Tableof Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

** **

**x****     ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

** **

**For thequarterly period ended June 30, 2009**

 

**OR**

** **

**o****        ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 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 executiveoffices)   (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)

 

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Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes x No o

 

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

 

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

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

 

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

 

As of July 29, 2009, 106,158,942shares of common stock, $.01 par value per share, were outstanding.

 

 

 

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**EARTHLINK, INC.**

**Quarterly Report on Form 10-Q**

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

** **

**TABLE OF CONTENTS**

 
| **Part I**                                                                                            |
|------------------------------------------------------------------------------------------------------------|
|                                                                                                       |   |   |
| Item 1.  Financial Statements                                                                         |   | 1 |
|                                                                                                       |   |   |
| Item  2.  Management’s Discussion and  Analysis of Financial Condition and Results of Operations |   | 23 |
|                                                                                                       |   |   |
| Item  3.  Quantitative and Qualitative  Disclosures About Market Risk                                 |   | 45 |
|                                                                                                       |   |   |
| Item  4.  Controls and Procedures                                                                     |   | 46 |
|                                                                                                       |   |   |
| **Part II**                                                                                           |
|                                                                                                       |   |   |
| Item 1.  Legal Proceedings                                                                            |   | 46 |
|                                                                                                       |   |   |
| Item 1A.  Risk Factors                                                                                |   | 46 |
|                                                                                                       |   |   |
| Item  4.  Submission of Matters to a Vote of  Security Holders                                        |   | 46 |
|                                                                                                       |   |   |
| Item 5.  Other Information                                                                            |   | 47 |
|                                                                                                       |   |   |
| Item 6.  Exhibits                                                                                     |   | 47 |
|                                                                                                       |   |   |
| Signatures                                                                                                 |   | 48 |

 

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**PART I**

 

**Item1.  Financial Statements.**

 

**EARTHLINK,INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(inthousands, except per share data)**

 
| ** **                                                                                                                                                                                                                                                 | ** ** | **December 31,** | ** **    | **June 30,**    | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|---------------|-----------------|------------|
| ** **                                                                                                                                                                                                                                                 | ** ** | **2008**         | ** **    | **2009**        | ** ** |
| ** **                                                                                                                                                                                                                                                 | ** ** | ** **       | ** **    | **(unaudited)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                 |       |
| Current assets:                                                                                                                                                                                                                                            |       |             |          |            |       |
| Cash and cash equivalents                                                                                                                                                                                                                                  |       | $                |  486,564 |            | $          |  510,497 |   |
| Accounts receivable, net of allowance of $4,048 and $2,214 as of  December 31, 2008 and June 30, 2009, respectively                                                                                                                                        |       | 30,569           |          | 28,698          |       |
| Marketable securities                                                                                                                                                                                                                                      |       | —           |          | 89,986          |       |
| Prepaid expenses                                                                                                                                                                                                                                           |       | 6,445            |          | 7,431           |       |
| Deferred income taxes, net                                                                                                                                                                                                                                 |       | 20,254           |          | 9,513           |       |
| Other current assets                                                                                                                                                                                                                                       |       | 15,452           |          | 19,647          |       |
| Total current assets                                                                                                                                                                                                                                       |       | 559,284          |          | 665,772         |       |
| Long-term marketable securities                                                                                                                                                                                                                            |       | 47,809           |          | 9,866           |       |
| Long-term investments                                                                                                                                                                                                                                      |       | 20,708           |          | 17,180          |       |
| Property and equipment, net                                                                                                                                                                                                                                |       | 37,246           |          | 33,326          |       |
| Deferred income taxes, net                                                                                                                                                                                                                                 |       | 43,757           |          | 20,550          |       |
| Purchased intangible assets, net                                                                                                                                                                                                                           |       | 19,552           |          | 15,367          |       |
| Goodwill                                                                                                                                                                                                                                                   |       | 112,812          |          | 112,812         |       |
| Other long-term assets                                                                                                                                                                                                                                     |       | 4,698            |          | 3,978           |       |
| Total assets                                                                                                                                                                                                                                               |       | $                |  845,866 |            | $          |  878,851 |   |
|                                                                                                                                                                                                                                                       |       |             |          |            |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                              |       |
| Current liabilities:                                                                                                                                                                                                                                       |       |             |          |            |       |
| Accounts payable                                                                                                                                                                                                                                           |       | $                |  13,109  |            | $          |  10,962 |   |
| Accrued payroll and related expenses                                                                                                                                                                                                                       |       | 37,470           |          | 20,999          |       |
| Other accrued liabilities                                                                                                                                                                                                                                  |       | 39,415           |          | 35,280          |       |
| Deferred revenue                                                                                                                                                                                                                                           |       | 33,649           |          | 29,167          |       |
| Convertible senior notes, net of discount of $32,908 as of June 30, 2009                                                                                                                                                                                   |       | —           |          | 225,842         |       |
| Total current liabilities                                                                                                                                                                                                                                  |       | 123,643          |          | 322,250         |       |
|                                                                                                                                                                                                                                                       |       |             |          |            |       |
| Convertible senior notes, net of discount of $39,017 as of December 31,  2008                                                                                                                                                                              |       | 219,733          |          | —          |       |
| Other long-term liabilities                                                                                                                                                                                                                                |       | 16,015           |          | 16,792          |       |
| Total liabilities                                                                                                                                                                                                                                          |       | 359,391          |          | 339,042         |       |
|                                                                                                                                                                                                                                                       |       |             |          |            |       |
| Stockholders’ equity:                                                                                                                                                                                                                                 |       |             |          |            |       |
| Convertible preferred stock, $0.01 par value, 100,000 shares authorized,  0 shares issued and outstanding as of December 31, 2008 and June 30, 2009                                                                                                        |       | —           |          | —          |       |
| Common stock, $0.01 par value, 300,000 shares authorized, 188,264 and  189,464 shares issued as of December 31, 2008 and June 30, 2009,  respectively, and 108,516 and 106,124 shares outstanding as of December 31,  2008 and June 30, 2009, respectively |       | 1,883            |          | 1,894           |       |
| Additional paid-in capital                                                                                                                                                                                                                                 |       | 2,135,887        |          | 2,141,152       |       |
| Accumulated deficit                                                                                                                                                                                                                                        |       | (1,016,833       | )             | (952,851        | )          |
| Treasury stock, at cost, 79,748 and 83,340 shares as of December 31,  2008 and June 30, 2009, respectively                                                                                                                                                 |       | (634,420         | )             | (656,760        | )          |
| Unrealized (losses) gains on investments                                                                                                                                                                                                                   |       | (42              | )             | 6,374           |       |
| Total stockholders’ equity                                                                                                                                                                                                                            |       | 486,475          |          | 539,809         |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                            |       | $                |  845,866 |            | $          |  878,851 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

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**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                             | ** ** | **Three Months Ended June 30,**      | ** **    | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|---------------|------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                  | ** **    | **2009**                           | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                                             | ** ** | **(in thousands, except per share data)** | ** **    |
| ** **                                             | ** ** | **(unaudited)**                           | ** **    |
|                                                   | ** ** | ** **                                |          |                               | ** ** | ** ** |   |   |   |
| Revenues                                               |       | $                                         |  245,603 |                               | $          |  185,597 |   | $ |  508,677 |   | $ |  384,660 |   |
|                                                   |       |                                      |          |                               |       |   |   |   |   |
| Operating  costs and expenses:                         |       |                                      |          |                               |       |   |   |   |   |
| Cost  of revenues                                      |       | 92,488                                    |          | 69,270                             |       | 190,039 |   | 144,835 |   |
| Sales  and marketing                                   |       | 25,806                                    |          | 14,543                             |       | 56,722 |   | 31,565 |   |
| Operations  and customer support                       |       | 33,642                                    |          | 23,940                             |       | 72,866 |   | 51,686 |   |
| General  and administrative                            |       | 23,768                                    |          | 16,409                             |       | 48,694 |   | 35,031 |   |
| Amortization  of intangible assets                     |       | 3,987                                     |          | 2,038                              |       | 8,000 |   | 4,185 |   |
| Facility  exit and restructuring costs                 |       | 2,061                                     |          | 4,927                              |       | 3,091 |   | 5,415 |   |
| Total  operating costs and expenses                    |       | 181,752                                   |          | 131,127                            |       | 379,412 |   | 272,717 |   |
|                                                   |       |                                      |          |                               |       |   |   |   |   |
| Income  from operations                                |       | 63,851                                    |          | 54,470                             |       | 129,265 |   | 111,943 |   |
| Gain  on investments, net                              |       | 1,325                                     |          | 11                                 |       | 1,325 |   | 270 |   |
| Interest  expense and other, net                       |       | (3,482                                    | )             | (5,100                             | )          | (4,523 | ) | (9,391 | ) |
| Income  from continuing operations before income taxes |       | 61,694                                    |          | 49,381                             |       | 126,067 |   | 102,822 |   |
| Income  tax provision                                  |       | (6,725                                    | )             | (17,896                            | )          | (15,999 | ) | (38,840 | ) |
| Income  from continuing operations                     |       | 54,969                                    |          | 31,485                             |       | 110,068 |   | 63,982 |   |
| Loss  from discontinued operations                     |       | (4,365                                    | )             | —                             |       | (7,757 | ) | — |   |
| Net  income                                            |       | $                                         |  50,604  |                               | $          |  31,485 |   | $ |  102,311 |   | $ |  63,982 |   |
|                                                   |       |                                      |          |                               |       |   |   |   |   |
| Basic  net income per share                            |       |                                      |          |                               |       |   |   |   |   |
| Continuing  operations                                 |       | $                                         |  0.50    |                               | $          |  0.30 |   | $ |  1.00 |   | $ |  0.60 |   |
| Discontinued  operations                               |       | (0.04                                     | )             | —                             |       | (0.07 | ) | — |   |
| Basic  net income per share                            |       | $                                         |  0.46    |                               | $          |  0.30 |   | $ |  0.93 |   | $ |  0.60 |   |
| Basic  weighted average common shares outstanding      |       | 110,033                                   |          | 105,908                            |       | 109,762 |   | 106,976 |   |
|                                                   |       |                                      |          |                               |       |   |   |   |   |
| Diluted  net income per share                          |       |                                      |          |                               |       |   |   |   |   |
| Continuing  operations                                 |       | $                                         |  0.49    |                               | $          |  0.29 |   | $ |  0.99 |   | $ |  0.59 |   |
| Discontinued  operations                               |       | (0.04                                     | )             | —                             |       | (0.07 | ) | — |   |
| Diluted  net income per share                          |       | $                                         |  0.45    |                               | $          |  0.29 |   | $ |  0.92 |   | $ |  0.59 |   |
| Diluted  weighted average common shares outstanding    |       | 112,256                                   |          | 107,080                            |       | 111,277 |   | 108,110 |   |

 

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

 

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**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                         | ** ** | **June 30,**    | ** ** |
| ** **                                                                         | ** ** | **2008**             | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**   | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**      | ** ** |
| Cash  flows from operating activities:                                             |       |                 |       |   |   |
| Net  income                                                                        |       | $                    | 102,311    |   | $ | 63,982 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                 |       |   |   |
| Depreciation  and amortization                                                     |       | 20,507               |       | 12,578 |   |
| Loss  on disposals and impairments of fixed assets                                 |       | 3,665                |       | 190 |   |
| Stock-based  compensation                                                          |       | 9,722                |       | 7,416 |   |
| Deferred  income taxes                                                             |       | 12,194               |       | 33,696 |   |
| Accretion  of debt discount and amortization of debt issuance costs                |       | 5,379                |       | 6,674 |   |
| Gain  on investments, net                                                          |       | (1,325               | )          | (271 | ) |
| Decrease  in accounts receivable, net                                              |       | 8,825                |       | 1,871 |   |
| (Increase)  decrease in prepaid expenses and other assets                          |       | (7,128               | )          | 5,073 |   |
| Decrease  in accounts payable and accrued and other liabilities                    |       | (39,659              | )          | (27,421 | ) |
| Decrease  in deferred revenue                                                      |       | (6,380               | )          | (4,482 | ) |
| Net  cash provided by operating activities                                         |       | 108,111              |       | 99,306 |   |
|                                                                               |       |                 |       |   |   |
| Cash  flows from investing activities:                                             |       |                 |       |   |   |
| Purchases  of property and equipment                                               |       | (2,258               | )          | (5,060 | ) |
| Purchases  of subscriber bases                                                     |       | (127                 | )          | — |   |
| Purchases  of marketable securities                                                |       | (53,027              | )          | (52,502 | ) |
| Sales  and maturities of marketable securities                                     |       | 97,160               |       | 2,950 |   |
| Proceeds  received from investments in other companies                             |       | 57,070               |       | 200 |   |
| Other  investing activities                                                        |       | 8                    |       | — |   |
| Net  cash provided by (used in) investing activities                               |       | 98,826               |       | (54,412 | ) |
|                                                                               |       |                 |       |   |   |
| Cash  flows from financing activities:                                             |       |                 |       |   |   |
| Principal  payments under capital lease obligations                                |       | (2,687               | )          | (17 | ) |
| Proceeds  from exercises of stock options                                          |       | 5,899                |       | 1,396 |   |
| Repurchases  of common stock                                                       |       | (9,126               | )          | (22,340 | ) |
| Net  cash used in financing activities                                             |       | (5,914               | )          | (20,961 | ) |
|                                                                               |       |                 |       |   |   |
| Net  increase in cash and cash equivalents                                         |       | 201,023              |       | 23,933 |   |
| Cash  and cash equivalents, beginning of period                                    |       | 173,827              |       | 486,564 |   |
| Cash  and cash equivalents, end of period                                          |       | $                    | 374,850    |   | $ | 510,497 |   |

 

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

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED**

** **

**1.  Organization**

** **

EarthLink, Inc.(“EarthLink” or the “Company”) is an Internet service provider (“ISP”),providing nationwide Internet access and related value-added services toindividual and business customers. The Company’s primary service offerings aredial-up and high-speed Internet access services and related value-addedservices, such as ancillary services sold as add-on features to the Company’sInternet access services, search and advertising. In addition, through theCompany’s wholly-owned subsidiary, New Edge Networks (“New Edge”), the Companybuilds and manages private IP-based wide area networks for businesses andcommunications carriers.

 

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

 

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

 

*Basis ofPresentation*

* *

Thecondensed consolidated financial statements of EarthLink, which include theaccounts of its wholly-owned subsidiaries, for the three and six months ended June 30,2008 and 2009 and the related footnote information are unaudited and have beenprepared on a basis consistent with the Company’s audited consolidatedfinancial statements as of December 31, 2008 contained in the Company’sAnnual Report on Form 10-K as filed with the Securities and ExchangeCommission (the “Annual Report”).  Allsignificant intercompany transactions have been eliminated.  In connection with the preparation of thecondensed consolidated financial statements and in accordance with the recentlyissued Statement of Financial Accounting Standards (“SFAS”) No. 165, “SubsequentEvents,” the Company evaluated subsequent events after the balance sheet dateof June 30, 2009 through July 31, 2009, the date of issuance of theCompany’s condensed consolidated financial statements. See Note 14, “SubsequentEvents.”

 

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 contain alladjustments (consisting of normal recurring adjustments), which managementconsiders necessary to present fairly the Company’s financial position, resultsof operations and cash flows for the interim periods presented.  The results of operations for the three andsix months ended June 30, 2009 are not necessarily indicative of theresults anticipated for the entire year ending December 31, 2009.

 

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

 

*Discontinued Operations*

* *

Inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets,” the Company reflected its municipal wireless broadbandresults of operations as discontinued operations for the three and six monthsended June 30, 2008. See Note 5, “Discontinued Operations,” for furtherdiscussion.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

** **

*Fair Value ofFinancial Instruments*

* *

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

 

*Reclassifications*

* *

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

 

*Recently Issued Accounting Pronouncement*

* *

In July 2009, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 168, “The FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles—a replacement of FASB Statement No. 162,” which willbecome the source of authoritative U.S. generally accepted accountingprinciples (“GAAP”) recognized by the FASB. SFAS No. 168 is effective forfinancial statements issued for interim and annual periods ending after September 15,2009. The adoption of SFAS No. 168 will not have a material impact on theCompany’s financial statements. However, the adoption of SFAS No. 168 willchange the Company’s references to GAAP in its consolidated financial statements.

 

*Adoption of Recent Accounting Pronouncement*

* *

On January 1,2009, the Company adopted FASB Staff Position No. APB 14-1, “Accountingfor Convertible Debt Instruments that May be Settled in Cash UponConversion” (“FSP APB 14-1”). FSP APB 14-1 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.Retrospective application to all periods presented is required. The adoption ofFSP APB 14-1 on January 1, 2009 affected the accounting for the Company’sConvertible Senior Notes due November 15, 2026 (the “Notes”), which wereissued in November 2006. Upon adoption, the Company recorded an adjustmentto increase additional paid-in capital as of the November 2006 issuancedate by approximately $62.1 million. The Company is accreting the resultingdebt discount to interest expense over the estimated five-year life of theNotes, which represents the first redemption date of November 2011. TheCompany 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 June 30, 2009 by $3.0 million and reduced basic anddiluted earnings per share by $0.03 per share, and reduced income fromcontinuing operations and net income for the six months ended June 30,2009 by $5.9 million and reduced basic and diluted earnings per share by $0.05per share and $0.06 per share, respectively. 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.

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

The following tables present theeffect of the adoption of FSP APB 14-1 on the Company’s affected financialstatement line items for the three and six months ended June 30, 2008 andas of December 31, 2008:

 
| ** **                                | ** ** | **Three Months Ended June 30, 2008** | ** ** | **Six Months Ended June 30, 2008** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                | ** ** | **As Originally**                         | ** ** | **As**                                  | ** ** | **Effect of** | ** ** | **As Originally** | ** ** | **As** | ** ** | **Effect of** | ** ** |
| ** **                                | ** ** | **Reported**                              | ** ** | **Adjusted**                            | ** ** | **Change** | ** ** | **Reported** | ** ** | **Adjusted** | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **(in thousands, except per share data)** | ** ** |
| Statement  of Operations:                 |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest  income (expense) and other, net |       | $                                         | (760       | )                                       | $          | (3,482 | ) | $ | (2,722 | ) | $ | 856 |   | $ | (4,523 | ) | $ | (5,379 | ) |
| Income  from continuing operations        |       | 57,691                                    |       | 54,969                                  |       | (2,722 | ) | 115,447 |   | 110,068 |   | (5,379 | ) |
| Net  income                               |       | 53,326                                    |       | 50,604                                  |       | (2,722 | ) | 107,690 |   | 102,311 |   | (5,379 | ) |
|                                      |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Basic  net income per share               |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Continuing  operations                    |       | $                                         | 0.52       |                                    | $          | 0.50 |   | $ | (0.02 | ) | $ | 1.05 |   | $ | 1.00 |   | $ | (0.05 | ) |
| Basic  net income per share               |       | 0.48                                      |       | 0.46                                    |       | (0.02 | ) | 0.98 |   | 0.93 |   | (0.05 | ) |
|                                      |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Diluted  net income per share             |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Continuing  operations                    |       | $                                         | 0.51       |                                    | $          | 0.49 |   | $ | (0.02 | ) | $ | 1.04 |   | $ | 0.99 |   | $ | (0.05 | ) |
| Diluted  net income per share             |       | 0.48                                      |       | 0.45                                    |       | (0.02 | ) | 0.97 |   | 0.92 |   | (0.05 | ) |

 
| ** **                  | ** ** | **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, restricted stockunits, phantom share units and convertible debt (collectively “Common StockEquivalents”), were exercised or converted into common stock. The dilutiveeffect of outstanding stock options, restricted stock units and convertibledebt is reflected in diluted earnings per share by application of the treasurystock method. Phantom share units are reflected on an if-converted basis. Inapplying the treasury stock method for stock-based compensation arrangements,the assumed proceeds are computed as the sum of the amount the employee mustpay upon exercise and the amounts of average unrecognized compensationcost attributed to future services.

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

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

 
| ** **                                          | ** ** | **Three Months Ended**                    | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------|------------|----------------------|------------|
| ** **                                          | ** ** | **June 30,**                         | ** ** | **June 30,**    | ** ** |
| ** **                                          | ** ** | **2008**                                  | ** ** | **2009**             | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                                          | ** ** | **(in thousands, except per share data)** | ** ** |
| **Numerator**                                       | ** ** | ** **                                | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income  from continuing operations                  |       | $                                         | 54,969     |                 | $          | 31,485 |   | $ | 110,068 |   | $ | 63,982 |   |
| Loss  from discontinued operations                  |       | (4,365                                    | )          | —               |       | (7,757 | ) | — |   |
| Net  income                                         |       | $                                         | 50,604     |                 | $          | 31,485 |   | $ | 102,311 |   | $ | 63,982 |   |
|                                                |       |                                      |       |                 |       |   |   |   |   |
| **Denominator**                                     |       |                                      |       |                 |       |   |   |   |   |
| Basic  weighted average common shares outstanding   |       | 110,033                                   |       | 105,908              |       | 109,762 |   | 106,976 |   |
| Dilutive  effect of Common Stock Equivalents        |       | 2,223                                     |       | 1,172                |       | 1,515 |   | 1,134 |   |
| Diluted  weighted average common shares outstanding |       | 112,256                                   |       | 107,080              |       | 111,277 |   | 108,110 |   |
|                                                |       |                                      |       |                 |       |   |   |   |   |
| **Basic net income per share**                      |       |                                      |       |                 |       |   |   |   |   |
| Continuing  operations                              |       | $                                         | 0.50       |                 | $          | 0.30 |   | $ | 1.00 |   | $ | 0.60 |   |
| Discontinued  operations                            |       | (0.04                                     | )          | —               |       | (0.07 | ) | — |   |
| Basic  net income per share                         |       | $                                         | 0.46       |                 | $          | 0.30 |   | $ | 0.93 |   | $ | 0.60 |   |
|                                                |       |                                      |       |                 |       |   |   |   |   |
| **Diluted net income per share**                    |       |                                      |       |                 |       |   |   |   |   |
| Continuing  operations                              |       | $                                         | 0.49       |                 | $          | 0.29 |   | $ | 0.99 |   | $ | 0.59 |   |
| Discontinued  operations                            |       | (0.04                                     | )          | —               |       | (0.07 | ) | — |   |
| Diluted  net income per share                       |       | $                                         | 0.45       |                 | $          | 0.29 |   | $ | 0.92 |   | $ | 0.59 |   |

 

Duringthe three months ended June 30, 2008 and 2009, approximately 8.0 millionand 5.1 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 futureservices exceeded the Company’s average stock price during the respectiveperiods. During the six months ended June 30, 2008 and 2009, approximately9.3 million and 5.9 million, respectively, stock options and restricted stockunits were excluded from the calculation of diluted EPS. Approximately 28.4million shares that underlie the Company’s convertible debt instruments werealso excluded from the calculations of diluted EPS because the exercise priceexceeded the Company’s average stock price during the periods. These securitiescould be dilutive in future periods.

 

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

 

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

 
| ** **                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                  | ** ** | **2008**                             | ** ** | **2009**                           | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**                   | ** ** |
| ** **                  | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2007  Restructuring Plan    |       | $                                    | 2,169      |                               | $          | 4,927 |   | $ | 3,262 |   | $ | 5,415 |   |
| Legacy  Restructuring Plans |       | (108                                 | )          | —                             |       | (171 | ) | — |   |
|                        |       | $                                    | 2,061      |                               | $          | 4,927 |   | $ | 3,091 |   | $ | 5,415 |   |

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

*2007 Restructuring Plan*

* *

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

 

The Company recorded $5.4 millionof facility exit and restructuring costs during the six months ended June 30,2009 as a result of changes to sublease estimates and further consolidation inits Atlanta, GA facility. The following table summarizes facility exit andrestructuring costs during the six months ended June 30, 2008 and 2009 andthe cumulative costs incurred to date as a result of the 2007 Plan. Such costshave been classified as facility exit and restructuring costs in the CondensedConsolidated Statements of Operations.

 
| ** **                                      | ** ** | ** **                         | ** ** | ** **   | ** ** | **Cumulative** | ** ** |
|-------------------------------------------------|------------|------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                      | ** ** | ** **                         | ** ** | ** **   | ** ** | **Costs**      | ** ** |
| ** **                                      | ** ** | **Six Months Ended June 30,** | ** ** | **Incurred** | ** ** |
| ** **                                      | ** ** | **2008**                           | ** ** | **2009**     | ** ** | **To Date**    | ** ** |
| ** **                                      | ** ** | **(in thousands)**                 | ** ** |
|                                            |       |                               |       |         |       |           |       |
| Severance  and personnel-related costs          |       | $                                  | 474        |         | $          | —         |       | $ | 30,764 |   |
| Lease  termination and facilities-related costs |       | 2,005                              |       | 5,369        |       | 22,393         |       |
| Non-cash  asset impairments                     |       | 313                                |       | 46           |       | 24,792         |       |
| Other  associated costs                         |       | 470                                |       | —       |       | 1,131          |       |
|                                            |       | $                                  | 3,262      |         | $          | 5,415          |       | $ | 79,080 |   |

 

 

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

 
| ** **                            | ** ** | **Severance**      | ** ** | ** **     | ** ** | **Asset**       | ** ** | **Other** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|--------------------|------------|----------------|------------|-----------------|------------|-----------|------------|------------|------------|
| ** **                            | ** ** | **and Benefits**   | ** ** | **Facilities** | ** ** | **Impairments** | ** ** | **Costs** | ** ** | **Total**  | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Balance  as of December 31, 2006 |       | $                  | —     |           | $          | —          |       | $         | —     |       | $          | — |   | $ | — |   |
| Accruals                              |       | 30,303             |       | 12,216         |       | 20,621          |       | 1,131     |       | 64,271     |       |
| Payments                              |       | (18,262            | )          | (480           | )          | —          |       | (760      | )          | (19,502    | )          |
| Non-cash  charges                     |       | —             |       | 4,388          |       | (20,621         | )          | (371      | )          | (16,604    | )          |
| Balance  as of December 31, 2007 |       | 12,041             |       | 16,124         |       | —          |       | —    |       | 28,165     |       |
| Accruals                              |       | 461                |       | 4,808          |       | 4,125           |       | —    |       | 9,394      |       |
| Payments                              |       | (12,502            | )          | (6,174         | )          | —          |       | —    |       | (18,676    | )          |
| Non-cash  charges                     |       | —             |       | 1,936          |       | (4,125          | )          | —    |       | (2,189     | )          |
| Balance  as of December 31, 2008 |       | —             |       | 16,694         |       | —          |       | —    |       | 16,694     |       |
| Accruals                              |       | —             |       | 5,369          |       | 46              |       | —    |       | 5,415      |       |
| Payments                              |       | —             |       | (2,617         | )          | —          |       | —    |       | (2,617     | )          |
| Non-cash  charges                     |       | —             |       | 392            |       | (46             | )          | —    |       | 346        |       |
| Balance  as of June 30, 2009     |       | $                  | —     |           | $          | 19,838          |       | $         | —     |       | $          | — |   | $ | 19,838 |   |

 

Facilityexit and restructuring liabilities due within one year of the balance sheetdate are classified as other accrued liabilities and facility exit andrestructuring liabilities due after one year of the balance sheet date 

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

are classified as other long-termliabilities in the Condensed Consolidated Balance Sheets. Of the unpaid balanceas of December 31, 2008 and June 30, 2009, approximately $5.9 millionand $7.4 million, respectively, were classified as other accrued liabilitiesand approximately $10.8 million and $12.4 million, respectively, wereclassified as other long-term liabilities.

 

*Legacy Restructuring Plans*

* *

Duringthe years ended December 31, 2003, 2004 and 2005, the Company executed aseries of plans to restructure and streamline the Company’s contact centeroperations and outsource certain internal functions (collectively referred toas “Legacy Plans”). The Legacy Plans included facility exit costs,personnel-related costs and asset disposals. EarthLink periodically evaluatesand adjusts its estimates for facility exit and restructuring costs based oncurrently-available information. Such adjustments are included as facility exitand restructuring costs in the Condensed Consolidated Statements of Operations.During the three and six months ended June 30, 2008, EarthLink recorded a$0.1 million and $0.2 million reduction, respectively, to facility exit andrestructuring costs as a result of changes in estimates for the Legacy Plans.As of June 30, 2009, the Company had a $1.0 million liability remainingfor real estate commitments related to the Legacy Plans, of which $0.7 millionwas classified as other accrued liabilities and $0.3 million was classified asother long-term liabilities in the Condensed Consolidated Balance Sheet. Allother costs have been paid.

 

**5.  Discontinued Operations**

** **

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

 

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

 
| ** **                          | ** ** | **Three Months**       | ** ** | **Six Months**         | ** ** |
|-------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **Ended**              | ** ** | **Ended**              | ** ** |
| ** **                          | ** ** | **June 30, 2008** | ** ** | **June 30, 2008** | ** ** |
| ** **                          | ** ** | **(in thousands)**     | ** ** |
| ** **                          | ** ** | ** **             | ** ** | ** **             | ** ** |
| Revenues                            |       | $                      | 551        |                   | $          | 1,288 |   |
| Operating  costs and expenses       |       | 1,513                  |       | 3,693                  |       |
| Impairment  and restructuring costs |       | 4,004                  |       | 5,953                  |       |
| Loss  from discontinued operations  |       | (4,365                 | )          | (7,757                 | )          |
|                                     |            |                        |            |                        |            |  |  |

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

**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-termmarketable securities as of December 31, 2008 also included investments inasset-backed, auction rate securities with interest rate reset periods of 90days or less but whose underlying agreements have original maturities of morethan 90 days. These securities were classified as short-term marketablesecurities as of June 30, 2009, which is more fully described below.

 

As of June 30,2009, the Company had $90.0 million of short-term marketable securities and$9.9 million of long-term marketable securities. As of June 30, 2009,$39.7 million of the Company’s short-term marketable securities and all of theCompany’s long-term marketable securities consisted of government agency notesand were classified as available-for-sale. Gross unrealized gains on thesesecurities as of June 30, 2009 were $0.1 million and there were no grossunrealized losses. As of June 30, 2009, $50.3 million of the Company’sshort-term marketable securities consisted of auction rate securities and wereclassified as trading. These securities are variable-rate debt instrumentswhose underlying agreements have contractual maturities of up to 40 years, buthave interest rate reset periods at pre-determined intervals, usually every 28days. These securities are predominantly secured by student loans guaranteed bystate related 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 the Company continuing to holdsuch securities. Accordingly, the Company classified these securities aslong-term marketable securities in the Condensed Consolidated Balance Sheet asof December 31, 2008 due to uncertainty surrounding the timing of a marketrecovery.

 

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”). Accordingly, the Company classified its auction rate securities asshort-term marketable securities in the Condensed Consolidated Balance Sheet asof June 30, 2009. The agreement also grants the broker the right to buythe Company’s auction rate securities at par plus accrued interest, until July 2,2012. The Company records the auction rate securities at fair value, withchanges in fair value included in earnings, as the Company no longer intends tohold the securities until a market recovery. 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 thesix months ended June 30, 2009, the Company recorded a $2.5 million gainon investments to record the auction rate securities at their fair value andrecorded a $2.4 million loss on investments to record the put right at its fairvalue. The net gain of $0.1 million during the six months ended June 30,2009 is included in gain on investments, net, in the Condensed ConsolidatedStatement of Operations. The change in fair value of the auction ratesecurities and the put right during the three months ended June 30, 2009was nominal.

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

*Investments*

** **

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

 
| ** **                        | ** ** | **As of**             | ** ** | **As of**         | ** ** |
|-----------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                        | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
| ** **                        | ** ** | **2008**              | ** ** | **2009**          | ** ** |
| ** **                        | ** ** | **(in thousands)**    | ** ** |
| Investments  stated at fair value |       | $                     | 11,408     |              | $          | 7,880 |   |
| Investments  stated at cost       |       | 9,300                 |       | 9,300             |       |
| Total  long-term investments      |       | $                     | 20,708     |              | $          | 17,180 |   |

 

Long-terminvestments in the Condensed Consolidated Balance Sheets include investments inother companies. Investments in other companies are accounted for under thecost method of accounting because the Company does not have the ability toexercise significant influence over the companies’ operations. Under the costmethod of accounting, investments in private companies are carried at cost andare only adjusted for other-than-temporary declines in fair value anddistributions of earnings. For cost method investments in public companies thathave readily determinable fair values, the Company classifies its investmentsas available-for-sale in accordance with SFAS No. 115 and, accordingly,records these investments at their fair values with unrealized gains and lossesincluded as a separate component of stockholders’ equity and in totalcomprehensive income. As of June 30, 2009, gross unrealized gains onavailable-for-sale investments were $6.3 million and there were no grossunrealized losses.  As of December 31,2008, gross unrealized losses on available-for-sale investments were nominaland there were no gross unrealized gains.

 

Long-terminvestments in the Condensed Consolidated Balance Sheet as of December 31,2008 also included the Company’s put right. The Company has a put right to sellits existing auction rate securities back to the broker beginning on June 30,2010, which had a carrying value and fair value of $9.8 million and $7.4million as of December 31, 2008 and June 30, 2009, respectively. TheCompany classified the put right as other current assets in the CondensedConsolidated Balance Sheet as of June 30, 2009. The Company elected thefair value option under SFAS No. 159, “The Fair Value Option for FinancialAssets and Financial Liabilities,” for the put right and records the put rightat fair value, with changes in fair value recognized in the CondensedConsolidated Statement of Operations. The fair value of the put right isestimated using a discounted cash 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.

* *

Duringthe six months ended June 30, 2008, the Company recognized a net gain oninvestments of $1.3 million. This consisted of a gain of $2.0 million from thesale of the Company’s 6.1 million shares of Covad Communications Group, LLCcommon stock to Platinum Equity, LLC, offset by an impairment loss of $0.7million due to other-than-temporary declines of the value of certain long-terminvestments. During the six months ended June 30, 2009, the Companyrecognized a net gain on investments of $0.3 million. This consisted of $0.2million in cash distributions from eCompanies Venture Group, L.P., a limitedpartnership that invested in domestic emerging Internet-related companies, anda net gain of $0.1 million related to the Company’s auction rate securities andput right.

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

**7.  Purchased Intangible Assets and Goodwill**

 

*Goodwill*

 

Therewere no changes in the carrying amount of goodwill during the six months ended June 30,2009.

 

*Purchased Intangible Assets*

 

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

 
| ** **                                     | ** ** | **As of December 31, 2008** | ** **   | **As of June 30, 2009** | ** ** |
|------------------------------------------------|------------|----------------------------------|--------------|------------------------------|------------|
| ** **                                     | ** ** | **Gross**                        | ** **   | ** **                   | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                                     | ** ** | **Carrying**                     | ** **   | **Accumulated**              | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| ** **                                     | ** ** | **Value**                        | ** **   | **Amortization**             | ** ** | **Value** | ** ** | **Value** | ** ** | **Amortization** | ** ** | **Value** | ** ** |
| ** **                                     | ** ** | **(in thousands)**               | ** **   |
| Intangible assets subject to amortization:     |       |                             |         |                         |       |   |   |   |   |   |   |   |   |
| Subscriber bases and customer relationships    |       | $                                | 94,039       |                         | $          | (77,758 | ) | $ | 16,281 |   | $ | 94,039 |   | $ | (81,722 | ) | $ | 12,317 |   |
| Software, technology and other                 |       | 739                              |         | (649                         | )          | 90 |   | 739 |   | (718 | ) | 21 |   |
| Trade names                                    |       | 1,521                            |         | (304                         | )          | 1,217 |   | 1,521 |   | (456 | ) | 1,065 |   |
|                                           |       | 96,299                           |         | (78,711                      | )          | 17,588 |   | 96,299 |   | (82,896 | ) | 13,403 |   |
| Intangible assets not subject to amortization: |       |                             |         |                         |       |   |   |   |   |   |   |   |   |
| Trade names                                    |       | 1,964                            |         | —                       |       | 1,964 |   | 1,964 |   | — |   | 1,964 |   |
|                                           |       | $                                |  98,263 |                         | $          | (78,711 | ) | $ | 19,552 |   | $ | 98,263 |   | $ | (82,896 | ) | $ | 15,367 |   |

 

Amortizationof intangible assets in the Condensed Consolidated Statements of Operations forthe three and six months ended June 30, 2008 and 2009 represents theamortization of definite-lived intangible assets.  The Company’s definite-lived intangibleassets primarily consist of subscriber bases and customer relationships,acquired software and technology, trade names and other assets acquired inconjunction with the purchases of businesses and subscriber bases from othercompanies that are not deemed to have indefinite lives. The Company’sidentifiable indefinite-lived intangible assets consist of certain trade names.Definite-lived intangible assets are amortized on a straight-line basis overtheir estimated useful lives, which are generally three to six years forsubscriber bases and customer relationships and three years for acquiredsoftware and technology.  As of June 30,2009, the weighted average amortization periods were 4.2 years for subscriberbase assets and customer relationships, 3.3 years for software and technologyand 5.0 years for trade names. Based on the current amount of definite-livedintangible assets, the Company expects to record amortization expense ofapproximately $3.5 million during the remaining six months in the year ending December 31,2009 and $4.1 million, $2.9 million, $1.5 million, $0.8 million and $0.6million during the years ending December 31, 2010, 2011, 2012, 2013 andthereafter, respectively. Actual amortization expense to be reported in futureperiods could differ materially from these estimates as a result of assetacquisitions, changes in useful lives and other relevant factors.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

**8.  Convertible SeniorNotes**

 

*General*

* *

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

 

TheNotes are payable with cash and, if applicable, are convertible into shares ofthe Company’s common stock 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, including the payment ofdividends in certain circumstances; (4) if the Company has called theNotes 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.

 

*Adoption of FSPAPB 14-1*

* *

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

 

As of December 31, 2008, theprincipal amount of the Notes, the unamortized discount and the net carryingvalue was $258.8 million, $39.0 million and $219.7 million, respectively. As ofJune 30, 2009, the principal amount of the Notes, the unamortized discountand the net carrying value was $258.8 million, $32.9 million and $225.8million, respectively. As of December 31, 2008 and June 30, 2009, thefair value of the Notes was approximately $236.6 million and $261.3 million,respectively, based on the quoted market prices.

 

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** **

**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

*Classification*

* *

In July 2009,the Company’s Board of Directors declared a quarterly cash dividend on itscommon stock of $0.14 per share to be paid on September 28, 2009 tostockholders of record on September 14, 2009. The Company currentlyintends to pay regular quarterly dividends on its common stock.  Under the terms of the indenture governingthe Notes, the Company’s payment of the cash dividend requires an adjustment tothe conversion rate for the Notes, which adjustment will be effective September 10,2009.  In addition, as a result of theadjustment, the Notes may be surrendered for conversion through September 9,2009, for the consideration provided for in the indenture. As a result, theCompany classified the Notes as a current liability in the CondensedConsolidated Balance Sheet as of June 30, 2009. The Notes were classifiedas long-term debt in the Condensed Consolidated Balance Sheet as of December 31,2008.

 

**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 and six months ended June 30,2008 and 2009 was as follows:

 
| ** **                                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                             | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                             | ** ** | **2008**               | ** ** | **2009**             | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                                                             | ** ** | **(in thousands)**     | ** ** |
| Net  income                                                            |       | $                      | 50,604     |                 | $          | 31,485 |   | $ | 102,311 |   | $ | 63,982 |   |
| Unrealized  holding (losses) gains on certain investments              |       | (767                   | )          | 5,185                |       | (1,024 | ) | 6,416 |   |
| Reclassification  adjustment for realized gains on certain investments |       | (1,779                 | )          | —               |       | (1,779 | ) | — |   |
| Total  comprehensive income                                            |       | $                      | 48,058     |                 | $          | 36,670 |   | $ | 99,508 |   | $ | 70,398 |   |

 

*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 June 30, 2009, the Company had $146.8 millionavailable under the current authorization. The Company may repurchase itscommon stock from time to time in compliance with Securities and ExchangeCommission regulations and other legal requirements, including through the useof derivative transactions, and subject to market conditions and other factors.The share repurchase program does not require the Company to acquire anyspecific number of shares and may be terminated by the Board of Directors atany time.

 

TheCompany repurchased 1.3 million shares of its common stock for $9.1 millionduring the six months ended June 30, 2008. The Company repurchased 3.6million shares of its common stock for $22.3 million during the six monthsended June 30, 2009.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

**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 $4.6 million and $3.0million during the three months ended June 30, 2008 and 2009,respectively, and $9.7 million and $7.4 million during the six months ended June 30,2008 and 2009, respectively.  Inaccordance with Staff Accounting Bulletin No. 107, “Share-Based Payment,”the Company has classified stock-based compensation expense during the threeand six months ended June 30, 2008 and 2009 within the same operatingexpense line items as cash compensation paid to employees.

 

*StockIncentive Plans*

* *

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

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

*OptionsOutstanding*

 

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

 
| ** **                                           | ** ** | ** **                            | ** ** | ** **   | ** ** | **Weighted**     | ** ** | ** **    | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|--------------|------------|------------------|------------|---------------|------------|
| ** **                                           | ** ** | ** **                            | ** ** | **Weighted** | ** ** | **Average**      | ** ** | ** **    | ** ** |
| ** **                                           | ** ** | ** **                            | ** ** | **Average**  | ** ** | **Remaining**    | ** ** | **Aggregate** | ** ** |
| ** **                                           | ** ** | ** **                            | ** ** | **Exercise** | ** ** | **Contractual**  | ** ** | **Intrinsic** | ** ** |
| ** **                                           | ** ** | **Stock Options**                     | ** ** | **Price**    | ** ** | **Term (Years)** | ** ** | **Value**     | ** ** |
| ** **                                           | ** ** | **(shares and dollars in thousands)** | ** ** |
|                                                 | ** ** | ** **                            |       |         |       |             |       |          |       |
| Outstanding as of December 31, 2008             |       | 7,159                                 |       | $            | 9.58       |             |       |          |       |   |
| Granted                                              |       | —                                |       | —       |       |             |       |          |       |
| Exercised                                            |       | (260                                  | )          | 6.63         |       |             |       |          |       |
| Forfeited and expired                                |       | (834                                  | )          | 13.87        |       |             |       |          |       |
| Outstanding as of June 30, 2009                 |       | 6,065                                 |       | 9.11         |       | 5.6              |       | $             | 1,387      |   |
|                                                 |       |                                  |       |         |       |             |       |          |       |
| Vested and expected to vest as of June 30, 2009 |       | 5,803                                 |       | $            | 9.19       |             | 5.5        |          | $          | 1,323 |   |
|                                                 |       |                                  |       |         |       |             |       |          |       |
| Exercisable as of June 30, 2009                 |       | 4,831                                 |       | $            | 9.45       |             | 5.1        |          | $          | 1,141 |   |

 

The aggregate intrinsic valueamounts in the table above represent the closing price of the Company’s commonstock on June 30, 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 June 30, 2009. The total intrinsic value of options exercisedduring the three months ended June 30, 2008 and 2009 was $1.0 million and$0.2 million, respectively. The total intrinsic value of options exercisedduring the six months ended June 30, 2008 and 2009 was $1.5 million and$0.3 million, respectively. The intrinsic value of stock options exercisedrepresents the difference between the closing price of the Company’s commonstock at the time of exercise and the exercise price, multiplied by the numberof stock options exercised. To the extent the forfeiture rate is different thanwhat the Company has anticipated, stock-based compensation related to theseawards will be different from the Company’s expectations.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

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

 

| **Stock Options  Outstanding** | ** ** | **Stock Options** | ** ** |
|--------------------------------|------------|-------------------|------------|
| ** **                     | ** ** | ** **        | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Exercisable** | ** ** |
| ** **                     | ** ** | ** **        | ** ** | ** ** | ** ** | **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       |       |   | 729 |   | 4.9 |   | $ | 6.07 |   | 588 |   | $ | 5.88 |   |
| 6.90                           | to         | 7.25              |       |   | 597 |   | 7.5 |   | 6.98 |   | 300 |   | 6.98 |   |
| 7.31                           | to         | 7.31              |       |   | 1,500 |   | 8.0 |   | 7.31 |   | 1,100 |   | 7.31 |   |
| 7.32                           | to         | 8.96              |       |   | 375 |   | 5.7 |   | 8.08 |   | 282 |   | 8.19 |   |
| 9.01                           | to         | 9.48              |       |   | 741 |   | 5.8 |   | 9.17 |   | 666 |   | 9.14 |   |
| 9.51                           | to         | 9.89              |       |   | 502 |   | 3.9 |   | 9.60 |   | 322 |   | 9.65 |   |
| 10.06                          | to         | 10.06             |       |   | 392 |   | 1.2 |   | 10.06 |   | 392 |   | 10.06 |   |
| 10.36                          | to         | 40.25             |       |   | 1,229 |   | 4.2 |   | 13.94 |   | 1,181 |   | 14.08 |   |
| $  5.10              | to         | $40.25            |       |   | 6,065 |   | 5.6 |   | $ | 9.11 |   | 4,831 |   | $ | 9.45 |   |

 

*RestrictedStock Units*

* *

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

 
| ** **                              | ** ** | ** **         | ** ** | **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                                  |       | (1,395             | )          | 7.17           |       |
| Forfeited                               |       | (265               | )          | 7.22           |       |
| Nonvested  as of June 30, 2009     |       | 2,653              |       | 7.17           |       |
|                                         |            |                    |            |                |            |  |

 

The fair value of restricted stockunits is determined based on the closing price of the Company’s common stock onthe grant date. The weighted-average grant date fair value of restricted stockunits granted during the six months ended June 30, 2008 and 2009 was $7.19and $6.74, respectively. As of June 30, 2009, there was $10.3 million oftotal unrecognized compensation cost related to nonvested restricted stockunits. That cost is expected to be recognized over a weighted-average period of1.6 years. The total fair value of shares vested during the six months ended June 30,2008 and 2009 was $4.9 million and $10.3 million, respectively, whichrepresents the closing price of the Company’s common stock on the vesting datemultiplied by the number of restricted stock units that vested.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

**11. Income Taxes**

 

EarthLinkrecorded an income tax provision of $6.7 million and $17.9 million during thethree months ended June 30, 2008 and 2009, respectively, and $16.0 millionand $38.8 million during the six months ended June 30, 2008 and 2009,respectively. The income tax provision was based on management’s currentexpectations in accordance with the interim reporting requirements of SFAS No. 109,“Accounting for Income Taxes,” Accounting Principles Board (“APB”) Opinion No. 28,“Interim Financial Reporting,” and FASB Interpretation No. 18 “Accountingfor Income Taxes in Interim Periods — an interpretation of APB Opinion No. 28.”

 

Themajor components of the income tax provision for the three and six months endedJune 30, 2008 and 2009 are as follows:

 
| ** **                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                       | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                       | ** ** | **2008**               | ** ** | **2009**             | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(in thousands)**     | ** ** |
|                             |       |                   |       |                 |       |   |   |   |   |
| Federal  alternative minumum tax |       | $                      | 1,158      |                 | $          | 816 |   | $ | 2,362 |   | $ | 1,849 |   |
| State  income tax                |       | 472                    |       | 1,941                |       | 1,258 |   | 3,295 |   |
| Other                            |       | 120                    |       | —               |       | (400 | ) | — |   |
| Current  provision               |       | 1,750                  |       | 2,757                |       | 3,220 |   | 5,144 |   |
|                             |       |                   |       |                 |       |   |   |   |   |
| Deferred  provision              |       | 4,975                  |       | 15,139               |       | 12,779 |   | 33,696 |   |
|                             |       |                   |       |                 |       |   |   |   |   |
| Total                            |       | $                      | 6,725      |                 | $          | 17,896 |   | $ | 15,999 |   | $ | 38,840 |   |

 

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 and six months ended June 30, 2009, the non-cash deferredtax provision recorded was primarily a result of the utilization of thesefederal and state net operating loss tax assets.  The current federal and state tax liabilitiesare payable as a result of limitations on net operating loss utilizationassociated with the alternative minimum 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 

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

financial condition, results ofoperations or cash flows.  The Company’s policy for recording interest andpenalties associated with audits is to record such items as a component ofincome taxes.  No adjustments were madeto the FIN No. 48 liability during the quarter.

 

**12.  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 as unobservableinputs in which little or no market data exists, therefore requiring an entityto develop its own assumptions.

 

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

 

Thefollowing table presents the Company’s assets measured at fair value on arecurring basis subject to the disclosure requirements of SFAS No. 157 asof June 30, 2009:

 
| ** **                             | ** ** | ** **   | ** ** | ** **            | ** ** | ** **        | ** ** | **Fair Value Measurements as of  June 30, 2009 Using** | ** ** |
|----------------------------------------|------------|--------------|------------|-----------------------|------------|-------------------|------------|-------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **   | ** ** | ** **            | ** ** | ** **        | ** ** | **Quoted Prices**                                           | ** ** | **Significant** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | ** **   | ** ** | ** **            | ** ** | ** **        | ** ** | **in Active**                                               | ** ** | **Other** | ** ** | **Significant** | ** ** |
| ** **                             | ** ** | ** **   | ** ** | **SFAS No. 107** | ** ** | **Assets**        | ** ** | **Markets for**                                             | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                             | ** ** | **Carrying** | ** ** | **Fair Value**        | ** ** | **Measured**      | ** ** | **Identical Assets**                                        | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**                        | ** ** | **Value**    | ** ** | **Estimate**          | ** ** | **at Fair Value** | ** ** | **(Level 1)**                                               | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| ** **                             | ** ** | ** **   | ** ** | ** **            | ** ** | ** **        | ** ** | **(in thousands)**                                          | ** ** |
| Cash  equivalents                      |       | $            | 494,128    |                  | $          | 494,128           |       | $                                                           | 494,128    |   | $ | 494,128 |   | $ | — |   | $ | — |   |
| Marketable  securities                 |       | 49,602       |       | 49,602                |       | 49,602            |       | 49,602                                                      |       | — |   | — |   |
| Auction  rate securities               |       | 50,250       |       | 50,250                |       | 50,250            |       | —                                                      |       | — |   | 50,250 |   |
| Equity  investments in other companies |       | 7,880        |       | 7,880                 |       | 7,880             |       | 667                                                         |       | 7,213 |   | — |   |
| Put  right                             |       | 7,408        |       | 7,408                 |       | 7,408             |       | —                                                      |       | — |   | 7,408 |   |
| Total                                  |       | $            | 609,268    |                  | $          | 609,268           |       | $                                                           | 609,268    |   | $ | 544,397 |   | $ | 7,213 |   | $ | 57,658 |   |

 

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

 

TheCompany has invested in auction rate securities, which are more fully describedin Note 6, “Investments.”  Beginning in February 2008, theseinstruments held by the Company failed to attract sufficientbuyers.  As a result, these securities do not have a readilydeterminable market value and are not liquid. The fair values of the Company’sauction rate securities as of June 30, 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.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

In October 2008,EarthLink entered into an agreement with the broker that sold the Company its auctionrate securities that gives the Company the right to sell its existing auctionrate securities back to the broker at par plus accrued interest, beginning on June 30,2010 until July 2, 2012. The Company elected the fair value option underSFAS No. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities,” for the put right to offset the fair value changes of the auctionrate securities. The fair value of the put right is estimated using adiscounted cash flow analysis and is classified within Level 3. The put rightwas classified as long-term investments as of December 31, 2008 and othercurrent assets as of June 30, 2009 in the Condensed Consolidated BalanceSheets.

 

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 ofJune 30, 2009:

 
| ** **                               | ** ** | **Auction**        | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|--------------------|------------|------------|------------|------------|------------|
| ** **                               | ** ** | **Rate**           | ** ** | **Put**    | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Securities**     | ** ** | **Right**  | ** ** | **Total**  | ** ** |
| ** **                               | ** ** | **(in thousands)** | ** ** |
| **Balance as of December 31, 2008** |       | $                  | 47,809     |       | $          | 9,828      |       | $ | 57,637 |   |
| Total  realized gains                    |       | 2,491              |       | —     |       | 2,491      |       |
| Total  realized losses                   |       | —             |       | (2,420     | )          | (2,420     | )          |
| Settlements                              |       | (50                | )          | —     |       | (50        | )          |
| **Balance as of June 30, 2009**     |       | $                  | 50,250     |       | $          | 7,408      |       | $ | 57,658 |   |

 

Duringthe six months ended June 30, 2009, the Company recorded a realized gainof $2.5 million to record its auction rate securities at their fair value andrecorded a realized loss of $2.4 million to record its put right at its fairvalue, 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 June 30, 2009.

 

**13.  Segment Information**

** **

Inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information,” the Company reports segment information along thesame lines that its chief executive officer reviews its operating results inassessing performance and allocating resources. The Company operates tworeportable segments, Consumer Services and Business Services. The Company’sConsumer Services segment provides Internet access services and relatedvalue-added services to individual customers. These services include dial-upand high-speed Internet access and voice services, among others. The Company’sBusiness 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.

 

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 development expenses,certain technology and facilities expenses, billing operations and provisionsfor doubtful accounts. Segment income from operations excludes other income andexpense items and certain expenses over which segment managers do not havediscretionary control. Costs excluded from segment income from operationsinclude various corporate expenses (consisting of certain costs such ascorporate management, human resources, finance and legal), amortization ofintangible assets, impairment of goodwill and intangible assets, facility exitand restructuring costs, and stock-based compensation expense under SFAS No. 123(R),as they are not considered in the measurement of segment performance.

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

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

 
| ** **                             | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                             | ** ** | **2008**                             | ** ** | **2009**                           | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                             | ** ** | **(in thousands)**                   | ** ** |
| **Consumer Services**                  |       |                                 |       |                               |       |   |   |   |   |
| Revenues                               |       | $                                    | 201,197    |                               | $          | 147,606 |   | $ | 417,541 |   | $ | 307,168 |   |
| Cost  of revenues                      |       | 67,331                               |       | 47,345                             |       | 138,503 |   | 99,679 |   |
| Gross  margin                          |       | 133,866                              |       | 100,261                            |       | 279,038 |   | 207,489 |   |
| Direct  segment operating expenses     |       | 53,692                               |       | 33,372                             |       | 114,693 |   | 70,578 |   |
| Segment  operating income              |       | $                                    | 80,174     |                               | $          | 66,889 |   | $ | 164,345 |   | $ | 136,911 |   |
|                                   |       |                                 |       |                               |       |   |   |   |   |
| **Business Services**                  |       |                                 |       |                               |       |   |   |   |   |
| Revenues                               |       | $                                    | 44,406     |                               | $          | 37,991 |   | $ | 91,136 |   | $ | 77,492 |   |
| Cost  of revenues                      |       | 25,157                               |       | 21,925                             |       | 51,536 |   | 45,156 |   |
| Gross  margin                          |       | 19,249                               |       | 16,066                             |       | 39,600 |   | 32,336 |   |
| Direct  segment operating expenses     |       | 11,957                               |       | 9,823                              |       | 26,827 |   | 21,082 |   |
| Segment  operating income              |       | $                                    | 7,292      |                               | $          | 6,243 |   | $ | 12,773 |   | $ | 11,254 |   |
|                                   |       |                                 |       |                               |       |   |   |   |   |
| **Consolidated**                       |       |                                 |       |                               |       |   |   |   |   |
| Revenues                               |       | $                                    | 245,603    |                               | $          | 185,597 |   | $ | 508,677 |   | $ | 384,660 |   |
| Cost  of revenues                      |       | 92,488                               |       | 69,270                             |       | 190,039 |   | 144,835 |   |
| Gross  margin                          |       | 153,115                              |       | 116,327                            |       | 318,638 |   | 239,825 |   |
| Direct  segment operating expenses     |       | 65,649                               |       | 43,195                             |       | 141,520 |   | 91,660 |   |
| Segment  operating income              |       | 87,466                               |       | 73,132                             |       | 177,118 |   | 148,165 |   |
| Stock-based  compensation expense      |       | 4,569                                |       | 3,026                              |       | 9,722 |   | 7,416 |   |
| Amortization  of intangible assets     |       | 3,987                                |       | 2,038                              |       | 8,000 |   | 4,185 |   |
| Facility  exit and restructuring costs |       | 2,061                                |       | 4,927                              |       | 3,091 |   | 5,415 |   |
| Other  operating expenses              |       | 12,998                               |       | 8,671                              |       | 27,040 |   | 19,206 |   |
| Income  from operations                |       | $                                    | 63,851     |                               | $          | 54,470 |   | $ | 129,265 |   | $ | 111,943 |   |

 

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

 

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

 

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

 

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**EARTHLINK, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED - (Continued)**

 

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

 
| ** **            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------|------------|------------------------|------------|----------------------|------------|
| ** **            | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **            | ** ** | **2008**               | ** ** | **2009**             | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **            | ** ** | **(in thousands)**     | ** ** |
| **Consumer Services** |       |                   |       |                 |       |   |   |   |   |
| Access  and service   |       | $                      | 176,280    |                 | $          | 129,479 |   | $ | 365,251 |   | $ | 269,269 |   |
| Value-added  services |       | 24,917                 |       | 18,127               |       | 52,290 |   | 37,899 |   |
| Total  revenues       |       | 201,197                |       | 147,606              |       | 417,541 |   | 307,168 |   |
|                  |       |                   |       |                 |       |   |   |   |   |
| **Business Services** |       |                   |       |                 |       |   |   |   |   |
| Access  and service   |       | 43,761                 |       | 37,439               |       | 89,639 |   | 76,347 |   |
| Value-added  services |       | 645                    |       | 552                  |       | 1,497 |   | 1,145 |   |
| Total  revenues       |       | 44,406                 |       | 37,991               |       | 91,136 |   | 77,492 |   |
|                  |       |                   |       |                 |       |   |   |   |   |
| **Consolidated**      |       |                   |       |                 |       |   |   |   |   |
| Access  and service   |       | 220,041                |       | 166,918              |       | 454,890 |   | 345,616 |   |
| Value-added  services |       | 25,562                 |       | 18,679               |       | 53,787 |   | 39,044 |   |
| Total  revenues       |       | $                      | 245,603    |                 | $          | 185,597 |   | $ | 508,677 |   | $ | 384,660 |   |

 

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

 

**14.  Subsequent Event**

** **

In July 2009, the Company’sBoard of Directors declared a quarterly cash dividend on its common stock of$0.14 per share to be paid on September 28, 2009 to stockholders of recordon September 14, 2009.  The Companycurrently intends to pay regular quarterly dividends on its common stock.  The Board of Directors also approved thepayment of cash dividend amounts on each outstanding restricted stock unit, theaccrued dividend payment amounts to be paid at the time the restricted stockunit vests. Any decision to declare future dividends will be made at thediscretion of the Board of Directors and will depend on, among other things,the Company’s results of operations, financial condition, cash requirements,investment opportunities and other factors the Board of Directors may deemrelevant.

 

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

 

Certain statements in thisQuarterly Report on Form 10-Q are forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995, Section 27Aof the Securities Act of 1933, and Section 21E of the Securities ExchangeAct of 1934. The words “estimate,” “plan,” “intend,” “expect,” “anticipate,” “believe”and similar expressions are intended to identify forward-looking statements.These forward-looking statements are found at various places throughout thisreport. EarthLink disclaims any intention or obligation to update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise. Although EarthLink believes that its expectations arebased on reasonable assumptions, it can give no assurance that its goals willbe achieved. Important factors that could cause actual results to differ fromestimates or projections contained in the forward-looking statements aredescribed under “Safe Harbor Statement” in this Item 2.

* *

*The following discussionshould be read in conjunction with the accompanying unaudited CondensedConsolidated Financial Statements and related Notes thereto and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andthe audited Consolidated Financial Statements and the Notes thereto containedin the Annual Report on Form 10-K for the year ended December 31, 2008.*

* *

**Overview**

** **

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

 

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

 

*BusinessStrategy*

* *

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

 

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

 

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

 

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and acquisitions from other ISPs. We also continue to evaluate potential strategic transactions that couldcomplement 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 events and circumstances that are beyondour control. Further, we can provide no assurance that we will be successful inachieving any or all of the strategies identified above, that the achievementor existence of such strategies will favorably impact profitability, or that otherfactors will not arise that would adversely affect future profitability.

 

*RevenueSources*

* *

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

 

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

 

*Trends in ourBusiness*

* *

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

 

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

 

Consistent with trends in the Internetaccess industry, the mix of our consumer access subscriber base has beenshifting from narrowband access to broadband access customers. Consumer broadbandaccess revenues 

 

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have lower gross margins than narrowband revenuesdue to the costs associated with delivering broadband services. This change inmix has negatively affected our profitability and we expect this trend tocontinue as broadband subscribers continue to become a greater proportion ofour consumer access subscriber base. However, our consumer broadband accesscustomers also have lower churn rates than our consumer narrowband accesscustomers. Accordingly, we expect to realize benefits from a more tenuredsubscriber 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-sitebusinesses to business customers with one site, often a home-based location.Many of our end user customers are retail businesses. Our wholesale customersconsist primarily of telecommunications carriers. Our business has become morefocused on end users as a result of mergers in the telecommunications industry.In addition, our small and medium-sized business customers, including retailbusinesses, are particularly exposed to the current economic downturn. We areexperiencing pressure on revenue and churn rates for our business services,given the current state of the economy. However, we seek to align our coststructure with 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 current 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.

 

*Second Quarter2009 Highlights*

* *

Totalrevenues decreased $60.0 million, or 24%, from the three months ended June 30,2008 to the three months ended June 30, 2009, as our subscriber basedecreased from approximately 3.3 million paying subscribers as of June 30,2008 to approximately 2.4 million paying subscribers as of June 30, 2009.The decrease in subscribers was attributable to the reduced sales and marketingactivities, as well as the continuing maturation of the narrowband Internetaccess market. Operating expenses decreased during the three months ended June 30,2009 compared to the prior year period primarily due to reduced sales andmarketing spending, reduced back-office support costs and reduced customersupport and bad debt expense as our overall subscriber base has decreased andbecome longer tenured. Our longer tenured customers require less customerservice and technical support and have a lower frequency of non-payment. Werecognized net income of $31.5 million during the three months ended June 30,2009 compared to $50.6 million during the three months ended June 30,2008. The decrease in net income was primarily due to the decrease in revenuesand an increase in our income tax provision, offset by the decrease in totaloperating costs and expenses.

 

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**RecentDevelopment**

** **

In July 2009, our Board ofDirectors declared a quarterly cash dividend on our common stock of $0.14 pershare to be paid on September 28, 2009 to stockholders of record on September 14,2009. We currently intend to continue to pay regular quarterly dividends on ourcommon stock.  The Board of Directorsalso approved the payment of cash dividend amounts on each outstandingrestricted stock unit, the accrued dividend payment amounts to be paid at thetime the restricted stock unit vests. Any decision to declare future dividendswill be made at the discretion of the Board of Directors and will depend on,among other things, our results of operations, financial condition, cashrequirements, investment opportunities and other factors the Board of Directorsmay deem relevant.

 

**Key OperatingMetrics**

** **

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

 
| ** **                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------|------------|-------------------|------------|-----------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                  | ** ** | **2008**          | ** ** | **2008**              | ** ** | **2009**           | ** ** | **2009**          | ** ** |
| **Subscriber Data (a)**                     |       |              |       |                  |       |               |       |              |       |
| **Consumer Services**                       |       |              |       |                  |       |               |       |              |       |
| Narrowband  access subscribers              |       | 2,130,000         |       | 1,747,000             |       | 1,587,000          |       | 1,456,000         |       |
| Broadband  access subscribers (b)           |       | 988,000           |       | 896,000               |       | 856,000            |       | 845,000           |       |
| Total  consumer services                    |       | 3,118,000         |       | 2,643,000             |       | 2,443,000          |       | 2,301,000         |       |
| **Business Services**                       |       |              |       |                  |       |               |       |              |       |
| Narrowband  access subscribers              |       | 24,000            |       | 17,000                |       | 14,000             |       | 11,000            |       |
| Broadband  access subscribers               |       | 63,000            |       | 59,000                |       | 57,000             |       | 56,000            |       |
| Web  hosting accounts                       |       | 94,000            |       | 87,000                |       | 84,000             |       | 81,000            |       |
| Total  business services                    |       | 181,000           |       | 163,000               |       | 155,000            |       | 148,000           |       |
| **Total subscriber count at end of period** |       | 3,299,000         |       | 2,806,000             |       | 2,598,000          |       | 2,449,000         |       |

 
| ** **                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                          | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                          | ** ** | **2008**               | ** ** | **2009**             | ** ** | **2008** | ** ** | **2009** | ** ** |
| **Subscriber Activity**             |       |                   |       |                 |       |   |   |   |   |
| Subscribers  at beginning of period |       | 3,581,000              |       | 2,598,000            |       | 3,876,000 |   | 2,806,000 |   |
| Gross  organic subscriber additions |       | 162,000                |       | 120,000              |       | 415,000 |   | 236,000 |   |
| Adjustment  (c)                     |       | —                 |       | —               |       | — |   | (7,000 | ) |
| Churn                               |       | (444,000               | )          | (269,000             | )          | (992,000 | ) | (586,000 | ) |
| Subscribers  at end of period       |       | 3,299,000              |       | 2,449,000            |       | 3,299,000 |   | 2,449,000 |   |
|                                |       |                   |       |                 |       |   |   |   |   |
| **Churn rate (d)**                  |       | 4.3                    | %          | 3.6                  | %          | 4.6 | % | 3.8 | % |
|                                |       |                   |       |                 |       |   |   |   |   |
| **Consumer Services Data**          |       |                   |       |                 |       |   |   |   |   |
| Average  subscribers (e)            |       | 3,250,000              |       | 2,371,000            |       | 3,394,000 |   | 2,457,000 |   |
| ARPU  (f)                           |       | $                      | 20.64      |                 | $          | 20.75 |   | $ | 20.50 |   | $ | 20.84 |   |
| Churn  rate (d)                     |       | 4.4                    | %          | 3.6                  | %          | 4.7 | % | 3.8 | % |
|                                |       |                   |       |                 |       |   |   |   |   |
| **Business Services Data**          |       |                   |       |                 |       |   |   |   |   |
| Average  subscribers (e)            |       | 184,000                |       | 152,000              |       | 187,000 |   | 156,000 |   |
| ARPU  (f)                           |       | $                      | 80.37      |                 | $          | 83.32 |   | $ | 81.14 |   | $ | 82.80 |   |
| Churn  rate (d)                     |       | 2.5                    | %          | 2.7                  | %          | 2.6 | % | 2.9 | % |

 

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

 

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

 

(c) During the six months ended June 30, 2009, we removed approximately 7,000satellite subscribers from our broadband subscriber count and total subscribercount as a result of our sale of these subscriber accounts.

 

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

 

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

 

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

 

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**Results ofOperations**

** **

***Consolidated Results of Operations***

*** ***

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

 
| ** **                                             | ** ** | **Three Months Ended June 30,** | ** ** | ** **  | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                                             | ** ** | **2008**                             | ** ** | **2009**    | ** ** | **Change Between** | ** ** |
| ** **                                             | ** ** | ** **                           | ** ** | **% of**    | ** ** | ** ** | ** ** | **% of** | ** ** | **2008 and 2009** | ** ** |
| ** **                                             | ** ** | **Amount**                           | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                                             | ** ** | **(dollars in thousands)**           | ** ** |
|                                                   |       |                                 |       |        |       |   |   |   |   |   |   |   |   |
| Revenues                                               |       | $                                    | 245,603    |        | 100        | % |   | $ | 185,597 |   | 100 | % |   | $ | (60,006 | ) | -24 | % |   |
|                                                   |       |                                 |       |        |       |   |   |   |   |   |   |   |   |   |   |   |
| Operating  costs and expenses:                         |       |                                 |       |        |       |   |   |   |   |   |   |   |   |   |   |   |
| Cost  of revenues                                      |       | 92,488                               |       | 38          | %          |   | 69,270 |   | 37 | % |   | (23,218 | ) | -25 | % |   |
| Sales  and marketing                                   |       | 25,806                               |       | 11          | %          |   | 14,543 |   | 8 | % |   | (11,263 | ) | -44 | % |   |
| Operations  and customer support                       |       | 33,642                               |       | 14          | %          |   | 23,940 |   | 13 | % |   | (9,702 | ) | -29 | % |   |
| General  and administrative                            |       | 23,768                               |       | 10          | %          |   | 16,409 |   | 9 | % |   | (7,359 | ) | -31 | % |   |
| Amortization  of intangible assets                     |       | 3,987                                |       | 2           | %          |   | 2,038 |   | 1 | % |   | (1,949 | ) | -49 | % |   |
| Facility  exit and restructuring costs                 |       | 2,061                                |       | 1           | %          |   | 4,927 |   | 3 | % |   | 2,866 |   | 139 | % |   |
| Total  operating costs and expenses                    |       | 181,752                              |       | 74          | %          |   | 131,127 |   | 71 | % |   | (50,625 | ) | -28 | % |   |
|                                                   |       |                                 |       |        |       |   |   |   |   |   |   |   |   |   |   |   |
| Income  from operations                                |       | 63,851                               |       | 26          | %          |   | 54,470 |   | 29 | % |   | (9,381 | ) | -15 | % |   |
| Gain  on investments, net                              |       | 1,325                                |       | 1           | %          |   | 11 |   | 0 | % |   | (1,314 | ) | 100 | % |   |
| Interest  expense and other, net                       |       | (3,482                               | )          | -1          | %          |   | (5,100 | ) | -3 | % |   | (1,618 | ) | 46 | % |   |
| Income  from continuing operations before income taxes |       | 61,694                               |       | 25          | %          |   | 49,381 |   | 27 | % |   | (12,313 | ) | -20 | % |   |
| Income  tax provision                                  |       | (6,725                               | )          | -3          | %          |   | (17,896 | ) | -10 | % |   | (11,171 | ) | 166 | % |   |
| Income  from continuing operations                     |       | 54,969                               |       | 22          | %          |   | 31,485 |   | 17 | % |   | (23,484 | ) | -43 | % |   |
| Loss  from discontinued operations                     |       | (4,365                               | )          | -2          | %          |   | — |   | 0 | % |   | 4,365 |   | -100 | % |   |
| Net  income                                            |       | $                                    | 50,604     |        | 21         | % |   | $ | 31,485 |   | 17 | % |   | $ | (19,119 | ) | -38 | % |   |

 

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

 
| ** **                                             | ** ** | **Six Months Ended June 30,** | ** ** | ** **  | ** ** | ** **         | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|-------------|------------|--------------------|------------|
| ** **                                             | ** ** | **2008**                           | ** ** | **2009**    | ** ** | **Change Between** | ** ** |
| ** **                                             | ** ** | ** **                         | ** ** | **% of**    | ** ** | ** **         | ** ** | **% of** | ** ** | **2008 and 2009** | ** ** |
| ** **                                             | ** ** | **Amount**                         | ** ** | **Revenue** | ** ** | **Amount**         | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                                             | ** ** | **(dollars in thousands)**         | ** ** |
|                                                   |       |                               |       |        |       |               |       |   |   |   |   |   |   |
| Revenues                                               |       | $                                  | 508,677    |        | 100        | %                  |       | $ | 384,660 |   | 100 | % |   | $ | (124,017 | ) | -24 | % |   |
|                                                   |       |                               |       |        |       |               |       |   |   |   |   |   |   |   |   |   |
| Operating  costs and expenses:                         |       |                               |       |        |       |               |       |   |   |   |   |   |   |   |   |   |
| Cost  of revenues                                      |       | 190,039                            |       | 37          | %          |               | 144,835    |   | 38 | % |   | (45,204 | ) | -24 | % |   |
| Sales  and marketing                                   |       | 56,722                             |       | 11          | %          |               | 31,565     |   | 8 | % |   | (25,157 | ) | -44 | % |   |
| Operations  and customer support                       |       | 72,866                             |       | 14          | %          |               | 51,686     |   | 13 | % |   | (21,180 | ) | -29 | % |   |
| General  and administrative                            |       | 48,694                             |       | 10          | %          |               | 35,031     |   | 9 | % |   | (13,663 | ) | -28 | % |   |
| Amortization  of intangible assets                     |       | 8,000                              |       | 2           | %          |               | 4,185      |   | 1 | % |   | (3,815 | ) | -48 | % |   |
| Facility  exit and restructuring costs                 |       | 3,091                              |       | 1           | %          |               | 5,415      |   | 1 | % |   | 2,324 |   | 75 | % |   |
| Total  operating costs and expenses                    |       | 379,412                            |       | 75          | %          |               | 272,717    |   | 71 | % |   | (106,695 | ) | -28 | % |   |
|                                                   |       |                               |       |        |       |               |       |   |   |   |   |   |   |   |   |   |
| Income  from operations                                |       | 129,265                            |       | 25          | %          |               | 111,943    |   | 29 | % |   | (17,322 | ) | -13 | % |   |
| Gain  on investments, net                              |       | 1,325                              |       | 0           | %          |               | 270        |   | 0 | % |   | (1,055 | ) | -80 | % |   |
| Interest  expense and other, net                       |       | (4,523                             | )          | -1          | %          |               | (9,391     | ) | -2 | % |   | (4,868 | ) | 108 | % |   |
| Income  from continuing operations before income taxes |       | 126,067                            |       | 25          | %          |               | 102,822    |   | 27 | % |   | (23,245 | ) | -18 | % |   |
| Income  tax provision                                  |       | (15,999                            | )          | -3          | %          |               | (38,840    | ) | -10 | % |   | (22,841 | ) | 143 | % |   |
| Income  from continuing operations                     |       | 110,068                            |       | 22          | %          |               | 63,982     |   | 17 | % |   | (46,086 | ) | -42 | % |   |
| Loss  from discontinued operations                     |       | (7,757                             | )          | -2          | %          |               | —     |   | 0 | % |   | 7,757 |   | -100 | % |   |
| Net  income                                            |       | $                                  | 102,311    |        | 20         | %                  |       | $ | 63,982 |   | 17 | % |   | $ | (38,329 | ) | -37 | % |   |

 

***Segment Results of Operations***

*** ***

Wehave two operating segments, Consumer Services and Business Services. We presentour segment information along the same lines that our chief executive reviewsour operating results in assessing performance and allocating resources. OurConsumer Services segment provides Internet access services and relatedvalue-added services to individual customers. These services include dial-upand high-speed Internet access and VoIP services, among others. Our BusinessServices segment provides integrated communications services 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.

 

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.

 

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

 
| ** **                             | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                             | ** ** | **2008**                             | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**           | ** ** |
| **Consumer Services**                  |       |                                 |       |       |       |              |       |   |   |
| Revenues                               |       | $                                    | 201,197    |       | $          | 147,606           |       | $ | (53,591 | ) | -27 | % |   |
| Cost  of revenues                      |       | 67,331                               |       | 47,345     |       | (19,986           | )          | -30 | % |   |
| Gross  margin                          |       | 133,866                              |       | 100,261    |       | (33,605           | )          | -25 | % |   |
| Direct  segment operating expenses     |       | 53,692                               |       | 33,372     |       | (20,320           | )          | -38 | % |   |
| Segment  operating income              |       | $                                    | 80,174     |       | $          | 66,889            |       | $ | (13,285 | ) | -17 | % |   |
|                                   |       |                                 |       |       |       |              |       |   |   |   |
| **Business Services**                  |       |                                 |       |       |       |              |       |   |   |   |
| Revenues                               |       | $                                    | 44,406     |       | $          | 37,991            |       | $ | (6,415 | ) | -14 | % |   |
| Cost  of revenues                      |       | 25,157                               |       | 21,925     |       | (3,232            | )          | -13 | % |   |
| Gross  margin                          |       | 19,249                               |       | 16,066     |       | (3,183            | )          | -17 | % |   |
| Direct  segment operating expenses     |       | 11,957                               |       | 9,823      |       | (2,134            | )          | -18 | % |   |
| Segment  operating income              |       | $                                    | 7,292      |       | $          | 6,243             |       | $ | (1,049 | ) | -14 | % |   |
|                                   |       |                                 |       |       |       |              |       |   |   |   |
| **Consolidated**                       |       |                                 |       |       |       |              |       |   |   |   |
| Revenues                               |       | $                                    | 245,603    |       | $          | 185,597           |       | $ | (60,006 | ) | -24 | % |   |
| Cost  of revenues                      |       | 92,488                               |       | 69,270     |       | (23,218           | )          | -25 | % |   |
| Gross  margin                          |       | 153,115                              |       | 116,327    |       | (36,788           | )          | -24 | % |   |
| Direct  segment operating expenses     |       | 65,649                               |       | 43,195     |       | (22,454           | )          | -34 | % |   |
| Segment  operating income              |       | 87,466                               |       | 73,132     |       | (14,334           | )          | -16 | % |   |
| Stock-based  compensation expense      |       | 4,569                                |       | 3,026      |       | (1,543            | )          | -34 | % |   |
| Amortization  of intangible assets     |       | 3,987                                |       | 2,038      |       | (1,949            | )          | -49 | % |   |
| Facility  exit and restructuring costs |       | 2,061                                |       | 4,927      |       | 2,866             |       | 139 | % |   |
| Other  operating expenses              |       | 12,998                               |       | 8,671      |       | (4,327            | )          | -33 | % |   |
| Income  from operations                |       | $                                    | 63,851     |       | $          | 54,470            |       | $ | (9,381 | ) | -15 | % |   |

 

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

 
| ** **                             | ** ** | **Six Months Ended June 30,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------------------------------|------------|------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                             | ** ** | **2008**                           | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**         | ** ** |
| **Consumer Services**                  |       |                               |       |       |       |              |       |   |   |
| Revenues                               |       | $                                  | 417,541    |       | $          | 307,168           |       | $ | (110,373 | ) | -26 | % |   |
| Cost  of revenues                      |       | 138,503                            |       | 99,679     |       | (38,824           | )          | -28 | % |   |
| Gross  margin                          |       | 279,038                            |       | 207,489    |       | (71,549           | )          | -26 | % |   |
| Direct  segment operating expenses     |       | 114,693                            |       | 70,578     |       | (44,115           | )          | -38 | % |   |
| Segment  operating income              |       | $                                  | 164,345    |       | $          | 136,911           |       | $ | (27,434 | ) | -17 | % |   |
|                                   |       |                               |       |       |       |              |       |   |   |   |
| **Business Services**                  |       |                               |       |       |       |              |       |   |   |   |
| Revenues                               |       | $                                  | 91,136     |       | $          | 77,492            |       | $ | (13,644 | ) | -15 | % |   |
| Cost  of revenues                      |       | 51,536                             |       | 45,156     |       | (6,380            | )          | -12 | % |   |
| Gross  margin                          |       | 39,600                             |       | 32,336     |       | (7,264            | )          | -18 | % |   |
| Direct  segment operating expenses     |       | 26,827                             |       | 21,082     |       | (5,745            | )          | -21 | % |   |
| Segment  operating income              |       | $                                  | 12,773     |       | $          | 11,254            |       | $ | (1,519 | ) | -12 | % |   |
|                                   |       |                               |       |       |       |              |       |   |   |   |
| **Consolidated**                       |       |                               |       |       |       |              |       |   |   |   |
| Revenues                               |       | $                                  | 508,677    |       | $          | 384,660           |       | $ | (124,017 | ) | -24 | % |   |
| Cost  of revenues                      |       | 190,039                            |       | 144,835    |       | (45,204           | )          | -24 | % |   |
| Gross  margin                          |       | 318,638                            |       | 239,825    |       | (78,813           | )          | -25 | % |   |
| Direct  segment operating expenses     |       | 141,520                            |       | 91,660     |       | (49,860           | )          | -35 | % |   |
| Segment  operating income              |       | 177,118                            |       | 148,165    |       | (28,953           | )          | -16 | % |   |
| Stock-based  compensation expense      |       | 9,722                              |       | 7,416      |       | (2,306            | )          | -24 | % |   |
| Amortization  of intangible assets     |       | 8,000                              |       | 4,185      |       | (3,815            | )          | -48 | % |   |
| Facility  exit and restructuring costs |       | 3,091                              |       | 5,415      |       | 2,324             |       | 75 | % |   |
| Other  operating expenses              |       | 27,040                             |       | 19,206     |       | (7,834            | )          | -29 | % |   |
| Income  from operations                |       | $                                  | 129,265    |       | $          | 111,943           |       | $ | (17,322 | ) | -13 | % |   |

 

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***Revenues***

** **

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

 
| ** **            | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|------------|------------|------------|------------|
| ** **            | ** ** | **June 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** | **June 30,**    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | **2008**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change**         | ** ** | **2008**   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **            | ** ** | **(dollars in thousands)** | ** ** |
| **Consumer Services** |       |                       |       |       |       |              |       |                 |       |       |       |       |       |   |   |   |   |
| Access  and service   |       | $176,280                   |       | $129,479   |       | $(46,801          | )          | -27                  | %          |       | $365,251   |       | $269,269   |   | $(95,982 | ) | -26 | % |   |
| Value-added  services |       | 24,917                     |       | 18,127     |       | (6,790            | )          | -27                  | %          |       | 52,290     |       | 37,899     |   | (14,391 | ) | -28 | % |   |
| Total  revenues       |       | 201,197                    |       | 147,606    |       | (53,591           | )          | -27                  | %          |       | 417,541    |       | 307,168    |   | (110,373 | ) | -26 | % |   |
|                  |       |                       |       |       |       |              |       |                 |       |       |       |       |       |   |   |   |   |   |   |
| **Business Services** |       |                       |       |       |       |              |       |                 |       |       |       |       |       |   |   |   |   |   |   |
| Access  and service   |       | 43,761                     |       | 37,439     |       | (6,322            | )          | -14                  | %          |       | 89,639     |       | 76,347     |   | (13,292 | ) | -15 | % |   |
| Value-added  services |       | 645                        |       | 552        |       | (93               | )          | -14                  | %          |       | 1,497      |       | 1,145      |   | (352 | ) | -24 | % |   |
| Total  revenues       |       | 44,406                     |       | 37,991     |       | (6,415            | )          | -14                  | %          |       | 91,136     |       | 77,492     |   | (13,644 | ) | -15 | % |   |
|                  |       |                       |       |       |       |              |       |                 |       |       |       |       |       |   |   |   |   |   |   |
| **Consolidated**      |       |                       |       |       |       |              |       |                 |       |       |       |       |       |   |   |   |   |   |   |
| Access  and service   |       | 220,041                    |       | 166,918    |       | (53,123           | )          | -24                  | %          |       | 454,890    |       | 345,616    |   | (109,274 | ) | -24 | % |   |
| Value-added  services |       | 25,562                     |       | 18,679     |       | (6,883            | )          | -27                  | %          |       | 53,787     |       | 39,044     |   | (14,743 | ) | -27 | % |   |
| Total  revenues       |       | $245,603                   |       | $185,597   |       | $(60,006          | )          | -24                  | %          |       | $508,677   |       | $384,660   |   | $(124,017 | ) | -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 $245.6 million during the three months ended June 30,2008 to $185.6 million during the three months ended June 30, 2009. Thiswas comprised of a $53.6 million decrease in consumer services revenue and a$6.4 million decrease in business services revenue. Total revenues decreasedfrom $508.7 million during the six months ended June 30, 2008 to $384.7million during the six months ended June 30, 2009. This was comprised of a$110.4 million decrease in consumer services revenue and a $13.6 milliondecrease in business services revenue.

 

The decreases in consumer services revenue were primarilyattributable to decreases in average consumer subscribers, which wereapproximately 3.3 million and 3.4 million during the three and six months endedJune 30, 2008, respectively, and 2.4 million and 2.5 million during thethree and six months ended June 30, 2009, respectively. The decreases weredriven primarily by narrowband and broadband subscribers. Slightly offsettingthe decrease in our average consumer subscribers were increases in consumerservices ARPU, which increased due to the shift in mix of our consumer accesssubscriber base from narrowband to broadband subscribers. The decreases inbusiness services revenue were primarily due to decreases in average businesssubscribers, which were approximately 184,000 and 187,000 during the three andsix months ended June 30, 2008, respectively, and 152,000 and 156,000during the three and six months ended June 30, 2009, respectively.Slightly offsetting the decreases in our average business subscribers wereincreases in business services ARPU, which increased due to the shift in mix ofour business access subscriber base to New Edge subscribers.

 

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*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 $46.8million, or 27%, from the three months ended June 30, 2008 to the threemonths ended June 30, 2009, and decreased $96.0 million, or 26%, from thesix months ended June 30, 2008 to the six months ended June 30,2009.  The decreases in consumer accessand service revenues were primarily due to decreases in narrowband access andbroadband access revenues.  Narrowbandaccess revenues decreased due to a decrease in average premium narrowband andvalue-priced narrowband subscribers resulting from reduced sales and marketingactivities and the continued maturation of and competition in the market fornarrowband Internet access. In accordance with our business strategy, 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 2.2 million and 2.4 million during thethree and six months ended June 30, 2008, respectively, to 1.5 million and1.6 million during the three and six months ended June 30, 2009,respectively. Our value-priced PeoplePC narrowband services comprised a largerproportion of this decrease, as average PeoplePC access subscribers decreasedfrom approximately 33% and 34% of our average consumer narrowband customer baseduring the three and six months ended June 30, 2008, respectively, to 25%and 26% during the three and six months ended June 30, 2009, respectively.Broadband access revenues decreased due to a decline in average broadbandsubscribers resulting from reduced sales and marketing efforts. Averageconsumer broadband subscribers decreased from 1.0 million during the threemonths ended June 30, 2008 to 0.9 million during the three months ended June 30,2009. However, we experienced an improvement in consumer subscriber churn ratesduring the three and six months ended June 30, 2009 compared to the prioryear period, as churn decreased from 4.4% and 4.7% during the three and sixmonths ended June 30, 2008, respectively, to 3.6% and 3.8% during thethree and six months ended June 30, 2009, respectively.

 

We expect our consumer access and service subscriber baseto continue to decrease due to our decreased sales and marketing activities anddue to the continued maturation of the market for narrowband Internet access.However, as our customers become more tenured, we expect our churn rates todecline.

 

*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 $6.8 million, or 27%, from the three months ended June 30,2008 to the three months ended June 30, 2009, and decreased $14.4 million,or 28%, from the six months ended June 30, 2008 to the six months ended June 30,2009.  The decreases were due primarilyto decreases in sales of ancillary services, primarily security services, andin search advertising revenues. The decreases were the result of decreases intotal average consumer subscribers from 3.2 million and 3.4 million during thethree and six months ended June 30, 2008, respectively, to 2.4 million and2.5 million during the three and six months ended June 30, 2009,respectively.  However, offsetting thesedecreases was an increase in subscription revenue per subscriber and searchrevenue per thousand searches. We expect our value-added services revenues todecrease during the remainder of 2009 as our subscriber base decreases.

 

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*Businessservices revenue*

* *

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

 

Business access and service revenues decreased $6.3million, or 14%, from the three months ended June 30, 2008 to the threemonths ended June 30, 2009 and decreased $13.3 million, or 15%, from thesix months ended June 30, 2008 to the six months ended June 30,2009.  The decreases were primarily dueto decreases in average business access and service subscribers, comprised ofdecreases in average web hosting accounts, average business narrowbandcustomers and average New Edge customers. Our churn rates for business servicescustomers increased during the three and six months ended June 30, 2009compared to the prior year periods, which was primarily driven by a decrease inbusiness narrowband customers resulting from maturation of and competition inthe market for these Internet access services. Our wholesale business was alsonegatively impacted by consolidation in the telecommunications industry.

 

We expect continued pressure on revenue and churn rates forour business services, especially given the state of the economy. However, wewill continue to seek opportunities to align our cost structure with trends inour 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 $23.2 million, or 25%, from the three months ended June 30,2008 to the three months ended June 30, 2009, and decreased as a percentof revenue from 38% to 37%.  Thisdecrease was comprised of a $20.0 million decrease in consumer services cost ofrevenues and $3.2 million decrease in business services cost of revenue.Consumer services cost of revenues decreased due to the decline in averageconsumer services subscribers. Offsetting this decrease was an increase inaverage consumer cost per subscriber due to a greater proportion of ourconsumer subscriber base consisting of broadband subscribers. Business servicescost of revenues decreased due to a decrease in average business servicessubscribers. The decrease in cost of revenues as a percent of revenues wasprimarily due to more favorable rates with service providers.

 

Totalcost of revenues decreased $45.2 million, or 24%, from the six months ended June 30,2008 to the six months ended June 30, 2009, but increased as a percent ofrevenue from 37% to 38%.  This decreasewas comprised of a $38.8 million decrease in consumer services cost of revenuesand $6.4 million decrease in business services cost of revenue. Consumerservices cost of revenues decreased primarily due to the decline in average consumerservices subscribers. Offsetting this decrease was an increase in averageconsumer cost per subscriber due to a greater proportion of our consumersubscriber base consisting of broadband subscribers. Business services cost ofrevenues decreased due to a decrease in average business services subscribers.

 

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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 $11.3 million, or44%, from the three months ended June 30, 2008 to the three months ended June 30,2009. Sales and marketing expenses decreased $25.2 million, or 44%, from thesix months ended June 30, 2008 to the six months ended June 30, 2009.The decreases consisted primarily of a decrease in advertising and promotionsexpense, personnel-related costs, outsourced labor and occupancy and relatedcosts resulting from our refocused business strategy and continued benefitsfrom our restructuring plan initiated in 2007 (“2007 Plan”). Sales andmarketing expenses decreased as a percent of revenues from 11% of revenues to8% of revenues during the three and six months ended June 30, 2009compared to the prior year periods as we reduced sales and marketing effortsand focused our efforts primarily on the retention of tenured customers and onmarketing channels that are more likely to produce an acceptable rate ofreturn.

 

Although we expect sales and marketing expenses to continueto decrease in 2009 as a result of our refocused strategy, we believe thatlarge-scale cost reduction opportunities will be limited.

 

***Operations and customer support***

** **

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

 

Operationsand customer support expenses decreased $9.7 million, or 29%, from the threemonths ended June 30, 2008 to the three months ended June 30, 2009.Operations and customer support expenses decreased $21.2 million, or 29%, fromthe six months ended June 30, 2008 to the six months ended June 30,2009. The decreases in operations and customer support expenses consisted ofdecreases in personnel-related costs, outsourced labor, professional fees andoccupancy and related costs. These decreases were primarily attributable to ourefforts to reduce our back-office cost structure, including benefits realizedas a result of the 2007 Plan, and a decrease in call volumes for customerservice and technical support as our overall subscriber base has decreased andas our tenured customers require less customer service and technical support.These factors also resulted in operations and customer support expenses as apercent of revenues to decrease from 14% of revenues to 13% of revenues duringthe three and six months ended June 30, 2009 compared to the prior yearperiods.

 

Although we expect operations and customer support expensesto continue to decrease in 2009 as a result of our efforts to align costs withtrends in our revenue, we believe that large-scale cost reduction opportunitieswill be limited.

 

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***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 $7.4 million,or 31%, from the three months ended June 30, 2008 to the three monthsended June 30, 2009, and decreased as a percent of revenues from 10% ofrevenues to 9% of revenues. General and administrative expenses decreased $13.7million, or 28%, from the six months ended June 30, 2008 to the six monthsended June 30, 2009, and decreased as a percent of revenues from 10% ofrevenues to 9% of revenues.  Thedecreases in general and administrative expenses consisted primarily ofdecreases in bad debt and payment processing fees, personnel-related costs andprofessional and legal fees. Bad debt and payment processing fees decreased dueto the decrease in our overall subscriber base and due to our subscriber baseconsisting of more tenured customers, who have a lower frequency ofnon-payment. The decrease in personnel-related costs and professional and legalfees was attributable to our efforts to reduce our back-office cost structure,including benefits realized as a result of the 2007 Plan.

 

Although we expect general and administrative expenses tocontinue to decrease in 2009 as a result of our efforts to align costs withtrends in our revenue, we believe that large-scale cost reduction opportunitieswill 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 three to six years. Amortization of intangibleassets decreased $1.9 million, or 49%, from the three months ended June 30,2008 to the three months ended June 30, 2009 and decreased $3.8 million,or 48%, from the six months ended June 30, 2008 to the six months ended June 30,2009.  The decreases in amortization ofintangible assets compared to the prior year periods were primarily due tocertain identifiable definite-lived intangible assets becoming fully amortizedover the past year.

 

***Facility exit and restructuring costs***

*** ***

Facility exit and restructuring costs consisted of thefollowing during the three and six months ended June 30, 2008 and 2009:

 
| ** **                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                  | ** ** | **2008**                             | ** ** | **2009**                           | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                  | ** ** | **(in thousands)**                   | ** ** |
| ** **                  | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2007  Restructuring Plan    |       | $                                    | 2,169      |                               | $          | 4,927 |   | $ | 3,262 |   | $ | 5,415 |   |
| Legacy  Restructuring Plans |       | (108                                 | )          | —                             |       | (171 | ) | — |   |
|                        |       | $                                    | 2,061      |                               | $          | 4,927 |   | $ | 3,091 |   | $ | 5,415 |   |

 

*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 during 2008. As a result of the 2007 Plan,we recorded facility exit and restructuring costs of $2.2 million and $3.3million during the three and six months ended June 30, 2008, respectivelyAs a result of the 2007 Plan, we recorded facility exit and 

 

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restructuring costs of $4.9 millionand $5.4 million during the three and six months ended June 30, 2009,respectively, which consisted primarily of facilities-related costs. Sincemanagement continues to evaluate EarthLink’s businesses, there have been andmay continue to be supplemental provisions for new plan initiatives as well aschanges 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 June 30, 2008, we recorded a $0.1 million and $0.2 millionreduction, respectively, to facility exit and restructuring costs as a resultof changes in estimates for the Legacy Plans.

 

***Gain on investments, net***

*** ***

Duringthe six months ended June 30, 2008, we recognized a net gain oninvestments of $1.3 million. This consisted of a gain of $2.0 million from thesale of our 6.1 million shares of Covad common stock to Platinum Equity, LLC,offset by an impairment loss of $0.7 million due to other-than-temporarydeclines of the value of certain long-term investments. During the six monthsended June 30, 2009, we recognized a net gain on investments of $0.3million. This consisted of $0.2 million in cash distributions from eCompaniesVenture Group, L.P. (“EVG”), a limited partnership that invested in domesticemerging Internet-related companies, and a net gain of $0.1 million related toour auction rate securities (as described below). These transactions wererecorded as gain on investments, net, in the Condensed Consolidated Statementsof Operations.

 

As of June 30,2009, 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 and Financial Liabilities,” for the put right to offsetthe fair value changes of the auction rate securities. During the six monthsended June 30, 2009, we recorded a $2.5 million gain on investments to reflectthe auction rate securities at their fair value and recorded a $2.4 millionloss on investments to reflect the put right at its fair value. The net gain of$0.1 million during the six months ended June 30, 2009 is included in gainon investments, net, in the Condensed Consolidated Statement 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 $1.6 million from the three months ended June 30,2008 to the three months ended June 30, 2009. Interest expense and other,net, increased $4.9 million from the six months ended June 30, 2008 to thesix months ended June 30, 2009. The increases were primarily due todecreases 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 increase for the six month period was theliquidation of our Covad debt investment, when Covad was acquired by PlatinumEquity, LLC in April 2008.

 

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***Income tax provision***

 

We recognized an income tax provision of $16.0 million during the sixmonths ended June 30, 2008, which consisted of $3.2 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 $12.8 million for non-cashdeferred tax provisions associated with the utilization of net operating losscarryforwards. We recognized an income tax provision of $38.8 million duringthe six months ended June 30, 2009, which consisted of $5.1 million stateincome and federal and state AMT amounts payable due to the net operating losscarryforward limitations associated with the AMT calculation and $33.7 millionfor non-cash deferred tax provisions associated with the utilization of netoperating loss carryforwards.

 

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

 

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

*** ***

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

 

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

 
| ** **                          | ** ** | **Three Months**       | ** ** | **Six Months**         | ** ** |
|-------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **Ended**              | ** ** | **Ended**              | ** ** |
| ** **                          | ** ** | **June 30, 2008** | ** ** | **June 30, 2008** | ** ** |
| ** **                          | ** ** | **(in thousands)**     | ** ** |
| ** **                          | ** ** | ** **             | ** ** | ** **             | ** ** |
| Revenues                            |       | $                      | 551        |                   | $          | 1,288 |   |
| Operating  costs and expenses       |       | 1,513                  |       | 3,693                  |       |
| Impairment  and restructuring costs |       | 4,004                  |       | 5,953                  |       |
| Loss  from discontinued operations  |       | (4,365                 | )          | (7,757                 | )          |
|                                     |            |                        |            |                        |            |  |  |

 

**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 

 

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considermany factors when estimating expected forfeitures, including types of awards,employee class and historical employee attrition rates. Actual results, andfuture changes in estimates, may differ substantially from our currentestimates.

 

Stock-basedcompensation expense under SFAS No. 123(R) was $4.6 million and $3.0million during the three months ended June 30, 2008 and 2009,respectively, and $9.7 million and $7.4 million during the six months ended June 30,2008 and 2009, respectively. Stock-based compensation expense is classifiedwithin the same operating expense line items as cash compensation paid toemployees. Stock-based compensation expense in accordance with SFAS No. 123(R) wasallocated as follows for the three and six months ended June 30, 2008 and2009:

 
| ** **                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **2008**                              | ** ** | **2009**                            | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(in thousands)**                    | ** ** |
| Sales  and marketing             |       | $                                     | 1,290      |                                | $          | 825 |   | $ | 2,824 |   | $ | 2,036 |   |
| Operations  and customer support |       | 2,251                                 |       | 1,440                               |       | 4,788 |   | 3,553 |   |
| General  and administrative      |       | 1,028                                 |       | 761                                 |       | 2,110 |   | 1,827 |   |
|                             |       | $                                     | 4,569      |                                | $          | 3,026 |   | $ | 9,722 |   | $ | 7,416 |   |

 

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** **

**Facility Exitand Restructuring Costs**

 

*2007 Plan*. * *We expect to incur future cashoutflows for real estate obligations through 2014 related to the 2007 Plan. Thefollowing table summarizes activity for the liability balances associated withthe 2007 Plan for the years ended December 31, 2007 and 2008 and for thesix months ended June 30, 2009, including changes during the yearattributable to costs incurred and charged to expense and costs paid orotherwise settled:

 
| ** **                            | ** ** | **Severance**      | ** ** | ** **     | ** ** | **Asset**       | ** ** | **Other** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|--------------------|------------|----------------|------------|-----------------|------------|-----------|------------|------------|------------|
| ** **                            | ** ** | **and Benefits**   | ** ** | **Facilities** | ** ** | **Impairments** | ** ** | **Costs** | ** ** | **Total**  | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Balance  as of December 31, 2006 |       | $                  | —     |           | $          | —          |       | $         | —     |       | $          | — |   | $ | — |   |
| Accruals                              |       | 30,303             |       | 12,216         |       | 20,621          |       | 1,131     |       | 64,271     |       |
| Payments                              |       | (18,262            | )          | (480           | )          | —          |       | (760      | )          | (19,502    | )          |
| Non-cash  charges                     |       | —             |       | 4,388          |       | (20,621         | )          | (371      | )          | (16,604    | )          |
| Balance  as of December 31, 2007 |       | 12,041             |       | 16,124         |       | —          |       | —    |       | 28,165     |       |
| Accruals                              |       | 461                |       | 4,808          |       | 4,125           |       | —    |       | 9,394      |       |
| Payments                              |       | (12,502            | )          | (6,174         | )          | —          |       | —    |       | (18,676    | )          |
| Non-cash  charges                     |       | —             |       | 1,936          |       | (4,125          | )          | —    |       | (2,189     | )          |
| Balance  as of December 31, 2008 |       | —             |       | 16,694         |       | —          |       | —    |       | 16,694     |       |
| Accruals                              |       | —             |       | 5,369          |       | 46              |       | —    |       | 5,415      |       |
| Payments                              |       | —             |       | (2,617         | )          | —          |       | —    |       | (2,617     | )          |
| Non-cash  charges                     |       | —             |       | 392            |       | (46             | )          | —    |       | 346        |       |
| Balance  as of June 30, 2009     |       | $                  | —     |           | $          | 19,838          |       | $         | —     |       | $          | — |   | $ | 19,838 |   |

 

*Legacy Plans*. As of June 30, 2009, we had $1.0 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 six months ended June 30, 2008 and 2009:

 
| ** **                                           | ** ** | **Six Months Ended June 30,** |
|------------------------------------------------------|------------|------------------------------------|
| ** **                                           | ** ** | **2008**                           | ** ** | **2009** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                 | ** ** |
|                                                 |       |                               |   |   |   |
| Net  income                                          |       | $                                  | 102,311 |   | $ | 63,982 |   |
| Non-cash  items                                      |       | 50,142                             |   | 60,283 |   |
| Changes  in working capital                          |       | (44,342                            | ) | (24,959 | ) |
| Net  cash provided by operating activities           |       | $                                  | 108,111 |   | $ | 99,306 |   |
|                                                 |       |                               |   |   |   |
| Net  cash provided by (used in) investing activities |       | $                                  | 98,826 |   | $ | (54,412 | ) |
|                                                 |       |                               |   |   |   |
| Net  cash used in financing activities               |       | $                                  | (5,914 | ) | $ | (20,961 | ) |

 

*Operatingactivities*

* *

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

 

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

 

Changesin working capital requirements include changes in accounts receivable, prepaidand other assets, accounts payable, accrued and other liabilities and deferredrevenue. Cash used for working capital requirements decreased during the sixmonths ended June 30, 2009 compared to the prior year period primarily dueto 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 $98.8 million during the six months ended June 30, 2008. Thisconsisted of $44.1 million of sales and maturities of investments in marketablesecurities, net of sales, and $57.1 million received for our Covad investment,offset by $2.3 million of capital expenditures. Our investing activities usedcash of $54.4 million during the six months ended June 30, 2009. Thisconsisted primarily of $49.6 million of purchases of investments in marketablesecurities, net of sales and maturities, and $5.1 million of capitalexpenditures, primarily associated with network and technology center relatedprojects.

 

*Financingactivities*

* *

Our financing activities used cashof $5.9 million during the six months ended June 30, 2008. This consistedof $9.1 million used to repurchase 1.3 million shares of our common stock and$2.7 million for principal payments under capital lease obligations, offset by$5.9 million of proceeds from the exercise of stock options. Our financingactivities used cash of $21.0 million during the six months ended June 30,2009. This consisted primarily of $22.3 million used to repurchase 3.6 millionshares of our common stock, offset by $1.4 million of proceeds from theexercise of stock options.

 

**Off-BalanceSheet Arrangements**

** **

As of June 30, 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 June 30, 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 not require us to acquire anyspecific number of shares and may be terminated by the Board of Directors atany time.

 

**Income Taxes**

 

Wecontinue to maintain a partial valuation allowance of $240.0 million againstour net deferred tax assets, consisting primarily of net operating losscarryforwards, and we may recognize deferred tax assets in future periods ifthey are determined to be realizable. To the extent we owe income taxes infuture periods, we 

 

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intendto use our net operating loss carryforwards to the extent available to reducecash outflows for income taxes. However, our ability to use our net operatingloss carryforwards to offset future taxable income and future taxes, may be subjectto restrictions attributable to equity transactions that result in changes inownership as defined by Internal Revenue Code 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. We also expect touse cash to pay dividends on our common stock and restricted stock units. In July 2009,our Board of Directors approved a cash dividend on our common stock. The Boardof Directors also approved the payment of cash dividend amounts on eachoutstanding restricted stock unit. Any decision to declare future dividendswill be made at the discretion of the board of directors and will depend on,among other things, our results of operations, financial condition, cashrequirements, investment opportunities and other factors the Board of Directorsmay deem relevant.  Finally, we may alsouse cash to invest in or acquire other companies, to repurchase common stock,to repurchase Notes or in connection with holders’ conversion of Notes.

 

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

 

*Sources of cash*. 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 six months ended June 30,2009, we generated $99.3 million in cash from operations. As of June 30,2009, we had $510.5 million in cash and cash equivalents. In addition, we heldshort- and long-term marketable securities valued at $90.0 million and $9.9million, 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. Short-term marketablesecurities also include $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 at pre-determinedintervals, usually every 28 days. Beginning in February 2008, all of ourauction rate securities failed to attract sufficient buyers, resulting in ourcontinuing to hold such securities. In October 2008, we entered into anagreement with the broker that sold us our auction rate securities that givesus the right to sell our existing auction rate securities back to the broker atpar plus accrued interest, beginning on June 30, 2010 until July 2,2012. The agreement also grants the broker the right to buy our auction ratesecurities at par plus accrued interest, until July 2, 2012. Based on ourremaining cash and marketable securities and operating cash flows, we do notanticipate the current lack of liquidity on these investments will affect ourability to operate our business as usual.

 

Weexpect to generate positive cash flows from operations during the year ended December 31,2009. Our available cash and marketable securities, together with our resultsof operations, are expected to be sufficient to meet our operating expenses,capital requirements, dividend payments and investment and other obligationsfor the next 12 months. However, as a result of other investment activities andpossible acquisition opportunities, we may seek additional financing in thefuture. We have no commitments for any additional financing and have no linesof credit or similar sources of financing. We cannot be sure that we can obtainadditional financing on favorable terms, if at all, through the issuance ofequity securities or the incurrence of additional debt. Additional equityfinancing may dilute our stockholders, and debt financing, if available, mayrestrict our ability to 

 

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repurchasecommon stock or debt, declare and pay dividends and raise future capital. If weare unable to obtain additional needed financing, it may prohibit us frommaking acquisitions, capital expenditures and/or investments, which couldmaterially and adversely affect our prospects for long-term growth.

 

**Recently Issued Accounting Pronouncement**

** **

In July 2009, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 168, “The FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles—a replacement of FASB Statement No. 162,” which willbecome the source of authoritative U.S. generally accepted accountingprinciples (“GAAP”) recognized by the FASB. SFAS No. 168 is effective forfinancial statements issued for interim and annual periods ending after September 15,2009. The adoption of SFAS No. 168 will not have a material impact on ourfinancial statements. However, the adoption of SFAS No. 168 will changeour references to GAAP in our consolidated financial statements.

 

**Adoption of Recent Accounting Pronouncement**

** **

On January 1,2009, we adopted FASB Staff Position No. APB 14-1, “Accounting forConvertible Debt Instruments that May be Settled in Cash Upon Conversion”(“FSP APB 14-1”). FSP APB 14-1 requires that the liability and equitycomponents of convertible debt instruments that may be settled in cash uponconversion (including partial cash settlement) be separately accounted for in amanner that reflects an issuer’s non-convertible debt borrowing rate. Theresulting debt discount is accreted over the period the convertible debt isexpected to be outstanding as additional non-cash interest expense.Retrospective application to all periods presented is required except forinstruments that were not outstanding during any of the periods that will bepresented in the annual financial statements for the period of adoption butwere outstanding during an earlier period. The adoption of FSP APB 14-1 on January 1,2009 affected the accounting for our Notes, which were issued in November 2006.Upon adoption, we recorded an adjustment to increase additional paid-in capitalas of the November 2006 issuance date by approximately $62.1 million. Weare accreting the resulting debt discount to interest expense over theestimated five-year life of the Notes, which represents the first redemptiondate of November 2011. We recorded a pre-tax adjustment of approximately$22.3 million to retained earnings that represents the debt discount accretionduring the years ended December 31, 2006, 2007 and 2008 and will recognizeadditional non-cash interest expense of $12.2 million, $13.4 million and $12.4million during the years ending December 31, 2009, 2010 and 2011,respectively, for accretion of the debt discount. As a result of the adoptionof FSP APB 14-1, the Company reduced income from continuing operations and netincome for the three months ended June 30, 2009 by $3.0 million andreduced basic and diluted earnings per share by $0.03 per share, and reducedincome from continuing operations and net income for the six months ended June 30,2009 by $5.9 million and reduced basic and diluted earnings per share by $0.05per share and $0.06 per share, respectively. 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.

 

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The following tables present theeffect of the adoption of FSP APB 14-1 on our affected financial statement lineitems for the three and six months ended June 30, 2008 and as of December 31,2008:

 
| ** **                                | ** ** | **Three Months Ended June 30, 2008** | ** ** | **Six Months Ended June 30, 2008** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                | ** ** | **As Originally**                         | ** ** | **As**                                  | ** ** | **Effect of** | ** ** | **As Originally** | ** ** | **As** | ** ** | **Effect of** | ** ** |
| ** **                                | ** ** | **Reported**                              | ** ** | **Adjusted**                            | ** ** | **Change** | ** ** | **Reported** | ** ** | **Adjusted** | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **(in thousands, except per share data)** | ** ** |
| Statement  of Operations:                 |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest  income (expense) and other, net |       | $                                         | (760       | )                                       | $          | (3,482 | ) | $ | (2,722 | ) | $ | 856 |   | $ | (4,523 | ) | $ | (5,379 | ) |
| Income  from continuing operations        |       | 57,691                                    |       | 54,969                                  |       | (2,722 | ) | 115,447 |   | 110,068 |   | (5,379 | ) |
| Net  income                               |       | 53,326                                    |       | 50,604                                  |       | (2,722 | ) | 107,690 |   | 102,311 |   | (5,379 | ) |
|                                      |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Basic  net income per share               |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Continuing  operations                    |       | $                                         | 0.52       |                                    | $          | 0.50 |   | $ | (0.02 | ) | $ | 1.05 |   | $ | 1.00 |   | $ | (0.05 | ) |
| Basic  net income per share               |       | 0.48                                      |       | 0.46                                    |       | (0.02 | ) | 0.98 |   | 0.93 |   | (0.05 | ) |
|                                      |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Diluted  net income per share             |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Continuing  operations                    |       | $                                         | 0.51       |                                    | $          | 0.49 |   | $ | (0.02 | ) | $ | 1.04 |   | $ | 0.99 |   | $ | (0.05 | ) |
| Diluted  net income per share             |       | 0.48                                      |       | 0.45                                    |       | (0.02 | ) | 0.97 |   | 0.92 |   | (0.05 | ) |

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

 

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**Safe Harbor Statement**

 

The Management’sDiscussion and Analysis 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 reputation anddeter 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 and intangibleassets, which would adversely affect our results of operations and financialposition; (20) that we may have exposure to greater than anticipated taxliabilities and the use of our net operating losses and certain other taxattributes could be limited in the future; (21) that our stock price has beenvolatile historically and may continue to be volatile; (22) that we may reduce,or cease payment of, quarterly dividends; (23) that our indebtedness couldadversely affect our financial health and limit our ability to react to changesin our industry; and (24) that provisions of our second restated certificate ofincorporation, amended and restated bylaws and other elements of our capitalstructure could limit our share price and delay a change of management. Theserisks and uncertainties, as well as other risks and uncertainties that couldcause our actual results to differ significantly from management’sexpectations, are not intended to represent a complete list of all risks anduncertainties inherent in our business, and should be read in conjunction withthe more detailed cautionary statements and risk factors included in our AnnualReport on Form 10-K for the year ended December 31, 2008.

 

**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.

 

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**Item 4. Controls and Procedures.**

 

**Evaluation ofDisclosure Controls and Procedures**

** **

Pursuantto Rule 13a-15(b) under the Securities Exchange Act of 1934, asamended (the “Exchange Act”), we carried out an evaluation, with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of our disclosure controls and procedures(as defined under Rule 13a-15(e) under the Exchange Act) as of theend of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures areeffective to ensure that information required to be disclosed in the reportsthat are filed or submitted under the Exchange Act, is recorded, processed,summarized and reported, within the time periods specified in the Securitiesand Exchange Commission’s rules and forms, and that such information isaccumulated and communicated to management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure.

 

**Changes inInternal Control over Financial Reporting**

** **

Therewere no changes in our internal control over financial reporting during thethree months ended June 30, 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.**

** **

Set forth below is a material update to the risk factors discussed in ourAnnual Report on Form 10-K for the year ended December 31, 2008.There were no other material changes from the risk factors disclosed inEarthLink’s Annual Report on Form 10-K for the year ended December 31,2008.

 

***We may reduce, or cease payment of, quarterly cash dividends.***

*** ***

Thepayment of future dividends is discretionary and is subject to determination byour Board of Directors each quarter following its review of our financialcondition, results of operations, cash requirements, investment opportunitiesand such other factors as are deemed relevant by our Board of Directors.Changes in our business needs, including working capital and funding foracquisitions, or a change in tax laws relating to dividends, among otherfactors, could cause our Board of Directors to decide to reduce, or cease thepayment of, dividends in the future. We cannot assure you that we will notdecrease or discontinue quarterly cash dividends, and if we do, our stock pricecould be negatively impacted.

 

**Item 4.  Submission of Matters to a Vote of Security Holders.**

** **

EarthLinkheld its 2009 annual meeting of stockholders on May 5, 2009. The followingsummarizes the voting results for the three proposals submitted for a vote ofthe stockholders at that meeting:

 

Proposal1.  To elect Marce Fuller, Thomas E. Wheeler and M. Wayne Wisehart toEarthLink’s Board of Directors as Class I directors for a three-year term.This proposal was approved by the EarthLink stockholders at the annual meeting.

 

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| ** **        | ** ** | **Votes For** | ** ** | **Votes Abstained** | ** ** |
|-------------------|------------|---------------|------------|---------------------|------------|
| Marce Fuller      |       | 91,914,085    |       | 4,769,944           |       |
| Thomas E. Wheeler |       | 92,813,830    |       | 3,870,199           |       |
| M. Wayne Wisehart |       | 91,954,460    |       | 4,729,569           |       |

 

Proposal2. To ratify the appointment of Ernst & Young LLP by the AuditCommittee of the Board of Directors to serve as EarthLink’s independentregistered public accounting firm for the fiscal year ending December 31,2009. This proposal was approved by the EarthLink stockholders at the annualmeeting.

 

VotesFor—92,167,816

VotesAgainst—4,404,809

VotesAbstained—111,404

 

Proposal3. To vote on a stockholder proposal regarding a report on our Internet networkmanagement practices, if properly presented at the meeting. This proposal wasnot approved by the EarthLink stockholders at the annual meeting.

 

VotesFor—5,478,331

VotesAgainst—53,758,398

VotesAbstained—14,890,952

Brokernon-votes—22,556,348

 

**Item 5.  Other Information.**

** **

None.

 

**Item 6.   Exhibits.**

** **

(a)   Exhibits.   The following exhibits are filed as part ofthis report**:**

 

31.1    Certification of Chief ExecutiveOfficer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14, asadopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2    Certification of Chief FinancialOfficer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14, asadopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1    Certification of Chief ExecutiveOfficer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002.

 

32.2    Certification of Chief FinancialOfficer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002.

 

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#### **SIGNATURES**

#### ** **

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

 
|   |               | EARTHLINK,  INC. |
|--------|--------------------|------------------|
|   |               |             |
|   |               |             |
| Date:  | July 31, 2009 |             | /s/  ROLLA P. HUFF |
|   |               |             | Rolla  P. Huff, Chairman of the Board and Chief |
|   |               |             | Executive  Officer (principal executive officer) |
|   |               |             |   |
|   |               |             |   |
| Date:  | July 31, 2009 |             | /s/  KEVIN M. DOTTS |
|   |               |             | Kevin  M. Dotts, Chief Financial Officer |
|   |               |             | (principal  financial officer) |
|   |               |             |   |
|   |               |             |   |
| Date:  | July 31, 2009 |             | /s/  BRADLEY A. FERGUSON |
|   |               |             | Bradley  A. Ferguson, Vice President and |
|   |               |             | Controller  (principal accounting officer) |

 

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