**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**
| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                      |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                        |
| ** ** |       | **For the quarterly period ended March 31, 2007**                                                                                                                 |
| ** ** |       | ** **                                                                                                                                                        |
| **OR**     |
| ** ** |       | ** **                                                                                                                                                        |
| **o**      |       | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                     |
| ** ** |       | ** **                                                                                                                                                        |
| ** ** |       | **For the transition period from             to           .** |

 

**CommissionFile Number: 001-15605**

**EARTHLINK, INC.**

(Exact name of registrant as specified in its charter)

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

 

**1375Peachtree St., Atlanta, Georgia     30309**

(Address of principal executive offices)     (ZipCode)

**(404)815-0770**

(Registrant’s telephone number, including area code)

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

----

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes xNo o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer (as defined in Rule 12b-2 of the Exchange Act):

Large acceleratedfiler x     Accelerated filer o      Non-accelerated filer o

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

As of April 30, 2007, 123,317,955 shares of commonstock, $.01 par value per share, were outstanding.

 

----

**EARTHLINK,INC.**

**QuarterlyReport on Form 10-Q**

**For the Quarterly Period Ended March 31, 2007**

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

 

----

**PART I**

**Item 1.  Financial Statements.**

**EARTHLINK,INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands, except per share data)**
| ** **                                                                                                                                                                                                                                                   | ** ** | **December 31,** | ** ** | **March 31,**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-----------------|------------|
| ** **                                                                                                                                                                                                                                                   | ** ** | **2006**         | ** ** | **2007**        | ** ** |
| ** **                                                                                                                                                                                                                                                   | ** ** | ** **       | ** ** | **(unaudited)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                   |
| Current assets:                                                                                                                                                                                                                                              |       |             |       |            |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                   |       | $                | 158,369    |            | $          | 108,724 |   |
| Investments in  marketable securities                                                                                                                                                                                                                        |       | 214,947          |       | 242,396         |       |
| Accounts receivable,  net of allowance of $8,062 and $8,428 as of December 31, 2006 and March 31,  2007, respectively                                                                                                                                        |       | 51,054           |       | 52,037          |       |
| Prepaid expenses                                                                                                                                                                                                                                             |       | 14,831           |       | 12,293          |       |
| Other current assets                                                                                                                                                                                                                                         |       | 17,549           |       | 21,876          |       |
| Total current assets                                                                                                                                                                                                                                         |       | 456,750          |       | 437,326         |       |
| Long-term investments in marketable securities                                                                                                                                                                                                               |       | 21,460           |       | 16,236          |       |
| Property and equipment, net                                                                                                                                                                                                                                  |       | 96,620           |       | 101,177         |       |
| Investment in equity affiliate                                                                                                                                                                                                                               |       | 61,743           |       | 45,922          |       |
| Investments in other companies                                                                                                                                                                                                                               |       | 59,325           |       | 55,961          |       |
| Purchased intangible assets, net                                                                                                                                                                                                                             |       | 59,798           |       | 56,269          |       |
| Goodwill                                                                                                                                                                                                                                                     |       | 202,277          |       | 202,277         |       |
| Other long-term assets                                                                                                                                                                                                                                       |       | 10,066           |       | 10,571          |       |
| Total assets                                                                                                                                                                                                                                                 |       | $                | 968,039    |            | $          | 925,739 |   |
|                                                                                                                                                                                                                                                         |       |             |       |            |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                               |
| Current liabilities:                                                                                                                                                                                                                                         |       |             |       |            |       |
| Trade accounts payable                                                                                                                                                                                                                                       |       | $                | 41,298     |            | $          | 37,497 |   |
| Accrued payroll and  related expenses                                                                                                                                                                                                                        |       | 41,079           |       | 28,747          |       |
| Other accounts payable  and accrued liabilities                                                                                                                                                                                                              |       | 94,882           |       | 93,813          |       |
| Deferred revenue                                                                                                                                                                                                                                             |       | 53,511           |       | 52,982          |       |
| Total current  liabilities                                                                                                                                                                                                                                   |       | 230,770          |       | 213,039         |       |
|                                                                                                                                                                                                                                                         |       |             |       |            |       |
| Long-term debt                                                                                                                                                                                                                                               |       | 258,750          |       | 258,750         |       |
| Other long-term liabilities                                                                                                                                                                                                                                  |       | 19,855           |       | 21,654          |       |
| Total liabilities                                                                                                                                                                                                                                            |       | 509,375          |       | 493,443         |       |
|                                                                                                                                                                                                                                                         |       |             |       |            |       |
| Stockholders’ equity:                                                                                                                                                                                                                                   |       |             |       |            |       |
| Convertible preferred  stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and  outstanding as of December 31, 2006 and March 31, 2007                                                                                                        |       | —           |       | —          |       |
| Common stock, $0.01 par  value, 300,000 shares authorized, 184,545 and 185,168 shares issued as of  December 31, 2006 and March 31, 2007, respectively, and 122,634 and 123,257  shares outstanding as of December 31, 2006 and March 31, 2007, respectively |       | 1,845            |       | 1,852           |       |
| Additional paid-in  capital                                                                                                                                                                                                                                  |       | 2,016,578        |       | 2,028,764       |       |
| Warrants to purchase  common stock                                                                                                                                                                                                                           |       | 259              |       | 231             |       |
| Accumulated deficit                                                                                                                                                                                                                                          |       | (1,044,995       | )          | (1,078,985      | )          |
| Treasury stock, at  cost, 61,911 shares as of December 31, 2006 and March 31, 2007                                                                                                                                                                           |       | (508,232         | )          | (508,232        | )          |
| Unrealized losses on  investments                                                                                                                                                                                                                            |       | (6,791           | )          | (11,334         | )          |
| Total stockholders’  equity                                                                                                                                                                                                                             |       | 458,664          |       | 432,296         |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                                                             |       | $                | 968,039    |            | $          | 925,739 |   |

 

The accompanying notesare an integral part of these financial statements.

1

----

 

**EARTHLINK, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                          | ** ** | **Three Months Ended March 31,**               | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                                           | ** ** | **2007** | ** ** |
| ** **                                          | ** ** | **(in thousands, except per share data)** | ** ** |
| ** **                                          | ** ** | **(unaudited)**                                                    | ** ** |
|                                                |       |                                                               |       |   |   |
| Revenues                                            |       | $                                                                  | 309,712    |   | $ | 324,406 |   |
|                                                |       |                                                               |       |   |   |
| Operating costs  and expenses:                      |       |                                                               |       |   |   |
| Service and equipment costs                         |       | 90,072                                                             |       | 111,158 |   |
| Sales incentives                                    |       | 2,277                                                              |       | 4,708 |   |
| Total cost of revenues                              |       | 92,349                                                             |       | 115,866 |   |
|                                                |       |                                                               |       |   |   |
| Sales and marketing                                 |       | 103,843                                                            |       | 98,631 |   |
| Operations and customer support                     |       | 60,668                                                             |       | 66,010 |   |
| General and administrative                          |       | 31,210                                                             |       | 44,353 |   |
| Amortization of intangible assets                   |       | 1,913                                                              |       | 3,496 |   |
| Total operating costs and expenses                  |       | 289,983                                                            |       | 328,356 |   |
|                                                |       |                                                               |       |   |   |
| Income (loss) from operations                       |       | 19,729                                                             |       | (3,950 | ) |
| Net losses of  equity affiliate                     |       | (7,591                                                             | )          | (29,346 | ) |
| Interest income  and other, net                     |       | 4,216                                                              |       | 3,503 |   |
| Income (loss) before income taxes                   |       | 16,354                                                             |       | (29,793 | ) |
| Provision for  income taxes                         |       | —                                                             |       | 169 |   |
| Net income (loss)                                   |       | $                                                                  | 16,354     |   | $ | (29,962 | ) |
|                                                |       |                                                               |       |   |   |
| Basic net income  (loss) per share                  |       | $                                                                  | 0.12       |   | $ | (0.24 | ) |
| Diluted net income  (loss) per share                |       | $                                                                  | 0.12       |   | $ | (0.24 | ) |
| Basic weighted  average common shares outstanding   |       | 131,514                                                            |       | 123,058 |   |
| Diluted weighted  average common shares outstanding |       | 133,489                                                            |       | 123,058 |   |

 

The accompanying notes are an integral part of these financialstatements.

2

----

 

**EARTHLINK,INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**
| ** **                                                                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                          | ** ** | **March 31,**               | ** ** |
| ** **                                                                                          | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| ** **                                                                                          | ** ** | **(in thousands)**          | ** ** |
| ** **                                                                                          | ** ** | **(unaudited)**                  | ** ** |
| Cash flows from  operating activities:                                                              |       |                             |       |   |   |
| Net income (loss)                                                                                   |       | $                                | 16,354     |   | $ | (29,962 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                                       |       | 9,654                            |       | 13,227 |   |
| Loss (gain) on disposals and impairments of fixed  assets                                           |       | 797                              |       | (4 | ) |
| Net losses of equity affiliate                                                                      |       | 7,591                            |       | 29,346 |   |
| Stock-based compensation                                                                            |       | 3,693                            |       | 7,905 |   |
| Other adjustments                                                                                   |       | (239                             | )          | (24 | ) |
| Decrease (increase) in accounts receivable, net                                                     |       | 3,499                            |       | (897 | ) |
| Decrease (increase) in prepaid expenses and other  assets                                           |       | 1,787                            |       | (3,601 | ) |
| Decrease in accounts payable and accrued and other  liabilities                                     |       | (12,885                          | )          | (16,983 | ) |
| Decrease in deferred revenue                                                                        |       | (1,028                           | )          | (400 | ) |
| Net cash provided by (used in) operating activities                                                 |       | 29,223                           |       | (1,393 | ) |
|                                                                                                |       |                             |       |   |   |
| Cash flows from  investing activities:                                                              |       |                             |       |   |   |
| Purchases of property and equipment                                                                 |       | (7,520                           | )          | (13,312 | ) |
| Purchases of subscriber bases                                                                       |       | (410                             | )          | (1,865 | ) |
| Proceeds from sales of fixed assets                                                                 |       | 3                                |       | 36 |   |
| Investments in marketable securities                                                                |       |                             |       |   |   |
| Purchases                                                                                           |       | (47,678                          | )          | (103,535 | ) |
| Sales and maturities                                                                                |       | 74,809                           |       | 81,385 |   |
| Investments in and net advances to equity affiliate                                                 |       | (38,653                          | )          | (13,724 | ) |
| Investments in other companies                                                                      |       | (50,803                          | )          | — |   |
| Net cash used in investing activities                                                               |       | (70,252                          | )          | (51,015 | ) |
|                                                                                                |       |                             |       |   |   |
| Cash flows from  financing activities:                                                              |       |                             |       |   |   |
| Repayment of note payable                                                                           |       | (2,000                           | )          | — |   |
| Principal payments under capital lease obligations                                                  |       | (7                               | )          | (12 | ) |
| Proceeds from exercises of stock options and other                                                  |       | 2,510                            |       | 2,775 |   |
| Repurchases of common stock                                                                         |       | (1,648                           | )          | — |   |
| Net cash (used in) provided by financing activities                                                 |       | (1,145                           | )          | 2,763 |   |
|                                                                                                |       |                             |       |   |   |
| Net decrease in  cash and cash equivalents                                                          |       | (42,174                          | )          | (49,645 | ) |
| Cash and cash  equivalents, beginning of period                                                     |       | 173,294                          |       | 158,369 |   |
| Cash and cash  equivalents, end of period                                                           |       | $                                | 131,120    |   | $ | 108,724 |   |

 

The accompanyingnotes are an integral part of these financial statements.

3

----

**EARTHLINK,INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UNAUDITED**

**1. Organization**

EarthLink, Inc.(“EarthLink” or the “Company”) is a total communications provider, providingintegrated communication services and related value-added services toindividual consumers and business customers utilizing Internet Protocol, or IP,based technologies.  EarthLink’s coreservice offerings are dial-up and wireline broadband Internet access servicesand value-added services. EarthLink’s growth initiatives include IP-based voiceservices, municipal wireless broadband services and services for businesscustomers.

**2.  Basis of Presentation**

*Basis of Presentation*

Thecondensed consolidated financial statements of EarthLink, which include theaccounts of its wholly-owned subsidiaries, for the three months ended March 31,2006 and 2007 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, 2006 contained in the Company’s AnnualReport on Form 10-K, as amended, as filed with the Securities and ExchangeCommission (the “Annual Report”).  Allsignificant intercompany transactions have been eliminated.

Thesefinancial statements should be read in conjunction with the auditedconsolidated financial statements and the related notes thereto contained inthe Company’s Annual Report.  In theopinion of management, the accompanying unaudited financial statements containall adjustments (consisting of normal recurring adjustments), which managementconsiders necessary to present fairly the Company’s financial position, resultsof operations and cash flows for the interim periods presented.  The results of operations for the threemonths ended March 31, 2007 are not necessarily indicative of the resultsanticipated for the entire year ending December 31, 2007.

The preparation of financialstatements in conformity with U.S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the amountsreported in the financial statements. Actual results may differ from those estimates.

*Adoption of Recent AccountingPronouncements*

On January 1, 2007,EarthLink adopted the consensus reached in Emerging Issues Task Force (“EITF”)Issue No. 06-2, “Accounting for Sabbatical Leave and Other Similar BenefitsPursuant to FASB Statement No. 43.” EITF Issue No. 06-2 provides recognitionguidance on the accrual of employees’ rights to compensated absences under asabbatical or other similar benefit arrangement. The adoption of EITF Issue No.06-2 resulted in a $4.0 million increase to accumulated deficit and accruedliabilities as of January 1, 2007.

On January 1, 2007,EarthLink adopted Financial Accounting Standards Board Interpretation (“FIN”)No. 48, “Accounting for Uncertainty in Income Taxes,” which prescribes acomprehensive model for how a company should recognize, measure, present anddisclose in its financial statements uncertain tax positions that the Companyhas taken or expects to take on a tax return (including a decision whether tofile or not to file a return in a particular jurisdiction). The adoption of FINNo. 48 on January 1, 2007 did not result in a material cumulative-effectadjustment.

*Reclassifications*

Certain amounts in the priorperiod financial statements have been reclassified to conform to the currentperiod presentation.

4

----

**3.  Recent Accounting Pronouncements**

InSeptember 2006, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 157, “Fair ValueMeasurements,” which establishes a framework for reporting fair value andexpands disclosures about fair value measurements. SFAS No. 157 iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. TheCompany is currently assessing the impact of the adoption of this standard onits financial statements.

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities,” which provides companies with anoption to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirementsdesigned to facilitate comparisons between companies that choose differentmeasurement attributes for similar types of assets and liabilities. SFASNo. 159 is effective as of the beginning of an entity’s first fiscal yearbeginning after November 15, 2007. The Company is currently assessing theimpact of the adoption of this standard on its financial statements.

**4.  Earnings per Share**

Netincome (loss) 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 representsnet income divided by the weighted average number of common shares outstandingduring a reported period.  Diluted EPSreflects the potential dilution that could occur if securities or othercontracts to issue common stock, including stock options, warrants, restrictedstock units, phantom share units and contingently issuable shares (commonly andhereinafter referred to as “Common Stock Equivalents”), were exercised orconverted into common stock. The dilutive effect of outstanding stock options,warrants and restricted stock units is reflected in diluted earnings per shareby application of the treasury stock method. Phantom share units andcontingently issuable shares are reflected on an if-converted basis. Inapplying the treasury stock method for stock-based compensation arrangements,the assumed proceeds were computed as the sum of the amount the employee mustpay upon exercise and the amounts of compensation cost attributed tofuture services and not yet recognized.

Thefollowing table sets forth the computation for basic and diluted net income pershare for the three months ended March 31, 2006:
|                                                         | ** ** | **Three Months Ended**          | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                              | ** ** | **March 31, 2006**              | ** ** |
| ** **                                              | ** ** | **(in thousands,**                   | ** ** |
| ** **                                              | ** ** | **except per share data)** | ** ** |
|                                                    |       |                                      |       |
| Net income (A)                                          |       | $                                         | 16,354     |   |
| Basic weighted average common shares outstanding (B)    |       | 131,514                                   |       |
| Dilutive effect  of Common Stock Equivalents            |       | 1,975                                     |       |
| Diluted weighted  average common shares outstanding (C) |       | 133,489                                   |       |
| Basic net income per share (A/B)                        |       | $                                         | 0.12       |   |
| Diluted net income  per share (A/C)                     |       | $                                         | 0.12       |   |

 

Duringthe three months ended March 31, 2006, approximately 11.4 million options andwarrants were excluded from the calculation of diluted EPS because the exerciseprices exceeded the Company’s average stock price during the respective years.

5

----

TheCompany has not included the effect of Common Stock Equivalents in thecalculation of diluted EPS for the three months ended March 31, 2007 becausesuch inclusion would have an anti-dilutive effect. As of March 31, 2007, theCompany had 19.6 million options outstanding and 28.5 million warrantsoutstanding. These options and warrants could be dilutive in future periods. Inaddition, approximately 28.4 million shares underlie the Company’s convertibledebt instruments, which could be dilutive in future periods.

**5.  Investments**

*Investmentsin marketable securities*

Investmentsin marketable securities are accounted for in accordance with SFASNo. 115, “Accounting for Certain Investments in Debt and EquitySecurities.” All investments with original maturities greater than 90 days areclassified as investments in marketable securities. Investments in marketablesecurities with maturities less than one year from the balance sheet date areconsidered short-term investments in marketable securities. Short-terminvestments also include investments in asset-backed, auction rate debtsecurities with interest rate reset periods of 90 days or less but whoseunderlying agreements have original maturities of more than 90 days, based onthe provisions of Accounting Research Bulletin No. 43, Chapter 3A, WorkingCapital-Current Assets and Liabilities, which allows classification ofinvestments based on management’s view. Investments in marketable securitieswith maturities greater than one year from the balance sheet date, excludinginvestments in asset-backed, auction rate debt securities with interest resetperiods of 90 days or less, are considered long-term investments in marketablesecurities. The Company has invested in government agency notes, asset-backeddebt securities (including auction rate debt securities), corporate notes andcommercial paper, all of which bear a minimum short-term rating of A1/P1 or aminimum long-term rating of A/A2.

TheCompany has classified all short- and long-term investments in marketablesecurities as available-for-sale. The Company may or may not hold itsinvestments in marketable securities until maturity. In response to changes inthe availability of and the yield on alternative investments as well asliquidity requirements, the Company occasionally sells its investments inmarketable securities prior to their stated maturities. Available for salesecurities are carried at fair value, with any unrealized gains and losses, netof tax, included in unrealized gains (losses) on investments as a separatecomponent of stockholders’ equity and in total comprehensive income (loss). Asof December 31, 2006 and March 31, 2007, gross unrealized losses were $0.2million and gross unrealized gains were nominal. The Company believes its grossunrealized losses are temporary because management has the intent and abilityto hold these investments until maturity, at which time the Company wouldexpect to receive the amortized cost basis of the investment based on theunderlying contractual arrangement.

Realizedgains and losses are included in interest income and other, net, in theaccompanying Condensed Consolidated Statements of Operations and are determinedon a specific identification basis. The Company has not experienced any significantrealized gains or losses on its investments in marketable securities during theperiods presented.

*Investments in other companies*

Asof December 31, 2006 and March 31, 2007, minority investments in othercompanies were $59.3 million and $56.0 million, respectively, and areclassified as investments in other companies in the Condensed ConsolidatedBalance Sheets. The Company accounts for minority investments in othercompanies under the cost method of accounting and classifies investments inother companies which are publicly traded as available-for-sale securities.Accordingly, the Company adjusts the carrying values of those investments tomarket value through unrealized (losses) gains included in stockholders’ equityand accumulated other comprehensive income (loss). Minority investments inother companies as of December 31, 2006 and March 31, 2007 included $11.0million of investments carried at cost, and $48.3 million and $45.0 million,respectively, of investments recorded at fair value. As of December 31, 2006and March 31, 2007, gross unrealized losses were $6.5 million and $11.1million, respectively, and there were no gross unrealized gains.

6

----

Managementregularly evaluates the recoverability of its investments in other companiesbased on the performance and the financial position of those companies as wellas other evidence of market value. Such evaluation includes, but is not limitedto, reviewing the investee’s cash position, recent financings, projected andhistorical financial performance, cash flow forecasts and financing needs.During the three months ended March 31, 2006 and 2007, the Company did notrecognize any losses due to other-than-temporary declines of the value ofinvestments.

*Investmentin equity affiliate*

TheCompany has a joint venture with SK Telecom Co., Ltd. (“SK Telecom”), HELIO.HELIO is a non-facilities-based mobile virtual network operator (“MVNO”)offering mobile communications services and handsets to U.S. consumers. As ofDecember 31, 2006 and March 31, 2007, EarthLink’s and SK Telecom’s economicownership interest in HELIO was approximately 48 percent, and EarthLink’s andSK Telecom’s voting interest was 50 percent.

Pursuantto the HELIO Contribution and Formation Agreement, the Company has contributed$214.0 million of cash and non-cash assets to date, including $122.0 millionduring 2005, $78.5 million during 2006 and $13.5 million that was contributedin February 2007. The Company is committed to invest an additional $6.0 millionof cash in HELIO in August 2007.

The Companyaccounts for its investment in HELIO under the equity method of accountingbecause the Company can exert significant influence over HELIO’s operating andfinancial policies. As a result, the Company records its proportionate share ofHELIO’s net loss in its Condensed Consolidated Statement of Operations. TheCompany is amortizing the difference between the book value and fair value ofnon-cash assets contributed to HELIO over their estimated useful lives. Theamortization increases the carrying value of the Company’s investment anddecreases the net losses of equity affiliate included in the CondensedConsolidated Statement of Operations. During the three months ended March 31,2006 and 2007, the Company recorded $7.6 million and $29.3 million, respectively,of net losses of equity affiliate related to its HELIO investment, which is netof amortization of basis differences and certain other equity method accountingadjustments.

Thefollowing table presents summarized statement of operations information ofHELIO for the three months ended March 31, 2006 and 2007:
|                | ** ** | **Three Months Ended** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **March 31,**               | ** ** |
| ** **     | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| ** **     | ** ** | **(in thousands)**          | ** ** |
|           |       |                             |       |   |   |
| Revenues       |       | $                                | 5,480      |   | $ | 30,356 |   |
| Operating loss |       | (21,992                          | )          | (65,117 | ) |
| Net loss       |       | (19,958                          | )          | (63,131 | ) |
|                |            |                                  |            |  |  |  |  |

 

7

----

**6.  Purchased Intangible Assets and Goodwill**

*PurchasedIntangible Assets*

Thefollowing table presents the components of the Company’s acquired identifiableintangible assets included in the accompanying Condensed Consolidated BalanceSheets as of December 31, 2006 and March 31, 2007:
| ** **                                   | ** ** | **As of December 31, 2006** | ** ** | **As of March 31, 2007** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                   | ** ** | **Gross**                                       | ** ** | ** **                                   | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                                   | ** ** | **Carrying**                                    | ** ** | **Accumulated**                              | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| ** **                                   | ** ** | **Value**                                       | ** ** | **Amortization**                             | ** ** | **Value** | ** ** | **Value** | ** ** | **Amortization** | ** ** | **Value** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                         | ** ** |
|                                         |       |                                            |       |                                         |       |   |   |   |   |   |   |   |   |
| Subscriber bases  and customer relationships |       | $                                               | 384,336    |                                         | $          | (337,708 | ) | $ | 46,628 |   | $ | 384,303 |   | $ | (340,972 | ) | $ | 43,331 |   |
| Software,  technology and other              |       | 3,864                                           |       | (1,551                                       | )          | 2,313 |   | 3,864 |   | (1,783 | ) | 2,081 |   |
| Trade names                                  |       | 10,857                                          |       | —                                       |       | 10,857 |   | 10,857 |   | — |   | 10,857 |   |
| Total                                        |       | $                                               | 399,057    |                                         | $          | (339,259 | ) | $ | 59,798 |   | $ | 399,024 |   | $ | (342,755 | ) | $ | 56,269 |   |

 

Amortization ofintangible assets in the Condensed Consolidated Statements of Operations forthe three months ended March 31, 2006 and 2007 represents the amortization ofdefinite lived intangible assets.  TheCompany’s definite lived intangible assets primarily consist of subscriberbases and customer relationships, acquired software and technology and otherassets acquired in conjunction with the purchases of businesses and subscriberbases from other companies that are not deemed to have indefinite lives.Definite lived intangible assets are amortized on a straight-line basis overtheir estimated useful lives, which are generally three to six years for subscriberbases and customer relationships and one to six years for acquired software andtechnology. As of December 31, 2006 and March 31, 2007, the weighted averageamortization periods were 3.3 years for subscriber base assets and customerrelationships and 4.1 years for software and technology. Based on the currentamount of definite lived intangible assets, the Company expects to recordamortization expense of approximately $11.8 million during the nine monthsending December 31, 2007 and $11.8 million, $8.9 million, $6.4 million, $6.3million and $0.2 million during the years ending December 31, 2008, 2009,2010, 2011 and thereafter, respectively. Actual amortization expense to bereported in future periods could differ materially from these estimates as aresult of asset acquisitions, changes in useful lives and other relevantfactors. The Company’s indefinite lived intangible assets consist of tradenames.

**7.  Long-Term Debt**

In November 2006, the Company issued$258.8 million aggregate principal amount of Convertible Senior Notes dueNovember 15, 2026 (the “Notes”) in a registered offering, which reflects theexercise by the underwriters of their option to purchase an additional $33.8million of principal to cover over-allotments. The Company received netproceeds of $251.6 million after transaction fees of $7.2 million. The Notesbear interest at 3.25% per year on the principal amount of the Notes untilNovember 15, 2011, and 3.50% interest per year on the principal amount of theNotes thereafter, payable semi-annually in May and November of each year. TheNotes rank as senior unsecured obligations of the Company.

TheNotes are payable with cash and, if applicable, convertible into shares of theCompany’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

8

----

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 after anyfive 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) upon theoccurrence of specified corporate transactions; (4) if the Company has calledthe Notes for redemption; and (5) at any time from, and including, October 15,2011 to, and including, November 15, 2011 and at any time on or after November15, 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 had 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, 2016and November 15, 2021.

As of December 31, 2006 and March 31,2007, the fair value of the Notes was approximately $277.3 million and $281.3million, respectively, based on the quoted market prices.

In connection with the issuance of theNotes, the Company entered into separate convertible note hedge transactionsand separate warrant transactions with respect to the Company’s common stock toreduce the potential dilution upon conversion of the Notes (collectivelyreferred to as the “Call Spread Transactions”). The Company purchased calloptions to cover approximately 28.4 million shares of the Company’s commonstock, subject to adjustment in certain circumstances, which is the number ofshares underlying the Notes. In addition, the Company sold warrants permittingthe purchasers to acquire up to approximately 28.4 million shares of theCompany’s common stock, subject to adjustment in certain circumstances. SeeNote 8, “Stockholders’ Equity,” for more information on the Call SpreadTransactions.

**8. Stockholders’ Equity**

*Comprehensive Income (Loss)*

Comprehensiveincome (loss) includes unrealized gains and losses on certain investmentsclassified as available-for-sale, net of tax, which are excluded from theCondensed Consolidated Statements of Operations in accordance with SFASNo. 130, “Reporting Comprehensive Income.” Comprehensive income (loss) forthe three months ended March 31, 2006 and 2007 was as follows:
|                                               | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **March 31,**               | ** ** |
| ** **                                    | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| ** **                                    | ** ** | **(in thousands)**          | ** ** |
| Net income  (loss)                            |       | $                                | 16,354     |   | $ | (29,962 | ) |
| Net unrealized gains  (losses) on investments |       | 2,245                            |       | (4,543 | ) |
| Total  comprehensive income (loss)            |       | $                                | 18,599     |   | $ | (34,505 | ) |

 

Thenet change in unrealized losses on investments for the three months ended March31, 2006 and 2007 was primarily due to the change in estimated fair value ofthe Company’s investments in other companies as a result of a decrease in theclosing price of the common stock of these companies as of March 31, 2006 and2007 compared to the prior period closing prices.

9

----

*Share Repurchases*

Sincethe inception of the Company’s share repurchase program, the Board of Directorshas authorized a total of $550.0 million for the repurchase of EarthLink’scommon stock. As of March 31, 2007, the Company had $95.3 million availableunder the current authorizations. The Company may repurchase its common stockfrom time to time in compliance with Securities and Exchange Commissionregulations and other legal requirements, including through the use of derivativetransactions, and subject to market conditions and other factors. The sharerepurchase program does not require the Company to acquire any specific numberof shares and may be terminated by the Board of Directors at any time.

Duringthe three months ended March 31, 2006, the Company purchased 0.2 million sharesof its common stock for an aggregate purchase price of $1.6 million. TheCompany did not repurchase any shares of its common stock during the threemonths ended March 31, 2007.

*Call Spread Transactions*

Inconnection with the issuance of the Notes (see Note 7, “Long-Term Debt”), theCompany entered into separate convertible note hedge transactions and separatewarrant transactions with respect to the Company’s common stock to minimize theimpact of the potential dilution upon conversion of the Notes.  The Company purchased call options in privatetransactions to cover approximately 28.4 million shares of the Company’s commonstock at a strike price of $9.12 per share, subject to adjustment in certaincircumstances, for $47.2 million. The call options generally allow the Companyto receive shares of the Company’s common stock from counterparties equal tothe number of shares of common stock payable to the holders of the Notes uponconversion. These call options will terminate the earlier of the maturity datesof the related senior convertible notes or the first day all of the relatedsenior convertible notes are no longer outstanding due to conversion orotherwise.  As of December 31, 2006 and March31, 2007, the estimated fair value of the call options was $58.4 million and$59.0 million, respectively.

TheCompany also sold warrants permitting the purchasers to acquire up toapproximately 28.4 million shares of the Company’s common stock at an exerciseprice of $11.20 per share, subject to adjustments in certain circumstances, inprivate transactions for total proceeds of approximately $32.1 million. Thewarrants expire at various dates in March 2012 through July 2012.  The warrants provide for net sharesettlement. In no event shall the Company be required to deliver a number ofshares in connection with the transaction in excess of twice the aggregatenumber of warrants. As of December 31, 2006 and March 31, 2007, the estimatedfair value of the warrants was $41.0 million.

TheCompany has analyzed the Call Spread Transactions under Emerging Issues TaskForce Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexedto, and Potentially Settled In, a Company’s Own Stock,” and other relevantliterature, and determined that they meet the criteria for classification asequity transactions. As a result, the Company recorded the purchase of the calloptions as a reduction in additional paid-in capital and the proceeds of thewarrants as an addition to paid-in capital, and the Company will not recognizesubsequent changes in fair value of the agreements.

10

----

**9.  Stock-Based Compensation**

TheCompany accounts for stock-based compensation pursuant to SFAS No. 123(R), “Share-BasedPayment,” which requires measurement of compensation cost for all stock awardsat fair value on the date of grant and recognition of compensation over therequisite service period for awards expected to vest. The Company estimates thefair value of stock options using the Black-Scholes valuation model, anddetermines the fair value of restricted stock units based on the number ofshares granted and the quoted price of EarthLink’s common stock on the date ofgrant*.* Such value is recognizedas expense over the requisite service period, net of estimated forfeitures,using the straight-line attribution method. The estimate of awards that willultimately vest requires significant judgment, and to the extent actual resultsor updated estimates differ from the Company’s current estimates, such amountswill be recorded as a cumulative adjustment in the period estimates arerevised. The Company considers many factors when estimating expectedforfeitures, including types of awards, employee class and historical employeeattrition rates. Actual results, and future changes in estimates, may differsubstantially from the Company’s current estimates.

Stock-basedcompensation expense under SFAS No. 123(R) was $3.7 million and $7.9 millionduring the three months ended March 31, 2006 and 2007, respectively, of which$3.3 million and $6.6 million, respectively, related to stock options and $0.4million and $1.3 million, respectively, related to restricted stock units. TheCompany classifies stock-based compensation expense within the same operatingexpense line items as cash compensation paid to employees. Included instock-based compensation expense for the three months ended March 31, 2007 was$4.9 million of stock-based compensation expense related to Charles G. Betty,EarthLink’s former President and Chief Executive Officer.

Mr.Betty passed away on January 2, 2007. Pursuant to Mr. Betty’s employmentagreement, all unvested stock options and restricted stock units immediatelyvested and became fully exercisable upon death. In addition, the Leadership andCompensation Committee of the Board of Directors extended the exercise periodof Mr. Betty’s stock options until December 31, 2008. This daterepresents the exercise period if Mr. Betty had terminated employment afterserving the full term of his employment agreement, which was set to expire inJuly 2008. During the three months ended March 31, 2007, EarthLink recordedstock-based compensation of $3.5 million related to the accelerated vesting of1.1 million stock options and 120,000 restricted stock units and recordedstock-based compensation expense of $1.4 million related to the extension ofthe exercise period for Mr. Betty’s stock options.

*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, phantomshare units and performance awards, among others. The plans are administered bythe Board of Directors or the Leadership and Compensation Committee of theBoard of Directors, which determine the terms of the awards granted. Stockoptions are generally granted with an exercise price equal to the market valueof EarthLink, Inc. common stock on the date of grant, have a term of ten yearsor less, and vest over terms of four to six years from the date of grant.Restricted stock units generally vest over terms of three to six years from thedate of grant.

*Deferred Compensation Plan*

TheCompany’s Second Deferred Compensation Plan for Directors and Certain KeyEmployees permits members of the Board of Directors and eligible employees toelect to defer receipt of shares of common stock pursuant to vested restrictedstock units and various cash consideration, such as directors’ fees and bonuses.The cash consideration is converted into phantom share units at the closingprice on the date the consideration would otherwise be paid, and vestedrestricted stock units are converted into phantom share units on a one-for-onebasis. Phantom share units are fully vested at the date of grant and areconverted to common stock upon the occurrence

11

----

of various events.As of December 31, 2006 and March 31, 2007, approximately 29,000 and 32,000phantom share units, respectively, were outstanding.

*Warrants*

Priorto December 31, 2000, the Company issued warrants to purchase shares ofthe Company’s common stock to certain members of its Board of Directors,customers, consultants, lessors, creditors and others. As of March 31, 2007,warrants to purchase a total of 52,000 shares of common stock were outstandingat an exercise price of $5.50. The warrants are currently exercisable andexpire in October 2007.

Duringthe year ended December 31, 2006, the Company sold warrants in connection withthe issuance of Notes permitting the purchasers to acquire up to approximately28.4 million shares of the Company’s common stock. See Note 8, “Shareholders’Equity,” for a description of those warrants.

*OptionsOutstanding*

The followingtable summarizes information concerning stock option activity as of and forthree months ended March 31, 2007: 
| ** **                                        | ** ** | ** **                                                | ** ** | ** **   | ** ** | **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, 2006              |       | 20,470                                                    |       | $            | 11.27      |                  |       |          |       |   |
| Granted                                           |       | 295                                                       |       | 7.28         |       |                  |       |          |       |
| Exercised                                         |       | (495                                                      | )          | 8.52         |       |                  |       |          |       |
| Forfeited and expired                             |       | (670                                                      | )          | 12.31        |       |                  |       |          |       |
| Outstanding as  of March 31, 2007                 |       | 19,600                                                    |       | $            | 11.24      |                  | 6.2        |          | $          | 4,960 |   |
| Vested and  expected to vest as of March 31, 2007 |       | 18,006                                                    |       | $            | 11.48      |                  | 6.0        |          | $          | 4,674 |   |
| Exercisable as  of March 31, 2007                 |       | 12,645                                                    |       | $            | 12.73      |                  | 5.0        |          | $          | 3,119 |   |
|                                                   |            |                                                           |            |              |            |                       |            |               |            |  |  |  |

 

The aggregate intrinsicvalue amounts in the table above represent the difference between the closingprice of the Company’s common stock on March 31, 2007 and the exercise price,multiplied by the number of in-the-money stock options as of the same date.This represents the amount that would have been received by the stock optionholders if they had all exercised their stock options on March 31, 2007. Thetotal intrinsic value of options exercised during the three months ended March31, 2006 and 2007 was $1.2 million and $0.5 million, respectively.

12

----

The followingtable summarizes the status of the Company’s stock options as of March 31,2007:
| **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)** | ** ** | ** ** | ** ** |
| $ 1.67                             | to         | $                       | 5.56       |   |   | 1,530 |   | 5.6 |   | $ | 5.36 |   | 1,110 |   | $ | 5.45 |   |
| 5.81                                    | to         | 6.72                    |       |   | 891 |   | 5.3 |   | 6.17 |   | 837 |   | 6.17 |   |
| 6.90                                    | to         | 7.82                    |       |   | 2,895 |   | 9.0 |   | 7.09 |   | 469 |   | 7.50 |   |
| 7.99                                    | to         | 9.24                    |       |   | 2,523 |   | 7.3 |   | 8.94 |   | 1,443 |   | 8.89 |   |
| 9.25                                    | to         | 9.93                    |       |   | 2,575 |   | 6.5 |   | 9.58 |   | 1,340 |   | 9.64 |   |
| 10.06                                   | to         | 10.06                   |       |   | 2,248 |   | 3.4 |   | 10.06 |   | 2,248 |   | 10.06 |   |
| 10.36                                   | to         | 10.51                   |       |   | 2,222 |   | 8.0 |   | 10.37 |   | 986 |   | 10.37 |   |
| 10.56                                   | to         | 15.63                   |       |   | 2,186 |   | 7.0 |   | 11.54 |   | 1,682 |   | 11.65 |   |
| 16.82                                   | to         | 51.44                   |       |   | 2,530 |   | 2.8 |   | 26.91 |   | 2,530 |   | 26.91 |   |
| $ 1.67                             | to         | $                       | 51.44      |   |   | 19,600 |   | 6.2 |   | $ | 11.24 |   | 12,645 |   | $ | 12.73 |   |

 

*ValuationAssumptions for Stock Options*

The fair value ofstock options granted during the three months ended March 31, 2006 and 2007 wasestimated using the Black-Scholes option-pricing model with the followingassumptions:
|                         | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                             | ** ** | **2007** | ** ** |
|                    |       |                                                 |       |   |   |
| Dividend yield          |       | 0                                                    | %          | 0 | % |
| Expected volatility     |       | 43                                                   | %          | 43 | % |
| Risk-free interest rate |       | 4.30                                                 | %          | 4.80 | % |
| Expected life           |       | 4.3 years                                            |       | 4.3 years |   |

 

Theweighted average grant date fair value of options granted during the threemonths ended March 31, 2006 and 2007 was $4.67 and $2.98, respectively.

Thedividend yield assumption is based on the Company’s history and expectation offuture dividend payouts. The expected volatility is based on a combination ofthe Company’s historical stock price and implied volatility. The selection ofimplied volatility data to estimate expected volatility is based upon theavailability of actively traded options on the Company’s stock. The risk-freeinterest rate assumption is based upon the U.S. Treasury yield curve in effectat the time of grant for periods corresponding with the expected life of theoption. The expected life of employee stock options represents theweighted-average period the stock options are expected to remain outstanding.

13

----

*RestrictedStock Units*

The following tablesummarizes the Company’s restricted stock units as of and for the three monthsended March 31, 2007:
|                                    | ** ** | ** **           | ** ** | **Weighted**        | ** ** |
|------------------------------------|------------|----------------------|------------|---------------------|------------|
| ** **                         | ** ** | ** **           | ** ** | **Average**         | ** ** |
| ** **                         | ** ** | **Restricted**       | ** ** | **Grant Date** | ** ** |
| ** **                         | ** ** | **Stock Units** | ** ** | **Fair Value** | ** ** |
|                               |       |                 |       |                |       |
| Nonvested as of  December 31, 2006 |       | 1,180,000            |       | $                   | 8.57       |   |
| Granted                            |       | 5,000                |       | 7.32                |       |
| Vested                             |       | (120,000             | )          | 10.51               |       |
| Forfeited                          |       | (36,000              | )          | 8.42                |       |
| Nonvested as of March  31, 2007    |       | 1,029,000            |       | 8.34                |       |
|                                    |            |                      |            |                     |            |  |

 

The fair value ofrestricted stock units is determined based on the closing trading price ofEarthLink’s common stock on the grant date. The weighted-average grant datefair value of restricted stock units granted during the three months endedMarch 31, 2007 was $7.32. There were no restricted stock units granted duringthe three months ended March 31, 2006. As of March 31, 2007, there was $5.8million of total unrecognized compensation cost related to nonvestedshare-based compensation arrangements. That cost is expected to be recognizedover a weighted-average period of 3.0 years. The total fair value of sharesvested during the three months ended March 31, 2007 was $0.9 million, whichrepresents the closing price of the Company’s common stock on the vesting datemultiplied by the number of restricted stock units that vested. No sharesvested during the three months ended March 31, 2006.

**10.Income Taxes**

EarthLink has recorded income taxes at an effectiveannual tax rate of 0% for the three months ended March 31, 2007 based onmanagement’s current expectations for the results of operations for the yearending December 31, 2007 in accordance with the interim reporting requirementsof SFAS No. 109, “Accounting for Income Taxes,” and APB Opinion No. 28, “InterimFinancial Reporting.”

EarthLink continues tomaintain a full valuation allowance against its unrealized deferred tax assets,consisting primarily of net operating loss carryforwards, and EarthLink mayrecognize deferred tax assets in future periods when they are estimated to berealizable. To the extent EarthLink may owe income taxes in future periods,EarthLink intends to use its net operating loss carryforwards to the extentavailable to offset taxable income and reduce cash outflows for income taxes.

**11. Related Party Transactions**

UponHELIO’s formation, EarthLink and HELIO entered into a services agreement forEarthLink to provide to HELIO facilities, accounting, tax, billing, procurement,risk management, payroll, human resource, employee benefit administration andother support services in exchange for management fees. However, as HELIOdevelops it business, the extent to which HELIO relies on EarthLink to providethese services has decreased. EarthLink believes that providing these servicesto HELIO enabled HELIO to more quickly and cost effectively launch its businessthan if it had purchased these services from third parties.  The management fees were determined based onEarthLink’s costs to provide the services, and management believes such feesare reasonable.  The total amount of feesthat HELIO pays to EarthLink depends on the extent to which HELIO utilizesEarthLink’s services.  Fees for servicesprovided to HELIO are reflected as reductions to the associated expensesincurred by EarthLink to provide such services. During the three months endedMarch 31, 2006 and 2007, fees received for services provided to HELIO were $0.7million and $0.5 million, respectively.

14

----

EarthLinkalso markets HELIO’s products and services and purchase wireless Internetaccess devices and services from HELIO. During the three months ended March 31,2006 and 2007, revenues generated from HELIO and fees paid for products andservices from HELIO were minimal.

**12.  SegmentInformation**

Inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” the Company reports segment information along the samelines that its chief executive reviews its operating results in assessingperformance and allocating resources. Effective March 2007, the Company nowoperates two reportable segments, Consumer Services and Business Services,which are described below in more detail.

TheCompany’s segments are strategic business units that are managed based upondifferences in customers, services and marketing channels. The Company’sConsumer Services segment provides integrated communications services andrelated value-added services to individual customers. These services includedial-up and high-speed Internet access, municipal wireless broadband and voiceservice, among others. The Company’s Business Services segment providesintegrated communications services and related value-added services tobusinesses and communications carriers. These services include managed datanetworks, dedicated Internet access and web hosting, among others.

TheCompany evaluates performance of its segments based on segment income fromoperations. Segment income from operations includes revenues to external customers,related cost of revenues and operating expenses directly attributable to thesegment, which include costs over which segment managers have directdiscretionary control, such as advertising and marketing programs, customersupport expenses, site operations expenses, product development expenses,certain technology and facilities expenses, billing operation 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 and stock-based compensation expense under SFAS No. 123(R),as they are not evaluated in the measurement of segment performance.

15

----

Informationon reportable segments and a reconciliation to consolidated income (loss) fromoperations for the three months ended March 31, 2006 and 2007 is as follows:
|                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                             | ** ** | **2007** | ** ** |
| ** **                         | ** ** | **(in thousands)**                              | ** ** |
| **Consumer Services**              | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Revenues                           |       | $                                                    | 291,467    |   | $ | 276,652 |   |
| Cost of revenues                   |       | 88,048                                               |       | 85,824 |   |
| Gross margin                       |       | 203,419                                              |       | 190,828 |   |
| Direct segment  operating expenses |       | 174,571                                              |       | 165,226 |   |
| Segment  operating income          |       | $                                                    | 28,848     |   | $ | 25,602 |   |
|                               |       |                                                 |       |   |   |
| **Business Services**              | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Revenues                           |       | $                                                    | 18,245     |   | $ | 47,754 |   |
| Cost of revenues                   |       | 4,301                                                |       | 30,042 |   |
| Gross margin                       |       | 13,944                                               |       | 17,712 |   |
| Direct segment  operating expenses |       | 2,591                                                |       | 17,168 |   |
| Segment  operating income          |       | $                                                    | 11,353     |   | $ | 544 |   |
|                               |       |                                                 |       |   |   |
| **Consolidated**                   | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Revenues                           |       | $                                                    | 309,712    |   | $ | 324,406 |   |
| Cost of revenues                   |       | 92,349                                               |       | 115,866 |   |
| Gross margin                       |       | 217,363                                              |       | 208,540 |   |
| Direct segment  operating expenses |       | 177,162                                              |       | 182,394 |   |
| Segment  operating income          |       | 40,201                                               |       | 26,146 |   |
| Stock-based  compensation expense  |       | 3,668                                                |       | 7,880 |   |
| Amortization of  intangible assets |       | 1,913                                                |       | 3,496 |   |
| Other operating  expenses          |       | 14,891                                               |       | 18,720 |   |
| Income (loss)  from operations     |       | $                                                    | 19,729     |   | $ | (3,950 | ) |

 

16

----

Informationon revenues by groups of similar services and by segment for the three monthsended March 31, 2006 and 2007 is as follows:
|                       | ** ** | **Three Months Ended** | ** ** |
|-----------------------|------------|----------------------------------|------------|
| ** **            | ** ** | **March 31,**               | ** ** |
| ** **            | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| ** **            | ** ** | **(in thousands)**          | ** ** |
| **Consumer Services** | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Access and  service   |       | $                                | 264,231    |   | $ | 243,059 |   |
| Value-added  services |       | 27,236                           |       | 33,593 |   |
| Total revenues        |       | $                                | 291,467    |   | $ | 276,652 |   |
| **Business Services** | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Access and  service   |       | $                                | 17,429     |   | $ | 46,955 |   |
| Value-added  services |       | 816                              |       | 799 |   |
| Total revenues        |       | $                                | 18,245     |   | $ | 47,754 |   |
| **Consolidated**      | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Access and  service   |       | $                                | 281,660    |   | $ | 290,014 |   |
| Value-added  services |       | 28,052                           |       | 34,392 |   |
| Total revenues        |       | $                                | 309,712    |   | $ | 324,406 |   |

 

TheCompany manages its working capital on a consolidated basis and does notallocate long-lived assets to segments. In addition, segment assets are notreported to, or used by, the chief operating decision maker and therefore,pursuant to SFAS No. 131, total segment assets have not been disclosed.

TheCompany has not provided information about geographic segments becausesubstantially all of the Company’s revenues and related results of operationsand identifiable assets are in the United States and additional geographicinformation is thus not material nor meaningful.

17

----

**Item2.   Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

Certain statementsin this Quarterly Report on Form 10-Q are forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995,Section 27A of the Securities Act of 1933, and Section 21E of theSecurities Exchange Act of 1934. The words “estimate,” “plan,” “intend,” “expect,”“anticipate,” “believe” and similar expressions are intended to identifyforward-looking statements. These forward-looking statements are found atvarious places throughout this report. EarthLink disclaims any intention orobligation to update or revise any forward-looking statements, whether as aresult of new information, future events or otherwise. Although EarthLinkbelieves that its expectations are based on reasonable assumptions, it can giveno assurance that its goals will be achieved. Important factors that couldcause actual results to differ from estimates or projections contained in theforward-looking statements are described under “Safe Harbor Statement” in thisItem 2.

*The following discussion should be read in conjunction with theaccompanying unaudited Condensed Consolidated Financial Statements and relatedNotes thereto and with “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” and the audited Consolidated Financial Statementsand the Notes thereto contained in the Annual Report on Form 10-K for the yearended December 31, 2006, as amended.*

**Overview**

EarthLink,Inc. is a total communications provider, providing integrated communicationservices and related value-added services to individual consumers and businesscustomers utilizing Internet Protocol, or IP, based technologies.  Our core service offerings are dial-up andwireline broadband Internet access services and value-added services. Ourgrowth initiatives include IP-based voice services, municipal wirelessbroadband services and our services for business customers.

EffectiveMarch 2007, we now operate two reportable segments, Consumer Services andBusiness Services. Our Consumer Services segment provides integratedcommunications services and related value-added services to individualcustomers. These services include narrowband Internet access, wireline andwireless broadband Internet access and IP-based voice services. Our BusinessServices segment provides integrated communications services and relatedvalue-added services to businesses and communications carriers. These servicesinclude managed data networks, dedicated Internet access and web hosting.

Wealso have a joint venture with SK Telecom Co., Ltd. (“SK Telecom”), HELIO.  HELIO is a non-facilities-based mobilevirtual network operator (MVNO) offering mobile communications services andhandsets to consumers in the U.S.  HELIOwas formed in March 2005 and began offering its products and services duringApril 2006.

*IndustryBackground*

Sincethe inception of our business, we have expanded from a traditional dial-upInternet service provider to a total communications provider. The Internetaccess market in the U.S. grew dramatically from the mid-1990s through 2000 buthas recently experienced slower growth, as the market has reached a maturestage of growth. Since 2000, broadband Internet access has been steadilyreplacing dial-up. During 2006, the number of households with broadband accesssurpassed the number of households with dial-up connections. Focused,value-priced narrowband access, which provides service with a limited set offeatures at a lower cost, is still attracting households new to the Internet orcurrent Internet users interested in reducing their cost of Internet access.

Consumerscontinue to migrate to broadband due to the faster connection and downloadspeeds provided by broadband access, the ability to free up their phone linesand the more reliable and “always on” connection. The pricing for broadbandservices, particularly for introductory promotional periods, services bundledwith cable and telephone services, and services with slower speeds, has beendeclining and is approaching prices for traditional dial-up services, making ita more viable option for consumers that continue to rely on dial-up connectionsfor Internet access. In addition, advanced applications such as online gaming,music

18

----

downloads andphoto sharing require greater bandwidth for optimal performance, which adds tothe demand for broadband.

Currently,most residential broadband consumers access the Internet via DSL or cable, butan increasing array of alternative broadband access technologies, such as wirelessbroadband and broadband over power lines, are now available. The availabilityof these alternatives is expected to further encourage future broadbanddeployment and market penetration. The growth of mobile devices that supportemail and sales of laptop computers and other mobile devices create anincreasing need for portable and mobile Internet access. In addition, one ofthe outgrowths from the rapid deployment of broadband connectivity has been theadoption of Voice over Internet Protocol (“VoIP”). VoIP is a technology thatenables voice communications over the Internet through the conversion of voicesignals into data packets. VoIP technology presents several advantages over thetechnology used in traditional wireline telephone networks and enables VoIPproviders to operate with lower capital expenditures and operating costs whileoffering both traditional and innovative service features.

*RevenueSources*

Weprovide access services (including traditional, fully-featured narrowbandaccess and value-priced narrowband access; high-speed access via DSL, cable andwireless technologies; and IP-based voice) and value-added services (includingancillary services sold as add-on feature to our services, search andadvertising). Our subscriber base remained consistent at approximately 5.3million paying subscribers as of March 31, 2006 and 2007, while total revenuesincreased from $309.7 million during the three months ended March 31, 2006 to$324.4 million during the three months ended March 31, 2007. The increase intotal revenues was primarily due to our acquisition of New Edge Holding Company(“New Edge”) in April 2006, the launch of our new IP-based voice services andan increase in value-added services. These increases were offset by a decreasein narrowband access revenues. Our traditional, premium-priced narrowbandsubscriber base and revenues have been declining due to the maturity of thisservice. In addition, the mix of our narrowband customers continues to shifttowards value-priced narrowband access.

*BusinessStrategy and Risks*

Ourbusiness strategy is to generate profits from our existing core access servicesand to reinvest the cash generated from these services in our various growthinitiatives with the objective of generating revenue growth and earnings growthin future periods; to continue to expand our presence in growth markets, suchas VoIP services, municipal wireless broadband services and business services;to support our HELIO joint venture with SK Telecom; and to market high quality,differentiated products and services.

Webelieve the most important factors for us to execute our business strategy arethe following:

·                  continuingto identify opportunities to improve the cost structure of our business withoutimpacting the quality of services we provide;

·                  maximizingthe return on our subscriber acquisition costs by balancing aggressivepromotional pricing with the number of subscribers we are able to add and/orretain while continuing to reduce and leverage operating costs;

·                  continuingthe growth of our PeoplePC-branded, value-priced narrowband access and ourbroadband service offerings in spite of competition from current and newcompetitors;

·                  renewing,extending or otherwise entering into wholesale broadband access agreements withtelecommunications providers at competitive and improved wholesale broadbandaccess prices and, in the event there are adverse changes in the retail pricingenvironment for broadband access services, at wholesale broadband access pricesthat decrease sufficiently to at least coincide with declines in retail prices;

·                  successfullyentering into arrangements with municipalities to build out and operatemunicipal wireless broadband networks and successfully constructing, upgradingand maintaining our municipal wireless networks;

19

----

·                  obtaininga sufficient number of customers to generate the returns anticipated on ourinvestments to construct and deploy municipal wireless broadband networks;

·                  growingour subscriber base for our IP-based voice and wireless broadband services togenerate revenues and profits;

·                  exploring,identifying and investing in additional growth opportunities and successfullyimplementing strategies to deliver these services cost effectively;

·                  differentiatingour products and services to enable us to deliver high quality services thatimprove customers’ Internet experiences, including bundling our variouscommunications services; and

·                  exploringand evaluating potential strategic transactions that we believe may complementour current and future business activities, and successfully integrating anynew acquisitions and investments into our business.

Theprimary challenges we face in executing our business strategy are maintainingprofitability in our existing services, successfully implementing new productsand services, competition and purchasing cost-effective wholesalebroadband access.

*FirstQuarter 2007 Highlights*

Asdiscussed above, total revenues during the three months ended March 31, 2007increased compared to the prior period. We continued to generate profits andoperating cash flow from our core access services. However, overall operatingexpenses increased during the three months ended March 31, 2007 compared to theprior period due to continued investments in our IP-based voice, municipal wirelessand business services growth initiatives. Specifically, we continued to marketand deploy our newly launched DSL and Home Phone service and municipal wirelessbroadband services. Operating expenses also increased during the three monthsended March 31, 2007 compared to the prior year period due to $6.5 million ofcash and non-cash compensation expense resulting from payments and benefits tothe estate of our former President and Chief Executive Officer, Charles G.Betty, following his death on January 2, 2007. Additionally, our net losses ofequity affiliate related to our HELIO joint venture increased as HELIO incurredlosses due to the start-up nature of their business. The increase in overalloperating costs and expenses and net losses of HELIO caused overall profits todecrease during the three months ended March 31, 2007 compared to the priorperiod.

*LookingAhead*

Weexpect overall profits to be adversely affected in 2007 as we continue toexpand our new products and services. Implementation of new services involvesinitial product development and infrastructure costs, followed by sales andmarketing costs to add customers who generate recurring revenues.  In the remainder of 2007, we expect toincrease sales and marketing efforts for our IP-based voice, municipalbroadband services and business services and incur increased customer supportand telecommunications costs to provide these services. However, we believemanagement can exercise discretion in deploying product development and salesand marketing resources to manage the expense associated with development ofIP-based voice and municipal broadband customer bases.  In addition, we expect to grow our IP-basedvoice and wireless broadband subscriber bases to increase revenue and we expectto expand our wireless broadband footprint. We also expect HELIO to incuradditional losses in the remainder of 2007 due to the continuing start-upnature of its business. We record our proportionate share of HELIO’s losses inour results of operations, so our results of operations in 2007 will also beadversely impacted because of HELIO’s losses.

20

----

**GrowthInitiatives**

*IP-based voice. *In October 2005, we began offering the next generationof our VoIP services, EarthLink trueVoiceSM. EarthLink trueVoice is a competitive alternative totraditional telephone service and is available to EarthLink and non-EarthLinkhigh-speed Internet access subscribers. In late 2005 and 2006, we launched DSLand Home Phone Service, a new DSL and VoIP service, which uses Covad CommunicationsGroup, Inc.’s (“Covad”) line-powered voice access that allows us to offerconsumers low-cost phone services along with high-speed Internet access. InMarch 2006, we invested $50.0 million in Covad to fund the network build-out ofthis service. The service is now available in 12 markets in the U.S. coveringapproximately 12.5 million households.

Weare actively marketing EarthLink DSL and Home Phone Service and will expand ourmarketing efforts to promote these services during the remainder of 2007. Wewill also continue to invest in the development of additional applications andservices and the marketing efforts for our IP-based voice services.

*Municipal wireless broadband*.We are investing in wireless, or Wi-Fi, broadband access to deploy a competitivealternative to DSL and cable for delivering broadband Internet access services.We began this initiative during 2005 by winning proposals to finance, build andmanage wireless broadband networks for the cities of Philadelphia, Pennsylvaniaand Anaheim, California. During 2006 and early 2007, we completed the initialphase for these networks and began offering our municipal wireless broadbandservices.  We also launched service inMilpitas, California and New Orleans, Louisiana, and have been selected by thecities of Alexandria, Virginia; San Francisco, California; Atlanta, Georgia;Houston, Texas; St. Petersburg, Florida; and Arlington County, Virginia tobuild, own and operate a wireless broadband network in those cities.

In March 2007, wepurchased a municipal wireless network from the city of Corpus Christi, Texasthat had already been deployed by the city. We also entered into a franchiseagreement to provide wireless Internet access to residents and businesses ofCorpus Christi.

Weexpect to expand our wireless broadband footprint and grow our wirelessbroadband subscriber base to increase revenues, with the target of offeringservice to nearly 1.0 million households by the end of 2007. These initiativesmay result in significant capital expenditures and operating costs in futureperiods to develop, implement and build wireless broadband networks in thesemunicipalities, as well as increased costs to market the new services.

*Business services*.In April 2006, we acquired New Edge, a single-source national provider ofsecure multi-site managed data networks and dedicated Internet access forbusinesses and communications carriers. The acquisition of New Edge expands ourservice offerings to small and medium-sized enterprises. During 2006, weintroduced new products, including Small Office DSL and hosted Virtual PrivateNetworks (“VPN”). In 2007, we expect to build upon our existing portfolio ofbusiness solutions, by expanding our product offerings and our distributionchannels.

**JointVenture**

We have a joint venturewith SK Telecom, HELIO. HELIO is a non-facilities-based mobile virtual networkoperator (MVNO) offering mobile communications services and handsets toconsumers in the U.S. EarthLink and SK Telecom invested an aggregate of $166.0million of cash and non-cash assets upon completing the formation of HELIO inMarch 2005, invested an aggregate of $78.0 million of cash in August 2005,invested an aggregate $157.0 million in 2006 and have committed to investadditional cash of $39.0 million in 2007, including $27.0 million that wasinvested in February 2007. As of March 31, 2007, EarthLink and SK Telecom eachhad an approximate 48% economic ownership interest and a 50% voting interest inHELIO.  HELIO will require additional funding in the future and we expectwe may invest additional cash in HELIO.

During 2006, HELIOlaunched its first three handheld devices, which are based on products SKTelecom offers in Korea. HELIO targets young, connected consumers with anextensive array of features, including MySpace Mobile, video services, 3D andmultiplayer games, and video, picture and text messaging, in 

21

----

addition to its wireless voice and data services.  HELIO is currently marketing its servicesthrough a variety of means. By the end of 2006, HELIO had distribution of itsdevices in over 2,700 retail and agent locations and began its nationaltelevision and print marketing campaign.

**Acquisition**

In April 2006, weacquired New Edge. The acquisition of New Edge expands our service offeringsfor businesses and communications carriers. Under the terms of the mergeragreement, we acquired 100% of New Edge in a merger transaction for 1.7 millionshares of EarthLink common stock and $108.7 million in net cash, including cashto be used to satisfy certain New Edge liabilities and direct transactioncosts.

**MarketingAlliances**

We have an agreement withTime Warner Cable and Bright House Networks, companies whose networks pass morethan 19 million homes, to offer our broadband Internet access servicesover their systems.  In connection withthe agreement, Time Warner Cable and Bright House Networks receiveconsideration from EarthLink for carrying the EarthLink service and relatedInternet traffic. As of December 31, 2006 and March 31, 2007, more than 25% ofour consumer broadband subscribers were serviced via either the Time WarnerCable or Bright House Networks network.

We had a marketingrelationship with Embarq Corporation (“Embarq”), a spin-off of Sprint NextelCorporation’s local communications business. The relationship provided thatEarthLink was the wholesale high-speed ISP for Embarq’s local residential andsmall business customers. The contracts associated with these arrangementsexpired in April 2007, and we and Embarq did not renew the wholesale broadbandcontract. During the three months ended March 31, 2007, the relationshipgenerated revenues of approximately $8.0 million. As of March 31, 2007, ourbroadband subscriber count and total subscriber count included approximately753,000 subscribers under the marketing relationship. These subscribers will beexcluded from our broadband subscriber count and total subscriber countbeginning in the second quarter of 2007.

22

----

**KeyOperating Metrics**

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:
|                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|---------------------------------------------|------------|--------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                  | ** ** | **2006**           | ** ** | **2006**              | ** ** | **2007**           | ** ** |
| **Subscriber Data (a)**                     | ** ** | ** **         | ** ** | ** **            | ** ** | ** **         | ** ** |
| **Consumer Services**                       | ** ** | ** **         | ** ** | ** **            | ** ** | ** **         | ** ** |
| Narrowband  access subscribers              |       | 3,477,000          |       | 3,261,000             |       | 3,208,000          |       |
| Broadband access  subscribers               |       | 1,683,000          |       | 1,831,000             |       | 1,849,000          |       |
| Total consumer  services                    |       | 5,160,000          |       | 5,092,000             |       | 5,057,000          |       |
| **Business Services**                       | ** ** | ** **         | ** ** | ** **            | ** ** | ** **         | ** ** |
| Narrowband  access subscribers              |       | 48,000             |       | 40,000                |       | 36,000             |       |
| Broadband access  subscribers               |       | 11,000             |       | 69,000                |       | 69,000             |       |
| Web hosting  accounts                       |       | 123,000            |       | 112,000               |       | 109,000            |       |
| Total business  services                    |       | 182,000            |       | 221,000               |       | 214,000            |       |
| **Total subscriber count at end of period** |       | 5,342,000          |       | 5,313,000             |       | 5,271,000          |       |

 
|                                     | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **March 31,**               | ** ** |
| ** **                          | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| **Subscriber  Activity**            | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Subscribers at  beginning of period |       | 5,315,000                        |       | 5,313,000 |   |
| Gross organic  subscriber additions |       | 770,000                          |       | 670,000 |   |
| Churn                               |       | (743,000                         | )          | (712,000 | ) |
| Subscribers at  end of period       |       | 5,342,000                        |       | 5,271,000 |   |
|                                |       |                             |       |   |   |
| **Churn  rate (b)**                 |       | 4.6                              | %          | 4.5 | % |
|                                |       |                             |       |   |   |
| **Consumer  Services Data**         | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Average  subscribers (c)            |       | 5,160,000                        |       | 5,086,000 |   |
| ARPU (d)                            |       | $                                | 18.83      |   | $ | 18.13 |   |
| Churn rate (b)                      |       | 4.7                              | %          | 4.6 | % |
|                                |       |                             |       |   |   |
| **Business  Services Data**         | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Average  subscribers (c)            |       | 173,000                          |       | 217,000 |   |
| ARPU (d)                            |       | $                                | 35.25      |   | $ | 73.32 |   |
| Churn rate (b)                      |       | 2.5                              | %          | 2.7 | % |

 

----

(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)  Churn rate is used to measure the rate atwhich subscribers discontinue service on a voluntary or involuntary basis.  Churn rate is computed by dividing theaverage monthly number of subscribers that discontinued service during theperiod by the average subscribers for the period.

23

----

(c)  Averagesubscribers or accounts for the three month periods is calculated by averagingthe ending monthly subscribers or accounts for the four months preceding andincluding the end of the quarterly period.

 (d) ARPU represents the average monthlyrevenue per user (subscriber). ARPU is computed by dividing average monthlyrevenue for the period by the average number of subscribers for the period.Average monthly revenue used to calculate ARPU includes recurring servicerevenue as well as nonrecurring revenues associated with equipment and otherone-time charges associated with initiating or discontinuing services.

**Resultsof Operations**

***ConsolidatedResults of Operations***

Thefollowing table sets forth statement of operations data for the periodsindicated:
|                                     | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                          | ** ** | **March 31,**                   | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                          | ** ** | **2006**                             | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                          | ** ** | **(dollars in thousands)** | ** ** |
| ** **                          | ** ** | ** **                           | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Revenues                            |       | $                                    | 309,712    |       | $          | 324,406           |       | 14,694 |   | 5 | % |
|                                |       |                                 |       |       |       |              |       |   |   |
| Operating costs and  expenses:      |       |                                 |       |       |       |              |       |   |   |
| Service and  equipment costs        |       | 90,072                               |       | 111,158    |       | 21,086            |       | 23 | % |
| Sales incentives                    |       | 2,277                                |       | 4,708      |       | 2,431             |       | 107 | % |
| Total cost of  revenues             |       | 92,349                               |       | 115,866    |       | 23,517            |       | 25 | % |
|                                |       |                                 |       |       |       |              |       |   |   |
| Sales and  marketing                |       | 103,843                              |       | 98,631     |       | (5,212            | )          | 5 | % |
| Operations and  customer support    |       | 60,668                               |       | 66,010     |       | 5,342             |       | 9 | % |
| General and  administrative         |       | 31,210                               |       | 44,353     |       | 13,143            |       | 42 | % |
| Amortization of  intangible assets  |       | 1,913                                |       | 3,496      |       | 1,583             |       | 83 | % |
| Total operating  costs and expenses |       | 289,983                              |       | 328,356    |       | 38,373            |       | 13 | % |
|                                |       |                                 |       |       |       |              |       |   |   |
| Income (loss)  from operations      |       | 19,729                               |       | (3,950     | )          | (23,679           | )          | -120 | % |
| Net losses of equity  affiliate     |       | (7,591                               | )          | (29,346    | )          | (21,755           | )          | * |   |
| Interest income and  other, net     |       | 4,216                                |       | 3,503      |       | (713              | )          | -17 | % |
| Income (loss)  before income taxes  |       | 16,354                               |       | (29,793    | )          | (46,147           | )          | * |   |
| Provision for income  taxes         |       | —                               |       | 169        |       | 169               |       | * |   |
| Net income  (loss)                  |       | $                                    | 16,354     |       | $          | (29,962           | )          | $ | (46,316 | ) | * |   |
|                                     |            |                                      |            |            |            |                   |            |  |  |  |  |  |

 

----

* denotes percentage isnot meaningful

24

----

***SegmentResults of Operations***

Ourbusiness segments are strategic business units that are managed based upondifferences in customers, services and marketing channels. Our ConsumerServices segment provides dial-up Internet access, high-speed Internet access,municipal wireless broadband and voice service, among others, to individualcustomers. Our Business Services segment provides managed data networks,dedicated Internet access and web hosting, among others, to business and communicationscarriers.

Weevaluate 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 directly attributableto the segment, which include expenses over which segment managers have directdiscretionary control, such as advertising and marketing programs, customersupport expenses, site operations expenses, product development expenses,certain technology and facilities expenses, billing operation 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 and stock-based compensation expense under Statement ofFinancial Accounting Standards (“SFAS”) No. 123(R), as they are not evaluatedin the measurement of segment performance.

Thefollowing table sets forth segment data for the periods indicated:

 
| ** **                        | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-----------------------------------|------------|----------------------------------|------------|------------|------------|-------------------|------------|
| ** **                        | ** ** | **2006**                         | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                        | ** ** | **(dollars in thousands)**       | ** ** |
| **Consumer Services**             | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Revenues                          |       | $291,467                         |       | $276,652   |       | $(14,815          | )          | -5 | % |   |
| Cost of revenues                  |       | 88,048                           |       | 85,824     |       | (2,224            | )          | -3 | % |   |
| Gross margin                      |       | 203,419                          |       | 190,828    |       | (12,591           | )          | -6 | % |   |
| Direct segment operating expenses |       | 174,571                          |       | 165,226    |       | (9,345            | )          | -5 | % |   |
| Segment income from operations    |       | $28,848                          |       | $25,602    |       | $(3,246           | )          | -11 | % |   |
|                              |       |                             |       |       |       |              |       |   |   |   |
| **Business Services**             | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** |
| Revenues                          |       | $18,245                          |       | $47,754    |       | $29,509           |       | 162 | % |   |
| Cost of revenues                  |       | 4,301                            |       | 30,042     |       | 25,741            |       | * |   |   |
| Gross margin                      |       | 13,944                           |       | 17,712     |       | 3,768             |       | 27 | % |   |
| Direct segment operating expenses |       | 2,591                            |       | 17,168     |       | 14,577            |       | * |   |   |
| Segment income from operations    |       | $11,353                          |       | $544       |       | $(10,809          | )          | -95 | % |   |
|                              |       |                             |       |       |       |              |       |   |   |   |
| **Consolidated**                  | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** |
| Revenues                          |       | $309,712                         |       | $324,406   |       | $14,694           |       | 5 | % |   |
| Cost of revenues                  |       | 92,349                           |       | 115,866    |       | 23,517            |       | 25 | % |   |
| Gross margin                      |       | 217,363                          |       | 208,540    |       | (8,823            | )          | -4 | % |   |
| Direct segment operating expenses |       | 177,162                          |       | 182,394    |       | 5,232             |       | 3 | % |   |
| Segment income from operations    |       | 40,201                           |       | 26,146     |       | (14,055           | )          | -35 | % |   |
| Stock-based compensation expense  |       | 3,668                            |       | 7,880      |       | 4,212             |       | 115 | % |   |
| Amortization of intangible assets |       | 1,913                            |       | 3,496      |       | 1,583             |       | 83 | % |   |
| Other operating expenses          |       | 14,891                           |       | 18,720     |       | 3,829             |       | 26 | % |   |
| Income (loss) from operations     |       | $19,729                          |       | $(3,950    | )          | $(23,679          | )          | -120 | % |   |

 

----

* denotes percentage is not meaningful

25

----

 

***Revenues***

Thefollowing table presents revenues by groups of similar services and by segmentfor the three months ended March 31, 2006 and 2007:
|                       | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|-----------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **            | ** ** | **March 31,**                   | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **            | ** ** | **2006**                             | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **            | ** ** | **(dollars in thousands)** | ** ** |
| **Consumer Services** | ** ** | ** **                           | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Access and  service   |       | $                                    | 264,231    |       | $          | 243,059           |       | $ | (21,172 | ) | -8 | % |
| Value-added  services |       | 27,236                               |       | 33,593     |       | 6,357             |       | 23 | % |
| Total revenues        |       | $                                    | 291,467    |       | $          | 276,652           |       | $ | (14,815 | ) | -5 | % |
|                  |       |                                 |       |       |       |              |       |   |   |
| **Business Services** | ** ** | ** **                           | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Access and  service   |       | $                                    | 17,429     |       | $          | 46,955            |       | $ | 29,526 |   | 169 | % |
| Value-added  services |       | 816                                  |       | 799        |       | (17               | )          | -2 | % |
| Total revenues        |       | $                                    | 18,245     |       | $          | 47,754            |       | $ | 29,509 |   | 162 | % |
|                  |       |                                 |       |       |       |              |       |   |   |
| **Consolidated**      | ** ** | ** **                           | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Access and service    |       | $                                    | 281,660    |       | $          | 290,014           |       | $ | 8,354 |   | 3 | % |
| Value-added  services |       | 28,052                               |       | 34,392     |       | 6,340             |       | 23 | % |
| Total revenues        |       | $                                    | 309,712    |       | $          | 324,406           |       | $ | 14,694 |   | 5 | % |

 

*Consolidatedrevenues*

Theprimary component of our revenues is access and service revenues, which consistof narrowband access services (including traditional, fully-featured narrowbandaccess and value-priced narrowband access); broadband access services(including high-speed access via DSL, cable and wireless technologies andIP-based voice); and web hosting services. We also earn revenues fromvalue-added services, which include ancillary services sold as add-on featuresto our access services, search and advertising revenues. Total revenuesincreased from $309.7 million during the three

26

----

months ended March31, 2006 to $324.4 million during the three months ended March 31, 2007, whichwas comprised of a $29.5 million increase in business services revenue offsetby a $14.8 million decrease in consumer services revenue. The increase inbusiness services revenue consisted of an increase in ARPU, from $35.25 duringthe three months ended March 31, 2006 to $73.32 during the three months endedMarch 31, 2007, and an increase in average subscribers, from 173,000 during thethree months ended March 31, 2006 to 217,000 during the three months endedMarch 31, 2007. These increases were primarily driven by our acquisition of NewEdge, as described below in more detail. The decrease in consumer servicesrevenue consisted of a 4% decrease in consumer ARPU and a 1% decrease inaverage consumer subscribers. The decrease in consumer services ARPU wasprimarily due to the shift in the mix of our narrowband customer base frompremium-priced to value-priced narrowband access customers, the shift in mix ofour broadband customer base from retail DSL to wholesale and retail cablesubscribers and general declines in Internet access prices.

*Consumerservices revenue*

*Access and service*.Consumer access and service revenues consist of narrowband access, broadbandaccess and voice services. These revenues are derived from monthly fees chargedto customers for dial-up Internet access; monthly retail and wholesale feescharged for high-speed, high-capacity access services including DSL, cable andsatellite; fees charged for IP-based voice services; usage fees; installationfees; termination fees; and fees for equipment. Consumer access and servicerevenues decreased 8% to $243.1 million during the three months ended March 31,2007 compared to the prior year period. The decrease in consumer access and service revenues during the threemonths ended March 31, 2007 was primarily due decreases in consumer access andservice ARPU. Also contributing to the decrease was a decrease in averagesubscribers.

ARPUdepends on a variety of factors including changes in the mix of customers andtheir related pricing plans; the use of promotions and discounted pricing plansto obtain or retain subscribers; increases or decreases in the prices of ourexisting services; and the addition of new services. We currently offer severalconsumer access services at different price plans and we provide servicesthrough retail and wholesale relationships. All of these have an effect on ouroverall ARPU.  Consumer access andservice ARPU decreased due to the following:

·                  the shift in themix of our narrowband subscriber base from premium narrowband access services,which are typically priced at $21.95 per month, to our PeoplePC value-pricednarrowband access services, which are generally priced at $10.95 per month.During the three months ended March 31, 2006 and 2007, average PeoplePC accesssubscribers were 1.3 million and 1.6 million, respectively, representing 37%and 49%, respectively, of our average consumer narrowband customer base;

·                  general declinesin retail DSL prices introduced as a result of declines in costs from our DSLservice providers;

·                  a shift in themix of our broadband subscriber base from retail services to wholesale servicesand, within our retail broadband customer base, from retail DSL subscribers toretail cable subscribers; and

·                  the increaseduse of promotional pricing for our service offerings.

Ourconsumer broadband subscriber base consists of consumers which are addedthrough retail and wholesale relationships. In a retail relationship, we marketthe service directly to consumers under an EarthLink brand, have latitude inestablishing price, and are responsible for most aspects of providing the service,including first tier customer support. In a wholesale relationship, atelecommunications partner markets the service, has latitude in establishingprice and pays us to provide underlying broadband access or Internet servicessuch as authentication, email, web space, news and varying degrees of customersupport. In a retail relationship, EarthLink generally recognizes the amountthe subscriber is billed as revenue, but in a wholesale relationship, EarthLinkrecognizes the amount due from the wholesale partner as revenue. Consumerretail broadband services are generally priced above $35 per month persubscriber to cover all of the costs of the service; however, certain retailrelationships, such as those with EarthLink Experience and certain cablecustomers, generate per month revenues that are less than $20 and havenegligible telecommunications service and equipment costs. Consumer wholesale broadbandrelationships are priced between $3 and $6 per month recognizing the limitedset of activities performed by EarthLink. The number of customers being addedor served at any

27

----

point in timethrough our wholesale efforts is subject to the business and marketingcircumstances of our telecommunications partners.

Average consumer accessand service subscribers decreased primarily due to the migration of premiumnarrowband subscribers to broadband services and the continued maturing andongoing competitiveness of the market for narrowband Internet access. Thisdecrease was offset by an increase in average PeoplePC subscribers, an increasein average broadband subscribers due to the continued growth in the market forbroadband access and our and our partners’ efforts to promote broadbandservices and an increase in average voice subscribers due to the launch ofEarthLink DSL and Home Phone Service in eight additional markets during the endof 2006. We expect the mix of our narrowband subscriber base to continue toshift from premium narrowband access services to PeoplePC access services forthe foreseeable future. We are also actively marketing EarthLink DSL and HomePhone Service and will expand our marketing efforts to promote these servicesduring the remainder of 2007.

*Value-added services revenues.*Value-addedservices revenues consist of search revenues; advertising revenues; ancillaryservices sold as add-on features to our Internet services, such as securityproducts, email by phone, Internet call waiting and email storage; and homenetworking products and services.* *We derive these revenues by paidplacements for searches; delivering traffic to our partners in the form ofsubscribers, page views or e-commerce revenues; advertising our partners’products and services in our various online properties and electronicpublications, including the Personal Start PageTM; referring our customers to our partners’products and services; and monthly fees charged for ancillary services.

Value-addedservices revenues increased 23% to $33.6 million during the three months endedMarch 31, 2007 compared to the prior year period due primarily to increasedsearch advertising revenues as a result of the increased use of the Internet asan advertising medium and an increase in sales of security products.

*Businessservices revenue*

*Access and service*.Business access and service revenues consist of retail and wholesale feescharged for high-speed, high-capacity access services including DSL, cable,satellite and dedicated circuit services; fees charged for high-speed datanetworks to small and medium-sized businesses; installation fees; terminationfees; fees for equipment; regulatory surcharges billed to customers; and webhosting. We earn web hosting revenues by leasing server space and providing webservices to individuals and businesses wishing to present a web or e-commercepresence on the Internet.

Business access andservice revenues increased from $17.4 million during the three months endedMarch 31, 2006 to $47.0 million during the three months ended March 31, 2007due to increases in ARPU and average subscribers, which were attributable tothe acquisition of New Edge in April 2006, offset by a decrease in web hostingrevenues primarily due to decreases in average web hosting accounts.

Our business broadbandsubscriber base consists of customers which are added through retail and wholesalerelationships. Retail business services generally have an ARPU between $110 and$130 for non-networked solutions and an ARPU between $175 and $225 fornetworked solutions. Wholesale business services generally have an ARPU between$60 and $80. The pricing for small and medium enterprises depends upon customerrequirements for different service delivery methods, amounts of bandwidth,quality of service and distance from the points of presence, and may varywidely from these ranges. The number of customers being added or served at anypoint in time through our wholesale efforts is subject to the business andmarketing circumstances of our telecommunications partners.

***Cost of revenues***

Serviceand equipment costs are the primary component of our cost of revenues andconsist of telecommunications fees, set-up fees, network equipment costsincurred to provide our Internet access services, depreciation of our networkequipment and surcharges due to regulatory agencies. Service and equipmentcosts also include the cost of Internet appliances sold. Our principalproviders for narrowband

28

----

telecommunicationsservices are Level 3 Communications, Inc. and Sprint Nextel Corporation,and our largest providers of broadband connectivity are Covad and Time WarnerCable. We also do lesser amounts of business with a wide variety of local,regional and other national providers. We purchase broadband access fromIncumbent Local Exchange Carriers, Competitive Local Exchange Carriers andcable providers. Cost of revenues also includes sales incentives. We frequentlyoffer sales incentives such as free Internet access on a trial basis andmodems.

Costof revenues increased 25% from $92.3 million during the three months endedMarch 31, 2006 to $115.9 million during the three months ended March 31, 2007.This was due to a $25.7 million increase in business services cost of revenuesduring the three months ended March 31, 2007 compared to the prior year period,offset by a $2.2 million decrease in consumer services cost of revenues. Businessservices cost of revenues increased from $4.3 million during the three monthsended March 31, 2006 to $30.0 million during the three months ended March 31,2007 primarily as a result of acquired New Edge subscribers and theirassociated cost. Consumer services cost of revenues decreased from $88.0million during the three months ended March 31, 2006 to $85.8 million duringthe three months ended March 31, 2007 primarily due to the 2% decrease inaverage subscribers. These decreases in consumer service cost of revenues wereoffset by an increase in sales incentives due to an increase in modems andother equipment provided to customers resulting from the increase in IP-basedvoice subscribers.

Our retail consumer broadbandaccess and business services have a higher telecommunications cost of revenueper subscriber than our other principal forms of Internet access and relatedservices. As a result, we expect service and equipment costs per subscriber toincrease in 2007 as we seek to grow our managed data networks services. Weexpect that there may be additional, although limited, opportunities to reducesuch costs by continuing to eliminate higher cost providers, reducing costsfrom the remaining vendors, and achieving higher utilization of existingtelecommunications capacity. These initiatives may offset the negative effectexpected to result from the increase in service and equipment costs persubscriber.

***Salesand marketing***

Sales and marketingexpenses include advertising and promotion expenses, fees paid to distributionpartners to acquire new paying subscribers, personnel-related expenses andtelemarketing costs incurred to acquire and retain subscribers. Sales andmarketing expenses decreased from $103.8 million during the three monthsended March 31, 2006 to $98.6 million during the three months ended March 31,2007, which was primarily comprised of a decrease in consumer services salesand marketing expenses, offset by an increase in business services sales andmarketing expenses. The decrease in consumer services sales and marketingexpenses was primarily attributable to decreased spending for our premiumnarrowband services, offset by an increase in sales and marketing expenses tolaunch our voice products and an increase due to the launch of municipalbroadband services. The increase in business services sales and marketingexpenses was primarily due to the inclusion of New Edge sales and marketingexpenses.  Sales and marketing expensesfor the three months ended March 31, 2006 and 2007 included $0.8 million and$0.7 million, respectively, of stock-based compensation expense in accordancewith SFAS No. 123(R), “Share-Based Payment.” Sales and marketing expenses mayincrease during the remainder of 2007 as we increase marketing efforts for ourvoice services and to launch our municipal wireless broadband services inadditional markets.

***Operationsand customer support***

Operations and customersupport expenses consist of costs associated with technical support andcustomer service, providing our subscribers with toll-free access to ourtechnical support and customer service centers, maintenance of customerinformation systems, software development and network operations. Operationsand customer support expenses increased 9% from $60.7 million during the threemonths ended March 31, 2006 to $66.0 million during the three months endedMarch 31, 2007. The increase was primarily the result of an increase inbusiness services operations and customer support expenses due to the inclusionof New Edge

29

----

expenses. The increased expenses primarily consistedof increases in personnel-related costs and professional fees. Consumerservices operations and customer support expenses remained relatively constantduring the three months ended March 31, 2007 compared to the prior year perioddue to a decrease in expenses for narrowband access, offset by an increase inexpenses associated with our municipal wireless broadband initiative.Operations and customer support expenses for the three months ended March 31,2006 and 2007 included $1.7 million and $1.4 million, respectively, ofstock-based compensation expense in accordance with SFAS No. 123(R).

***Generaland administrative***

Generaland administrative expenses consist of fully burdened costs associated with theexecutive, finance, legal and human resources departments; outside professionalservices; payment processing; credit card fees; collections and bad debt.General and administrative expenses increased 42% from $31.2 millionduring the three months ended March 31, 2006 to $44.4 million during thethree months ended March 31, 2007. The increase was due to an increase incorporate general and administrative expenses and an increase in businessservices general and administrative expenses. Corporate general andadministrative expenses increased primarily due to cash and non-cashcompensation expense related to the death of Mr. Betty and an increase inprofessional fees. Business services general and administrative expensesincreased due to the acquisition of New Edge, which caused an increase ingeneral and administrative expenses and bad debt expense. General andadministrative expenses for the three months ended March 31, 2006 and 2007included $1.2 million and $5.8 million, respectively, of stock-basedcompensation expense in accordance with SFAS No. 123(R). Stock-based compensationexpense for the three months ended March 31, 2007 included $4.9 million ofstock-based compensation expense related to Mr. Betty.

Mr.Betty passed away on January 2, 2007. Pursuant to Mr. Betty’s employmentagreement, all unvested stock options and restricted stock units immediatelyvested and became fully exercisable upon death. In addition, the Leadership andCompensation Committee of the Board of Directors extended the exercise periodof Mr. Betty’s stock options until December 31, 2008. This daterepresents the exercise period if Mr. Betty had terminated employment afterserving the full term of his employment agreement, which was set to expire inJuly 2008.  During the three months endedMarch 31, 2007, we recorded stock-based compensation of $3.5 million related tothe accelerated vesting of 1.1 million stock options and 120,000 restrictedstock units and recorded stock-based compensation expense of $1.4 millionrelated to the extension of the exercise period for Mr. Betty’s stock options. Wealso recorded $1.5 million of compensation expense for a payment to Mr. Betty’sestate in accordance with his employment agreement.

***Amortization of intangibleassets***

Amortization ofintangible 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 technologyand other assets, are amortized on a straight-line basis over their estimateduseful lives, which range from one to six years. Amortization of intangibleassets increased from $1.9 million during the three months ended March 31, 2006to $3.5 million during the three months ended March 31, 2007 primarily due tothe amortization of identifiable definite lived intangible assets resultingfrom the acquisition of New Edge in April 2006.

***Netlosses of equity affiliate***

We account for ourinvestment in HELIO under the equity method of accounting because we can exertsignificant influence over HELIO’s operating and financial policies.Accordingly, we record our proportionate share of HELIO’s net losses. Theseequity method losses are offset by increases in the carrying value of our investmentassociated with amortizing the difference between the book value of non-cashassets contributed to HELIO and their fair value. These increases, which resultin decreases in the net losses of equity affiliate in our statements ofoperations, are being recorded over the estimated useful lives of the non-cashassets contributed. Net losses of equity affiliate for the three months endedMarch 31, 2006 and 2007 of $7.6 million and $29.3 million, respectively,included our proportionate share of HELIO’s net losses offset by amortizationassociated with recognizing the difference between the carrying value and fairvalue of non-cash assets contributed. Due to the start-up nature of HELIO’soperations and HELIO’s recent product launches, we expect HELIO’s net loss to

30

----

continue to increase, and, as a result, we expect ournet losses of equity affiliate to increase as we record our proportionate shareof HELIO’s net losses.

***Interestincome and other, net***

Interest income andother, net, decreased from $4.2 million during the three months ended March 31,2006 to $3.5 million during the three months ended March 31, 2007 primarily dueto interest expense incurred on our Convertible Senior Notes due November 15,2026 (“Notes”), offset by an increase in interest income. During November 2006,we issued $258.8 million aggregate principal amount of Notes in a registeredoffering. The Notes bear interest at 3.25% per year on the principal amount ofthe Notes until November 15, 2011, and 3.50% interest per year on the principalamount of the Notes thereafter, payable semi-annually in May and November ofeach year.

Interest income increaseddue to higher investment yields on our cash and marketable securities andinterest income earned on our Covad Senior Convertible Notes, offset by adecrease in our average cash and marketable securities balance. Our weightedaverage investment yields increased from approximately 4.3% during three monthsended March 31, 2006 to approximately 5.2% during the three months ended March31, 2007, as the U.S. Federal Reserve Bank has increased interest rates. Ouraverage cash and marketable securities balance decreased from $401.9 millionduring the three months ended March 31, 2006 to $379.7 million during the threemonths ended March 31, 2007. Our cash and investment balances decreased overthe past year as a result of investments in the HELIO joint venture, ouracquisition of New Edge, investments in other companies, capital expenditures,the purchases of subscriber bases from other companies and repurchases of ourcommon stock, offset by cash raised by the issuance of convertible senior notesand cash provided by operations.

***Provisionfor income taxes***

Based on management’scurrent expectations, we have recorded income taxes at an effective tax rate of0% during the three months ended March 31, 2007 in accordance with interimreporting requirements of SFAS No. 109, “Accounting for Income Taxes,” andAccounting Principles Board Opinion No. 28, “Interim Financial Reporting.”

Wecontinue to maintain a full valuation allowance against our deferred taxassets, consisting primarily of net operating loss carryforwards, and we mayrecognize deferred tax assets in future periods when they are determined to berealizable.

**Liquidity and Capital Resources**

The following table setsforth summarized cash flow data for the three months ended March 31, 2006 and2007:
|                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                             | ** ** | **2007** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                              | ** ** |
|                                                 |       |                                                 |       |   |   |
| Net income (loss)                                    |       | $                                                    | 16,354     |   | $ | (29,962 | ) |
| Non-cash items                                       |       | 21,496                                               |       | 50,450 |   |
| Changes in working  capital                          |       | (8,627                                               | )          | (21,881 | ) |
| Net cash provided by  (used in) operating activities |       | $                                                    | 29,223     |   | $ | (1,393 | ) |
|                                                 |       |                                                 |       |   |   |
| Net cash used in  investing activities               |       | $                                                    | (70,252    | ) | $ | (51,015 | ) |
|                                                 |       |                                                 |       |   |   |
| Net cash (used in) provided by financing activities  |       | $                                                    | (1,145     | ) | $ | 2,763 |   |

 

31

----

*Operating activities*

Netcash provided by (used in) operating activities decreased during the threemonths ended March 31, 2007 compared to the prior period. This was primarilydue to an increase in costs related to our growth initiatives, includingmunicipal wireless broadband and IP-based voice services, as we used cashgenerated from our core access services to fund these initiatives, and anincrease in costs due to the acquisition of New Edge. Cash flows from operatingactivities are expected to be adversely affected in 2007 as we continue to fundour growth initiatives in the form of increased operating and sales andmarketing expenses; however, we do seek to effectively manage expensesassociated with our core access services and our working capital to mitigatethe adverse impact our growth initiatives are expected to have on our operatingcash flows.

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, net losses of equity affiliate, deferred income taxes,stock-based compensation and non-cash disposals and impairments of fixedassets. Non-cash items increased during the three months ended March 31, 2007compared to the prior period due to an increase in net losses of equityaffiliate, an increase in stock-based compensation expense and an increase indepreciation and amortization expense.

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 increased during the threemonths ended March 31, 2007 compared to the prior period primarily due to anincrease in costs related to our growth initiatives.

*Investing activities*

Cash used for investingactivities decreased during the three months ended March 31, 2007 compared tothe prior year period, which was due to a decrease in investments in othercompanies and a decrease in investments in HELIO, offset by an increase in net purchasesof investments in marketable securities. Our investing activities used cash of$70.3 million during the three months ended March 31, 2006. This consistedprimarily of our $50.0 million investment in Covad and our $39.5 millionscheduled contribution to HELIO. In addition, we used $7.5 million for capitalexpenditures, primarily associated with network and technology center relatedprojects. Offsetting these investing outlays were proceeds of $27.1 millionfrom sales and maturities of investments in marketable securities, net ofpurchases.

Our investing activitiesused cash of $51.0 million during the three months ended March 31, 2007. Thisconsisted primarily of $22.2 million of purchases of investments in marketablesecurities, net of sales and maturities, our $13.5 million scheduledcontribution to HELIO and $13.3 million of capital expenditures, primarilyassociated with network and technology center related projects. We haveinvested significantly in our network and technology center infrastructure, andwe expect to continue to invest capital to enhance the reliability and capacityof our network as well as to improve the efficiency of our technical andcustomer support services. In addition, management continuously reviewsindustry and economic conditions to identify opportunities to pursueacquisitions of subscriber bases, and we may invest in or acquire othercompanies.

*Financing activities*

Our financing activitiesused cash of $1.1 million during the three months ended March 31, 2006. Thisconsisted primarily of $2.0 million used to repay a note payable and $1.6million used to repurchase 0.2 million shares of our common stock. Offsettingcash used for financing activities were proceeds from the exercise of stockoptions of $2.5 million during the three months ended March 31, 2006. Ourfinancing activities provided cash of $2.8 million during the three monthsended March 31, 2007, which primarily consisted of proceeds from the exerciseof stock options.

32

----

**Off-BalanceSheet Arrangements**

As of March 31, 2007, wedid not have any off-balance sheet arrangements that have or are reasonablylikely to have a current or future effect on our financial condition, changesin financial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources that are material to investors.

**Share Repurchase Program**

The Board of Directorshas authorized a total of $550.0 million to repurchase our common stock underour share repurchase program. As of April 30, 2007, we had utilizedapproximately $454.7 million pursuant to the authorizations and had $95.3million available under the current authorization. We may repurchase our commonstock from time to time in compliance with the Securities and ExchangeCommission’s regulations and other legal requirements, and subject to marketconditions and other factors. The share repurchase program does not require usto acquire any specific number of shares and may be terminated by the Board ofDirectors at any time. We have not repurchased common stock under this programsince October 2006.

**Income Taxes**

We continue to maintain afull valuation allowance against our deferred tax assets of approximately$368.0 million, consisting primarily of net operating loss carryforwards. Wemay recognize deferred tax assets in future periods when they are determined tobe realizable. To the extent we may owe income taxes in future periods, weintend to use our net operating loss carryforwards to the extent available toreduce cash outflows for income taxes.

**Future Uses of Cash and FundingSources**

Weexpect to use and invest cash during the remainder of 2007 for a number ofreasons, including building municipal wireless networks and growing oursubscriber base for municipal wireless services, IP-based voice services andbusiness services. This will primarily consist of increased operating and salesand marketing expenditures. We also expect to use cash for commitments pursuantto the Contribution and Formation Agreement for our HELIO joint venture,including cash contributions of $6.0 million to be paid in August 2007, as wellas for possible additional investments in HELIO.

We have expended and willcontinue to expend significant resources enhancing our existing services anddeveloping, acquiring, implementing and launching new services, such asIP-based voice services and wireless broadband services. We believe IP-basedvoice services and wireless broadband services represent significant growthopportunities and may require significant cash outlays. These uses of cash willbe in the form of initial product development and infrastructure costs,followed by sales and marketing costs to add customers that will generaterecurring revenues. Capital expenditures are expected to increase in 2007 as weinvest in our growth initiatives. These initiatives may result in significantcapital expenditures to develop, implement and build wireless broadbandnetworks in various municipalities. We also expect to incur capitalexpenditures to maintain and upgrade our network and technology infrastructure.The actual amount of capital expenditures in 2007 as well as in future periodsmay fluctuate due to a number of factors which are difficult to predict andcould change significantly over time, including, without limitation, the timingand extent of municipal wireless network build-outs and additional awards tobuild out networks. Additionally, technological advances may require us to makecapital expenditures to develop or acquire new equipment or technology in orderto replace aging or technologically obsolete equipment. We also expect tocontinue to use cash to acquire and retain new and existing subscribers for ourcore access services.

HELIOis our joint venture with SK Telecom, that markets wireless voice and dataservices in the U.S. Pursuant to the Contribution and Formation Agreement, weinvested $82.0 million of cash in 2005, invested $78.5 million of cash in 2006,invested $13.5 million in February 2007 and are committed to invest additionalcash of $6.0 million in HELIO in August 2007. HELIO will require additionalfunding in the future and we

33

----

expect we mayinvest additional cash in HELIO. We expect the future commitments to invest inHELIO to adversely affect our cash position.

Ourcash requirements depend on numerous factors, including the rate of marketacceptance of our and HELIO’s services, our ability to successfully develop newrevenue sources, our ability to maintain and expand our customer base, the rateof expansion of our network infrastructure, the size and types of acquisitionsin which we may engage and the level of resources required to expand our salesand marketing programs.

Ourprincipal sources of liquidity are our cash, cash equivalents and investmentsin marketable securities, as well as the cash flow we generate from our coreaccess operations. As of March 31, 2007, we had $108.7 million in cash and cashequivalents. In addition, we held short- and long-term investments inmarketable securities valued at $242.4 million and $16.2 million, respectively.Short-term investments in marketable securities consist of investments thathave maturity dates of up to one year from the balance sheet date andasset-backed, auction rate securities that have interest rate reset periods ofup to one year from the balance sheet date, and long-term investments inmarketable securities consist of investments that have maturity dates of morethan one year from the balance sheet date.

During November 2006, we issued $258.8million aggregate principal amount of Convertible Senior Notes due November 15,2026 in a registered offering, which includes the exercise by the underwritersof their option to purchase an additional $33.8 million to coverover-allotments. We received net proceeds of $251.6 million after transactionfees of $7.2 million. We used $15.1 million of the proceeds for hedgetransactions and warrant transactions to reduce the potential dilution uponconversion of the convertible senior notes. The remaining proceeds will be usedfor general corporate purposes, including expenditures related to our growthinitiatives.

Wehave a financing lease agreement with General Electric Capital Corporation tolease certain equipment necessary to build out our municipal wirelessinfrastructure in selected markets. Under the agreement, we can lease up to$75.0 million of assets. As of March 31, 2007, we had committed to leaseapproximately $5.0 million of equipment pursuant to the financing agreement.However, none of the leases had commenced.

Ouravailable cash and marketable securities, together with our results ofoperations, are expected to be sufficient to meet our operating expenses, capitalrequirements and investment and other obligations for the next 12 months.However, as a result of our growth initiatives and other investment activities,we may seek additional financing in the future. Except for our financing leaseagreement discussed above, we have no commitments for any additional financingand have no lines of credit or similar sources of financing. We cannot be surethat we can obtain additional financing on favorable terms, if at all, throughthe issuance of equity securities or the incurrence of additional debt.Additional equity financing may dilute our stockholders, and debt financing, ifavailable, may restrict our ability to declare and pay dividends and raisefuture capital. If we are unable to obtain additional needed financing, we maybe required to reduce our planned capital expenditures, suspend or reduce ourinvestment activities and/or reduce any of our planned growth initiatives,which could materially and adversely affect our prospects for long-term growth.

**Related Party Transactions**

*HELIO*

EarthLinkand HELIO have entered into a services agreement pursuant to which we provideHELIO facilities, accounting, tax, billing, procurement, risk management,payroll, human resource, employee benefit administration and other supportservices in exchange for management fees. However, as HELIO develops itsbusiness, the extent to which HELIO relies on us to provide these services hasdecreased. We believe that providing these services to HELIO enabled HELIO tomore quickly and cost effectively launch its business than if it were topurchase these services from third parties. The management fees were determinedbased on our costs to provide the services, and management believes such feesare reasonable.  The total amount of feesthat HELIO pays to us depends on the extent to which HELIO utilizes ourservices.  Fees for services provided toHELIO are reflected as reductions to the associated expenses incurred by us toprovide such services. During the three

34

----

months ended March31, 2006 and 2007, fees received for services provided to HELIO were $0.7million and $0.5 million, respectively.

Wealso market HELIO’s products and services and purchase wireless Internet accessdevices and services from HELIO. During the three months ended March 31, 2006and 2007, revenues generated from HELIO and fees paid for products and servicesfrom HELIO were minimal.

**Recent Accounting Pronouncements**

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements,” which establishes a framework for reporting fair value andexpands disclosures about fair value measurements. SFAS No. 157 iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. We arecurrently assessing the impact of the adoption of this standard on ourfinancial statements.

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities,” which provides companies with anoption to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirementsdesigned to facilitate comparisons between companies that choose differentmeasurement attributes for similar types of assets and liabilities. SFASNo. 159 is effective as of the beginning of an entity’s first fiscal yearbeginning after November 15, 2007. We are currently assessing the impactof the adoption of this standard on our financial statements.

35

----

**Safe Harbor Statement**

TheManagement’s Discussion and Analysis and other portions of this QuarterlyReport on Form 10-Q include “forward-looking” statements (rather thanhistorical facts) that are subject to risks and uncertainties that could causeactual results to differ materially from those described. Although we believethat the expectations expressed in these forward-looking statements arereasonable, 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 we may not successfullyenhance existing or develop new products and services in a cost-effectivemanner to meet customer demand in the rapidly evolving market for Internet,wireless and IP-based voice communications services, including new products andservices offered in connection with our voice and municipal broadband networkgrowth initiatives, and we expect these growth initiatives to not be profitablein their early stages; (2) that our service offerings may fail to becompetitive with existing and new competitors; (3) that competitive product, priceor marketing pressures could cause us to lose existing customers to competitors(churn), or may cause us to reduce prices for our services which couldadversely impact average revenue per user; (4) that we may be unsuccessful inmaking and integrating acquisitions into our business, which could result inoperating difficulties, losses and other adverse consequences; (5) that thecontinued decline of our narrowband revenues could adversely affect ourprofitability and adversely impact our ability to invest in our growthinitiatives; (6) that we may not be able to successfully manage the costsassociated with delivering our wireline broadband services, which couldadversely affect our ability to grow or sustain revenues and our profitability;(7) that companies may not provide last mile broadband access to us on awholesale basis or on terms or at prices that allow us to grow and beprofitable; (8) that our commercial and alliance arrangements may be terminatedor may not be as beneficial as anticipated, which could adversely affect ourability to increase our subscriber base; (9) that our business may suffer ifour third-parties for technical and customer support and certain billingservices are unable to provide these services, cannot expand to meet our needsor terminate their relationships with us; (10) that service interruptions orimpediments could harm our business; (11) that government regulations couldforce us to change our business practices; (12) that changes in, orinterpretations of, laws regarding consumer protection could subject us toliability or cause us to change our practices; (13) that we may not be able toprotect our proprietary technologies or successfully defend infringement claimsand may be required to enter licensing arrangements on unfavorable terms; (14)that we may be accused of infringing upon the intellectual property rights ofthird parties, which is costly to defend and could limit our ability to usecertain technologies in the future; (15) that we could face substantial liabilitiesif we are unable to successfully defend against legal actions; (16) that ourbusiness depends on the continued development of effective business supportsystems, processes and personnel; (17) that we may be unable to hire and retainsufficient qualified personnel, and the loss of any of our key executiveofficers could adversely affect us; (18) that we may not be successful inentering into arrangements with municipalities to build out and operatemunicipal wireless broadband networks and we may not obtain a sufficient numberof customers to generate the returns anticipated on our investments toconstruct and deploy municipal wireless broadband networks; (19) that municipalwireless networks may not perform as expected or may result in unanticipatedcosts, which could increase our churn and our cost of providing services; (20)that we may experience difficulties in constructing, upgrading and maintainingour municipal wireless network, which could adversely affect customersatisfaction, increase subscriber churn and reduce our revenues; (21) that themarket for VoIP services may not develop as anticipated, which would adverselyaffect our ability to execute our voice strategy; (22) that certain aspects ofour VoIP service are not the same as traditional telephone service, which maylimit the acceptance of our services by mainstream consumers and our potentialfor growth; (23) that our E911 emergency services are different from thoseoffered by traditional wireline telephone companies and may expose us tosignificant liability; (24) that our ability to provide our VoIP service isdependent upon third-party facilities and equipment, the failure of which couldcause delays or interruptions of our service, damage our reputation, cause usto lose customers and limit our growth; (25) that we may not realize thebenefits we are seeking from our investments in the HELIO joint venture orother investment activities as a result of lower than predicted revenues orsubscriber levels of the companies in which we invest, larger fundingrequirements for those companies or otherwise; (26) that our stock price hasbeen volatile historically and may continue to be volatile; (27) that ourindebtedness could adversely affect our financial health and limit our abilityto react to changes in our industry or to implement our strategic initiatives;(28) that we may be unable to repurchase our convertible senior notes for cashwhen required by the holders, including following a fundamental 

36

----

change, or to paythe cash portion of the conversion value upon conversion of any notes by theholders; (29) that the convertible note hedge and warrant transactions mayaffect the value of our common stock; and (30) that some provisions of Delawarelaw, our second restated certificate of incorporation and amended and restatedbylaws may be deemed to have an anti-takeover effect and may delay or prevent atender offer to takeover attempt that a stockholder might consider in its bestinterest. These risks and uncertainties, as well as other risks anduncertainties that could cause our actual results to differ significantly frommanagement’s expectations, are not intended to represent a complete list of allrisks and uncertainties inherent in our business, and should be read inconjunction with the more detailed cautionary statements and risk factorsincluded in our Annual Report on Form 10-Kfor the year ended December 31, 2006, as amended.

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

*Interest Rate Risk*

We are exposed tointerest rate risk with respect to our investments in marketable securities. Achange in prevailing interest rates may cause the fair value of our investmentsto fluctuate. For example, if we hold a security that was issued with a fixedinterest rate at the then-prevailing rate and the prevailing interest ratelater rises, the fair value of its investment may decline. To minimize thisrisk, we have historically held many investments until maturity, and as aresult, we receive interest and principal amounts pursuant to the underlyingagreements. To further mitigate risk, we maintain a portfolio of investments ina variety of securities, including government agency notes, asset-backed debtsecurities (including auction rate debt securities), corporate notes andcommercial paper, all of which bear a minimum short-term rating of A1/P1 or aminimum long-term rating of A/A2. As of December 31, 2006 and March 31, 2007,net unrealized losses in these investments were not material.  In general, money market funds are notsubject to market risk because the interest paid on such funds fluctuates withthe prevailing interest rate. In addition, we invest in relatively short-termsecurities and, therefore, changes in short-term interest rates impact theamount of interest income included in the statements of operations.

Thefollowing table presents the amounts of our cash equivalents and short- andlong-term investments that are subject to interest rate risk by range ofexpected maturity and weighted-average interest rates as of December 31,2006 and March 31, 2007. This table does not include money market funds becausethose funds are not subject to interest rate risk.

|                                               | ** ** | **As of December 31, 2006** | ** ** | **As of March 31, 2007** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                      | ** ** | **Estimated**                                | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                    | ** ** | **Amortized**                                   | ** ** | **Fair**                                     | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                                    | ** ** | **Cost**                                        | ** ** | **Value**                                    | ** ** | **Cost** | ** ** | **Value** | ** ** |
| ** **                                    | ** ** | **(dollars in thousands)**            | ** ** |
| Included in cash and  cash equivalents        |       | $                                               | 46,289     |                                         | $          | 46,289 |   | $ | 11,073 |   | $ | 11,073 |   |
| Weighted average  interest rate               |       | 5.3                                             | %          |                                         |       | 5.2 | % |   |   |
| Weighted average  maturity (mos.)             |       | 1.0                                             |       |                                         |       | 0.4 |   |   |   |
|                                          |       |                                            |       |                                         |       |   |   |   |   |
| Included in marketable  securities-short-term |       | $                                               | 215,181    |                                         | $          | 214,947 |   | $ | 242,576 |   | $ | 242,396 |   |
| Weighted average  interest rate               |       | 5.2                                             | %          |                                         |       | 5.2 | % |   |   |
| Weighted average  maturity (mos.)*            |       | 2.7                                             |       |                                         |       | 2.2 |   |   |   |
|                                          |       |                                            |       |                                         |       |   |   |   |   |
| Included in marketable  securities-long-term  |       | $                                               | 21,497     |                                         | $          | 21,460 |   | $ | 16,252 |   | $ | 16,236 |   |
| Weighted average  interest rate               |       | 5.2                                             | %          |                                         |       | 5.2 | % |   |   |
| Weighted average maturity (mos.)              |       | 19.3                                            |       |                                         |       | 20.8 |   |   |   |

 

----

* The maturity ofasset-backed, auction rate securities for purposes of this calculation isconsistent with management’s view as to the availability of such securities tofund current operating activities.

37

----

We are also exposed tointerest rate risk with respect to our convertible senior notes due November15, 2026. The fair value of our convertible senior notes may be adverselyimpacted due to a rise in interest rates. In general, securities with longermaturities are subject to greater interest rate risk than those with shortermaturities. Our convertible senior notes bear interest at a fixed rate of 3.25%per year until November 15, 2011, and 3.50% interest per year thereafter. As ofDecember 31, 2006 and March 31, 2007, the carrying value of our convertiblesenior notes was $258.8 million and the fair value was approximately $277.3million and $281.3 million, respectively, which was based on the quoted marketprice.

*Equity Risk*

Weare exposed to equity price risk as it relates to changes in the market valueof our equity investments and call options. We invest in equity instruments ofpublic and private companies for operational and strategic purposes. Inconnection with the issuance of our convertible senior notes, we purchased calloptions to cover approximately 28.4 million shares of our common stock, subjectto adjustment in certain circumstances, which is the number of sharesunderlying the notes. These securities are subject to significant fluctuationsin fair market value due to volatility of the stock market and the industriesin which the companies operate. We typically do not attempt to reduce oreliminate our market exposure in these equity instruments.

The following tablepresents the carrying value and fair value of our financial instruments subjectto equity risk as of December 31, 2006 and March 31, 2007:
| ** **                                       | ** ** | **As of December 31, 2006** | ** ** | **As of March 31, 2007** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                       | ** ** | ** **                                      | ** ** | **Estimated**                                | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                       | ** ** | **Carrying**                                    | ** ** | **Fair**                                     | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                       | ** ** | **Amount**                                      | ** ** | **Value**                                    | ** ** | **Amount** | ** ** | **Value** | ** ** |
| ** **                                       | ** ** | **(dollars in thousands)**            | ** ** |
| Investments in other  companies for which it is: |       |                                            |       |                                         |       |   |   |   |   |
| Practicable to  estimate fair value              |       | $                                               | 48,325     |                                         | $          | 48,325 |   | $ | 44,961 |   | $ | 44,961 |   |
| Not practicable  to estimate fair value          |       | 11,000                                          |       | —                                       |       | 11,000 |   | — |   |
| Call options                                     |       | 47,162                                          |       | 58,361                                       |       | 47,162 |   | 58,960 |   |
|                                                  |            |                                                 |            |                                              |            |  |  |  |  |  |  |  |  |

 

**Item4. Controls and Procedures.**

**Evaluation of Disclosure Controlsand Procedures**

Pursuantto Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “ExchangeAct”), EarthLink’s management, including EarthLink’s Chief Executive Officerand Chief Financial Officer, evaluated the effectiveness of EarthLink’sdisclosure controls and procedures (as defined under Rule 13a-15(e) underthe Exchange Act) as of the end of the period covered by this report. Basedupon that evaluation, EarthLink’s Chief Executive Officer and Chief FinancialOfficer concluded that EarthLink’s 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 EarthLink’s ChiefExecutive Officer and Chief Financial Officer, to allow timely decisionsregarding required disclosure.

**Changesin Internal Control over Financial Reporting**

Therewere no changes in our internal control over financial reporting during thethree months ended March 31, 2007 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

38

----

**Part II**

**Item 1.    Legal Proceedings.**

EarthLink is aparty to various legal proceedings that are ordinary and incidental to itsbusiness. Management does not expect that any currently pending legalproceedings will have a material adverse effect on EarthLink’s results of operationsor financial position.

**Item 1A. Risk Factors.**

There were no material changes from the risk factors disclosed inEarthLink’s Annual Report on Form 10-K for the year ended December 31, 2006, asamended.

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

None.

**Item 5.    Other Information.**

None.

**Item 6.    Exhibits.**
| (a)    | Exhibits. |    The  following exhibits are filed as part of this report:                                                                                                        |
|--------|-----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |      | ** **                                                                                                                                                                    |
|   | 31.1      | Certification of Chief Executive Officer pursuant to  Securities Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|   |      |                                                                                                                                                                          |
|   | 31.2      | Certification of Chief Financial Officer pursuant to  Securities Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|   |      |                                                                                                                                                                          |
|   | 32.1      | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                          |
|   |      |                                                                                                                                                                          |
|   | 32.2      | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                          |

 

39

----

#### **SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|        |        | EARTHLINK, INC.                                        |
|--------|-------------|--------------------------------------------------------|
|   |        |                                                   |
|   |        |                                                   |
| Date:  | May 7, 2007 |                                                   |   | /s/ MICHAEL C. LUNSFORD |
|   |        | Michael C. Lunsford, Interim Chief Executive   Officer |
|   |        |                                                   |
|   |        |                                                   |
| Date:  | May 7, 2007 |                                                   |   | /s/ KEVIN M. DOTTS |
|   |        | Kevin M. Dotts,  Chief Financial Officer               |
|   |        | (principal  financial and accounting officer)          |

 

40

----