Tableof Contents

 

 

 

**UNITED STATES SECURITIES ANDEXCHANGE 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 March 31, 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 andformer fiscal year, if changed since last report date)

 

----

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of thischapter) during the preceding 12 months (or for such shorter period that theregistrant was required to submit and post such files).  Yes o  No o

 

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

Large accelerated filer x    Accelerated filer o      Non-acceleratedfiler 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 April 30,2009, 105,694,831 shares of common stock, $.01 par value per share, wereoutstanding.

 

 

 

----

Table of Contents

** **

**EARTHLINK, INC.**

**Quarterly Report on Form 10-Q**

**For the Quarterly Period Ended March 31,2009**

** **

**TABLE OF CONTENTS**

** **
| **Part I**                                                                                     |       |
|-----------------------------------------------------------------------------------------------------|------------|
|                                                                                                |       |
| Item 1.  Financial Statements                                                                       | 1          |
|                                                                                                |       |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 21         |
|                                                                                                |       |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 | 40         |
|                                                                                                |       |
| Item 4. Controls and Procedures                                                                     | 41         |
|                                                                                                |       |
| **Part II**                                                                                    | ** ** |
| ** **                                                                                          | ** ** |
| Item 1. Legal Proceedings                                                                           | 41         |
|                                                                                                |       |
| Item 1A. Risk Factors                                                                               | 41         |
|                                                                                                |       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                | 41         |
|                                                                                                |       |
| Item 5. Other Information                                                                           | 42         |
|                                                                                                |       |
| Item  6. Exhibits                                                                                   | 42         |
|                                                                                                |       |
| Signatures                                                                                          | 43         |

 

----

Table of Contents

** **

**PART I**

 

**Item 1.  Financial Statements.**

 

**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                                                                        | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                                                        | ** ** | **2008**              | ** ** | **2009**           | ** ** |
| ** **                                                                                                                                                                                                                                                                        | ** ** | ** **            | ** ** | **(unaudited)**    | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                        |       |
| Current assets:                                                                                                                                                                                                                                                                   |       |                  |       |               |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                        |       | $                     | 486,564    |               | $          | 471,510 |   |
| Accounts  receivable, net of allowance of $4,048 and $3,275 as of December 31,  2008 and March 31, 2009, respectively                                                                                                                                                   |       | 30,569                |       | 24,952             |       |
| Marketable  securities                                                                                                                                                                                                                                                            |       | —                |       | 40,575             |       |
| Prepaid expenses                                                                                                                                                                                                                                                                  |       | 6,445                 |       | 6,802              |       |
| Deferred income  taxes, net                                                                                                                                                                                                                                                       |       | 20,254                |       | 15,858             |       |
| Other current  assets                                                                                                                                                                                                                                                             |       | 15,452                |       | 11,652             |       |
| Total current  assets                                                                                                                                                                                                                                                             |       | 559,284               |       | 571,349            |       |
| Long-term  marketable securities                                                                                                                                                                                                                                                  |       | 47,809                |       | 53,756             |       |
| Long-term  investments                                                                                                                                                                                                                                                            |       | 20,708                |       | 19,473             |       |
| Property and  equipment, net                                                                                                                                                                                                                                                      |       | 37,246                |       | 35,293             |       |
| Deferred income  taxes, net                                                                                                                                                                                                                                                       |       | 43,757                |       | 29,596             |       |
| Purchased  intangible assets, net                                                                                                                                                                                                                                                 |       | 19,552                |       | 17,405             |       |
| Goodwill                                                                                                                                                                                                                                                                          |       | 112,812               |       | 112,812            |       |
| Other long-term  assets                                                                                                                                                                                                                                                           |       | 4,698                 |       | 4,147              |       |
| Total assets                                                                                                                                                                                                                                                                      |       | $                     | 845,866    |               | $          | 843,831 |   |
|                                                                                                                                                                                                                                                                              |       |                  |       |               |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                     |       |
| Current  liabilities:                                                                                                                                                                                                                                                             |       |                  |       |               |       |
| Accounts payable                                                                                                                                                                                                                                                                  |       | $                     | 13,109     |               | $          | 17,732 |   |
| Accrued payroll  and related expenses                                                                                                                                                                                                                                             |       | 37,470                |       | 17,083             |       |
| Other accrued  liabilities                                                                                                                                                                                                                                                        |       | 39,415                |       | 41,192             |       |
| Deferred revenue                                                                                                                                                                                                                                                                  |       | 33,649                |       | 31,189             |       |
| Total current  liabilities                                                                                                                                                                                                                                                        |       | 123,643               |       | 107,196            |       |
|                                                                                                                                                                                                                                                                              |       |                  |       |               |       |
| Long-term debt,  net of discount of $39,017 and $35,999 as of December 31, 2008 and  March 31, 2009, respectively                                                                                                                                                       |       | 219,733               |       | 222,751            |       |
| Other long-term  liabilities                                                                                                                                                                                                                                                      |       | 16,015                |       | 13,787             |       |
| Total  liabilities                                                                                                                                                                                                                                                                |       | 359,391               |       | 343,734            |       |
|                                                                                                                                                                                                                                                                              |       |                  |       |               |       |
| Stockholders’  equity:                                                                                                                                                                                                                                                       |       |                  |       |               |       |
| Convertible  preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued  and outstanding as of December 31, 2008 and March 31, 2009                                                                                                                   |       | —                |       | —             |       |
| Common stock,  $0.01 par value, 300,000 shares authorized, 188,264 and 188,969 shares issued  as of December 31, 2008 and March 31, 2009, respectively, and  108,516 and 105,629 shares outstanding as of December 31, 2008 and March 31,  2009, respectively |       | 1,883                 |       | 1,890              |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                       |       | 2,135,887             |       | 2,138,114          |       |
| Accumulated  deficit                                                                                                                                                                                                                                                              |       | (1,016,833            | )          | (984,336           | )          |
| Treasury stock,  at cost, 79,748 and 83,340 shares as of December 31, 2008 and  March 31, 2009, respectively                                                                                                                                                            |       | (634,420              | )          | (656,760           | )          |
| Unrealized  (losses) gains on investments                                                                                                                                                                                                                                         |       | (42                   | )          | 1,189              |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                                  |       | 486,475               |       | 500,097            |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                                  |       | $                     | 845,866    |               | $          | 843,831 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

1

----

Table of Contents

 

**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                             | ** ** | **Three Months Ended March 31,**               | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                           | ** ** | **2009** | ** ** |
| ** **                                             | ** ** | **(in thousands, except per share data)** | ** ** |
| ** **                                             | ** ** | **(unaudited)**                                                    | ** ** |
|                                                   |       |                                                               |       |   |   |
| Revenues                                               |       | $                                                                  | 263,074    |   | $ | 199,063 |   |
|                                                   |       |                                                               |       |   |   |
| Operating costs  and expenses:                         |       |                                                               |       |   |   |
| Cost of revenues                                       |       | 97,551                                                             |       | 75,565 |   |
| Sales and  marketing                                   |       | 30,916                                                             |       | 17,022 |   |
| Operations and  customer support                       |       | 39,224                                                             |       | 27,746 |   |
| General and  administrative                            |       | 24,926                                                             |       | 18,622 |   |
| Amortization of  intangible assets                     |       | 4,013                                                              |       | 2,147 |   |
| Facility exit  and restructuring costs                 |       | 1,030                                                              |       | 488 |   |
| Total operating  costs and expenses                    |       | 197,660                                                            |       | 141,590 |   |
|                                                   |       |                                                               |       |   |   |
| Income from  operations                                |       | 65,414                                                             |       | 57,473 |   |
| Gain on  investments, net                              |       | —                                                             |       | 259 |   |
| Interest expense  and other, net                       |       | (1,041                                                             | )          | (4,291 | ) |
| Income from  continuing operations before income taxes |       | 64,373                                                             |       | 53,441 |   |
| Income tax  provision                                  |       | (9,274                                                             | )          | (20,944 | ) |
| Income from  continuing operations                     |       | 55,099                                                             |       | 32,497 |   |
| Loss from  discontinued operations                     |       | (3,392                                                             | )          | — |   |
| Net income                                             |       | $                                                                  | 51,707     |   | $ | 32,497 |   |
|                                                   |       |                                                               |       |   |   |
| Basic net income  per share                            |       |                                                               |       |   |   |
| Continuing  operations                                 |       | $                                                                  | 0.50       |   | $ | 0.30 |   |
| Discontinued  operations                               |       | (0.03                                                              | )          | — |   |
| Basic net income  per share                            |       | $                                                                  | 0.47       |   | $ | 0.30 |   |
| Basic weighted  average common shares outstanding      |       | 109,493                                                            |       | 108,071 |   |
|                                                   |       |                                                               |       |   |   |
| Diluted net  income per share                          |       |                                                               |       |   |   |
| Continuing  operations                                 |       | $                                                                  | 0.50       |   | $ | 0.30 |   |
| Discontinued  operations                               |       | (0.03                                                              | )          | — |   |
| Diluted net  income per share                          |       | $                                                                  | 0.47       |   | $ | 0.30 |   |
| Diluted weighted  average common shares outstanding    |       | 110,300                                                            |       | 109,168 |   |

 

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

 

2

----

Table of Contents

 

**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**               | ** ** |
| ** **                                                                         | ** ** | **2008**                         | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**          | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                  | ** ** |
| Cash flows from  operating activities:                                             |       |                             |       |   |   |
| Net income                                                                         |       | $                                | 51,707     |   | $ | 32,497 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                             |       |   |   |
| Depreciation and  amortization                                                     |       | 10,519                           |       | 6,509 |   |
| Loss on  disposals and impairments of fixed assets                                 |       | 2,370                            |       | 61 |   |
| Stock-based compensation                                                           |       | 5,152                            |       | 4,390 |   |
| Deferred income  taxes                                                             |       | 7,219                            |       | 18,512 |   |
| Accretion of  debt discount and amortization of debt issuance costs                |       | 3,028                            |       | 3,301 |   |
| Gain on  investments, net                                                          |       | —                           |       | (259 | ) |
| Decrease in  accounts receivable, net                                              |       | 1,223                            |       | 5,617 |   |
| (Increase)  decrease in prepaid expenses and other assets                          |       | (6,674                           | )          | 3,789 |   |
| Decrease in  accounts payable and accrued and other liabilities                    |       | (29,852                          | )          | (17,884 | ) |
| Decrease in  deferred revenue                                                      |       | (2,959                           | )          | (2,609 | ) |
| Net cash  provided by operating activities                                         |       | 41,733                           |       | 53,924 |   |
|                                                                               |       |                             |       |   |   |
| Cash flows from  investing activities:                                             |       |                             |       |   |   |
| Purchases of  property and equipment                                               |       | (278                             | )          | (3,133 | ) |
| Purchases of  subscriber bases                                                     |       | (117                             | )          | — |   |
| Purchases of  marketable securities                                                |       | (53,027                          | )          | (44,075 | ) |
| Sales and  maturities of marketable securities                                     |       | 86,059                           |       | — |   |
| Other investing  activities                                                        |       | 87                               |       | 200 |   |
| Net cash  provided by (used in) investing activities                               |       | 32,724                           |       | (47,008 | ) |
|                                                                               |       |                             |       |   |   |
| Cash flows from  financing activities:                                             |       |                             |       |   |   |
| Principal  payments under capital lease obligations                                |       | (145                             | )          | (8 | ) |
| Proceeds from  exercises of stock options                                          |       | 1,943                            |       | 378 |   |
| Repurchases of  common stock                                                       |       | (9,125                           | )          | (22,340 | ) |
| Net cash used in  financing activities                                             |       | (7,327                           | )          | (21,970 | ) |
|                                                                               |       |                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | 67,130                           |       | (15,054 | ) |
| Cash and cash  equivalents, beginning of period                                    |       | 173,827                          |       | 486,564 |   |
| Cash and cash  equivalents, end of period                                          |       | $                                | 240,957    |   | $ | 471,510 |   |

 

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

 

3

----

Tableof Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED**

** **

**1.  Organization**

** **

EarthLink, Inc. (“EarthLink”or the “Company”) is an Internet service provider (“ISP”), providing nationwideInternet access and related value-added services to individual and businesscustomers. The Company’s primary service offerings are dial-up and high-speedInternet access services and related value-added services, such as ancillaryservices sold as add-on features to the Company’s Internet access services,search and advertising. In addition, through the Company’s wholly-ownedsubsidiary, New Edge Networks (“New Edge”), the Company builds and managesprivate IP-based wide area networks for businesses and communications carriers.

 

The Company operates two reportablesegments, Consumer Services and Business Services. The Company’s ConsumerServices segment provides Internet access and related value-added services to individualcustomers. These services include dial-up and high-speed Internet access and voice-over-Internetprotocol (“VoIP”) 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. For further information concerning the Company’sbusiness segments, see Note 14, “Segment Information.”

 

**2. ****Summary of Significant AccountingPolicies**

* *

*Basis ofPresentation*

* *

Thecondensed consolidated financial statements of EarthLink, which include theaccounts of its wholly-owned subsidiaries, for the three months ended March 31,2008 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.

 

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 threemonths ended March 31, 2009 are not necessarily indicative of the resultsanticipated 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 thoseestimates.

 

*Discontinued Operations*

* *

Inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” the Companyreflected its municipal wireless broadband results of operations asdiscontinued operations for the three months ended March 31, 2008. SeeNote 5, “Discontinued Operations,” for further discussion.

 

*Reclassifications*

* *

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

 

4

----

Table of Contents

* *

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

* *

*Adoption of Recent Accounting Pronouncement*

* *

On January 1,2009, the Company adopted Financial Accounting Standards Board (“FASB”) StaffPosition No. APB 14-1, “Accounting for Convertible Debt Instruments that May beSettled in Cash Upon Conversion” (“FSP APB 14-1”). FSP APB 14-1 requires thatthe liability and equity components of convertible debt instruments that may besettled in cash upon conversion (including partial cash settlement) beseparately accounted for in a manner that reflects an issuer’s non-convertibledebt borrowing rate. The resulting debt discount is accreted over the periodthe convertible debt is expected to be outstanding as additional non-cashinterest expense. Retrospective application to all periods presented isrequired. The adoption of FSP APB 14-1 on January 1, 2009 affected theaccounting 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 FSP APB14-1, the Company reduced income from continuing operations and net income forthe three months ended March 31, 2009 by $2.9 million and reduced basicand diluted earnings per share by $0.03 per share. The Company also recorded adeferred tax liability for temporary differences resulting from the applicationof FASB Statement No. 109, “Accounting for Income Taxes.” However, thiswas offset by a corresponding decrease in the valuation allowance for deferredtax assets.

 

The following tables present theeffect of the adoption of FSP APB 14-1 on the Company’s affected financialstatement line items for the three months ended March 31, 2008 and as of December 31,2008:

 

| ** **                                | ** ** | **Three Months Ended March 31, 2008**     | ** ** |
|-------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                | ** ** | **As Originally**                                             | ** ** | **As** | ** ** | **Effect of** | ** ** |
| ** **                                | ** ** | **Reported**                                                       | ** ** | **Adjusted** | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **(in thousands, except per share data)** | ** ** |
| Statement of  Operations:                 |       |                                                               |       |   |   |   |   |
| Interest income  (expense) and other, net |       | $                                                                  | 1,616      |   | $ | (1,041 | ) | $ | (2,657 | ) |
| Income from  continuing operations        |       | 57,756                                                             |       | 55,099 |   | (2,657 | ) |
| Net income                                |       | 54,364                                                             |       | 51,707 |   | (2,657 | ) |
|                                      |       |                                                               |       |   |   |   |   |
| Basic net income  per share               |       |                                                               |       |   |   |   |   |
| Continuing  operations                    |       | $                                                                  | 0.53       |   | $ | 0.50 |   | $ | (0.02 | ) |
| Basic net income  per share               |       | 0.50                                                               |       | 0.47 |   | (0.02 | ) |
|                                      |       |                                                               |       |   |   |   |   |
| Diluted net  income per share             |       |                                                               |       |   |   |   |   |
| Continuing  operations                    |       | $                                                                  | 0.52       |   | $ | 0.50 |   | $ | (0.02 | ) |
| Diluted net  income per share             |       | 0.49                                                               |       | 0.47 |   | (0.02 | ) |

 

5

----

Tableof Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

| ** **                  | ** ** | **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**

* *

Netincome per share has been computed according to SFAS No. 128, “Earningsper Share,” which requires a dual presentation of basic and diluted earningsper share (“EPS”). Basic EPS represents net income divided by the weightedaverage number of common shares outstanding during a reported period. DilutedEPS reflects the potential dilution that could occur if securities or othercontracts to issue common stock, including stock options, warrants, restrictedstock units, phantom share units and convertible debt (collectively “CommonStock Equivalents”), were exercised or converted into common stock. Thedilutive effect of outstanding stock options, warrants, restricted stock unitsand convertible debt is reflected in diluted earnings per share by applicationof the treasury stock method. Phantom share units are reflected on anif-converted basis. In applying the treasury stock method for stock-basedcompensation arrangements, the assumed proceeds are computed as the sum of theamount the employee must pay upon exercise and the amounts of averageunrecognized compensation cost attributed to future services.

 

Thefollowing table sets forth the computation for basic and diluted net income pershare for the three months ended March 31, 2008 and 2009:

 
| ** **                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                          | ** ** | **2008**                                             | ** ** | **2009** | ** ** |
| ** **                                          | ** ** | **(in thousands,**                              | ** ** |
| ** **                                          | ** ** | **except per share data)**            | ** ** |
| **Numerator**                                       | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Income from  continuing operations                  |       | $                                                    | 55,099     |   | $ | 32,497 |   |
| Loss from  discontinued operations                  |       | (3,392                                               | )          | — |   |
| Net income                                          |       | $                                                    | 51,707     |   | $ | 32,497 |   |
|                                                |       |                                                 |       |   |   |
| **Denominator**                                     |       |                                                 |       |   |   |
| Basic weighted  average common shares outstanding   |       | 109,493                                              |       | 108,071 |   |
| Dilutive effect  of Common Stock Equivalents        |       | 807                                                  |       | 1,097 |   |
| Diluted weighted  average common shares outstanding |       | 110,300                                              |       | 109,168 |   |
|                                                |       |                                                 |       |   |   |
| **Basic  net income per share**                     |       |                                                 |       |   |   |
| Continuing  operations                              |       | $                                                    | 0.50       |   | $ | 0.30 |   |
| Discontinued  operations                            |       | (0.03                                                | )          | — |   |
| Basic net income  per share                         |       | $                                                    | 0.47       |   | $ | 0.30 |   |
|                                                |       |                                                 |       |   |   |
| **Diluted  net income per share**                   |       |                                                 |       |   |   |
| Continuing  operations                              |       | $                                                    | 0.50       |   | $ | 0.30 |   |
| Discontinued  operations                            |       | (0.03                                                | )          | — |   |
| Diluted net  income per share                       |       | $                                                    | 0.47       |   | $ | 0.30 |   |

 

6

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

Duringthe three months ended March 31, 2008 and 2009, approximately 10.1 millionand 6.7 million, respectively, stock options and restricted stock units wereexcluded from the calculation of diluted EPS because the exercise pricesplus the amount of unrecognized compensation cost attributed to future servicesexceeded the Company’s average stock price during the respective periods.Approximately 28.4 million shares that underlie the Company’s convertible debtinstruments were also excluded from the calculation of diluted EPS because theexercise price exceeded the Company’s average stock price during the periods.These securities could be dilutive in future periods.

 

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

** **

Facility exit and restructuringcosts consisted of the following during the three months ended March 31,2008 and 2009:

 

| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                             | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**                              | ** ** |
| ** **                  | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| 2007  Restructuring Plan    |       | $                                                    | 1,093      |   | $ | 488 |   |
| Legacy  Restructuring Plans |       | (63                                                  | )          | — |   |
|                        |       | $                                                    | 1,030      |   | $ | 488 |   |

 

*2007 Restructuring Plan*

* *

In August 2007, EarthLink adopted a restructuringplan (the “2007 Plan”) to reduce costs and improve the efficiency of theCompany’s operations. The 2007 Plan was the result of a comprehensive review ofoperations within and across the Company’s functions and businesses. Under the2007 Plan, the Company reduced its workforce by approximately 900 employees,closed office facilities in Orlando, Florida; Knoxville, Tennessee; Harrisburg,Pennsylvania; and San Francisco, California and consolidated its office facilities in Atlanta, Georgia and Pasadena,California. The 2007 Plan was implemented during the latter half of 2007 andcompleted during the year ended December 31, 2008. Management continues toevaluate EarthLink’s businesses and, therefore, there may be supplementalprovisions for new plan initiatives as well as changes in estimates to amountspreviously recorded.

 

Thefollowing table summarizes facility exit and restructuring costs during thethree months ended March 31, 2008 and 2009 and the cumulative costsincurred to date as a result of the 2007 Plan. Such costs have been classifiedas facility exit and restructuring costs in the Condensed ConsolidatedStatements of Operations.

 
| ** **                                      | ** ** | ** **                                           | ** ** | ** **   | ** ** | **Cumulative**   | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|--------------|------------|------------------|------------|
| ** **                                      | ** ** | ** **                                           | ** ** | ** **   | ** ** | **Costs**        | ** ** |
| ** **                                      | ** ** | **Three Months Ended March 31,** | ** ** | **Incurred** | ** ** |
| ** **                                      | ** ** | **2008**                                             | ** ** | **2009**     | ** ** | **To Date** | ** ** |
|                                            |       | **(in thousands)**                                   |       |
|                                            |       |                                                 |       |         |       |             |       |
| Severance and  personnel-related costs          |       | $                                                    | 367        |         | $          | —           |       | $ | 30,764 |   |
| Lease  termination and facilities-related costs |       | —                                               |       | 488          |       | 17,512           |       |
| Non-cash asset  impairments                     |       | 286                                                  |       | —       |       | 24,753           |       |
| Other associated  costs                         |       | 440                                                  |       | —       |       | 1,124            |       |
|                                            |       | $                                                    | 1,093      |         | $          | 488              |       | $ | 74,153 |   |

 

7

----

Tableof Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL 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 thethree months ended March 31, 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                              |       | —                  |       | 488            |       | —          |       | —    |       | 488        |       |
| Payments                              |       | —                  |       | (1,359         | )          | —          |       | —    |       | (1,359     | )          |
| Non-cash charges                      |       | —                  |       | —         |       | —          |       | —    |       | —     |       |
| Balance as of  March 31, 2009    |       | $                       | —     |           | $          | 15,823          |       | $         | —     |       | $          | — |   | $ | 15,823 |   |

 

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 are classified as other long-termliabilities in the Condensed Consolidated Balance Sheets. Of the unpaid balanceas of December 31, 2008 and March 31, 2009, approximately $5.9million and $6.6 million, respectively, was classified as other accruedliabilities and approximately $10.8 million and $9.2 million, respectively, wasclassified 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 our contact center operations andoutsource certain internal functions (collectively referred to as “Legacy Plans”).The Legacy Plans included facility exit costs, personnel-related costs andasset disposals. EarthLink periodically evaluates and adjusts its estimates forfacility exit and restructuring costs based on currently-available information.Such adjustments are included as facility exit and restructuring costs in theCondensed Consolidated Statements of Operations. During the three months ended March 31,2008, EarthLink recorded a $0.1 million reduction to facility exit andrestructuring costs as a result of changes in estimates for legacyrestructuring plans. As of March 31, 2009, the Company had a $1.3 millionliability remaining for real estate commitments related to Legacy Plans, ofwhich $0.8 million was classified as other accrued liabilities and $0.5 millionwas classified as other long-term liabilities in the Condensed ConsolidatedBalance Sheet. All other costs have been paid.

 

8

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL 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.

 

The following table presentssummarized results of operations related to the Company’s discontinuedoperations for the three months ended March 31, 2008:

 

| ** **                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **March 31, 2008**     | ** ** |
| ** **                          | ** ** | **(in thousands)**          | ** ** |
| ** **                          | ** ** | ** **                       | ** ** |
| Revenues                            |       | $                                | 737        |   |
| Operating costs  and expenses       |       | (2,180                           | )          |
| Impairment and  restructuring costs |       | (1,949                           | )          |
| Loss from  discontinued operations  |       | (3,392                           | )          |
|                                     |            |                                  |            |  |

 

**6.  Investments**

** **

*Marketable Securities*

* *

Marketablesecurities are accounted for in accordance with SFAS No. 115, “Accountingfor Certain Investments in Debt and Equity Securities.” All investments withoriginal maturities greater than 90 days are classified as marketablesecurities. Marketable securities with maturities less than one year from thebalance 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-terminvestments in marketable securities as of December 31, 2008 and March 31,2009 also included investments in asset-backed, auction rate securities withinterest rate reset periods of 90 days or less but whose underlying agreementshave original maturities of more than 90 days.

 

As of March 31,2009, $40.6 million of the Company’s short-term marketable securities and $3.5million of the Company’s long-term marketable securities consisted ofgovernment agency notes and were classified as available-for-sale. Grossunrealized gains on these securities as of March 31, 2009 were $0.1million and there were no gross unrealized losses. As of March 31, 2009,$50.3 million of the Company’s long-term marketable securities consisted ofauction rate securities and 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 began classifying these securities as long-termmarketable securities in the Condensed Consolidated Balance Sheet due touncertainty surrounding the timing of a market recovery.

 

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 (herein referred to as “putright”). 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

 

9

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

value included in earnings, as the Company no longerintends to hold the securities until maturity. The Company also elected aone-time transfer of its auction rate securities from the available-for-salecategory to the trading category. The Company also records the value of the putright at fair value, with changes in fair value included in earnings, as theCompany elected the fair value option under SFAS No. 159, “The Fair ValueOption for Financial Assets and Financial Liabilities,” for the put right tooffset the fair value changes of the auction rate securities. The fair value ofthe put right is estimated using a discounted cash flow analysis. During thethree months ended March 31, 2009, the Company recorded a $2.4 milliongain on investments to record the auction rate securities at their fair valueand recorded a $2.4 million loss on investments to record the put right at itsfair value. The net gain of $0.1 million during the three months ended March 31,2009 is included in gain on investments, net, in the Condensed ConsolidatedStatement of Operations.

 

*Investments*

** **

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

 
| ** **                        | ** ** | **As of**          | ** ** | **As of**     | ** ** |
|-----------------------------------|------------|-------------------------|------------|--------------------|------------|
| ** **                        | ** ** | **December 31,**   | ** ** | **March 31,** | ** ** |
| ** **                        | ** ** | **2008**                | ** ** | **2009**           | ** ** |
| ** **                        | ** ** | **(in thousands)** | ** ** |
| Investments  stated at fair value |       | $                       | 11,408     |               | $          | 10,173 |   |
| Investments  stated at cost       |       | 9,300                   |       | 9,300              |       |
| Total long-term  investments      |       | $                       | 20,708     |               | $          | 19,473 |   |

 

Long-terminvestments in the Condensed Consolidated Balance Sheets consist of investmentsin other companies and the Company’s put right. Investments in other companiesare accounted for under the cost method of accounting because the Company doesnot have the ability to exercise significant influence over the companies’operations. Under the cost method of accounting, investments in privatecompanies are carried at cost and are only adjusted for other-than-temporarydeclines in fair value and distributions of earnings. For cost methodinvestments in public companies that have readily determinable fair values, theCompany classifies its investments as available-for-sale in accordance withSFAS No. 115 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 March 31, 2009,gross unrealized gains on available-for-sale investments were $1.1 million andthere were no gross unrealized losses. As of December 31, 2008, gross unrealized losses onavailable-for-sale investments were nominal and there were no gross unrealized gains.

 

TheCompany has a right to sell its existing auction rate securities back to thebroker, which is classified as a long-term investment in the CondensedConsolidated Balance Sheets. The Company elected the fair value option underSFAS No. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities,” for the put right and records the put right at fair value, withchanges in fair value recognized in the Condensed Consolidated Statement ofOperations. The fair value of the put right is estimated using a discountedcash flow analysis.

 

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.

 

10

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**UNAUDITED -(Continued)**

 

During the three months ended March 31,2009, the Company recognized a 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*

* *

There were no changes in thecarrying amount of goodwill during the three months ended March 31, 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 March 31, 2009:

 
| ** **                                      | ** ** | **As of December 31, 2008** | ** ** | **As of March 31, 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 |   | $ | (79,769 | ) | $ | 14,270 |   |
| Software,  technology and other                 |       | 739                                             |       | (649                                         | )          | 90 |   | 739 |   | (709 | ) | 30 |   |
| Trade names                                     |       | 1,521                                           |       | (304                                         | )          | 1,217 |   | 1,521 |   | (380 | ) | 1,141 |   |
|                                            |       | 96,299                                          |       | (78,711                                      | )          | 17,588 |   | 96,299 |   | (80,858 | ) | 15,441 |   |
| Intangible  assets not subject to amortization: |       |                                            |       |                                         |       |   |   |   |   |   |   |   |   |
| Trade names                                     |       | 1,964                                           |       | —                                       |       | 1,964 |   | 1,964 |   | — |   | 1,964 |   |
|                                            |       | $                                               | 98,263     |                                         | $          | (78,711 | ) | $ | 19,552 |   | $ | 98,263 |   | $ | (80,858 | ) | $ | 17,405 |   |

 

Amortizationof intangible assets in the Condensed Consolidated Statements of Operations forthe three months ended March 31, 2008 and 2009 represents the amortizationof definite-lived intangible assets.  TheCompany’s definite-lived intangible assets primarily consist of subscriberbases and customer relationships, acquired software and technology, trade namesand other assets acquired in conjunction with the purchases of businesses andsubscriber bases from other companies that are not deemed to have indefinitelives. The Company’s identifiable indefinite-lived intangible assets consist ofcertain trade names. Definite-lived intangible assets are amortized on astraight-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 March 31, 2009, the weighted average amortization periodswere 4.2 years for subscriber base assets and customer relationships, 3.3 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 $5.6 million during the remaining ninemonths in the year ending December 31, 2009 and $4.1 million, $2.9million, $1.5 million, $0.8 million and $0.5 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.

 

11

----

Table of Contents

** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

** **

**8.  Long-Term Debt**

 

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 based on an initial conversion rate, subject toadjustment, of 109.6491 shares per $1,000 principal amount of Notes (whichrepresents an initial conversion price of approximately $9.12 per share). Uponconversion, a holder will receive cash up to the principal amount of the Notesand, at the Company’s option, cash, or shares of the Company’s common stock ora combination of cash and shares of common stock for the remainder, if any, ofthe conversion obligation. The conversion obligation is based on the sum of the“daily settlement amounts” for the 20 consecutive trading days that beginon, and include, the second trading day after the day the notes are surrenderedfor conversion. The Notes will be convertible only in the followingcircumstances: (1) during any calendar quarter after the calendar quarterending December 31, 2006 (and only during such calendar quarter), if theclosing sale price of the Company’s common stock for each of 20 or more tradingdays in a period of 30 consecutive trading days ending on the last trading dayof the immediately preceding calendar quarter exceeds 130% of the conversionprice in effect on the last trading day of the immediately preceding calendarquarter; (2) during the five consecutive business days immediately afterany five consecutive trading day period in which the average trading price per$1,000 principal amount of Notes was equal to or less than 98% of the averageconversion value of the Notes during the note measurement period; (3) uponthe occurrence of specified corporate transactions; (4) if the Company hascalled the Notes for redemption; and (5) at any time from, and including, October 15,2011 to, and including, 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.

 

On January 1,2009, the Company adopted FSP APB 14-1, which requires that the liability andequity components of convertible debt instruments that may be settled in cashupon conversion (including partial cash settlement) be separately accounted forin a manner 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. Theadoption of FSP APB 14-1 on January 1, 2009 affected the accounting forthe Company’s 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, $39.1 million and $219.7 million, respectively. As ofMarch 31, 2009, the principal amount of the Notes, the unamortizeddiscount and the net carrying value was $258.8 million, $36.0 million and$222.8 million, respectively. As of December 31, 2008 and March 31,2009, the fair value of the Notes was approximately $236.6 million and $252.1million, respectively, based on the quoted market prices.

 

12

----

Table of Contents

** **

**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 in accordance with SFAS No. 130, “ReportingComprehensive Income.” Comprehensive income for the three months ended March 31,2008 and 2009 was as follows:

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **March 31,**     | ** ** |
| ** **                                                | ** ** | **2008**               | ** ** | **2009** | ** ** |
| ** **                                                | ** ** | **(in thousands)**     | ** ** | ** ** | ** ** |
| Net income                                                |       | $                      | 51,707     |   | $ | 32,497 |   |
| Unrealized  holding (losses) gains on certain investments |       | (257                   | )          | 1,231 |   |
| Total comprehensive  income                               |       | $                      | 51,450     |   | $ | 33,728 |   |

 

*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 March 31, 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 and 3.6 million shares, respectively, of itscommon stock for $9.1 million and $22.3 million, respectively, during the threemonths ended March 31, 2008 and 2009.

 

**10.  Stock-Based Compensation**

** **

TheCompany accounts for stock-based compensation pursuant to SFAS No. 123(R),“Share-Based Payment,” which requires measurement of compensation cost for allstock awards at fair value on the date of grant and recognition of compensationexpense over the requisite service period for awards expected to vest. TheCompany estimates the fair value of stock options using the Black-Scholesvaluation model, and determines the fair value of restricted stock units basedon the number of shares granted and the quoted price of EarthLink’s commonstock on the date of grant*.* Suchvalue 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 the Company’scurrent estimates, such amounts will be recorded as a cumulative adjustment inthe period estimates are revised. The Company considers many factors whenestimating expected forfeitures, including types of awards, employee class andhistorical employee attrition rates. Actual results, and future changes inestimates, may differ substantially from the Company’s current estimates.

 

Stock-basedcompensation expense under SFAS No. 123(R) was $5.2 million and $4.4million during the three months ended March 31, 2008 and 2009,respectively.  In accordance with StaffAccounting Bulletin No. 107, “Share-Based Payment,” the Company hasclassified stock-based compensation expense during the three months ended March 31,2008 and 2009 within the same operating expense line items as cash compensationpaid to employees.

 

13

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

*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 EarthLink, Inc.common stock on the date of grant, have a term of ten years or less, and vestover terms of four to six years from the date of grant. Restricted stock unitsare granted with various vesting terms that range from one to six years fromthe date of grant.

 

*OptionsOutstanding*

 

The following table summarizesinformation concerning stock option activity as of and for the three monthsended March 31, 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                                              |       | (63                                   | )          | 5.80         |       |             |       |          |       |
| Forfeited and  expired                                 |       | (366                                  | )          | 13.36        |       |             |       |          |       |
| Outstanding as  of March 31, 2009                 |       | 6,730                                 |       | 9.41         |       | 5.9              |       | $             | 476        |   |
| Vested and  expected to vest as of March 31, 2009 |       | 6,395                                 |       | $            | 9.51       |             | 5.8        |          | $          | 476 |   |
| Exercisable as  of March 31, 2009                 |       | 5,136                                 |       | $            | 9.90       |             | 5.3        |          | $          | 476 |   |

 

The aggregate intrinsic valueamounts in the table above represent the closing price of the Company’s commonstock on March 31, 2009 in excess of the exercise price, multiplied by thenumber of stock options outstanding or exercisable, when the closing price isgreater 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 March 31, 2009. The total intrinsic value of options exercisedduring the three months ended March 31, 2008 and 2009 was $0.5 million and$0.1 million, respectively. The intrinsic value of stock options exercisedrepresents the difference between the Company’s common stock at the time ofexercise and the exercise price, multiplied by the number of stock optionsexercised. To the extent the forfeiture rate is different than what the Companyhas anticipated, stock-based compensation related to these awards will bedifferent from the Company’s expectations.

 

14

----

Tableof Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

Thefollowing table summarizes the status of the Company’s stock options as of March 31,2009:

 

| **Stock Options Outstanding** | ** ** | **Stock Options  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 |   | 760 |   | 5.1 |   | $ | 6.04 |   | 603 |   | $ | 5.83 |   |
| 6.90                          |       | to                             |       | 7.25 |   | 771 |   | 7.8 |   | 6.97 |   | 368 |   | 6.96 |   |
| 7.31                          |       | to                             |       | 7.31 |   | 1,500 |   | 8.2 |   | 7.31 |   | 1,050 |   | 7.31 |   |
| 7.32                          |       | to                             |       | 8.96 |   | 606 |   | 6.5 |   | 8.15 |   | 404 |   | 8.27 |   |
| 9.01                          |       | to                             |       | 9.24 |   | 574 |   | 5.6 |   | 9.05 |   | 540 |   | 9.03 |   |
| 9.48                          |       | to                             |       | 9.89 |   | 738 |   | 5.0 |   | 9.56 |   | 480 |   | 9.60 |   |
| 10.06                         |       | to                             |       | 10.06 |   | 411 |   | 1.4 |   | 10.06 |   | 411 |   | 10.06 |   |
| 10.36                         |       | to                             |       | 48.61 |   | 1,370 |   | 4.3 |   | 15.37 |   | 1,280 |   | 15.71 |   |
| $                             | 5.10       |                           | to         |   | $ | 48.61 |   | 6,730 |   | 5.9 |   | $ | 9.41 |   | 5,136 |   | $ | 9.90 |   |

* *

*RestrictedStock Units*

* *

The following table summarizes theCompany’s restricted stock units as of and for the three months ended March 31,2009:

 
| ** **                              | ** ** | ** **         | ** ** | **Weighted**   | ** ** |
|-----------------------------------------|------------|--------------------|------------|----------------|------------|
| ** **                              | ** ** | ** **         | ** ** | **Average**    | ** ** |
| ** **                              | ** ** | **Restricted**     | ** ** | **Grant Date** | ** ** |
| ** **                              | ** ** | **Stock Units**    | ** ** | **Fair Value** | ** ** |
| ** **                              | ** ** | **(in thousands)** | ** ** | ** **     | ** ** |
| Nonvested as of  December 31, 2008 |       | 4,123              |       | $              | 7.20       |   |
| Granted                                 |       | 190                |       | 6.74           |       |
| Vested                                  |       | (962               | )          | 7.04           |       |
| Forfeited                               |       | (215               | )          | 7.18           |       |
| Nonvested as of  March 31, 2009    |       | 3,136              |       | 7.22           |       |
|                                         |            |                    |            |                |            |  |

 

The fair value of restricted stockunits is determined based on the closing price of EarthLink’s common stock onthe grant date. The weighted-average grant date fair value of restricted stockunits granted during the three months ended March 31, 2008 and 2009 was$7.16 and $6.74, respectively. As of March 31, 2009, there was $12.2million of total unrecognized compensation cost related to nonvested restrictedstock units. That cost is expected to be recognized over a weighted-averageperiod of 1.9 years. The total fair value of shares vested during the threemonths ended March 31, 2008 and 2009 was $0.4 million and $7.0 million,respectively, which represents the closing price of the Company’s common stockon the vesting date multiplied by the number of restricted stock units thatvested.

 

15

----

Table of Contents

** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

** **

**11. Income Taxes**

 

EarthLinkrecorded an income tax provision of $9.3 million and $20.9 million during thethree months ended March 31, 2008 and 2009, respectively. The income taxprovision for the three months ended March 31, 2008 and 2009 was based onmanagement’s current expectations in accordance with the interim reportingrequirements of SFAS No. 109, “Accounting for Income Taxes,” AccountingPrinciples Board (“APB”) Opinion No. 28, “Interim Financial Reporting,”and FASB Interpretation No. 18 “Accounting for Income Taxes in InterimPeriods — an interpretation of APB Opinion No. 28.”

 

Themajor components of the income tax provision for the three months ended March 31,2008 and 2009 are as follows:

 
| ** **                       | ** ** | **Three Months Ended** | ** ** |
|----------------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **March 31,**     | ** ** |
| ** **                       | ** ** | **2008**               | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(in thousands)**     | ** ** |
|                             |       |                   |       |   |   |
| Federal  alternative minumum tax |       | $                      | 1,204      |   | $ | 1,033 |   |
| State income tax                 |       | 786                    |       | 1,354 |   |
| Other                            |       | (520                   | )          | — |   |
| Current  provision               |       | 1,470                  |       | 2,387 |   |
|                             |       |                   |       |   |   |
| Deferred  provision              |       | 7,804                  |       | 18,557 |   |
|                             |       |                   |       |   |   |
| Total                            |       | $                      | 9,274      |   | $ | 20,944 |   |

 

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, in accordance with SFAS No. 109, it would more likely than notbe able to utilize due to the generation of sufficient taxable income in 2009.For the three months ended March 31, 2009, the non-cash deferred taxprovision recorded was primarily a result of the utilization of these federaland state net operating loss tax assets. The current tax federal and state liabilities are payable as a result oflimitations on net operating loss utilization associated with the alternativeminimum tax calculation and state laws.

 

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 incomeand reduce cash outflows for income taxes.  The Company’s ability to useits federal and state net operating loss carryforwards and federal and statetax credit carryforwards may be subject to restrictions attributable to equitytransactions in the future resulting from changes in ownership as defined underthe Internal Revenue Code.

 

On January 1,2007, EarthLink adopted Financial Interpretation (“FIN”) No. 48.  TheCompany has identified its federal tax return and its state tax returns inCalifornia, Florida, Georgia and Illinois as “major” tax jurisdictions, asdefined in FIN No. 48.  Periods extending back to 1994 are stillsubject to examination for all “major” jurisdictions. The adoption of FIN No. 48on January 1, 2007 did not result in a material cumulative-effectadjustment. The Company believes that its income tax filing positions anddeductions will be sustained on audit and does not anticipate any adjustmentsthat will result in a material adverse effect on the Company’s financialcondition, results of operations or cash flows.  The Company’s policy forrecording interest and 

 

16

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

penalties associated with audits is to record suchitems as a component of income taxes.  Noadjustments were made to the FIN No. 48 liability during the quarter.

 

**13.  Fair Value Measurements**

** **

SFAS No. 157,“Fair Value Measurements,” defines fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date (an exitprice). SFAS No. 157 establishes a three-tier fair value hierarchy, whichprioritizes the inputs used in measuring fair value.  These tiersinclude: Level 1, defined as observable inputs such as quoted prices in activemarkets; Level 2, defined as inputs other than quoted prices in active marketsthat are either directly or indirectly observable; and Level 3, defined asunobservable inputs in which little or no market data exists, thereforerequiring an entity to develop its own assumptions.

 

As of March 31,2009, 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 put right.

 

Thefollowing table presents the Company’s assets measured at fair value on arecurring basis subject to the disclosure requirements of SFAS No. 157 asof March 31, 2009:

** **
| ** **                             | ** ** | ** **              | ** ** | **Fair Value Measurements as of March 31, 2009 Using** | ** ** |
|----------------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **              | ** ** | **Quoted Prices in**                                        | ** ** | **Significant Other** | ** ** | **Significant** | ** ** |
| ** **                             | ** ** | ** **              | ** ** | **Active Markets for**                                      | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                             | ** ** | **Balance as of**       | ** ** | **Identical Assets**                                        | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**                        | ** ** | **March 31, 2009** | ** ** | **(Level 1)**                                               | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| ** **                             | ** ** | **(in thousands)**      | ** ** |
| Cash equivalents                       |       | $                       | 448,331    |                                                        | $          | 448,331 |   | $ | — |   | $ | — |   |
| Marketable  securities                 |       | 44,075                  |       | 44,075                                                      |       | — |   | — |   |
| Auction rate  securities               |       | 50,256                  |       | —                                                      |       | — |   | 50,256 |   |
| Equity  investments in other companies |       | 2,732                   |       | 417                                                         |       | 2,315 |   | — |   |
| Put right                              |       | 7,441                   |       | —                                                      |       | — |   | 7,441 |   |
| Total                                  |       | $                       | 552,835    |                                                        | $          | 492,823 |   | $ | 2,315 |   | $ | 57,697 |   |

** **

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 Mobilepartnership units is valued using quoted prices for similar assets and isclassified within Level 2. Investments in auction rate securities areclassified within Level 3 because they are valued using a discounted cash flowmodel. Some of the inputs to this model are unobservable in the market and aresignificant. The Company’s put right is estimated using a discounted cash flowanalysis and is classified within Level 3. The Company has consistently appliedthese valuation techniques in 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 March 31, 2009 were estimated utilizing adiscounted cash flow analysis.  These analyses consider, among otheritems, the collateralization underlying the security investments, thecreditworthiness of the counterparty, and the timing and value of expectedfuture cash flows.  These securities were also compared, whenpossible, to other observable market data with similar characteristics to thesecurities held 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 

 

17

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

plus accrued interest, beginning on June 30,2010 until July 2, 2012. The Company recorded the value of the put rightto long-term investments in its Condensed Consolidated Balance Sheet andelected the fair value option under SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities,” for the put right to offsetthe fair value changes of the auction rate securities. The fair value of theput right is estimated using a discounted cash flow analysis and is classifiedwithin Level 3.

 

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 defined in SFAS No. 157 as ofMarch 31, 2009:

 
| ** **                           | ** ** | **Auction**        | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|--------------------|------------|------------|------------|------------|------------|
| ** **                           | ** ** | **Rate**           | ** ** | **Put**    | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Securities**     | ** ** | **Right**  | ** ** | **Total**  | ** ** |
| ** **                           | ** ** | **(in thousands)** | ** ** |
| **Balance  as of December 31, 2008** |       | $                  | 47,809     |       | $          | 9,828      |       | $ | 57,637 |   |
| Total realized  gains                |       | 2,447              |       | —     |       | 2,447      |       |
| Total realized  losses               |       | —             |       | (2,387     | )          | (2,387     | )          |
| **Balance  as of March 31, 2009**    |       | $                  | 50,256     |       | $          | 7,441      |       | $ | 57,697 |   |

 

Duringthe three months ended March 31, 2009, the Company recorded a realizedgain of $2.4 million to record its auction rate securities at their fair valueand recorded a realized loss of $2.4 million to record its put right at itsfair value, which are included in gain on investments, net, in the CondensedConsolidated Statement of Operations. The entire amount of realized gains and losses relate to assets stillheld as of March 31, 2009.

 

**14.  Segment Information**

** **

In accordance with SFAS No. 131,“Disclosures about Segments of an Enterprise and Related 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, site operations expenses, product developmentexpenses, certain technology and facilities expenses, billing operations andprovisions for doubtful accounts. Segment income from operations excludes otherincome and expense items and certain expenses over which segment managers donot have discretionary control. Costs excluded from segment income fromoperations include various corporate expenses (consisting of certain costs suchas corporate management, human resources, finance and legal), amortization ofintangible assets, impairment of goodwill and intangible assets, facility exitand restructuring costs, and stock-based compensation expense under SFAS No. 123(R),as they are not considered in the measurement of segment performance.

 

18

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

Information on reportable segments and a reconciliation to consolidatedincome from operations for the three months ended March 31, 2008 and 2009is as follows:

 

| ** **                             | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|
| ** **                             | ** ** | **2008**                              | ** ** | **2009** | ** ** |
| ** **                             | ** ** | **(in thousands)**                    | ** ** |
| **Consumer Services**                  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Revenues                               |       | $                                     | 216,344    |   | $ | 159,562 |   |
| Cost of revenues                       |       | 71,173                                |       | 52,334 |   |
| Gross margin                           |       | 145,171                               |       | 107,228 |   |
| Direct segment  operating expenses     |       | 61,001                                |       | 37,206 |   |
| Segment  operating income              |       | $                                     | 84,170     |   | $ | 70,022 |   |
|                                   |       |                                  |       |   |   |
| **Business Services**                  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Revenues                               |       | $                                     | 46,730     |   | $ | 39,501 |   |
| Cost of revenues                       |       | 26,378                                |       | 23,231 |   |
| Gross margin                           |       | 20,352                                |       | 16,270 |   |
| Direct segment  operating expenses     |       | 14,871                                |       | 11,259 |   |
| Segment  operating income              |       | $                                     | 5,481      |   | $ | 5,011 |   |
|                                   |       |                                  |       |   |   |
| **Consolidated**                       | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Revenues                               |       | $                                     | 263,074    |   | $ | 199,063 |   |
| Cost of revenues                       |       | 97,551                                |       | 75,565 |   |
| Gross margin                           |       | 165,523                               |       | 123,498 |   |
| Direct segment  operating expenses     |       | 75,872                                |       | 48,465 |   |
| Segment  operating income              |       | 89,651                                |       | 75,033 |   |
| Stock-based  compensation expense      |       | 5,152                                 |       | 4,390 |   |
| Amortization of  intangible assets     |       | 4,013                                 |       | 2,147 |   |
| Facility exit  and restructuring costs |       | 1,030                                 |       | 488 |   |
| Other operating  expenses              |       | 14,042                                |       | 10,535 |   |
| Income from  operations                |       | $                                     | 65,414     |   | $ | 57,473 |   |

 

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 to customersfor dial-up Internet access; monthly fees charged for high-speed accessservices; 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.

 

19

----

Table of Contents

 

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

Informationon revenues by groups of similar services and by segment for the three monthsended March 31, 2008 and 2009 is as follows:

 

| ** **            | ** ** | **Three Months Ended** | ** ** |
|-----------------------|------------|------------------------|------------|
| ** **            | ** ** | **March 31,**     | ** ** |
| ** **            | ** ** | **2008**               | ** ** | **2009** | ** ** |
| ** **            | ** ** | **(in thousands)**     | ** ** |
| **Consumer Services** | ** ** | ** **             | ** ** | ** ** | ** ** |
| Access and  service   |       | $                      | 188,971    |   | $ | 139,790 |   |
| Value-added  services |       | 27,373                 |       | 19,772 |   |
| Total revenues        |       | $                      | 216,344    |   | $ | 159,562 |   |
|                  |       |                   |       |   |   |
| **Business Services** | ** ** | ** **             | ** ** | ** ** | ** ** |
| Access and  service   |       | $                      | 45,878     |   | $ | 38,908 |   |
| Value-added  services |       | 852                    |       | 593 |   |
| Total revenues        |       | $                      | 46,730     |   | $ | 39,501 |   |
|                  |       |                   |       |   |   |
| **Consolidated**      | ** ** | ** **             | ** ** | ** ** | ** ** |
| Access and  service   |       | $                      | 234,849    |   | $ | 178,698 |   |
| Value-added  services |       | 28,225                 |       | 20,365 |   |
| Total revenues        |       | $                      | 263,074    |   | $ | 199,063 |   |

 

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,pursuant to SFAS No. 131, 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.

 

20

----

Tableof Contents

** **

**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. Importantfactors that could cause actual results to differ from estimates or projectionscontained in the forward-looking statements are described under “Safe HarborStatement” in this Item 2.

* *

*The following discussion should be read in conjunction with the accompanyingunaudited Condensed Consolidated Financial Statements and related Notes theretoand with “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and the audited Consolidated Financial Statements andthe Notes thereto contained in the Annual Report on Form 10-K for the yearended 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.

 

We operate two reportable segments,Consumer Services and Business Services. Our Consumer Services segment providesInternet access and related value-added services to individual customers. Theseservices include dial-up and high-speed Internet access and voice-over-InternetProtocol (“VoIP”) services, among others. Our Business Services segment providesintegrated communications services, dedicated Internet access and relatedvalue-added services to businesses and communications carriers. These servicesinclude managed private IP-based wide area networks, dedicated Internet accessand web hosting, among others.

 

*BusinessStrategy*

* *

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

 

·                  *CustomerRetention*. We are focused on retaining our existing tenuredcustomers. We believe focusing on the customer relationship increases loyaltyand reduces churn.  We also believe thatthese tenured customers provide cost benefits, including reduced call centersupport costs and reduced bad debt expense. We continue to focus on offeringour access services with high-quality customer service and technical 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 costsand streamlining our internal processes 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 acceptable rate of returnand increase the number of subscribers we add through alliances, partnerships

 

21

----

Table of Contents

 

and acquisitions from other ISPs. We also continue to evaluate potential strategic transactions that couldcomplement our business.

 

Inresponse to declining revenues, changes in our industry and changes in consumerbehavior, we implemented a restructuring plan (“the 2007 Plan”) to reduceoperating costs and improve the efficiency of our organization. Under the 2007Plan, we significantly reduced employees, closed or consolidated certainfacilities, discontinued certain projects and reduced sales and marketingefforts. The 2007 Plan was implemented during 2007 and completed during 2008.The strategies noted above represent the future plans for our business. 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. The factors we believe are instrumental to the achievement of ourbusiness strategy may be subject to competitive, regulatory and other eventsand circumstances that are beyond our control. Further, we can provide noassurance that we will be successful in achieving any or all of the strategiesidentified above, that the achievement or existence of such strategies willfavorably impact profitability, or that other factors will not arise that wouldadversely 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, email by phone, Internet call waiting, email storage andhome networking; search revenues; and advertising revenues.

 

Narrowbandaccess revenues consist of monthly fees charged to customers for dial-upInternet access. Broadband access revenues consist of fees charged forhigh-speed access services; fees charged for managing private IP-basednetworks; fees charged for VoIP services; usage fees; activation fees;termination fees; fees for equipment; and regulatory surcharges billed tocustomers. Web hosting revenues consist of fees charged for leasing serverspace and providing web services to customers wishing to have a web ore-commerce presence. Value-added services revenues consist of monthly feescharged for ancillary services; fees charged for paid placements for searches;delivering traffic to EarthLink’s partners in the form of subscribers, page viewsor e-commerce transactions; advertising EarthLink partners’ products andservices in EarthLink’s various online properties and electronic 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. Thischange has resulted in a decrease in gross subscriber additions, which weexpect will continue. However, we expect the rate of revenue decline todecrease as our subscriber base becomes more tenured. We experienced animprovement in consumer subscriber churn rates during the three 

 

22

----

Table of Contents

 

monthsended March 31, 2009 compared to the prior year period. However, ourconsumer access services are discretionary and dependent upon levels ofconsumer spending. Unfavorable economic conditions could cause customers toslow spending in the future, which could adversely affect our revenues andchurn, and we may not be able to align our cost structure with a decline in ourrevenue.

 

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 an economic downturn. We may experiencepressure on revenue and churn rates for our business services, especially giventhe state of the economy. However, we will seek to align our cost structurewith trends in our revenue.

 

Werecognized an impairment charge of $78.7 million during the fourth quarter of2008 related to our Business Services segment in conjunction with our annualtest of goodwill and intangible assets. The primary factor contributing to theimpairment charge was the recent significant economic downturn, which resultedin management updating its long-range financial outlook. As the ongoingexpected cash flows and carrying amounts of our remaining goodwill and otherintangible assets are assessed, changes in economic conditions, changes to ourbusiness strategy, changes in operating performance or other indicators ofimpairment, could cause us to realize an additional impairment charge.

 

*First Quarter2009 Highlights*

* *

Totalrevenues decreased $64.0 million, or 24%, from the three months ended March 31,2008 to the three months ended March 31, 2009, as our subscriber basedecreased from approximately 3.6 million paying subscribers as of March 31,2008 to approximately 2.6 million paying subscribers as of March 31, 2009.The decrease in subscribers was attributable to the change in our businessstrategy to reduce sales and marketing activities, as well as the continuingmaturation of the narrowband Internet access market. Operating expensesdecreased during the three months ended March 31, 2009 compared to theprior year period primarily due to a reduction in costs to acquire new subscribersand a decrease in support costs due to fewer customers and a more tenuredsubscriber base. We recognized net income of $51.7 million during the threemonths ended March 31, 2008 compared to net income of $32.5 million duringthe three months ended March 31, 2009. The decrease in net income was dueto the decrease in revenues and an increase in our income tax provision, offsetby the decrease in total operating costs and expenses.

 

23

----

Table of Contents

 

**Key OperatingMetrics**

** **

We utilize certain non-financial and operatingmeasures to assess our financial performance. Terms such as churn and averagerevenue per user (“ARPU”) are terms commonly used in our industry. Thefollowing table sets forth subscriber and operating data for the periodsindicated:

** **
| ** **                                  | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                  | ** ** | **2008**                | ** ** | **2008**              | ** ** | **2009**           | ** ** |
| **Subscriber Data (a)**                     | ** ** | ** **              | ** ** | ** **            | ** ** | ** **         | ** ** |
| **Consumer Services**                       | ** ** | ** **              | ** ** | ** **            | ** ** | ** **         | ** ** |
| Narrowband  access subscribers              |       | 2,368,000               |       | 1,747,000             |       | 1,587,000          |       |
| Broadband access  subscribers (b)           |       | 1,026,000               |       | 896,000               |       | 856,000            |       |
| Total consumer  services                    |       | 3,394,000               |       | 2,643,000             |       | 2,443,000          |       |
| **Business Services**                       | ** ** | ** **              | ** ** | ** **            | ** ** | ** **         | ** ** |
| Narrowband  access subscribers              |       | 25,000                  |       | 17,000                |       | 14,000             |       |
| Broadband access  subscribers               |       | 65,000                  |       | 59,000                |       | 57,000             |       |
| Web hosting  accounts                       |       | 97,000                  |       | 87,000                |       | 84,000             |       |
| Total business  services                    |       | 187,000                 |       | 163,000               |       | 155,000            |       |
| **Total subscriber count at end of period** |       | 3,581,000               |       | 2,806,000             |       | 2,598,000          |       |
| ** **                                  | ** ** | ** **              | ** ** | ** **            | ** ** |
| ** **                                  | ** ** | **Three  Months Ended** | ** ** | ** **            | ** ** |
| ** **                                  | ** ** | **March 31,**      | ** ** | ** **            | ** ** |
| ** **                                  | ** ** | **2008**                | ** ** | **2009**              | ** ** | ** **         | ** ** |
| **Subscriber  Activity**                    | ** ** | ** **              | ** ** | ** **            | ** ** | ** **         | ** ** |
| Subscribers at  beginning of period         |       | 3,876,000               |       | 2,806,000             |       |               |       |
| Gross organic  subscriber additions         |       | 253,000                 |       | 116,000               |       |               |       |
| Adjustment (c)                              |       | —                  |       | (7,000                | )          |               |       |
| Churn                                       |       | (548,000                | )          | (317,000              | )          |               |       |
| Subscribers at  end of period               |       | 3,581,000               |       | 2,598,000             |       |               |       |
|                                        |       |                    |       |                  |       |               |       |
| **Churn  rate (d)**                         |       | 4.9                     | %          | 3.9                   | %          |               |       |
|                                        |       |                    |       |                  |       |               |       |
| **Consumer  Services Data**                 | ** ** | ** **              | ** ** | ** **            | ** ** | ** **         | ** ** |
| Average  subscribers (e)                    |       | 3,538,000               |       | 2,539,000             |       |               |       |
| ARPU (f)                                    |       | $                       | 20.38      |                  | $          | 20.95              |       |   |   |
| Churn rate (d)                              |       | 5.0                     | %          | 4.0                   | %          |               |       |
|                                        |       |                    |       |                  |       |               |       |
| **Business  Services Data**                 | ** ** | ** **              | ** ** | ** **            | ** ** | ** **         | ** ** |
| Average  subscribers (e)                    |       | 190,000                 |       | 160,000               |       |               |       |
| ARPU (f)                                    |       | $                       | 81.88      |                  | $          | 82.37              |       |   |   |
| Churn rate (d)                              |       | 2.7                     | %          | 3.1                   | %          |               |       |

 

----

(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 three months ended March 31, 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.

 

24

----

Table of Contents

 

(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.

 

(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.

 

**Results ofOperations**

** **

***Consolidated Results of Operations***

*** ***

Thefollowing table sets forth statement of operations data for the periodsindicated:

 
| ** **                                             | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                             | ** ** | **March 31,**         | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                             | ** ** | **2008**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                             | ** ** | **(dollars in thousands)** | ** ** |
|                                                   |       |                       |       |       |       |              |       |   |   |
| Revenues                                               |       | $                          | 263,074    |       | $          | 199,063           |       | (64,011 | ) | -24% |   |
|                                                   |       |                       |       |       |       |              |       |   |   |
| Operating costs and expenses:                          |       |                       |       |       |       |              |       |   |   |
| Cost of revenues                                       |       | 97,551                     |       | 75,565     |       | (21,986           | )          | -23% |   |
| Sales and  marketing                                   |       | 30,916                     |       | 17,022     |       | (13,894           | )          | -45% |   |
| Operations and  customer support                       |       | 39,224                     |       | 27,746     |       | (11,478           | )          | -29% |   |
| General and  administrative                            |       | 24,926                     |       | 18,622     |       | (6,304            | )          | -25% |   |
| Amortization of  intangible assets                     |       | 4,013                      |       | 2,147      |       | (1,866            | )          | -46% |   |
| Facility exit,  restructuring and other costs          |       | 1,030                      |       | 488        |       | (542              | )          | -53% |   |
| Total operating  costs and expenses                    |       | 197,660                    |       | 141,590    |       | (56,070           | )          | -28% |   |
|                                                   |       |                       |       |       |       |              |       |   |   |
| Income from  operations                                |       | 65,414                     |       | 57,473     |       | (7,941            | )          | -12% |   |
| Gain on investments, net                               |       | —                     |       | 259        |       | 259               |       | 100% |   |
| Interest expense and other, net                        |       | (1,041                     | )          | (4,291     | )          | (3,250            | )          | 312% |   |
| Income from  continuing operations before income taxes |       | 64,373                     |       | 53,441     |       | (10,932           | )          | -17% |   |
| Income tax provision                                   |       | (9,274                     | )          | (20,944    | )          | (11,670           | )          | 126% |   |
| Income from  continuing operations                     |       | 55,099                     |       | 32,497     |       | (22,602           | )          | -41% |   |
| Loss from discontinued operations                      |       | (3,392                     | )          | —     |       | 3,392             |       | -100% |   |
| Net income                                             |       | $                          | 51,707     |       | $          | 32,497            |       | $ | (19,210 | ) | -37% |   |
|                                                        |            |                            |            |            |            |                   |            |  |  |  |  |  |

 

25

----

Table of Contents

*** ***

***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, site operations expenses, product developmentexpenses, certain technology and facilities expenses, billing operations andprovisions for doubtful accounts. Segment income from operations excludes otherincome and expense items and certain expenses over which segment managers donot have discretionary control. Costs excluded from segment income fromoperations include various corporate expenses (consisting of certain costs suchas corporate management, human resources, finance and legal), amortization ofintangible assets, impairment of goodwill and intangible assets, facility exitand restructuring costs and stock-based compensation expense under Statement ofFinancial Accounting Standards (“SFAS”) No. 123(R), as they are notconsidered in the measurement of segment performance.

 

26

----

Table of Contents

 

Thefollowing tables set forth segment data for the three months ended March 31,2008 and 2009:

 
| ** **                             | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                             | ** ** | **2008**                              | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**            | ** ** |
| **Consumer Services**                  | ** ** | ** **                            | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Revenues                               |       | $                                     | 216,344    |       | $          | 159,562           |       | $ | (56,782 | ) | -26% |   |
| Cost of revenues                       |       | 71,173                                |       | 52,334     |       | (18,839           | )          | -26% |   |
| Gross margin                           |       | 145,171                               |       | 107,228    |       | (37,943           | )          | -26% |   |
| Direct segment  operating expenses     |       | 61,001                                |       | 37,206     |       | (23,795           | )          | -39% |   |
| Segment  operating income              |       | $                                     | 84,170     |       | $          | 70,022            |       | $ | (14,148 | ) | -17% |   |
|                                   |       |                                  |       |       |       |              |       |   |   |
| **Business Services**                  | ** ** | ** **                            | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Revenues                               |       | $                                     | 46,730     |       | $          | 39,501            |       | $ | (7,229 | ) | -15% |   |
| Cost of revenues                       |       | 26,378                                |       | 23,231     |       | (3,147            | )          | -12% |   |
| Gross margin                           |       | 20,352                                |       | 16,270     |       | (4,082            | )          | -20% |   |
| Direct segment  operating expenses     |       | 14,871                                |       | 11,259     |       | (3,612            | )          | -24% |   |
| Segment  operating income              |       | $                                     | 5,481      |       | $          | 5,011             |       | $ | (470 | ) | -9% |   |
|                                   |       |                                  |       |       |       |              |       |   |   |
| **Consolidated**                       | ** ** | ** **                            | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Revenues                               |       | $                                     | 263,074    |       | $          | 199,063           |       | $ | (64,011 | ) | -24% |   |
| Cost of revenues                       |       | 97,551                                |       | 75,565     |       | (21,986           | )          | -23% |   |
| Gross margin                           |       | 165,523                               |       | 123,498    |       | (42,025           | )          | -25% |   |
| Direct segment  operating expenses     |       | 75,872                                |       | 48,465     |       | (27,407           | )          | -36% |   |
| Segment  operating income              |       | 89,651                                |       | 75,033     |       | (14,618           | )          | -16% |   |
| Stock-based  compensation expense      |       | 5,152                                 |       | 4,390      |       | (762              | )          | -15% |   |
| Amortization of  intangible assets     |       | 4,013                                 |       | 2,147      |       | (1,866            | )          | -46% |   |
| Facility exit  and restructuring costs |       | 1,030                                 |       | 488        |       | (542              | )          | -53% |   |
| Other operating  expenses              |       | 14,042                                |       | 10,535     |       | (3,507            | )          | -25% |   |
| Income from  operations                |       | $                                     | 65,414     |       | $          | 57,473            |       | $ | (7,941 | ) | -12% |   |

 

27

----

Table of Contents

*** ***

***Revenues***

** **

The following table presentsrevenues by groups of similar services and by segment for the three monthsended March 31, 2008 and 2009:

 
| ** **            | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|-----------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **            | ** ** | **March 31,**         | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **            | ** ** | **2008**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **            | ** ** | **(dollars in thousands)** | ** ** |
| **Consumer Services** | ** ** | ** **                 | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Access and  service   |       | $                          | 188,971    |       | $          | 139,790           |       | $ | (49,181 | ) | -26% |   |
| Value-added  services |       | 27,373                     |       | 19,772     |       | (7,601            | )          | -28% |   |
| Total revenues        |       | $                          | 216,344    |       | $          | 159,562           |       | $ | (56,782 | ) | -26% |   |
|                  |       |                       |       |       |       |              |       |   |   |
| **Business Services** | ** ** | ** **                 | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Access and  service   |       | $                          | 45,878     |       | $          | 38,908            |       | $ | (6,970 | ) | -15% |   |
| Value-added  services |       | 852                        |       | 593        |       | (259              | )          | -30% |   |
| Total revenues        |       | $                          | 46,730     |       | $          | 39,501            |       | $ | (7,229 | ) | -15% |   |
|                  |       |                       |       |       |       |              |       |   |   |
| **Consolidated**      | ** ** | ** **                 | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Access and  service   |       | $                          | 234,849    |       | $          | 178,698           |       | $ | (56,151 | ) | -24% |   |
| Value-added  services |       | 28,225                     |       | 20,365     |       | (7,860            | )          | -28% |   |
| Total revenues        |       | $                          | 263,074    |       | $          | 199,063           |       | $ | (64,011 | ) | -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 $263.1 million during the three months ended March 31,2008 to $199.1 million during the three months ended March 31, 2009. Thiswas comprised of a $56.8 million decrease in consumer services revenue and a$7.2 million decrease in business services revenue. The decrease in consumerservices revenue was primarily attributable to a decrease in average consumersubscribers, which were approximately 3.5 million and 2.5 million during thethree months ended March 31, 2008 and 2009, respectively. The decrease wasdriven primarily by narrowband and broadband subscribers. Slightly offsettingthe decrease in our average consumer subscribers was an increase in consumerservices ARPU, which increased due to the shift in mix of our consumer accesssubscriber base from narrowband to broadband subscribers. The decrease inbusiness services revenue was primarily due to a decrease in average businesssubscribers, which were approximately 190,000 and 160,000 during the threemonths ended March 31, 2008 and 2009, respectively. Slightly offsettingthe decrease in our average business subscribers was an increase in businessservices ARPU, which increased due to the shift in mix of our business accesssubscriber base to New Edge subscribers.

 

*Consumerservices revenue*

* *

*Access and service*. Consumer access and servicerevenues consist of narrowband access, broadband access and VoIP services.These revenues are derived from monthly fees charged to customers for dial-upInternet access; monthly fees charged for high-speed access services includingDSL and cable; monthly fees charged for VoIP services; usage fees; activationfees; termination fees; and fees for equipment.

 

Consumer access and service revenues decreased $49.2million, or 26%, from the three months ended March 31, 2008 to the threemonths ended March 31, 2009.  Thedecrease in consumer access and service

 

28

----

Table of Contents

 

revenueswas primarily due to decreases in narrowband access and broadband accessrevenues.  Narrowband access revenuesdecreased due to a decrease in average premium narrowband and value-pricednarrowband subscribers resulting from the change in our business strategy andthe continued maturation of and competition in the market for narrowbandInternet access. We continue to reduce sales and marketing efforts. We arefocusing our efforts primarily on the retention of tenured customers and addingcustomers that have similar characteristics of our tenured customer base andare more likely to produce an acceptable rate of return. Average consumernarrowband subscribers decreased from 2.5 million during the three months endedMarch 31, 2008 to 1.7 million during the three months ended March 31,2009. Our value-priced narrowband services comprised a larger proportion ofthis decrease, as average PeoplePC access subscribers decreased fromapproximately 50% of our average consumer narrowband customer base during thethree months ended March 31, 2008 to 42% during the three months ended March 31,2009.  Broadband access revenuesdecreased due to a decline in average broadband subscribers resulting fromreduced sales and marketing efforts. Average consumer broadband subscribersdecreased from 1.0 million during the three months ended March 31, 2008 to0.9 million during the three months ended March 31, 2009.

 

We expect our consumer access and service subscriber baseto continue to decrease due to the change in our business strategy and due tothe continued maturation of the market for narrowband Internet access. However,as our customers become more tenured, we expect our churn rates to decline.

 

*Value-added services revenues.*Value-added services revenuesconsist of revenues from ancillary services sold as add-on features to ourInternet access services, such as security products, email by phone, Internetcall 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 $7.6 million, or 28%, from the three months ended March 31,2008 to the three months ended March 31, 2009.  The decrease was due primarily to decreasesin search advertising revenues and in sales of ancillary services, primarilysecurity services, as a result of the decrease in total average consumersubscribers from 3.5 million during the three months ended March 31, 2008to 2.5 million during the three months ended March 31, 2009.  However, offsetting this decrease was anincrease in subscription revenue per subscriber. We expect our value-addedservices revenues to decrease during the remainder of 2009 as our subscriberbase decreases.

 

*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 $7.0million, or 15%, from the three months ended March 31, 2008 to the threemonths ended March 31, 2009.  Thedecrease was primarily due to a decrease in average business access and servicesubscribers, comprised of decreases in average web hosting accounts, averagebusiness narrowband customers and average New Edge customers. Our wholesalebusiness was also negatively impacted over the past year by consolidation inthe telecommunications industry. Our churn rates for business servicescustomers increased during the three months ended March 31, 2009 comparedto the prior year 

 

29

----

Table of Contents

 

period,which was primarily driven by a decrease in business narrowband customersresulting from maturation of and competition in the market for these Internetaccess services.

 

We expect continued pressure on revenue and churn rates forour business services, especially given the state of the economy. However, weexpect to continue to seek opportunities to align our cost structure withtrends in our revenue.

 

***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. and CovadCommunications Group, Inc. (“Covad”). We also do lesser amounts ofbusiness with a wide variety of local, regional and other national providers.Cost of revenues also includes sales incentives. We offer sales incentives,such as free modems and Internet access on a trial basis, for certain productsand promotions.

 

Totalcost of revenues decreased $22.0 million, or 23%, from the three months ended March 31,2008 to the three months ended March 31, 2009.  This decrease was comprised of an $18.8million decrease in consumer services cost of revenues and $3.1 milliondecrease in business services cost of revenue. Consumer services cost ofrevenues decreased due to the decline in average consumer services subscribersand more favorable rates with service providers. Offsetting this decrease wasan increase in average consumer cost per subscriber due to a greater proportionof our consumer subscriber base consisting of broadband subscribers. Businessservices cost of revenues decreased due to a decrease in average businessservices 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.

 

***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 $13.9 million, or45%, from the three months ended March 31, 2008 to the three months ended March 31,2009. The decrease consisted primarily of a decrease in advertising andpromotions expense, personnel-related costs, outsourced labor and occupancy andrelated costs resulting from the change in our business strategy and continued benefitsfrom the 2007 Plan.

 

Although we expect to continue to realize benefits as wescale back sales and marketing efforts in connection with our refocusedstrategy, we do not anticipate the type of large-scale cost reductionopportunities in 2009 that we experienced in 2008.

 

30

----

Table of Contents

*** ***

***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).

 

Operations and customer support expenses decreased $11.5million, or 29%, from the three months ended March 31, 2008 to the threemonths ended March 31, 2009. The decrease in operations and customersupport expenses consisted of decreases in personnel-related costs, outsourcedlabor and occupancy and related costs. These decreases were primarilyattributable to our efforts to reduce our back-office cost structure, includingbenefits realized as a result of the 2007 Plan, and a decrease in call volumesfor customer service and technical support as our overall subscriber base hasdecreased and as our tenured customers require less customer service andtechnical support.

 

Although we expect operations and customer support expensesto continue to decrease during 2009 as a result of our refocused strategy, wedo not anticipate the type of large-scale cost reduction opportunities that weexperienced in 2008.

 

***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 $6.3 million,or 25%, from the three months ended March 31, 2008 to the three monthsended March 31, 2009.  The decreasein general and administrative expenses consisted primarily of decreases in baddebt and payment processing fees, personnel-related costs and professional andlegal fees. Bad debt and payment processing fees decreased due to the decreasein our overall subscriber base and due to our subscriber base consisting ofmore tenured customers, who have a lower frequency of non-payment. The decreasein personnel-related costs and professional and legal fees was attributable toour efforts to reduce our back-office cost structure, including benefitsrealized as a result of the 2007 Plan.

 

Although we expect general and administrative expenses tocontinue to decrease in 2009 as a result our refocused strategy, we believethat large-scale cost reduction opportunities will be limited.

 

***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 one to six years. Amortization ofintangible assets decreased $1.9 million, or 46%, from the three months ended March 31,2008 to the three months ended March 31, 2009.  The decrease in amortization of intangibleassets during the three months ended March 31, 2009 was primarily due tocertain identifiable definite-lived intangible assets becoming fully amortizedover the past year.

 

31

----

Table of Contents

*** ***

***Facility exit, restructuring and other costs***

*** ***

Facility exit and restructuring costs consisted of thefollowing during the three months ended March 31, 2008 and 2009:

 
| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|
| ** **                  | ** ** | **2008**                              | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**                    | ** ** |
|                        |       |                                  |       |   |   |
| 2007  Restructuring Plan    |       | $                                     | 1,093      |   | $ | 488 |   |
| Legacy  Restructuring Plans |       | (63                                   | )          | — |   |
|                        |       | $                                     | 1,030      |   | $ | 488 |   |

 

*2007 Restructuring Plan.*In August 2007,we adopted a restructuring plan to reduce costs and improve the efficiency ofour operations. The 2007 Plan was the result of a comprehensive review ofoperations within and across our functions and businesses. Under the 2007 Plan,we reduced our workforce by approximately 900 employees, consolidated ouroffice facilities in Atlanta, Georgia and Pasadena, California and closedoffice facilities in Orlando, Florida; Knoxville, Tennessee; Harrisburg,Pennsylvania; and San Francisco, California. The Plan was primarily implementedduring the latter half of 2007 and completed during 2008. As a result of the2007 Plan, we recorded facility exit and restructuring costs of $1.1 millionduring the three months ended March 31, 2008, including $0.4 million forseverance and personnel-related costs; $0.3 million for non-cash assetimpairments; and $0.4 million for other associated costs.  As a result of the 2007 Plan, we recordedfacility exit and restructuring costs of $0.5 million during the three monthsended March 31, 2009, which consisted of facilities-related costs.  Management continues to evaluate EarthLink’sbusinesses and, therefore, there may be supplemental provisions for new planinitiatives as well as changes in estimates to amounts previously recorded.

 

*Legacy Restructuring Plans.*During the years ended December 31,2003, 2004 and 2005, we executed a series of plans to restructure andstreamline our contact center operations and outsource certain internalfunctions (collectively referred to as “Legacy Plans”). The Legacy Plansincluded facility exit costs, personnel-related costs and asset disposals. Weperiodically evaluate and adjust our estimates for facility exit andrestructuring costs based on currently-available information and record suchadjustments as facility exit and restructuring costs. During the three monthsended March 31, 2008, we recorded a $0.1 million reduction to facilityexit and restructuring costs as a result of changes in estimates for LegacyPlans.

 

***Gain on investments, net***

*** ***

Duringthe three months ended March 31, 2009, we recognized a net gain oninvestments of $0.3 million. This consisted of $0.2 million in cashdistributions from eCompanies Venture Group, L.P. (“EVG”), a limitedpartnership that invested in domestic emerging Internet-related companies, anda net gain of $0.1 million related to our auction rate securities (as describedbelow). These transactions were recorded as gain on investments, net, in theCondensed Consolidated Statements of Operations.

 

As of March 31,2009, we held auction rate securities with a carrying value and fair value of$50.3 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’). We record the auction rate securities at fairvalue, with changes in fair value included in earnings. We also record the putright at fair value, with changes in fair value included in earnings, as weelected the fair value option under SFAS No. 159, “The Fair Value Optionfor Financial Assets 

 

32

----

Table of Contents

 

and Financial Liabilities,” for the put right tooffset the fair value changes of the auction rate securities. During the threemonths ended March 31, 2009, we recorded a $2.4 million gain oninvestments to reflect the auction rate securities at their fair value andrecorded a $2.4 million loss on investments to reflect the put right at itsfair value. The net gain of $0.1 million during the three months ended March 31,2009 is included in gain on investments, net, in the Condensed ConsolidatedStatement of 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 $3.3 million from the three months ended March 31,2008 to the three months ended March 31, 2009. This was primarily due to adecrease in interest earned on our cash, cash equivalents and marketablesecurities, despite an increase in our average cash and marketable securitiesbalance, due to lower investment yields from deteriorating financial and creditmarkets. Also contributing to the decrease was the liquidation of our Covaddebt investment, which was repurchased by Platinum Equity, LLC in April 2008.

 

***Provision for income taxes***

*** ***

We recognized an income tax provision of $9.3 million during the threemonths ended March 31, 2008, which consisted of $1.5 million state incomeand federal and state alternative minimum tax (“AMT”) amounts payable due tothe net operating loss carryforward limitations associated with the AMTcalculation and other current provision items, and $7.8 million for non-cashdeferred tax provisions associated with the utilization of net operating losscarryforwards which were acquired in connection with the acquisitions ofOneMain, PeoplePC and Cidco. We recognized an income tax provision of $20.9million during the three months ended March 31, 2009, which consisted of$2.4 million state income and federal and state AMT amounts payable due to thenet operating loss carryforward limitations associated with the AMT calculationand $18.5 million for non-cash deferred tax provisions associated with theutilization of net operating loss carryforwards.

 

Wecontinue to maintain a partial valuation allowance against our unrealizeddeferred tax assets, which include net operating loss carryforwards.  We may recognize deferred tax assets infuture periods when they are determined to be more likely than not realizable.To the extent we report income in future periods, we intend to use our netoperating loss carryforwards to the extent available to offset taxable incomeand reduce cash outflows for income taxes. Our ability to use our federal and state net operating losscarryforwards and federal and state tax credit carryforwards may be subject torestrictions attributable to equity transactions in the future resulting fromchanges in ownership as defined under the Internal Revenue Code.

 

***Loss from discontinued operations***

*** ***

Loss from discontinued operations,net of tax, for the three months ended March 31, 2008 reflects ourmunicipal wireless broadband operations. In November 2007, managementconcluded that our municipal wireless broadband operations were no longerconsistent with our strategic direction and our Board of Directors authorizedmanagement to pursue the divestiture of our municipal wireless broadbandassets. The municipal wireless results of operations were previously includedin our Consumer Services segment. As of December 31, 2008, the divestitureof our municipal wireless broadband assets was complete.

 

Thefollowing table presents summarized results of operations related to ourdiscontinued operations for the three months ended March 31, 2008:

 

33

----

Table of Contents

 
| ** **                                         | ** ** | **Three Months Ended**  | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **March 31, 2008** | ** ** |
| ** **                                         | ** ** | **(in thousands)**      | ** ** |
|                                               |       |                    |       |
| Revenues                                           |       | $                       | 737        |   |
| Operating costs  and expenses                      |       | (2,180                  | )          |
| Impairment,  facility exit and restructuring costs |       | (1,949                  | )          |
| Loss from  discontinued operations                 |       | (3,392                  | )          |
|                                                    |            |                         |            |  |

 

**Stock-BasedCompensation**

 

Weaccount for stock-based compensation in accordance with SFAS No. 123(R), “Stock-BasedCompensation,” which requires measurement of compensation cost for all stockawards at fair value on the date of grant and recognition of compensation overthe requisite service period for awards expected to vest. The fair value of ourstock options is estimated using the Black-Scholes valuation model, and thefair value of restricted stock units is determined based on the number ofshares granted and the quoted price of our 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 management’s current estimates, such amountswill be recorded as a cumulative adjustment in the period estimates arerevised. We consider many factors when estimating expected forfeitures,including types of awards, employee class and historical employee attritionrates. Actual results, and future changes in estimates, may differsubstantially from our current estimates.

 

Stock-based compensation expense under SFASNo. 123(R) was $5.2 million and $4.4 million during the three monthsended March 31, 2008 and 2009, respectively. Stock-based compensationexpense is classified within the same operating expense line items as cashcompensation paid to employees. Stock-based compensation expense in accordancewith SFAS No. 123(R) was allocated as follows for the three monthsended March 31, 2008 and 2009:

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2008**                              | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(in thousands)**                    | ** ** |
| Sales and  marketing             |       | $                                     | 1,534      |   | $ | 1,211 |   |
| Operations and  customer support |       | 2,536                                 |       | 2,113 |   |
| General and  administrative      |       | 1,082                                 |       | 1,066 |   |
|                             |       | $                                     | 5,152      |   | $ | 4,390 |   |

 

34

----

Table of Contents

** **

**Facility Exitand Restructuring Costs**

 

*2007 Plan.*We expect to incur future cash outflows for realestate obligations through 2014 related to the 2007 Plan. The following tablesummarizes activity for the liability balances associated with the 2007 Planfor the years ended December 31, 2007 and 2008 and for the three monthsended March 31, 2009, including changes during the year attributable tocosts incurred and charged to expense and costs paid 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                             |       | —             |       | 488            |       | —          |       | —    |       | 488        |       |
| Payments                             |       | —             |       | (1,359         | )          | —          |       | —    |       | (1,359     | )          |
| Non-cash charges                     |       | —             |       | —         |       | —          |       | —    |       | —     |       |
| Balance as of March 31, 2009    |       | $                  | —     |           | $          | 15,823          |       | $         | —     |       | $          | — |   | $ | 15,823 |   |

 

*Legacy Plans*. As of March 31, 2009, we had $1.3 million remainingfor real estate commitments associated with the Legacy Plans. All other costshave been paid or otherwise settled. We expect to incur future cash outflowsfor real estate obligations through 2010 related to the Legacy Plans.

 

**Liquidity andCapital Resources**

 

The following table sets forthsummarized cash flow data for the three months ended March 31, 2008 and 2009:

 
| ** **                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                           | ** ** | **2008**                              | ** ** | **2009** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                    | ** ** |
|                                                 |       |                                  |       |   |   |
| Net income                                           |       | $                                     | 51,707     |   | $ | 32,497 |   |
| Non-cash items                                       |       | 28,288                                |       | 32,514 |   |
| Changes in  working capital                          |       | (38,262                               | )          | (11,087 | ) |
| Net cash  provided by operating activities           |       | $                                     | 41,733     |   | $ | 53,924 |   |
|                                                 |       |                                  |       |   |   |
| Net cash  provided by (used in) investing activities |       | $                                     | 32,724     |   | $ | (47,008 | ) |
|                                                 |       |                                  |       |   |   |
| Net cash used in  financing activities               |       | $                                     | (7,327     | ) | $ | (21,970 | ) |

 

35

----

Table of Contents

 

*Operatingactivities*

* *

Netcash provided by operating activities increased during the three months ended March 31,2009 compared to the prior year period primarily due to a decrease in costs toacquire and support new customers, a decrease in operating costs resulting fromour efforts to reduce our back-office cost structure, benefits realized fromthe 2007 Plan, and a reduction in customer support costs and bad debt expenseas our overall subscriber base has decreased and become more tenured. This waspartially offset by a decrease in revenues as our overall subscriber base hasdecreased over the past year.

 

Non-cash items include items thatare not expected to generate or require the use of cash, such as depreciationand amortization relating to our network, facilities and intangible assets,deferred income taxes, stock-based compensation, non-cash disposals andimpairments of fixed assets, gain (loss) on investments in other companies,net, and accretion of debt discount and amortization of debt issuance costs.Non-cash items increased during the three months ended March 31, 2009compared to the prior year period due to an increase in deferred income taxes,which was partially offset by decreases in depreciation expense and loss ondisposals 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 threemonths ended March 31, 2009 compared to the prior year period primarilydue to reduced back office support and sales and marketing spending. Alsocontributing to the decrease were decreases in payments resulting from the 2007Plan and from the discontinuation of our municipal wireless broadbandoperations.

 

*Investingactivities*

* *

Our investing activities providedcash of $32.7 million during the three months ended March 31, 2008, whichconsisted primarily of sales and maturities of investments in marketablesecurities, net of purchases. Our investing activities used cash of $47.0million during the three months ended March 31, 2009. This consistedprimarily of $44.1 million of purchases of investments in marketablesecurities, net of sales and maturities, and $3.1 million of capitalexpenditures, primarily associated with network and technology center relatedprojects.

 

*Financingactivities*

* *

Our financing activities used cashof $7.3 million during the three months ended March 31, 2008. Thisconsisted primarily of $9.1 million used to repurchase 1.3 million shares ofour common stock, offset by $1.9 million of proceeds from the exercise of stockoptions. Our financing activities used cash of $22.0 million during the threemonths ended March 31, 2009. This consisted primarily of $22.3 millionused to repurchase 3.6 million shares of our common stock, offset by $0.4million of proceeds from the exercise of stock options

 

**Off-BalanceSheet Arrangements**

** **

As of March 31, 2009, we didnot have any off-balance sheet arrangements that have or are reasonably likelyto have a current or future effect on our financial condition, changes infinancial 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 March 31, 2009, wehad 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

 

36

----

Table of Contents

 

not require us to acquire any specific number ofshares and may be terminated by the Board of Directors at any time.

 

**Income Taxes**

** **

Wecontinue to maintain a partial valuation allowance of $247.0 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 retain existing andacquire new subscribers for our services, including purchases of subscriberbases from other ISPs. We will also use cash to pay real estate obligationsassociated with facilities exited in our restructuring plans. We expect toincur capital expenditures to maintain and upgrade our network and technologyinfrastructure. The actual amount of capital expenditures may fluctuate due toa number of factors which are difficult to predict and could changesignificantly over time. Additionally, technological advances may require us tomake capital expenditures to develop or acquire new equipment or technology inorder to replace aging or technologically obsolete equipment. Finally, we mayalso use cash to invest in or acquire other companies, to repurchase commonstock, to repurchase long-term debt or to pay dividends on our common stock. Wehave never declared or paid cash dividends on our common stock. Our Board ofDirectors will determine our future dividend policy. 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.

 

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 and marketingactivities, among others.

 

*Sources of cash*. Our principal sources of liquidity are our cash,cash equivalents and investments in marketable securities, as well as the cashflow we generate from our operations. During the three months ended March 31,2009, we generated $53.9 million in cash from operations. As of March 31,2009, we had $471.5 million in cash and cash equivalents. In addition, we heldshort- and long-term marketable securities valued at $40.6 million and $53.8million, respectively. Short-term marketable securities consist of investmentsthat have maturity dates of up to one year from the balance sheet date, andlong-term marketable securities consist of investments that have maturity datesof more than one year from the balance sheet date. Long-term marketablesecurities also consist of $50.3 million of auction rate securities. Thesesecurities are variable-rate debt instruments whose underlying agreements havecontractual maturities of up to 40 years. The securities are issued by variousstate related higher education agencies and predominantly secured by studentloans guaranteed by the agencies and reinsured by the United States Departmentof Education. Liquidity for these auction rate securities is typically providedby an auction process that resets the applicable interest rate atpre-determined intervals, usually every 28 days. Beginning in February 2008,all of our auction rate securities failed to attract sufficient buyers,resulting in our continuing to hold such securities. In October 2008, weentered into an agreement with the broker that sold us our auction ratesecurities that gives us the right to sell our existing auction rate securitiesback to the broker at par plus accrued interest, beginning on June 30,2010 until July 2, 2012. The agreement also grants the broker the right tobuy our auction rate securities at par plus accrued interest, until July 2,2012. Based on our remaining cash and marketable securities and operating cashflows, we do not anticipate the current lack of liquidity on these investmentswill affect our ability to operate our business as usual.

 

37

----

Tableof Contents

 

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 and investment and other obligations for the next 12months. However, as a result of other investment activities and possibleacquisition opportunities, we may seek additional financing in the future. Wehave no commitments for any additional financing and have no lines of credit orsimilar sources of financing. We cannot be sure that we can obtain additionalfinancing on favorable terms, if at all, through the issuance of equitysecurities or the incurrence of additional debt. Additional equity financingmay dilute our stockholders, and debt financing, if available, may restrict ourability to repurchase common stock or debt, declare and pay dividends and raisefuture capital. If we are unable to obtain additional needed financing, it mayprohibit us from making acquisitions, capital expenditures and/or investments,which could materially and adversely affect our prospects for long-term growth.

 

**Adoption of Recent Accounting Pronouncement**

** **

On January 1,2009, we adopted Financial Accounting Standards Board Staff Position No. APB14-1, “Accounting for Convertible Debt Instruments that May be Settled inCash Upon Conversion” (“FSP APB 14-1”). FSP APB 14-1 requires that theliability and equity components of convertible debt instruments that may besettled in cash upon conversion (including partial cash settlement) beseparately accounted for in a manner that reflects an issuer’s non-convertibledebt borrowing rate. The resulting debt discount is accreted over the periodthe convertible debt is expected to be outstanding as additional non-cashinterest expense. Retrospective application to all periods presented isrequired except for instruments that were not outstanding during any of theperiods that will be presented in the annual financial statements for the periodof adoption but were outstanding during an earlier period. The adoption of FSPAPB 14-1 on January 1, 2009 affected the accounting for our ConvertibleSenior Notes due November 15, 2026 (the “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 FSP APB 14-1, we reduced income from continuing operations and net incomefor the three months ended March 31, 2009 by $2.9 million and reducedbasic and diluted earnings per share by $0.03 per share. The Company alsorecorded a deferred tax liability for temporary differences resulting from theapplication of FASB Statement No. 109, “Accounting for Income Taxes.”However, this was offset by a corresponding decrease in the valuation allowancefor deferred tax assets.

 

38

----

Tableof Contents

** **

The following tables present theeffect of the adoption of FSP APB 14-1 on our affected financial statement lineitems for the three months ended March 31, 2008 and as of December 31,2008:

 
| ** **                                | ** ** | **Three Months Ended March 31, 2008**     | ** ** |
|-------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                | ** ** | **As Originally**                                             | ** ** | **As** | ** ** | **Effect of** | ** ** |
| ** **                                | ** ** | **Reported**                                                       | ** ** | **Adjusted** | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **(in thousands, except per share data)** | ** ** |
| Statement of  Operations:                 |       |                                                               |       |   |   |   |   |
| Interest income  (expense) and other, net |       | $                                                                  | 1,616      |   | $ | (1,041 | ) | $ | (2,657 | ) |
| Income from  continuing operations        |       |                                                               | 57,756     |   |   | 55,099 |   |   | (2,657 | ) |
| Net income                                |       | 54,364                                                             |       | 51,707 |   | (2,657 | ) |
|                                      |       |                                                               |       |   |   |   |   |
| Basic net income  per share               |       |                                                               |       |   |   |   |   |
| Continuing  operations                    |       | $                                                                  | 0.53       |   | $ | 0.50 |   | $ | (0.02 | ) |
| Basic net income  per share               |       | 0.50                                                               |       | 0.47 |   | (0.02 | ) |
|                                      |       |                                                               |       |   |   |   |   |
| Diluted net  income per share             |       |                                                               |       |   |   |   |   |
| Continuing  operations                    |       | $                                                                  | 0.52       |   | $ | 0.50 |   | $ | (0.02 | ) |
| Diluted net  income per share             |       | 0.49                                                               |       | 0.47 |   | (0.02 | ) |

 
| ** **                  | ** ** | **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 | ) |
|                             |            |                                                 |            |  |  |  |  |  |  |  |

 

39

----

Tableof Contents

 

 **Safe Harbor Statement**

 

The Management’s Discussion andAnalysis and other portions of this Quarterly Report on Form   10-Q include “forward-looking” statements(rather than historical facts) that are subject to risks and uncertainties thatcould cause actual results to differ materially from those described. Althoughwe believe that the expectations expressed in these forward-looking statementsare reasonable, we cannot promise that our expectations will turn out to becorrect. Our actual results could be materially different from and worse thanour expectations. With respect to such forward-looking statements, we seek theprotections afforded by the Private Securities Litigation Reform Act of 1995.These risks include, without limitation, (1) that the continued decline ofour consumer access subscribers, combined with the change in mix of ourconsumer access subscriber base from narrowband to broadband, will adverselyaffect our results of operations; (2) that we face significant competitionwhich could reduce our profitability; (3) that adverse economic conditionsmay harm our business; (4) that as a result of our continuing review ofour business, we may have to undertake further restructuring plans that wouldrequire additional 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 beunsuccessful in making and integrating acquisitions and investments into ourbusiness, which could result in operating difficulties, losses and otheradverse consequences; (7) that our business is dependent on theavailability of third-party telecommunications service providers; (8) thatour commercial and alliance arrangements may not be renewed, which couldadversely affect our results of operations; (9) that our business maysuffer if third parties used for customer service and technical support andcertain billing services are unable to provide these services or terminatetheir relationships with us; (10) that service interruptions orimpediments could harm our business; (11) that government regulations couldadversely affect our business or force us to change our business practices;(12) that privacy concerns relating to our business could damage our reputationand deter current and potential users from using our services;  (13) that we may not be able to protect ourintellectual property; (14) that we may be accused of infringing upon theintellectual property rights of third parties, which is costly to defend andcould limit our ability to use certain technologies in the future; (15) that wecould face substantial liabilities if we are unable to successfully defendagainst legal actions; (16) that our business depends on effective businesssupport systems, processes and personnel; (17) that we may be unable to hireand retain sufficient qualified personnel, and the loss of any of our keyexecutive 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 ourindebtedness could adversely affect our financial health and limit our abilityto react to changes in our industry; and (23) that provisions of our secondrestated certificate of incorporation, amended and restated bylaws and otherelements of our capital structure could limit our share price and delay achange of management. These risks and uncertainties, as well as other risks anduncertainties that could cause our actual results to differ significantly frommanagement’s expectations, are not intended to represent a complete list of allrisks and uncertainties inherent in our business, and should be read inconjunction with the more detailed cautionary statements and risk factorsincluded in our Annual Report on Form 10-K for the year ended December 31,2008.

 

**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.

 

40

----

Table of Contents

** **

**Item 4. Controls and Procedures.**

 

**Evaluation ofDisclosure Controls and Procedures**

** **

Pursuant to Rule 13a-15(b) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), wecarried out an evaluation, with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, of the effectivenessof our disclosure controls and procedures (as defined under Rule 13a-15(e) underthe 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 March 31, 2009 that have materially affected, or arereasonably 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.

 

**Item 2. ****Unregistered Salesof Equity Securities and Use of Proceeds****.**

 

The number of shares repurchasedand the average price paid per share for each month in the three months ended March 31,2009 are as follows:

 
| ** **                                | ** ** | ** **                                                                                 | ** ** | ** **          | ** ** | **Total Number of**          | ** ** | **Maximum Dollar**         | ** ** |
|-------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|---------------------|------------|----------------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **Total Number**                                                                      | ** ** | **Average**         | ** ** | **Shares Repurchased**            | ** ** | **Value that May**    | ** ** |
| ** **                                | ** ** | **of Shares**                                                                         | ** ** | **Price Paid** | ** ** | **as Part of Publicly** | ** ** | **Yet be Purchased**  | ** ** |
| **2009**                                  | ** ** | **Repurchased**                                                                            | ** ** | **per Share**  | ** ** | **Announced Program (1)**    | ** ** | **Under the Program** | ** ** |
| ** **                                | ** ** | **(in thousands, except average price paid per share)** | ** ** |
| January 1  through January 31   |       | —                                                                                     |       | $                   | —     |                                   | —     |                            | $          | 169,108 |   |
| February 1  through February 28 |       | 556                                                                                        |       | 6.19                |       | 556                                    |       | 165,668                         |       |
| March 1  through March 31       |       | 3,036                                                                                      |       | 6.23                |       | 3,036                                  |       | 146,768                         |       |
| Total                                     |       | 3,592                                                                                      |       |                |       | 3,592                                  |       |                            |       |
|                                           |            |                                                                                            |            |                     |            |                                        |            |                                 |            |  |  |

 

----

(1)   Since the inception of the sharerepurchase program (“Repurchase Program”), the Board of Directors hasauthorized a total of $750.0 million for the repurchase of our common stock.The Board of Directors has also approved repurchasing common stock pursuant toplans under Rule 10b5-1 of the Securities Exchange Act of 1934, asamended. We may repurchase our common stock

 

41

----

Tableof Contents

 

fromtime to time in compliance with the Securities and Exchange Commission’sregulations and other legal requirements, including through the use ofderivative transactions, and subject to market conditions and other factors.The Repurchase Program does not require EarthLink to acquire any specificnumber of shares and may be terminated at any time.

 

**Item 5.  Other Information.**

** **

None.

 

**Item 6.   Exhibits.**

** **
| (a)   Exhibits.     The  following exhibits are filed as part of this report**:** |
|----------------------------------------------------------------------------------------------------------------------|
|                                                                                                                 |   |   |
| 10.1#                                                                                                                |   | Amended and Restated Employment Agreement, dated  December 30, 2008, between EarthLink, Inc. and Rolla P. Huff,  President and Chief Executive Officer of EarthLink, Inc. |
|                                                                                                                 |   |   |
| 10.2#                                                                                                                |   | Amended and Restated Employment Agreement, dated  December 30, 2008, between EarthLink, Inc. and Joseph M. Wetzel,  Chief Operating Officer of EarthLink, Inc. |
|                                                                                                                 |   |   |
| 10.3#                                                                                                                |   | Form of Executive Retention Incentive Award  Agreement under the EarthLink, Inc. 2006 Equity and Cash Incentive Plan. |
|                                                                                                                 |   |   |
| 10.4#                                                                                                                |   | Form of Executive Retention Incentive Award  Agreement. |
|                                                                                                                 |   |   |
| 10.5+                                                                                                                |   | High-Speed Service Agreement, dated June 30,  2006, between EarthLink, Inc. and Time Warner Cable Inc. |
|                                                                                                                 |   |   |
| 31.1                                                                                                                 |   | Certification  of Chief Executive Officer pursuant to Securities Exchange Act  Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|                                                                                                                 |   |   |
| 31.2                                                                                                                 |   | Certification  of Chief Financial Officer pursuant to Securities Exchange Act  Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|                                                                                                                 |   |   |
| 32.1                                                                                                                 |   | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|                                                                                                                 |   |   |
| 32.2                                                                                                                 |   | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

----

#Management compensatory plan orarrangement.

+Portionsof this exhibit have been omitted and separately filed with the Securities andExchange Commission in connection with a request for confidential treatment.

 

42

----

#### **Table of Contents**

 

#### **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:  | May 1,  2009 |   | /s/  ROLLA P. HUFF                                                                               |
|   |              |   | Rolla P. Huff,  Chairman of the Board and Chief Executive Officer (principal executive  officer) |
|   |              |   |                                                                                             |
|   |              |   |                                                                                             |
| Date:  | May 1,  2009 |   | /s/  KEVIN M. DOTTS                                                                              |
|   |              |   | Kevin M. Dotts, Chief  Financial Officer (principal financial officer)                           |
|   |              |   |                                                                                             |
|   |              |   |                                                                                             |
| Date:  | May 1,  2009 |   | /s/  BRADLEY A. FERGUSON                                                                         |
|   |              |   | Bradley  A. Ferguson, Vice President and Controller (principal accounting officer)               |

 

43

----