |           | $          | —          |       | $         | —     |       | $          | — |   | $ | — |   |
| Accruals                               |       | 30,303             |       | 12,216         |       | 20,621          |       | 1,131     |       | 64,271     |       |
| Payments                               |       | (18,262            | )          | (480           | )          | —          |       | (760      | )          | (19,502    | )          |
| Non-cash  charges                      |       | —             |       | 4,388          |       | (20,621         | )          | (371      | )          | (16,604    | )          |
| Balance  as of December 31, 2007  |       | 12,041             |       | 16,124         |       | —          |       | —    |       | 28,165     |       |
| Accruals                               |       | 461                |       | 4,808          |       | 4,125           |       | —    |       | 9,394      |       |
| Payments                               |       | (12,502            | )          | (6,174         | )          | —          |       | —    |       | (18,676    | )          |
| Non-cash  charges                      |       | —             |       | 1,936          |       | (4,125          | )          | —    |       | (2,189     | )          |
| Balance  as of December 31, 2008  |       | —             |       | 16,694         |       | —          |       | —    |       | 16,694     |       |
| Accruals                               |       | —             |       | 5,400          |       | 46              |       | —    |       | 5,446      |       |
| Payments                               |       | —             |       | (3,732         | )          | —          |       | —    |       | (3,732     | )          |
| Non-cash  charges                      |       | —             |       | 392            |       | (46             | )          | —    |       | 346        |       |
| Balance  as of September 30, 2009 |       | $                  | —     |           | $          | 18,754          |       | $         | —     |       | $          | — |   | $ | 18,754 |   |

 

Facilityexit and restructuring liabilities due within one year of the balance sheetdate are classified as other accrued liabilities and facility exit andrestructuring liabilities due after one year of the balance sheet date areclassified as other long-term liabilities in the Condensed Consolidated BalanceSheets. Of the unpaid balance as of December 31, 2008 and September 30,2009, approximately $5.9 million and $5.8 million, respectively, wereclassified as other accrued liabilities and approximately $10.8 million and$13.0 million, respectively, were classified as other long-term liabilities.

 

*Legacy Restructuring Plans*

* *

Duringthe years ended December 31, 2003, 2004 and 2005, the Company executed aseries of plans to restructure and streamline the Company’s contact centeroperations and outsource certain internal functions (collectively referred toas “Legacy Plans”). The Legacy Plans included facility exit costs,personnel-related costs and asset disposals. EarthLink periodically evaluatesand adjusts its estimates for facility exit and restructuring costs based oncurrently-available information. Such adjustments are included as facility exitand restructuring costs in the Condensed Consolidated Statements of Operations.During the three and nine months ended September 30, 2008, EarthLinkrecorded a $0.1 million and $0.3 million reduction, respectively, to facilityexit and restructuring costs as a result of changes in estimates for the LegacyPlans. During the three and nine months ended September 30, 2009,EarthLink recorded a $0.1 million reduction to facility exit and restructuringcosts as a result of changes in estimates for the Legacy Plans. As of September 30,2009, the Company had a $0.7 million liability remaining for real estatecommitments related to the Legacy Plans which was classified as other accruedliabilities in the Condensed Consolidated Balance Sheet. All other costs havebeen paid.

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

**5.  Discontinued Operations**

** **

In November 2007,management concluded that its municipal wireless broadband operations were nolonger consistent with the Company’s strategic direction and the Company’sBoard of Directors authorized management to pursue the divestiture of theCompany’s municipal wireless broadband assets. As a result of that decision,the Company classified the municipal wireless broadband assets as held for saleand presented the municipal wireless broadband results of operations asdiscontinued operations. The results of operations for municipal wirelessbroadband were previously included in the Consumer Services segment.  As of December 31, 2008, the Company hadcompleted the divestiture of its municipal wireless broadband assets. As aresult, the Company did not record discontinued operations during the three andnine months ended September 30, 2009.

 

Thefollowing table presents summarized results of operations related to theCompany’s discontinued operations for the three and nine months ended September 30,2008:

 
| ** **                          | ** ** | **Three Months Ended**      | ** ** | **Nine Months Ended**       | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                          | ** ** | **September 30, 2008** | ** ** | **September 30, 2008** | ** ** |
| ** **                          | ** ** | **(in thousands)**          | ** ** |
| ** **                          | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Revenues                            |       | $                           | 18         |                        | $          | 1,306 |   |
| Operating  costs and expenses       |       | (842                        | )          | (4,534                      | )          |
| Impairment  and restructuring costs |       | (128                        | )          | (6,081                      | )          |
| Income  tax benefit                 |       | 271                         |       | 871                         |       |
| Loss  from discontinued operations  |       | $                           | (681       | )                           | $          | (8,438 | ) |

 

**6.  Investments**

** **

*Marketable Securities*

* *

Allinvestments with original maturities greater than 90 days are classified asmarketable securities. Marketable securities with maturities less than one yearfrom the balance sheet date are classified as short-term marketable securities.Marketable securities with maturities greater than one year from the balancesheet date are classified as long-term marketable securities. Long-termmarketable securities as of December 31, 2008 also included investments inasset-backed, auction rate securities with interest rate reset periods of 90days or less but whose underlying agreements have original maturities of morethan 90 days. These securities were classified as short-term marketablesecurities as of September 30, 2009, which is more fully described below.

 

As of December 31,2008, the Company’s long term marketable securities consisted of auction ratesecurities classified as trading with a carrying value and fair value of $47.8million. As of September 30, 2009, the Company had $90.8 million ofshort-term marketable securities and $1.8 million of long-term marketablesecurities. As of September 30, 2009, $47.8 million of the Company’sshort-term marketable securities and the $1.8 million of the Company’slong-term marketable securities consisted of government agency notes and wereclassified as available-for-sale. The amortized cost for these securities was$49.5 million and the aggregate fair value was $49.6 million. Gross unrealizedgains on these securities as of September 30, 2009 were $0.1 million andthere were no gross unrealized losses. As of September 30, 2009, $43.0million of the Company’s short-term marketable securities consisted of auctionrate securities which were classified as trading. These securities arevariable-rate debt instruments whose underlying agreements have contractualmaturities of up to 40 years, but have interest rate reset periods atpre-determined intervals, usually every 28 days. These securities arepredominantly secured by student loans guaranteed by state related highereducation agencies and reinsured by the U.S. Department of Education. Beginningin February 2008, auctions for these securities failed to attractsufficient buyers, resulting in the Company continuing to hold such securities.Accordingly, the Company classified these securities as long-term marketablesecurities in the Condensed Consolidated Balance Sheet as of December 31,2008 due to uncertainty surrounding the timing of a market recovery.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

In October 2008, EarthLinkentered into an agreement with the broker that sold the Company its auctionrate securities that gives the Company the right to sell its existing auctionrate securities back to the broker at par plus accrued interest, beginning on June 30,2010 until July 2, 2012 (herein referred to as “put right”). Accordingly,the Company classified its auction rate securities as short-term marketablesecurities in the Condensed Consolidated Balance Sheet as of September 30,2009. The agreement also grants the broker the right to buy the Company’sauction rate securities at par plus accrued interest, until July 2, 2012.The Company records the auction rate securities at fair value, with changes infair value included in earnings, as the Company no longer intends to hold thesecurities until a market recovery. The Company also elected a one-timetransfer of its auction rate securities from the available-for-sale category tothe trading category. The Company also records the value of the put right atfair value, with changes in fair value included in earnings, as the Companyelected the fair value option under ASC 825, “Financial Instruments,” for theput right to offset the fair value changes of the auction rate securities.During the nine months ended September 30, 2009, the Company redeemed $9.5million of auction rate securities at par, plus accrued interest. During thenine months ended September 30, 2009, the Company recorded a $4.7 milliongain on investments related to the auction rate securities and recorded a $4.6million loss on investments related to the put right. The net gain of $0.1million during the nine months ended September 30, 2009 is included ingain on investments, net, in the Condensed Consolidated Statement ofOperations. The net gain during the three months ended September 30, 2009was nominal. Refer to Note 12, “Fair Value Measurements,” for a table thatreconciles the beginning and ending balances of the auction rate securities.

 

*Investments*

** **

Long-terminvestments consisted of the following as of December 31, 2008 and September 30,2009:

 
| ** **                        | ** ** | **As of**             | ** ** | **As of**              | ** ** |
|-----------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                        | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
| ** **                        | ** ** | **2008**              | ** ** | **2009**               | ** ** |
| ** **                        | ** ** | **(in thousands)**    | ** ** |
| Investments  stated at fair value |       | $                     | 11,408     |                   | $          | 9,789 |   |
| Investments  stated at cost       |       | 9,300                 |       | 9,300                  |       |
| Total  long-term investments      |       | $                     | 20,708     |                   | $          | 19,089 |   |

 

Long-terminvestments in the Condensed Consolidated Balance Sheets include investments inother companies. Investments in other companies are accounted for under thecost method of accounting because the Company does not have the ability toexercise significant influence over the companies’ operations. Under the costmethod of accounting, investments in private companies are carried at cost andare only adjusted for other-than-temporary declines in fair value anddistributions of earnings. For cost method investments in public companies thathave readily determinable fair values, the Company classifies its investmentsas available-for-sale and, accordingly, records these investments at their fairvalues with unrealized gains and losses included as a separate component ofstockholders’ equity and in total comprehensive income. As of September 30,2009, gross unrealized gains on available-for-sale investments were $8.2million and there were no gross unrealized losses.  As of December 31, 2008, grossunrealized losses on available-for-sale investments were nominal and there wereno gross unrealized gains.

 

Long-terminvestments in the Condensed Consolidated Balance Sheet as of December 31,2008 also included the Company’s put right. The Company has a put right to sellits existing auction rate securities back to the broker beginning on June 30,2010, which had a carrying value and fair value of $9.8 million and $5.3million as of December 31, 2008 and September 30, 2009, respectively.The Company classified the put right as other current assets in the CondensedConsolidated Balance Sheet as of September 30, 2009. The Company electedthe fair value option under ASC 825 for the put right and records the put rightat fair value, with changes in fair value recognized as gain on investments, netin the Condensed Consolidated Statement of Operations. The fair value of theput right is estimated using a discounted cash flow analysis.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

Managementregularly evaluates the recoverability of its investments based on theperformance and the financial position of those companies as well as otherevidence of market value. Such evaluation includes, but is not limited to,reviewing the investee’s cash position, recent financings, projected andhistorical financial performance, cash flow forecasts and financing needs.Management also regularly evaluates whether declines in fair values of itsinvestments below their cost are potentially other than temporary. Thisevaluation consists of several qualitative and quantitative factors regardingthe severity and duration of the unrealized loss as well as the Company’sability and intent to hold the investment for a period of time to recover thecost basis of the investment.

* *

Duringthe nine months ended September 30, 2008, the Company recognized a netgain on investments of $5.7 million. This consisted of a gain of $4.4 millionfrom the sale of HELIO to Virgin Mobile USA, Inc. and a gain of $2.0million from the sale of the Company’s 6.1 million shares of CovadCommunications Group, LLC common stock to Platinum Equity, LLC, offset by animpairment loss of $0.7 million due to other-than-temporary declines of thevalue of certain long-term investments. During the nine months ended September 30,2009, the Company recognized a net gain on investments of $0.3 million. Thisconsisted of $0.2 million in cash distributions from eCompanies Venture Group,L.P., a limited partnership that invested in domestic emerging Internet-relatedcompanies, and a net gain of $0.1 million related to the Company’s auction ratesecurities and put right.

 

**7.  Purchased Intangible Assets and Goodwill**

 

*Goodwill*

* *

Therewere no changes in the carrying amount of goodwill during the nine months endedSeptember 30, 2009.

 

*Purchased Intangible Assets*

* *

Thefollowing table presents the components of the Company’s acquired identifiableintangible assets included in the accompanying Condensed Consolidated BalanceSheets as of December 31, 2008 and September 30, 2009:

 
| ** **                                     | ** ** | **As of December 31, 2008** | ** **   | **As of September 30, 2009** | ** ** |
|------------------------------------------------|------------|----------------------------------|--------------|-----------------------------------|------------|
| ** **                                     | ** ** | **Gross**                        | ** **   | ** **                        | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                                     | ** ** | **Carrying**                     | ** **   | **Accumulated**                   | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| ** **                                     | ** ** | **Value**                        | ** **   | **Amortization**                  | ** ** | **Value** | ** ** | **Value** | ** ** | **Amortization** | ** ** | **Value** | ** ** |
| ** **                                     | ** ** | **(in thousands)**               | ** **   |
| Intangible assets subject to amortization:     |       |                             |         |                              |       |   |   |   |   |   |   |   |   |
| Subscriber bases and customer relationships    |       | $                                | 94,039       |                              | $          | (77,758 | ) | $ | 16,281 |   | $ | 94,039 |   | $ | (83,664 | ) | $ | 10,375 |   |
| Software, technology and other                 |       | 739                              |         | (649                              | )          | 90 |   | 711 |   | (711 | ) | — |   |
| Trade names                                    |       | 1,521                            |         | (304                              | )          | 1,217 |   | 1,521 |   | (532 | ) | 989 |   |
|                                           |       | 96,299                           |         | (78,711                           | )          | 17,588 |   | 96,271 |   | (84,907 | ) | 11,364 |   |
| Intangible assets not subject to amortization: |       |                             |         |                              |       |   |   |   |   |   |   |   |   |
| Trade names                                    |       | 1,964                            |         | —                            |       | 1,964 |   | 1,964 |   | — |   | 1,964 |   |
|                                           |       | $                                |  98,263 |                              | $          | (78,711 | ) | $ | 19,552 |   | $ | 98,235 |   | $ | (84,907 | ) | $ | 13,328 |   |

 

Amortizationof intangible assets in the Condensed Consolidated Statements of Operations forthe three and nine months ended September 30, 2008 and 2009 represents theamortization of definite-lived intangible assets. The Company’s definite-livedintangible assets primarily consist of subscriber bases and customerrelationships, acquired software and technology, trade names and other assetsacquired in conjunction with the purchases of businesses and subscriber basesfrom other companies that are not deemed to have indefinite lives. The Company’sidentifiable indefinite-lived intangible assets consist of certain trade names.Definite-lived

 

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Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

intangible assets are amortized ona straight-line basis over their estimated useful lives, which are generallythree to six years for subscriber bases and customer relationships and threeyears for acquired software and technology. As of September 30, 2009, the weighted average amortization periodswere 4.2 years for subscriber base assets and customer relationships, 3.0 yearsfor software and technology and 5.0 years for trade names. Based on the currentamount of definite-lived intangible assets, the Company expects to recordamortization expense of approximately $1.5 million during the remaining threemonths in the year ending December 31, 2009 and $4.1 million, $2.9million, $1.5 million, $0.8 million and $0.6 million during the years ending December 31,2010, 2011, 2012, 2013 and thereafter, respectively. Actual amortizationexpense to be reported in future periods could differ materially from theseestimates as a result of asset acquisitions, changes in useful lives and otherrelevant factors.

 

**8.  Convertible SeniorNotes**

 

*General*

* *

In November 2006,the Company issued $258.8 million aggregate principal amount of the Notes in aregistered offering. The Company received net proceeds of $251.6 million aftertransaction fees of $7.2 million. The Notes bear interest at 3.25% per year onthe principal amount of the Notes until November 15, 2011, and 3.50%interest per year on the principal amount of the Notes thereafter, payablesemi-annually in May and November of each year. The Notes rank assenior unsecured obligations of the Company.

 

TheNotes are payable with cash and, if applicable, are convertible into shares ofthe Company’s common stock. The initial conversion rate was 109.6491 shares per$1,000 principal amount of Notes (which represented an initial conversion priceof approximately $9.12 per share). As a result of the Company’s cash dividendpayment in September 2009, the conversion rate was adjusted and is111.5096 shares per $1,000 principal amount of Notes (which represents aconversion price of approximately $8.97 per share), subject to furtheradjustment. Upon conversion, a holder will receive cash up to the principalamount of the Notes and, at the Company’s option, cash, or shares of theCompany’s common stock or a combination of cash and shares of common stock forthe remainder, if any, of the conversion obligation. The conversion obligationis based on the sum of the “daily settlement amounts” for the20 consecutive trading days that begin on, and include, the second tradingday after the day the notes are surrendered for conversion. The Notes willbe convertible only in the following circumstances: (1) during anycalendar quarter after the calendar quarter ending December 31, 2006 (andonly during such calendar quarter), if the closing sale price of the Company’scommon stock for each of 20 or more trading days in a period of 30 consecutivetrading days ending on the last trading day of the immediately precedingcalendar quarter exceeds 130% of the conversion price in effect on the lasttrading day of the immediately preceding calendar quarter; (2) during thefive consecutive business days immediately after any five consecutive tradingday period in which the average trading price per $1,000 principal amount ofNotes was equal to or less than 98% of the average conversion value of theNotes during the note measurement period; (3) upon the occurrence ofspecified corporate transactions, including the payment of dividends in certaincircumstances; (4) if the Company has called the Notes for redemption; and(5) at any time from, and including, October 15, 2011 to, andincluding, November 15, 2011 and at any time on or after November 15,2024.  The Company has the option toredeem the Notes, in whole or in part, for cash, on or after November 15,2011, provided that the Company has made at least ten semi-annual interestpayments. In addition, the holders may require the Company to purchase all or aportion of their Notes on each of November 15, 2011, November 15,2016 and November 15, 2021.

 

*Adoption of NewAccounting Guidance*

* *

On January 1,2009, the Company adopted new accounting guidance related to accounting forconvertible debt instruments that may be settled in cash upon conversion, whichrequires that the liability and equity components of convertible debtinstruments that may be settled in cash upon conversion (including partial cashsettlement) be separately accounted for in a manner that reflects an issuer’snon-convertible debt borrowing rate. The resulting debt discount is accretedover the period the convertible debt is expected to be outstanding as additionalnon-cash interest expense. The adoption of the new guidance on January 1,2009 affected the 

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

Company’saccounting for the Notes. Upon adoption, the Company recorded an adjustment toincrease additional paid-in capital as of the November 2006 issuance dateby approximately $62.1 million. The Company is accreting the resulting debtdiscount to interest expense over the estimated five-year life of the Notes,which represents the first redemption date of November 2011. The Companyrecorded a pre-tax adjustment of approximately $22.3 million to retainedearnings that represents the debt discount accretion during the years ended December 31,2006, 2007 and 2008 and will recognize additional non-cash interest expense of$12.2 million, $13.4 million and $12.4 million during the years ending December 31,2009, 2010 and 2011, respectively, for accretion of the debt discount.

 

As of December 31, 2008, theprincipal amount of the Notes, the unamortized discount and the net carryingvalue was $258.8 million, $39.0 million and $219.7 million, respectively. As ofSeptember 30, 2009, the principal amount of the Notes, the unamortizeddiscount and the net carrying value was $258.8 million, $29.7 million and$229.0 million, respectively. As of December 31, 2008 and September 30,2009, the fair value of the Notes was approximately $236.6 million and $284.9million, respectively, based on the quoted market prices.

 

*Classification*

* *

In July 2009 and October 2009,the Company’s Board of Directors declared quarterly cash dividends on its commonstock. The Company currently intends to pay regular quarterly dividends on itscommon stock.  Under the terms of theindenture governing the Notes, the Company’s payment of cash dividends requiresan adjustment to the conversion rate for the Notes. In addition, as a result ofthe adjustment, the Notes may be surrendered for conversion for a period oftime between the declaration date and the record date, as defined in theindenture, for the consideration provided for in the indenture. As a result,the Company classified the Notes as a current liability in the CondensedConsolidated Balance Sheet as of September 30, 2009. The Notes wereclassified as long-term debt in the Condensed Consolidated Balance Sheet as of December 31,2008.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

**9.  Stockholders’ Equity**

** **

*Comprehensive Income*

* *

Comprehensiveincome includes unrealized gains and losses on certain investments classifiedas available-for-sale, net of tax, which are excluded from the CondensedConsolidated Statements of Operations. Comprehensive income for the three andnine months ended September 30, 2008 and 2009 was as follows:

 
| ** **                                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                             | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                             | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                                                             | ** ** | **(in thousands)**     | ** ** |
| Net  income                                                            |       | $                      | 51,895     |                   | $          | 29,867 |   | $ | 154,206 |   | $ | 93,849 |   |
| Unrealized  holding (losses) gains on certain investments              |       | (1,190                 | )          | 1,877                  |       | (2,214 | ) | 8,293 |   |
| Reclassification  adjustment for realized gains on certain investments |       | —                 |       | —                 |       | (1,779 | ) | — |   |
| Total  comprehensive income                                            |       | $                      | 50,705     |                   | $          | 31,744 |   | $ | 150,213 |   | $ | 102,142 |   |

 

*ShareRepurchases*

* *

Sincethe inception of the Company’s share repurchase program, the Board of Directorshas authorized a total of $750.0 million for the repurchase of EarthLink’scommon stock. As of September 30, 2009, the Company had $146.8 millionavailable under the current authorization. The Company may repurchase itscommon stock from time to time in compliance with Securities and ExchangeCommission regulations and other legal requirements, including through the useof derivative transactions, and subject to market conditions and other factors.The share repurchase program does not require the Company to acquire anyspecific number of shares and may be terminated by the Board of Directors atany time.

 

TheCompany repurchased 1.3 million shares of its common stock for $9.1 millionduring the nine months ended September 30, 2008. The Company repurchased3.6 million shares of its common stock for $22.3 million during the nine monthsended September 30, 2009.

 

*Dividends*

* *

In July 2009, the Company’sBoard of Directors declared a quarterly cash dividend on its common stock of$0.14 per share to stockholders of record on September 14, 2009.  The dividend was paid on September 28,2009 and totaled $15.0 million. In October 2009, our Board ofDirectors declared a quarterly cash dividend on our common stock of $0.14 pershare to be paid on December 23, 2009 to stockholders of record on December 9,2009. The Company currently intends to pay regular quarterly dividends on itscommon stock.  The Board of Directorsalso approved the payment of cash dividend amounts on each outstandingrestricted stock unit to be paid at the time the restricted stock unit vests.Any decision to declare future dividends will be made at the discretion of theBoard of Directors and will depend on, among other things, the Company’sresults of operations, financial condition, cash requirements, investmentopportunities and other factors the Board of Directors may deem relevant.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

** **

**10.  Stock-Based Compensation**

** **

TheCompany measures compensation cost for all stock awards at fair value on thedate of grant and recognition of compensation expense over the requisiteservice period for awards expected to vest. The Company estimates the fairvalue of stock options using the Black-Scholes valuation model, and determinesthe fair value of restricted stock units based on the number of shares grantedand the quoted price of EarthLink’s common stock on the date of grant*.* Such value is recognized as expense overthe requisite service period, net of estimated forfeitures, using thestraight-line attribution method. For performance-based awards, the Companyrecognizes expense over the requisite service period, net of estimatedforfeitures, using the accelerated attribution method when it is probable thatthe performance measure will be achieved. The estimate of awards that willultimately vest requires significant judgment, and to the extent actual resultsor updated estimates differ from the Company’s current estimates, such amountswill be recorded as a cumulative adjustment in the period estimates arerevised. The Company considers many factors when estimating expectedforfeitures, including types of awards, employee class and historical employeeattrition rates. Actual results, and future changes in estimates, may differsubstantially from the Company’s current estimates.

 

Stock-basedcompensation expense was $4.6 million and $3.1 million during the three monthsended September 30, 2008 and 2009, respectively, and $14.3 million and$10.6 million during the nine months ended September 30, 2008 and 2009,respectively.  The Company has classifiedstock-based compensation expense during the three and nine months ended September 30,2008 and 2009 within the same operating expense line items as cash compensationpaid to employees.

 

*StockIncentive Plans*

* *

TheCompany has granted options to employees and directors to purchase the Company’scommon stock under various stock incentive plans. The Company has also grantedrestricted stock units to employees and directors under various stock incentiveplans. Under the plans, employees and non-employee directors are eligible toreceive awards of various forms of equity-based incentive compensation,including stock options, restricted stock, restricted stock units andperformance awards, among others. The plans are administered by the Board ofDirectors or the Leadership and Compensation Committee of the Board ofDirectors, which determine the terms of the awards granted. Stock options aregenerally granted with an exercise price equal to the market value of the Company’scommon stock on the date of grant, have a term of ten years or less, and vestover terms of four to nine years from the date of grant. Restricted stock unitsare granted with various vesting terms that range from one to nine years fromthe date of grant.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

* *

*Options Outstanding*

 

Thefollowing table summarizes information concerning stock option activity as ofand for the nine months ended September 30, 2009:

 
| ** **                                                | ** ** | ** **                            | ** ** | ** **   | ** ** | **Weighted**     | ** ** | ** **    | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|--------------|------------|------------------|------------|---------------|------------|
| ** **                                                | ** ** | ** **                            | ** ** | **Weighted** | ** ** | **Average**      | ** ** | ** **    | ** ** |
| ** **                                                | ** ** | ** **                            | ** ** | **Average**  | ** ** | **Remaining**    | ** ** | **Aggregate** | ** ** |
| ** **                                                | ** ** | ** **                            | ** ** | **Exercise** | ** ** | **Contractual**  | ** ** | **Intrinsic** | ** ** |
| ** **                                                | ** ** | **Stock Options**                     | ** ** | **Price**    | ** ** | **Term (Years)** | ** ** | **Value**     | ** ** |
| ** **                                                | ** ** | **(shares and dollars in thousands)** | ** ** |
|                                                      |       |                                  |       |         |       |             |       |          |       |
| Outstanding as of December 31, 2008                  |       | 7,159                                 |       | $            | 9.58       |             |       |          |       |   |
| Granted                                                   |       | —                                |       | —       |       |             |       |          |       |
| Exercised                                                 |       | (1,917                                | )          | 6.92         |       |             |       |          |       |
| Forfeited and expired                                     |       | (998                                  | )          | 13.61        |       |             |       |          |       |
| Outstanding as of September 30, 2009                 |       | 4,244                                 |       | 9.83         |       | 4.8              |       | $             | 1,950      |   |
| Vested and expected to vest as of September 30, 2009 |       | 4,072                                 |       | $            | 9.94       |             | 4.7        |          | $          | 1,748 |   |
| Exercisable as of September 30, 2009                 |       | 3,269                                 |       | $            | 10.48      |             | 4.1        |          | $          | 991 |   |

 

The aggregate intrinsic valueamounts in the table above represent the closing price of the Company’s commonstock on September 30, 2009 in excess of the exercise price, multiplied bythe number of stock options outstanding or exercisable, when the closing priceis greater than the exercise price. This represents the amount that would havebeen received by the stock option holders if they had all exercised their stockoptions on September 30, 2009. The total intrinsic value of optionsexercised during the three and nine months ended September 30, 2008 was$0.7 million and $2.2 million, respectively. The total intrinsic value ofoptions exercised during the three and nine months ended September 30,2009 was $2.2 million and $2.5 million, respectively. The intrinsic value ofstock options exercised represents the difference between the closing price ofthe Company’s common stock at the time of exercise and the exercise price,multiplied by the number of stock options exercised. To the extent theforfeiture rate is different than what the Company has anticipated, stock-basedcompensation related to these awards will be different from the Company’sexpectations.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

Thefollowing table summarizes the status of the Company’s stock options as of September 30,2009:

 
| ** **                     | ** ** | ** **      | ** ** | ** **         | ** ** | ** **    | ** ** | ** **      | ** ** | **Stock Options**  | ** ** |
|--------------------------------|------------|-----------------|------------|--------------------|------------|---------------|------------|-----------------|------------|--------------------|------------|
| **Stock Options  Outstanding** | ** ** | **Exercisable** | ** ** |
| ** **                     | ** ** | ** **      | ** ** | ** **         | ** ** | **Weighted**  | ** ** | ** **      | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **                     | ** ** | ** **      | ** ** | ** **         | ** ** | **Average**   | ** ** | **Weighted**    | ** ** | ** **         | ** ** | **Weighted** | ** ** |
| ** **                     | ** ** | ** **      | ** ** | ** **         | ** ** | **Remaining** | ** ** | **Average**     | ** ** | ** **         | ** ** | **Average** | ** ** |
| **Range of**                   | ** ** | **Number**      | ** ** | **Contractual**    | ** ** | **Exercise**  | ** ** | **Number**      | ** ** | **Exercise**       | ** ** |
| **Exercise  Prices**           | ** ** | **Outstanding** | ** ** | **Life**           | ** ** | **Price**     | ** ** | **Exercisable** | ** ** | **Price**          | ** ** |
| ** **                     | ** ** | ** **      | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** **      | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| $                              |  5.10 | to              | $          | 6.86               |       | 384           |       | 5.5             |       | $                  | 6.28       |   | 259 |   | $ | 6.01 |   |
| 6.90                           | to         | 7.25            |       | 383                |       | 7.4           |       | 7.00            |       | 156                |       | 7.01 |   |
| 7.31                           | to         | 7.31            |       | 400                |       | 7.7           |       | 7.31            |       | 50                 |       | 7.31 |   |
| 7.32                           | to         | 8.96            |       | 330                |       | 5.4           |       | 8.10            |       | 254                |       | 8.22 |   |
| 9.01                           | to         | 9.01            |       | 440                |       | 4.8           |       | 9.01            |       | 440                |       | 9.01 |   |
| 9.23                           | to         | 9.51            |       | 429                |       | 6.2           |       | 9.44            |       | 244                |       | 9.41 |   |
| 9.64                           | to         | 10.06           |       | 694                |       | 1.6           |       | 9.88            |       | 694                |       | 9.88 |   |
| 10.36                          | to         | 35.25           |       | 1,184              |       | 4.0           |       | 13.65           |       | 1,172              |       | 13.67 |   |
| $                              |  5.10 | to              | $          | 35.25              |       | 4,244         |       | 4.8             |       | $                  | 9.83       |   | 3,269 |   | $ | 10.48 |   |

* *

*RestrictedStock Units*

* *

The following table summarizes theCompany’s restricted stock units as of and for the nine months ended September 30,2009:

 
| ** **                               | ** ** | ** **         | ** ** | **Weighted**   | ** ** |
|------------------------------------------|------------|--------------------|------------|----------------|------------|
| ** **                               | ** ** | ** **         | ** ** | **Average**    | ** ** |
| ** **                               | ** ** | **Restricted**     | ** ** | **Grant Date** | ** ** |
| ** **                               | ** ** | **Stock Units**    | ** ** | **Fair Value** | ** ** |
| ** **                               | ** ** | **(in thousands)** | ** ** | ** **     | ** ** |
| Nonvested  as of December 31, 2008  |       | 4,123              |       | $              | 7.20       |   |
| Granted                                  |       | 352                |       | 7.39           |       |
| Vested                                   |       | (1,781             | )          | 7.19           |       |
| Forfeited                                |       | (285               | )          | 7.20           |       |
| Nonvested  as of September 30, 2009 |       | 2,409              |       | $              | 7.23       |   |

 

The fair value of restricted stockunits is determined based on the closing price of the Company’s common stock onthe grant date. The weighted-average grant date fair value of restricted stockunits granted during the nine months ended September 30, 2008 and 2009 was$7.20 and $7.39, respectively. As of September 30, 2009, there was $6.9million of total unrecognized compensation cost related to nonvested restrictedstock units. That cost is expected to be recognized over a weighted-averageperiod of 1.6 years. The total fair value of shares vested during the ninemonths ended September 30, 2008 and 2009 was $5.7 million and $13.5million, respectively, which represents the closing price of the Company’scommon stock on the vesting date multiplied by the number of restricted stockunits that vested.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

* *

**11. Income Taxes**

 

EarthLinkrecorded an income tax provision of $7.9 million and $16.9 million during thethree months ended September 30, 2008 and 2009, respectively, and $23.9million and $55.8 million during the nine months ended September 30, 2008and 2009, respectively. The income tax provision was based on management’scurrent expectations in accordance with the interim reporting requirements.

 

Themajor components of the income tax provision for the three and nine monthsended September 30, 2008 and 2009 are as follows:

 
| ** **                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                       | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(in thousands)**     | ** ** |
|                             |       |                   |       |                   |       |   |   |   |   |
| Federal  alternative minumum tax |       | $                      | 1,030      |                   | $          | 329 |   | $ | 3,392 |   | $ | 2,525 |   |
| State  income tax                |       | 2,967                  |       | 884                    |       | 4,225 |   | 4,179 |   |
| Other                            |       | (100                   | )          | —                 |       | (500 | ) | — |   |
| Current  provision               |       | 3,897                  |       | 1,213                  |       | 7,117 |   | 6,704 |   |
|                             |       |                   |       |                   |       |   |   |   |   |
| Deferred  provision              |       | 4,027                  |       | 15,701                 |       | 16,806 |   | 49,050 |   |
|                             |       |                   |       |                   |       |   |   |   |   |
| Total                            |       | $                      | 7,924      |                   | $          | 16,914 |   | $ | 23,923 |   | $ | 55,754 |   |

 

Duringthe year ended December 31, 2008, the Company released $65.6 million ofits valuation allowance related to its deferred tax assets. These deferred taxassets primarily related to net operating loss carryforwards which the Companydetermined it would more likely than not be able to utilize due to thegeneration of sufficient taxable income in 2009. For the three and nine monthsended September 30, 2009, the non-cash deferred tax provision recorded wasprimarily a result of the utilization of these federal and state net operatingloss tax assets.  The current federal andstate tax liabilities are payable as a result of limitations on net operating lossutilization associated with the alternative minimum tax calculation and statelaws.

 

EarthLinkcontinues to maintain a partial valuation allowance against its unrealizeddeferred tax assets, which include net operating loss carryforwards. EarthLink may recognize additional deferred tax assets in future periods whenthey are determined to be more likely than not realizable.  To the extentEarthLink reports income in future periods, EarthLink intends to use its netoperating loss carryforwards to the extent available to offset taxable income andreduce cash outflows for income taxes.  The Company’s ability to use itsfederal and state net operating loss carryforwards and federal and state taxcredit carryforwards may be subject to restrictions attributable to equitytransactions in the future resulting from changes in ownership as defined underthe Internal Revenue Code.

 

TheCompany has identified its federal tax return and its state tax returns inCalifornia, Florida, Georgia and Illinois as “major” tax jurisdictions, forpurposes of calculating its uncertain tax positions.  Periods extendingback to 1994 are still subject to examination for all “major” jurisdictions.The Company believes that its income tax filing positions and deductions willbe sustained on audit and does not anticipate any adjustments that will resultin a material adverse effect on the Company’s financial condition, results ofoperations or cash flows.  The Company’s policy for recording interest andpenalties associated with audits is to record such items as a component ofincome taxes.  No adjustments were madefor uncertain tax positions during the quarter.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

**12.  Fair Value Measurements**

** **

Fairvalue is defined as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date (an exit price). A three-tier fair value hierarchy isused to prioritize the inputs used in measuring fair value.  Thesetiers include: Level 1, defined as observable inputs such as quoted prices inactive markets; Level 2, defined as inputs other than quoted prices in activemarkets that are either directly or indirectly observable; and Level 3, definedas unobservable inputs in which little or no market data exists, thereforerequiring an entity to develop its own assumptions.

 

As of September 30,2009, the Company held certain assets that are required to be measured at fairvalue on a recurring basis.  These included the Company’s cashequivalents, marketable securities, auction rate securities, equity investmentsin other companies, and the put right.

 

Thefollowing table presents the Company’s assets measured at fair value on arecurring basis as of September 30, 2009:

** **
| ** **                             | ** ** | ** **   | ** ** | ** **         | ** ** | **Fair Value Measurements as of  September 30, 2009 Using** | ** ** |
|----------------------------------------|------------|--------------|------------|--------------------|------------|------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **   | ** ** | ** **         | ** ** | **Quoted Prices**                                                | ** ** | **Significant** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | ** **   | ** ** | ** **         | ** ** | **in Active**                                                    | ** ** | **Other** | ** ** | **Significant** | ** ** |
| ** **                             | ** ** | ** **   | ** ** | ** **         | ** ** | **Markets for**                                                  | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                             | ** ** | **Carrying** | ** ** | **Fair**           | ** ** | **Identical Assets**                                             | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**                        | ** ** | **Value**    | ** ** | **Value**          | ** ** | **(Level 1)**                                                    | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| ** **                             | ** ** | ** **   | ** ** | **(in thousands)** | ** ** |
| Cash  equivalents                      |       | $            | 544,904    |               | $          | 544,904                                                          |       | $ | 544,904 |   | $ | — |   | $ | — |   |
| Marketable  securities                 |       | 49,611       |       | 49,611             |       | 49,611                                                           |       | — |   | — |   |
| Auction  rate securities               |       | 42,987       |       | 42,987             |       | —                                                           |       | — |   | 42,987 |   |
| Equity  investments in other companies |       | 9,789        |       | 9,789              |       | 750                                                              |       | 9,039 |   | — |   |
| Put  right                             |       | 5,256        |       | 5,256              |       | —                                                           |       | — |   | 5,256 |   |
| Total                                  |       | $            | 652,547    |               | $          | 652,547                                                          |       | $ | 595,265 |   | $ | 9,039 |   | $ | 48,243 |   |

** **

Cash equivalents, marketablesecurities, auction rate securities, equity investments in other companies andthe Company’s put right are measured at fair value.  Cash equivalents, marketable securities andequity investments in other companies that are valued using quoted marketprices are classified within Level 1. The Company’s investment in Virgin Mobileis valued using quoted prices for similar assets and is classified within Level2. Investments in auction rate securities are classified within Level 3 becausethey are valued using a discounted cash flow model. Some of the inputs to thismodel are unobservable in the market and are significant. The Company’s putright is estimated using a discounted cash flow analysis and is classifiedwithin Level 3. The Company has consistently applied these valuation techniquesin all periods presented.

 

TheCompany has invested in auction rate securities, which are more fully describedin Note 6, “Investments.”  Beginning in February 2008, theseinstruments held by the Company failed to attract sufficientbuyers.  As a result, these securities do not have a readilydeterminable market value and are not liquid. The fair values of the Company’sauction rate securities as of September 30, 2009 were estimated utilizinga discounted cash flow analysis.  These analyses consider, amongother items, the collateralization underlying the security investments, thecreditworthiness of the counterparty, and the timing and value of expected futurecash flows.  These securities were also compared, when possible, toother observable market data with similar characteristics to the securitiesheld by the Company.

 

In October 2008,EarthLink entered into an agreement with the broker that sold the Company itsauction rate securities that gives the Company the right to sell its existingauction rate securities back to the broker at par plus accrued interest,beginning on June 30, 2010 until July 2, 2012. The Company electedthe fair value option for the put right to offset the fair value changes of theauction rate securities. The fair value of the put right is 

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

estimatedusing a discounted cash flow analysis and is classified within Level 3. The putright was classified as long-term investments as of December 31, 2008 andas other current assets as of September 30, 2009 in the CondensedConsolidated Balance Sheets.

 

Thefollowing table presents a reconciliation of the beginning and ending balancesof the Company’s assets measured at fair value on a recurring basis usingsignificant unobservable inputs (Level 3) as of September 30, 2009:

** **
| ** **                                | ** ** | **Auction**        | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|--------------------|------------|------------|------------|------------|------------|
| ** **                                | ** ** | **Rate**           | ** ** | **Put**    | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Securities**     | ** ** | **Right**  | ** ** | **Total**  | ** ** |
| ** **                                | ** ** | **(in thousands)** | ** ** |
| **Balance as of December 31, 2008**  |       | $                  | 47,809     |       | $          | 9,828      |       | $ | 57,637 |   |
| Total  realized gains                     |       | 4,678              |       | —     |       | 4,678      |       |
| Total  realized losses                    |       | —             |       | (4,572     | )          | (4,572     | )          |
| Settlements                               |       | (9,500             | )          | —     |       | (9,500     | )          |
| **Balance as of September 30, 2009** |       | $                  | 42,987     |       | $          | 5,256      |       | $ | 48,243 |   |

** **

Duringthe nine months ended September 30, 2009, the Company redeemed $9.5million of auction rate securities at par, plus accrued interest. During thenine months ended September 30, 2009, the Company recorded realized gainsof $4.7 million related to its auction rate securities and recorded realizedlosses of $4.6 million related to its put right, which are included in gain oninvestments, net, in the Condensed Consolidated Statement of Operations.

 

**13.  Segment Information**

** **

TheCompany reports segment information along the same lines that its chiefexecutive officer reviews its operating results in assessing performance andallocating resources. The Company operates two reportable segments, ConsumerServices and Business Services. The Company’s Consumer Services segmentprovides Internet access services and related value-added services toindividual customers. These services include dial-up and high-speed Internetaccess and voice services, among others. The Company’s Business Servicessegment provides integrated communications services and related value-addedservices to businesses and communications carriers. These services includemanaged private IP-based wide area networks, dedicated Internet access and webhosting, among others.

 

TheCompany evaluates performance of its segments based on segment income fromoperations. Segment income from operations includes revenues from externalcustomers, related cost of revenues and operating expenses directlyattributable to the segment, which include costs over which segment managershave direct discretionary control, such as advertising and marketing programs,customer support expenses, operations expenses, product development expenses,certain technology and facilities expenses, billing operations and provisionsfor doubtful accounts. Segment income from operations excludes other income andexpense items and certain expenses over which segment managers do not havediscretionary control. Costs excluded from segment income from operationsinclude various corporate expenses (consisting of certain costs such ascorporate management, human resources, finance and legal), amortization ofintangible assets, impairment of goodwill and intangible assets, facility exitand restructuring costs, and stock-based compensation expense, as they are notconsidered in the measurement of segment performance.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

Information on reportable segments and a reconciliation to consolidatedincome from operations for the three and nine months ended September 30,2008 and 2009 is as follows:

 
| ** **                             | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                             | ** ** | **2008**                                                 | ** ** | **2009**                                                | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                             | ** ** | **(in thousands)**                                  | ** ** |
| **Consumer Services**                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Revenues                               |       | $                                                        | 187,799    |                                                    | $          | 138,176 |   | $ | 605,340 |   | $ | 445,344 |   |
| Cost  of revenues                      |       | 62,550                                                   |       | 45,211                                                  |       | 201,053 |   | 144,890 |   |
| Gross  margin                          |       | 125,249                                                  |       | 92,965                                                  |       | 404,287 |   | 300,454 |   |
| Direct  segment operating expenses     |       | 49,803                                                   |       | 31,039                                                  |       | 164,496 |   | 101,617 |   |
| Segment  operating income              |       | $                                                        | 75,446     |                                                    | $          | 61,926 |   | $ | 239,791 |   | $ | 198,837 |   |
|                                   |       |                                                     |       |                                                    |       |   |   |   |   |
| **Business Services**                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Revenues                               |       | $                                                        | 43,032     |                                                    | $          | 36,345 |   | $ | 134,168 |   | $ | 113,837 |   |
| Cost  of revenues                      |       | 25,066                                                   |       | 21,674                                                  |       | 76,602 |   | 66,830 |   |
| Gross  margin                          |       | 17,966                                                   |       | 14,671                                                  |       | 57,566 |   | 47,007 |   |
| Direct  segment operating expenses     |       | 12,481                                                   |       | 10,257                                                  |       | 39,308 |   | 31,339 |   |
| Segment  operating income              |       | $                                                        | 5,485      |                                                    | $          | 4,414 |   | $ | 18,258 |   | $ | 15,668 |   |
|                                   |       |                                                     |       |                                                    |       |   |   |   |   |
| **Consolidated**                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Revenues                               |       | $                                                        | 230,831    |                                                    | $          | 174,521 |   | $ | 739,508 |   | $ | 559,181 |   |
| Cost  of revenues                      |       | 87,616                                                   |       | 66,885                                                  |       | 277,655 |   | 211,720 |   |
| Gross  margin                          |       | 143,215                                                  |       | 107,636                                                 |       | 461,853 |   | 347,461 |   |
| Direct  segment operating expenses     |       | 62,284                                                   |       | 41,296                                                  |       | 203,804 |   | 132,956 |   |
| Segment  operating income              |       | 80,931                                                   |       | 66,340                                                  |       | 258,049 |   | 214,505 |   |
| Stock-based  compensation expense      |       | 4,597                                                    |       | 3,136                                                   |       | 14,319 |   | 10,552 |   |
| Amortization  of intangible assets     |       | 3,153                                                    |       | 2,039                                                   |       | 11,153 |   | 6,224 |   |
| Facility  exit and restructuring costs |       | 1,078                                                    |       | (97                                                     | )          | 4,169 |   | 5,318 |   |
| Other  operating expenses              |       | 12,674                                                   |       | 9,449                                                   |       | 39,714 |   | 28,655 |   |
| Income  from operations                |       | $                                                        | 59,429     |                                                    | $          | 51,813 |   | $ | 188,694 |   | $ | 163,756 |   |

 

Theprimary component of the Company’s revenues is access and service revenues,which consist of narrowband access services (including traditional,fully-featured narrowband access and value-priced narrowband access); broadbandaccess services (including high-speed access via DSL and cable technologies,VoIP and managed private IP-based networks); and web hosting services. TheCompany also earns revenues from value-added services, which include ancillaryservices sold as add-on features to the Company’s access services, search andadvertising revenues.

 

Consumeraccess and service revenues consist of narrowband access, broadband access andvoice services. These revenues are derived from monthly fees charged tocustomers for dial-up Internet access; monthly fees charged for high-speedaccess services; fees charged for VoIP services; usage fees; installation fees;termination fees; and fees for equipment. Consumer value-added servicesrevenues consist of revenues from ancillary services sold as add-on features tothe Company’s Internet services, such as security products, email by phone,Internet call waiting, email storage and home networking; search revenues; andadvertising revenues.

 

Businessaccess and service revenues consist of fees charged for managing privateIP-based networks; fees charged for business Internet access and dedicatedcircuit services; installation fees; termination fees; fees for equipment;regulatory surcharges billed to customers; and fees charged for leasing serverspace and providing web services to customers wishing to have a web ore-commerce presence.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

Informationon revenues by groups of similar services and by segment for the three and ninemonths ended September 30, 2008 and 2009 is as follows:

 
| ** **            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------|------------|------------------------|------------|------------------------|------------|
| ** **            | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **            | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **            | ** ** | **(in thousands)**     | ** ** |
| **Consumer Services** |       |                   |       |                   |       |   |   |   |   |
| Access  and service   |       | $                      | 164,306    |                   | $          | 120,935 |   | $ | 529,557 |   | $ | 390,204 |   |
| Value-added  services |       | 23,493                 |       | 17,241                 |       | 75,783 |   | 55,140 |   |
| Total  revenues       |       | 187,799                |       | 138,176                |       | 605,340 |   | 445,344 |   |
|                  |       |                   |       |                   |       |   |   |   |   |
| **Business Services** |       |                   |       |                   |       |   |   |   |   |
| Access  and service   |       | 42,387                 |       | 35,796                 |       | 132,026 |   | 112,143 |   |
| Value-added  services |       | 645                    |       | 549                    |       | 2,142 |   | 1,694 |   |
| Total  revenues       |       | 43,032                 |       | 36,345                 |       | 134,168 |   | 113,837 |   |
|                  |       |                   |       |                   |       |   |   |   |   |
| **Consolidated**      |       |                   |       |                   |       |   |   |   |   |
| Access  and service   |       | 206,693                |       | 156,731                |       | 661,583 |   | 502,347 |   |
| Value-added  services |       | 24,138                 |       | 17,790                 |       | 77,925 |   | 56,834 |   |
| Total  revenues       |       | $                      | 230,831    |                   | $          | 174,521 |   | $ | 739,508 |   | $ | 559,181 |   |

 

TheCompany manages its working capital on a consolidated basis and does notallocate long-lived assets to segments. In addition, segment assets are notreported to, or used by, the chief operating decision maker and, therefore,total segment assets have not been disclosed.

 

TheCompany has not provided information about geographic segments becausesubstantially all of the Company’s revenues, results of operations andidentifiable assets are in the United States.

 

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**Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

Certain statements in this Quarterly Report on Form 10-Q areforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995, Section 27A of the Securities Act of 1933,and Section 21E of the Securities Exchange Act of 1934. The words “estimate,”“plan,” “intend,” “expect,” “anticipate,” “believe” and similar expressions areintended to identify forward-looking statements. These forward-lookingstatements are found at various places throughout this report. EarthLinkdisclaims any intention or obligation to update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.Although EarthLink believes that its expectations are based on reasonableassumptions, it can give no assurance that its goals will be achieved.Important factors that could cause actual results to differ from estimates orprojections contained in the forward-looking statements are described under “SafeHarbor Statement” in this Item 2.

* *

*The following discussion should be read in conjunction with theaccompanying unaudited Condensed Consolidated Financial Statements and relatedNotes thereto and with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and the audited Consolidated FinancialStatements and the Notes thereto contained in the Annual Report on Form 10-Kfor the year ended December 31, 2008.*

* *

**Overview**

** **

EarthLink, Inc.is an Internet service provider (“ISP”), providing nationwide Internet accessand related value-added services to individual and business customers. Ourprimary service offerings are dial-up and high-speed Internet access servicesand related value-added services, such as ancillary services sold as add-onfeatures to our Internet access services, search and advertising. In addition,through our wholly-owned subsidiary, New Edge Networks (“New Edge”), we buildand manage private IP-based wide area networks for businesses andcommunications carriers.

 

Weoperate two reportable segments, Consumer Services and Business Services. OurConsumer Services segment provides Internet access and related value-addedservices to individual customers. These services include dial-up and high-speedInternet access and voice-over-Internet Protocol (“VoIP”) services, amongothers. Our Business Services segment provides integrated communicationsservices, dedicated Internet access and related value-added services tobusinesses and communications carriers. These services include managed privateIP-based wide area networks, dedicated Internet access and web hosting, amongothers.

 

*BusinessStrategy*

* *

Ourbusiness strategy is to focus on customer retention, operational efficiency andopportunities for growth.

 

·                  *Customer Retention*. We are focused on retaining ourexisting tenured customers. We believe focusing on the customer relationshipincreases loyalty and reduces churn.  Wealso believe that these tenured customers provide cost benefits, includingreduced call center support costs and reduced bad debt expense. We continue tofocus on offering our access services with high-quality customer service andtechnical support.

 

·                  *Operational Efficiency*. We are focused onimproving the cost structure of our business and aligning our cost structurewith trends in our revenue, without impacting the quality of services weprovide. We are focused on delivering our services more cost effectively byreducing and more efficiently handling the number of calls to contact centers,managing cost-effective outsourcing opportunities, managing our network costs,implementing workforce reduction initiatives and streamlining our internalprocesses and operations.

 

·                  *Opportunities for Growth*.  In response to changes in our business, wehave significantly reduced our sales and marketing spending. However, wecontinue to seek to add customers that generate an 

 

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acceptable rate of return and increase the number of subscribers we addthrough alliances, partnerships and acquisitions from other ISPs.  We also continue to evaluate potentialstrategic transactions within the business segments in which we currentlyoperate.

 

Theprimary challenges we face in executing our business strategy are managing therate of decline in our revenues, responding to competition, reducing churn,implementing cost reduction initiatives, purchasing cost-effective wholesalebroadband access and adding customers that generate an acceptable rate ofreturn. In addition, there can be no assurance that we will be able toconsummate any such potential strategic transaction. The factors we believe areinstrumental to the achievement of our business strategy may be subject toevents and circumstances that are beyond our control. Further, we can provideno assurance that we will be successful in achieving any or all of thestrategies identified above, that the achievement or existence of suchstrategies will favorably impact profitability, or that other factors will notarise that would adversely affect future profitability.

 

*RevenueSources*

* *

The primary component of our revenues is access and servicerevenues, which consist of narrowband access services (including traditional,fully-featured narrowband access and value-priced narrowband access); broadbandaccess services (including high-speed access via DSL and cable; VoIP; andmanaged private IP-based networks); and web hosting services. We also earnrevenues from value-added services, which include revenues from ancillaryservices sold as add-on features to our Internet access services, such assecurity products, premium email only, email by phone, Internet call waiting,email storage and home networking; search revenues; and advertising revenues.

 

Narrowbandaccess revenues consist of fees charged to customers for dial-up Internetaccess. Broadband access revenues consist of fees charged for high-speed accessservices; fees charged for managing private IP-based networks; fees charged forVoIP services; usage fees; activation fees; termination fees; fees forequipment; and regulatory surcharges billed to customers. Web hosting revenuesconsist of fees charged for leasing server space and providing web services tocustomers wishing to have a web or e-commerce presence. Value-added servicesrevenues consist of fees charged for ancillary services; fees charged for paid placementsfor searches; delivering traffic to EarthLink’s partners in the form ofsubscribers, page views or e-commerce transactions; advertising EarthLinkpartners’ products and services in EarthLink’s various online properties andelectronic publications; and referring EarthLink customers to partners’products and services.

 

*Trends in ourBusiness*

* *

*Consumer services*. We operate in the Internet access market, which ischaracterized by intense competition, changing technology, changes in customerneeds and new service and product introductions. Consumers continue to migratefrom dial-up to broadband access service due to the faster connection anddownload speeds provided by broadband access, the ability to free up theirphone lines and the more reliable and “always on” connection. The pricing forbroadband services has been declining, making it a more viable option forconsumers that continue to rely on dial-up connections for Internet access. Inaddition, advanced applications such as online gaming, music downloads, videosand social networking require greater bandwidth for optimal performance, whichadds to the demand for broadband access. Our narrowband subscriber base andrevenues have been declining and are expected to continue to decline due to thecontinued maturation of the market for narrowband access.

 

In light of this continued maturation of the market fornarrowband access, we refocused our business strategy to significantly reduceour sales and marketing efforts and focus instead on retaining tenuredcustomers and adding customers that have similar characteristics of our tenuredcustomer base and are more likely to produce an acceptable rate of return.However, we expect the rate of revenue decline to decrease as our subscriberbase becomes more tenured. We experienced an improvement in consumer subscriberchurn rates during the three and nine months ended September 30, 2009compared to the prior year periods. However, our consumer access services arediscretionary and dependent upon levels of consumer spending. Unfavorableeconomic conditions could cause customers to slow spending in the future, whichcould adversely affect our revenues and churn, and we may not be able to alignour cost structure with a decline in our revenue.

 

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Consistent with trends in the Internetaccess industry, the mix of our consumer access subscriber base has beenshifting from narrowband access to broadband access customers. Consumerbroadband access revenues have lower gross margins than narrowband revenues dueto the costs associated with delivering broadband services. This change in mixhas negatively affected our profitability and we expect this trend to continueas broadband subscribers continue to become a greater proportion of ourconsumer access subscriber base. However, our consumer broadband accesscustomers also have lower churn rates than our consumer narrowband access customers.Accordingly, we expect to realize benefits from a more tenured subscriber base,such as reduced support costs and lower bad debt expense.

 

*Business services.*The markets in which we operate ourbusiness services are characterized by industry consolidation, the emergence ofnew technologies and intense competition. We sell our services to end userbusiness customers and to wholesale customers. Our end users range from largeenterprises with many locations, to small and medium-sized multi-site businessesto business customers with one site, often a home-based location. Many of ourend user customers are retail businesses. Our wholesale customers consistprimarily of telecommunications carriers. Our business has become more focusedon end users as a result of mergers in the telecommunications industry. Inaddition, our small and medium-sized business customers, including retailbusinesses, are particularly exposed to the current economic downturn. We haveexperienced pressure on revenue for our business services, given the currentstate of the economy. However, we are seeking ways to grow our businessservices revenue while operating this segment more efficiently.

 

*Third Quarter2009 Highlights*

* *

Totalrevenues decreased $56.3 million, or 24%, from the three months ended September 30,2008 to the three months ended September 30, 2009, as our subscriber basedecreased from approximately 3.0 million paying subscribers as of September 30,2008 to approximately 2.3 million paying subscribers as of September 30,2009. The decrease in subscribers was attributable to our reduced sales andmarketing activities, as well as the continuing maturation of the narrowbandInternet access market. Offsetting the decline in total revenues was a $48.7million, or 28%, decline in total operating costs and expenses. Total operatingcosts and expenses decreased primarily due to reduced telecommunications costs,sales and marketing spending, back-office support costs and customer supportand bad debt expense as our overall subscriber base has decreased and becomelonger tenured. Our longer tenured customers require less customer service andtechnical support and have a lower frequency of non-payment. We recognized netincome of $29.9 million during the three months ended September 30, 2009compared to $51.9 million during the three months ended September 30,2008. The decrease in net income was primarily due to the decrease in revenuesand an increase in our income tax provision, offset by the decrease in totaloperating costs and expenses described above.

 

*Looking Ahead*

* *

We expect total revenues to continue to decrease during theremainder of 2009 and into 2010 as we continue to reduce our sales andmarketing efforts, and as the market for Internet access continues to mature.However, we expect the rate of revenue decline to decelerate as our customerbase becomes longer tenured and churn rates go down. Consistent with trends inthe Internet access industry, we expect the mix of our consumer accesssubscriber base to continue to shift from narrowband access to broadband accesscustomers, which will negatively affect our profitability. We also expecteconomic conditions to put continued pressure on revenue and churn rates forour business services, and may impact revenue and churn for our consumerservices. We expect cost savings associated with our decreased sales andmarketing activities during the remainder of 2009 and into 2010, and decreasedsupport costs from a lower and longer tenured customer base and as a result ofour efforts to reduce our cost structure. We are implementing certain costcutting initiatives in the remainder of 2009 as part of our efforts to aligncosts with trends in our revenue. However, we believe that large-scale costreduction opportunities will be more limited in the future.  In addition, although we seek to align ourcost structure with trends in our revenue, we may not be able to reduce ourcost structure to the same extent as our revenue declines.

 

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**Dividends**

** **

In July 2009, our Board ofDirectors declared a quarterly cash dividend on our common stock of $0.14 pershare to stockholders of record on September 14, 2009. The dividend waspaid on September 28, 2009 and totaled $15.0 million. In October 2009,our Board of Directors declared a quarterly cash dividend on our common stockof $0.14 per share to be paid on December 23, 2009 to stockholders ofrecord on December 9, 2009. We currently intend to continue to pay regularquarterly dividends on our common stock. The Board of Directors also approved the payment of cash dividendamounts on each outstanding restricted stock unit to be paid at the time therestricted stock unit vests. Any decision to declare future dividends will bemade at the discretion of the Board of Directors and will depend on, amongother things, our results of operations, financial condition, cashrequirements, investment opportunities and other factors the Board of Directorsmay deem relevant.

** **

**Key OperatingMetrics**

** **

Weutilize certain non-financial and operating measures to assess our financialperformance. Terms such as churn and average revenue per user (“ARPU”) areterms commonly used in our industry. The following table sets forthsubscriber and operating data for the periods indicated:

** **
| ** **                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **2008**               | ** ** | **2008**              | ** ** | **2009**          | ** ** | **2009**               | ** ** |
| **Subscriber Data (a)**                     |       |                   |       |                  |       |              |       |                   |       |
| **Consumer Services**                       |       |                   |       |                  |       |              |       |                   |       |
| Narrowband  access subscribers              |       | 1,920,000              |       | 1,747,000             |       | 1,456,000         |       | 1,329,000              |       |
| Broadband  access subscribers (b)           |       | 933,000                |       | 896,000               |       | 845,000           |       | 832,000                |       |
| Total  consumer services                    |       | 2,853,000              |       | 2,643,000             |       | 2,301,000         |       | 2,161,000              |       |
| **Business Services**                       |       |                   |       |                  |       |              |       |                   |       |
| Narrowband  access subscribers              |       | 19,000                 |       | 17,000                |       | 11,000            |       | 9,000                  |       |
| Broadband  access subscribers               |       | 61,000                 |       | 59,000                |       | 56,000            |       | 55,000                 |       |
| Web  hosting accounts                       |       | 91,000                 |       | 87,000                |       | 81,000            |       | 78,000                 |       |
| Total  business services                    |       | 171,000                |       | 163,000               |       | 148,000           |       | 142,000                |       |
| **Total subscriber count at end of period** |       | 3,024,000              |       | 2,806,000             |       | 2,449,000         |       | 2,303,000              |       |

 
| ** **                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                          | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008** | ** ** | **2009** | ** ** |
| **Subscriber Activity**             |       |                   |       |                   |       |   |   |   |   |
| Subscribers  at beginning of period |       | 3,299,000              |       | 2,449,000              |       | 3,876,000 |   | 2,806,000 |   |
| Gross  organic subscriber additions |       | 137,000                |       | 108,000                |       | 552,000 |   | 344,000 |   |
| Aquired  subscribers                |       | 2,000                  |       | —                 |       | 2,000 |   | — |   |
| Adjustment  (c)                     |       | (15,000                | )          | —                 |       | (15,000 | ) | (7,000 | ) |
| Churn                               |       | (399,000               | )          | (254,000               | )          | (1,391,000 | ) | (840,000 | ) |
| Subscribers  at end of period       |       | 3,024,000              |       | 2,303,000              |       | 3,024,000 |   | 2,303,000 |   |
|                                |       |                   |       |                   |       |   |   |   |   |
| **Churn rate (d)**                  |       | 4.2                    | %          | 3.6                    | %          | 4.5 | % | 3.7 | % |
|                                |       |                   |       |                   |       |   |   |   |   |
| **Consumer Services Data**          |       |                   |       |                   |       |   |   |   |   |
| Average  subscribers (e)            |       | 2,980,000              |       | 2,207,000              |       | 3,256,000 |   | 2,382,000 |   |
| ARPU  (f)                           |       | $                      | 21.00      |                   | $          | 20.87 |   | $ | 20.66 |   | $ | 20.77 |   |
| Churn  rate (d)                     |       | 4.3                    | %          | 3.7                    | %          | 4.6 | % | 3.8 | % |
|                                |       |                   |       |                   |       |   |   |   |   |
| **Business Services Data**          |       |                   |       |                   |       |   |   |   |   |
| Average  subscribers (e)            |       | 176,000                |       | 144,000                |       | 183,000 |   | 152,000 |   |
| ARPU  (f)                           |       | $                      | 81.50      |                   | $          | 84.08 |   | $ | 81.33 |   | $ | 82.98 |   |
| Churn  rate (d)                     |       | 3.2                    | %          | 2.5                    | %          | 2.8 | % | 2.8 | % |

 

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----

(a) Subscribercounts do not include nonpaying customers. Customers receiving service underpromotional programs that include periods of free service at inception are notincluded in subscriber counts until they become paying customers.

 

(b) Customerswho subscribe to our EarthLink DSL and Home Phone service are counted as both abroadband subscriber and a voice subscriber.

 

(c) During the nine months ended September 30, 2009, we removed approximately7,000 satellite subscribers from our broadband subscriber count and totalsubscriber count as a result of our sale of these subscriber accounts. Duringthe three and nine months ended September 30, 2008, we removedapproximately 15,000 EarthLink supported Sprint customers from our broadbandsubscriber counts due to the termination of a wholesale arrangement by Sprint.

 

(d) Churn rate is used to measure the rate at which subscribers discontinue serviceon a voluntary or involuntary basis. Churn rate is computed by dividing the average monthly number ofsubscribers that discontinued service during the period by the averagesubscribers for the period.

 

(e)  Average subscribers oraccounts for the three month periods is calculated by averaging the endingmonthly subscribers or accounts for the four months preceding and including theend of the quarterly period. Average subscribers or accounts for the nine monthperiods is calculated by averaging the ending monthly subscribers or accountsfor the ten months preceding and including the end of the quarterly period.

 

(f) ARPUrepresents the average monthly revenue per user (subscriber). ARPU is computedby dividing average monthly revenue for the period by the average number ofsubscribers for the period. Average monthly revenue used to calculate ARPUincludes recurring service revenue as well as nonrecurring revenues associatedwith equipment and other one-time charges associated with initiating ordiscontinuing services.

 

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**Results ofOperations**

** **

***Consolidated Results of Operations***

*** ***

Thefollowing table sets forth statement of operations data for the three monthsended September 30, 2008 and 2009:

 
| ** **                                             | ** ** | **Three Months Ended September 30,** | ** ** | **Change Between** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|--------------------|------------|
| ** **                                             | ** ** | **2008**                                  | ** ** | **2009**           | ** ** | **2008 and 2009** | ** ** |
| ** **                                             | ** ** | ** **                                | ** ** | **% of**           | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Amount**                                | ** ** | **Revenue**        | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                                             | ** ** | **(dollars in thousands)**                | ** ** |
|                                                   |       |                                      |       |               |       |   |   |   |   |   |   |   |   |
| Revenues                                               |       | $                                         | 230,831    |               | 100%       |   | $ | 174,521 |   | 100% |   | $ | (56,310 | ) | -24% |   |
|                                                   |       |                                      |       |               |       |   |   |   |   |   |   |   |   |
| Operating  costs and expenses:                         |       |                                      |       |               |       |   |   |   |   |   |   |   |   |
| Cost  of revenues                                      |       | 87,616                                    |       | 38%                |       | 66,885 |   | 38% |   | (20,731 | ) | -24% |   |
| Sales  and marketing                                   |       | 22,191                                    |       | 10%                |       | 13,840 |   | 8% |   | (8,351 | ) | -38% |   |
| Operations  and customer support                       |       | 34,048                                    |       | 15%                |       | 23,569 |   | 14% |   | (10,479 | ) | -31% |   |
| General  and administrative                            |       | 23,316                                    |       | 10%                |       | 16,472 |   | 9% |   | (6,844 | ) | -29% |   |
| Amortization  of intangible assets                     |       | 3,153                                     |       | 1%                 |       | 2,039 |   | 1% |   | (1,114 | ) | -35% |   |
| Facility  exit and restructuring costs                 |       | 1,078                                     |       | 0%                 |       | (97 | ) | 0% |   | (1,175 | ) | -109% |   |
| Total  operating costs and expenses                    |       | 171,402                                   |       | 74%                |       | 122,708 |   | 70% |   | (48,694 | ) | -28% |   |
|                                                   |       |                                      |       |               |       |   |   |   |   |   |   |   |   |
| Income  from operations                                |       | 59,429                                    |       | 26%                |       | 51,813 |   | 30% |   | (7,616 | ) | -13% |   |
| Gain  on investments, net                              |       | 4,352                                     |       | 2%                 |       | 35 |   | 0% |   | (4,317 | ) | -99% |   |
| Interest  expense and other, net                       |       | (3,281                                    | )          | -1%                |       | (5,067 | ) | -3% |   | (1,786 | ) | 54% |   |
| Income  from continuing operations before income taxes |       | 60,500                                    |       | 26%                |       | 46,781 |   | 27% |   | (13,719 | ) | -23% |   |
| Income  tax provision                                  |       | (7,924                                    | )          | -3%                |       | (16,914 | ) | -10% |   | (8,990 | ) | 113% |   |
| Income  from continuing operations                     |       | 52,576                                    |       | 23%                |       | 29,867 |   | 17% |   | (22,709 | ) | -43% |   |
| Loss  from discontinued operations                     |       | (681                                      | )          | 0%                 |       | — |   | 0% |   | 681 |   | -100% |   |
| Net  income                                            |       | $                                         | 51,895     |               | 22%        |   | $ | 29,867 |   | 17% |   | $ | (22,028 | ) | -42% |   |

 

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Thefollowing table sets forth statement of operations data for the nine monthsended September 30, 2008 and 2009:

 
| ** **                                             | ** ** | **Nine Months Ended September 30,** | ** ** | **Change Between** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------|------------|--------------------|------------|
| ** **                                             | ** ** | **2008**                                 | ** ** | **2009**           | ** ** | **2008 and 2009** | ** ** |
| ** **                                             | ** ** | ** **                               | ** ** | **% of**           | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Amount**                               | ** ** | **Revenue**        | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                   |       | **(dollars in thousands)**               |       |
|                                                   |       |                                     |       |               |       |   |   |   |   |   |   |   |   |
| Revenues                                               |       | $                                        | 739,508    |               | 100%       |   | $ | 559,181 |   | 100% |   | $ | (180,327 | ) | -24% |   |
|                                                   |       |                                     |       |               |       |   |   |   |   |   |   |   |   |
| Operating  costs and expenses:                         |       |                                     |       |               |       |   |   |   |   |   |   |   |   |
| Cost  of revenues                                      |       | 277,655                                  |       | 38%                |       | 211,720 |   | 38% |   | (65,935 | ) | -24% |   |
| Sales  and marketing                                   |       | 78,913                                   |       | 11%                |       | 45,405 |   | 8% |   | (33,508 | ) | -42% |   |
| Operations  and customer support                       |       | 106,914                                  |       | 14%                |       | 75,255 |   | 13% |   | (31,659 | ) | -30% |   |
| General  and administrative                            |       | 72,010                                   |       | 10%                |       | 51,503 |   | 9% |   | (20,507 | ) | -28% |   |
| Amortization  of intangible assets                     |       | 11,153                                   |       | 2%                 |       | 6,224 |   | 1% |   | (4,929 | ) | -44% |   |
| Facility  exit and restructuring costs                 |       | 4,169                                    |       | 1%                 |       | 5,318 |   | 1% |   | 1,149 |   | 28% |   |
| Total  operating costs and expenses                    |       | 550,814                                  |       | 74%                |       | 395,425 |   | 71% |   | (155,389 | ) | -28% |   |
|                                                   |       |                                     |       |               |       |   |   |   |   |   |   |   |   |
| Income  from operations                                |       | 188,694                                  |       | 26%                |       | 163,756 |   | 29% |   | (24,938 | ) | -13% |   |
| Gain  on investments, net                              |       | 5,677                                    |       | 1%                 |       | 305 |   | 0% |   | (5,372 | ) | -95% |   |
| Interest  expense and other, net                       |       | (7,804                                   | )          | -1%                |       | (14,458 | ) | -3% |   | (6,654 | ) | 85% |   |
| Income  from continuing operations before income taxes |       | 186,567                                  |       | 25%                |       | 149,603 |   | 27% |   | (36,964 | ) | -20% |   |
| Income  tax provision                                  |       | (23,923                                  | )          | -3%                |       | (55,754 | ) | -10% |   | (31,831 | ) | 133% |   |
| Income  from continuing operations                     |       | 162,644                                  |       | 22%                |       | 93,849 |   | 17% |   | (68,795 | ) | -42% |   |
| Loss  from discontinued operations                     |       | (8,438                                   | )          | -1%                |       | — |   | 0% |   | 8,438 |   | -100% |   |
| Net  income                                            |       | $                                        | 154,206    |               | 21%        |   | $ | 93,849 |   | 17% |   | $ | (60,357 | ) | -39% |   |

 

***Segment Results of Operations***

*** ***

Wehave two operating segments, Consumer Services and Business Services. Wepresent our segment information along the same lines that our chief executivereviews our operating results in assessing performance and allocatingresources. Our Consumer Services segment provides Internet access services andrelated value-added services to individual customers. These services includedial-up and high-speed Internet access and VoIP services, among others. OurBusiness Services segment provides integrated communications services andrelated value-added services to businesses and communications carriers. Theseservices include managed private IP-based wide area networks, dedicatedInternet access and web hosting, among others.

 

Weevaluate the performance of our operating segments based on segment income fromoperations. Segment income from operations includes revenues from externalcustomers, related cost of revenues and operating expenses directlyattributable to the segment, which include expenses over which segment managershave direct discretionary control, such as advertising and marketing programs,customer support expenses, operations expenses, product development expenses,certain technology and facilities expenses, billing operations and provisionsfor doubtful accounts. Segment income from operations excludes other income andexpense items and certain expenses over which segment managers do not havediscretionary control. Costs excluded from segment income from operationsinclude various corporate expenses (consisting of certain costs such ascorporate management, human resources, finance and legal), amortization of intangibleassets, impairment of goodwill and intangible assets, facility exit andrestructuring costs and stock-based compensation expense, as they are notconsidered in the measurement of segment performance.

 

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Thefollowing table sets forth segment data for the three months ended September 30,2008 and 2009:

 
| ** **                             | ** ** | **Three Months Ended September 30,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                             | ** ** | **2008**                                  | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**                | ** ** |
| **Consumer Services**                  |       |                                      |       |       |       |              |       |   |   |
| Revenues                               |       | $                                         | 187,799    |       | $          | 138,176           |       | $ | (49,623 | ) | -26% |   |
| Cost  of revenues                      |       | 62,550                                    |       | 45,211     |       | (17,339           | )          | -28% |   |
| Gross  margin                          |       | 125,249                                   |       | 92,965     |       | (32,284           | )          | -26% |   |
| Direct  segment operating expenses     |       | 49,803                                    |       | 31,039     |       | (18,764           | )          | -38% |   |
| Segment  operating income              |       | $                                         | 75,446     |       | $          | 61,926            |       | $ | (13,520 | ) | -18% |   |
|                                   |       |                                      |       |       |       |              |       |   |   |
| **Business Services**                  |       |                                      |       |       |       |              |       |   |   |
| Revenues                               |       | $                                         | 43,032     |       | $          | 36,345            |       | $ | (6,687 | ) | -16% |   |
| Cost  of revenues                      |       | 25,066                                    |       | 21,674     |       | (3,392            | )          | -14% |   |
| Gross  margin                          |       | 17,966                                    |       | 14,671     |       | (3,295            | )          | -18% |   |
| Direct  segment operating expenses     |       | 12,481                                    |       | 10,257     |       | (2,224            | )          | -18% |   |
| Segment  operating income              |       | $                                         | 5,485      |       | $          | 4,414             |       | $ | (1,071 | ) | -20% |   |
|                                   |       |                                      |       |       |       |              |       |   |   |
| **Consolidated**                       |       |                                      |       |       |       |              |       |   |   |
| Revenues                               |       | $                                         | 230,831    |       | $          | 174,521           |       | $ | (56,310 | ) | -24% |   |
| Cost  of revenues                      |       | 87,616                                    |       | 66,885     |       | (20,731           | )          | -24% |   |
| Gross  margin                          |       | 143,215                                   |       | 107,636    |       | (35,579           | )          | -25% |   |
| Direct  segment operating expenses     |       | 62,284                                    |       | 41,296     |       | (20,988           | )          | -34% |   |
| Segment  operating income              |       | 80,931                                    |       | 66,340     |       | (14,591           | )          | -18% |   |
| Stock-based  compensation expense      |       | 4,597                                     |       | 3,136      |       | (1,461            | )          | -32% |   |
| Amortization  of intangible assets     |       | 3,153                                     |       | 2,039      |       | (1,114            | )          | -35% |   |
| Facility  exit and restructuring costs |       | 1,078                                     |       | (97        | )          | (1,175            | )          | -109% |   |
| Other  operating expenses              |       | 12,674                                    |       | 9,449      |       | (3,225            | )          | -25% |   |
| Income  from operations                |       | $                                         | 59,429     |       | $          | 51,813            |       | $ | (7,616 | ) | -13% |   |

 

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Thefollowing table sets forth segment data for the nine months ended September 30,2008 and 2009:

 
| ** **                             | ** ** | **Nine Months Ended September 30,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                             | ** ** | **2008**                                 | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**               | ** ** |
| **Consumer Services**                  |       |                                     |       |       |       |              |       |   |   |
| Revenues                               |       | $                                        | 605,340    |       | $          | 445,344           |       | $ | (159,996 | ) | -26% |   |
| Cost  of revenues                      |       | 201,053                                  |       | 144,890    |       | (56,163           | )          | -28% |   |
| Gross  margin                          |       | 404,287                                  |       | 300,454    |       | (103,833          | )          | -26% |   |
| Direct  segment operating expenses     |       | 164,496                                  |       | 101,617    |       | (62,879           | )          | -38% |   |
| Segment  operating income              |       | $                                        | 239,791    |       | $          | 198,837           |       | $ | (40,954 | ) | -17% |   |
|                                   |       |                                     |       |       |       |              |       |   |   |
| **Business Services**                  |       |                                     |       |       |       |              |       |   |   |
| Revenues                               |       | $                                        | 134,168    |       | $          | 113,837           |       | $ | (20,331 | ) | -15% |   |
| Cost  of revenues                      |       | 76,602                                   |       | 66,830     |       | (9,772            | )          | -13% |   |
| Gross  margin                          |       | 57,566                                   |       | 47,007     |       | (10,559           | )          | -18% |   |
| Direct  segment operating expenses     |       | 39,308                                   |       | 31,339     |       | (7,969            | )          | -20% |   |
| Segment  operating income              |       | $                                        | 18,258     |       | $          | 15,668            |       | $ | (2,590 | ) | -14% |   |
|                                   |       |                                     |       |       |       |              |       |   |   |
| **Consolidated**                       |       |                                     |       |       |       |              |       |   |   |
| Revenues                               |       | $                                        | 739,508    |       | $          | 559,181           |       | $ | (180,327 | ) | -24% |   |
| Cost  of revenues                      |       | 277,655                                  |       | 211,720    |       | (65,935           | )          | -24% |   |
| Gross  margin                          |       | 461,853                                  |       | 347,461    |       | (114,392          | )          | -25% |   |
| Direct  segment operating expenses     |       | 203,804                                  |       | 132,956    |       | (70,848           | )          | -35% |   |
| Segment  operating income              |       | 258,049                                  |       | 214,505    |       | (43,544           | )          | -17% |   |
| Stock-based  compensation expense      |       | 14,319                                   |       | 10,552     |       | (3,767            | )          | -26% |   |
| Amortization  of intangible assets     |       | 11,153                                   |       | 6,224      |       | (4,929            | )          | -44% |   |
| Facility  exit and restructuring costs |       | 4,169                                    |       | 5,318      |       | 1,149             |       | 28% |   |
| Other  operating expenses              |       | 39,714                                   |       | 28,655     |       | (11,059           | )          | -28% |   |
| Income  from operations                |       | $                                        | 188,694    |       | $          | 163,756           |       | $ | (24,938 | ) | -13% |   |

 

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***Revenues***

** **

Thefollowing table presents revenues by groups of similar services and by segmentfor the three and nine months ended September 30, 2008 and 2009:

 
| ** **            | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** | **Nine Months Ended**      | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------------------|------------|------------|------------|-------------------|------------|----------------------------|------------|------------|------------|------------|------------|
| ** **            | ** ** | **September 30,** | ** ** | ** ** | ** ** | ** **        | ** ** | **September 30,**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | **2008**               | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change**               | ** ** | **2008**   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **            |       |                   |       |       |       |              |       | **(dollars in thousands)** |       |       |       |       |       |   |   |
| **Consumer Services** |       |                   |       |       |       |              |       |                       |       |       |       |       |       |   |   |   |   |
| Access  and service   |       | $                      | 164,306    |       | $          | 120,935           |       | $                          | (43,371    | )          | -26%       |       | $          | 529,557 |   | $ | 390,204 |   | $ | (139,353 | ) | -26% |   |
| Value-added  services |       | 23,493                 |       | 17,241     |       | (6,252            | )          | -27%                       |       | 75,783     |       | 55,140     |       | (20,643 | ) | -27% |   |
| Total  revenues       |       | 187,799                |       | 138,176    |       | (49,623           | )          | -26%                       |       | 605,340    |       | 445,344    |       | (159,996 | ) | -26% |   |
|                  |       |                   |       |       |       |              |       |                       |       |       |       |       |       |   |   |   |   |
| **Business Services** |       |                   |       |       |       |              |       |                       |       |       |       |       |       |   |   |   |   |
| Access  and service   |       | 42,387                 |       | 35,796     |       | (6,591            | )          | -16%                       |       | 132,026    |       | 112,143    |       | (19,883 | ) | -15% |   |
| Value-added  services |       | 645                    |       | 549        |       | (96               | )          | -15%                       |       | 2,142      |       | 1,694      |       | (448 | ) | -21% |   |
| Total  revenues       |       | 43,032                 |       | 36,345     |       | (6,687            | )          | -16%                       |       | 134,168    |       | 113,837    |       | (20,331 | ) | -15% |   |
|                  |       |                   |       |       |       |              |       |                       |       |       |       |       |       |   |   |   |   |
| **Consolidated**      |       |                   |       |       |       |              |       |                       |       |       |       |       |       |   |   |   |   |
| Access  and service   |       | 206,693                |       | 156,731    |       | (49,962           | )          | -24%                       |       | 661,583    |       | 502,347    |       | (159,236 | ) | -24% |   |
| Value-added  services |       | 24,138                 |       | 17,790     |       | (6,348            | )          | -26%                       |       | 77,925     |       | 56,834     |       | (21,091 | ) | -27% |   |
| Total  revenues       |       | $                      | 230,831    |       | $          | 174,521           |       | $                          | (56,310    | )          | -24%       |       | $          | 739,508 |   | $ | 559,181 |   | $ | (180,327 | ) | -24% |   |

 

*Consolidatedrevenues*

* *

The primary component of our revenues is access and servicerevenues, which consist of narrowband access services (including traditional,fully-featured narrowband access and value-priced narrowband access); broadbandaccess services (including high-speed access via DSL and cable; VoIP; andmanaged private IP-based wide area networks); and web hosting services. We alsoearn revenues from value-added services, which include ancillary services soldas add-on features to our access services, search and advertising. Totalrevenues decreased from $230.8 million during the three months ended September 30,2008 to $174.5 million during the three months ended September 30, 2009.This was comprised of a $49.6 million decrease in consumer services revenue anda $6.7 million decrease in business services revenue. Total revenues decreasedfrom $739.5 million during the nine months ended September 30, 2008 to$559.2 million during the nine months ended September 30, 2009. This wascomprised of a $160.0 million decrease in consumer services revenue and a $20.3million decrease in business services revenue.

 

The decreases in consumer services revenue were primarilyattributable to decreases in average consumer subscribers, which wereapproximately 3.0 million and 3.3 million during the three and nine monthsended September 30, 2008, respectively, and 2.2 million and 2.4 millionduring the three and nine months ended September 30, 2009, respectively.These decreases were driven primarily by narrowband and broadband subscribers,as we reduced our sales and marketing efforts and as the market for Internetaccess continues to mature. Contributing to the decrease in consumer servicesrevenue during the three months ended September 30, 2009 was a decrease inconsumer services ARPU. Partially offsetting the decrease in consumer servicesrevenue during the nine months ended September 30, 2009 was an increase inconsumer services ARPU, which was primarily driven by the shift in mix of ourconsumer access subscriber base from narrowband to broadband subscribers.

 

The decreases in business services revenue were primarilydue to decreases in average business subscribers, which were approximately176,000 and 183,000 during the three and nine months ended September 30,2008, respectively, and 144,000 and 152,000 during the three and nine monthsended September 30, 2009, respectively. Slightly offsetting the decreasesin our average business subscribers were increases in business services ARPU,which increased due to the shift in mix of our business access subscriber baseto New Edge subscribers.

 

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* *

*Consumerservices revenue*

* *

*Access and service*.Consumer access and service revenues consist of narrowband access, broadbandaccess and VoIP services. These revenues are derived from monthly fees chargedto customers for dial-up Internet access; monthly fees charged for high-speedaccess services including DSL and cable; monthly fees charged for VoIPservices; usage fees; activation fees; termination fees; and fees forequipment.

 

Consumer access and service revenues decreased $43.4million, or 26%, from the three months ended September 30, 2008 to thethree months ended September 30, 2009, and decreased $139.4 million, or26%, from the nine months ended September 30, 2008 to the nine monthsended September 30, 2009.  Thedecreases in consumer access and service revenues were primarily due todecreases in narrowband access and broadband access revenues.  Narrowband access revenues decreased due to adecrease in average premium narrowband and value-priced narrowband subscribersresulting from reduced sales and marketing activities and the continuedmaturation of and competition in the market for narrowband Internet access. Inaccordance with our business strategy, we are focusing our efforts primarily onthe retention of tenured customers and adding customers that have similarcharacteristics of our tenured customer base and are more likely to produce anacceptable rate of return. Average consumer narrowband subscribers decreasedfrom 2.0 million and 2.3 million during the three and nine months ended September 30,2008, respectively, to 1.4 million and 1.5 million during the three and ninemonths ended September 30, 2009, respectively. Our value-priced PeoplePCnarrowband services comprised a larger proportion of this decrease, as averagePeoplePC access subscribers decreased from approximately 46% and 48% of ouraverage consumer narrowband customer base during the three and nine monthsended September 30, 2008, respectively, to 37% and 40% of our averageconsumer narrowband customer base during the three and nine months ended September 30,2009, respectively. Broadband access revenues decreased due to a decline inaverage broadband subscribers resulting from reduced sales and marketingefforts and competitive pressures. Average consumer broadband subscribersdecreased from 1.0 million during the three and nine months ended September 30,2008 to 0.8 million and 0.9 million during the three and nine months ended September 30,2009, respectively. However, we experienced an improvement in consumersubscriber churn rates during the three and nine months ended September 30,2009 compared to the prior year period, as churn decreased from 4.3% and 4.6%during the three and nine months ended September 30, 2008, respectively,to 3.7% and 3.8% during the three and nine months ended September 30,2009, respectively.

 

Contributing to the decrease in consumer access and servicerevenue during the three months ended September 30, 2009 was a decrease inconsumer access and service ARPU, which was driven by an increase in promotionsand save offers for our narrowband services offset by the shift in mix of ourconsumer access subscriber base from narrowband to broadband subscribers.Partially offsetting the decrease in consumer services revenue during the ninemonths ended September 30, 2009 was an increase in consumer access andservice ARPU, which was primarily driven by the shift in mix of our consumeraccess subscriber base from narrowband to broadband subscribers.

 

We expect our consumer access and service subscriber baseto continue to decrease due to decreased sales and marketing activities,competitive pressures and the continued maturation of the market for narrowbandInternet access. However, as our customers become more tenured, we expect ourchurn rates to decline.

 

*Value-added services revenues.*Value-added services revenues consist of revenuesfrom ancillary services sold as add-on features to our Internet accessservices, such as security products, premium email only, email by phone,Internet call waiting, email storage and home networking; search revenues; andadvertising revenues.* *We derive these revenues frommonthly fees charged for ancillary services; paid placements for searches;delivering traffic to our partners in the form of subscribers, page viewsor e-commerce transactions; advertising our partners’ products and services inour various online properties and electronic publications; and referring ourcustomers to our partners’ products and services.

 

Value-addedservices revenues decreased $6.3 million, or 27%, from the three months ended September 30,2008 to the three months ended September 30, 2009, and decreased $20.6million, or 27%, from the nine months ended September 30, 2008 to the ninemonths ended September 30, 2009. The decreases were due primarily to decreases in subscribers forancillary services, primarily security services, and in search advertisingrevenues. The decreases were the result of decreases in total average consumersubscribers from 3.0 million and 3.3 million during the three and nine monthsended September 30, 2008, respectively, to 2.2 million and 2.4 millionduring the three and nine months ended September 30, 2009,respectively.  However, offsetting thesedecreases was an increase in subscription revenue per subscriber and searchrevenue per thousand searches. We expect our value-added services revenues todecrease during the remainder of 2009 as our subscriber base decreases.

 

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* *

*Businessservices revenue*

* *

The primary component of business services revenues isaccess and service revenues, and includes New Edge access and service revenues.Business access and service revenues consist of fees charged for businessInternet access services; fees charged for managed private IP-based wide areanetworks; installation fees; termination fees; fees for equipment; andregulatory surcharges billed to customers. Business access and service revenuesalso consist of web hosting revenues from leasing server space and providingweb services to customers wishing to have a web or e-commerce presence on theInternet. We sell our services to end-user business customers and to wholesalecustomers. Our end users range from large enterprises with many locations, tosmall and medium-sized multi-site businesses to business customers with onesite, often a home-based location. Our wholesale customers consist primarily oftelecommunications carriers. Many of our end user customers are retailbusinesses.

 

Business access and service revenues decreased $6.6million, or 16%, from the three months ended September 30, 2008 to thethree months ended September 30, 2009 and decreased $19.9 million, or 15%,from the nine months ended September 30, 2008 to the nine months ended September 30,2009.  The decreases were primarily dueto decreases in average business access and service subscribers, comprised ofdecreases in average web hosting accounts, average business narrowbandcustomers and average New Edge customers. Our wholesale business during thenine month period was also negatively impacted by consolidation in thetelecommunications industry.

 

***Cost of revenues***

*** ***

Costof revenues consist of telecommunications fees, set-up fees, the costs ofequipment sold to customers for use with our services, depreciation of ournetwork equipment and surcharges due to regulatory agencies. Our principalprovider for narrowband telecommunications services is Level 3 Communications, Inc.Our largest providers of broadband connectivity are Time Warner Cable,AT&T, Qwest Corporation, Verizon Communications, Inc., CovadCommunications Group, Inc. (“Covad”) and Comcast Corporation. We also dolesser amounts of business with a wide variety of local, regional and othernational providers. Cost of revenues also includes sales incentives. We offersales incentives, such as free modems and Internet access on a trial basis, forcertain products and promotions.

 

Totalcost of revenues decreased $20.7 million, or 24%, from the three months ended September 30,2008 to the three months ended September 30, 2009, but remained constantas a percent of revenue from 38% to 38%. This decrease was comprised of a $17.3 million decrease in consumerservices cost of revenues and $3.4 million decrease in business services costof revenue. Consumer services cost of revenues decreased due to the decline inaverage consumer services subscribers. Business services cost of revenuesdecreased due to a decrease in average business services subscribers.

 

Totalcost of revenues decreased $65.9 million, or 24%, from the nine months ended September 30,2008 to the nine months ended September 30, 2009, but remained constant asa percent of revenue from 38% to 38%. This decrease was comprised of a $56.2 million decrease in consumerservices cost of revenues and $9.8 million decrease in business services costof revenue. Consumer services cost of revenues decreased primarily due to thedecline in average consumer services subscribers. Business services cost ofrevenues decreased due to a decrease in average business services subscribers.

 

Weexpect cost of revenues to decrease as our subscriber base decreases. We alsoexpect the mix of our consumer access subscriber base to continue to shift fromnarrowband access to broadband access customers, which will negatively affectour average monthly cost per subscriber. However, we will continue to seek costefficiencies by managing our network and associated expenses, including networkconsolidation and entering into more favorable agreements with networkproviders.

 

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*** ***

***Sales and marketing***

*** ***

Sales and marketing expenses include advertising andpromotion expenses, fees paid to distribution partners to acquire new payingsubscribers and compensation and related costs (including stock-basedcompensation).

 

Sales and marketing expenses decreased $8.4 million, or38%, from the three months ended September 30, 2008 to the three monthsended September 30, 2009. Sales and marketing expenses decreased $33.5million, or 42%, from the nine months ended September 30, 2008 to the ninemonths ended September 30, 2009. The decreases consisted primarily ofdecreases in advertising and promotions expense, personnel-related costs,outsourced labor and occupancy and related costs resulting from our refocusedbusiness strategy and continued cost reduction initiatives. Sales and marketingexpenses decreased as a percent of revenues from 10% and 11% of revenues duringthe three and nine months ended September 30, 2008, respectively, to 8% ofrevenues during the three and nine months ended September 30, 2009 as wereduced sales and marketing efforts and focused our efforts primarily on theretention of tenured customers and on marketing channels that are more likelyto produce an acceptable rate of return.

 

***Operations and customer support***

** **

Operationsand customer support expenses consist of costs associated with technicalsupport and customer service, maintenance of customer information systems,software development, network operations and compensation and related costs(including stock-based compensation).

 

Operationsand customer support expenses decreased $10.5 million, or 31%, from the threemonths ended September 30, 2008 to the three months ended September 30,2009. Operations and customer support expenses decreased $31.7 million, or 30%,from the nine months ended September 30, 2008 to the nine months ended September 30,2009. The decreases in operations and customer support expenses consisted ofdecreases in personnel-related costs, outsourced labor and occupancy and relatedcosts. These decreases were primarily attributable to our cost reductioninitiatives, including benefits realized as a result of the 2007 Plan and otherworkforce reductions, and a decrease in call volumes for customer service andtechnical support as our overall subscriber base has decreased and as ourtenured customers require less customer service and technical support. Thesefactors also resulted in operations and customer support expenses as a percentof revenues to decrease during the three and nine months ended September 30,2009 compared to the prior year periods.

 

***General and administrative***

*** ***

General and administrative expenses consist of compensationand related costs (including stock-based compensation) associated with ourfinance, legal, facilities and human resources organizations; fees forprofessional services; payment processing; credit card fees; collections andbad debt.

 

General and administrative expenses decreased $6.8 million,or 29%, from the three months ended September 30, 2008 to the three monthsended September 30, 2009, and decreased as a percent of revenues from 10%of revenues to 9% of revenues. General and administrative expenses decreased$20.5 million, or 28%, from the nine months ended September 30, 2008 tothe nine months ended September 30, 2009, and decreased as a percent ofrevenues from 10% of revenues to 9% of revenues.  The decreases in general and administrativeexpenses consisted primarily of decreases in bad debt and payment processingfees, personnel-related costs and professional and legal fees. Bad debt andpayment processing fees decreased due to the decrease in our overall subscriberbase and due to our subscriber base consisting of longer tenured customers, whohave a lower frequency of non-payment. The decrease in personnel-related costsand professional and legal fees was attributable to our efforts to reduce ourback-office cost structure, including benefits realized as a result of the 2007Plan.

 

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*** ***

***Amortization of intangible assets***

*** ***

Amortizationof intangible assets represents the amortization of definite-lived intangibleassets acquired in purchases of businesses and purchases of customer bases fromother companies. Definite-lived intangible assets, which primarily consist ofsubscriber bases and customer relationships, acquired software and technology,trade names and other assets, are amortized on a straight-line basis over theirestimated useful lives, which range from three to six years. Amortization ofintangible assets decreased $1.1 million, or 35%, from the three months ended September 30,2008 to the three months ended September 30, 2009 and decreased $4.9 million,or 44%, from the nine months ended September 30, 2008 to the nine monthsended September 30, 2009.  Thedecreases in amortization of intangible assets compared to the prior yearperiods were primarily due to certain identifiable definite-lived intangibleassets becoming fully amortized over the past year. In addition, we impairedcertain identifiable definite-lived intangible assets during the fourth quarterof 2008, which also contributed to the decrease in amortization expense.

 

***Facility exit and restructuring costs***

*** ***

Facility exit and restructuring costs consisted of thefollowing during the three and nine months ended September 30, 2008 and2009:

 
| ** **                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                  | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**     | ** ** |
| ** **                  | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2007  Restructuring Plan    |       | $                      | 1,159      |                   | $          | 31 |   | $ | 4,421 |   | $ | 5,446 |   |
| Legacy  Restructuring Plans |       | (81                    | )          | (128                   | )          | (252 | ) | (128 | ) |
|                        |       | $                      | 1,078      |                   | $          | (97 | ) | $ | 4,169 |   | $ | 5,318 |   |

 

*2007 Restructuring Plan.*In August 2007, we adopted a restructuring planto reduce costs and improve the efficiency of our operations. The 2007 Plan wasthe result of a comprehensive review of operations within and across ourfunctions and businesses. Under the 2007 Plan, we reduced our workforce byapproximately 900 employees, consolidated our office facilities in Atlanta,Georgia and Pasadena, California and closed office facilities in Orlando,Florida; Knoxville, Tennessee; Harrisburg, Pennsylvania; and San Francisco,California. The Plan was primarily implemented during the latter half of 2007and during 2008. As a result of the 2007 Plan, we recorded facility exit andrestructuring costs of $1.2 million and $4.4 million during the three and ninemonths ended September 30, 2008, respectively, and $5.4 million during thenine months ended September 30, 2009, which consisted primarily offacilities-related costs. Since management continues to evaluate EarthLink’sbusinesses, there have been and may continue to be supplemental provisions fornew plan initiatives as well as changes in estimates to amounts previouslyrecorded.

 

*Legacy Restructuring Plans.*During the years ended December 31, 2003, 2004 and 2005, we executeda series of plans to restructure and streamline our contact center operationsand outsource certain internal functions (collectively referred to as “LegacyPlans”). The Legacy Plans included facility exit costs, personnel-related costsand asset disposals. We periodically evaluate and adjust our estimates forfacility exit and restructuring costs based on currently-available informationand record such adjustments as facility exit and restructuring costs. Duringthe three and nine months ended September 30, 2008, we recorded a $0.1million and $0.3 million reduction, respectively, to facility exit andrestructuring costs as a result of changes in estimates for the Legacy Plans.During the three and nine months ended September 30, 2009, we recorded a$0.1 million reduction to facility exit and restructuring costs as a result ofchanges in estimates for the Legacy Plans.

 

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*** ***

***Gain on investments, net***

*** ***

Duringthe nine months ended September 30, 2008, we recognized a net gain on investmentsof $5.7 million. This consisted of a gain of $4.4 million related to the saleof HELIO to Virgin Mobile USA, Inc. and a gain of $2.0 million from thesale of our 6.1 million shares of Covad common stock to Platinum Equity, LLC,offset by an impairment loss of $0.7 million due to other-than-temporarydeclines of the value of certain long-term investments. During the nine monthsended September 30, 2009, we recognized a net gain on investments of $0.1million. This consisted of $0.2 million in cash distributions from eCompaniesVenture Group, L.P. (“EVG”), a limited partnership that invested in domesticemerging Internet-related companies, and a net gain of $0.1 million related toour auction rate securities (as described below). These transactions wererecorded as gain on investments, net, in the Condensed Consolidated Statementsof Operations.

 

As of September 30,2009, we held auction rate securities with a carrying value and fair value of$43.0 million. These securities are variable-rate debt instruments whoseunderlying agreements have contractual maturities of up to 40 years, but haveinterest rate reset periods at pre-determined intervals, usually every 28 days.These securities are predominantly secured by student loans guaranteed by staterelated higher education agencies and reinsured by the U.S. Department ofEducation. Beginning in February 2008, auctions for these securitiesfailed to attract sufficient buyers, resulting in us continuing to hold suchsecurities. In October 2008, we entered into an agreement with the brokerthat sold us our auction rate securities that gives us the right to sell ourexisting auction rate securities back to the broker at par plus accruedinterest, beginning on June 30, 2010 until July 2, 2012 (hereinreferred to as “put right”). During the nine months ended September 30,2009, the Company redeemed $9.5 million of auction rate securities at par, plusaccrued interest. We record the auction rate securities at fair value, withchanges in fair value included in earnings. We also record the put right atfair value, with changes in fair value included in earnings. The changes infair value of the put right offset the fair value changes of the auction ratesecurities. During the nine months ended September 30, 2009, we recorded a$4.7 million gain on investments related to the auction rate securities andrecorded a $4.6 million loss on investments related to the put right. The netgain of $0.1 million during the nine months ended September 30, 2009 isincluded in gain on investments, net, in the Condensed Consolidated Statementof Operations.

 

***Interest expense and other, net***

*** ***

Interest expense and other, net, is primarily comprised ofinterest expense incurred on our Convertible Senior Notes due November 15,2026 (“Notes”); interest earned on our cash, cash equivalents and marketablesecurities; and other miscellaneous income and expense items. Interest expenseand other, net, increased $1.8 million from the three months ended September 30,2008 to the three months ended September 30, 2009. Interest expense andother, net, increased $6.7 million from the nine months ended September 30,2008 to the nine months ended September 30, 2009. The increases wereprimarily due to decreases in interest earned on our cash, cash equivalents andmarketable securities, despite an increase in our average cash and marketablesecurities balance, due to lower investment yields from deteriorating financialand credit markets. Also contributing to the increase for the nine month periodwas the liquidation of our Covad debt investment, when Covad was acquired byPlatinum Equity, LLC in April 2008.

 

***Income tax provision***

*** ***

We recognized an income tax provision of $23.9 million during the ninemonths ended September 30, 2008, which consisted of $7.1 million stateincome and federal and state alternative minimum tax (“AMT”) amounts payabledue to the net operating loss carryforward limitations associated with the AMTcalculation and other current provision items, and $16.8 million for non-cashdeferred tax provisions associated with the utilization of net operating losscarryforwards. We recognized an income tax provision of $55.7 million duringthe nine months ended September 30, 2009, which consisted of $6.7 millionstate income and federal and state AMT amounts payable due to the net operatingloss carryforward limitations associated with the AMT calculation and $49.0million for non-cash deferred tax provisions associated with the utilization ofnet operating loss carryforwards.

 

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Wecontinue to maintain a partial valuation allowance against our unrealizeddeferred tax assets, which include net operating loss carryforwards.  We may recognize additional deferred taxassets in future periods when they are determined to be more likely than notrealizable. To the extent we report income in future periods, we intend to useour net operating loss carryforwards to the extent available to offset taxableincome and reduce cash outflows for income taxes.  Our ability to use our federal and state netoperating loss carryforwards and federal and state tax credit carryforwards maybe subject to restrictions attributable to equity transactions in the futureresulting from changes in ownership as defined under the Internal Revenue Code.

 

***Loss from discontinued operations, net of tax***

*** ***

Lossfrom discontinued operations, net of tax, for the three and nine months ended September 30,2008 reflects our municipal wireless broadband operations. In November 2007,management concluded that our municipal wireless broadband operations were nolonger consistent with our strategic direction and our Board of Directorsauthorized management to pursue the divestiture of our municipal wirelessbroadband assets. The municipal wireless results of operations were previouslyincluded in our Consumer Services segment. As of December 31, 2008, thedivestiture of our municipal wireless broadband assets was complete. As aresult, we did not record a loss from discontinued operations during the threeand nine months ended September 30, 2009.

 

Thefollowing table presents summarized results of operations related to ourdiscontinued operations for the three and nine months ended September 30,2008:

 
| ** **                                     | ** ** | **Three Months Ended**      | ** ** | **Nine Months Ended**       | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **September 30, 2008** | ** ** | **September 30, 2008** | ** ** |
| ** **                                     | ** ** | **(in thousands)**          | ** ** |
| ** **                                     | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Revenues                                       |       | $                           | 18         |                        | $          | 1,306 |   |
| Operating  costs and expenses                  |       | (842                        | )          | (4,534                      | )          |
| Impairment  and other costs                    |       | (128                        | )          | (6,081                      | )          |
| Income  tax benefit                            |       | 271                         |       | 871                         |       |
| Loss  from discontinued operations, net of tax |       | $                           | (681       | )                           | $          | (8,438 | ) |

 

**Goodwill andIntangible Assets**

** **

Weperform an impairment test of our goodwill and indefinite-lived intangibleassets annually during the fourth quarter of our fiscal year or when events andcircumstances indicate the indefinite-lived intangible assets might bepermanently impaired. We have identified three reporting units for evaluatinggoodwill, which are Consumer Services, New Edge and Web Hosting. During thefourth quarter of 2008, our annual impairment test concluded that goodwill andcertain intangible assets recorded as a result of our April 2006acquisition of New Edge were impaired and we recorded non-cash impairmentcharges related to the New Edge reporting unit of $64.0 million for goodwill,$3.1 million for the indefinite-lived trade name and $11.6 million for customerrelationships. The primary factor contributing to the impairment charge was thesignificant economic downturn, which resulted in management updating itslong-range financial outlook. As of the date of the last impairment test, thecarrying value of the New Edge reporting unit exceeded its estimated fair valueby approximately 55%. As of September 30, 2009, the amount of goodwillallocated to the New Edge reporting unit was $23.9 million. The fair values ofour Consumer Services and Web Hosting reporting units have historicallyexceeded the carrying values.

 

Impairmenttesting of goodwill is required at the reporting unit level and involves atwo-step process. The first step of the impairment test involves comparing theestimated fair value of our reporting units with the reporting unit’s carryingamount, including goodwill. We estimate the fair value of our reporting units usingdiscounted expected future cash flows, supported by the results of variousmarket approach valuation models. If the fair value of a reporting unit exceedsits net book value, goodwill is not impaired, and no further testing isnecessary. If the net book value of a reporting unit exceeds its fair value, weperform a second test to measure the amount of impairment loss, if any.

 

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Thekey estimates and assumptions that drive the fair value of the reporting unitinclude the discount rate, terminal growth rates and expected future cashflows.  Changes in these estimates and assumptions could materially affectthe determination of fair value for the reporting unit which could triggerimpairment or impact the amount of the impairment.  The fair value of theNew Edge reporting unit could be negatively impacted if improvements are notrealized in the recent actual operating trends that would include attractingand retaining more customers or if we experience continued softness in thesmall to medium sized business market due to the economy. As a result, we couldrecognize an additional non-cash impairment charge related to our New Edgereporting unit.

 

**Stock-BasedCompensation**

 

Wemeasure compensation cost for all stock awards at fair value on the date ofgrant and recognize compensation over the requisite service period for awardsexpected to vest. The fair value of our stock options is estimated using theBlack-Scholes valuation model, and the fair value of restricted stock units isdetermined based on the number of shares granted and the quoted price of ourcommon stock on the date of grant*.*Such value is recognized as expense over the requisite service period, net ofestimated forfeitures, using the straight-line attribution method. Forperformance-based awards, the Company recognizes expense over the requisiteservice period, net of estimated forfeitures, using the accelerated attributionmethod when it is probable that the performance measure will be achieved. Theestimate of awards that will ultimately vest requires significant judgment, andto the extent actual results or updated estimates differ from management’s currentestimates, such amounts will be recorded as a cumulative adjustment in theperiod estimates are revised. We consider many factors when estimating expectedforfeitures, including types of awards, employee class and historical employeeattrition rates. Actual results, and future changes in estimates, may differsubstantially from our current estimates.

 

Stock-basedcompensation expense was $4.6 million and $3.1 million during the three monthsended September 30, 2008 and 2009, respectively, and $14.3 million and$10.6 million during the nine months ended September 30, 2008 and 2009,respectively. Stock-based compensation expense is classified within the sameoperating expense line items as cash compensation paid to employees.Stock-based compensation expense was allocated as follows for the three andnine months ended September 30, 2008 and 2009:

 
| ** **                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                       | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(in thousands)**     | ** ** |
| Sales  and marketing             |       | $                      | 1,259      |                   | $          | 849 |   | $ | 4,083 |   | $ | 2,885 |   |
| Operations  and customer support |       | 2,197                  |       | 1,626                  |       | 6,985 |   | 5,179 |   |
| General  and administrative      |       | 1,141                  |       | 661                    |       | 3,251 |   | 2,488 |   |
|                             |       | $                      | 4,597      |                   | $          | 3,136 |   | $ | 14,319 |   | $ | 10,552 |   |

 

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** **

**Facility Exitand Restructuring Costs**

 

*2007 Plan*. * *We expect to incurfuture cash outflows for real estate obligations through 2014 related to the2007 Plan. The following table summarizes activity for the liability balancesassociated with the 2007 Plan for the years ended December 31, 2007 and2008 and for the nine months ended September 30, 2009, including changesduring the year attributable to costs incurred and charged to expense and costspaid or otherwise settled:

 
| ** **                             | ** ** | **Severance**      | ** ** | ** **     | ** ** | **Asset**       | ** ** | **Other** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|--------------------|------------|----------------|------------|-----------------|------------|-----------|------------|------------|------------|
| ** **                             | ** ** | **and Benefits**   | ** ** | **Facilities** | ** ** | **Impairments** | ** ** | **Costs** | ** ** | **Total**  | ** ** |
| ** **                             | ** ** | **(in thousands)** | ** ** |
| Balance  as of December 31, 2006  |       | $                  | —     |           | $          | —          |       | $         | —     |       | $          | — |   | $ | — |   |
| Accruals                               |       | 30,303             |       | 12,216         |       | 20,621          |       | 1,131     |       | 64,271     |       |
| Payments                               |       | (18,262            | )          | (480           | )          | —          |       | (760      | )          | (19,502    | )          |
| Non-cash  charges                      |       | —             |       | 4,388          |       | (20,621         | )          | (371      | )          | (16,604    | )          |
| Balance  as of December 31, 2007  |       | 12,041             |       | 16,124         |       | —          |       | —    |       | 28,165     |       |
| Accruals                               |       | 461                |       | 4,808          |       | 4,125           |       | —    |       | 9,394      |       |
| Payments                               |       | (12,502            | )          | (6,174         | )          | —          |       | —    |       | (18,676    | )          |
| Non-cash  charges                      |       | —             |       | 1,936          |       | (4,125          | )          | —    |       | (2,189     | )          |
| Balance  as of December 31, 2008  |       | —             |       | 16,694         |       | —          |       | —    |       | 16,694     |       |
| Accruals                               |       | —             |       | 5,400          |       | 46              |       | —    |       | 5,446      |       |
| Payments                               |       | —             |       | (3,732         | )          | —          |       | —    |       | (3,732     | )          |
| Non-cash  charges                      |       | —             |       | 392            |       | (46             | )          | —    |       | 346        |       |
| Balance  as of September 30, 2009 |       | $                  | —     |           | $          | 18,754          |       | $         | —     |       | $          | — |   | $ | 18,754 |   |

 

*Legacy Plans*. As of September 30,2009, we had $1.0 million remaining for real estate commitments associated withthe Legacy Plans. All other costs have been paid or otherwise settled. Weexpect to incur future cash outflows for real estate obligations through 2010related to the Legacy Plans.

 

**Liquidity andCapital Resources**

 

The following table sets forthsummarized cash flow data for the nine months ended September 30, 2008 and2009:

 
| ** **                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                 | ** ** | **2009** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                       | ** ** |
|                                                 |       |                                     |       |   |   |
| Net  income                                          |       | $                                        | 154,206    |   | $ | 93,849 |   |
| Non-cash  items                                      |       | 68,424                                   |       | 88,317 |   |
| Changes  in working capital                          |       | (48,053                                  | )          | (23,727 | ) |
| Net  cash provided by operating activities           |       | $                                        | 174,577    |   | $ | 158,439 |   |
|                                                 |       |                                     |       |   |   |
| Net  cash provided by (used in) investing activities |       | $                                        | 109,280    |   | $ | (50,477 | ) |
|                                                 |       |                                     |       |   |   |
| Net  cash used in financing activities               |       | $                                        | (25,145    | ) | $ | (32,252 | ) |

 

*Operatingactivities*

* *

Netcash provided by operating activities decreased during the nine months ended September 30,2009 compared to the prior year period primarily due to a decrease in revenuesas our overall subscriber base has decreased over the past year. However, thisdecrease was offset by an increase in cash resulting from reduced sales andmarketing spending, reduced back-office support costs and reduced customersupport and bad debt expense as our overall subscriber base has decreased andbecome longer tenured.

 

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Non-cashitems include items that are not expected to generate or require the use ofcash, such as depreciation and amortization relating to our network, facilitiesand intangible assets, deferred income taxes, stock-based compensation, non-cashdisposals and impairments of fixed assets, gain (loss) on investments in othercompanies, net, and accretion of debt discount and amortization of debtissuance costs. Non-cash items increased during the nine months ended September 30,2009 compared to the prior year period due to an increase in deferred incometaxes, which was partially offset by decreases in depreciation expense and losson disposals and impairments of fixed assets.

 

Changesin working capital requirements include changes in accounts receivable, prepaidand other assets, accounts payable, accrued and other liabilities and deferredrevenue. Cash used for working capital requirements decreased during the ninemonths ended September 30, 2009 compared to the prior year periodprimarily due to reduced back office support and sales and marketing spending.Also contributing to the decrease were decreases in payments resulting from the2007 Plan, from other workforce reductions and from the discontinuation of ourmunicipal wireless broadband operations.

 

*Investingactivities*

* *

Our investing activities providedcash of $109.3 million during the nine months ended September 30, 2008.This consisted of $56.9 million of sales and maturities of investments inmarketable securities, net of sales, and $57.1 million received for our Covadinvestment, offset by $3.9 million of capital expenditures. Our investingactivities used cash of $50.5 million during the nine months ended September 30,2009. This consisted primarily of $40.0 million of purchases of investments inmarketable securities, net of sales and maturities, and $10.6 million ofcapital expenditures, primarily associated with network and technology centerrelated projects.

 

*Financingactivities*

* *

Our financing activities used cashof $25.1 million during the nine months ended September 30, 2008. Thisconsisted of $31.9 million used to repurchase 3.8 million shares of our commonstock and $2.7 million for principal payments under capital lease obligations,offset by $8.0 million of proceeds from the exercise of stock options. Ourfinancing activities used cash of $32.2 million during the nine months ended September 30,2009. This consisted primarily of $22.3 million used to repurchase 3.6 millionshares of our common stock and $15.0 million for payment of dividends declaredin July 2009, offset by $5.1 million of proceeds from the exercise ofstock options.

 

**Off-BalanceSheet Arrangements**

** **

As of September 30, 2009, wedid not have any off-balance sheet arrangements that have or are reasonablylikely to have a current or future effect on our financial condition, changesin financial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources that are material to investors.

 

**Share RepurchaseProgram**

** **

TheBoard of Directors has authorized a total of $750.0 million to repurchase ourcommon stock under our share repurchase program. As of September 30, 2009,we had utilized approximately $603.2 million and had $146.8 million availableunder the current authorization. We may repurchase our common stock from timeto time in compliance with the Securities and Exchange Commission’s regulationsand other legal requirements, and subject to market conditions and otherfactors. The share repurchase program does not require us to acquire anyspecific number of shares and may be terminated by the Board of Directors atany time.

 

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**Income Taxes**

** **

Wecontinue to maintain a partial valuation allowance of $240.0 million againstour net deferred tax assets, consisting primarily of net operating losscarryforwards, and we may recognize deferred tax assets in future periods ifthey are determined to be realizable. To the extent we owe income taxes infuture periods, we intend to use our net operating loss carryforwards to theextent available to reduce cash outflows for income taxes. However, our abilityto use our net operating loss carryforwards to offset future taxable income andfuture taxes, may be subject to restrictions attributable to equitytransactions that result in changes in ownership as defined by Internal RevenueCode Section 382.

 

**Future Uses ofCash and Funding Sources**

 

*Uses of cash*. We expect to continue to use cash to retainexisting and acquire new subscribers for our services, including purchases ofsubscriber bases from other ISPs. We will also use cash to pay real estateobligations associated with facilities exited in our restructuring plans andfor workforce reduction initiatives. We expect to incur capital expenditures tomaintain and upgrade our network and technology infrastructure. The actualamount of capital expenditures may fluctuate due to a number of factors whichare difficult to predict and could change significantly over time.Additionally, technological advances may require us to make capitalexpenditures to develop or acquire new equipment or technology in order toreplace aging or technologically obsolete equipment. We also expect to use cashto pay dividends on our common stock and restricted stock units. In July 2009and October 2009, our Board of Directors approved quarterly cash dividendson our common stock. The Board of Directors also approved the payment of cashdividend amounts on each outstanding restricted stock unit. We currently intendto pay regular quarterly dividends on our common stock. Any decision to declarefuture dividends will be made at the discretion of the board of directors andwill depend on, among other things, our results of operations, financialcondition, cash requirements, investment opportunities and other factors theBoard of Directors may deem relevant. Finally, we may also use cash to invest in or acquire other companies,to repurchase common stock, to repurchase Notes or in connection with holders’conversion of Notes. Although we continue to consider and evaluate potentialinvestments or acquisitions that could create shareholder value, there can beno assurance that we will be able to consummate any such transaction. We alsocontinue to evaluate potential capital return strategies.

 

Ourcash requirements depend on numerous factors, including the pricing of ouraccess services, our ability to maintain our customer base, the costs requiredto maintain our network infrastructure, the size and types of acquisitions inwhich we may engage, and the level of resources used for our sales andmarketing activities, among others.

 

*Sources of cash*. Ourprincipal sources of liquidity are our cash, cash equivalents and investmentsin marketable securities, as well as the cash flow we generate from ouroperations. During the nine months ended September 30, 2009, we generated$158.4 million in cash from operations. As of September 30, 2009, we had$562.3 million in cash and cash equivalents. In addition, we held short- andlong-term marketable securities valued at $90.8 million and $1.8 million, respectively.Short-term marketable securities consist of investments that have maturitydates of up to one year from the balance sheet date, and long-term marketablesecurities consist of investments that have maturity dates of more than oneyear from the balance sheet date. Short-term marketable securities also include$43.0 million of auction rate securities. These securities are variable-ratedebt instruments whose underlying agreements have contractual maturities of upto 40 years. The securities are issued by various state related highereducation agencies and predominantly secured by student loans guaranteed by theagencies and reinsured by the United States Department of Education. Liquidityfor these auction rate securities is typically provided by an auction processthat resets the applicable interest rate at pre-determined intervals, usuallyevery 28 days. Beginning in February 2008, all of our auction ratesecurities failed to attract sufficient buyers, resulting in our continuing tohold such securities. In October 2008, we entered into an agreement withthe broker that sold us our auction rate securities that gives us the right tosell our existing auction rate securities back to the broker at par plusaccrued interest, beginning on June 30, 2010 until July 2, 2012. Theagreement also grants the broker the right to buy our auction rate securitiesat par plus accrued interest, until July 2, 2012. Based on our remainingcash and marketable securities and operating cash flows, we do not anticipatethe current lack of liquidity on these investments will affect our ability tooperate our business as usual.

 

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Weexpect to generate positive cash flows from operations during the year ended December 31,2009. Our available cash and marketable securities, together with our resultsof operations, are expected to be sufficient to meet our operating expenses,capital requirements, dividend payments and investment and other obligationsfor the next 12 months. However, as a result of other investment activities andpossible acquisition opportunities, we may seek additional financing in thefuture. We have no commitments for any additional financing and have no linesof credit or similar sources of financing. We cannot be sure that we can obtainadditional financing on favorable terms, if at all, through the issuance ofequity securities or the incurrence of additional debt. Additional equityfinancing may dilute our stockholders, and debt financing, if available, mayrestrict our ability to repurchase common stock or debt, declare and paydividends and raise future capital. If we are unable to obtain additionalneeded financing, it may prohibit us from making acquisitions, capitalexpenditures and/or investments, which could materially and adversely affectour prospects for long-term growth.

 

**Recently Issued Accounting Pronouncement**

** **

In September 2009,the Financial Accounting Standards Board (“FASB”) issued new guidance onrevenue recognition. The new guidance addresses the accounting formultiple-deliverable arrangements to enable vendors to account for products orservices (deliverables) separately rather than as a combined unit and to modifythe manner in which the transaction consideration is allocated across theseparately identifiable deliverables and how revenue is recognized. The newguidance also significantly expands the disclosure requirements formultiple-element arrangements. The new guidance is effective prospectively forrevenue arrangements entered into or materially modified in fiscal yearsbeginning on or after June 15, 2010. We do not expect the adoption of thenew guidance to have a material impact on our financial statements.

 

**Adoption ofRecent Accounting Pronouncements**

 

*Codification*. In thethird quarter of 2009, we adopted the FASB Accounting Standards Codification (“ASC”).The ASC became the single official source of authoritative U.S. generallyaccepted accounting principles (“GAAP”) recognized by the FASB, other thanguidance issued by the Securities and Exchange Commission. The adoption of theASC did not have a material impact on our financial statements. However, theadoption of the ASC changed our references to GAAP in our consolidatedfinancial statements.

 

*Convertible Debt*. OnJanuary 1, 2009, we adopted new accounting guidance related to accountingfor convertible debt instruments that may be settled in cash upon conversion,which was codified in ASC Subtopic 470-20, “Debt With Conversion and OtherOptions.” The new accounting guidance requires that the liability and equitycomponents of convertible debt instruments that may be settled in cash uponconversion (including partial cash settlement) be separately accounted for in amanner that reflects an issuer’s non-convertible debt borrowing rate. Theresulting debt discount is accreted over the period the convertible debt isexpected to be outstanding as additional non-cash interest expense. Retrospectiveapplication to all periods presented is required except for instruments thatwere not outstanding during any of the periods that will be presented in theannual financial statements for the period of adoption but were outstandingduring an earlier period. The adoption of this new guidance on January 1,2009 affected the accounting for our Notes, which were issued in November 2006.Upon adoption, we recorded an adjustment to increase additional paid-in capitalas of the November 2006 issuance date by approximately $62.1 million. Weare accreting the resulting debt discount to interest expense over theestimated five-year life of the Notes, which represents the first redemptiondate of November 2011. We recorded a pre-tax adjustment of approximately$22.3 million to retained earnings that represents the debt discount accretionduring the years ended December 31, 2006, 2007 and 2008 and will recognizeadditional non-cash interest expense of $12.2 million, $13.4 million and $12.4million during the years ending December 31, 2009, 2010 and 2011,respectively, for accretion of the debt discount. As a result of the adoptionof this new guidance, we reduced income from continuing operations and netincome for the three months ended September 30, 2009 by $3.1 million andreduced basic and diluted earnings per share by $0.03 per share, and reducedincome from continuing operations and net income for the nine months ended September 30,2009 by $9.0 million and reduced basic and diluted earnings per share by $0.08per share. We also recorded a deferred tax liability for temporary taxdifferences. However, this was offset by a corresponding decrease in thevaluation allowance for deferred tax assets.

 

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The following tables present theeffect of the new guidance on our affected financial statement line items forthe three and nine months ended September 30, 2008 and as of December 31,2008:

 
| ** **                                | ** ** | **Three Months Ended September 30,  2008** | ** ** | **Nine Months Ended September 30,  2008** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                | ** ** | **As Originally**                               | ** ** | **As**                                         | ** ** | **Effect of** | ** ** | **As Originally** | ** ** | **As** | ** ** | **Effect of** | ** ** |
| ** **                                | ** ** | **Reported**                                    | ** ** | **Adjusted**                                   | ** ** | **Change** | ** ** | **Reported** | ** ** | **Adjusted** | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **(in thousands, except per share data)**       | ** ** |
| Statement  of Operations:                 |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Interest  income (expense) and other, net |       | $                                               | (490       | )                                              | $          | (3,281 | ) | $ | (2,791 | ) | $ | 366 |   | $ | (7,804 | ) | $ | (8,170 | ) |
| Income  from continuing operations        |       | 55,367                                          |       | 52,576                                         |       | (2,791 | ) | 170,814 |   | 162,644 |   | (8,170 | ) |
| Net  income                               |       | 54,686                                          |       | 51,895                                         |       | (2,791 | ) | 162,376 |   | 154,206 |   | (8,170 | ) |
|                                      |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Basic  net income per share               |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Continuing  operations                    |       | $                                               | 0.50       |                                           | $          | 0.48 |   | $ | (0.03 | ) | $ | 1.55 |   | $ | 1.48 |   | $ | (0.07 | ) |
| Basic  net income per share               |       | 0.50                                            |       | 0.47                                           |       | (0.03 | ) | 1.48 |   | 1.40 |   | (0.07 | ) |
|                                      |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Diluted  net income per share             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Continuing  operations                    |       | $                                               | 0.49       |                                           | $          | 0.47 |   | $ | (0.02 | ) | $ | 1.53 |   | $ | 1.46 |   | $ | (0.07 | ) |
| Diluted  net income per share             |       | 0.49                                            |       | 0.46                                           |       | (0.02 | ) | 1.46 |   | 1.38 |   | (0.07 | ) |

 
| ** **                  | ** ** | **As of December 31, 2008** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **As Originally**                | ** ** | **As** | ** ** | **Effect of** | ** ** |
| ** **                  | ** ** | **Reported**                     | ** ** | **Adjusted** | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **(in thousands)**               | ** ** |
| Balance  Sheet:             |       |                             |       |   |   |   |   |
| Other  long-term assets     |       | $                                | 5,725      |   | $ | 4,698 |   | $ | (1,027 | ) |
| Long-term  debt             |       | 258,750                          |       | 219,733 |   | (39,017 | ) |
| Additional  paid-in capital |       | 2,075,571                        |       | 2,135,887 |   | 60,316 |   |
| Accumulated  deficit        |       | (994,507                         | )          | (1,016,833 | ) | (22,326 | ) |
|                             |            |                                  |            |  |  |  |  |  |  |  |

 

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**Safe Harbor Statement**

 

TheManagement’s Discussion and Analysis and other portions of this QuarterlyReport on Form   10-Q include “forward-looking”statements (rather than historical facts) that are subject to risks anduncertainties that could cause actual results to differ materially from thosedescribed. Although we believe that the expectations expressed in theseforward-looking statements are reasonable, we cannot promise that ourexpectations will turn out to be correct. Our actual results could bematerially different from and worse than our expectations. With respect to suchforward-looking statements, we seek the protections afforded by the PrivateSecurities Litigation Reform Act of 1995. These risks include, withoutlimitation, (1) that the continued decline of our consumer accesssubscribers, combined with the change in mix of our consumer access subscriberbase from narrowband to broadband, will adversely affect our results ofoperations and we will have less ability in the future to implement offsettingcost reductions; (2) that we face significant competition which could reduceour profitability; (3) that adverse economic conditions may harm ourbusiness; (4) that as a result of our continuing review of our business,we may have to undertake further restructuring plans that would requireadditional charges, including incurring facility exit and restructuringcharges; (5) that if we do not continue to innovate and provide productsand services that are useful to subscribers, we may not remain competitive, andour revenues and operating results could suffer; (6) that we may be unsuccessfulin making and integrating acquisitions and investments into our business, whichcould result in operating difficulties, losses and other adverse consequences; (7) thatour business is dependent on the availability of third-party telecommunicationsservice providers; (8) that our commercial and alliance arrangements maynot be renewed, which could adversely affect our results of operations; (9) thatour business may suffer if third parties used for customer service andtechnical support and certain billing services are unable to provide theseservices or terminate their relationships with us; (10) that serviceinterruptions or impediments could harm our business; (11) that governmentregulations could adversely affect our business or force us to change ourbusiness practices; (12) that privacy concerns relating to our business coulddamage our reputation and deter current and potential users from using ourservices;  (13) that we may not be ableto protect our intellectual property; (14) that we may be accused of infringingupon the intellectual property rights of third parties, which is costly todefend and could limit our ability to use certain technologies in the future;(15) that we could face substantial liabilities if we are unable to successfullydefend against legal actions; (16) that our business depends on effectivebusiness support systems, processes and personnel; (17) that we may be unableto hire and retain sufficient qualified personnel, and the loss of any of ourkey executive officers could adversely affect us; (18) that our VoIP businessexposes us to certain risks that could cause us to lose customers, expose us tosignificant liability or otherwise harm our business; (19) that we may berequired to recognize additional impairment charges on our goodwill andintangible assets, which would adversely affect our results of operations andfinancial position; (20) that we may have exposure to greater than anticipatedtax liabilities and the use of our net operating losses and certain other taxattributes could be limited in the future; (21) that our stock price has beenvolatile historically and may continue to be volatile; (22) that we may reduce,or cease payment of, quarterly dividends; (23) that our indebtedness couldadversely affect our financial health and limit our ability to react to changesin our industry; and (24) that provisions of our second restated certificate ofincorporation, amended and restated bylaws and other elements of our capitalstructure could limit our share price and delay a change of management. Theserisks and uncertainties, as well as other risks and uncertainties that couldcause our actual results to differ significantly from management’sexpectations, are not intended to represent a complete list of all risks anduncertainties inherent in our business, and should be read in conjunction withthe more detailed cautionary statements and risk factors included in our AnnualReport on Form 10-K for the year ended December 31, 2008.

 

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**Item 3.   Quantitative andQualitative Disclosures About Market Risk.**

 

There have been no material changesin market risk from the information provided in Part II, Item 7A “Quantitativeand Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-Kfor the year ended December 31, 2008.

* *

**Item 4. Controls and Procedures.**

 

**Evaluation ofDisclosure Controls and Procedures**

** **

Pursuantto Rule 13a-15(b) under the Securities Exchange Act of 1934, asamended (the “Exchange Act”), we carried out an evaluation, with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of our disclosure controls andprocedures (as defined under Rule 13a-15(e) under the Exchange Act)as of the end of the period covered by this report.  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective to ensure that information required to bedisclosed in the reports that are filed or submitted under the Exchange Act, isrecorded, processed, summarized and reported, within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, and that suchinformation is accumulated and communicated to management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure.

 

**Changes inInternal Control over Financial Reporting**

** **

Therewere no changes in our internal control over financial reporting during thethree months ended September 30, 2009 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

**Part II**

** **

**Item 1.    Legal Proceedings.**

** **

EarthLink is a party to various legal proceedings that are ordinary andincidental to its business. Management does not expect that any currentlypending legal proceedings will have a material adverse effect on EarthLink’sresults of operations or financial position.

 

**Item 1A.  Risk Factors.**

** **

There were no material changes from the risk factors disclosed inEarthLink’s Annual Report on Form 10-K for the year ended December 31,2008 and in EarthLink’s Quarterly Report on Form 10-Q for the quarterended June 30, 2009.

 

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**Item 5.  Other Information.**

** **

None.

 

**Item 6.   Exhibits.**

** **

(a)   Exhibits.  Thefollowing exhibits are filed as part of this report**:**

** **

31.1    Certification ofChief Executive Officer pursuant to Securities Exchange Act Rules 13a-14and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002.

 

31.2    Certification ofChief Financial Officer pursuant to Securities Exchange Act Rules 13a-14and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002.

 

32.1    Certification ofChief Executive Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2    Certification ofChief Financial Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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#### **SIGNATURES**

#### ** **

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|   |                                                                                             | EARTHLINK,  INC.                              |
|--------|--------------------------------------------------------------------------------------------------|-----------------------------------------------|
|   |                                                                                             |                                          |
|   |                                                                                             |                                          |
| Date:  | October 30, 2009                                                                            |                                          | /s/  ROLLA P. HUFF |
|   | Rolla  P. Huff, Chairman of the Board and Chief Executive Officer (principal executive  officer) |
|   |                                                                                             |
|   |                                                                                             |
| Date:  | October 30, 2009                                                                            |                                          | /s/  BRADLEY A. FERGUSON |
|   |                                                                                             | Bradley  A. Ferguson, Chief Financial Officer |
|   |                                                                                             | (principal financial  and accounting officer) |

 

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