**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

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

**Forthe fiscal year ended December 31, 2006**

**OR**

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

**Forthe transition period from              to              **

**CommissionFile Number: 001-15605**

**EARTHLINK,INC.**

(Exact name of registrantas specified in its charter)

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

 

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

(Address of Principal ExecutiveOffices, Including Zip Code)

**(404) 815-0770**

(Registrant’s telephonenumber, including area code)

Securities registeredpursuant to Section 12(b) of the Act: None

Securities registeredpursuant to Section 12(g) of the Act: Common Stock, $.01 par value

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Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes x   No o

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o   No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation of S-Kis not contained herein, and will not be contained, to the best of theregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. 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 ExchangeAct):

Large acceleratedfiler x      Acceleratedfiler o      Non-accelerated filer o

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

The aggregate market valueof the registrant’s outstanding common stock held by non-affiliates of theregistrant on June 30, 2006 was $1,107.9 million.

As of February 28,2007, 123,214,658 shares of common stock were outstanding.

Portions of the Proxy Statement to be filed with theSecurities and Exchange Commission and to be used in connection with the AnnualMeeting of Stockholders to be held on May 1, 2007 are incorporated byreference in Part III of this Form 10-K.

 

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**EARTHLINK, INC.**

**Annual Report on Form 10-KFor the Year Ended December 31, 2006**

**TABLEOF CONTENTS**

| **PART I**   |
|-------------------|
| Item 1.           |   | Business |   | 3 |   |
| Item 1A.          |   | Risk Factors |   | 15 |   |
| Item 1B.          |   | Unresolved Staff Comments |   | 30 |   |
| Item 2.           |   | Properties |   | 30 |   |
| Item 3.           |   | Legal Proceedings |   | 31 |   |
| Item 4.           |   | Submission of Matters to a  Vote of Security Holders |   | 31 |   |
| **PART II**  |
| Item 5.           |   | Market for Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities |   | 31 |   |
| Item 6.           |   | Selected Financial Data |   | 33 |   |
| Item 7.           |   | Management’s Discussion and  Analysis of Financial Condition and Results of Operation |   | 34 |   |
| Item 7A.          |   | Quantitative and Qualitative  Disclosures about Market Risk |   | 61 |   |
| Item 8.           |   | Financial Statements and Supplementary  Data |   | 63 |   |
| Item 9.           |   | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure |   | 102 |   |
| Item 9A.          |   | Controls and Procedures |   | 102 |   |
| Item 9B.          |   | Other Information |   | 103 |   |
| **PART III** |
| Item 10.          |   | Directors, Executive  Officers and Corporate Governance |   | 103 |   |
| Item 11.          |   | Executive Compensation |   | 104 |   |
| Item 12.          |   | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters |   | 104 |   |
| Item 13.          |   | Certain Relationships and  Related Transactions, and Director Independence |   | 105 |   |
| Item 14.          |   | Principal Accounting Fees  and Services |   | 105 |   |
| **PART IV**  |
| Item 15.          |   | Exhibits, Financial Statement  Schedules |   | 105 |   |
| **SIGNATURES**    |   | 111 |   |
| **EXHIBIT INDEX** |   | E-1 |   |
|                   |  |  |  |  |  |  |

 

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**FORWARD-LOOKINGSTATEMENTS**

Certain statements in thisReport on Form 10-K are forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995, Section 27Aof the Securities Act of 1933, and Section 21E of the Securities ExchangeAct of 1934. The words “estimate,” “plan,” “intend,” “expect,” “anticipate,” “believe”and similar expressions are intended to identify forward-looking statements.These forward-looking statements are found at various places throughout thisreport. EarthLink, Inc. disclaims any intention or obligation to update orrevise any forward-looking statements, whether as a result of new information,future events or otherwise. Although EarthLink, Inc. believes that itsexpectations are based on reasonable assumptions, it can give no assurance thatits targets and goals will be achieved. Important factors that could causeactual results to differ from estimates or projections contained in theforward-looking statements are described under “Risk Factors” in Item 1A of Part Iand under “Safe Harbor Statement” in Item 7 of Part II.

**PART I**

**Item 1.**                        Business.

**Overview**

EarthLink, Inc. is a total communicationsprovider, providing integrated communication services and related value-addedservices to individual consumers and business customers utilizing InternetProtocol, or IP, based technologies. Our core service offerings include dial-upand wireline broadband Internet access services and value-added services. Ourgrowth initiatives include IP-based voice services, municipal wirelessbroadband services and services for business customers.

We also have a joint venture with SK Telecom Co., Ltd.(“SK Telecom”), HELIO. HELIO is a non-facilities-based mobile virtual networkoperator (MVNO) offering mobile communications services and handsets toconsumers in the U.S. HELIO was formed in March 2005 and began offeringits products and services during April 2006.

Our corporate offices arelocated at 1375 Peachtree St., Atlanta, Georgia 30309, and our telephone numberat that location is (404) 815 0770.

**Business Strategy**

Our business strategy isto generate profits from our existing core access services and to reinvest cashgenerated from these services in our various growth initiatives with theobjective of generating company-wide revenue growth and earnings growth infuture periods; to continue to expand our presence in growth markets, such asVoice over Internet Protocol (“VoIP”) services, municipal wireless broadbandservices and business services; to support our HELIO joint venture with SKTelecom; and to market high-quality, differentiated products and services.

*Generate profitsfrom our existing core access services to fund investments in our growthinitiatives*

Our core access services include dial-up access,wireline broadband access and value-added services. We believe the mostimportant factor in continuing to be able to generate profits from our coreaccess services is to manage the return on our subscriber acquisition costs. Wemanage these costs primarily by controlling the amount of sales and marketingexpenses reinvested in these core access services. Our ability to generateprofits from our core access services is instrumental to our ability to fundinvestments in our growth initiatives. Other factors we believe are importantare as follows:

*Managingthe rate of decline of our premium-priced narrowband access service.*   Themarket for traditional, premium dial-up services has been shrinking ascustomers move to broadband access services 

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and to value-priced accessservices. As a result, our premium narrowband subscriber base and revenues havebeen decreasing, and we expect this trend to continue during 2007. We willcontinue to seek to identify opportunities to add new subscribers throughproduct innovation and effective sales and marketing. We also seek to reducechurn and “up-sell” customers to our high-speed Internet, voice, wireless orvalue-added services.

*Improvingor maintaining operating margins.*   We are focusedon delivering our core services more cost effectively by capitalizing on thecontinuing decline in telecommunications costs, leveraging the benefits ofscale throughout our business, reducing and more efficiently handling thenumber of calls to contact centers, managing cost effective outsourcingopportunities and streamlining our internal processes and operations. Weleverage our national footprint by continuing to migrate customers to lowercost telecommunications networks, utilizing volume discounts and managing ournetwork to increase its efficiency. We are also focused on improving ourmarketing effectiveness and utilizing cost effective distribution channels. Weplan to continue to manage operating expenses, and to leverage our infrastructureas we seek to expand our service offerings.

*Continuingto grow our value-priced narrowband access service.*   Themarket for value priced narrowband access services has grown over the pastseveral years by attracting households new to the Internet or current Internetusers interested in reducing their cost of Internet access. We providevalue-priced Internet access services through our PeoplePC Online offering. Weanticipate the market for value-priced narrowband access will continue to grow,and we expect to continue to devote sales and marketing resources to market thePeoplePC Online offering to increase our value priced narrowband customer base.

*Pursuing new partnershipsand relationships with wholesale broadband providers.*   Broadband,or high-speed, access is growing and the estimated number of households withbroadband access surpassed the number of households with dial-up connectionsduring 2006. We provide wireline high-speed Internet access services in marketsthroughout the U.S. and have established a national broadband footprint viamultiple wholesale vendors, enabling us to offer digital subscriber line (“DSL”),cable and/or satellite broadband services in multiple markets throughout theU.S. We will continue our efforts to expand our broadband footprint by pursuingnew partnerships and relationships with wholesale broadband providers.

*Continue to expandour presence in growth markets*

We will continue to introduce new products andservices to enhance our competitive position with the objective of generatingadditional revenues and profits. The communications market is characterized byintense competition and changing industry and regulatory standards. In order tobe successful, we must adapt to this ever changing market to delivercompelling, competitive and useful services to consumers and businesses. Sincethe inception of our business, we have expanded from a traditional dial-upservice provider to a total communications provider. We are currently focusedon growing our IP-based voice services, municipal wireless broadband servicesand services for business customers.

*IP-basedvoice.*   In late 2005 and 2006, we launchedEarthlink DSL and Home Phone Service, a new DSL and VoIP service, which usesCovad Communications Group Inc. (“Covad”) line-powered voice access that allowsus to offer consumers low-cost phone services along with high-speed Internetaccess. The service is now available in 12 markets covering approximately 10.0million households.

We are actively marketing EarthLink DSL and Home PhoneService and will expand our marketing efforts to promote these services during2007. We will also continue to invest in the development of additionalapplications and services for our IP-based voice services.

*Municipalwireless broadband.*   We are investing in wirelessbroadband access to deploy a competitive alternative to DSL and cable fordelivering broadband Internet access services. We began this initiative during2005 by winning proposals to build, own and operate wireless broadband networksfor the cities of 

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Philadelphia, Pennsylvaniaand Anaheim, California. During 2006 and early 2007, we completed the initialphase for these networks and began offering our municipal wireless services. Wealso launched service in Milpitas, California and New Orleans, Louisiana, andwere selected by the cities of Alexandria, Virginia; San Francisco, California;Atlanta, Georgia; Houston, Texas; and St. Petersburg, Florida to build, own andoperate municipal wireless networks in those cities.

We expect to significantly expand our wirelessbroadband footprint in 2007 with the objective of increasing our wirelessbroadband subscriber base and revenues. These initiatives may requiresignificant capital expenditures and operating costs to develop, implement andbuild wireless broadband networks in these municipalities, as well as increasedcosts to market the new services.

*Business services.*   InApril 2006, we acquired New Edge Networks (“New Edge”), a single-sourcenational provider of secure multi-site managed data networks and dedicatedInternet access for businesses and communications carriers. Also during 2006,we introduced new products for business customers, including Small Office DSLand hosted Virtual Private Networks (“VPN”). In 2007, we expect to build uponour existing portfolio of business services products, by expanding our productofferings and our distribution channels.

*Support our HELIOjoint venture with SK Telecom*

In March 2005, wecompleted the formation of HELIO, a joint venture with SK Telecom that offerswireless voice and data services to individual and business customersnationwide. Our investment in HELIO allows us the opportunity to expand andfurther diversify the markets in which we are investing to include the growingvoice and data services segment of the wireless market. HELIO launched itsfirst products and services in April 2006 and began marketing its servicesin July 2006. As of February 28, 2007, we have contributed $214.0million in cash and non-cash assets in HELIO pursuant to the Contribution andFormation Agreement, and we are committed to invest an additional $6.0 millionin August 2007. We may invest additional amounts in HELIO as they expandtheir marketing and product development efforts.

*Markethigh-quality, differentiated products and services*

We continue to focus significant resources onattracting and retaining Internet access subscribers by providing them withfast and reliable access to the Internet through a variety of platforms andservices. We are focused on deploying products and services that enhancecustomers’ Internet experiences, such as spamBlocker, Pop-Up BlockerSM, EarthLink Spyware BlockerSM, TotalAccess® with ParentalControls (including the EarthLink Kid Patrol Browser), Virus BlockerSM, ScamBlockerTM, EarthLink Protection Control Center,web browsing acceleration-related applications for value-priced and premiumnarrowband subscribers and various security products. In addition, we provide acustomizable Personal Start PageTM that lets subscribers create their own launchpoint to the Internet. We also offer premium services such as Internet callwaiting, email by-phone, additional email storage or email addresses, gaming,music downloads and a photo center. We are devoted to delivering innovativeproducts, services and applications that customers can use to enhance theirInternet experiences and believe customer adoption of these innovative toolsimproves customer loyalty and reduces churn.

We have always beencommitted to delivering high-quality customer service and technical support andhave been recognized by several industry publications and groups as a leader inproviding excellent customer service. We believe that a high level of customersatisfaction allows us to compete more effectively. We focus on the customerrelationship in an effort to increase loyalty and reduce churn. In 2007, wewill focus on increasing our advertising and other value-added servicesrevenues without negatively impacting the customer experience throughoverly-intrusive advertising techniques. To do this, we will seek to increasethe EarthLink start page utilization, seek partnerships to increase searchtraffic and revenues from non-access customers and offer new services, amongother efforts.

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**Service Offerings**

Our service offeringsinclude narrowband access over traditional telephone lines; broadband accessvia DSL, cable, satellite and wireless technologies; advertising and othervalue-added services; and web hosting.

***Narrowband Access***

*Premium Dial-up Internet Access*

Dial-up, or narrowband,access is a way to access the Internet, using a modem to dial the Internetservice provider’s node. A dial-up server type such as the Point-to-PointProtocol and TCP/IP protocols is used to establish a modem-to-modem link, whichis then routed to the Internet. Our premium dial-up access is asubscription-based service that provides customers with access to the Internetand an interactive community offering a wide variety of content, features,services, applications, tools and 24/7 customer support. Revenues primarilyconsist of monthly fees charged to customers for dial-up Internet access.

*Value Dial-up Internet Access*

We provide value-pricedInternet access services through our PeoplePC Online offering. Our valuedial-up access is a subscription-based service that provides customers accessto the Internet with limited functionality and support services at comparativelylower prices.

***Broadband Access***

*High-Speed Internet Access*

High-speed access offers ahigh speed, always on Internet connection that uses a modem to supply anInternet connection across an existing home phone line. The Internet servicedoesn’t interfere with a customer’s voice service, so there is no need for asecond phone line. We provide high-speed access services via DSL, cable and/orsatellite and offer three different speeds of service (up to 1.5Mbps, 3.0Mbpsand 6.0Mbps). Availability for these services is based on the service provider,the distance from the provider’s equipment and what is available in the area. Ourhigh-speed access service includes the same features and benefits included withour premium, dial-up access service. Broadband access revenues consist ofmonthly fees charged for high-speed, high-capacity access services includingDSL, cable, satellite and dedicated circuit services; installation fees; earlytermination fees; reactivation fees; shipping and handling fees; and equipmentrevenues associated with the sale of modems and other access devices to oursubscribers.

*Municipal Wireless Broadband*

Municipal wireless, orWi-Fi, broadband access provides a fast, low cost Internet connection. Wi-Fi isshort for wireless fidelity. It enables a person to connect his or her Wi-Fienabled computer, cell phone or personal digital assistant (PDA) to theInternet or another Wi-Fi enabled device, without a traditional “wired”connection. We partner with city governments to fund, build and deploy awireless broadband infrastructure to provide city-wide Internet access. Wi-Finodes are placed on light poles or other points of access throughout the cityto create a “mesh network.” From these nodes, wireless signals are beamedbetween points (for seamless connectivity for users), and certain nodes willtransmit Internet signals back to access towers that will “haul” the Internettraffic back (“backhaul”) to our landline network that will then transmit theInternet messages over the public Internet. These towers also will providefixed wireless broadband support to government offices, and other standardbusinesses that might be in need of this type of fixed wireless broadbandsolution.

We provide municipal Wi-Fiservice under two brands, EarthLink Wi-FiSM and Feather by EarthLink. EarthLink Wi-Fi isavailable to consumers on a monthly subscription basis that includes home-based

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connectionsand portable city-wide access. Feather by EarthLink offers free and occasionaluse access on our Wi-Fi network around the city. We currently offer municipalWi-Fi service in the cities of Philadelphia, Pennsylvania; Anaheim, California;New Orleans, Louisiana; and Milpitas, California. PeoplePC also offersmunicipal wireless service under the brand PeoplePC Wi-Fi.

*IP-Based Voice*

*EarthLinkDSL and Home Phone Service.*   EarthLink DSL andHome Phone Service is a bundle offer that includes EarthLink high-speedInternet at speeds up to 8.0Mbp and home phone service. It combines the lastmile of traditional telephone copper wiring with the advanced features of VoIPby taking advantage of the next-generation Digital Subscriber Line AccessMultiplexer, or DSLAM, technology. We offer subscription-based service undervarious plans that include features such as voicemail, call waiting, caller ID,call forwarding and E911 service. We currently offer this service in 12 marketsin the U. S. covering approximately 10.0 million households.

*EarthLink trueVoice*SM*.*   EarthLinktrueVoice is a competitive alternative to traditional phone service availableto EarthLink and non-EarthLink high-speed Internet access subscribers. EarthLinktrueVoice uses VoIP technology, which enables voice communications over theInternet through the conversion of voice signals into data packets. We offersubscription-based service under various plans that include features such asvoicemail, call waiting, caller ID, call forwarding and E911 service.

*Business Services*

We provide high-speed access,hosted VPN networks and e-commerce solutions for business customers. Inaddition, through our wholly-owned subsidiary, New Edge, we provide securemulti-site managed data networks and dedicated Internet access for businessesand communications carriers.

***Advertising and Other Value-Added Services***

We generate advertising revenues by leveraging thevalue of our customer base and user traffic; through paid placements forsearches, powered by the GoogleTM search engine; fees generated through revenuesharing arrangements with online partners whose products and services can beaccessed through our properties; commissions received from partners for thesale of partners’ services to our subscribers; and sales of advertising on ourvarious online properties, such as the Personal Start Page.

We also offer serviceswhich are incremental to our Internet access services. Our value-added servicesportfolio includes products for protection, communication, performance andentertainment, such as security, web acceleration, Internet call waiting, mailstorage, gaming, digital music and photo center, among others. We offer freeand fee-based value-added services to both subscribers and non-subscribers,focused on making the Internet a more meaningful, secure experience.

***Web Hosting***

We lease server space andprovide web hosting services to companies and individuals wishing to have anInternet or electronic commerce presence.

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**ServiceEnhancements**

*Premium Dial Up andBroadband Internet Access*

Our premium dial-upand broadband Internet access offerings include TotalAccess, our Internetaccess software. This software provides tools and email features to enhancecustomers’ Internet experiences. Key features include the followingapplications and services at no additional charge:

·       *Pop-Up Blocker*.   Pop-Up Blocker is software designed toprevent advertising windows from appearing above (pop-up) or under (pop-under)a customer’s main browser window. Pop-Up Blocker lets subscribers choosewhether or not they want to view pop-up ads and rich media (Macromedia Flash)ads.

·       *spamBlocker*.   spamBlocker is software that enablessubscribers to eliminate virtually all junk email by invoking a ‘permission-based’auto-response to spam and unrecognized email addresses.

·       *Spyware Blocker*.   Spyware installs on a computerwithout the user’s knowledge or permission and can corrupt the user’s harddrive, track online activities, steal personal information or allow strangersto access a user’s computer. EarthLink Spyware Blocker is software thatdisables all common forms of spyware found on a user’s computer and blocks newspyware before it installs.

·       *ScamBlocker*.   ScamBlocker is a consumer protectionapplication designed to help protect Internet users from “phisher” site scams. Phisherscams trick consumers into giving personal information by mimicking legitimatecorporate web sites.

·       *EarthLink Accelerator*.   EarthLink Accelerator enablesfaster surfing speeds by utilizing a web acceleration technology that reducesthe size of web pages and page elements sent to customers’ browsers.

·       *Virus Blocker*.   Email is the most common way thatcomputer viruses and other malicious software can infect a user’s computer. EarthLinkVirus Blocker scans incoming email messages and attachments for viruses and othermalicious code and removes them before they can cause infection.

·       *Parental Controls*.   EarthLink Parental Controls letparents choose how long, when and with whom their kids play on the Internet.

·       *Protection Control Center*.   EarthLink ProtectionControl Center is an integrated suite of protection and security features thatprovides a central location for customers to easily manage EarthLink AntiVirus,Spyware Blocker and EarthLink Firewall protection tools.

Other features of TotalAccess include a task panel that provides one-click access to the Internet,email and personal web space; automatic notification when newer versions ofrelevant software are available; improved email features; and enhanced searchfeatures powered by Google.

*PeoplePC Online*

PeoplePC’s access softwareis distinct from TotalAccess. The PeoplePC software has fewer features andapplications than TotalAccess and uses Smart Dialer technology that allowscustomers to access a fast and reliable connection. PeoplePC’s access softwarealso includes web accelerator technology, Internet call waiting, virusprotection, a pop-up blocker and spam filtering controls to enhance customers’Internet experiences, all of which are similar to the functionality included inTotalAccess.

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**Marketing Channels**

Our sales andmarketing efforts consist of the following programs:

*Advertising.*   Weadvertise our services in print, billboard, electronic and broadcast media. Weutilize various campaigns which may include national and regional television,radio, print and Internet ads. Our campaigns may also include sponsorships ofvarious community programs and sporting events.

*DirectMarketing.*   We promote our services directly tocustomers in the form of direct mail offers, which generally advertise a freeor discounted trial period to incent consumers to sign-up for our services, andthrough promotional inserts in packages, periodicals and newspapers.

*OriginalEquipment Manufacturers.*   We have marketingarrangements with a number of leading hardware and software manufacturers toinclude our Internet access software pre-installed on or included with theirproducts. Our hardware and software manufacturing partners include, amongnumerous others, Dell Inc. (“Dell”) and Hewlett Packard.

*Retail.*   Wemarket our products and services through retail outlets such as Best Buy, Fry’s,Circuit City, RadioShack, Staples and OfficeMax.

*Affinity Marketing.*   Ouraffinity marketing partners include many AAA clubs, AARP and several airlinesincluding Delta, Northwest and Southwest. Partners typically bundle ourInternet access software with their own goods or services to create a packagethat promotes EarthLink to potential customers.

**NetworkInfrastructure**

We provide subscribers with Internet access throughboth EarthLink-managed facilities and third-party telecommunications serviceproviders. Approximately 95% and 92% of the U.S. population can access ourpremium-priced and value-priced access services, respectively, through a localtelephone call. We have developed, maintain and operate a network ofapproximately 11,000 access numbers and maintain additional access numbers forbackup and other purposes.

We maintain a leased backbone connecting multiplecities and our technology centers. Our backbone is a networked loop ofconnections that we have acquired the right to use. Through a combination ofbackbone, peering and transit, our network is capable of supporting more thanfive gigabits per second of traffic at peak.

We have network service agreements with Level 3Communications, Inc., Verizon Communications Inc. (“Verizon”), QwestCorporation (“Qwest”) and other carriers to provide dial-up services. We haveagreements with Covad Communications Group, Inc. (“Covad”), AT&T Inc.(“AT&T”), Qwest and Verizon that allow us to provide DSL services. We alsohave agreements with Time Warner Cable, Bright House Networks and ComcastCorporation (“Comcast”) that allow us to provide broadband services over eachcompany’s cable network in substantially all Time Warner Cable and Bright HouseNetworks markets and certain Comcast markets.

New Edge’s network iscomprised of ATM/frame relay/DSL switches in central office collocations. Inaddition, New Edge has access under wholesale agreements to additional uniquecentral offices throughout the U.S. It has interconnection agreements with allmajor local exchange carriers to lease DSL and T-1 unbundled networkelements, as well as commercial services agreements with regional belloperating companies (“RBOCs”), competitive local exchange carriers (“CLECs”), andcable and satellite service providers to provide last mile connectivity ontoits network. Taken together, the network provides coverage via frame relay,DSL, and/or T-1 access to service small and medium sized businesses andcarriers alike.

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**Regulatory Environment**

*Overview*

The regulatory environmentrelating to our business and operations continues to evolve. A number oflegislative and regulatory proposals under consideration by federal, state andlocal governmental entities may lead to the repeal, modification orintroduction of laws or regulations which do or could affect our business.Significant areas of regulation for our business include generaltelecommunications industry regulation, including our Internet access servicesand our VoIP services, broadband regulation, CLEC regulation and Internettaxation.

*Telecommunications Regulation*

*Internet access.*   Neitherthe Federal Communications Commission (“FCC”) nor any other governmental agencydirectly regulates Internet service providers (“ISPs”), which are classified asproviders of unregulated “information services” rather than regulated “telecommunicationsservices” under the Communications Act. Accordingly, most regulations whichapply to telephone companies and other common carriers do not apply to us. Forexample, we are not currently required to contribute a percentage of grossrevenues from our Internet access services to universal service funds used tosupport local telephone service and advanced telecommunications services forschools, libraries and rural health care facilities.

The classification ofInternet access services as “information services” generally precludes statesfrom regulating ISPs as telecommunications carriers or imposing similar subsidyobligations. While some state commissions may continue to review potentialregulation of these services, and their legal authority and ability to do so isunlikely, Internet-related regulatory policies are continuing to develop, andit is possible that we could be exposed to regulation in the future.

We could also be affectedby any change in the ability of customers to reach our network through dial-uptelephone connections without any additional charges. The FCC has ruled thatISPs are not subject to payment of interstate interexchange access charges thatapply to telecommunications carriers that use the local network. Localtelephone companies typically assess charges on long distance companies for theuse of the local telephone network to originate and terminate long distancecalls, generally on a per-minute basis. Were there to be a regulatory changethat would result in the imposition of access charges, it would adverselyaffect us because this would substantially increase our cost of providing ISPservices.

*VoIP.*   Thecurrent regulatory environment for VoIP services is still unclear. Traditionaltelephone service historically has been subject to extensive federal and stateregulation, while Internet services generally have been subject to lessregulation. Because some elements of VoIP resemble the services provided bytraditional telephone companies and others resemble the services provided by ISPs,the VoIP industry has not fit easily within the existing framework oftelecommunications law and until recently has developed in an environmentlargely free from regulation. The FCC has not yet ruled on whether VoIPservices are “telecommunications services” or “information services.” Adetermination that the services constitute “telecommunications services” couldadversely affect us if the ruling requires additional regulation. The FCC hasalready ruled that VoIP services are exclusively interstate and has barred thestates from regulation. The FCC’s interstate ruling has been appealed infederal appellate court and if the FCC’s decision were reversed or remanded, itcould adversely affect the provision of VoIP services by allowing stateregulation.

The FCC has also begun to assert regulatory authorityover VoIP providers and is continuing to evaluate how VoIP will be regulated inthe future. In addition, while some of the existing regulation concerning VoIPis applicable to the entire industry, some rulings are limited to individualcompanies or categories of service. As a result, the application of existing rules tous and our competitors remains contentious, and the effects of futureregulatory developments are uncertain.

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Our VoIP services are notcurrently subject to all of the same regulations that apply to traditionaltelephone services. It is possible that Congress and state legislatures, aswell as the FCC, will seek to impose increased fees and administrative and regulatoryburdens on VoIP providers that could adversely affect VoIP services. The FCChas already required VoIP providers that interconnect with the public switchedtelephone network to contribute directly into the federal Universal ServiceFund, as well as to meet certain emergency service requirements (such as “E911”)that require VoIP providers to provide E911 capability to nomadic VoIP servicesand interception or wiretapping requirements, such as the CommunicationsAssistance for Law Enforcement Act. The FCC may impose additional E911requirements that could impose substantial costs on VoIP providers dependingupon technical capability requirements. The FCC is also considering imposingdisability access requirements, consumer protection requirements, numberassignment, customer privacy, and portability requirements. Such regulationscould result in substantial costs depending on the technical changes requiredto accommodate the requirements, and any increased costs could erode ourpricing advantage over competing forms of communication.

*Broadband Access*

*Broadbandservice access.*   We purchase last mile broadbandservice access from incumbent local exchange carriers (“ILECs”), CLECs andcable providers. The term “last mile” generally refers to the element oftelecommunications networks that is directly connected to homes and businesses.ILECs were previously required to make DSL-based broadband access serviceavailable on a non-discriminatory basis to ISPs like us. However, an FCC orderpublished in September 2005 eliminated the FCC’s long-standing regulatedaccess requirements. The FCC decision provides for a one-year transition periodthat ended in November 2006 for ISPs and others to negotiate accessarrangements with ILECs that no longer choose to offer wholesale broadbandtransmission services on a regulated basis. EarthLink and other parties arechallenging the FCC’s September 2005 order in federal appeals court. Ourexisting contracts with the ILECs are discussed below. However, these newlyadopted policies will affect our ability to extend or renew our currentcontracts with the ILECs at the same terms and conditions and could adverselyaffect our ability to serve customers with DSL-based broadband access if we areunable to enter into favorable agreements.

Cable providers have generally resisted granting uswholesale access to their networks to provide high-speed access services andhave generally not been required by law to make access available to ISPs likeus. In June 2005, the U.S. Supreme Court held that the FCC’s conclusionthat cable modem service is an end-to-end unregulated “information service” wasa reasonable interpretation of the Communications Act. Cable operators are thusnot required to make last mile access available to ISPs on a non-discriminatorybasis. The U.S. Supreme Court noted the FCC has jurisdiction to requirenondiscriminatory access and the FCC has a proceeding to consider whether itshould do so. The U.S. Supreme Court decision does not impact our existingagreements with cable wholesale broadband providers because contracts such asour agreement with Time Warner Cable are not predicated on regulated access. Weoffer broadband Internet access over cable to Time Warner Cable customers insubstantially all of their markets, to Bright House Networks in six of theirmarkets, and to Comcast customers in the Seattle, Boston, Houston, Memphis,Shreveport, Jackson and Minneapolis area markets.

While the long-term implications of the U.S. SupremeCourt decision and the FCC’s decisions are not certain, they may adverselyaffect our ability to sustain or grow our broadband access customer base andrevenues, and our profitability. We will continue our efforts to partner withwholesale broadband providers, including cable providers, ILECs, CLECs andwireless providers, to expand our broadband footprint and the varioustechnologies we can use in various markets to deliver our broadband services.To this end, we are attempting to gain access to a larger number of cablesystems over which we can offer our services and to demonstrate our ability todeliver meaningful volumes of customers to our DSL and cable providers bycontinuing to actively grow our retail broadband subscriber base. We continueto evaluate the 

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commercial feasibility ofemerging alternative broadband access technologies, including broadband overpower lines and other technologies, to gain further wholesale broadband accessin order to create greater retail broadband competition. We will also continueto offer products, features and services which enhance customers’ onlineexperiences and thus create consumer demand.

*Wholesalenetwork access.*   In August 2003, the FCCissued its UNE Triennial Review Order which, among other things, eliminatedline sharing over a three-year transition period. Line sharing allowed CLECssuch as Covad, one of our largest providers of wholesale broadband access, to purchasethe High Frequency Portion of the Loop (“HFPL”) from an ILEC for less than thecost of purchasing an entire line. Purchasing the HFPL as a separate UnbundledNetwork Element (“UNE”) allows Covad to offer wholesale DSL services toEarthLink on favorable rates and terms. In addition, the FCC has determinedthat ILECs are not required to offer to CLECs such as Covad fiber-based andhybrid fiber-based UNEs, meaning that as the ILECs deploy fiber throughouttheir networks, access to those consumers could be limited.

*Other.*   Inconnection with the FCC’s approval of the merger of AT&T Corp. withBellSouth Communications, the FCC required the merged entity to commit tocertain conditions, which could affect our operations. Generally, AT&T mustabide by the conditions for 42 months (June 29, 2010) although specificconditions may have longer or shorter compliance periods. The conditionsgenerally obligate AT&T to offer: all existing UNEs and collocations atcurrent rates; high-capacity loops; special access services at current ratesand on a non-discriminatory basis; wholesale ADSL transmission services atcapped rates; rate rollbacks for DS1, DS3 and Ethernet services; serviceperformance metrics for special access services; a commitment to abide by theFCC’s Net Neutrality Policy Statement; settlement-free Internet peering;divestiture of the 2.5 GHz spectrum held by BellSouth; and build-outrequirements for the 2.3 GHz band. Many of these conditions could benefit ourservices, such as our line-powered voice services and New Edge’s services, byhaving a positive impact on our costs and provisioning for EarthLink and NewEdge services. In addition, the net neutrality obligation could provide apositive long-term impact by facilitating consumer use of the Internet.

These conditions benefitour services, such as the UNE-L and collocation rate certainty and availabilitywhich benefits our line-powered voice services and New Edge; the ADSLtransmission requirement which mandates that services are offered; the specialaccess conditions which should have a positive impact on costs and provisioningtimes to enterprise customers for New Edge and EarthLink services and couldextend to our municipal wireless to the extent it uses special access forbackhaul/network; and the net neutrality obligation which provides a positivelong-term impact on constraining AT&T (and possibly other ILECs/cableoperators) from engaging in overt discrimination and provides enforceablerecourse in the event of discrimination.

*Broadband Access Agreements*

Wehave commercial agreements with varying terms with all of our significantbroadband network providers. Our largest providers of broadband connectivityare Covad and Time Warner Cable. We also do lesser amounts of business with awide variety of local, regional and other national providers. The followingtable summarizes the expiration dates for these agreements:

| **Broadband  Network Provider**            | ** ** | ** **         | ** ** | **Contract Expiration** |
|--------------------------------------------|------------|--------------------|------------|-------------------------|
| Covad Communications  Group Inc.           |       | Month-to-Month     |
| Comcast Corporation                        |       | January 2009  |
| Verizon Communications  Inc.               |       | October 2008  |
| AT&T (formerly  BellSouth Corporation) |       | December 2008 |
| Qwest Corporation                          |       | November 2009 |
| Time Warner Cable/Bright House Networks    |       | November 2010 |

 

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Our contract with Covad automatically renews on amonth-to-month basis, and the contract will continue to renew unless eitherparty elects to terminate the contract. In the event that Covad elects toterminate the contract, we would have six months to transition our customers toother providers’ networks.

We also purchase wholesaleDSL service from AT&T affiliates. While we are currently negotiating acommercial DSL agreement with AT&T, AT&T continues to provide us withwholesale DSL services under pre-existing rates, terms and conditions. Pursuantto its FCC merger commitments, AT&T will continue to offer wholesale DSL toISPs such as EarthLink until at least through June 2010.

*CLEC Regulation*

New Edge, our wholly-ownedsubsidiary, is a regulated CLEC. As such, New Edge relies on certain regulatoryrights of CLECs to provide services to business and enterprise customers,including rights to last-mile UNEs of ILECs and rights to collocate New Edgeequipment at the central offices of ILECs. As a CLEC, New Edge is also subjectto federal and state regulation of its services, and it must comply with manytelecommunications laws and regulations, such as contributing to state andfederal Universal Service Funds. In addition, New Edge makes use of the specialaccess services and DSL services of ILECs and other CLECs in order to provisionNew Edge services to its customers.

*Internet Taxation*

The Internet TaxNon-Discrimination Act, which was passed by Congress in November 2004 andsigned into law in December 2004, renewed and extended until November 2007a moratorium on taxes on Internet access and multiple, discriminatory taxes onelectronic commerce. This moratorium had previously expired in November 2003.As with the preceding Internet Tax Freedom Act, “grandfathered” states whichtaxed Internet access prior to October 1998 may continue to do so. Certainstates have enacted various taxes on Internet access and/or electroniccommerce, and selected states’ taxes are being contested on a variety of bases.However, state tax laws may not be successfully contested, and future state andfederal laws imposing taxes or other regulations on Internet access andelectronic commerce may arise, any of which could increase the cost ofproviding Internet services and could materially adversely affect our business.

**Competition**

*Internetservices.*   We operate in the Internet servicesmarket, which is extremely competitive. Current and prospective competitorsinclude many large companies that have substantially greater market presenceand greater financial, technical, marketing and other resources than we have.Competition in the market for Internet access services is likely to continueincreasing, and competition impacts the pricing of our services, sales andmarketing costs to acquire new subscribers and the number of customers thatdiscontinue using our services, or churn.

*VoIPservices.*   The market for VoIP services isemerging, intensely competitive, and characterized by rapid technologicalchange. Many traditional telecommunications carriers and cable providers offer,or have indicated that they plan to offer, VoIP services that compete with theservices we provide. Competitors for our VoIP services include establishedtelecommunications and cable companies; Internet access companies; leadingInternet companies; and companies that offer VoIP-based services as theirprimary business.

*Otherservices.**  *Wecompete for advertising revenues with major ISPs, content providers, large webpublishers, web search engine and portal companies, Internet advertisingproviders, content aggregation companies, social-networking web sites, andvarious other companies that facilitate Internet advertising. Competition inthe market for advertising services may impact the rates we charge.

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While the personal webhosting business is fragmented, a number of significant companies, includingYahoo!, currently compete actively for these users. In addition, the personalweb-hosting industry is very application specific, with many of the competitorsfocusing on specific applications, such as photo sharing, to generateadditional users.

**Proprietary Rights**

We rely on a combinationof copyright, trademark, patent and trade secret laws and contractualrestrictions to establish and protect technology and proprietary rights andinformation. We require employees and consultants and, when possible, suppliersand distributors to sign confidentiality agreements. From time to time, thirdparties have alleged that certain of our trademarks and technologies infringeon their intellectual property rights. To date, none of these claims has had anadverse effect on our ability to market and sell our services.

**Employees**

As of December 31,2006, we employed 2,210 permanent and temporary employees, including 496 salesand marketing personnel, 1,356 operations and customer support personnel and358 administrative personnel. None of our employees are represented by a laborunion, and we have no collective bargaining agreement.

**AvailableInformation**

We file annual, quarterly,and current reports, proxy statements, and other documents with the Securitiesand Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934,as amended. The public may read and copy any materials that we file with theSEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC20549. The public may obtain information on the operation of the PublicReference Room by calling the SEC at (202) 942-8090. Also, the SECmaintains an Internet web site that contains reports, proxy and informationstatements, and other information regarding issuers, including EarthLink, thatfile electronically with the SEC. The public can obtain any documents that wefile with the SEC at http://www.sec.gov.

We also make available free of charge on or throughour Internet web site (http://www.earthlink.net) our Annual Report on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on Form 8-K,and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) ofthe Securities Exchange Act of 1934, as amended, as well as Section 16reports filed on Forms 3, 4 and 5, as soon as reasonably practicable after weelectronically file such material with, or furnish it to, the SEC. Our Internetweb site is not meant to be incorporated by reference into this Annual Reporton Form 10-K.

We also provide a copy of our Annual Report on Form 10-Kvia mail, at no cost, upon receipt of a written request to the followingaddress:

InvestorRelationsEarthLink, Inc.1375 Peachtree StreetAtlanta, GA 30309

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**Item 1A.**                RiskFactors.

The following risk factorsand other information included in this Annual Report on Form 10-Kshould be carefully considered. The risks and uncertainties described below arenot the only ones we face. Additional risks and uncertainties not presentlyknown to us or that we currently deem immaterial also may adversely impact ourbusiness operations. If any of the following risks occur, our business,financial condition, operating results and cash flows could be materiallyadversely affected.

**Risks Related ToOur Business in General**

***We may notsuccessfully enhance existing or develop new products and services in acost-effective manner to meet customer demand in the rapidly evolving marketfor Internet, wireless and IP-based voice communications services, includingnew products and services offered in connection with our voice and municipalbroadband network growth initiatives, and we expect these growth initiativesnot to be profitable in their early stages.***

The market for Internet and telecommunicationsservices is characterized by rapidly changing technology, evolving industrystandards, changes in customer needs and frequent new service and productintroductions. We are currently focused on utilizing IP-based technologies todeliver voice services and deploying wireless networks to deliver broadbandservices, among others. Our future success will depend, in part, on our abilityto use leading technologies effectively, to continue to develop our technicalexpertise, to enhance our existing services and to develop new services thatmeet changing customer needs on a timely and cost-effective basis. We may notbe able to adapt quickly enough to changing technology, customer requirementsand industry standards. If we fail to use new technologies effectively, todevelop our technical expertise and new services, or to enhance existingservices on a timely basis, either internally or through arrangements withthird parties, our product and service offerings may fail to meet customerneeds which would adversely affect our revenues and prospects for growth.

We have spent and willcontinue to spend significant resources enhancing our existing services anddeveloping, acquiring, implementing and launching new services, such as voiceservices and wireless broadband services. We believe IP-based voice servicesand wireless broadband services represent significant growth opportunities andmay require significant investment. These investments consist of initialproduct development and infrastructure costs, followed by sales and marketingcosts to add customers who generate recurring revenues. The operating modelsfor these services are similar to the ISP operating model upon which we havebased our current core operations. Specifically, after developing an infrastructureto support the offering, we plan to invest in sales and marketing to addcustomers who generate recurring revenues, while incurring customer support andtelecommunications costs to provide the services. Losses are expected to resultin the early stages of these products’ life cycles until a sufficient amount ofcustomers are added whose recurring revenues, net of recurring costs, more thanoffset sales and marketing expenses incurred to add additional customers.

***Our service offerings may fail to be competitive withexisting and new competitors.***

*Competition for ourInternet Access Services*

The Internetservices market is extremely competitive. Current and prospective competitorsinclude many large companies that have substantially greater market presenceand greater financial, technical, marketing and other resources than we have.We compete directly or indirectly with the following categories of companies:

·       establishedonline services companies, such as Time Warner (AOL) and the Microsoft Network(MSN);

·       localand regional ISPs;

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·       freeor value-priced ISPs such as United Online;

·       nationaltelecommunications companies, such as AT&T and Verizon Communications Inc.;

·       regionalBell operating companies, such as Qwest;

·       contentcompanies, such as Yahoo! and Google, who have expanded their serviceofferings;

·       cablecompanies providing broadband access, including Comcast, Charter Communications, Inc.and Cox Communications, Inc.;

·       localand long distance telephone companies;

·       municipalitiesand other entities operating municipal wireless networks, some of which arefree or subsidized;

·       wirelessInternet service providers using licensed or unlicensed spectrum;

·       satelliteand fixed wireless service providers offering or developing broadband Internetconnectivity;

·       electricutilities and other providers offering or planning to offer broadband Internetconnectivity over power lines; and

·       resellersproviding wireless Internet or other wireless services using infrastructuredeveloped and operated by others.

Competition is likely to continue increasing,particularly as large diversified telecommunications and media companiescontinue to provide ISP services. Diversified competitors may continue tobundle other content, services and products with Internet access services,potentially placing us at a significant competitive disadvantage. The abilityto bundle services, as well as the financial strength and the benefits of scaleenjoyed by certain of these competitors, may enable them to offer services at pricesthat are below the prices at which we can offer comparable services. If wecannot compete effectively with these service providers, our revenues andgrowth may be adversely affected.

Because we operate in ahighly competitive environment, the number of subscribers we are able to addmay decline, the cost of acquiring new subscribers through our own sales andmarketing efforts may increase, and/or churn may increase. Increased churnrates indicate more customers are discontinuing services which results in adecrease in our customer base and adversely impacts revenues.

*Competition in theTelephony Market*

The market for VoIP services is emerging, intenselycompetitive, and characterized by rapid technological change. Many traditionaltelecommunications carriers and cable providers offer, or have indicated thatthey plan to offer, VoIP services that compete with the services we provide.Competitors for our VoIP services include established telecommunications andcable companies; Internet access companies including AOL and MSN; leadingInternet companies including Yahoo!, eBay and Google; and companies that offerVoIP-based services as their primary business, such as Vonage. In addition,some competitors, such as telecommunications carriers and cable providers, maybe able to bundle services and products that we do not offer with VoIPtelephony services. These services could include various forms of wirelesscommunications, voice and data services, and video services. This form ofbundling would put us at a competitive disadvantage if these providers cancombine a variety of service offerings at a single attractive price. We canprovide no assurance that our VoIP services will achieve significant consumeradoption or, even if such services do achieve consumer adoption, that our VoIPservices will generate growth in subscribers or revenues.

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Many of our current andpotential competitors for VoIP services have longer operating histories, aresubstantially larger, and have greater financial, marketing, technical, andother resources. Many also have greater name recognition and a larger installedbase of customers than us. Because of their greater resources, many current andpotential competitors may be able to lower their prices substantially, whichcould eliminate our ability to offer price-competitive services. As a result,our VoIP customer base and revenues would be adversely affected.

*Competition forOther Services*

We compete for advertising revenues with major ISPs,content providers, large web publishers, web search engine and portalcompanies, Internet advertising providers, content aggregation companies,social-networking web sites, and various other companies that facilitateInternet advertising. Many of our competitors have longer operating histories,greater name recognition, larger user bases and significantly greater financialand sales and marketing resources than us. This may allow them to devotegreater resources to the development, promotion and sale of advertisingservices.

The companies we competewith for Internet access subscribers also compete with us for subscribers tovalue-added services, such as email storage and security products. In certaincases, companies offer value-added services for free, and we can provide noassurance that our offerings will remain competitive or commercially viable.While the personal web hosting business is fragmented, a number of significantcompanies, including Yahoo!, currently compete actively for these users. Inaddition, the personal web hosting industry is very application specific, withmany of the competitors focusing on specific applications, such as photosharing, to generate additional users. We can provide no assurance that any ofthese value-added services will remain competitive or will generate customer andrevenue growth.

***Competitiveproduct, price or marketing pressures could cause us to lose existing customersto competitors (churn), or may cause us to reduce prices for our services whichcould adversely impact average revenue per user.***

Competition impacts our ability to price our servicesand retain customers. As the market for Internet access remains competitive,some providers have reduced and may continue to reduce the retail price oftheir Internet services to maintain or increase their market share, which wouldcause us to reduce, or prevent us from raising, our prices and potentiallycausing our subscriber base to decrease. We may encounter further marketpressures to migrate existing customers to lower-priced service offeringpackages; restructure service offering packages to offer more value; reduceprices; and respond to particular short-term, market-specific situations, suchas special introductory pricing or new product or service offerings. As aresult, our revenues could be adversely impacted and our business may suffer.Additionally, we may incur increased sales and marketing expenses in an effortto maintain our existing customers or to attract new customers, which wouldadversely impact our profitability.

We continue to implementplans to address churn, which is adversely affected by increased competition.Our efforts to reduce churn focus on improving the customer’s Internetexperience and enhancing service offerings. However, we can provide noassurance that our plans will be successful in mitigating the adverse impactincreased churn may have on our subscriber base and operating results. Inaddition, competitive factors outside of our control may also adversely affectfuture rates of customer churn. If we experience an increase in monthly churnrates, or if we are unable to attract new subscribers in numbers sufficient toincrease or maintain the level of our overall subscriber base, our business,financial position, results of operations and cash flows could be adverselyaffected.

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***We may beunsuccessful in making and integrating acquisitions and investments into ourbusiness, which could result in operating difficulties, losses and otheradverse consequences.***

We have acquired and invested in businesses in thepast, including the acquisition of New Edge in April 2006. We also havehistorically acquired subscriber bases from ISPs.

We expect tocontinue to evaluate and consider a wide array of potential strategictransactions that we believe may complement our current or future businessactivities, including acquisitions and dispositions of businesses,technologies, services, products and other assets. At any given time, we may beengaged in discussions or negotiations with respect to one or more of suchtransactions that may be material to our financial condition and results ofoperations. There can be no assurance that any such discussions or negotiationswill result in the consummation of any transaction. The process of integratingany acquired business or assets may create unforeseen operating difficultiesand expenditures and is itself risky. Acquisitions and investments createdifficulties or risks such as:

·       diversionof management time, as well as a shift in focus from operating the business toissues of integration and future products;

·       decliningemployee morale and retention issues resulting from changes in compensation,reporting relationships, future prospects or the direction of the business;

·       theneed to integrate each company’s accounting, management information, humanresource and other administrative systems to permit effective management, andthe lack of control if such integration is delayed or not implemented;

·       theneed to implement controls, procedures and policies appropriate for a largerpublic company at companies that, prior to acquisition, had lacked suchcontrols, procedures and policies;

·       theneed to remediate significant control deficiencies that may exist at acquiredcompanies, which, if unremediated, could result in a material weakness orsignificant deficiency in our internal control structure;

·       insome cases, the need to transition operations, users, and/or customers onto ourexisting platforms;

·       thepotential impairment of customer and other relationships as a result of anyintegration of operations;

·       thepotential unknown liabilities associated with a company we acquire or in whichwe invest; and

·       thepotential impairment of amounts capitalized as intangible assets as part of anacquisition.

Additionally, as a resultof future acquisitions or investments, we may issue additional equitysecurities, which could dilute existing shareholders’ interests. We may alsospend our cash or incur debt or contingent liabilities to complete transactionswhich could adversely affect our liquidity. Lastly, as a result of acquisitions,we would record amortization expenses related to acquired definite livedintangible assets, which would adversely affect our results of operations.

***The continueddecline of our narrowband revenues could adversely affect our profitability andadversely impact our ability to invest in our growth initiatives.***

The number of U.S. households using broadband hasgrown significantly over the last few years and is expected to continue togrow. Broadband access generally offers users faster connection and downloadspeeds than narrowband access. Pricing for broadband services, particularly forintroductory promotional periods; services bundled with cable and telephoneservices; and services with slower speeds has been declining and is approachingprices for premium narrowband services. As a result of broadband adoption, 

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the total number ofnarrowband accounts in the U.S. has declined, and industry analysts predict thetotal number of narrowband accounts will continue to decline. The decline inthe size of the narrowband market will likely continue as broadband servicesbecome more widely available at lower prices and consumer adoption of broadbandapplications, such as online video, telephony and music downloads which dependupon connections that provide significant bandwidth, increases.

Our premium-pricednarrowband service is our most profitable service offering; however, consistentwith trends in the market for narrowband access, our premium-priced narrowbandsubscriber base and revenues have been declining. We expect our premium-pricednarrowband subscriber base and revenues to continue to decline, which couldadversely affect our results of operations in the future and adversely impactour ability to invest in our growth businesses.

***We may not be ableto successfully manage the costs associated with delivering our broadbandservices, which could adversely affect our ability to grow or sustain revenuesand our profitability.***

As of December 31, 2006, subscribers for ourbroadband services comprised approximately 36% of our total customer base, andour broadband services favorably contribute to our overall average monthlyservice revenue per subscriber. However, our ability to provide these servicesprofitably is dependent upon cost-effectively purchasing wholesale broadbandaccess and managing the costs associated with delivering broadband services.

The costs associated withdelivering broadband services include recurring service costs such astelecommunications and customer support costs as well as costs incurred to addnew broadband customers, such as sales and marketing and installation andhardware costs. While we continuously evaluate cost reduction opportunitiesassociated with the delivery of broadband access services to improve ourprofitability, our overall profitability would be adversely affected if we areunable to continue to manage and reduce recurring service costs associated withthe delivery of broadband services and costs incurred to add new broadbandcustomers.

***Companies may notprovide last mile wireline broadband access to us on a wholesale basis or onterms or at prices that allow us to grow and be profitable.***

We provide our wireline broadband services tocustomers using the last mile element of telecommunications and cable companies’networks. The term “last mile” generally refers to the element of the networkthat is directly connected to homes and businesses. We have agreements withseveral network providers that allow us to use the last mile element of theirnetwork to provide high-speed Internet access services via DSL or cable. Theavailability of and charges for access with any of our network providers at theexpiration of current terms cannot be assured and may reflect legislative orregulatory as well as competitive and business factors. We cannot be certain ofrenewal or non-termination of our contracts. Our results of operations could bematerially adversely affected if we are unable to renew or extend contractswith our current network providers on acceptable terms, renew or extend currentcontracts with network providers at all, acquire similar network capacity fromother network providers, or otherwise maintain or extend our footprint.

One of our largest network providers of wholesalebroadband access is Covad, a CLEC. Covad has agreements with varying terms withmany of the ILECs; however, if Covad is unable to continue to obtain reasonableline-sharing rates due to recent legal and regulatory developments orotherwise, its wholesale broadband access services may become uneconomic or itmay cease selling wholesale broadband access services. In either event, we maybe able to use other wholesale broadband providers’ networks to continue toprovide retail broadband services. Such events may cause us to incur additionalcosts, pay increased rates for wholesale broadband access services, cause us toincrease the retail prices of our broadband 

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service offerings and/ormay cause us to discontinue providing retail DSL services, any of which wouldadversely affect our ability to compete in the market for retail broadbandaccess services.

An order adopted in 2005 by the FCC reclassifiedwireline broadband services as information services and eliminated the FCC’slong-standing non-discriminatory access requirements. While the long-termimplications of the FCC’s new policies are not certain, they may adverselyaffect our ability to sustain or grow our broadband access customer base andrevenues, and our profitability. We will continue our efforts to partner withwholesale broadband providers, including cable providers, ILECs, CLECs andwireless providers, to expand our broadband footprint and the varioustechnologies we can use in various markets to deliver our broadband services.However, we can provide no assurance that we will be successful in our efforts.

Each of ourtelecommunications vendors provides network access to some of our competitorsand could choose to grant those competitors preferential network access orpricing. Many of our telecommunications providers compete with us in the marketto provide consumer Internet access. As a result, any or all of our currenttelecommunications service providers could discontinue providing us withservice at rates acceptable to us, or at all, which could materially andadversely affect our business, financial position and results of operations.

***Our commercial andalliance arrangements may be terminated or may not be as beneficial asanticipated, which could adversely affect our ability to increase oursubscriber base.***

A significant number ofour subscribers have been generated through strategic alliances. Generally, ourstrategic alliances and marketing relationships are not exclusive. In addition,as our agreements expire or otherwise terminate, we may be unable to renew orreplace these agreements on comparable terms, or at all. Our inability tomaintain our marketing relationships or establish new marketing relationshipscould result in delays and increased costs in adding paying subscribers andadversely affect our ability to increase or sustain the size of our subscriberbase, which could, in turn, have a material adverse effect on us. The number ofcustomers we are able to add through these marketing relationships is dependenton the marketing efforts of our partners, and a significant decrease in the numberof gross subscriber additions generated through these relationships couldadversely affect the size of our customer base and revenues. During 2006, we and Embarq agreedthat our wholesale broadband contract would not be renewed following thecontract’s expiration in April 2007. During the years ended December 31,2005 and 2006, our relationship with Embarq generated more than 10% of ourtotal gross organic subscriber additions. As of December 31, 2006, ourbroadband subscriber count and total subscriber count included approximately755,000 subscribers under the marketing relationship.

***We utilizethird-parties for technical and customer support and certain billing services,and our business may suffer if our partners are unable to provide these services,cannot expand to meet our needs or terminate their relationships with us.***

Our business and financialresults depend, in part, on the availability and quality of our customersupport services and billing services. We outsource a majority of our technicaland customer support functions. As a result, we maintain only a small number ofinternal customer service and technical support personnel. We are not currentlyequipped to provide the necessary range of customer service functions in theevent that our service providers become unable or unwilling to offer theseservices to us. Our outsourced contact center service providers utilize severalinternationally geographically dispersed locations to provide us with technicaland customer support services, and as a result, our contact center serviceproviders may become subject to financial, economic, and political risks beyondour or the providers’ control, which could jeopardize their ability to delivercustomer support services. We also utilize third parties for certain billingservices. If one or more of our service providers does not provide us withquality services, or if our relationship with any of our third partiesterminates and we are unable to provide 

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thoseservices internally or identify a replacement vendor in an orderly,cost-effective and timely manner, our business, financial position and resultsof operations would suffer.

***Service interruptions or impediments could harm ourbusiness.***

We may experience service interruptions or systemfailures in the future. Any service interruption adversely affects our abilityto operate our business and could result in an immediate loss of revenues. Ifwe experience frequent or persistent system or network failures, our reputationand brand could be permanently harmed. We may make significant capitalexpenditures to increase the reliability of our systems, but these capitalexpenditures may not achieve the results we expect.

*Harmfulsoftware programs.*   Our network infrastructureand the networks of our third-party providers are vulnerable to damagingsoftware programs, such as computer viruses and worms. Certain of theseprograms have disabled the ability of computers to access the Internet,requiring users to obtain technical support in order to gain access to the Internet.Other programs have had the potential to damage or delete computer programs.The development and widespread dissemination of harmful programs has thepotential to seriously disrupt Internet usage. If Internet usage issignificantly disrupted for an extended period of time, or if the prevalence ofthese programs results in decreased residential Internet usage, our businesscould be materially and adversely impacted.

*Securitybreaches.*   We depend on the security of ournetworks and, in part, on the security of the network infrastructures of ourthird-party telecommunications service providers, our outsourced customersupport service providers and our other vendors. Unauthorized or inappropriateaccess to, or use of, our network, computer systems and services couldpotentially jeopardize the security of confidential information, includingcredit card information, of our users and of third parties. Some consumers andbusinesses have in the past used our network, services and brand names toperpetrate crimes and may do so in the future. Users or third parties mayassert claims of liability against us as a result of any failure by us toprevent these activities. Although we use security measures, there can be noassurance that the measures we take will be successfully implemented or will beeffective in preventing these activities. Further, the security measures of ourthird-party network providers, our outsourced customer support serviceproviders and our other vendors may be inadequate. These activities may subjectus to legal claims, may adversely impact our reputation, and may interfere withour ability to provide our services, all of which could have a material adverseeffect on our business, financial position and results of operations.

*Naturaldisaster or other catastrophic event.*   Ouroperations and services depend on the extent to which our computer equipmentand the computer equipment of our third-party network providers are protectedagainst damage from fire, flood, earthquakes, power loss, telecommunicationsfailures, break-ins, acts of war or terrorism and similar events. We have threetechnology centers at various locations in the U.S. which contain a significantportion of our computer and electronic equipment. These technology centers hostand manage Internet content, email, web hosting and authentication applicationsand services. Despite precautions taken by us and our third-party networkproviders, over which we have no control, a natural disaster or otherunanticipated problem that impacts one of our locations or our third-partyproviders’ networks could cause interruptions in the services that we provide.Such interruptions in our services could have a material adverse effect on ourability to provide Internet services to our subscribers and, in turn, on ourbusiness, financial condition and results of operations.

*Network infrastructure.*   Thesuccess of our business depends on the capacity, reliability and security ofour network infrastructure, including that of our third-partytelecommunications providers’ networks. We may be required to expand andimprove our infrastructure and/or purchase additional capacity from third-partyproviders to meet the needs of an increasing number of subscribers and toaccommodate the expanding amount and type of information our customerscommunicate over the Internet. Such expansion and improvement may requiresubstantial financial, operational and managerial resources.

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***Government regulations could force us to change ourbusiness practices.***

*Internetaccess.*   Changes in the regulatory environmentregarding the Internet could cause our revenues to decrease and/or our costs toincrease. Currently, ISPs as “information service” providers, are largelyunregulated, other than with respect to regulations that govern businessesgenerally, such as regulations related to consumer protection. As informationservices and telecommunications services converge, however, the FCC may seek toimpose additional regulations, including the imposition of regulatory fees suchas Universal Service Fund payments, on information service providers that couldadversely affect our business.

*VoIP.*   Thecurrent regulatory environment for VoIP services remains unclear. Our VoIPservices are not currently subject to all of the same regulations that apply totraditional telephony. It is possible that Congress and some state legislaturesmay seek to impose increased fees and administrative burdens on VoIP providers.The FCC has already required certain VoIP providers to contribute directly intothe Universal Service Fund as well as to meet various emergency servicerequirements (such as E911) and interception or wiretapping requirements, suchas the Communications Assistance for Law Enforcement Act, or CALEA. In additionthe FCC may seek to impose other traditional telephony requirements such asdisability access requirements, consumer protection requirements, numberassignment and portability requirements, and other obligations, includingadditional obligations regarding E911 and CALEA. Such regulations could resultin substantial costs depending on the technical changes required to accommodatethe requirements, and any increased costs could erode our pricing advantageover competing forms of communication and may adversely affect our business.

*CLECregulation.*   New Edge is a regulated CLEC.Telecommunications laws and regulations applicable to CLECs have been subjectto change and to reversal by the courts, and we cannot be certain that suchchanges will not continue to occur in the future. Our results of operationscould be materially, adversely affected by future changes of these legal andregulatory rights or obligations. In addition, New Edge makes use of ILECs andother CLECS. Such services are often made available by regulation. Changes insuch regulation that might curtail New Edge’s access to such services or thatwould otherwise negatively impact the rates or conditions of such services forNew Edge could have a material adverse impact on our operations.

*Tax.*   Thetax treatment of activities on or relating to the Internet is currentlyunsettled. A number of proposals have been made at the federal, state and locallevels and by foreign governments that could impose taxes on the online sale ofgoods and services and other Internet activities. Future federal and state lawsimposing taxes on the provision of goods and services over the Internet couldmake it substantially more expensive to operate our business.

*Other.*   Ourbusiness is also subject to a variety of other U.S. laws and regulations thatcould subject us to liabilities, claims or other remedies, such as lawsrelating to bulk email or “spam,” access to various types of content by minors,anti-spyware initiatives, encryption, data protection, data retention, securitybreaches and consumer protection. Compliance with these laws and regulations iscomplex and may require significant costs. In addition, the regulatoryframework relating to Internet services is evolving and both the federalgovernment and states from time to time pass legislation that impacts ourbusiness. It is likely that additional laws and regulations will be adoptedthat would affect our business. We cannot predict the impact future regulatorychanges or developments may have on our business, financial condition, resultsof operations or cash flows. The enactment of any additional laws orregulations, increased enforcement activity of existing laws and regulations,or claims by individuals could significantly impact our costs or the manner in whichwe conduct business, all of which could adversely impact our results ofoperations and cause our business to suffer.

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***Changes in, orinterpretations of, laws regarding consumer protection could subject us toliability or cause us to change our practices.***

Consumer protection lawsand enforcement actions regarding advertising and user privacy, especiallyrelating to children, are becoming more prevalent. The Federal Trade Commission(“FTC”) and some state Attorney General offices have conducted investigationsinto the privacy practices of companies that collect information aboutindividuals on the Internet. The FTC has also investigated Internet serviceproviders in connection with marketing, billing, customer retention,cancellation and disclosure practices. Various state agencies as well asindividuals have also asserted claims against, or instituted inquiries into,Internet service providers in connection with marketing, billing, customerretention, cancellation and disclosure practices. Although we believe that wecomply with applicable consumer protection laws, we cannot assure you that ourservices and business practices, or changes to our services and businesspractices, will not subject us to claims and liability by private parties, theFTC or other governmental agencies.

***We may not be ableto protect our proprietary technologies or successfully defend infringementclaims and may be required to enter licensing arrangements on unfavorableterms.***

We regard our trademarks, service marks, copyrights,patents, trade secrets, proprietary technologies, domain names and similarintellectual property as critical to our success. We rely on trademark,copyright and patent law; trade secret protection; and confidentialityagreements with our employees, customers, partners and others to protect ourproprietary rights. The efforts we have taken to protect our proprietary rightsmay not be sufficient or effective. Third parties may infringe ormisappropriate our copyrights, trademarks, patents and similar proprietaryrights. If we are unable to protect our proprietary rights from unauthorizeduse, our brand image may be harmed and our business may suffer.

The protection of ourtrademarks, service marks, copyrights, patents, trade secrets, domain names,proprietary technologies and intellectual property may require the expenditureof significant financial and managerial resources. Moreover, we can not becertain the steps we take to protect these assets will adequately protect ourrights or that others will not independently develop or otherwise acquireequivalent or superior technology or other intellectual property rights. Suchevents could substantially diminish the value of our technology and propertywhich could adversely affect our business.

***We may be accusedof infringing upon the intellectual property rights of third parties, which iscostly to defend and could limit our ability to use certain technologies in thefuture.***

Internet, technology and media companies often possessa significant number of patents. Further, many of these companies and otherparties are actively developing or purchasing Internet-related technologies. Webelieve that these parties will continue to take steps to protect thesetechnologies, including, but not limited to, seeking patent protection. As aresult, disputes regarding the ownership of technologies and rights associatedwith online business are likely to continue to arise in the future.

From time to time, thirdparties have alleged that we infringed on their proprietary rights. We havebeen subject to, and expect to continue to be subject to, claims and legalproceedings regarding alleged infringement by us of the patents, trademarks andother intellectual property rights of third parties. None of these claims hashad an adverse effect on our ability to market and sell and support ourInternet access services. As we expand our business and develop new technologies,products and services, we may become increasingly subject to intellectualproperty infringement claims. Such claims, whether or not meritorious, mayresult in the expenditure of significant financial and managerial resources,injunctions against us or the imposition of damages that we must pay. We mayneed to obtain licenses from third parties who allege that we have infringedtheir rights, but such licenses may not be available on acceptable terms or atall. In addition, we may not be able to obtain or utilize on terms which areacceptable to us, or at all, licenses or other rights with respect tointellectual property we do not own in providing and supporting our service 

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offerings.Any of these could result in increases in operating expenses or could limit orreduce the number of our service offerings.

***If we are unable to successfully defend against legalactions, we could face substantial liabilities.***

We are currently a partyto various legal actions, including class action litigation. Defending againstthese lawsuits may involve significant expense and diversion of management’sattention and resources from other matters. Due to the inherent uncertaintiesof litigation, we may not prevail in these actions. In addition, our ongoingoperations may subject us to litigation risks and costs in the future. Both thecosts of defending lawsuits and any settlements or judgments against us couldmaterially and adversely affect our operating expenses and liquidity.

***Our businessdepends on the continued development of effective business support systems,processes and personnel.***

In recent years, we have expanded our serviceofferings and will endeavor to expand further by offering new products andservices to maintain and increase our customer base. Such expansion increasesthe complexity of our business and places a significant strain on ourmanagement, operations, financial resources, and internal financial control andreporting functions. Our current and planned personnel, systems, procedures andcontrols may not be adequate to support and effectively manage our growthinitiatives which would strain our management, operational and financialresources. Consequently, we may not be able to hire, train, retain, motivateand manage required personnel and develop, implement, and manage adequatesystems, procedures and controls to support new products and services, whichmay limit our growth potential and adversely affect our business.

Additionally, our businessrelies on our financial reporting and data systems, including our billingsystems, which have grown increasingly complex due to the diversification andcomplexity of our business. Our ability to operate our business efficientlydepends on these systems, and if we are unable to modify or develop new systemsto support our growth initiatives, our business will be adversely affected.

***We may be unable tohire and retain sufficient qualified personnel, and the loss of any of our keyexecutive officers could adversely affect us.***

We believe that oursuccess will depend in large part on our ability to attract and retain highlyskilled, knowledgeable, sophisticated and qualified managerial, professionaland technical personnel. We may have limited or no experience in new productand service initiatives, making it more important to find qualified personnel.We have experienced significant competition in attracting and retainingpersonnel who possess the skills that we are seeking. As a result of thiscompetition, we may experience a shortage of qualified personnel. In addition,the loss of any of our key executives, including the recent death of Charles G.Betty, our former Chief Executive Officer, could have a material adverse effecton us. Mr. Betty was very experienced in the industry and had a longhistory with EarthLink. His loss could have a negative impact on our results ofoperations or on our ability to carry out our growth initiatives.

**Additional Risksrelated to Our Growth Initiatives**

***We may not besuccessful in entering into arrangements with municipalities to build out andoperate municipal wireless broadband networks and we may not obtain asufficient number of subscribers to generate the returns anticipated on ourinvestments to construct and deploy municipal wireless broadband networks.***

An important element ofour business strategy is to deploy competitive alternatives to DSL and cablefor delivering broadband Internet access services, reflected in our municipalwireless initiative. We have begun to operate networks in the cities ofPhiladelphia, Pennsylvania; Anaheim, California; Milpitas, California; and NewOrleans, Louisiana. We are pursuing additional similar arrangements with other 

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municipalities,but there is no assurance that we will be successful in these efforts. Themunicipal network business is a largely untested business model and we may notobtain the subscriber levels required to earn a return on our investment inthis business. The success of our municipal wireless service depends on growthin the number of municipal wireless broadband users, which in part depends onwider public acceptance of this service. Our municipal wireless broadbandservices may not achieve consumer adoption or, even if these services doachieve consumer adoption, we may not be able generate growth in subscribers orrevenue. In addition, this initiative may result in significant capitalexpenditures in future periods to develop, implement and build wirelessbroadband networks in various municipalities, and we may not generate thereturns anticipated on the capital expenditures and operating losses that maybe incurred in this effort.

***Municipal wirelessnetworks may not perform as expected or may result in unanticipated costs,which could increase our churn and our cost of providing services.***

Municipal wireless networksmay not perform as we expect, and therefore we may not be able to deliver thequality or types of service we expect. We also may discover unanticipated costsassociated with deploying and maintaining our network or delivering services wemust offer in order to remain competitive. These risks could reduce oursubscriber growth, increase our costs of providing services or increase oursubscriber churn.

***We may experiencedifficulties in constructing, upgrading and maintaining our municipal wirelessnetwork, which could adversely affect customer satisfaction, increasesubscriber churn and reduce our revenues.***

The success of our municipal wireless broadbandinitiative depends on developing and providing services that give subscribers ahigh quality experience. We expect to expend significant resources inconstructing, maintaining and improving our network. Additionally, as thenumber of subscribers using our network increases, as the usage habits of oursubscribers change and as we increase our service offerings, we may need toupgrade our network to maintain or improve the quality of our services. If wedo not successfully implement upgrades to our network, the quality of ourservices may decline and the rate of our subscriber churn may increase.

We may experience quality deficiencies, cost overrunsand delays with our construction, maintenance and upgrade projects includingthe portions of those projects not within our control. The construction of ournetwork requires permits and approvals from numerous governmental bodies,including municipalities and zoning boards. Such entities often limit theexpansion of transmission towers and other construction necessary for ournetwork. Failure to receive approvals in a timely fashion can delay systemrollouts and raise the cost of completing construction projects. In addition,we typically are required to obtain rights from land, building and tower ownersto install the antennas and other equipment that provide our service to oursubscribers. We may not be able to obtain, on terms acceptable to us or at all,the rights necessary to construct our network and expand our services.

We also may facechallenges in managing and operating our network. These challenges includeensuring the availability of subscriber equipment that is compatible with ournetwork and managing sales, advertising, customer support, billing andcollection functions of our business. We also must provide reliable networkservice that meets our subscribers’ expectations. There is no industryprecedent for the operation of a network of this type over a large municipalarea and we may experience technological or other difficulties that we do notcurrently expect. Our failure in any of these areas could adversely affectcustomer satisfaction, increase subscriber churn, increase our costs, decreaseour revenues and otherwise have a material adverse effect on our business,prospects, financial condition and results of operations.

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***The market for VoIPservices may not develop as anticipated, which would adversely affect ourability to execute our voice strategy.***

The success of our VoIP service depends on growth inthe number of VoIP users, which in part depends on wider public acceptance ofVoIP telephony. The VoIP communications medium is still in its growth stages.Potential new users may view VoIP as unattractive relative to traditionaltelephone services for a number of reasons, including the perception that theprice advantage for VoIP is insufficient to justify the perceivedinconvenience.

We have experienced lossesin connection with these services due to the costs of developing and operatingthem. It is likely we will continue to expend significant resources developing,enhancing, operating and marketing these services. We expect these services tocontinue to adversely impact our profitability, at least in the near term. Ifour VoIP services are not commercially successful we will continue to incuroperating losses in connection with these services, which would negativelyimpact our financial condition and results of operations.

***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.***

Certain aspects ofour service are not the same as traditional telephone service. Our continuedgrowth is dependent on the adoption of our services by mainstream customers, sothese differences are becoming increasingly important. For example:

·       Bothour new E911 and emergency calling services are different, in significantrespects, from the 911 service associated with traditional wireline andwireless telephone providers and, in certain cases, with other VoIP providers.

·       Ourcustomers may experience lower call quality than they are used to fromtraditional wireline telephone companies, including static, echoes and delaysin transmissions.

·       Ourcustomers may experience higher dropped-call rates than they are used to fromtraditional wireline telephone companies.

·       Customerswho obtain new phone numbers from us do not appear in the phone book and theirphone numbers are not available through directory assistance services offeredby traditional telephone companies.

·       Ourcustomers cannot accept collect calls.

·       OurVoIP service requires an operative broadband connection.

In the event of a power loss or Internet accessinterruption experienced by a customer, our service is interrupted. Unlike someof our competitors, we have not installed batteries at customer premises toprovide emergency power for our customers’ equipment if they lose power,although we do have backup power systems for our network equipment and serviceplatform.

If customers do not acceptthe differences between our service and traditional telephone service, they maychoose to remain with their current telephone service provider or may choose toreturn to service provided by traditional telephone companies.

***Our E911 emergencyservices are different from those offered by traditional wireline telephonecompanies and may expose us to significant liability.***

Our E911 emergency service is different in significantrespects from the emergency calling services offered by traditional wirelinetelephone companies. In each case, those differences may cause significantdelays, or even failures, in callers’ receipt of the emergency assistance theyneed. If one of our customers 

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experiences a broadband orpower outage, or if a network failure were to occur, the customer will not beable to reach an emergency services provider. In addition, we rely on customersof our trueVoice VoIP service to register their location with us so thatemergency services can be sent to the correct location. If they move theirservice without updating us and are unable to verbally communicate with anemergency operator, then they will not receive necessary emergency services. Delaysor failures in receiving emergency services can be catastrophic.

While traditional phonecompanies may also experience problems in providing emergency calling services,they are covered by legislation that significantly limits their liability forfailures of emergency calling services and we are not. This liability could besubstantial. In addition, we have lost, and may in the future lose, existingand prospective customers because of the limitations inherent in our emergencycalling services. Any of these factors could cause us to lose revenues, incurgreater expenses or cause our reputation or financial results to suffer.

***Our ability toprovide our VoIP service is dependent upon third-party facilities andequipment, the failure of which could cause delays or interruptions of ourservice, damage our reputation, cause us to lose customers and limit ourgrowth.***

The success of our VoIPservice depends on our ability to provide quality and reliable service, whichis in part dependent upon the proper functioning of facilities and equipmentowned and operated by third parties and is, therefore, beyond our control.Unlike traditional wireline telephone service or wireless service, our servicerequires our customers to have an operative broadband Internet connection andan electrical power supply, which are provided by the customer’s Internetservice provider, which may or may not be us, and electric utility company,respectively. The quality of some broadband Internet connections may be toopoor for customers to use our services properly. In addition, if there is anyinterruption to a customer’s broadband Internet service or electrical powersupply, that customer will be unable to make or receive calls, including emergencycalls, using our service. We also outsource several of our network functions tothird-party providers. For example, we outsource the maintenance of ourregional data connection points, which are the facilities at which our networkinterconnects with the public switched telephone network. If our third-partyservice providers fail to maintain these facilities properly, or fail torespond quickly to problems, our customers may experience serviceinterruptions. Our customers have experienced such interruptions in the pastand will experience interruptions in the future. In addition, our new E911service is currently dependent upon several third-party providers.Interruptions in service from these vendors could cause failures in ourcustomers’ access to E911 services. Interruptions in our service caused bythird-party facilities have in the past caused and may in the future cause usto lose customers, or cause us to offer substantial customer credits, whichcould adversely affect our revenues and profitability. If interruptionsadversely affect the perceived reliability of our service, we may havedifficulty attracting new customers and our brand, reputation and growth willbe negatively impacted.

***We may not realizethe benefits 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.***

We have made equity investments in several companies,including HELIO, a joint venture with SK Telecom that offers wirelessvoice and data services to consumers in the U.S. As of February 28, 2007,we have invested an aggregate of $214.0 million of cash and non-cash assets in HELIO.HELIO will require additional funding in the future and we expect we may investadditional cash amounts in HELIO. The financing of HELIO’s operations hasadversely affected our cash position. In addition, HELIO has incurred lossesand we expect HELIO to continue to incur losses due to the start-up nature ofits operations, and we include our proportionate share of the losses of HELIOin our statements of operations, which adversely affects our earnings andearnings per share. In addition, HELIO may not be successful in implementingand marketing its wireless voice and data initiatives, and there can be no 

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assurance that theseinitiatives will be commercially successful. This would adversely affect ourfinancial position and results of operations.

HELIO operates in a highly competitive environment. HELIO’swireless business faces intense competition from other wireless providers, fromother MVNOs and from wireless hardware manufacturers such as Apple. Many ofthose competitors are major communications companies that have substantiallygreater financial, technical and marketing resources than HELIO has. Thesecompetitors also have greater name recognition and more establishedrelationships with a larger base of current and potential customers and,accordingly, HELIO may not be able to compete successfully. Companies that havethe resources to sustain losses for some time have an advantage over thosecompanies without access to these resources. We cannot assure you HELIO will beable to achieve or maintain adequate market share or revenue or competeeffectively. HELIO’s ability to compete will depend, in part, on its ability toanticipate and respond to various competitive factors affecting thetelecommunications industry.

We continue to evaluateinvestment opportunities and may make investments in the future in companiesthat offer products and services that are complementary to our offerings and incompanies that allow us to vertically integrate our business. The value of eachof our investments is subject to general economic, technological and markettrends, as well as to the operating and financial decisions of each company’smanagement team, all of which are outside of our control. In addition, thesecompanies may not gain the expected number of customers and/or generate theexpected level of revenues, and consequently, these companies may requireadditional funding, any of which could diminish the value of or dilute ourinvestment. Our current and future investments in other companies, includingour investment in the HELIO joint venture, may not provide the economic returnswe are seeking and may lose value, which would materially, adversely affect ourfinancial position and results of operations.

**Other Risks**

***Our stock price has been volatile historically and maycontinue to be volatile.***

The trading price of our common stock has been and maycontinue to be subject to fluctuations. Our stock price may fluctuate inresponse to a number of events and factors, such as quarterly variations inoperating results; announcements of technological innovations or new productsby us or our competitors; developments in our business strategy; changes infinancial estimates and recommendations by securities analysts; the operatingand stock price performance of other companies that investors may deemcomparable to us; and news reports relating to trends in the markets in whichwe operate or general economic conditions.

In addition, the stockmarket in general and the market prices for Internet-related companies inparticular, have experienced volatility that often has been unrelated to theoperating performance of such companies. These broad market and industryfluctuations may adversely affect the price of our stock, regardless of ouroperating performance. Additionally, volatility or a lack of positiveperformance in our stock price may adversely affect our ability to retain keyemployees, many of whom have been granted stock incentive awards.

***Our indebtednesscould adversely affect our financial health and limit our ability to react tochanges in our industry or to implement our strategic initiatives.***

As of December 31,2006, we had $258.8 million of indebtedness outstanding due to the issuance ofour 3.25% Convertible Senior Notes Due 2026 (the “Notes”) in November 2006.Our indebtedness could have important consequences to us. For example, itcould:

·       requireus to dedicate a substantial portion of our cash flow from operations topayments on our indebtedness, thereby reducing the availability of our cashflow to fund our business activities;

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·       limitour ability to secure additional financing to implement our strategicinitiatives;

·       increaseour vulnerability to general adverse economic and industry conditions;

·       limitour flexibility in planning for, or reacting to, changes in our business andthe industry in which we operate;

·       placeus at a disadvantage compared to our competitors that may have proportionatelyless debt; and

·       restrict us from makingstrategic acquisitions, introducing new technologies or otherwise exploitingbusiness opportunities.

***We may be unable torepurchase the Notes for cash when required by the holders, including followinga fundamental change, or to pay the cash portion of the conversion value uponconversion of any Notes by the holders.***

Holders of the Notes havethe right to require us to repurchase the Notes on November 15, 2011, November 15,2016 and November 15, 2021 or upon the occurrence of a fundamental changeprior to maturity. Moreover, upon conversion of the Notes, we are required tosettle a portion of the conversion value in cash. Any debt agreements that wemay enter into in the future may contain similar repurchase and cash settlementprovisions. We may not have sufficient funds to make the required cash paymentupon conversion or to purchase or repurchase the Notes in cash at such time orthe ability to arrange necessary financing on acceptable terms. In addition,our ability to pay cash upon conversion or to purchase or repurchase the Notesin cash may be limited by law or the terms of agreements relating to our debtoutstanding at the time. However, if we fail to repurchase or purchase theNotes or pay cash upon conversion as required by the indenture for the Notes,it would constitute an event of default under the indenture, which, in turn,would constitute an event of default under our other debt agreements, if any.In addition, the requirement to pay the fundamental change repurchase price,including the related make whole premium, may discourage a change in control ofour company.

***The convertible notes hedge and warrant transactionsmay affect the value of our common stock.***

In November 2006,in connection with the offering of our Notes, we entered into convertible notehedge transactions and warrant transactions with affiliates of UBS InvestmentBank and Banc of America Securities LLC. These transactions are expected tooffset the potential dilution upon conversion of the Notes. In connection withhedging these transactions, such affiliates of UBS Investment Bank and Banc ofAmerica Securities LLC:

·       enteredinto various over-the-counter derivative transactions with respect to ourcommon stock, and may purchase our common stock; and

·       mayenter into, or may unwind, various over-the-counter derivatives and/or purchaseor sell our common stock in secondary market transactions.

The affiliates of UBS Investment Bank and Banc ofAmerica Securities LLC party to these transactions are likely to modify theirhedge positions from time to time prior to conversion or maturity of the Notesor termination of the transactions by purchasing and selling shares of ourcommon stock, other of our securities, or other instruments they may wish touse in connection with such hedging. In addition, we intend to exercise optionswe hold under the convertible note hedge transactions whenever Notes areconverted. In order to unwind their hedge position with respect to thoseexercised options, the affiliates of UBS Investment Bank and Banc of AmericaSecurities LLC party to these transactions expect to sell shares of our commonstock in secondary market transactions or unwind various over-the-counterderivative transactions with respect to our common stock during the conversionreference period for the converted Notes.

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The effect, if any, of anyof these transactions and activities on the market price of our common stockwill depend in part on market conditions and cannot be ascertained at thistime, but any of these activities could adversely affect the value of ourcommon stock. In addition, in the event that these transactions fail to offsetall of the dilution resulting from the conversion of the Notes, the issuance ofadditional shares of our common stock as a consequence of such conversion wouldresult in some dilution to our shareholders and could adversely affect thevalue of our common stock.

***Provisions of oursecond restated certificate of incorporation, amended and restated bylaws andother elements of our capital structure could limit our share price and delay achange of management.***

Our second restatedcertificate of incorporation, amended and restated bylaws and shareholderrights plan contain provisions that could make it more difficult or evenprevent a third party from acquiring us without the approval of our incumbentboard of directors. These provisions, among other things:

·       dividethe board of directors into three classes, with members of each class to beelected in staggered three-year terms;

·       limitthe right of stockholders to call special meetings of stockholders; and

·       authorizethe board of directors to issue preferred stock in one or more series withoutany action on the part of stockholders.

These provisions couldlimit the price that investors might be willing to pay in the future for sharesof our common stock and significantly impede the ability of the holders of ourcommon stock to change management. In addition, we have adopted a rights plan,which has anti-takeover effects. The rights plan, if triggered, could causesubstantial dilution to a person or group that attempts to acquire our commonstock on terms not approved by the board of directors. Provisions andagreements that inhibit or discourage takeover attempts could reduce the marketvalue of our common stock.

**Item 1B.**               UnresolvedStaff Comments.

None.

**Item 2.**                        Properties.

Wecurrently maintain and occupy the following principal properties:

| ** **                                 | ** ** | ** **        | ** ** | **Approximate** | ** ** | **Lease**            | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------|------------|----------------------|------------|
| **Facilities**                             | ** ** | ** **        | ** ** | **Location**    | ** ** | **Square Feet** | ** ** | **Expiration** | ** ** |
| Principal  executive and corporate offices |       | Atlanta,  GA      |       |            | 328,000    |                 |       |   | 2014 |   |   |
| Operations and  corporate offices          |       | Pasadena,  CA     |       |            | 110,000    |                 |       |   | 2014 |   |   |
| Operations and  corporate offices          |       | Vancouver,  WA    |       |            | 60,000     |                 |       |   | 2012 |   |   |
| Operations and corporate  offices          |       | San Francisco, CA |       |            | 26,000     |                 |       |   | 2014 |   |   |
|                                            |            |                   |            |                 |            |                      |            |  |  |  |  |  |  |

 

Our principal executive offices are in Atlanta,Georgia. We also maintain and occupy certain other leased space for operationsand administrative purposes. Certain of our leases include scheduled base rentincreases over the respective lease terms. The total amount of base rentpayments, net of allowances and incentives, is being charged to expense usingthe straight-line method over the terms of the leases. In addition to the baserent payments, we generally pay a monthly allocation of the buildings’operating expenses. We believe we have adequate facilities to meet our futuregrowth needs.

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We have three technologycenters at various locations in the U.S. which contain computer and electronicequipment. We own one and lease two of our three technology centers. Thetechnology centers have a combined square footage of approximately 23,000 feet.Our technology centers host and manage Internet content, email, web hosting andauthentication applications and services. We may acquire additional amounts ofstorage and processing capacity in relatively small increments and,consequently, we expect our future capital expenditures for processing andstorage capacity to be largely variable to our needs.

**Item3.        Legal Proceedings.**

We are a party to variouslegal proceedings that are ordinary and incidental to our business. Managementdoes not expect that any currently pending legal proceedings will have amaterial adverse effect on our results of operations or financial position.

**Item4.        Submission of Matters to a Voteof Security Holders.**

During the quarter endedDecember 31, 2006, there were no matters submitted to a vote of security holders.

**PART II**

**Item5.**                        Market forRegistrant’s Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities. 

*Market Information*

Ourcommon stock is traded on the Nasdaq Global Market under the symbol “ELNK.”**Thefollowing table sets forth the high and low sale prices for our common stockfor the periods indicated, as reported by the Nasdaq Global Market.

| ** **                                     | ** ** | **EarthLink, Inc.** | ** ** |
|------------------------------------------------|------------|--------------------------|------------|
| ** **                                     | ** ** | **High**                 | ** ** | **Low** | ** ** |
| **YEAR ENDED DECEMBER 31,  2005**         | ** ** | ** **               | ** ** | ** ** | ** ** |
| First Quarter                                  |       | $                        | 11.77      |   | $ | 8.11 |   |
| Second Quarter                                 |       | 10.72                    |       | 8.32 |   |
| Third Quarter                                  |       | 10.75                    |       | 8.65 |   |
| Fourth Quarter                                 |       | 12.06                    |       | 10.07 |   |
| **Year  Ended December 31, 2006**         | ** ** | ** **               | ** ** | ** ** | ** ** |
| First Quarter                                  |       | $                        | 12.21      |   | $ | 8.67 |   |
| Second Quarter                                 |       | 10.00                    |       | 7.77 |   |
| Third Quarter                                  |       | 8.81                     |       | 6.82 |   |
| Fourth Quarter                                 |       | 7.64                     |       | 6.16 |   |
| **Year  Ending December 31, 2007**        | ** ** | ** **               | ** ** | ** ** | ** ** |
| First Quarter (through February 28, 2007) | ** ** | $                        | 7.61       | ** ** | $ | 6.87 | ** ** |

 

The last reported saleprice of our common stock on the Nasdaq Global Market on February 28, 2007was $7.12 per share.

*Holders*

There were approximately 1,972holders of record of our common stock on February 28, 2007.

*Dividends*

We have never declared or paid cash dividends on ourcommon stock. We intend to retain all future earnings to finance future growth,including investing in our various growth initiatives and investing in ourjoint venture HELIO. Therefore, we do not anticipate paying any cash dividendsin the foreseeable future.

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*Performance Graph*

The following indexed linegraph indicates our total return to stockholders from January 1, 2001to December 31, 2006, as compared to the total return for the NasdaqGlobal Market and the Morgan Stanley Internet Index for the same period. Thecalculations in the graph assume that $100 was invested on January 1, 2001in our common stock and each index and also assumes dividend reinvestment.

| ** **                     | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2001**              | ** ** | **2002**              | ** ** | **2003**              | ** ** | **2004**              | ** ** | **2005**              | ** ** | **2006**              | ** ** |
| EarthLink, Inc.           |       |                  | 100.0      |                  |       |                  | 44.8       |                  |       |                  | 82.2       |                  |       |   | 94.7 |   |   |   | 91.3 |   |   |   | 58.3 |   |   |
| Nasdaq Global Market           |       |                  | 100.0      |                  |       |                  | 68.5       |                  |       |                  | 102.7      |                  |       |   | 111.5 |   |   |   | 113.1 |   |   |   | 123.8 |   |   |
| Morgan Stanley Internet  Index |       |                  | 100.0      |                  |       |                  | 57.1       |                  |       |                  | 93.8       |                  |       |   | 107.1 |   |   |   | 107.9 |   |   |   | 118.1 |   |   |

 

*Purchases of EquitySecurities by the Issuer*

Thenumber of shares repurchased and the average price paid per share for eachmonth in the three months ended December 31, 2006 were as follows:

| ** **                                | ** ** | ** **                                                                                 | ** ** | ** **          | ** ** | **Total Number of**          | ** ** | **Maximum Dollar**         | ** ** |
|-------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|---------------------|------------|----------------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **Total Number**                                                                      | ** ** | **Average**         | ** ** | **Shares Repurchased**            | ** ** | **Value that May**    | ** ** |
| ** **                                | ** ** | **of Shares**                                                                         | ** ** | **Price Paid** | ** ** | **as Part of Publicly** | ** ** | **Yet be Purchased**  | ** ** |
| **2006**                                  | ** ** | **Repurchased**                                                                            | ** ** | **per Share**  | ** ** | **Announced Program(1)**          | ** ** | **Under the Program** | ** ** |
| ** **                                | ** ** | **(in thousands, except average price paid per share)** | ** ** |
| October 1  through October 31   |       |                                                                                       | 800        |                |       |                                   | $          | 7.21                            |       |   |   | 800 |   |   |   | $ | 95,295 |   |   |
| November 1  through November 30 |       |                                                                                       | —     |                |       |                                   | —     |                            |       |   | — |   |   |   | 95,295 |   |   |
| December 1  through December 31 |       |                                                                                       | —     |                |       |                                   | —     |                            |       |   | — |   |   |   | 95,295 |   |   |
| Total                                     |       |                                                                                       | 800        |                |       |                                   |       |                            |       |   | 800 |   |   |   |   |   |   |

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(1)          Since the inception of the share repurchase program (“Repurchase Program”),the Board of Directors has authorized a total of $550.0 million for therepurchase of our common stock. The Board of Directors has also approved repurchasingcommon stock pursuant to plans under Rule 10b5-1 of the SecuritiesExchange Act of 1934, as amended. Wemay repurchase our common stock from time to time in compliance with the SEC’sregulations and other legal requirements, including through the use ofderivative transactions, and subject to market conditions and other factors.The Repurchase Program does not require us to acquire any specific number ofshares and may be terminated at any time.

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**Item 6.**                        SelectedFinancial Data. 

The following selected consolidated financial data wasderived from our consolidated financial statements. The data should be read inconjunction with “Management’s Discussion and Analysis of Financial Conditionand Results of Operation” and the consolidated financial statements and notesthereto included elsewhere in this Annual Report on Form 10-K.

| ** **                                             | ** ** | **Year Ended December 31,**                            | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2002**                                                              | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                             | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Statement of operations data:**                      | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                               |       | $                                                                     | 1,357,421  |   | $ | 1,401,930 |   | $ | 1,382,202 |   | $ | 1,290,072 |   | $ | 1,301,267 |   |
| Operating costs and  expenses                          |       | 1,517,442                                                             |       | 1,468,894 |   | 1,271,444 |   | 1,125,576 |   | 1,225,625 |   |
| Income (loss) from  operations                         |       | (160,021                                                              | )          | (66,964 | ) | 110,758 |   | 164,496 |   | 75,642 |   |
| Net income (loss)                                      |       | (148,033                                                              | )          | (62,194 | ) | 111,009 |   | 142,780 |   | 4,987 |   |
| Deductions for accretion  dividends(1)                 |       | (19,987                                                               | )          | (4,586 | ) | — |   | — |   | — |   |
| Net income (loss)  attributable to common stockholders |       | $                                                                     | (168,020   | ) | $ | (66,780 | ) | $ | 111,009 |   | $ | 142,780 |   | $ | 4,987 |   |
| Basic net income (loss)  per share                     |       | $                                                                     | (1.11      | ) | $ | (0.42 | ) | $ | 0.72 |   | $ | 1.04 |   | $ | 0.04 |   |
| Diluted net income  (loss) per share                   |       | $                                                                     | (1.11      | ) | $ | (0.42 | ) | $ | 0.70 |   | $ | 1.02 |   | $ | 0.04 |   |
| Basic weighted average  common shares outstanding      |       | 151,355                                                               |       | 157,321 |   | 154,233 |   | 137,080 |   | 128,790 |   |
| Diluted weighted average  common shares outstanding    |       | 151,355                                                               |       | 157,321 |   | 157,815 |   | 139,950 |   | 130,583 |   |
| **Cash  flow data:**                                   | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash provided by  operating  activities                |       | $                                                                     | 18,958     |   | $ | 101,728 |   | $ | 188,152 |   | $ | 188,704 |   | $ | 115,249 |   |
| Cash provided by (used  in) investing activities       |       | 3,126                                                                 |       | 25,003 |   | (69,070 | ) | (65,081 | ) | (283,064 | ) |
| Cash (used in) provided  by financing activities       |       | (24,485                                                               | )          | (88,882 | ) | (108,912 | ) | (169,239 | ) | 152,890 |   |

 

| ** **                                                     | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                     | ** ** | **2002**                              | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                     | ** ** | **(in thousands)**               | ** ** |
| **Balance sheet data:**                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                     |       | $                                     | 170,891    |   | $ | 208,740 |   | $ | 218,910 |   | $ | 173,294 |   | $ | 158,369 |   |
| Investments in marketable  securities(2)                       |       | 344,546                               |       | 279,125 |   | 312,060 |   | 248,825 |   | 236,407 |   |
| Cash and marketable  securities                                |       | 515,437                               |       | 487,865 |   | 530,970 |   | 422,119 |   | 394,776 |   |
| Total assets                                                   |       | 1,023,553                             |       | 827,020 |   | 805,450 |   | 749,149 |   | 968,039 |   |
| Long-term debt,  including long-term portion of capital leases |       | 937                                   |       | 342 |   | 287 |   | 1,067 |   | 258,984 |   |
| Total liabilities                                              |       | 331,253                               |       | 283,357 |   | 257,843 |   | 227,285 |   | 509,375 |   |
| Accumulated deficit                                            |       | (1,236,991                            | )          | (1,303,771 | ) | (1,192,762 | ) | (1,049,982 | ) | (1,044,995 | ) |
| Stockholders’ equity                                      |       | 692,300                               |       | 543,663 |   | 547,607 |   | 521,864 |   | 458,664 |   |
|                                                                |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Reflectsthe accretion of liquidation dividends on Series A and Series Bconvertible preferred stock at a 3% annual rate, compounded quarterly, and theaccretion of a dividend related to the beneficial conversion feature inaccordance with Emerging Issues Task Force (“EITF”) Issue No. 98-5. During

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2003, Sprintconverted all remaining shares of Series A and Series B convertiblepreferred stock into common stock. Consequently, there are currently no sharesof Series A or Series B convertible preferred stock outstanding andno associated dividend obligations.

(2)          Investmentsin marketable securities consist of debt securities classified asavailable-for-sale and have maturities greater than 90 days from the dateof acquisition. We have invested primarily in government agency notes,asset-backed debt securities (including auction rate debt securities),corporate notes and commercial paper, all of which bear a minimum short-termrating of A1/P1 or a minimum long-term rating of A/A2.

**Item7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operation. 

The following discussionof our financial condition and results of operations should be read inconjunction with the consolidated financial statements and notes theretoincluded elsewhere in this Annual Report on Form 10-K.

**Safe Harbor Statement**

The Management’sDiscussion and Analysis and other portions of this Annual Report include“forward-looking” statements (rather than historical facts) that aresubject to risks and uncertainties that could cause actual results to differmaterially from those described. Although we believe that the expectationsexpressed in these forward-looking statements are reasonable, we cannot promisethat our expectations will turn out to be correct. Our actual results could bematerially different from and worse than our expectations. With respect to suchforward-looking statements, we seek the protections afforded by the PrivateSecurities Litigation Reform Act of 1995. These risks include, withoutlimitation, (1) that we may not successfully enhance existing or developnew products and services in a cost-effective manner to meet customer demand inthe rapidly evolving market for Internet, wireless and IP-based voicecommunications services, including new products and services offered inconnection with our voice and municipal broadband network growth initiatives,and we expect these growth initiatives to not be profitable in their earlystages; (2) that our service offerings may fail to be competitive withexisting and new competitors; (3) that competitive product, price ormarketing 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 unsuccessfulin making and integrating acquisitions into our business, which could result inoperating difficulties, losses and other adverse consequences; (5) thatthe continued 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 beterminated or may not be as beneficial as anticipated, which could adverselyaffect our ability to increase our subscriber base; (9) that our businessmay suffer if our 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 interruptionsor impediments 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 use certaintechnologies in the future; (15) that we could face substantial liabilities ifwe 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 

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hire andretain sufficient 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 change, or topay the cash portion of the conversion value upon conversion of any notes bythe holders; (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.

**Overview**

EarthLink, Inc. is atotal communications provider, providing integrated communication services andrelated value-added services to individual consumers and business customersutilizing Internet Protocol, or IP, based technologies. Our core serviceofferings are dial-up and wireline broadband Internet access services andvalue-added services. Our growth initiatives include IP-based voice services,municipal wireless broadband services and our services for business customers.

We also have a jointventure with SK Telecom Co., Ltd. (“SK Telecom”), HELIO. HELIO is a non-facilities-basedmobile virtual network operator (MVNO) offering mobile communications servicesand handsets to consumers in the U.S. HELIO was formed in March 2005 andbegan offering its products and services during April 2006.

*Industry Background*

Since the inception of ourbusiness, we have expanded from a traditional dial-up Internet service providerto a total communications provider. The Internet access market in the U.S. grewdramatically from the mid-1990s through 2000 but has recently experiencedslower growth, as the market has reached a mature stage of growth. Since 2000,broadband Internet access has been steadily replacing dial-up. During 2006, thenumber of households with broadband access surpassed the number of householdswith dial-up connections. Focused, value-priced narrowband access, whichprovides service with a limited set of features at a lower cost, is stillattracting households new to the Internet or current Internet users interestedin reducing their cost of Internet access.

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Consumers continue to migrate to broadband due to thefaster connection and download speeds provided by broadband access, the abilityto free up their phone lines and the more reliable and “always on” connection.The pricing for broadband services, particularly for introductory promotionalperiods, services bundled with cable and telephone services, and services withslower speeds, has been declining and is approaching prices for traditionaldial-up services, making it a more viable option for consumers that continue torely on dial-up connections for Internet access. In addition, advancedapplications such as online gaming, music downloads and photo sharing requiregreater bandwidth for optimal performance, which adds to the demand forbroadband.

Currently, mostresidential broadband consumers access the Internet via DSL or cable, but anincreasing 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.

*Revenue Sources*

We provide narrowband access services (includingtraditional, fully-featured narrowband access and value-priced narrowbandaccess); broadband access services (including high-speed access via DSL, cableand wireless technologies and IP-based voice); advertising and othervalue-added services; and web hosting services. Our subscriber base remainedconsistent at approximately 5.3 million paying subscribers as of December 31,2005 and 2006, while total revenues increased from $1,290.1 million during theyear ended December 31, 2005 to $1,301.3 million during the year ended December 31,2006. The increase in total revenues was primarily due to an increase inbroadband revenues due to our acquisition of New Edge Holding Company (“NewEdge”) and due to our expanded broadband footprint and offerings, and anincrease in advertising and other value-added services. Our traditional,premium-priced narrowband subscriber base and revenues have been declining dueto the maturity of this service. In addition, the mix of our narrowbandcustomers continues to shift towards value-priced narrowband access.

We derive substantiallyall of our revenues from communications services, and such revenues represented98% or more of total revenues for each of the three years in the period ended December 31,2006. The remaining revenues relate to sales of equipment and devices used byour subscribers to access our services. We had approximately 3.3 millionnarrowband subscribers, 1.9 million broadband subscribers and 112,000 webhosting accounts as of December 31, 2006. Narrowband access revenues, broadbandaccess revenues, advertising and other value-added services revenues and webhosting revenues represented 47%, 43%, 7% and 3%, respectively, of totalrevenues for the year ended December 31, 2006.

*Business Strategy*

Our business strategy is to generate profits from ourexisting core access services and to reinvest the cash generated from theseservices in our various growth initiatives with the objective of generatingrevenue growth and earnings growth in future periods; to continue to expand ourpresence in growth markets, such as VoIP services, municipal wireless broadbandservices and business services; to support our HELIO joint venture with SKTelecom; and to market high quality, differentiated products and services.

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We believe the mostimportant factors for us to execute our business strategy are the 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;

·       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

·       exploring and evaluatingpotential strategic transactions that we believe may complement our current andfuture business activities, and successfully integrating any new acquisitionsand investments into our business

*Challenges andRisks*

The primary challenges we face in executing ourbusiness strategy are maintaining profitability in our existing services,successfully implementing new products and services, competition and purchasingcost-effective wholesale broadband access.

*Profitabilityof existing services.*   We have been focused onand have been successful in improving operating margins. During 2006, our coreaccess services continued to provide operating cash flow. This cash flow isinstrumental to our ability to fund future investments in our growth initiatives.We generate lower percentage gross profit margins on our broadband accessservices than on our other principal forms of Internet access and relatedservices. In addition, customer and technical support costs per subscriber forbroadband services generally exceed those of our other services. We continue towork towards reducing telecommunications costs per customer in all productlines and reducing total operations and customer support expenses. We will alsocontinue to evaluate opportunities to more cost effectively provide customerand technical support to broadband customers and manage direct sales andmarketing expenses required to add new broadband customers.

*Newproducts and services.*   The market for Internetand telecommunications services is characterized by rapidly changingtechnology, evolving industry standards, changes in customer needs and frequentnew service and product introductions. We are currently focused on utilizingVoIP technologies to deliver voice services and utilizing technologies todeploy wireless networks to deliver broadband services, among 

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others. However, thesecommunications mediums are still in growth stages. The success of these growthinitiatives depends on the adoption of our services by customers, our abilityto develop and use technologies effectively, our ability to enhance ourexisting services and to develop new services that meet changing customer needson a timely and cost-effective basis, and our ability to employ sales andmarketing efforts to add customers. We will continue to evaluate thefeasibility of new technologies and technological advancements and develop newservice offerings that allow us to expand our service offerings or deliver ourservices more cost effectively.

*Competition.*   Weoperate in a highly competitive market for each of our service offerings, andthe competitive environment impacts the churn rates we experience as well asthe number of new customers we are able to add. The largest competitors inbroadband access are the cable companies and regional bell operating companies(“RBOCs”) offering broadband access over their own cable or telephone lines.However, to attract and retain customers, we continue to focus on improving thehigh-quality Internet experience EarthLink offers, including providing superiorcustomer and technical support and differentiating our products and serviceswith innovative and useful tools that improve the Internet experience. We alsocontinue to seek out new marketing partners and distribution opportunities inour efforts to compete more effectively in adding customers. We expectcompetitive pressures will result in continued aggressive promotional pricingoffers on our service offerings, which may adversely impact our ability tosustain or grow revenues.

*Purchasing cost-effectivewholesale broadband access.*   The profitability ofour broadband services is dependent upon cost-effectively purchasing wholesalebroadband access and managing the costs associated with delivering broadbandservices. The costs associated with delivering broadband services include recurringservice costs such as telecommunications and customer support costs as well ascosts incurred to add new broadband customers, such as sales and marketing andinstallation and hardware costs. While we continuously evaluate cost reductionopportunities associated with the delivery of broadband access services toimprove our profitability, our overall profitability would be adverselyaffected if we are unable to continue to manage and reduce recurring servicecosts associated with the delivery of broadband services and costs incurred toadd new broadband customers.

*2006 Highlights*

As discussed above, totalrevenues during the year ended December 31, 2006 increased compared to theprior year due to an increase in broadband revenues and an increase in advertisingand other value-added services revenues, offset by a decrease in narrowbandrevenues. We continued to generate profits and operating cash flow from ourcore access services. However, overall operating expenses increased during theyear ended December 31, 2006 compared to the prior year due to theinvestments in our IP-based voice, municipal wireless and business servicesgrowth initiatives. Specifically, we launched DSL and Home Phone service in 12markets in the U.S. covering approximately 10.0 million households; launchedwireless broadband networks in four cities and were selected by four additionalcities to build and operate wireless broadband networks; completed theacquisition of New Edge and integrated its operations with our existingbusiness; and increased product offerings and distribution channels for ourbusiness services. Overall operating expenses also increased due to theadoption of Statement of Financial Accounting Standards (“SFAS’’) No. 123(R),“Share Based Payment,” on January 1, 2006. 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 year ended December 31, 2006 compared to the prioryear.

*Looking Ahead*

We expect overall profitsto be adversely affected in 2007 as we continue to expand our new products andservices. Implementation of new services involves initial product developmentand infrastructure costs, 

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followedby sales and marketing costs to add customers who generate recurring revenues. In2007, we expect to increase sales and marketing efforts for our IP-based voice,municipal broadband services and business services and incur increased customersupport and telecommunications costs to provide these services. However, webelieve management can exercise discretion in deploying product development andsales and marketing resources to manage the expense associated with developmentof IP-based voice and municipal broadband customer bases. In addition, weexpect to grow our IP-based voice and wireless broadband subscriber bases toincrease revenues and we expect to expand our wireless broadband footprint. Wealso expect HELIO to incur additional losses in 2007 due to the continuingstart-up nature of its business. We record our proportionate share of HELIO’slosses in our results of operations, so our results of operations in 2007 willalso be adversely impacted because of HELIO’s losses.

**Growth Initiatives**

*IP-basedvoice.**  *In October 2005,we began offering the next generation of our VoIP services, EarthLink trueVoiceSM. EarthLink trueVoice is acompetitive alternative to traditional telephone service and is available toEarthLink and non-EarthLink high-speed Internet access subscribers. In late2005 and 2006, we launched DSL and Home Phone Service, a new DSL and VoIPservice, which uses Covad Communications Group, Inc.’s (“Covad”)line-powered voice access that allows us to offer consumers low-cost phoneservices along with high-speed Internet access. In March 2006, we invested$50.0 million in Covad to fund the network build-out of this service. Theservice is now available in 12 markets in the U.S. covering approximately 10.0million households.

We are actively marketing EarthLink DSL and Home PhoneService and will expand our marketing efforts to promote these services during2007. We will also continue to invest in the development of additionalapplications and services and the marketing efforts for our IP-based voice services.

*Municipalwireless broadband.*   We are investing inwireless, or Wi-Fi, broadband access to deploy a competitive alternative to DSLand cable for delivering broadband Internet access services. We began thisinitiative during 2005 by winning proposals to finance, build and manage wirelessbroadband networks for the cities of Philadelphia, Pennsylvania and Anaheim,California. During 2006 and early 2007, we completed the initial phase forthese networks and began offering our municipal wireless broadband services. Wealso launched service in Milpitas, California and New Orleans, Louisiana, andwere selected by the cities of Alexandria, Virginia; San Francisco, California;Atlanta, Georgia; Houston, Texas; and St. Petersburg, Florida to build,own and operate a wireless broadband network in those cities.

We expect to expand our wireless broadband footprintand grow our wireless broadband subscriber base to increase revenues, with thetarget of offering service to 1.5 million households by the end of 2007. Theseinitiatives may result in significant capital expenditures and operating costsin future periods to develop, implement and build wireless broadband networksin these municipalities, as well as increased costs to market the new services.

*Business services.*   InApril 2006, we acquired New Edge, a single-source national provider ofsecure multi-site managed data networks and dedicated Internet access forbusinesses and communications carriers. Theacquisition of New Edge expands our service offerings to small and medium-sizedenterprises. During 2006, we introduced new products, including Small OfficeDSL and hosted Virtual Private Networks (“VPN”). In 2007, we expect tobuild upon our existing portfolio of business solutions, by expanding ourproduct offerings and our distribution channels.

**Joint Venture**

We have a joint venture with SK Telecom, HELIO. HELIOis a non-facilities-based mobile virtual network operator (MVNO) offeringmobile communications services and handsets to consumers in the U.S. EarthLinkand SK Telecom invested an aggregate of $166.0 million of cash and non-cashassets upon 

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completing the formationof HELIO in March 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 December 31, 2006, EarthLink and SKTelecom each had an approximate 48% economic ownership interest and a 50%voting interest in HELIO. HELIO will require additional funding in the futureand we expect we may invest additional cash in HELIO.

During 2006, HELIOlaunched its first three handheld devices, which are based on products SK Telecomoffers in Korea. HELIO targets young, connected consumers with an extensivearray of features, including MySpace Mobile, video services, 3D and multiplayergames, and video, picture and text messaging, in addition to its wireless voiceand data services. HELIO is currently marketing its services through a varietyof means. By the end of 2006, HELIO had distribution of its devices in over2,700 retail and agent locations and began its national television and printmarketing campaign.

**Acquisition**

In April 2006, weacquired New Edge. Theacquisition of New Edge expands our service offerings for businesses andcommunications carriers. Under the terms of the merger agreement, weacquired 100% of New Edge in a merger transaction for 1.7 million shares ofEarthLink common stock and $108.7 million in net cash, including cash to beused to satisfy certain New Edge liabilities and direct transaction costs.

**Marketing Alliances**

We have an agreement with Time Warner Cable and BrightHouse Networks, companies whose networks pass more than 19 million homes,to offer our broadband Internet access services over their systems. Inconnection with the agreement, Time Warner Cable and Bright House Networksreceive consideration from EarthLink for carrying the EarthLink service andrelated Internet traffic. As of December 31, 2005 and 2006, more than 25%of our broadband subscribers were serviced via either the Time Warner Cable orBright House Networks network.

We have a marketingrelationship with Embarq Corporation (“Embarq”), a spin-off of Sprint NextelCorporation’s local communications business. The relationship provides thatEarthLink is the wholesale high-speed ISP for Embarq’s local residential andsmall business customers. In addition, we provide Embarq with wholesale narrowbandaccess services. The contracts associated with these arrangements expire in April 2007.During 2006, we and Embarq decided not to renew the wholesale broadbandcontract. During the years ended December 31, 2005 and 2006, ourrelationship with Embarq generated more than 10% of our total gross organicsubscriber additions. As of December 31, 2006, our broadband subscribercount and total subscriber count included approximately 755,000 subscribersunder the marketing relationship. During the year ended December 31, 2006,the relationship generated revenues of approximately $28.9 million.

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**Key OperatingMetrics**

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

| ** **                        | ** ** | **As of December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Subscriber Data (a)**           | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Narrowband  subscribers           |       | 3,880,000                             |       | 3,580,000 |   | 3,301,000 |   |
| Broadband  subscribers            |       | 1,364,000                             |       | 1,608,000 |   | 1,886,000 |   |
| Web hosting  accounts             |       | 144,000                               |       | 127,000 |   | 112,000 |   |
| Total subscribers at end  of year |       | 5,388,000                             |       | 5,315,000 |   | 5,299,000 |   |

 

|  

** **                  | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Subscriber Activity**             | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Subscribers at  beginning of year   |       | 5,206,000                                  |       | 5,388,000 |   | 5,315,000 |   |
| Gross organic  subscriber additions |       | 3,137,000                                  |       | 2,766,000 |   | 2,700,000 |   |
| Acquired  subscribers (b)           |       | 12,000                                     |       | 147,000 |   | 162,000 |   |
| Adjustment (c)                      |       | —                                     |       | (27,000 | ) | — |   |
| Churn                               |       | (2,967,000                                 | )          | (2,959,000 | ) | (2,878,000 | ) |
| Subscribers at  end of year         |       | 5,388,000                                  |       | 5,315,000 |   | 5,299,000 |   |
| **Churn rate (d)**                  |       | 4.6%                                       |       | 4.6% |   | 4.5% |   |
| **Narrowband  Data**                | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Average  subscribers (e)            |       | 3,965,000                                  |       | 3,726,000 |   | 3,390,000 |   |
| ARPU (f)                            |       | $                                          | 18.37      |   | $ | 16.61 |   | $ | 15.49 |   |
| Churn rate (d)                      |       | 5.3%                                       |       | 5.5% |   | 5.6% |   |
| **Broadband Data**                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Average  subscribers (e)            |       | 1,215,000                                  |       | 1,495,000 |   | 1,825,000 |   |
| ARPU (f)                            |       | $                                          | 28.77      |   | $ | 24.62 |   | $ | 24.93 |   |
| Churn rate (d)                      |       | 2.5%                                       |       | 2.6% |   | 2.5% |   |
| **Web Hosting Data**                | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Average accounts  (e)               |       | 153,000                                    |       | 136,000 |   | 118,000 |   |
| ARPU (f)                            |       | $                                          | 25.84      |   | $ | 24.97 |   | $ | 25.55 |   |
| Churn rate (d)                      |       | 2.4%                                       |       | 2.2% |   | 2.0% |   |

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

(b)          Acquiredsubscribers for the year ended December 31, 2006 includes approximately58,000 broadband subscribers acquired in the New Edge merger transaction.

(c)           EffectiveMarch 24, 2005, we transferred approximately 27,000 wireless subscribersto HELIO in connection with completing the formation of HELIO.

(d)          Churnrate is used to measure the rate at which subscribers discontinue service on avoluntary or involuntary basis. Churn rate is computed by dividing the averagemonthly number of subscribers that discontinued service during the year by theaverage subscribers for the year.

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(e)           Averagesubscribers or accounts is calculated by averaging the ending monthlysubscribers or accounts for the thirteen months preceding and including the endof the year.

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

**Results ofOperations**

Thefollowing table sets forth statement of operations data, cash flow data andemployee data for the periods indicated:

| ** **                                         | ** ** | **Year Ended December 31,** | ** ** | **2005 vs. 2004** | ** ** | **2006 vs. 2005** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                         | ** ** | **2004**                                   | ** ** | **2005**                    | ** ** | **2006**                    | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                         | ** ** | **(dollars in thousands)**       | ** ** |
| **Statement  of operations data:**                 | ** ** | ** **                                 | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues:                                          |       |                                       |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Narrowband access                                  |       | $                                          | 874,010    |                        | $          | 742,757                     |       | $ | 617,963 |   | $ | (131,253 | ) |   | -15 | % |   | $ | (124,794 | ) |   | -17 | % |   |
| Broadband access                                   |       | 419,411                                    |       | 441,736                     |       | 559,681                     |       | 22,325 |   |   | 5 | % |   | 117,945 |   |   | 27 | % |   |
| Advertising and other value-added services         |       | 41,234                                     |       | 64,909                      |       | 88,140                      |       | 23,675 |   |   | 57 | % |   | 23,231 |   |   | 36 | % |   |
| Web hosting                                        |       | 47,547                                     |       | 40,670                      |       | 35,483                      |       | (6,877 | ) |   | -14 | % |   | (5,187 | ) |   | -13 | % |   |
| Total revenues                                     |       | 1,382,202                                  |       | 1,290,072                   |       | 1,301,267                   |       | (92,130 | ) |   | -7 | % |   | 11,195 |   |   | 1 | % |   |
| Operating costs and expenses:                      |       |                                       |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Telecommunications service and quipment costs |       | 431,162                                    |       | 366,654                     |       | 424,425                     |       | (64,508 | ) |   | -15 | % |   | 57,771 |   |   | 16 | % |   |
| Sales incentives                                   |       | 10,040                                     |       | 8,973                       |       | 10,916                      |       | (1,067 | ) |   | -11 | % |   | 1,943 |   |   | 22 | % |   |
| Total cost of revenues                             |       | 441,202                                    |       | 375,627                     |       | 435,341                     |       | (65,575 | ) |   | -15 | % |   | 59,714 |   |   | 16 | % |   |
| Sales and marketing                                |       | 417,250                                    |       | 389,522                     |       | 389,079                     |       | (27,728 | ) |   | -7 | % |   | (443 | ) |   | 0 | % |   |
| Operations and customer support                    |       | 255,192                                    |       | 233,907                     |       | 260,941                     |       | (21,285 | ) |   | -8 | % |   | 27,034 |   |   | 12 | % |   |
| General and administrative                         |       | 105,043                                    |       | 112,173                     |       | 128,479                     |       | 7,130 |   |   | 7 | % |   | 16,306 |   |   | 15 | % |   |
| Amortization of intangible assets                  |       | 24,363                                     |       | 12,267                      |       | 11,902                      |       | (12,096 | ) |   | -50 | % |   | (365 | ) |   | -3 | % |   |
| Facility exit and restructuring costs              |       | 28,394                                     |       | 2,080                       |       | (117                        | )          | (26,314 | ) |   | -93 | % |   | (2,197 | ) |   | -106 | % |   |
| Total operating costs and expenses                 |       | 1,271,444                                  |       | 1,125,576                   |       | 1,225,625                   |       | (145,868 | ) |   | -11 | % |   | 100,049 |   |   | 9 | % |   |
| Income from operations                             |       | 110,758                                    |       | 164,496                     |       | 75,642                      |       | 53,738 |   |   | 49 | % |   | (88,854 | ) |   | -54 | % |   |
| Net losses of equity affiliate                     |       | —                                     |       | (15,608                     | )          | (84,782                     | )          | (15,608 | ) |   | * |   |   | (69,174 | ) |   | * |   |   |
| Gain (loss) on investments in other companies, net |       | (1,420                                     | )          | 2,877                       |       | 377                         |       | 4,297 |   |   | * |   |   | (2,500 | ) |   | -87 | % |   |
| Interest income and other, net                     |       | 6,131                                      |       | 13,491                      |       | 14,636                      |       | 7,360 |   |   | 120 | % |   | 1,145 |   |   | 8 | % |   |
| Income before income taxes                         |       | 115,469                                    |       | 165,256                     |       | 5,873                       |       | 49,787 |   |   | 43 | % |   | (159,383 | ) |   | -96 | % |   |
| Provision for income taxes                         |       | 4,460                                      |       | 22,476                      |       | 886                         |       | 18,016 |   |   | * |   |   | (21,590 | ) |   | -96 | % |   |
| Net income                                         |       | $                                          | 111,009    |                        | $          | 142,780                     |       | $ | 4,987 |   | $ | 31,771 |   |   | 29 | % |   | $ | (137,793 | ) |   | -97 | % |   |
| **Cash  flow data:**                               | ** ** | ** **                                 | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Cash provided by operating activities              |       | $                                          | 188,152    |                        | $          | 188,704                     |       | $ | 115,249 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash used in investing activities                  |       | $                                          | (69,070    | )                           | $          | (65,081                     | )          | $ | (283,064 | ) |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash (used in) provided by financing activities    |       | $                                          | (108,912   | )                           | $          | (169,239                    | )          | $ | 152,890 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Employee  data:**                                | ** ** | ** **                                 | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Number of  employees at year end (#)               |       | 2,067                                      |       | 1,732                       |       | 2,210                       |       |   |   |   |   |   |   |   |   |   |   |   |   |

----

*                     denotes percentage is not meaningful or is notcalculable

#                   Represents full-time equivalents

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*Narrowband accessrevenues*

Narrowband access revenues primarily consist of monthly fees charged to customersfor dial-up Internet access. Narrowband revenues decreased 15% to$742.8 million during the year ended December 31, 2005 and decreased17% to $618.0 million during the year ended December 31, 2006,compared to the prior years. The decreases in narrowband revenues in both yearswere due to decreases in narrowband ARPU and decreases in average narrowbandsubscribers. Revenues also decreased during the year ended December 31,2005 due to the transfer of wireless operations to HELIO effective March 24,2005, which caused narrowband access revenues to decrease by $17.8 million andcontributed to the decrease in average narrowband subscribers compared to theyear ended December 31, 2004.

*ARPU.*   NarrowbandARPU decreased from $18.37 during the year ended December 31, 2004 to$16.61 during the year ended December 31, 2005 and to $15.49 during theyear ended December 31, 2006. These decreases were due to 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. Duringthe years ended December 31, 2004, 2005 and 2006, average PeoplePC accesssubscribers were 0.6 million, 1.1 million and 1.4 million, respectively,representing 16%, 29% and 42%, respectively, of our average narrowband customerbase. Also contributing to the decreases in narrowband service ARPU, althoughto a lesser extent, was the increased use of promotional pricing for ourservice offerings.

*Subscribers.*   Thefollowing table summarizes narrowband subscriber activity for the years ended December 31,2004, 2005 and 2006:

| ** **                                                       | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Subscribers at  beginning of year                                |       | 3,984,000                                  |       | 3,880,000 |   | 3,580,000 |   |
| Gross organic  subscriber additions                              |       | 2,450,000                                  |       | 2,131,000 |   | 1,978,000 |   |
| Acquired  subscribers                                            |       | 12,000                                     |       | 147,000 |   | 104,000 |   |
| Narrowband  subscribers converted to our broadband services, net |       | (15,000                                    | )          | (88,000 | ) | (44,000 | ) |
| Adjustment (a)                                                   |       | —                                     |       | (27,000 | ) | — |   |
| Churn                                                            |       | (2,551,000                                 | )          | (2,463,000 | ) | (2,317,000 | ) |
| Subscribers at end of  year                                      |       | 3,880,000                                  |       | 3,580,000 |   | 3,301,000 |   |

----

(a)           Effective March 24,2005, we transferred approximately 27,000 wireless subscribers to HELIO inconnection with completing the formation of HELIO.

Average narrowband subscribers were 4.0 million, 3.7million and 3.4 million during the years ended December 31, 2004, 2005 and2006, respectively. In addition to the overall decrease in average narrowbandsubscribers over the past three years, the mix of customers shifted frompremium narrowband subscribers to PeoplePCnarrowband subscribers because the growth in our average PeoplePC narrowbandsubscribers was offset by a decline in our average premium narrowbandcustomers, the combination of which resulted in a change in the composition ofour narrowband customer base. Average premium narrowband subscribers decreasedby 0.7 million and 0.7 million during 2005 and 2006, respectively, whileaverage PeoplePC subscribersincreased 0.4 million and 0.4 million, respectively. The decreases in premiumnarrowband subscribers resulted from the migration of subscribers to broadbandservices and the continued maturing and ongoing competitiveness of themarket for narrowband Internet access. Weexpect the mix of our narrowband subscriber base to continue to shift frompremium narrowband access services to PeoplePC access services for theforeseeable future.

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Our results of operationsare significantly affected by subscriber cancellations, or “churn.” Our averagemonthly churn rates for narrowband subscribers were 5.3%, 5.5% and 5.6% duringthe years ended December 31, 2004, 2005 and 2006, respectively. The increasein churn over the past few years was due to early-life churn related to thehigh level of gross subscriber additions, particularly for our PeoplePC accessservices whose shorter-tenured customers comprise an increasingly greaterproportion of our customer base and an increased number of subscribers who aremigrating to broadband services. If churn rates continue to be at or above therate experienced in 2006, our narrowband subscriber base may decrease at anaccelerated rate which could adversely affect our business.

*Broadband access revenues*

Broadband access revenuesconsist of retail and wholesale fees charged for high-speed, high-capacityaccess services including DSL, cable, satellite and wireless services; feescharged for high-speed data networks to businesses and communications carriers;fees charged for IP-based voice services; installation fees; termination fees;fees for equipment; and regulatory surcharges billed to customers. Broadbandrevenues increased 5% to $441.7 million and 27% to $559.7 million during theyears ended December 31, 2005 and 2006, respectively, compared to theprior years. The increases were primarily due to increases in average broadbandsubscribers.

*Subscribers.*   Thefollowing table summarizes broadband subscriber activity for the years ended December 31,2004, 2005 and 2006:

| ** **                                                       | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Subscribers at  beginning of year                                |       | 1,061,000                                  |       | 1,364,000 |   | 1,608,000 |   |
| Gross organic  subscriber additions                              |       | 660,000                                    |       | 616,000 |   | 708,000 |   |
| Acquired  subscribers (a)                                        |       | —                                     |       | — |   | 58,000 |   |
| Narrowband  subscribers converted to our broadband services, net |       | 15,000                                     |       | 88,000 |   | 44,000 |   |
| Churn                                                            |       | (372,000                                   | )          | (460,000 | ) | (532,000 | ) |
| Subscribers at end of  year                                      |       | 1,364,000                                  |       | 1,608,000 |   | 1,886,000 |   |

----

(a)           Acquiredsubscribers for year ended December 31, 2006 represents broadbandsubscribers acquired in the New Edge merger transaction.

The average number ofbroadband subscribers was 1.2 million, 1.5 million and 1.8 million during theyears ended December 31, 2004, 2005 and 2006, respectively. The averagenumber of broadband subscribers increased over the past three years primarilydue to the continued growth in the market for broadband access and our and ourpartners’ efforts to promote broadband services. Also contributing to theincrease in average broadband subscribers during the year ended December 31,2006 compared to the prior year was the acquisition of New Edge and theaddition of IP-based voice subscribers due to the launch of EarthLink DSL andHome Phone Service in several markets during 2006.

*ARPU.*   BroadbandARPU depends on a variety of factors including changes in the mix of customersand their related pricing plans; the use of promotions and discounted pricingplans to obtain or retain subscribers; increases or decreases in the prices ofour existing services; and the addition of new services. We currently offerseveral broadband access services at different price plans, we offer ourbroadband access services to consumers and businesses, and we provide servicesthrough retail and wholesale relationships. All of these have an effect on ouroverall broadband ARPU.

In a retail relationship,we market the service directly to consumers and businesses under an EarthLinkbrand, have latitude in establishing price, and are responsible for mostaspects of providing the service, including first tier customer support. In awholesale relationship, a telecommunications partner markets the service, haslatitude in establishing price and pays us to provide underlying broadbandaccess 

44

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orInternet services such as authentication, email, web space, news and varyingdegrees of customer support. In a retail relationship, we generally recognizethe amount the subscriber is billed as revenue, but in a wholesalerelationship, we recognize the amount due from the wholesale partner asrevenue. Consumer retail broadband services are generally priced above $35 permonth per subscriber to cover all of the costs of the service; however, certainretail relationships, 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 retailvoice services are generally priced between $25 and $70 per month and consumerretail wireless broadband services are generally priced at $22 per month.Consumer wholesale broadband relationships are priced between $3 and $6 permonth recognizing the limited set of activities performed by EarthLink. Retailbusiness services generally have an ARPU between $110 and $130 fornon-networked solutions and an ARPU between $175 and $225 for networkedsolutions. 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.

Broadband ARPU declined 14% during the year ended December 31,2005 compared to the prior year due primarily to lower retail DSL ARPUresulting from the increased use of promotional pricing and general declines inretail DSL prices introduced as a result of declines in costs from our DSLservice providers. Also contributing to the decrease in broadband ARPU was ashift in the mix of our broadband subscriber base from retail services towholesale services. The shift in the mix of our broadband customer base wasattributable to growing our wholesale DSL customer base at a faster rate during2005 than our retail customer base.

Broadband ARPU increased 1% during the year ended December 31,2006 compared to the prior year due primarily to the addition of higher ARPUNew Edge subscribers. Offsetting these increases was lower retail DSL ARPU resultingfrom the increased use of promotional pricing; general declines in retail DSLprices introduced as a result of declines in costs from our DSL serviceproviders; and a shift in the mix of our broadband subscriber base from retailservices to wholesale services and, within our retail broadband customer base,from retail DSL subscribers to retail cable subscribers.

The pricing of our retail broadband access services issubject to competitive pressures that are beyond our control. Incumbent localexchange carriers (“ILECs”) have generally reduced retail prices for theirbroadband service offerings. Such competitive pressures may cause us todecrease the price of our retail broadband access services which may cause ourservice offerings to be uneconomical in certain markets and may result in adecrease in overall broadband ARPU and/or a reduction in gross margin dollarsper subscriber. Any of these could materially adversely affect our business.

We purchase broadbandaccess from ILECs, competitive local exchange carriers (“CLECs”), and cableproviders. Please refer to “Regulatory Environment” in Item 1 of this AnnualReport on Form 10-K and to “Risk Factors” in Item 1A of Part Ifor further discussion of the regulatory environment and further discussion regardingour contracts with broadband access providers.

*Advertising andother value-added services revenues*

Advertising and othervalue-added services revenues consist of revenues from promotional arrangementswith advertisers, retailers, service providers and content providers. We earnthese revenues by paid placements for searches; delivering traffic to ourpartners in the form of subscribers, page views or e-commerce revenues;advertising our partners’ products and services in our various online propertiesand electronic publications, including the Personal Start PageTM; and referring our customersto our partners’ 

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productsand services. Advertising and other value-added services revenues also includecertain ancillary services sold as add-on features to our Internet services,such as email storage, security products and Internet call waiting.

Advertising and othervalue-added services revenues increased 57% to $64.9 million and 36% to $88.1 millionduring the years ended December 31, 2005 and 2006, respectively, comparedto the prior years due primarily to increased search advertising revenues andrevenues from our promotional arrangements, resulting from increased use of theInternet as an advertising medium. Also contributing to the increases wereincreases of $9.0 million and $5.7 million in ancillary services revenuesduring the years ended December 31, 2005 and 2006, respectively, comparedto the prior years. We expect our advertising and other value-added services tocontinue to grow as we continue to develop and market new products.

*Web hosting revenues*

We earn web hostingrevenues by leasing server space and providing web services to individuals andbusinesses wishing to present a web or e-commerce presence on the Internet. Webhosting revenues decreased 14% to $40.7 million during the year ended December 31,2005 and decreased 13% to $35.5 million during the year ended December 31,2006, compared to the prior year periods. The decreases were primarily due todecreases in average web hosting accounts, which were 153,000, 136,000 and118,000 during the years ended December 31, 2004, 2005 and 2006,respectively. Contributing to the decrease during the year ended December 31,2005 was a 3% decrease in ARPU, from $25.84 during the year ended December 31,2004 to $24.97 during the year ended December 31, 2005. The decreaseduring the year ended December 31, 2006 was offset by an increase in ARPU,which increased 2% from $24.97 during the year ended December 31, 2005 to$25.55 during the year ended December 31, 2006, due to the launch of newproducts with higher price points.

*Cost of revenues*

Telecommunications 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 and depreciation of ournetwork equipment. Telecommunications service and equipment costs also includethe cost of equipment and devices used by our subscribers to access ourservices. Our principal providers for narrowband telecommunications servicesare Level 3 Communications, Inc. and Sprint Nextel Corporation, and ourlargest providers of broadband connectivity are Covad and Time Warner Cable. Wealso do lesser amounts of business with a wide variety of local, regional andother national providers. EarthLink purchases broadband access from ILECs,CLECs and cable providers.

Telecommunications serviceand equipment costs decreased 15% to $366.7 million during the year ended December 31,2005, and decreased as a percentage of total revenues from 31.2% to 28.4%. Thedecrease in telecommunications service and equipment costs was primarily aresult of more favorable agreements with telecommunications service providersas well as optimizing network capacity to reduce costs. In general, thetelecommunications cost per subscriber has declined over time, resulting fromimprovements in communications technology, the increasing scale ofInternet-related business, and competition among telecommunications providers.Also contributing to the decrease was a $6.1 million decline in equipment andrelated costs primarily due to the transfer of wireless operations to HELIO in March 2005;an $8.4 million decrease in depreciation expense due to network-related assets becomingfully depreciated and lower capital expenditures in recent years; and the shiftin the mix of our broadband customer base to wholesale and certain retail cablecustomers who have nominal telecommunications service and equipment costs.

Telecommunications serviceand equipment costs increased 16% from $366.7 million during the year ended December 31,2005 to $424.4 million during the year ended December 31, 2006, andincreased as a percentage of total revenues from 28.4% to 32.6%. This was dueto an increase in average monthly costs 

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persubscriber, primarily a result of acquired New Edge subscribers who have ahigher average cost per subscriber as New Edge provides high-speed datanetworks to small and medium-sized businesses. Offsetting this increase werereduced costs resulting from more favorable agreements with telecommunicationsservice providers as well as optimizing network capacity to reduce costs.

Our retail broadbandaccess and managed data networks services have a higher telecommunications costof revenue per subscriber than our other principal forms of Internet access andrelated services. As a result, we expect telecommunications service andequipment costs per subscriber to increase in 2007 as we seek to grow ourmanaged data networks services. We expect that there may be additional,although limited, opportunities to reduce such costs by continuing to eliminatehigher cost providers, reducing costs from the remaining vendors, and achievinghigher utilization of existing telecommunications capacity. These initiativesmay offset the negative effect expected to result from the increase intelecommunications service and equipment costs per subscriber.

Cost of revenues alsoincludes sales incentives. We frequently offer sales incentives such as freeInternet access on a trial basis and modems. Sales incentives decreased 11%from $10.0 million during the year ended December 31, 2004 to $9.0 millionduring the year ended December 31, 2005 due to a decline in modem pricesand a decrease in the number of modems provided to customers as a result of adecrease in retail DSL gross adds. Sales incentives increased 22% to $10.9million during the year ended December 31, 2006 due to an increase inmodems and other equipment provided to customers resulting from the launch ofour IP-based voice services during 2006.

*Sales and 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 7% to $389.5 million during the year ended December 31,2005 compared to the prior year. The decrease was primarily due to declines inamounts payable to our distribution partners as a result of declines in grosssubscriber additions and continued declines in our telemarketing salesexpenses, which were favorably impacted by the closing of four contact centersduring the first quarter of 2004. These decreases were offset by an increase inour sales and marketing expenses for PeoplePC and broadband services.

Sales and marketingexpenses remained relatively constant at $389.1 million during the yearended December 31, 2006 compared to the prior year. This was primarily dueto sales and marketing expenses to launch our IP-based voice products andmunicipal wireless broadband services, an increase in sales and marketing forour value-added services, the inclusion of New Edge sales and marketingexpenses, and stock-based compensation expense from the adoption of Statementof Financial Accounting Standards (“SFAS”) No. 123(R), “Share-BasedPayment,” on January 1, 2006. Sales and marketing expenses for the yearended December 31, 2006 included $3.3 million of stock-based compensationexpense. Substantially offsetting these increases was a decrease in sales andmarketing for our premium narrowband services. Sales and marketing expenses mayincrease during 2007 as we increase marketing efforts for our voice servicesand to launch our municipal wireless broadband services in additional markets.

*Operations and 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 decreased 8% to $233.9 million during the yearended December 31, 2005 compared to the prior year. The decrease duringthe year ended December 31, 2005 was primarily due to decreases inoutsourcing costs resulting from lower rates from service providers as well ascontinued cost savings from the contact center closings completed during thefirst quarter of 2004.

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Operations and customersupport expenses increased 12% from $233.9 million during the year ended December 31,2005 to $260.9 million during the year ended December 31, 2006. Theincrease was primarily the result of the inclusion of New Edge operations andcustomer support expenses, expenses associated with our municipal wirelessbroadband growth initiative, an increase in operations expense for ourvalue-added services and an increase due to stock-based compensation expensefrom the adoption of SFAS No. 123(R) on January 1, 2006.Operations and customer support expenses for the year ended December 31,2006 included $6.5 million of stock-based compensation expense. Partiallyoffsetting these increases was a decrease in operations and customer supportexpenses for our premium narrowband services, including a decrease incommunications costs for providing subscribers with toll-free access to ourtechnical support and customer service centers.

*General andadministrative*

General and administrative expenses consist of fullyburdened costs associated with the executive, finance, legal and humanresources departments; outside professional services; payment processing;credit card fees; collections and bad debt. General and administrative expensesincreased 7% to $112.2 million and 15% to $128.5 million during the years endedDecember 31, 2005 and 2006, respectively, compared to the prior years. Theincrease during the year ended December 31, 2005 was primarily due to anincrease in legal fees, increased professional and investment advisor feesresulting from the formation of the HELIO joint venture in March 2005 andcertain state sales tax refunds received during 2004. These increases werepartially offset by decreases in bad debt and payment processing expenses anddepreciation expense.

The increase during theyear ended December 31, 2006 was primarily due to the inclusion of NewEdge general and administrative expenses; increases in personnel, professionalfees and travel costs resulting from the implementation of our various growthinitiatives; and an increase due to stock-based compensation expense from theadoption of SFAS No. 123(R) on January 1, 2006. General andadministrative expenses for the year ended December 31, 2006 included $4.4million of stock-based compensation expense.

*Amortization ofintangible assets*

Amortization of intangibleassets represents the amortization of definite lived intangible assets acquiredin purchases of businesses and purchases of customer bases from othercompanies. 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 decreased 50% from $24.4 million during the year ended December 31,2004 to $12.3 million during the year ended December 31, 2005 and decreased3% to $11.9 million during the year ended December 31, 2006. The decreaseswere primarily the result of several subscriber base assets becoming fullyamortized over the past three years and a decrease in subscriber baseacquisitions in recent years. Additionally, contributing to the decrease duringthe year ended December 31, 2005 was the subscriber base acquired in theCidco Incorporated (“Cidco”) transaction becoming fully amortized in November 2004.Offsetting the decrease during the year ended December 31, 2006 was anincrease due to amortization of identifiable definite lived intangible assetsresulting from the acquisition of New Edge.

*Facility exit andrestructuring costs*

*2004costs.*   During the first quarter of 2004, weexecuted a plan to restructure and further streamline our contact centeroperations (the “2004 Plan”). Under the 2004 Plan, we closed contact centeroperations in Harrisburg, Pennsylvania; Roseville, California; San Jose,California; and Pasadena, California; and reduced contact center operations inAtlanta, Georgia. Approximately 1,140 employees were directly impacted,primarily customer support personnel. In connection with the 2004 Plan, werecorded facility 

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exit costs of $30.2million, including $10.5 million for employee, personnel and relatedcosts; $11.3 million for real estate and telecommunications costs; and $8.4million in asset disposals.

We evaluate and adjust our estimates for facility exitcosts as events occur and record such adjustments as facility exit costs.During the year ended December 31, 2004, we reduced our estimates for realestate commitments associated with our facility exit and restructuring plans by$2.0 million and realized additional expense of $0.2 million associated withthe disposal and write-down of fixed assets, net of proceeds received. As aresult of the 2004 Plan and the subsequent changes in estimates to the 2003Plan and 2004 Plan, we recorded facility exit costs of $28.4 million during theyear ended December 31, 2004.

*2005costs.*   During the third quarter of 2005, weexecuted plans to further streamline operations by outsourcing certain contactcenter and credit and collections activities (the “2005 Plans”). Approximately227 employees were directly impacted. As a result of the 2005 Plans, werecorded restructuring costs of $1.4 million for severance and personnelrelated costs.

During year ended December 31,2005, we increased our estimate for real estate commitments associated with the2004 Plan by $0.7 million, primarily associated with estimates of operatingexpenses for various facilities. As a result of the 2005 Plans and thesubsequent changes in estimates to the liabilities recorded for our contactcenter restructurings, we recorded facility exit and restructuring costs of$2.1 million during the year ended December 31, 2005.

*Net losses ofequity 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. These equity methodlosses 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 years ended December 31,2005 and 2006 of $15.6 million and $84.8 million, respectively, included ourproportionate share of HELIO’s net losses offset by amortization associatedwith recognizing the difference between the carrying value and fair value ofnon-cash assets contributed. Due to the start-up nature of HELIO’s operationsand HELIO’s product launches in 2006, we expect HELIO’s net loss to continue toincrease, and, as a result, we expect our net losses of equity affiliate toincrease as we record our proportionate share of HELIO’s net losses.

*Gain (loss) oninvestments in other companies, net*

During the years ended December 31, 2004 and2005, we recorded losses of $1.4 million and $0.9 million, respectively,on certain of our investments in other companies as a result of declines infair value that were considered to be other than temporary.

During the year ended December 31, 2005, wereceived $4.4 million in cash distributions from eCompanies Venture Group, L.P.(“EVG”). In applying the cost method, we recorded $0.6 million as a return ofour investment based on the carrying value of our investment in EVG, and gainsof $3.8 million were included in gain (loss) on investments in other companies,net. During the year ended December 31, 2006 we recorded a $0.4 milliongain on investments due to an additional EVG distribution.

Except for HELIO, we donot exercise significant influence or control over the operating and financialpolicies of the companies in which we have invested. We are not the primarybeneficiary for any of the companies in which we have invested. Accordingly, weuse the cost method to account for our investments in other companies.

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*Interest income andother, net*

Interest income and other, net, increased from $6.1million during the year ended December 31, 2004 to $13.5 million duringthe year ended December 31, 2005 primarily due to an increase ininvestment yields, offset by a decrease in our average cash and marketablesecurities balances. Our weighted average investment yields increased fromapproximately 1.6% during year ended December 31, 2004 to approximately3.1% during the year ended December 31, 2005, as the U.S. Federal ReserveBank has increased interest rates. Our average cash and marketable securitiesbalance decreased from $507.4 million during the year ended December 31,2004 to $446.5 million during the year ended December 31, 2005. Our cashand investment balances decreased as a result of repurchases of our commonstock, investments in the HELIO joint venture, capital expenditures and thepurchases of businesses and subscriber bases, offset by cash provided byoperations.

Interest income and other,net, increased from $13.5 million during the year ended December 31, 2005to $14.6 million during the year ended December 31, 2006 primarily due toan increase in investment yields and an increase due to interest income fromour investment in Covad, substantially offset by a decrease in our average cashand marketable securities balances. Our weighted average investment yieldsincreased from approximately 3.1% during year ended December 31, 2005 toapproximately 4.8% during the year ended December 31, 2006, as the U.S.Federal Reserve Bank has increased interest rates. Our average cash and marketablesecurities balance decreased from $446.5 million during the year ended December 31,2005 to $295.5 million during the year ended December 31, 2006. Our cashand investment balances decreased as a result of repurchases of our commonstock, investments in the HELIO joint venture, our investment in Covad to fundline-powered voice, capital expenditures, the acquisition of New Edge and purchasesof subscriber bases from other companies, offset by cash provided by operationsand cash provided by the issuance of convertible senior notes.

*Provision forincome taxes*

The provision for income taxes was $4.5 million, $22.5million and $0.9 million during the years ended December 31, 2004, 2005and 2006, respectively. Although we utilized net operating loss carryforwardsto offset taxable income in those years, state income and federal and statealternative minimum tax (“AMT”) amounts aggregating $5.4 million were payablein 2005, and the AMT was payable primarily due to the net operating losscarryforward limitations associated with the AMT calculation. Although certainof the AMT amounts can be used in future periods to offset taxable income, weestablished a valuation allowance for the AMT amounts payable due touncertainty regarding their realizability, which resulted in an income taxprovision of $2.6 million in 2005. The provision for income taxes in 2005 alsoincludes a non-cash deferred tax provision of $17.1 million associated with theutilization of net operating loss carryforwards which were acquired inconnection with the acquisitions of OneMain, PeoplePC and Cidco. The increasein the provision for income taxes during the year ended December 31, 2005compared to the prior year was primarily due to the realization of NOLs ofacquired companies and the mix of organic and acquired NOLs realized, becausethe realization of NOLs of acquired companies results in non-cash, deferredincome tax expense. The provision for income taxes during the year ended December 31,2006 primarily consisted of state income tax amounts due in jurisdictions wherewe do not have NOLs.

We continue to maintain afull valuation allowance against our deferred tax assets, consisting primarilyof net operating loss carryforwards, and we may recognize deferred tax assetsin future periods when they are determined to be realizable.

**Stock-BasedCompensation**

Prior to January 1, 2006, we accounted forstock-based compensation issued to employees using the intrinsic value method. Generally,no stock-based employee compensation cost related to stock options 

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was reflected in netincome, as all options granted under stock-based compensation plans had anexercise price equal to the market value of the underlying common stock on thegrant date. Compensation cost related to restricted stock units granted tonon-employee directors and certain key employees was reflected in net income asservices were rendered.

On January 1, 2006, we adopted SFAS No. 123(R),which requires measurement of compensation cost for all stock awards at fairvalue on the date of grant and recognition of compensation over the requisiteservice period for awards expected to vest. The fair value of our stock optionsis estimated using the Black-Scholes valuation model, and the fair value ofrestricted stock units is determined based on the number of shares granted andthe quoted price of our common stock on the date of grant*.* Such value is recognized as expense overthe requisite service period, net of estimated forfeitures, using thestraight-line attribution method. The estimate of awards that will ultimatelyvest requires significant judgment, and to the extent actual results or updatedestimates differ from management’s current estimates, such amounts will berecorded as a cumulative adjustment in the period estimates are revised. Weconsider many factors when estimating expected forfeitures, including types ofawards, employee class and historical employee attrition rates. Actual results,and future changes in estimates, may differ substantially from our currentestimates.

We adopted SFAS 123(R) usingthe modified prospective method which requires the application of theaccounting standard as of January 1, 2006. Our consolidated financialstatements as of and for the year ended December 31, 2006 reflects theimpact of SFAS 123(R). In accordance with the modified prospective method,the consolidated financial statements for the prior years have not beenrestated to reflect, and do not include, the impact of SFAS 123(R). Thecumulative effect of adoption of SFAS No. 123(R) was notmaterial. Stock-based compensation expense under SFAS No. 123(R) was$14.2 million during the year ended December 31, 2006, of which $12.2million related to stock options and $2.0 million related to restricted stockunits. Stock-based compensation during the year ended December 31, 2006 isclassified within the same operating expense line items as cash compensationpaid to employees. Stock-based compensation expense was $0.6 million and $1.5million during the years ended December 31, 2004 and 2005, respectively,which related to restricted stock units and modifications of stock options.

**Facility Exit andRestructuring Costs**

During the years ended December 31, 2003, 2004and 2005, we executed plans to streamline our contact center facilities andoperations. Under the 2003 Plan, we closed contact centers in Dallas, Texas;Sacramento, California; Pasadena, California; and Seattle, Washington. Theclosure of the four contact centers resulted in the termination of 1,220employees and a net reduction of 920 employees, primarily customer supportpersonnel. Under the 2004 Plan, EarthLink closed contact center operations inHarrisburg, Pennsylvania; Roseville, California; San Jose, California; andPasadena, California; and reduced contact center operations in Atlanta,Georgia. Approximately 1,140 employees were directly impacted, primarily customersupport personnel. Under the 2005 Plans, we outsourced certain contact centerand credit and collections activities. Approximately 227 employees weredirectly impacted. We realized reduced costs following the years of therestructurings as a result of completing the various plans.

As of December 31, 2006, we had paid alltelecommunications service termination costs and employee and personnel relatedcosts related to the 2003 Plan, the 2004 Plan and the 2005 Plans. As of December 31,2006, we had $1.2 million and $2.6 million remaining for real estatecommitments associated with the 2003 Plan and the 2004 Plan, respectively. Weexpect to incur future cash outflows for real estate obligations through 2010related to the 2003 Plan and through 2008 related to the 2004 Plan.

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**Liquidity andCapital Resources**

Thefollowing table sets forth summarized cash flow data for the years ended December 31,2004, 2005 and 2006:

| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **(in thousands)**                    | ** ** |
| Net income                                          |       | $                                          | 111,009    |   | $ | 142,780 |   | $ | 4,987 |   |
| Non-cash items                                      |       | 119,597                                    |       | 100,844 |   | 169,207 |   |
| Changes in  working capital                         |       | (42,454                                    | )          | (54,920 | ) | (58,945 | ) |
| Net cash provided  by operating activities          |       | $                                          | 188,152    |   | $ | 188,704 |   | $ | 115,249 |   |
| Net cash used in investing activities               |       | $                                          | (69,070    | ) | $ | (65,081 | ) | $ | (283,064 | ) |
| Net cash (used in) provided by financing activities |       | $                                          | (108,912   | ) | $ | (169,239 | ) | $ | 152,890 |   |

 

*Operatingactivities*

Net cash provided by operating activities wasrelatively constant during the years ended December 31, 2004 and 2005, butdecreased during the year ended December 31, 2006 compared to the prioryears. This was primarily due to an increase in costs related to our broadbandinitiatives, including municipal wireless broadband and IP-based voiceservices, as we used cash generated from our core access services to fund theseinitiatives. Cash flows from operating activities are expected to be adverselyaffected in 2007 as we continue to fund our strategic initiatives in the formof increased operating and sales and marketing expenses; however, we must seekto effectively manage expenses associated with our core access services and ourworking capital to mitigate the adverse impact our growth initiatives areexpected to have on our operating cash flows.

Non-cash items include items that are not expected togenerate or require the use of cash, such as depreciation and amortizationrelating to our network, facilities and intangible assets, net losses of equityaffiliate, deferred income taxes, stock-based compensation, non-cash disposalsand impairments of fixed assets and gain (loss) on investments in othercompanies, net. Non-cash items decreased during the year ended December 31,2005 due to decreases in depreciation and amortization expense, offset by netlosses of equity affiliate related to our investment in HELIO and deferredincome taxes associated with the utilization of acquired net operating losscarryforwards. Non-cash items increased during the year ended December 31,2006 due to an increase in net losses of equity affiliate and stock-basedcompensation expense from the adoption of SFAS No. 123(R).

Changes in working capitalrequirements include changes in accounts receivable, prepaid and other assets,accounts payable, accrued and other liabilities and deferred revenue. Cash usedfor working capital requirements increased during 2005 primarily due todeclines in accrued liabilities for telecommunications costs due largely todecreases in such costs and payments for contractual commitments associatedwith facility exit and restructuring costs. Cash used for working capitalrequirements increased during 2006 primarily due to an increase in prepaidexpenses and other assets.

*Investingactivities*

Net cash used for investing activities was relativelyconstant during the years ended December 31, 2004 and 2005, but increasedduring the year ended December 31, 2006 compared to the prior years. Thiswas primarily due to investments in our strategic initiatives, includingmunicipal wireless broadband, IP-based voice services and New Edge, and investmentsin HELIO. Additionally, over the past few years we have invested significantlyin our network and technology center infrastructure, and we expect to 

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continue to invest capitalto enhance the reliability and capacity of our network, to improve theefficiency of our technical and customer support services and to build outmunicipal wireless broadband networks.

Our investing activities used cash of $69.1 millionduring the year ended December 31, 2004. This consisted primarily of $33.7million for purchases of investments in marketable securities, net of sales andmaturities, as a result of investing cash flows generated by operatingactivities in marketable securities; $29.9 million for capital expenditures,primarily associated with network and technology center related projects; $3.8million for investments in other companies; and $2.4 million for acquiringsubscriber bases from other companies, primarily related to paying liabilitiesincurred in the acquisitions of subscriber bases during 2003.

Our investing activities used cash of $65.1 millionduring the year ended December 31, 2005. This consisted primarily of $82.3million for our investment in HELIO. In addition, we used $33.9 million forcapital expenditures, primarily associated with network and technology centerrelated projects; $9.4 million to purchase the assets of Aluria; and $6.7million for acquiring subscriber bases from other companies. Offsetting theseinvesting outlays were proceeds of $63.5 million from sales and maturities ofinvestments in marketable securities, net of purchases, and $4.4 million ofdistributions received from our equity investments in other companies.

Our investing activitiesused cash of $283.1 million during the year ended December 31, 2006. Thisconsisted of $108.7 million for our acquisition of New Edge; $79.0 million forour investment in HELIO; $60.0 million for investments in other companies,including our investment in Covad; $38.9 million for capital expenditures,primarily associated with network and technology center related projects; and$8.9 million for acquiring subscriber bases from other companies. Managementcontinuously reviews industry and economic conditions to identify opportunitiesto pursue acquisitions of subscriber bases and invest in and acquire othercompanies. Offsetting these investing outlays were proceeds of $12.7 millionfrom sales and maturities of investments in marketable securities, net ofpurchases.

*Financingactivities*

Our financing activitiesused cash of $108.9 million and $169.2 million during the years ended December 31,2004 and 2005, respectively. This consisted primarily of $125.7 million and$192.6 million, respectively, used to repurchase 12.7 million and 20.5 millionshares, respectively, of our common stock. Offsetting cash used for repurchaseswere proceeds from the exercise of stock options and from the sale of commonstock pursuant to our employee stock purchase plan of $17.7 million and $23.4million during the years ended December 31, 2004 and 2005, respectively.Our financing activities provided cash of $152.9 million during the year ended December 31,2006. This consisted primarily of $251.6 million from the issuance ofconvertible senior notes in November 2006, net of issuance costs.Approximately $15.1 million of the proceeds from the issuance of convertiblesenior notes were used for hedging transactions to reduce the potentialdilution upon conversion. The remaining proceeds will be used for generalcorporate purposes. We also received $4.0 million in proceeds from the exerciseof stock options. Offsetting this cash provided was $85.6 million used torepurchase 11.3 million shares of our common stock.

**Off-Balance SheetArrangements**

As of December 31,2006, we did not have any off-balance sheet arrangements that have or arereasonably likely to have a current or future effect on our financialcondition, changes in financial condition, revenues or expenses, results ofoperations, liquidity, capital expenditures or capital resources that arematerial to investors.

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**ContractualObligations and Commitments**

As of December 31,2006, we had the following contractual commitments:

| ** **                                                             | ** ** | **Year Ending December 31,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                             | ** ** | **2007**                                    | ** ** | **2008** | ** ** | **2009** | ** ** | **2010 –  2014** | ** ** |
| ** **                                                             | ** ** | **(in millions)**                      | ** ** |
| Non-cancelable  operating leases(1)                                    |       | $                                           | 14.9       |   | $ | 11.1 |   | $ | 12.5 |   | $ | 50.5 |   |
| Non-cancelable  network service agreements and purchase commitments(2) |       | 55.6                                        |       | 37.1 |   | 5.1 |   | — |   |
| Long-term debt(3)                                                      |       | —                                      |       | — |   | — |   | 258.8 |   |
|                                                                   |       | $                                           | 70.5       |   | $ | 48.2 |   | $ | 17.6 |   | $ | 309.3 |   |

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(1)   These amountsrepresent base rent payments under non-cancelable operating leases forfacilities and equipment that expire in various years through 2014, as well asan allocation for operating expenses. Not included in these amounts iscontracted sublease income of $3.6 million, $2.5 million, $1.7 million, $1.2million and $0.1 million during the years ending December 31, 2007, 2008, 2009,2010 and 2011, respectively.

(2)   Theseamounts represent non-cancelable network service agreements with third-partyproviders of Internet access that expire at various dates through 2009 andother purchase commitments.

(3)   During November 2006, we issued $258.8 million aggregateprincipal amount of Convertible Senior Notes due November 15, 2026 (the “Notes”)in a registered offering, which includes the exercise by the underwriters oftheir option to purchase an additional $33.8 million to cover over-allotments.The Notes bear interest at 3.25% per year on the principal amount of the Notesuntil 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.

During the year ended December 31,2006, we entered into a financing lease agreement with General Electric CapitalCorporation to lease certain equipment necessary to build out our municipalwireless infrastructure in selected markets. Under the agreement, we can leaseup to $75.0 million of assets. As of December 31, 2006, no equipment wasleased pursuant to the financing agreement.

**Share RepurchaseProgram**

The Board of Directors hasauthorized a total of $550.0 million to repurchase our common stock under ourshare repurchase program. As of February 28, 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 $356.9 million,consisting primarily of net operating loss carryforwards, and we may recognizedeferred tax assets in future periods when they are determined to berealizable. To the extent we may owe income taxes in future periods, we intendto use our net operating loss carryforwards to the extent available to reducecash outflows for income taxes.

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**Future Uses of Cashand Funding Sources**

We expect to use and invest cash during the yearending December 31, 2007 for a number of reasons, including buildingmunicipal wireless networks and growing our subscriber base for municipalwireless services, IP-based voice services and business services. This willprimarily consist of increased operating and sales and marketing expenditures.We also expect to use cash for commitments pursuant to the Contribution andFormation Agreement for our HELIO joint venture, including cash contributionsof $13.5 million paid in February 2007 and $6.0 million to be paid in August 2007,as well as for possible additional investments in HELIO.

We have expended and will continue to expendsignificant resources enhancing our existing services and developing,acquiring, implementing and launching new services, such as IP-based voiceservices and wireless broadband services. We believe IP-based voice servicesand wireless broadband services represent significant growth opportunities andmay require significant cash outlays. These uses of cash will be in the form ofinitial product development and infrastructure costs, followed by sales andmarketing costs to add customers that will generate recurring revenues. Capitalexpenditures are expected to increase in 2007 as we invest in our growthinitiatives. These initiatives may result in significant capital expendituresto develop, implement and build wireless broadband networks in variousmunicipalities. We also expect to incur capital expenditures to maintain andupgrade our network and technology infrastructure. The actual amount of capitalexpenditures in 2007 as well as in future periods may fluctuate due to a numberof factors which are difficult to predict and could change significantly overtime, including, without limitation, the timing and extent of municipalwireless network build-outs and additional awards to build out networks.Additionally, technological advances may require us to make capital expendituresto develop or acquire new equipment or technology in order to replace aging ortechnologically obsolete equipment. We also expect to continue to use cash toacquire and retain new and existing subscribers for our core access services.

HELIO is our joint venture with SK Telecom, thatmarkets wireless voice and data services in the U.S. Pursuant to theContribution and Formation Agreement, we invested $82.0 million of cash in2005, invested $78.5 million of cash in 2006, invested $13.5 million in February 2007and are committed to invest additional cash of $6.0 million in HELIO in August 2007.HELIO will require additional funding in the future and we expect we may investadditional cash in HELIO. We expect the future commitments to invest in HELIOto adversely affect our cash position.

Our cash requirements depend on numerous factors,including the rate of market acceptance of our and HELIO’s services, ourability to successfully develop new revenue sources, our ability to maintainand expand our customer base, the rate of expansion of our networkinfrastructure, the size and types of acquisitions in which we may engage andthe level of resources required to expand our sales and marketing programs.

Our principal sources of liquidity are our cash, cashequivalents and investments in marketable securities, as well as the cash flowwe generate from our core access operations. As of December 31, 2006, wehad $158.4 million in cash and cash equivalents. In addition, we held short-and long-term investments in marketable securities valued at $214.9 million and$21.5 million, respectively. Short-term investments in marketable securitiesconsist of investments that have maturity dates of up to one year from thebalance sheet date and asset-backed, auction rate securities that have interestrate reset periods of up to one year from the balance sheet date, and long-terminvestments in marketable securities consist of investments that have maturitydates of more than one year from the balance sheet date.

During November 2006, we issued $258.8 millionaggregate 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 cover over-allotments.We received net proceeds of $251.6 million after transaction fees of $7.2million. We used $15.1 million of the proceeds for hedge 

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transactions and warranttransactions to reduce the potential dilution upon conversion of theconvertible senior notes. The remaining proceeds will be used for generalcorporate purposes, including expenditures related to our growth initiatives.

During the year ended December 31, 2006, weentered into a financing lease agreement with General Electric CapitalCorporation to lease certain equipment necessary to build out our municipalwireless infrastructure in selected markets. Under the agreement, we can leaseup to $75.0 million of assets. As of December 31, 2006, no equipment wasleased pursuant to the financing agreement.

Our available cash andmarketable securities, together with our results of operations, are expected tobe sufficient to meet our operating expenses, capital requirements andinvestment and other obligations for the next 12 months. However, as a resultof our growth initiatives and other investment activities, we may seekadditional financing in the future. Except for our financing lease agreementdiscussed above, we have no commitments for any additional financing and haveno lines of credit or similar sources of financing. We cannot be sure that wecan obtain additional financing on favorable terms, if at all, through theissuance of equity securities or the incurrence of additional debt. Additionalequity financing may dilute our stockholders, and debt financing, if available,may restrict our ability to declare and pay dividends and raise future capital.If we are unable to obtain additional needed financing, we may be required toreduce our planned capital expenditures, suspend or reduce our investmentactivities and/or reduce any of our planned growth initiatives, which couldmaterially and adversely affect our prospects for long-term growth.

**Related PartyTransactions**

*HELIO*

EarthLink and HELIO have entered into a servicesagreement pursuant to which we provide HELIO facilities, accounting, tax,billing, procurement, risk management, payroll, human resource, employeebenefit administration and other support services in exchange for managementfees. However, as HELIO develops its business, the extent to which HELIO relieson us to provide these services has decreased. We believe that providing theseservices to HELIO enabled HELIO to more quickly and cost effectively launch itsbusiness than if it were to purchase these services from third parties. Themanagement fees were determined based on our costs to provide the services, andmanagement believes such fees are reasonable. The total amount of fees thatHELIO pays to us depends on the extent to which HELIO utilizes our services. Feesfor services provided to HELIO are reflected as reductions to the associatedexpenses incurred by us to provide such services. During the years ended December 31,2005 and 2006, fees received for services provided to HELIO were $3.0 millionand $2.3 million, respectively.

We market HELIO’s products and services, and duringthe years ended December 31, 2005 and 2006, we generated revenues of $0.3million and $0.9 million, respectively, associated with marketing HELIO’sservices.

We purchase wireless Internet access devices andservices from HELIO. During the years ended December 31, 2005 and 2006,fees paid for products and services received from HELIO were $0.9 million and$0.9 million, respectively.

As of December 31,2005 and 2006, we had accounts receivable from HELIO of approximately $0.3 millionand $0.8 million.

*Sprint*

Through its ownershipinterest in us, Sprint was considered a related party during the year ended December 31,2004. Due to sales of shares of our common stock during the year ended December 31,2005, Sprint is no longer considered a related party. We have a marketing relationshipwith Embarq, a 

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spin-off of Sprint’s localcommunications business. Our marketing relationship with Embarq generatedapproximately 10% of our total gross organic subscriber additions during theyear ended December 31, 2004. In connection with our marketingrelationship with Embarq,we provide wholesale broadband, narrowband and other services to Embarq. We receivedapproximately $27.6 million during the year ended December 31, 2004 forthese services. The prices for services provided by us to Embarq were negotiated atarms-length.

Sprint is one of ourprincipal telecommunications service providers. We paid Sprint approximately$57.6 million during the year ended December 31, 2004 associated withnetwork and voice services agreements. The prices paid for services purchasedfrom Sprint were negotiated at arms-length.

*Officers and Directors*

Our investments in othercompanies include an investment in EVG, a limited partnership formed to investin domestic emerging Internet-related companies. Sky Dayton, a member of ourBoard of Directors and a member of HELIO’s Board of Directors, is a foundingpartner in EVG. EVG also has an affiliation with eCompanies. Sky Dayton is afounder and director of eCompanies. During the years ended December 31,2005 and 2006, we received $4.4 million and $0.4 million in cash distributionsfrom EVG.

**Critical Accounting Policies and Estimates**

Set forth below is adiscussion of the accounting policies and related estimates that we believe arethe most critical to understanding our consolidated financial statements,financial condition, and results of operations and which require complexmanagement judgments, uncertainties and/or estimates. The preparation of financialstatements in accordance with U.S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, the disclosure of contingent assets andliabilities, and the reported amounts of revenues and expenses during areporting period; however, actual results could differ from those estimates.Management has discussed the development, selection and disclosure of thecritical accounting policies and estimates with the Audit Committee of theBoard of Directors. Information regarding our other accounting policies isincluded in the Notes to Consolidated Financial Statements.

*Revenue recognition*

*Gross versus net revenuerecognition.*   Wemaintain relationships with certain telecommunications partners in which weprovide services to customers using the “last mile” element of thetelecommunications providers’ networks. The term “last mile” generally refersto the element of telecommunications networks that is directly connected tohomes and businesses. In these instances, management evaluates the criteriaoutlined in Emerging Issues Task Force (“EITF”) Issue No. 99-19,“Reporting Revenue Gross as a Principal versus Net as an Agent,” in determiningwhether it is appropriate to record the gross amount of revenue and relatedcosts or the net amount due from the telecommunications partner as revenue.Generally, when we are the primary obligor in the transaction with thesubscriber, have latitude in establishing prices, are the party determining theservice specifications or have several but not all of these indicators, werecord the revenue at the amount billed the subscriber. If we are not theprimary obligor and/or the telecommunications partner has latitude inestablishing prices, we record revenue associated with the related subscriberson a net basis, netting the cost of revenue associated with the service againstthe gross amount billed the customer and recording the net amount as revenue.The determination of whether we meet many of the attributes specified in EITFIssue No. 99-19 for gross and net revenue recognition is judgmentalin nature and is based on an evaluation of the terms of each arrangement. Achange in the determination of gross versus net revenue recognition would havean impact on the gross amounts of revenues and cost of revenues we recognizeand the gross profit margin percentages in the period in which suchdetermination is made and in subsequent periods; however, such a change indetermination of revenue recognition would not affect net income.

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*Sales incentives.*   We have marketingarrangements with a number of leading hardware and software manufacturers toinclude our Internet access software pre-installed on or included with theirproducts. We also market our products and services through retailers. We payfees to retailers, manufacturers or other marketing partners for marketing ourproducts and services. Depending on the nature of the arrangement, themarketing partners may purchase our products and services in addition toproviding marketing services. For these types of arrangements, management usesthe guidance provided in EITF Issue No. 01-9, “Accounting forConsideration Given by a Vendor to a Customer (Including a Reseller of theVendor’s Products),” which states that cash consideration given by a vendor toa customer is presumed to be a reduction of the selling price of the vendor’sproducts or services and should be classified as a reduction of revenue. If theretailer or manufacturer does not purchase our products or services, weclassify the fees as a sales and marketing expense when incurred because theretailer or manufacturer is not a reseller and the accounting in EITF Issue No. 01-9does not apply. If the retailer or manufacturer purchases and then resells ourproducts or services, we account for the fees as a reduction in revenue becausethe consideration is presumed to be a reduction of the selling price of ourproducts or services; however, if we receive an identifiable benefit whose fairvalue can be reasonably estimated in exchange for the fees, we classify thefees as operating expenses. Management applies judgment in determining whethera retailer or manufacturer is reselling our products and services or solelyproviding marketing services. Any change in this determination would have animpact on the gross amounts of revenues and cost of revenues we recognize andthe gross profit margin percentages in the period in which such determinationis made and in subsequent periods; however, such a change in determination ofrevenue recognition would not generally affect net income.

*Allowance fordoubtful accounts*

We maintain allowances for doubtful accounts forestimated losses resulting from the inability of our customers to makepayments. With respect to receivables due from consumers, our policy is tospecifically reserve for all consumer receivables 60 days or more past due andprovide additional reserves for receivables less than 60 days past due based onexpected write-offs. We provide reserves for commercial accounts receivable andperiodically evaluate commercial accounts receivable and provide specificreserves when accounts are deemed uncollectible. Commercial accounts receivableare written off when management determines there is no possibility ofcollection.

In judging the adequacy ofthe allowance for doubtful accounts, we consider multiple factors including theaging of our receivables, historical write-off experience and the generaleconomic environment. Management applies considerable judgment in assessing therealization of receivables, including assessing the probability of collectionand the current creditworthiness of classes of customers. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may be required.

*Deferred tax assetvaluation allowance*

We recognize deferred taxassets and liabilities using estimated future tax rates for the effect oftemporary differences between the book and tax bases of recorded assets andliabilities, including net operating loss carryforwards. Management assessesthe realizability of deferred tax assets and records a valuation allowance ifit is more likely than not that all or a portion of the deferred tax assetswill not be realized. Based on management’s assessment, a valuation allowancehas been established for all of our deferred tax assets as of December 31,2006, primarily net operating loss carryforwards, due to uncertainty regardingtheir realization. We consider the probability of future taxable income and ourhistorical profitability, among other factors, in assessing the amount of thevaluation allowance. However, adjustments could be required in the future if weestimate that the amount of deferred tax assets to be realized is more than thenet amount we have recorded. Any decrease in the valuation allowance could 

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have theeffect of increasing stockholders’ equity, reducing goodwill and/or increasingor decreasing the income tax provision in the statement of operations based onthe nature of the deferred tax asset deemed realizable in the period in whichsuch determination is made.

*Recoverability ofnoncurrent assets*

Our indefinite lived intangible assets consistprimarily of goodwill. As of December 31, 2006, the carrying value ofgoodwill was $202.3 million. We account for intangible assets in accordancewith SFAS No. 142, “Goodwill and Other Intangible Assets,” whichrequires that goodwill be tested for impairment at least annually. We performan impairment test of our goodwill annually during the fourth quarter of ourfiscal year or when events and circumstances indicate the indefinite livedintangible assets might be permanently impaired. Impairment testing of goodwillis tested at the reporting unit level by comparing the reporting unit’scarrying amount, including goodwill, to the fair value of the reporting unit.The fair values of the reporting unit are estimated using discounted projectedcash flows. If the carrying amount of the reporting unit exceeds its fairvalue, goodwill is considered impaired and a second step is performed tomeasure the amount of the impairment loss, if any. Based on our test during thefourth quarter of 2006, we concluded that there was no impairment of ourgoodwill and other indefinite lived intangible assets. Application of thegoodwill impairment test requires judgment, including the identification ofreporting units, assigning assets and liabilities to reporting units, assigninggoodwill to reporting units, and determining the fair value of each reportingunit. Significant judgments required to estimate the fair value of reportingunits include estimating future cash flows, determining appropriate discountrates, growth rates and other assumptions. Changes in these estimates andassumptions could materially affect the determination of fair value for eachreporting unit which could trigger an impairment. Additionally, ifmanagement determines that events or circumstances have occurred which couldresult in an other than temporary impairment of goodwill, we may be required torecord a significant impairment adjustment, which would reduce earnings.

For noncurrent assets suchas property and equipment, purchased intangible assets and investments in othercompanies, we perform tests of impairment when certain events or changes incircumstances indicate that the carrying amount may not be recoverable. Ourtests involve critical estimates reflecting management’s best assumptions andestimates related to, among other factors, subscriber additions, churn, prices,marketing spending, operating costs and capital spending. Significant judgmentis involved in estimating these factors, and they include inherentuncertainties. Management periodically evaluates and updates the estimatesbased on the conditions that influence these factors. The variability of thesefactors depends on a number of conditions, including uncertainty about futureevents, and thus our accounting estimates may change from period to period. Ifother assumptions and estimates had been used in the current period, thebalances for noncurrent assets of $215.7 million could have been materiallyimpacted. Furthermore, if management uses different assumptions or if differentconditions occur in future periods, future operating results could bematerially impacted.

*Investments*

From time to time, we make investments in othercompanies. At the date we become involved with an entity and upon changes inthe capital structure and corporate governance provisions of the entity,management evaluates investments in other companies to determine if we mustconsolidate the results of the investee pursuant to Financial AccountingStandards Board (“FASB”) Interpretation No. 46, “Consolidation of VariableInterest Entities”. Variable interest entities (“VIEs”) are entities thateither do not have equity investors with proportionate economic and votingrights or have equity investors that do not provide sufficient financialresources for the entity to support its activities. Consolidation is requiredif we are the primary beneficiary of the VIE, meaning we absorb a majority ofthe expected losses and/or receive a majority of the expected returns. Indetermining if an equity investee is a VIE and whether we 

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must consolidate itsresults, management evaluates whether the equity of the entity is sufficient toabsorb its expected losses and whether we are the primary beneficiary. Ifmanagement determines the investee is not a VIE or if it is a VIE and we arenot the primary beneficiary, management evaluates whether we should include ourproportionate share of the investee’s operating results in our results pursuantto Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Methodof Accounting for Investments In Common Stock,” and related interpretationsbecause we may be able to significantly influence financial and operatingpolicies of the investee or whether we should consolidate the results based onour ability to control the operating and financial policies of the investee.

The assessment as to whether the investee is a VIE,whether we are the primary beneficiary, and whether we can exert significantinfluence over or control the operating and financial policies of the investeerequires estimates and judgments. Management has determined that we are notrequired to consolidate any of our investments. In addition, managementdetermined that except with respect to our investment in HELIO, we cannotsignificantly influence the operating and financial policies of any ourinvestees. Consequently, investments in other companies, other than ourinvestment in HELIO, are included in other long-term assets and are accountedfor under the cost method. Under the cost method of accounting, investments inprivate companies are carried at cost and are only adjusted for other-than-temporarydeclines in fair value and distributions of earnings. We have investments in companiesaccounted for under the cost method whose stock has a readily determinablemarket value. When our investments have a readily determinable market valuebased on quoted prices on a national exchange, we adjust the carrying value ofthe investment to market value through “unrealized gains (losses) oninvestments” which is included as a component of stockholders’ equity.

With respect to ourinvestment in the HELIO joint venture, management determined HELIO did notqualify as a VIE, but we are able to exert significant influence over HELIO’soperating and financial policies. As a result, we apply the equity method toour investment in HELIO and record our proportionate share of HELIO’s netincome (loss) in our statement of operations as “net earnings (losses) ofequity affiliates,” which is expected to adversely affect our net results inthe near term. However, this accounting treatment is subject to change as HELIOenters into financial and operating arrangements that impact the joint venturepartners’ economic and voting interests.

*Stock-basedcompensation*

Effective January 1, 2006 we adopted SFAS No. 123(R) usingthe modified prospective method and therefore have not restated prior periods’results. Under the fair value recognition provisions of SFAS 123R, werecognize stock-based compensation net of an estimated forfeiture rate andtherefore only recognize compensation cost for those shares expected to vestover the service period of the award. Prior to SFAS No. 123(R) adoption,we accounted for share-based payments under APB No. 25 and accordingly,recognized stock-based compensation expense related to restricted stock unitsand modifications of stock options and accounted for forfeitures as theyoccurred.

Calculating stock-basedcompensation expense requires the input of highly subjective assumptions,including the expected term of the stock-based awards, stock price volatilityand the pre-vesting option forfeiture rate. We estimate the expected life ofoptions granted based on historical exercise patterns, which we believe arerepresentative of future behavior. We estimate the volatility of our commonstock on the date of grant based on historical volatility and on the impliedvolatility of publicly traded options on our common stock, with a term of oneyear or greater. The assumptions used in calculating the fair value ofstock-based awards represent our best estimates, but these estimates involveinherent uncertainties and the application of management judgment. As a result,if factors change and we use different assumptions, our stock-basedcompensation expense could be materially different in the future. In addition,we are required to estimate the expected forfeiture rate and only recognizeexpense for those shares expected to vest. We estimate the forfeiture ratebased on historical experience of our stock-based awards that are granted, 

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exercisedand cancelled. If our actual forfeiture rate is materially different from ourestimate, the stock-based compensation expense could be significantlydifferent from what we have recorded in the current period.

**Recently IssuedAccounting Pronouncements**

In June 2006, the FASB ratified the consensusreached in EITF Issue No. 06-2, “Accounting for Sabbatical Leave andOther Similar Benefits Pursuant to FASB Statement No. 43.” EITF Issue No. 06-2provides recognition guidance on the accrual of employees’ rights tocompensated absences under a sabbatical or other similar benefit arrangement.EITF Issue No. 06-2 is effective for the Company for all financialstatements after December 31, 2006. We are currently assessing the impactof the adoption of EITF Issue No. 06-2 on our financial statements.

In July 2006, the FASB issued FIN No. 48, “Accountingfor Uncertainty in Income Taxes,” which prescribes a comprehensive model forhow a company should recognize, measure, present and disclose in its financialstatements uncertain tax positions that the company has taken or expects totake on a tax return (including a decision whether to file or not to file areturn in a particular jurisdiction). The accounting provisions of FIN No. 48are effective for fiscal years beginning after December 15, 2006. We willadopt FIN No. 48 on January 1, 2007 and we do not believe itsadoption will result in a material cumulative-effect adjustment.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”, which establishesa framework for reporting fair value and expands disclosures about fair valuemeasurements. SFAS No. 157 is effective for financial statements issuedfor fiscal years beginning after November 15, 2007 and interim periodswithin those fiscal years. We are currently assessing the impact of theadoption of this standard on our financial statements.

**Item 7A.   Quantitativeand Qualitative Disclosures about Market Risk.**

*Interest Rate Risk*

We are exposed to interest rate risk with respect toour investments in marketable securities. A change in prevailing interest ratesmay cause the fair value of our investments to fluctuate. For example, if wehold a security that was issued with a fixed interest rate at thethen-prevailing rate and the prevailing interest rate later rises, the fairvalue of its investment may decline. To minimize this risk, we have historicallyheld many investments until maturity, and as a result, we receive interest andprincipal amounts pursuant to the underlying agreements. To further mitigaterisk, we maintain a portfolio of investments in a variety of securities,including government agency notes, asset-backed debt securities (includingauction rate debt securities), corporate notes and commercial paper, all ofwhich bear a minimum short-term rating of A1/P1 or a minimum long-term ratingof A/A2. As of December 31, 2005 and 2006, net unrealized losses in theseinvestments were not material. In general, money market funds are not subjectto market risk because the interest paid on such funds fluctuates with theprevailing 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.

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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 31,2005 and 2006. This table does not include money market funds because thosefunds are not subject to interest rate risk.

| ** **                                   | ** ** | **As of December 31, 2005** | ** ** | **As of December 31, 2006** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                   | ** ** | ** **                                      | ** ** | **Estimated**                                   | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                   | ** ** | **Amortized**                                   | ** ** | **Fair**                                        | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                                   | ** ** | **Cost**                                        | ** ** | **Value**                                       | ** ** | **Cost** | ** ** | **Value** | ** ** |
| ** **                                   | ** ** | **(dollars in thousands)**            | ** ** |
| Included in cash  and cash equivalents       |       | $                                               | 66,068     |                                            | $          | 66,068 |   | $ | 46,289 |   | $ | 46,289 |   |
| Weighted average  interest rate              |       | 4.3%                                            |       |                                            |       | 5.3% |   |   |   |
| Weighted average  maturity (mos.)            |       | 1.2                                             |       |                                            |       | 1.0 |   |   |   |
| Included in marketable securities-short-term |       | $                                               | 208,265    |                                            | $          | 207,845 |   | $ | 215,181 |   | $ | 214,947 |   |
| Weighted average  interest rate              |       | 4.0%                                            |       |                                            |       | 5.2% |   |   |   |
| Weighted average  maturity (mos.)*           |       | 3.9                                             |       |                                            |       | 2.7 |   |   |   |
| Included in marketable securities-long-term  |       | $                                               | 41,130     |                                            | $          | 40,980 |   | $ | 21,497 |   | $ | 21,460 |   |
| Weighted average  interest rate              |       | 4.2%                                            |       |                                            |       | 5.2% |   |   |   |
| Weighted average  maturity (mos.)            |       | 22.1                                            |       |                                            |       | 19.3 |   |   |   |

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*       Thematurity of asset-backed, auction rate securities for purposes of thiscalculation is consistent with management’s view as to the availability of suchsecurities to fund current operating activities.

We are also exposed tointerest rate risk with respect to our convertible senior notes due November 15,2026. The fair value of our convertible senior notes may be adversely impacteddue to a rise in interest rates. In general, securities with longer maturitiesare subject to greater interest rate risk than those with shorter maturities.Our convertible senior notes bear interest at a fixed rate of 3.25% per yearuntil November 15, 2011, and 3.50% interest per year thereafter. As of December 31,2006, the carrying value of our convertible senior notes was $258.8 million andthe fair value was approximately $277.3 million, which was based on the quotedmarket price.

*Equity Risk*

We are exposed to equity price risk as it relates tochanges in the market value of our equity investments and call options. Weinvest in equity instruments of public and private companies for operationaland strategic purposes. In connection with the issuance of our convertiblesenior notes, we purchased call options to cover approximately 28.4 millionshares of our common stock, subject to adjustment in certain circumstances,which is the number of shares underlying the notes. These securities aresubject to significant fluctuations in fair market value due to volatility ofthe stock market and the industries in which the companies operate. Wetypically do not attempt to reduce or eliminate our market exposure in theseequity instruments.

Thefollowing table presents the carrying value and fair value of our financialinstruments subject to equity risk as of December 31, 2005 and 2006:

| ** **                                       | ** ** | **As of December 31, 2005** | ** ** | **As of December 31, 2006** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                       | ** ** | ** **                                      | ** ** | **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               |       |                                            | $          | 417                                             |       |   |   | $ | 417 |   |   |   | $ | 48,325 |   |   |   | $ | 48,325 |   |   |
| Not practicable to estimate fair value           |       |                                            | 1,000      |                                            |       |   | — |   |   |   | 11,000 |   |   |   | — |   |   |
| Call options                                     |       |                                            | —     |                                            |       |   | — |   |   |   | 47,162 |   |   |   | 58,361 |   |   |
|                                                  |            |                                                 |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Item 8.**                        FinancialStatements And Supplementary Data. 

**EARTHLINK,INC.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**
|                                                                                                                                                  | ** ** | **Page** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Reports of Independent Registered  Public Accounting Firm                                                                                        |       | 64       |   |
| Consolidated Balance Sheets as of  December 31, 2005 and 2006                                                                               |       | 66       |   |
| Consolidated Statements of  Operations for the years ended December 31, 2004, 2005 and 2006                                                 |       | 67       |   |
| Consolidated Statements of  Stockholders’ Equity and Comprehensive Income (Loss) for the years ended  December 31, 2004, 2005 and 2006 |       | 68       |   |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2004, 2005 and 2006                                                 |       | 69       |   |
| Notes  to Consolidated Financial Statements                                                                                                      |       | 70       |   |

 

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

The Board of Directors andStockholders of EarthLink, Inc.

We have audited the accompanying consolidated balancesheets of EarthLink, Inc. as of December 31, 2005 and 2006, and therelated consolidated statements of operations, stockholders’ equity andcomprehensive income (loss), and cash flows for each of the three years in theperiod ended December 31, 2006. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

We conducted our audits in accordance with standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of EarthLink, Inc. at December 31, 2005 and 2006,and the consolidated results of its operations and its cash flows for each ofthe three years in the period ended December 31, 2006, in conformity withU.S. generally accepted accounting principles.

As discussed in Note 2 of the Notes to theConsolidated Financial Statements, in 2006 the Company adopted Statement ofFinancial Accounting Standards No. 123 (revised), *Share-Based Payment*.

We alsohave audited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the effectiveness of EarthLink, Inc.’sinternal control over financial reporting as of December 31, 2006, basedon criteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated February 28, 2007 expressed an unqualified opinion thereon.
|                        | /s/ Ernst & Young  LLP |
|------------------------|---------------------------------|
| Atlanta, Georgia       |
| February 28, 2007 |

 

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ONINTERNAL CONTROL OVER FINANCIAL REPORTING**

The Board of Directors andStockholders of EarthLink, Inc.

We have audited management’sassessment, included in the accompanying Management’s Report on InternalControl Over Financial Reporting, that EarthLink, Inc. maintainedeffective internal control over financial reporting as of December 31,2006, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(the COSO criteria). EarthLink, Inc.’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting.Our responsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that EarthLink, Inc. maintained effective internal control overfinancial reporting as of December 31, 2006 is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, EarthLink, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 31, 2006 based on the COSO criteria.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets asof December 31, 2005 and 2006, and the related consolidated statements ofoperations, stockholders’ equity and comprehensive income (loss), and cashflows for each of the three years in the period ended December 31, 2006 ofEarthLink, Inc. and our report dated February 28, 2007 expressed anunqualified opinion thereon.

|                         | /s/  Ernst & Young LLP |
|-------------------------|---------------------------------|
| Atlanta, Georgia        |
| February 28,  2007 |

 

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**EARTHLINK, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except per share data)**

| ** **                                                                                                                                                                                                                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                         | ** ** | **2005**              | ** ** | **2006** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                         |
| Current assets:                                                                                                                                                                                                                                    |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                         |       | $                     | 173,294    |   | $ | 158,369 |   |
| Investments in  marketable securities                                                                                                                                                                                                              |       | 207,845               |       | 214,947 |   |
| Accounts receivable, net  of allowance of $8,054 and $8,062 as of December 31, 2005 and 2006,  respectively                                                                                                                                   |       | 36,033                |       | 51,054 |   |
| Prepaid expenses                                                                                                                                                                                                                                   |       | 14,225                |       | 14,831 |   |
| Other current assets                                                                                                                                                                                                                               |       | 13,121                |       | 17,549 |   |
| Total current assets                                                                                                                                                                                                                               |       | 444,518               |       | 456,750 |   |
| Long-term investments in  marketable securities                                                                                                                                                                                                    |       | 40,980                |       | 21,460 |   |
| Property and equipment,  net                                                                                                                                                                                                                       |       | 73,177                |       | 96,620 |   |
| Investment in equity  affiliate                                                                                                                                                                                                                    |       | 67,143                |       | 61,743 |   |
| Investments in other  companies                                                                                                                                                                                                                    |       | 1,417                 |       | 59,325 |   |
| Purchased intangible  assets, net                                                                                                                                                                                                                  |       | 16,278                |       | 59,798 |   |
| Goodwill                                                                                                                                                                                                                                           |       | 101,125               |       | 202,277 |   |
| Other long-term assets                                                                                                                                                                                                                             |       | 4,511                 |       | 10,066 |   |
| Total assets                                                                                                                                                                                                                                       |       | $                     | 749,149    |   | $ | 968,039 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                                                     |
| Current liabilities:                                                                                                                                                                                                                               |       |                  |       |   |   |
| Trade accounts payable                                                                                                                                                                                                                             |       | $                     | 31,578     |   | $ | 41,298 |   |
| Accrued payroll and  related expenses                                                                                                                                                                                                              |       | 37,741                |       | 41,079 |   |
| Other accounts payable  and accrued liabilities                                                                                                                                                                                                    |       | 84,139                |       | 94,882 |   |
| Deferred revenue                                                                                                                                                                                                                                   |       | 58,359                |       | 53,511 |   |
| Total current  liabilities                                                                                                                                                                                                                         |       | 211,817               |       | 230,770 |   |
| Long-term debt                                                                                                                                                                                                                                     |       | —                |       | 258,750 |   |
| Other long-term  liabilities                                                                                                                                                                                                                       |       | 15,468                |       | 19,855 |   |
| Total liabilities                                                                                                                                                                                                                                  |       | 227,285               |       | 509,375 |   |
| Commitments and contingencies (See Note 14)                                                                                                                                                                                                        |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                                                                                                         |       |                  |       |   |   |
| Convertible preferred  stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and  outstanding as of December 31, 2005 and 2006                                                                                              |       | —                |       | — |   |
| Common stock, $0.01 par  value, 300,000 shares authorized, 181,962 and 184,545 shares issued as of  December 31, 2005 and 2006, respectively, and 131,390 and 122,634 shares  outstanding as of December 31, 2005 and 2006, respectively |       | 1,820                 |       | 1,845 |   |
| Additional paid-in  capital                                                                                                                                                                                                                        |       | 1,997,906             |       | 2,016,578 |   |
| Warrants to purchase  common stock                                                                                                                                                                                                                 |       | 259                   |       | 259 |   |
| Accumulated deficit                                                                                                                                                                                                                                |       | (1,049,982            | )          | (1,044,995 | ) |
| Treasury stock, at cost,  50,572 and 61,911 shares, respectively, as of December 31, 2005 and 2006                                                                                                                                            |       | (422,619              | )          | (508,232 | ) |
| Unrealized losses on  investments                                                                                                                                                                                                                  |       | (653                  | )          | (6,791 | ) |
| Deferred compensation                                                                                                                                                                                                                              |       | (4,867                | )          | — |   |
| Total stockholders’  equity                                                                                                                                                                                                                   |       | 521,864               |       | 458,664 |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                    |       | $                     | 749,149    |   | $ | 968,039 |   |

 

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

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**EARTHLINK, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

| ** **                                          | ** ** | **Year Ended December 31,**                         | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                                           | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **(in thousands, except per share data)** | ** ** |
| Revenues                                            |       | $                                                                  | 1,382,202  |   | $ | 1,290,072 |   | $ | 1,301,267 |   |
| Operating costs  and expenses:                      |       |                                                               |       |   |   |   |   |
| Telecommunications service and equipment costs      |       | 431,162                                                            |       | 366,654 |   | 424,425 |   |
| Sales incentives                                    |       | 10,040                                                             |       | 8,973 |   | 10,916 |   |
| Total cost of revenues                              |       | 441,202                                                            |       | 375,627 |   | 435,341 |   |
| Sales and marketing                                 |       | 417,250                                                            |       | 389,522 |   | 389,079 |   |
| Operations and customer support                     |       | 255,192                                                            |       | 233,907 |   | 260,941 |   |
| General and administrative                          |       | 105,043                                                            |       | 112,173 |   | 128,479 |   |
| Amortization of intangible assets                   |       | 24,363                                                             |       | 12,267 |   | 11,902 |   |
| Facility exit and restructuring costs               |       | 28,394                                                             |       | 2,080 |   | (117 | ) |
| Total operating costs and expenses                  |       | 1,271,444                                                          |       | 1,125,576 |   | 1,225,625 |   |
| Income from operations                              |       | 110,758                                                            |       | 164,496 |   | 75,642 |   |
| Net losses of  equity affiliate                     |       | —                                                             |       | (15,608 | ) | (84,782 | ) |
| Gain (loss) on  investments in other companies, net |       | (1,420                                                             | )          | 2,877 |   | 377 |   |
| Interest income  and other, net                     |       | 6,131                                                              |       | 13,491 |   | 14,636 |   |
| Income before income taxes                          |       | 115,469                                                            |       | 165,256 |   | 5,873 |   |
| Provision for  income taxes                         |       | 4,460                                                              |       | 22,476 |   | 886 |   |
| Net income                                          |       | $                                                                  | 111,009    |   | $ | 142,780 |   | $ | 4,987 |   |
| Basic net income per share                          |       | $                                                                  | 0.72       |   | $ | 1.04 |   | $ | 0.04 |   |
| Diluted net  income per share                       |       | $                                                                  | 0.70       |   | $ | 1.02 |   | $ | 0.04 |   |
| Basic weighted average common shares outstanding    |       | 154,233                                                            |       | 137,080 |   | 128,790 |   |
| Diluted weighted average  common shares outstanding |       | 157,815                                                            |       | 139,950 |   | 130,583 |   |

 

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

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**EARTHLINK, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)**

| ** ** | ** ** | ** **              | ** ** | ** **  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **              | ** ** | ** **          | ** ** | ** **  | ** ** | **Unrealized**          | ** ** | ** **   | ** ** | **Total**  | ** ** | **Total**              | ** ** |
|------------|------------|-------------------------|------------|-------------|------------|----------------|------------|--------------|------------|-------------------------|------------|---------------------|------------|-------------|------------|-------------------------|------------|--------------|------------|------------|------------|------------------------|------------|
| ** ** | ** ** | ** **              | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **   | ** ** | **Accumu-**             | ** ** | ** **          | ** ** | ** **  | ** ** | **Gains (Losses)** | ** ** | **Deferred** | ** ** | **Stock-** | ** ** | **Compre-**            | ** ** |
| ** ** | ** ** | **Common Stock**   | ** ** | **Paid-in** | ** ** | ** **     | ** ** | **lated**    | ** ** | **Treasury Stock** | ** ** | **on Invest-** | ** ** | **Compen-** | ** ** | **holders’**       | ** ** | **hensive**  | ** ** |
| ** ** | ** ** | **Shares**              | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Warrants** | ** ** | **Deficit**             | ** ** | **Shares**          | ** ** | **Amount**  | ** ** | **ments**               | ** ** | **sation**   | ** ** | **Equity** | ** ** | **Income (Loss)** | ** ** |
| ** ** | ** ** | **(in thousands)** | ** ** |        |

| Balance as of December 31, 2003                                                                  |   | 176,410 |   |   | $      | 1,764  |   |   |      | $      | 1,949,105 |   |   |   | $      | 1,223      |   |    | $      | (1,303,771 | )      | (17,368 | )      | $      | (104,344 | )      |   | $      | (117   | )        |   |   | $       | (197    | )      |   | $ | 543,663 |   |   |   |   |   |
|-------------------------------------------------------------------------------------------------------|--------|---------|--------|--------|--------|--------|--------|--------|-----------|--------|-----------|--------|--------|--------|--------|------------|--------|---------|--------|------------|--------|---------|--------|--------|----------|--------|--------|--------|--------|----------|--------|--------|---------|---------|--------|--------|---|---------|--------|--------|--------|--------|--------|
| Issuance of common stock pursuant to exercise of  stock options and vesting of restricted stock units |   | 2,132   |   |   | 22     |   |   |   | 15,845    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 15,867   |   |   |    |    |   |
| Issuance of common stock pursuant to employee stock  purchase plan                                    |   | 223     |   |   | 2      |   |   |   | 1,694     |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 1,696    |   |   |    |    |   |
| Issuance of restricted stock units and phantom share  units                                           |   | —  |   |   | — |   |   |   | 4,564     |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | (4,431 | )      |   | 133      |   |   |    |    |   |
| Amortization of deferred compensation                                                                 |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | 633    |   |   | 633      |   |   |    |    |   |
| Repurchase of common stock                                                                            |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | —     |   | (12,677 | )      | (125,712   | )      |    | — |   |     |   | — |   |   | (125,712 | )      |   |    |    |   |
| Unrealized holding gains on certain investments                                                       |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | 318    |   |     |   | — |   |   | 318      |   |   | $       | 318     |   |   |
| Net income                                                                                            |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | 111,009    |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 111,009  |   |   | 111,009 |    |   |
| Total comprehensive income                                                                            |   |    |   |   |   |   |   |   |      |   |      |   |   |   |   |       |   |    |   |       |   |    |   |   |     |   |   |   |   |     |   |   | $       | 111,327 |   |   |
| Balance as of December 31, 2004                                                                  |   | 178,765 |   |   | 1,788  |   |   |   | 1,971,208 |   |      |   | 1,223  |   |   | (1,192,762 | )      | (30,045 | )      | (230,056   | )      |    | 201    |   |     |   | (3,995 | )      |   | 547,607  |   |   |    |    |   |
| Issuance of common stock pursuant to exercise of  stock options and vesting of restricted stock units |   | 3,150   |   |   | 32     |   |   |   | 22,876    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 22,908   |   |   |    |    |   |
| Issuance of common stock pursuant to employee stock  purchase plan                                    |   | 47      |   |   | — |   |   |   | 444       |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 444      |   |   |    |    |   |
| Issuance of restricted stock units and phantom share  units                                           |   | —  |   |   | — |   |   |   | 2,048     |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | (2,001 | )      |   | 47       |   |   |    |    |   |
| Amortization of deferred compensation                                                                 |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | 1,129  |   |   | 1,129    |   |   |    |    |   |
| Stock-based compensation expense                                                                      |   | —  |   |   | — |   |   |   | 366       |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 366      |   |   |    |    |   |
| Repurchase of common stock                                                                            |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | —     |   | (20,527 | )      | (192,563   | )      |    | — |   |     |   | — |   |   | (192,563 | )      |   |    |    |   |
| Expiration of warrants                                                                                |   | —  |   |   | — |   |   |   | 964       |   |      |   | (964   | )      |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | —   |   |   |    |    |   |
| Unrealized holding losses on certain investments                                                      |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | (854   | )      |     |   | — |   |   | (854     | )      |   | $       | (854    | )      |   |
| Net income                                                                                            |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | 142,780    |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 142,780  |   |   | 142,780 |    |   |
| Total comprehensive income                                                                            |   |    |   |   |   |   |   |   |      |   |      |   |   |   |   |       |   |    |   |       |   |    |   |   |     |   |   |   |   |     |   |   | $       | 141,926 |   |   |
| Balance as of December 31, 2005                                                                  |   | 181,962 |   |   | 1,820  |   |   |   | 1,997,906 |   |      |   | 259    |   |   | (1,049,982 | )      | (50,572 | )      | (422,619   | )      |    | (653   | )      |     |   | (4,867 | )      |   | 521,864  |   |   |    |    |   |
| Issuance of common stock pursuant to exercise of  stock options and vesting of restricted stock units |   | 844     |   |   | 8      |   |   |   | 4,023     |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 4,031    |   |   |    |    |   |
| Issuance of common stock for acquisition of New Edge                                                  |   | 1,739   |   |   | 17     |   |   |   | 20,177    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 20,194   |   |   |    |    |   |
| Issuance of phantom share units                                                                       |   | —  |   |   | — |   |   |   | 43        |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 43       |   |   |    |    |   |
| Reclass of deferred compensation                                                                      |   | —  |   |   | — |   |   |   | (4,867    | )      |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | 4,867  |   |   | —   |   |   |    |    |   |
| Stock-based compensation expense                                                                      |   | —  |   |   | — |   |   |   | 14,242    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 14,242   |   |   |    |    |   |
| Tax provision from stock options                                                                      |   | —  |   |   | — |   |   |   | 117       |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 117      |   |   |    |    |   |
| Purchase of call options                                                                              |   | —  |   |   | — |   |   |   | (47,162   | )      |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | (47,162  | )      |   |    |    |   |
| Issuance of warrants                                                                                  |   | —  |   |   | — |   |   |   | 32,099    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 32,099   |   |   |    |    |   |
| Repurchase of common stock                                                                            |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | —     |   | (11,339 | )      | (85,613    | )      |    | — |   |     |   | — |   |   | (85,613  | )      |   |    |    |   |
| Unrealized holding losses on certain investments                                                      |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | —     |   | —  |   | —     |   |    | (6,138 | )      |     |   | — |   |   | (6,138   | )      |   | $       | (6,138  | )      |   |
| Net income                                                                                            |   | —  |   |   | — |   |   |   | —    |   |      |   | — |   |   | 4,987      |   | —  |   | —     |   |    | — |   |     |   | — |   |   | 4,987    |   |   | 4,987   |    |   |
| Total comprehensive loss                                                                              |   |    |   |   |   |   |   |   |      |   |      |   |   |   |   |       |   |    |   |       |   |    |   |   |     |   |   |   |   |     |   |   | $       | (1,151  | )      |   |
| Balance as of  December 31, 2006                                                                 |   | 184,545 |   |   | $      | 1,845  |   |   |      | $      | 2,016,578 |   |   |   | $      | 259        |   |    | $      | (1,044,995 | )      | (61,911 | )      | $      | (508,232 | )      |   | $      | (6,791 | )        |   |   | $       | —  |   |   | $ | 458,664 |   |   |   |   |   |

 

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

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**EARTHLINK, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**

| ** **                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**                    | ** ** |
| Cash flows from operating activities:                                              | ** ** | ** **                                 |       |   |   |   |   |
| Net income                                                                         |       | $                                          | 111,009    |   | $ | 142,780 |   | $ | 4,987 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and  amortization                                                     |       | 79,219                                     |       | 47,138 |   | 46,287 |   |
| Bad debt expense                                                                   |       | 26,253                                     |       | 22,622 |   | 23,033 |   |
| Loss (gain) on disposals  and impairments of fixed assets                          |       | 10,103                                     |       | (73 | ) | 1,351 |   |
| Loss (gain) on investments  in other companies, net                                |       | 1,420                                      |       | (2,877 | ) | (377 | ) |
| Net losses of equity  affiliate                                                    |       | —                                     |       | 15,608 |   | 84,782 |   |
| Stock-based compensation                                                           |       | 633                                        |       | 1,542 |   | 14,285 |   |
| Deferred income taxes                                                              |       | 1,969                                      |       | 17,139 |   | 588 |   |
| Other adjustments                                                                  |       | —                                     |       | (255 | ) | (375 | ) |
| Increase in accounts  receivable                                                   |       | (21,401                                    | )          | (28,876 | ) | (26,131 | ) |
| Decrease (increase) in  prepaid expenses and other assets                          |       | 74                                         |       | 4,630 |   | (3,968 | ) |
| Decrease in accounts  payable and accrued and other liabilities                    |       | (11,746                                    | )          | (22,306 | ) | (24,060 | ) |
| Decrease in deferred  revenue                                                      |       | (9,381                                     | )          | (8,368 | ) | (5,153 | ) |
| Net cash provided by  operating activities                                         |       | 188,152                                    |       | 188,704 |   | 115,249 |   |
| Cash flows from investing activities:                                              |       |                                       |       |   |   |   |   |
| Purchases of property  and equipment                                               |       | (29,890                                    | )          | (33,879 | ) | (38,852 | ) |
| Purchases of subscriber  bases                                                     |       | (2,419                                     | )          | (6,690 | ) | (8,879 | ) |
| Proceeds from sales of  fixed assets                                               |       | 733                                        |       | 124 |   | 8 |   |
| Investments in marketable securities                                               |       |                                       |       |   |   |   |   |
| Purchases                                                                          |       | (540,881                                   | )          | (411,006 | ) | (179,165 | ) |
| Sales and maturities                                                               |       | 507,222                                    |       | 474,512 |   | 191,882 |   |
| Investments in and net  advances to equity affiliate                               |       | —                                     |       | (82,301 | ) | (79,020 | ) |
| Purchase of business,  net of cash acquired                                        |       | —                                     |       | (9,352 | ) | (108,663 | ) |
| Investments in other  companies                                                    |       | (3,835                                     | )          | — |   | (60,000 | ) |
| Distributions received  from investments in other companies                        |       | —                                     |       | 4,440 |   | 377 |   |
| Other                                                                              |       | —                                     |       | (929 | ) | (752 | ) |
| Net cash used in  investing activities                                             |       | (69,070                                    | )          | (65,081 | ) | (283,064 | ) |
| Cash flows from  financing activities:                                             |       |                                       |       |   |   |   |   |
| Principal payments under  capital lease obligations                                |       | (896                                       | )          | (28 | ) | (31 | ) |
| Repayment of note  payable                                                         |       | —                                     |       | — |   | (2,000 | ) |
| Proceeds from issuance  of convertible senior notes, net                           |       | —                                     |       | — |   | 251,568 |   |
| Purchase of call options                                                           |       | —                                     |       | — |   | (47,162 | ) |
| Proceeds from issuance  of warrants                                                |       | —                                     |       | — |   | 32,099 |   |
| Proceeds from exercises  of stock options and other                                |       | 17,696                                     |       | 23,352 |   | 4,029 |   |
| Repurchases of common  stock                                                       |       | (125,712                                   | )          | (192,563 | ) | (85,613 | ) |
| Net cash (used in)  provided by financing activities                               |       | (108,912                                   | )          | (169,239 | ) | 152,890 |   |
| Net increase (decrease)  in cash and cash equivalents                              |       | 10,170                                     |       | (45,616 | ) | (14,925 | ) |
| Cash and cash  equivalents, beginning of year                                      |       | 208,740                                    |       | 218,910 |   | 173,294 |   |
| Cash and cash equivalents, end of year                                             |       | $                                          | 218,910    |   | $ | 173,294 |   | $ | 158,369 |   |

 

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

69

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.**   Organization

EarthLink, Inc. (“EarthLink”or the “Company”) is a total communications provider, providing integratedcommunication services and related value-added services to individual consumersand business customers utilizing Internet Protocol, or IP, based technologies. EarthLink’score service offerings are dial-up and wireline broadband Internet accessservices and value-added services. EarthLink’s growth initiatives includeIP-based voice services, municipal wireless broadband services and services forbusiness customers.

**2.**   Summaryof Significant Accounting Policies

*Basis ofConsolidation*

The consolidated financialstatements include the accounts of EarthLink and all wholly-owned subsidiaries.All intercompany transactions and balances have been eliminated.

*Use of Estimates inPreparation of Financial Statements*

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, revenues and expenses, and thedisclosure of contingent assets and liabilities in the consolidated financialstatement and accompanying footnotes. On an ongoing basis, the Companyevaluates its estimates, including, but not limited to, those related to theallowance for doubtful accounts; the use, recoverability, and/or realizabilityof certain assets, including deferred tax assets; useful lives of intangibleassets and property and equipment; the fair values of assets acquired andliabilities assumed in acquisitions of businesses, including acquiredintangible assets; facility exit and restructuring liabilities; fair values ofinvestments; stock-based compensation; contingent liabilities and long-livedasset impairments. The Company bases its estimates on historical experience andon various other assumptions that are believed to be reasonable. Actual resultscould differ from those estimates.

*Revenues*

*General.*   EarthLinkrecognizes revenue in accordance with Securities and Exchange Commission (“SEC”)Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition.” Revenueis recognized when persuasive evidence of an arrangement exists, delivery hasoccurred, the sales price is fixed or determinable and collectibility isprobable. Generally, these criteria are met monthly as EarthLink’s service isprovided on a month-to-month basis and collection for the service is generallymade within 30 days of the service being provided. Revenues are recorded asearned. Deferred revenue is recorded when payments are received in advance ofEarthLink performing its service obligations and recognized ratably over theservice period.

Narrowband access revenues consist of monthly feescharged to customers for dial-up Internet access. Broadband access revenuesconsist of retail and wholesale fees charged for high-speed, high-capacityaccess services including DSL, cable, satellite, wireless and dedicated circuitservices; fees charged for high-speed data networks to businesses andcommunications carriers; fees charged for IP-based voice services; installationfees; fees for equipment; early termination fees; and regulatory surchargesbilled to customers. Web hosting revenues consist of fees charged for leasingserver space and providing web services to companies and individuals wishing topresent a web or e-commerce presence. Advertising and other value-addedservices revenues consist of revenues earned from promotional arrangements withadvertisers, 

70

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

retailers, serviceproviders and content providers. Advertising and other value-added servicesrevenues also include revenues from certain ancillary services sold as add-onfeatures to the Company’s Internet services, such as email storage and securityproducts.

Advertising and other value-added services revenuesinclude amounts derived from selling other companies’ products and services toEarthLink subscribers, subscribers using and buying other vendors’ products andservices, and other companies purchasing advertising on EarthLink’s onlineproperties, among other activities. Advertising revenues are recorded whenearned based on the per unit contractual rate and the number of units sold,number of subscriber impressions, or number of subscriber purchases or actions.

*Gross versus net revenuerecognition.*   EarthLinkmaintains relationships with certain telecommunications partners (includingcable companies) in which it provides services to customers using the “lastmile” element of the telecommunication providers’ networks. The term “last mile”generally refers to the element of telecommunications networks that is directlyconnected to homes and businesses. In these instances, EarthLink evaluates thecriteria outlined in Emerging Issues Task Force (“EITF”) Issue No. 99-19,“Reporting Revenue Gross as a Principal versus Net as an Agent,” in determiningwhether it is appropriate to record the gross amount of revenue and relatedcosts or the net amount due it from the telecommunications partner. Generally,when EarthLink is the primary obligor in the transaction with the subscriber,has latitude in establishing prices, is the party determining the servicespecifications or has several but not all of these indicators, EarthLinkrecords the revenue at the amount billed the subscriber. If EarthLink is notthe primary obligor and/or the telecommunications partner has latitude inestablishing prices, EarthLink records revenue associated with the relatedsubscribers on a net basis, netting the cost of revenue associated with theservice against the gross amount billed the customer and recording the netamount as revenue.

*Cost of Revenues*

Cost of revenues include telecommunications serviceand equipment costs and sales incentives. Telecommunications service andequipment costs include telecommunications fees and network operations costsincurred to provide the Company’s Internet access services; fees paid tocontent providers for information provided on the Company’s online properties,including the Company’s Personal Start PageTM; the costs of equipment sold tocustomers for use with the Company’s services; activation and deactivation feespaid to the Company’s network providers for the provisioning and disconnectionof services; depreciation of network equipment; and surcharges due toregulatory agencies.

Sales incentives include the cost of promotionalproducts and services provided to potential and new subscribers, including freeInternet access on a trial basis and free modems and other hardware. EarthLinkaccounts for sales incentives in accordance with EITF Issue No. 01-09,“Accounting for Consideration Given by a Vendor to a Customer (Including aReseller of the Vendor’s Products),” which requires the costs of salesincentives to be classified as cost of revenues.

The Company also pays feesto retailers, manufacturers or other marketing partners for marketing EarthLink’sproducts and services. Depending on the nature of the arrangement, themarketing partners may purchase EarthLink’s products and services in additionto providing marketing services. If the retailer or manufacturer does notpurchase EarthLink’s products or services, the Company classifies the fees assales and marketing expenses when incurred. In this scenario, the retailer ormanufacturer is not a reseller and the accounting in EITF Issue No. 01-09does not apply. If the retailer or manufacturer purchases and 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

thenresells EarthLink’s products or services, the Company accounts for the fees asa reduction in revenue in accordance with EITF Issue No. 01-09because the consideration is presumed to be a reduction of the selling price ofEarthLink’s products or services; however, if the Company receives anidentifiable benefit whose fair value can be reasonably estimated in exchangefor the fees, the Company classifies the fees as operating expenses.

*Sales and Marketing*

Sales and marketing expenses include advertising andpromotion expenses, fees paid to distribution partners to acquire new payingsubscribers, personnel-related expenses for sales and marketing personnel andtelemarketing costs incurred to acquire and retain subscribers. The Company’smarketing strategies include national branding campaigns comprised oftelevision, radio, Internet, print and outdoor advertising. Marketing andadvertising costs to promote the Company’s products and services are expensedin the period incurred. The Company also uses direct mail advertising, and theCompany incurs production, printing, mailing and postage related to its directmail advertising activities. Media and direct mail production costs areexpensed the first time the advertisement is run. Media and agency costs areexpensed over the period the advertising runs. Advertising expenses were $224.4million, $245.7 million and $242.0 million during the years ended December 31,2004, 2005 and 2006, respectively. Prepaid advertising expenses were $2.0million and $3.6 million as of December 31, 2005 and 2006, respectively.

During the years ended December 31,2004, 2005 and 2006, EarthLink incurred various shipping charges in connectionwith providing welcome kits to new customers and shipping equipment. TheCompany classifies shipping and handling charges associated with welcome kitsas sales and marketing expenses, which were $1.8 million, $1.2 million and $1.0million during the years ended December 31, 2004, 2005 and 2006,respectively, because the Company does not invoice the customer for the welcomekits or the associated shipping. All other shipping and handling costs areincluded in cost of revenues.

*SoftwareDevelopment Costs*

EarthLink accounts for research and development costsin accordance with several accounting pronouncements, including Statement ofFinancial Accounting Standards (“SFAS”) No. 2, “Accounting for Researchand Development Costs,” and SFAS No. 86, “Accounting for the Costs ofComputer Software to be Sold, Leased, or Otherwise Marketed.” SFAS No. 86specifies that costs incurred internally in creating a computer softwareproduct should be charged to expense when incurred as research and developmentuntil technological feasibility has been established for the product. Oncetechnological feasibility is established, all software costs should becapitalized until the product is available for general release to customers.Judgment is required in determining when the technological feasibility of aproduct is established. The Company has determined that technologicalfeasibility for its products is reached very shortly before the products arereleased. Costs incurred after technological feasibility is established are notmaterial, and, accordingly, the Company expenses research and development costswhen incurred.

EarthLink accounts forcosts incurred to develop software for internal use in accordance withStatement of Position 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use,” whichrequires such costs be capitalized and amortized over the estimated useful lifeof the software. Costs related to design or maintenance of internal-usesoftware are expensed as incurred.

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Income Taxes*

The Company recognizesdeferred tax assets and liabilities for operating loss carryforwards, taxcredit carryforwards and the estimated future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using enacted tax rates in effect for the year inwhich the temporary differences are expected to be recovered or settled. Avaluation allowance is recorded to reduce the carrying amounts of net deferredtax assets if there is uncertainty regarding their realization. EarthLinkconsiders many factors when assessing the likelihood of future realizationincluding the Company’s recent cumulative earnings experience by taxingjurisdiction, expectations of future taxable income, the carryforward periodsavailable to the Company for tax reporting purposes and other relevant factors.

*Net Income per Share*

Net income per share hasbeen computed according to SFAS No. 128, “Earnings per Share,” whichrequires a dual presentation of basic and diluted earnings per share (“EPS”).Basic EPS represents net income divided by the weighted average number ofcommon shares outstanding during a reported period. Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock, including stock options, warrants, restricted stock units,phantom share units and contingently issuable shares (collectively “CommonStock Equivalents”), were exercised or converted into common stock. Thedilutive effect of outstanding stock options, warrants and restricted stockunits is reflected in diluted earnings per share by application of the treasurystock method. Phantom share units and contingently issuable shares arereflected on an if-converted basis. EarthLink’s convertible debt instrumentswere excluded from the calculation of diluted earnings per share as theireffect was antidilutive. In applying the treasury stock method for stock-basedcompensation arrangements during the year ended December 31, 2006, theassumed proceeds were computed as the sum of the amount the employee must payupon exercise and the amounts of compensation cost attributed to futureservices and not yet recognized.

Thefollowing table sets forth the computation for basic and diluted net income pershare for the years ended December 31, 2004, 2005 and 2006:

| ** **                                              | ** ** | **Year Ended December 31,**                         | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **2004**                                                           | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                              | ** ** | **(in thousands, except per share data)** | ** ** |
| Net income (A)                                          |       | $                                                                  | 111,009    |   | $ | 142,780 |   | $ | 4,987 |   |
| Basic weighted average common shares outstanding (B)    |       | 154,233                                                            |       | 137,080 |   | 128,790 |   |
| Dilutive effect  of Common Stock Equivalents            |       | 3,582                                                              |       | 2,870 |   | 1,793 |   |
| Diluted weighted  average common shares outstanding (C) |       | 157,815                                                            |       | 139,950 |   | 130,583 |   |
| Basic net income per share (A/B)                        |       | $                                                                  | 0.72       |   | $ | 1.04 |   | $ | 0.04 |   |
| Diluted net income per  share (A/C)                     |       | $                                                                  | 0.70       |   | $ | 1.02 |   | $ | 0.04 |   |

 

During the years ended December 31,2004, 2005 and 2006, approximately 8.7 million, 9.9 million and 21.2 million,respectively, options and warrants were excluded from the calculation ofdiluted EPS because the exercise prices exceeded the Company’s average stockprice during the respective years. These options and warrants could be dilutivein future periods. In addition, approximately 28.4 million shares underlie theCompany’s convertible debt instruments, which could be dilutive in futureperiods.

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Stock-BasedCompensation*

As of December 31, 2006, EarthLink had variousstock-based compensation plans, which are more fully described in Note 11,“Stock-Based Compensation.” Prior to January 1, 2006, the Companyaccounted for stock-based compensation using the intrinsic value method, whichfollows the recognition and measurement principles of Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,”and Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 44,“Accounting for Certain Transactions Involving Stock Compensation.” Generally,no stock-based employee compensation cost related to stock options wasreflected in net income (loss) prior to January 1, 2006, as all optionsgranted under stock-based compensation plans had an exercise price equal to themarket value of the underlying common stock on the grant date. However, to theextent that the Company modified stock options subsequent to the grant date,the Company recorded compensation expense based on the modification, asrequired by SFAS No. 123, “Accounting for Stock-Based Compensation,” andAPB Opinion No. 25. Compensation cost related to restricted stock unitsgranted to non-employee directors and certain key employees was reflected innet income as services were rendered.

On January 1, 2006, the Company adopted SFAS No. 123(R),“Share-Based Payment,” using the modified prospective method, which requiresmeasurement of compensation cost for all stock awards at fair value on the dateof grant and recognition of compensation over the requisite service period forawards expected to vest. In accordance with the modified prospective method,the Company’s financial statements for periods prior to implementation have notbeen restated to reflect, and do not include, the impact of SFAS No. 123(R).The Company estimates the fair value of stock options using the Black-Scholesvaluation model, and determines the fair value of restricted stock units basedon the number of shares granted and the quoted price of EarthLink’s commonstock on the date of grant*.* Suchvalue is recognized as expense over the requisite service period, net ofestimated forfeitures, using the straight-line attribution method. The estimateof awards that will ultimately vest requires significant judgment, and to theextent actual results or updated estimates differ from the Company’s currentestimates, such amounts will be recorded as a cumulative adjustment in theperiod estimates are revised. The Company considers many factors whenestimating expected forfeitures, including types of awards, employee class andhistorical employee attrition rates. Actual results, and future changes inestimates, may differ substantially from the Company’s current estimates.

In March 2005, the SEC published SAB No. 107,which provides the Staff’s views on a variety of matters relating tostock-based payments. SAB No. 107 requires stock-based compensation to beclassified in the same expense line items as cash compensation. The Company hasclassified stock-based compensation expense during the year ended December 31,2006 within the same operating expense line items as cash compensation paid toemployees.

In November 2005, the FASB issued FASB StaffPosition (“FSP”) No. FAS 123(R)-3, “Transition Election Related toAccounting for Tax Effects of Share-Based Payment Awards,” which provides anelective transition method for calculating the initial pool of excess taxbenefits available to absorb tax deficiencies recognized subsequent to theadoption of SFAS No. 123(R). Companies were permitted to take up to oneyear from the effective date of this FASB Staff Position to evaluate theavailable transition alternatives and make a one-time election as to whichmethod to adopt. The Company elected to use the alternative method provided inFSP No. FAS 123(R)-3.

The cumulative effect of adoption of SFAS No. 123(R) usingthe modified prospective transition method, which resulted from estimatingforfeitures on nonvested shares of restricted stock rather than 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

accounting for forfeituresas they occurred, was not material. Prior to the adoption of SFAS No. 123(R),deferred compensation relating to restricted stock units was presented as aseparate component of stockholders’ equity. Upon adoption of SFAS No. 123(R) onJanuary 1, 2006, the deferred compensation balance of $4.9 million wasreclassified to additional paid-in capital.

Stock-based compensation expense under SFAS No. 123(R) was$14.2 million during the year ended December 31, 2006, of which $12.2million related to stock options and $2.0 million related to restricted stockunits. Stock-based compensation expense during the year ended December 31,2005 was $1.5 million, of which $1.1 million related to restricted stock unitsand $0.4 million was stock-based compensation expense arising frommodifications to extend the exercise periods of certain vested stock optionsfor EarthLink employees transferring to HELIO. As a result of adopting SFAS No. 123(R) onJanuary 1, 2006, the Company’s income from operations and net income forthe year ended December 31, 2006 were $12.3 million lower than if it hadcontinued to account for share-based compensation using the intrinsic method ofaccounting under APB Opinion No. 25. Basic and diluted net income pershare for the year ended December 31, 2006 were $0.10 per share and $0.09per share lower, respectively, than if the Company had continued to account forshare-based compensation using the intrinsic method of accounting under APBOpinion No. 25. The incremental impact of SFAS No. 123(R) duringthe year ended December 31, 2006 represents stock-based compensationexpense related to stock options and the impact of estimating forfeituresrelated to nonvested shares of restricted stock.

If theCompany had elected to adopt the optional recognition provisions of SFASNo. 123, which uses the fair value based method for stock-basedcompensation, and amortized the grant date fair value of stock options tocompensation expense on a straight-line basis over the vesting period of theoptions, net income and basic and diluted net income per share for the yearsended December 31, 2004 and 2005 would have been changed to the pro formaamounts indicated below:

| ** **                                                                                                  | ** ** | **Year Ended December 31,**                     | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2004**                                                       | ** ** | **2005** | ** ** |
| ** **                                                                                                  | ** ** | **(in thousands, except  per share data)** | ** ** |
| Net income, as  reported                                                                                    |       | $                                                              | 111,009    |   | $ | 142,780 |   |
| Add: Stock-based  compensation expense associated with stock options included in reported net  income       |       | —                                                         |       | 366 |   |
| Deduct:  Stock-based compensation expense determined using a fair value based method  for all stock options |       | (23,311                                                        | )          | (15,900 | ) |
| Pro forma net  income                                                                                       |       | $                                                              | 87,698     |   | $ | 127,246 |   |
| Basic net income per  share:                                                                                |       |                                                           |       |   |   |
| As reported                                                                                                 |       | $                                                              | 0.72       |   | $ | 1.04 |   |
| Pro forma                                                                                                   |       | $                                                              | 0.57       |   | $ | 0.93 |   |
| Diluted net income per  share:                                                                              |       |                                                           |       |   |   |
| As reported                                                                                                 |       | $                                                              | 0.70       |   | $ | 1.02 |   |
| Pro forma                                                                                                   |       | $                                                              | 0.57       |   | $ | 0.92 |   |

 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Cash and Cash Equivalents*

All highly liquidinvestments with original maturities of three months or less at the date ofacquisition are considered cash equivalents. These investments primarilyconsist of money market funds and commercial paper.

*Investments in Marketable Securities*

Investments in marketablesecurities are accounted for in accordance with SFAS No. 115, “Accountingfor Certain Investments in Debt and Equity Securities.” All investments withoriginal maturities greater than 90 days are classified as investments inmarketable securities. Investments in marketable securities with maturitiesless than one year from the balance sheet date are considered short-terminvestments. Short-term investments also include investments in asset-backed,auction rate debt securities with interest rate reset periods of 90 days orless but whose underlying agreements have original maturities of more than 90days, based on the provisions of Accounting Research Bulletin No. 43,Chapter 3A, Working Capital-Current Assets and Liabilities, which allowsclassification of investments based on management’s view. Investments inmarketable securities with maturities greater than one year from the balancesheet date, excluding investments in asset-backed, auction rate debt securitieswith interest reset periods of 90 days or less, are considered long-terminvestments. 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.

The Company has classifiedall short- and long-term investments in marketable securities as available-for-sale.The Company may or may not hold its investments in marketable securities untilmaturity. In response to changes in the availability of and the yield onalternative investments as well as liquidity requirements, the Companyoccasionally sells its investments in marketable securities prior to theirstated maturities. Available for sale securities are carried at fair value,with any unrealized gains and losses, net of tax, included in unrealized gains(losses) on investments as a separate component of stockholders’ equity and intotal comprehensive income (loss). Realized gains and losses are included ininterest income and other, net, in the Consolidated Statements of Operationsand are determined on a specific identification basis.

The Company periodicallyevaluates whether declines in fair values of its investments below their costare potentially other than temporary. This evaluation consists of severalqualitative and quantitative factors regarding the severity and duration of theunrealized loss as well as the Company’s ability and intent to hold theinvestment for a period of time which may be sufficient for an anticipatedrecovery in market value.

*Allowance for Doubtful Accounts*

EarthLink maintains anallowance for doubtful accounts for estimated losses resulting from theinability of EarthLink’s customers to make payments. In assessing the adequacyof the allowance for doubtful accounts, management considers multiple factorsincluding the aging of its receivables, historical write-offs, the creditquality of its customers, the general economic environment and other factorsthat may affect customers’ ability to pay. If the financial condition ofEarthLink’s customers were to deteriorate, resulting in an impairment of theirability to make payments, additional allowances may be required. The Company’sallowance for doubtful accounts was $8.1 million as of December 31, 2005and 2006. The Company recorded bad debt expense of $26.3 million, $22.6 millionand $23.0 million during the years 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

ended December 31,2004, 2005 and 2006, respectively. The Company’s write-offs of uncollectibleaccounts were $24.3 million, $22.4 million and $25.2 million during the yearsended December 31, 2004, 2005 and 2006, respectively. The Company acquireda $2.2 million allowance for doubtful accounts in its acquisition of NewEdge Holding Company (“New Edge”).

*Property and Equipment*

Property and equipment arestated at cost less accumulated depreciation. Depreciation expense isdetermined using the straight-line method over the estimated useful lives ofthe various asset classes, which are generally three to five years forcomputers, telecommunications equipment and furniture and other officeequipment and 15 years for buildings. Leasehold improvements are depreciated usingthe straight-line method over the shorter of their estimated useful lives orthe remaining term of the lease. When leases are extended, the remaining usefullives of leasehold improvements are increased as appropriate, but not for aperiod in excess of the remaining lease term. Expenditures for maintenance andrepairs are charged to operating expense as incurred. Upon retirements orsales, the original cost and related accumulated depreciation are removed fromthe respective accounts, and the gains and losses are included in interestincome and other, net, or as facility exit and restructuring costs, asappropriate. Upon impairment, the Company accelerates depreciation of the assetand such cost is included in operating expenses.

*Investments in Other Companies*

Minority investments inother companies are classified as investments in other companies in theConsolidated Balance Sheets and are accounted for under the cost method ofaccounting because the Company does not have the ability to exercise significantinfluence over the companies’ operations. Under the cost method of accounting,investments in private companies are carried at cost and are only adjusted forother-than-temporary declines in fair value and distributions of earnings. Forcost method investments in public companies that have readily determinable fairvalues, the Company classifies its investments as available-for-sale inaccordance with SFAS No. 115 and, accordingly, records these investmentsat their fair values with unrealized gains and losses included as a separatecomponent of stockholders’ equity and in total comprehensive income (loss).Upon sale or liquidation, realized gains and losses are included in theConsolidated Statement of Operations.

Management regularlyevaluates the recoverability of its investments in other companies based on theperformance and the financial position of those companies as well as otherevidence of market value. Such evaluation includes, but is not limited to,reviewing the investee’s cash position, recent financings, projected andhistorical financial performance, cash flow forecasts and financing needs.During the years ended December 31, 2004 and 2005, the Company recognizedlosses due to other-than-temporary declines of the value of investments of $1.4million and $0.9 million, respectively. These losses are included in gain(loss) on investments in other companies, net, in the Consolidated Statementsof Operations. During the year ended December 31, 2006, the Company didnot recognize any losses due to other-than-temporary declines of the value ofinvestments.

*Variable Interest Entities*

The Company applies theguidance prescribed in FIN No. 46, “Consolidation of Variable InterestEntities,” to determine if the Company must consolidate the results of companiesin which the Company has invested. Variable interest entities (“VIEs”) areentities that either do not have equity investors with proportionate economicand voting rights or have equity investors that do not provide sufficientfinancial 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

resourcesfor the entity to support its activities. Consolidation is required if it isdetermined that the Company absorbs a majority of the expected losses and/orreceives a majority of the expected returns. In determining if an investee is aVIE and whether EarthLink must consolidate its results, management evaluateswhether the equity of the entity is sufficient to absorb its expected lossesand whether EarthLink is the primary beneficiary. Management generally performsthis assessment at the date EarthLink becomes involved with the entity and uponchanges in the capital structure or related governing documents of the entity. Managementhas concluded that the Company does not have any arrangements with entitiesthat would require consolidation pursuant to FIN No. 46.

*Investment in Equity Affiliate*

The Company has a jointventure with SK Telecom Co., Ltd. (“SK Telecom”), HELIO. HELIO is anon-facilities-based mobile virtual network operator (“MVNO”) offering mobilecommunications services and handsets to U.S. consumers. EarthLink and SKTelecom each have an equal voting and economic ownership interest inHELIO. EarthLink and SK Telecom, as partners, invested an aggregate of$166.0 million of cash and non-cash assets upon completing the formation ofHELIO in March 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.

The Company accounts forits investment in HELIO under the equity method of accounting because theCompany can exert significant influence over HELIO’s operating and financialpolicies. The Company determined that HELIO does not qualify as a VIE under FINNo. 46, so consolidation pursuant to FIN No. 46 is not required.In accordance with the equity method of accounting, EarthLink’s investment inHELIO was recorded at original cost and is adjusted to recognize EarthLink’sproportionate share of HELIO’s net income (loss), amortization of basisdifferences and additional contributions made.

*Goodwill and Purchased Intangible Assets*

Goodwill is the excess ofthe purchase price over the fair value of identifiable net assets acquired inbusiness combinations accounted for under the purchase method of accountingpursuant to SFAS No. 141, “Business Combinations.” Purchased intangibleassets consist primarily of subscriber basesand customer relationships, acquired software and technology and other assets acquiredin conjunction with the purchases of businesses and subscriber bases from othercompanies. Subscriber bases acquired directly are valued at cost plus assumedservice liabilities, which approximates fair value at the time of purchase.When management determines material intangible assets are acquired inconjunction with the purchase of a company, EarthLink engages an independentthird party to determine the allocation of the purchase price to the intangibleassets acquired. Intangible assets determined to have definite lives areamortized on a straight-line basis over their estimated useful lives.

The Company accounts forgoodwill and intangible assets in accordance with SFAS No. 142, “Goodwilland Other Intangible Assets,” which prohibits the amortization of goodwill andcertain intangible assets deemed to have indefinite lives. SFAS No. 142requires the Company to test its goodwill for impairment at least annually. TheCompany performs an impairment test of its goodwill annually during the fourthquarter of its fiscal year or when events and circumstances indicate thatgoodwill might be permanently impaired. Impairment testing of goodwill istested at the reporting unit level by comparing the reporting unit’s carryingamount, including goodwill, to the estimated fair value of the reporting unit.The fair values of the reporting unit are estimated using discounted expectedfuture cash flows. If the 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

carryingamount of the reporting unit exceeds its fair value, goodwill is consideredimpaired and a second step is performed to measure the amount of the impairmentloss, if any. The Company conducted its annual impairment test as of October 1,2006 and determined that the estimated fair value exceeded the carrying value.There have not been any events or circumstances from the date of the Company’sassessment through December 31, 2006 that would cause the Company toretest its goodwill.

*Long-Lived Assets*

The Company accounts forlong-lived assets in accordance with SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” which addresses financialaccounting and reporting for the impairment and disposition of long-livedassets, including property and equipment and purchased intangible assets. TheCompany evaluates the recoverability of long-lived assets for impairment whenevents or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. Conditions that would necessitate an impairmentassessment include a significant decline in the observable market value of anasset, a significant change in the extent or manner in which an asset is used,or a significant adverse change that would indicate the carrying amount of anasset or group of assets is not recoverable. For long-lived assets to be heldand used, EarthLink recognizes an impairment loss only if its carrying amountis not recoverable through its undiscounted cash flows and measures theimpairment loss, if any, based on the difference between the carrying amountand fair value. Long-lived assets held for sale are reported at the lower ofcost or fair value less costs to sell.

*Leases*

The Company accounts forlease agreements in accordance with SFAS No. 13, “Accounting for Leases,”which requires categorization of leases at their inception as either operatingor capital leases depending on certain criteria. The Company recognizes rentexpense for operating leases on a straight-line basis without regard todeferred payment terms, such as rent holidays or fixed escalations. Incentivesare treated as a reduction of the Company’s rent costs over the term of thelease agreement. The Company records leasehold improvements funded by landlordsunder operating leases as leasehold improvements and deferred rent.

*Facility Exit and Restructuring Costs*

The Company accounts forfacility exit and restructuring costs in accordance with SFAS No. 144 andSFAS No. 146, “Accounting for Costs Associated with Exit or DisposalActivities,” which requires that a liability for a cost associated with an exitor disposal activity be recognized when the liability is incurred. Facilityexit and restructuring liabilities include estimates for, among other things,severance payments and amounts due under lease obligations, net of estimatedsublease income, if any. Key variables in determining such estimates include operatingexpenses due under lease arrangements, the timing and amounts of subleaserental payments, tenant improvement costs and brokerage and other relatedcosts. The Company periodically evaluates and, if necessary, adjusts itsestimates based on currently-available information. Such adjustments areclassified as facility exit and restructuring costs in the ConsolidatedStatements of Operations.

*Comprehensive Income (Loss)*

Comprehensive income(loss) as presented in the Consolidated Statements of Stockholders’ Equity andComprehensive Income (Loss) includes unrealized gains and losses which areexcluded from the 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

ConsolidatedStatements of Operations in accordance with SFAS No. 130, “ReportingComprehensive Income.” For the years ended December 31, 2004, 2005 and2006, these amounts included changes in unrealized gains and losses on certaininvestments classified as available-for-sale. The amounts are presented net oftax-related effects, which management estimated to be approximately zero.

*Certain Risks and Concentrations*

*Credit Risk.**  *By their nature, all financial instruments involverisk, including credit risk for non-performance by counterparties. Financialinstruments that potentially subject the Company to credit risk consistprincipally of cash, cash equivalents, investments in marketable securities,trade receivables and investments in other companies. The Company’s cashinvestment policy limits investments to investment grade instruments. Accountsreceivable are typically unsecured and are derived from revenues earned fromcustomers primarily located in the U.S. Credit risk with respect to tradereceivables is limited due to the large number of customers comprising theCompany’s customer base. Additionally, the Company performs ongoing creditevaluations of its customers and maintains allowances for potential creditlosses. As of December 31, 2005 and 2006, two companies each accounted formore than 10% of gross accounts receivable. Management regularly evaluates therecoverability of its investments in other companies based on the performanceand the financial position of those companies as well as other evidence ofmarket value.

*Regulatory Risk.**  *EarthLink purchases broadband access from incumbentlocal exchange carriers, competitive local exchange carriers and cableproviders. Please refer to “Regulatory Environment” in the Business section ofthis Annual Report on 10-K for a discussion of the regulatory environmentas well as a discussion regarding the Company’s contracts with broadband accessproviders.

*Supply Risk.**  *The Company’s business substantially depends on thecapacity, affordability, reliability and security of third-party telecommunicationsand data service providers. Only a small number of providers offer the networkservices the Company requires, and the majority of its telecommunicationsservices are currently purchased from a limited number of telecommunicationsservice providers. Telecommunications service providers have recently mergedand may continue to merge, which would reduce the number of suppliers fromwhich the Company could purchase telecommunications services. Althoughmanagement believes that alternate telecommunications providers could be foundin a timely manner, any disruption of these services could have a materialadverse effect on the Company’s financial position, results of operations andcash flows.

The Company also relies onthe reliability, capacity and effectiveness of its outsourced contact centerservice providers. The Company purchases contact center services from severalgeographically dispersed service providers. The contact center serviceproviders may become subject to financial, economic and political risks beyondthe Company’s or the providers’ control which could jeopardize their ability todeliver services. Although management believes that alternate contact centerservice providers could be found in a timely manner, any disruption of theseservices could have a material adverse effect on the Company’s financialposition, results of operations and cash flows.

*Fair Value of Financial Instruments*

The carrying amounts ofthe Company’s cash, cash equivalents, trade receivables and trade payablesapproximate their fair values because of their nature and respective durations.The Company’s short- and long-term investments in marketable securities consistof available-for-sale securities and are carried at market value, which isbased on quoted market prices, with unrealized gains and losses included in 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

stockholders’equity. The Company’s equity investments in publicly-held companies are statedat fair value, which is based on quoted market prices, with unrealized gainsand losses included in stockholders’ equity. The Company’s investments inprivately-held companies are stated at cost, net of other-than-temporaryimpairments. The Company’s long-term debt is carried at cost, and the estimatedfair value of the Company’s long-term debt is based on the quoted market price.

*Segments*

The Company operates inone principal business segment, IP-based access and communications services.Substantially all of the Company’s operating results and identifiable assetsare in the U.S.

*Reclassifications*

Certain amounts in theprior year financial statements have been reclassified to conform to thecurrent year presentation.

*Recently Issued Accounting Pronouncements*

In June 2006, theFASB ratified the consensus reached in EITF Issue No. 06-2, “Accountingfor Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43.”EITF Issue No. 06-2 provides recognition guidance on the accrual ofemployees’ rights to compensated absences under a sabbatical or other similarbenefit arrangement. EITF Issue No. 06-2 is effective for theCompany for all financial statements after December 31, 2006. The Companyis currently assessing the impact of the adoption of EITF Issue No. 06-2on its financial statements.

In July 2006, theFASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes,”which prescribes a comprehensive model for how a company should recognize,measure, present and disclose in its financial statements uncertain taxpositions that the company has taken or expects to take on a tax return(including a decision whether to file or not to file a return in a particularjurisdiction). The accounting provisions of FIN No. 48 are effective for fiscal years beginning after December 15,2006. The Company is currently assessing the impact that the adoption ofFIN No. 48 will have, if any, on its consolidated financial statements.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements,” which establishesa framework for reporting fair value and expands disclosures about fair valuemeasurements. SFAS No. 157 is effective for financial statements issuedfor fiscal years beginning after November 15, 2007 and interim periodswithin those fiscal years. The Company is currently assessing the impact of theadoption of this standard on its financial statements.

**3.**                 Acquisitions andAsset Purchases

*Aluria Software LLC*

In September 2005,the Company acquired the assets of Aluria Software LLC (“Aluria”), a privatelyheld developer and provider of protection and security products for consumers,small businesses and enterprise customers, for $13.4 million, which consistedof $9.3 million in cash and notes payable of $4.1 million. The Company repaid$2.0 million of the notes payable during the year ended December 31, 2006.The acquisition of Aluria enabled EarthLink to enhance and improve its suite ofprotection applications.

The acquisition wasaccounted for pursuant to SFAS No. 141, “Business Combinations.” The Company assumed net liabilities ofapproximately $0.1 million and allocated $3.1 million to identifiable 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

definitelived intangible assets, primarily acquired software and technology, resultingin $10.4 million of goodwill. The amounts of identifiable intangible assetsacquired were based on a third-party appraisal. The purchase price wasallocated to the assets acquired and liabilities assumed based on theirestimated fair values, including identifiable intangible assets. The acquiredsoftware and technology is being amortized on a straight-line basis over theestimated useful lives of the assets, which range from one to six years, fromthe date of the acquisition. The pro forma effect of the transaction was notmaterial.

*New Edge*

In April 2006,EarthLink acquired New Edge, a single-source national provider of securemulti-site managed data networks and dedicated Internet access for businessesand communications carriers. Through this acquisition, EarthLink expanded its business inthe small and medium-sized business market. New Edge is a wholly-ownedsubsidiary of EarthLink and continues to operate under its current name. Theresults of operations of New Edge are included in the consolidated financialstatements from the date of the acquisition.

The acquisition wasaccounted for pursuant to SFAS No. 141. The total purchase price of $144.8million consisted of $108.7 million net cash paid, including direct transactioncosts of $3.7 million; $20.2 million in EarthLink, Inc. common stock,representing approximately 1.7 million shares; and estimated net liabilitiesassumed of $15.9 million. In addition, approximately 0.9 million shares ofEarthLink, Inc. common stock are being held in escrow and will be used tocover liabilities that may arise under EarthLink’s indemnification rights underthe merger agreement. The fair value ofEarthLink, Inc. common stock was determined based on the average marketprice per share the three days before and the three days after the announcementof the execution of the merger agreement.

EarthLink allocated $37.0million of the total purchase price to identifiable definite lived intangibleassets, consisting of acquired customer relationships and software, and $7.8million of the total purchase price to identifiable indefinite lived intangibleassets, consisting of trade names. The fair values of identifiable intangibleassets acquired were based on a third-party appraisal. The purchase priceallocation resulted in $100.0 million of goodwill. The purchase price wasallocated to the assets acquired and liabilities assumed based on theirestimated fair values, including identifiable intangible assets. The acquiredcustomer relationships and software are being amortized on a straight-linebasis from the date of the acquisition over the estimated useful lives of theassets, which range from three to nine years. The weighted average amortizablelife of the acquired intangible assets is 5.9 years. The acquired trade nameswere deemed to have indefinite useful lives. The amounts of liabilities assumedand identifiable assets acquired are subject to adjustment for up to one yearfrom the date of acquisition. Any change will change the amount of purchaseprice allocable to goodwill. The pro forma effect of the transaction was notmaterial.

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**4.   Investments**

*Investments inMarketable Securities*

Thefollowing table summarizes unrealized gains and losses on the Company’sinvestments in marketable securities based on quoted market prices as of December 31,2005 and 2006:

|                                                   | ** ** | **As of December 31, 2005** | ** **     | **As of December 31, 2006** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------|----------------|-------------------------------------------------|------------|
| ** **                                        | ** ** | ** **                                      | ** **     | **Gross**                                       | ** ** | **Gross** | ** ** | **Estimated** | ** ** | ** ** | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                        | ** ** | **Amortized**                                   | ** **     | **Unrealized**                                  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                        | ** ** | **Cost**                                        | ** **     | **Losses**                                      | ** ** | **Gains** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Losses** | ** ** | **Gains** | ** ** | **Value** | ** ** |
| ** **                                        | ** ** | **(in thousands)**                         | ** **     |
| **Short-term**                                    |       |                                            |           | ** **                                      |       |   |   |   |   |   |   | ** ** |   |   |   | ** ** |   |   |   | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   | ** ** |   |
| Government agency notes                           |       |                                            | $ 101,226 | ** **                                      |       |   | $ (376 | ) |   |   | $ — | ** ** |   |   | $ 100,850 | ** ** |   |   | $ 46,666 | ** ** |   |   | $ (154 | ) |   |   | $ — | ** ** |   |   | $ 46,512 | ** ** |   |
| Asset-backed (including auction rate)  securities |       |                                            | 85,107         | ** **                                      |       |   | — |   |   |   | — | ** ** |   |   | 85,107 | ** ** |   |   | 85,050 | ** ** |   |   | — |   |   |   | — | ** ** |   |   | 85,050 | ** ** |   |
| Corporate notes                                   |       |                                            | 12,445         | ** **                                      |       |   | (24 | ) |   |   | 3 | ** ** |   |   | 12,424 | ** ** |   |   | 8,498 | ** ** |   |   | (6 | ) |   |   | 3 | ** ** |   |   | 8,495 | ** ** |   |
| Commercial paper                                  |       |                                            | 9,487          | ** **                                      |       |   | (23 | ) |   |   | — | ** ** |   |   | 9,464 | ** ** |   |   | 74,967 | ** ** |   |   | (77 | ) |   |   | — | ** ** |   |   | 74,890 | ** ** |   |
|                                              |       |                                            | $ 208,265 | ** **                                      |       |   | $ (423 | ) |   |   | $ 3 | ** ** |   |   | $ 207,845 | ** ** |   |   | $ 215,181 | ** ** |   |   | $ (237 | ) |   |   | $ 3 | ** ** |   |   | $ 214,947 | ** ** |   |
| **Long-term**                                     | ** ** |                                            | ** **     | ** **                                      |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Government agency notes                           |       |                                            | $ 20,110  | ** **                                      |       |   | $ (133 | ) |   |   | $ — | ** ** |   |   | $ 19,977 | ** ** |   |   | $ 20,997 | ** ** |   |   | $ (39 | ) |   |   | $ 1 | ** ** |   |   | $ 20,959 | ** ** |   |
| Asset-backed securities                           |       |                                            | 4,951          | ** **                                      |       |   | (13 | ) |   |   | — | ** ** |   |   | 4,938 | ** ** |   |   | — | ** ** |   |   | — |   |   |   | — | ** ** |   |   | — | ** ** |   |
| Corporate notes                                   |       |                                            | 16,069         | ** **                                      |       |   | (15 | ) |   |   | 11 | ** ** |   |   | 16,065 | ** ** |   |   | 500 | ** ** |   |   | — |   |   |   | 1 | ** ** |   |   | 501 | ** ** |   |
|                                                   |       |                                            | $ 41,130  | ** **                                      |       |   | $ (161 | ) |   |   | $ 11 | ** ** |   |   | $ 40,980 | ** ** |   |   | $ 21,497 | ** ** |   |   | $ (39 | ) |   |   | $ 2 | ** ** |   |   | $ 21,460 | ** ** |   |
| **Total**                                         | ** ** |                                            | ** **     | ** **                                      |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Government agency notes                           |       |                                            | $ 121,336 | ** **                                      |       |   | $ (509 | ) |   |   | $ — | ** ** |   |   | $ 120,827 | ** ** |   |   | $ 67,663 | ** ** |   |   | $ (193 | ) |   |   | $ 1 | ** ** |   |   | $ 67,471 | ** ** |   |
| Asset-backed (including auction rate) securities  |       |                                            | 90,058         | ** **                                      |       |   | (13 | ) |   |   | — | ** ** |   |   | 90,045 | ** ** |   |   | 85,050 | ** ** |   |   | — |   |   |   | — | ** ** |   |   | 85,050 | ** ** |   |
| Corporate notes                                   |       |                                            | 28,514         | ** **                                      |       |   | (39 | ) |   |   | 14 | ** ** |   |   | 28,489 | ** ** |   |   | 8,998 | ** ** |   |   | (6 | ) |   |   | 4 | ** ** |   |   | 8,996 | ** ** |   |
| Commercial paper                                  |       |                                            | 9,487          | ** **                                      |       |   | (23 | ) |   |   | — | ** ** |   |   | 9,464 | ** ** |   |   | 74,967 | ** ** |   |   | (77 | ) |   |   | — | ** ** |   |   | 74,890 | ** ** |   |
|                                                   |       |                                            | $ 249,395 | ** **                                      |       |   | $ (584 | ) |   |   | $ 14 | ** ** |   |   | $ 248,825 | ** ** |   |   | $ 236,678 | ** ** |   |   | $ (276 | ) |   |   | $ 5 | ** ** |   |   | $ 236,407 | ** ** |   |

 

The unrealized losses on the Company’s investments inmarketable securities were caused primarily by changes in interest rates. TheCompany’s investment portfolio consists of government and high-qualitycorporate securities. Investments in both fixed rate and floating rate interestearning instruments carry a degree of interest rate risk. Fixed rate securitiesmay have their fair market value adversely impacted due to a rise in interestrates, while floating rate securities may produce less income than expected ifinterest rates fall. The longer the term of the securities, the moresusceptible they are to changes in market rates of interest and yields on bonds.Investments are reviewed periodically to identify possible other-than-temporaryimpairment. When evaluating the investments, the Company reviews factors suchas the length of time and extent to which fair value has been below cost basis,the financial condition of the issuer and the Company’s ability and intent tohold the investment for a period of time which may be sufficient foranticipated recovery in market value. The Company believes its gross unrealizedlosses are temporary because management has the intent and ability to holdthese investments until maturity, at which time the Company would expect toreceive the amortized cost basis of the investment based on the underlyingcontractual arrangement. The Company has not experienced any significantrealized gains or losses on its investments in marketable securities during theyears presented.

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Thefollowing table summarizes the estimated fair value of the Company’sinvestments in marketable securities designated as available-for-sale classifiedby the maturity of the security:

| ** **                              | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                              | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **(in thousands)**               | ** ** |
| Due within one  year                    |       | $ 207,845                        |       | $ 214,947 |   |
| Due after one  year through two years   |       | 32,934                                |       | 19,466 |   |
| Due after two  years through five years |       | 8,046                                 |       | 1,994 |   |
|                                    |       | $ 248,825                        |       | $ 236,407 |   |

 

*Investments inOther Companies*

As of December 31, 2005 and 2006, minorityinvestments in other companies were $1.4 million and $59.3 million,respectively, and are classified as investments in other companies in theConsolidated Balance Sheets. Minority investments in other companies as of December 31,2005 and 2006 included $1.0 million and $11.0 million, respectively, ofinvestments carried at cost, and $0.4 million and $48.3 million, respectively,of investments recorded at fair value. As of December 31, 2005, grossunrealized losses were $0.1 million and there were no gross unrealized gains.As of December 31, 2006, gross unrealized losses were $6.5 million andthere were no gross unrealized gains.

In March 2006, the Company invested $50.0 millionin Covad Communications Group, LLC (“Covad”), which consisted of 6.1 millionshares of Covad common stock for an aggregate purchase price of $10.0 millionand $40.0 million aggregate principal amount of 12% Senior Secured ConvertibleNotes due 2011 (the “Covad Notes”). The Company cannot exert significantinfluence over Covad’s operating and financial policies and, as such, accountsfor its investment in Covad under the cost method of accounting and classifiesthe investment as available-for-sale. The Company deferred $0.8 million ofdirect loan origination costs that are being recognized as a reduction in theeffective yield over the term of the Covad Notes.

In April 2006, the Company invested $10.0 millionin Current Communications Group, LLC (“Current”), a privately-heldbroadband-over-powerline provider. The Company accounts for its investment inCurrent under the cost method of accounting because the Company cannot exertsignificant influence over Current’s operating and financial policies.

During the year ended December 31,2005, the Company received $4.4 million in cash distributions from eCompaniesVenture Group, L.P. (“EVG”), a limited partnership that invested in domestic emergingInternet-related companies. In applying the cost method, EarthLinkrecorded $0.6 million as a return of EarthLink’s investment based on thecarrying value of the investment, and the gain of $3.8 million was included ingain (loss) on investments in other companies, net, in the ConsolidatedStatement of Operations for the year ended December 31, 2005. During theyear ended December 31, 2006, the Company recorded a $0.4 million gain oninvestments in other companies resulting from an additional EVG dividend.

*Investment inEquity Affiliate*

In March 2005, the Company completed theformation of a joint venture with SK Telecom, HELIO, to market and sellwireless voice and data services in the U.S. EarthLink and SK Telecom each havean equal voting and economic ownership interest in HELIO. Upon formation,the Company invested 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

$43.0 million of cashand contributed non-cash assets valued at $40.0 million, including 27,000wireless customers, contractual arrangements and agreements to prospectivelymarket HELIO’s services. The non-cash assets contributed were recorded by theCompany as an additional investment of $0.5 million based on the Company’scarrying value of the assets. The Company recorded its initial investment at$43.5 million, reflecting the cash invested plus the carrying value of assetscontributed. In addition, the Company paid HELIO to assume $0.9 million of netliabilities associated with wireless customers and related operations. TheCompany recorded no gain or loss in March 2005 associated with thecontribution of non-cash assets, the transfer of net liabilities, or theassociated payment to HELIO to assume the net liabilities upon completing theformation of HELIO.

Pursuant to the HELIO Contribution and FormationAgreement, the Company contributed $122.0 million of cash and noncash assetsduring 2005, $78.5 million during 2006 and is committed to invest an additional$19.5 million of cash in HELIO during 2007, which includes $13.5 million thatwas contributed in February 2007. During 2006, HELIO received minorityinvestments, which reduced EarthLink’s and SK Telecom’s economic ownershipinterest in HELIO from 50 percent at formation to approximately 48 percent asof December 31, 2006. However, EarthLink’s and SK Telecom’s votinginterest remains the same.

The Company accounts for its investment in HELIO underthe equity method of accounting because the Company can exert significantinfluence over HELIO’s operating and financial policies. As a result, theCompany records its proportionate share of HELIO’s net loss in its ConsolidatedStatement of Operations. The Company is amortizing the difference between thebook value and fair value of non-cash assets contributed to HELIO over theirestimated useful lives. The amortization increases the carrying value of theCompany’s investment and decreases the net losses of equity affiliate includedin the Consolidated Statement of Operations. During the years ended December 31,2005 and 2006, the Company recorded $15.6 million and $84.8 million,respectively, of net losses of equity affiliate related to its HELIOinvestment, which is net of amortization of basis differences and certain otherequity method accounting adjustments.

Thefollowing is summarized statement of operations information of HELIO for theyears ended December 31, 2005 and 2006:

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2005**                                   | ** ** | **2006** | ** ** |
| ** **     | ** ** | **(in thousands)**                    | ** ** |
| Revenues       |       | $ 16,365                              |       | $  46,580 |   |
| Operating loss |       | (45,658                                    | )          | (201,266 | ) |
| Net loss       |       | (42,023                                    | )          | (191,755 | ) |

 

Thefollowing is summarized balance sheet information of HELIO as of December 31,2005 and 2006:

| ** **            | ** ** | **As of December 31,** | ** ** |
|-----------------------|------------|---------------------------------------|------------|
| ** **            | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| ** **            | ** ** | **(in thousands)**               | ** ** |
| Current assets        |       | $ 164,377                        |       | $ 189,661 |   |
| Long-term assets      |       | 59,570                                |       | 75,309 |   |
| Current  liabilities  |       | 17,912                                |       | 78,889 |   |
| Long-term liabilities |       | 2,394                                 |       | 4,853 |   |

 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**5.   Propertyand Equipment**

Propertyand equipment is recorded at cost and consisted of the following as of December 31,2005 and 2006: 

| ** **                         | ** ** | **As of December 31,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|
| ** **                         | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **(in thousands)**               | ** ** |
| Data center and  network equipment |       | $ 247,677                        |       | $ 286,805 |   |
| Office and other  equipment        |       | 185,734                               |       | 193,692 |   |
| Land and  buildings                |       | 14,777                                |       | 15,113 |   |
| Leasehold  improvements            |       | 58,332                                |       | 65,333 |   |
| Construction in  progress          |       | 11,266                                |       | 13,848 |   |
|                               |       | 517,786                               |       | 574,791 |   |
| Less accumulated  depreciation     |       | (444,609                              | )          | (478,171 | ) |
|                               |       | $  73,177                   |       | $  96,620 |   |

 

During the year ended December 31, 2005, theCompany wrote-down and retired abandoned and disposed property and equipmentthat had a cost basis and accumulated depreciation of $6.8 million.

Depreciation expense chargedto operations, which includes depreciation expense associated with propertyunder capital leases, was $54.9 million, $34.9 million and $34.4 million forthe years ended December 31, 2004, 2005 and 2006, respectively.

**6.   Goodwilland Purchased Intangible Assets**

*Goodwill*

Pursuant to SFAS No. 142, the Company performs animpairment test annually during the fourth quarter of its fiscal year or whenevents and circumstances indicate goodwill might be permanently impaired.During the years ended December 31, 2004, 2005 and 2006, the Company’stests indicated its goodwill was not impaired.

During the year ended December 31, 2005, thecarrying amount of goodwill decreased $6.7 million. This consisted of a $17.1million decrease in goodwill due to the realization of tax benefits associatedwith net operating loss carryforwards which were acquired in connection withacquisitions, offset by a $10.4 million increase in goodwill resulting from theacquisition of Aluria. During the year ended December 31, 2006, thecarrying amount of goodwill increased $101.2 million, which consisted of a$100.0 million increase in goodwill resulting from the acquisition of New Edgeand $1.2 million of purchase accounting adjustments.

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Purchased Intangible Assets*

Thefollowing table presents the components of the Company’s acquired identifiableintangible assets included in the accompanying Consolidated Balance Sheets asof December 31, 2005 and 2006:

| ** **                                   | ** ** | **As of December 31, 2005** | ** ** | **As of December 31, 2006** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                   | ** ** | **Gross**                                       | ** ** | ** **                                      | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                                   | ** ** | **Carrying**                                    | ** ** | **Accumulated**                                 | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| ** **                                   | ** ** | **Value**                                       | ** ** | **Amortization**                                | ** ** | **Value** | ** ** | **Value** | ** ** | **Amortization** | ** ** | **Value** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                         | ** ** |
| Subscriber bases  and customer relationships |       | $                                               | 337,511    |                                            |       | $ | (327,020 | ) |   | $ | 10,491 |   | $ | 384,336 |   |   | $ | (337,708 | ) |   | $ | 46,628 |   |
| Software,  technology and other              |       | 3,125                                           |       |                                            | (338       | ) |   | 2,787 |   | 3,864 |   |   | (1,551 | ) |   | 2,313 |   |
| Trade names                                  |       | 3,000                                           |       |                                            | —     |   |   | 3,000 |   | 10,857 |   |   | — |   |   | 10,857 |   |
| Total                                        |       | $                                               | 343,636    |                                            |       | $ | (327,358 | ) |   | $ | 16,278 |   | $ | 399,057 |   |   | $ | (339,259 | ) |   | $ | 59,798 |   |

 

Amortization of intangibleassets in the Consolidated Statements of Operations for the years ended December 31,2004, 2005 and 2006 represents the amortization of definite lived intangibleassets. The Company’s definite lived intangible assets primarily consist of subscriber bases and customer relationships,acquired software and technology and other assets acquired inconjunction with the purchases of businesses and subscriber bases from otherISPs that are not deemed to have indefinite lives. Definite lived intangibleassets are amortized on a straight-line basis over their estimated usefullives, which are generally three to six years for subscriber bases and customerrelationships and one to six years for acquired software and technology. As ofDecember 31, 2006, the weighted average amortization periods were 3.3 years forsubscriber bases and customer relationships and 4.1 years for software andtechnology. Based on the current amount of definite lived intangible assets,the Company expects to record amortization expense of approximately $13.8million, $11.8 million, $9.0 million, $6.4 million, $6.0 million and $1.9 millionduring the years ending December 31, 2007, 2008, 2009, 2010, 2011 andthereafter, respectively. Actual amortization expense to be reported in futureperiods could differ materially from these estimates as a result of assetacquisitions, changes in useful lives and other relevant factors. The Company’sindefinite lived intangible assets consist of trade names.

In connection with theformation of HELIO and the transfer of 27,000 wireless subscribers to HELIO,EarthLink reclassified a subscriber base asset with a net book value of $0.4million associated with certain wireless subscribers to its investment in HELIOduring the year ended December 31, 2005. The subscriber base asset had acost basis of $1.9 million and accumulated amortization of $1.5 million.

**7.   Facility Exit and Restructuring Costs**

During the year ended December 31,2003, EarthLink executed a plan to streamline its contact center facilities(the “2003 Plan”). In connection with the 2003 Plan, EarthLink closed contactcenter facilities in Dallas, Texas; Sacramento, California; Pasadena,California; and Seattle, Washington. The closure of the four contact centerfacilities resulted in the termination of 1,220 employees and the net reductionof 920 employees, primarily customer support personnel. In connection withthe 2003 Plan, EarthLink recorded facility exit costs of $36.6 million,including $10.7 million for employee, personnel and related costs; $18.2million for real estate and telecommunications costs; and $7.7 million in assetdisposals. As of December 31, 2006, the Company had a $1.2 million liabilityremaining for real estate commitments. All other costs have been paid.

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

During the year ended December 31,2004, EarthLink executed a plan to restructure and further streamline itscontact center operations (the “2004 Plan”). Under the 2004 Plan, EarthLinkclosed contact center operations in Harrisburg, Pennsylvania; Roseville,California; San Jose, California; and Pasadena, California; and reduced itscontact center operations in Atlanta, Georgia. Approximately 1,140 employeeswere directly impacted, primarily customer support personnel. As a result ofthe 2004 Plan, EarthLink recorded facility exit costs of $30.2 million,including $10.5 million for employee, personnel and related costs; $11.3million for real estate and telecommunications costs; and $8.4 million in assetdisposals. As of December 31, 2006, the Company had a $2.6 millionliability remaining for real estate commitments. All other costs have beenpaid.

During the year ended December 31,2005, EarthLink executed plans to further streamline operations by outsourcingcertain contact center and credit and collections activities (the “2005 Plans”).Approximately 227 employees were directly impacted. As a result of the 2005Plans, EarthLink recorded $1.4 million of restructuring costs for severance andpersonnel-related costs. As of December 31, 2006, all severance andpersonnel-related costs related to the 2005 Plans were paid and there was noremaining liability.

EarthLink periodicallyevaluates and adjusts its estimates for facility exit and restructuring costsbased on currently-available information. Such adjustments are included asfacility exit and restructuring costs in the Consolidated Statements ofOperations. During the years ended December 31, 2004 and 2006, EarthLinkreduced its estimates for facility exit costs by $1.8 million and $0.1 million,respectively, based on events occurring during the periods. During the yearended December 31, 2005, EarthLink increased its estimates for facilityexit costs by $0.7 million based on events occurring during the period.

Facility exit andrestructuring liabilities due within one year of the balance sheet date areclassified as other accounts payable and accrued liabilities and liabilitiesdue after one year are classified as other long-term liabilities in theConsolidated Balance Sheets. Of the unpaid balance as of December 31,2006, approximately $2.1 million associated with the 2003 Plan and 2004 Planwas classified as long-term.

**8.   Other Accounts Payable and AccruedLiabilities**

Otheraccounts payable and accrued liabilities consisted of the following as of December 31,2005 and 2006:

| ** **                                                   | ** ** | **As of December 31,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                   | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**               | ** ** |
| Accrued  communications costs                                |       | $                                     | 7,952      |   | $ | 14,052 |   |
| Accrued  advertising                                         |       | 19,026                                |       | 17,299 |   |
| Accrued taxes                                                |       | 7,923                                 |       | 11,874 |   |
| Accrued bounties                                             |       | 9,760                                 |       | 1,442 |   |
| Accrued  professional fees and settlements                   |       | 3,755                                 |       | 5,475 |   |
| Liabilities  associated with non-cancelable operating leases |       | 3,473                                 |       | 2,704 |   |
| Accrued  outsourced customer support                         |       | 10,088                                |       | 8,021 |   |
| Subscriber base  and fixed asset purchases                   |       | 3,858                                 |       | 6,457 |   |
| Deposits and due  to customers                               |       | 4,088                                 |       | 5,654 |   |
| Other                                                        |       | 14,216                                |       | 21,904 |   |
|                                                         |       | $                                     | 84,139     |   | $ | 94,882 |   |

 

88

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**9.   Long-TermDebt**

In November 2006, the Company issued $258.8million aggregate principal amount of Convertible Senior Notes due November 15,2026 (the “Notes”) in a registered offering, which reflects the exercise by theunderwriters of their option to purchase an additional $33.8 million ofprincipal to cover over-allotments. The Company received net proceeds of $251.6million after transaction fees of $7.2 million. The Notes bear interest at3.25% per year on the principal amount of the Notes until November 15,2011, and 3.50% interest per year on the principal amount of the Notesthereafter, payable semi-annually in May and November of each year.The Notes rank as senior unsecured obligations of the Company.

The Notes are payable with cash and, if applicable,convertible into shares of the Company’s common stock based on an initialconversion rate, subject to adjustment, of 109.6491 shares per $1,000 principalamount of Notes (which represents an initial conversion price of approximately$9.12 per share). Upon conversion, a holder will receive cash up to theprincipal amount of the Notes and, at the Company’s option, cash, or shares ofthe Company’s common stock or a combination of cash and shares of common stockfor the remainder, if any, of the conversion obligation. The conversionobligation is based on the sum of the “daily settlement amounts” for the20 consecutive trading days that begin on, and include, the second tradingday after the day the notes are surrendered for conversion. The Notes willbe convertible only in the following circumstances: (1) during anycalendar quarter after the calendar quarter ending December 31, 2006 (andonly during such calendar quarter), if the closing sale price of the Company’scommon stock for each of 20 or more trading days in a period of 30 consecutivetrading days ending on the last trading day of the immediately precedingcalendar quarter exceeds 130% of the conversion price in effect on the lasttrading day of the immediately preceding calendar quarter; (2) during thefive consecutive business days immediately after any five consecutive tradingday period in which the average trading price per $1,000 principal amount ofNotes was equal to or less than 98% of the average conversion value of the Notesduring the note measurement period; (3) upon the occurrence of specifiedcorporate transactions; (4) if the Company has called the Notes forredemption; and (5) at any time from, and including, October 15, 2011to, and including, November 15, 2011 and at any time on or after November 15,2024. The Company has the option to redeem the Notes, in whole or in part, forcash, on or after November 15, 2011, provided that the Company had made atleast ten semi-annual interest payments. In addition, the holders may requirethe Company to purchase all or a portion of their notes on each of November 15,2011, November 15, 2016 and November 15, 2021.

As of December 31, 2006, the fair value of theNotes was approximately $277.3 million based on the quoted market price.

In connection with theissuance of the Notes, the Company entered into separate convertible note hedgetransactions and separate warrant transactions with respect to the Company’scommon stock to reduce the potential dilution upon conversion of the Notes(collectively referred to as the “Call Spread Transactions”). The Companypurchased call options to cover approximately 28.4 million shares of theCompany’s common stock, subject to adjustment in certain circumstances, whichis the number of shares underlying the Notes. In addition, the Company soldwarrants permitting the purchasers to acquire up to approximately 28.4 millionshares of the Company’s common stock, subject to adjustment in certaincircumstances. See Note 10, “Shareholders’ Equity,” for more information on theCall Spread Transactions.

89

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**10.   Shareholders’Equity**

*Shareholder RightsPlan*

During 2002, the Board of Directors adopted ashareholder rights plan (the “Rights Plan”). In connection with the RightsPlan, the Board of Directors also declared a dividend of one right for eachoutstanding share of EarthLink’s common stock for stockholders of record at theclose of business on August 5, 2002.

Each right entitles theholder to purchase one one-thousandth (1¤1000)of a share (a “Unit”) of EarthLink’s Series D Junior Preferred Stock at aprice of $60.00 per Unit upon certain events. Generally, in the event a personor entity acquires, or initiates a tender offer to acquire, at least 15% ofEarthLink’s then outstanding common stock, the rights will become exercisablefor common stock having a value equal to two times the exercise price of theright, or effectively at one-half of EarthLink’s then-current stock price. Therights are redeemable under certain circumstances at $0.01 per right and willexpire, unless earlier redeemed, on August 6, 2012.

*Share Repurchases*

Since the inception of the Company’s share repurchaseprogram, the Board of Directors has authorized a total of $550.0 million forthe repurchase of EarthLink’s common stock. During the years ended December 31,2004 and 2005, the Board of Directors also approved repurchasing common stockpursuant to plans under Rule 10b5-1 of the Securities Exchange Actof 1934, as amended. As of December 31, 2006, the Company had $95.3million available under the current authorizations. The Company may repurchaseits common stock from time to time in compliance with the SEC regulations andother legal requirements, including through the use of derivative transactions,and subject to market conditions and other factors. The share repurchaseprogram does not require the Company to acquire any specific number of sharesand may be terminated by the Board of Directors at any time.

Thefollowing table summarizes share repurchases during the years ended December 31,2004, 2005 and 2006 pursuant to the share repurchase program, which have beenrecorded as treasury stock:

| ** **                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|
| ** **                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **(in thousands)**                    | ** ** |
| Number of shares  repurchased |       | 12,628                                     |       | 20,527 |   | 11,339 |   |
| Aggregate purchase price      |       | $                                          | 125,286    |   | $ | 192,563 |   | $ | 85,613 |   |
|                               |            |                                            |            |  |  |  |  |  |  |  |

 

*Call SpreadTransactions*

In connection with the issuance of the Notes (see Note9, “Long-Term Debt”), the Company entered into separate convertible note hedgetransactions and separate warrant transactions with respect to the Company’scommon stock to minimize the impact of the potential dilution upon conversionof the Notes. The Company purchased call options in private transactions tocover approximately 28.4 million shares of the Company’s common stock at astrike 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 

90

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

no longer outstanding dueto conversion or otherwise. As of December 31, 2006, the estimated fairvalue of the call options was $58.4 million.

The Company also sold warrants permitting thepurchasers to acquire up to approximately 28.4 million shares of theCompany’s common stock at an exercise price of $11.20 per share, subject toadjustments in certain circumstances, in private transactions for totalproceeds of approximately $32.1 million. The warrants expire at variousdates in March 2012 through July 2012. The warrants provide for netshare settlement. In no event shall the Company be required to deliver a numberof shares in connection with the transaction in excess of twice the aggregatenumber of warrants. As of December 31, 2006, the estimated fair value ofthe warrants was $41.0 million.

The Company has analyzedthe Call Spread Transactions under EITF Issue No. 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled In, aCompany’s Own Stock,” and other relevant literature, and determined that theymeet the criteria for classification as equity transactions. As a result, theCompany recorded the purchase of the call options as a reduction in additionalpaid-in capital and the proceeds of the warrants as an addition to paid-incapital, and the Company will not recognize subsequent changes in fair value ofthe agreements.

**11.   Stock-BasedCompensation**

*Stock IncentivePlans*

The Company has grantedoptions to employees and directors to purchase the Company’s common stock undervarious stock incentive plans. The Company has also granted restricted stockunits to employees and directors under various stock incentive plans. Under theplans, employees and non-employee directors are eligible to receive awards ofvarious forms of equity-based incentive compensation, including stock options,restricted stock, restricted stock units, phantom share units and performanceawards, among others. The plans are administered by the Board of Directors orthe Leadership and Compensation Committee of the Board of Directors, whichdetermine the terms of the awards granted. Stock options are generally grantedwith an exercise price equal to the market value of EarthLink, Inc. commonstock on the date of grant, have a term of ten years or less, and vest overterms of four to six years from the date of grant. Restricted stock unitsgenerally vest over terms of three to six years from the date of grant. As of December 31,2006, the Company had reserved 31.3 million shares of common stock for theissuance of equity-based incentive compensation under its stock incentiveplans. As of December 31, 2006, approximately 20.5 million stock options,restricted stock units and phantom share units were outstanding under variousstock incentive plans that expire in 2010 and 2016 and approximately 10.8million shares were available for grant.

*DeferredCompensation Plan*

The Company’s SecondDeferred Compensation Plan for Directors and Certain Key Employees permitsmembers of the Board of Directors and eligible employees to elect to deferreceipt of shares of common stock pursuant to vested restricted stock units andvarious cash consideration, such as directors’ fees and bonuses. The cashconsideration is converted into phantom share units at the closing price on thedate the consideration would otherwise be paid, and vested restricted stockunits are converted into phantom share units on a one-for-one basis. Phantomshare units are fully vested at the date of grant and are converted to commonstock upon the occurrence of various events. As of December 31, 2005 and2006, approximately 18,000 and 29,000 phantom share units, respectively, wereoutstanding.

91

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Employee StockPurchase Plan*

In January 2005, theCompany terminated its employee stock purchase plan (“ESPP”). Under the termsof the ESPP, eligible employees were able to have up to 15% of eligiblecompensation deducted from their pay to purchase EarthLink common stock. Underthe ESPP, withholdings were used to purchase shares at the beginning of eachquarter at a per share purchase price equal to 85% of the lesser of the closingprice on the first trading day of the just completed quarter or the closingprice on the last trading day of the just completed quarter. During the yearsended December 31, 2004 and 2005, employees purchased approximately223,000 and 47,000 shares, respectively, pursuant to the ESPP at weighted averageper share purchase prices of $7.58 and $9.14, respectively.

*Warrants*

Prior to December 31, 2000, the Company issuedwarrants to purchase shares of the Company’s common stock to certain members ofits Board of Directors, customers, consultants, lessors, creditors and others.As of December 31, 2006, warrants to purchase a total of 61,000 shares ofcommon stock were outstanding at exercise prices ranging from $4.02 to $5.50.The warrants are currently exercisable and expire at various dates through October 2007.

During the year ended December 31,2006, the Company sold warrants in connection with the issuance of Notespermitting the purchasers to acquire up to approximately 28.4 million shares ofthe Company’s common stock. See Note 10, “Stockholders’ Equity,” for adescription of those warrants.

*Options Outstanding*

Thefollowing table summarizes information concerning stock option activity as ofand for year ended December 31, 2006:

| ** **                                                | ** ** | ** **                                                | ** ** | ** **   | ** ** | **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, 2005                 |       |                                                      | 19,831     |         |       |                  | $          | 11.90         |       |   |   |   |   |   |   |   |   |   |
| Granted                                                   |       |                                                      | 3,729      |         |       |                  | 7.94       |          |       |   |   |   |   |   |   |   |   |
| Exercised                                                 |       |                                                      | (717       | )            |       |                  | 6.00       |          |       |   |   |   |   |   |   |   |   |
| Forfeited and expired                                     |       |                                                      | (2,373     | )            |       |                  | 12.88      |          |       |   |   |   |   |   |   |   |   |
| Outstanding as of  December 31, 2006                 |       |                                                      | 20,470     |         |       |                  | 11.27      |          |       |   | 6.4 |   |   |   | $ | 4,559 |   |   |
| Vested and expected to vest as of December 31,  2006 |       |                                                      | 18,691     |         |       |                  | $          | 11.52         |       |   |   | 6.1 |   |   |   | $ | 4,386 |   |   |
| Exercisable as of  December 31, 2006                 |       |                                                      | 12,200     |         |       |                  | $          | 13.02         |       |   |   | 4.8 |   |   |   | $ | 2,947 |   |   |

                                                

92

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

The weighted average estimated fair value of stockoptions granted during the year ended December 31, 2006 was $3.28 pershare. The aggregate intrinsic value amounts in the table above represent thedifference between the closing price of the Company’s common stock on December 31,2006 and the exercise price, multiplied by the number of in-the-money stockoptions as of the same date. This represents the amount that would have beenreceived by the stock option holders if they had all exercised their stock optionson December 31, 2006. The total intrinsic value of options exercisedduring the years ended December 31, 2004, 2005 and 2006 was $6.1 million,$10.1 million and $2.4 million, respectively.

Thefollowing table summarizes the status of the Company’s stock options as of December 31,2006:

| ** **                                                             | ** ** | ** **                                                      | ** ** | ** **                                                      | ** ** | ** **                                                   | ** ** | **Stock Options**                                          | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **Stock Options Outstanding**                                | ** ** | **Exercisable**                                                 | ** ** |
| ** **                                                             | ** ** | ** **                                                      | ** ** | **Weighted**                                                    | ** ** | ** **                                                   | ** ** | ** **                                                      | ** ** |
| ** **                                                             | ** ** | ** **                                                      | ** ** | **Average**                                                     | ** ** | **Weighted**                                                 | ** ** | ** **                                                      | ** ** | **Weighted** | ** ** |
| ** **                                                             | ** ** | ** **                                                      | ** ** | **Remaining**                                                   | ** ** | **Average**                                                  | ** ** | ** **                                                      | ** ** | **Average** | ** ** |
| **Range of**                                                      | ** ** | **Number**                                                      | ** ** | **    Contractual    ** | ** ** | **    Exercise    ** | ** ** | **Number**                                                      | ** ** | **    Exercise    ** | ** ** |
| **Exercise Prices**                                               | ** ** | **    Outstanding    ** | ** ** | **Life**                                                        | ** ** | **Price**                                                    | ** ** | **    Exercisable    ** | ** ** | **Price** | ** ** |
| ** **                                                             | ** ** | **(in thousands)**                                         | ** ** | ** **                                                      | ** ** | ** **                                                   | ** ** | **(in thousands)**                                         | ** ** | ** ** | ** ** |
| $ 1.17  to  $ 5.56                       |       |                                                            | 1,845      |                                                            |       |                                                         | 5.7        |                                                            |       |   | $ | 5.28 |   |   |   | 1,267 |   |   |   | $ | 5.36 |   |   |
|    5.81  to     6.72 |       |                                                            | 907        |                                                            |       |                                                         | 5.6        |                                                            |       |   | 6.17 |   |   |   | 808 |   |   |   | 6.19 |   |   |
|    6.90  to     7.82 |       |                                                            | 2,716      |                                                            |       |                                                         | 9.1        |                                                            |       |   | 7.07 |   |   |   | 262 |   |   |   | 7.72 |   |   |
|    7.99  to     9.24 |       |                                                            | 2,664      |                                                            |       |                                                         | 7.5        |                                                            |       |   | 8.93 |   |   |   | 1,373 |   |   |   | 8.87 |   |   |
|    9.25  to     9.93 |       |                                                            | 2,659      |                                                            |       |                                                         | 6.8        |                                                            |       |   | 9.58 |   |   |   | 1,373 |   |   |   | 9.64 |   |   |
|  10.06  to   10.06                       |       |                                                            | 2,290      |                                                            |       |                                                         | 3.7        |                                                            |       |   | 10.06 |   |   |   | 2,290 |   |   |   | 10.06 |   |   |
|  10.36  to   10.51                       |       |                                                            | 2,322      |                                                            |       |                                                         | 8.3        |                                                            |       |   | 10.37 |   |   |   | 871 |   |   |   | 10.37 |   |   |
|  10.56  to   15.00                       |       |                                                            | 2,410      |                                                            |       |                                                         | 6.8        |                                                            |       |   | 11.67 |   |   |   | 1,299 |   |   |   | 12.22 |   |   |
|  15.63  to   51.44                       |       |                                                            | 2,657      |                                                            |       |                                                         | 3.0        |                                                            |       |   | 26.98 |   |   |   | 2,657 |   |   |   | 26.98 |   |   |
| $ 1.17  to $51.44                                  |       |                                                            | 20,470     |                                                            |       |                                                         | 6.4        |                                                            |       |   | $ | 11.27 |   |   |   | 12,200 |   |   |   | $ | 13.02 |   |   |

 

*ValuationAssumptions for Stock Options*

Thefair value of stock options granted during the years ended December 31,2004, 2005 and 2006 was estimated using the Black-Scholes option-pricing modelwith the following assumptions:

| ** **               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Dividend yield           |       | 0                                          | %          | 0 | % | 0 | % |
| Expected  volatility     |       | 58                                         | %          | 49 | % | 43 | % |
| Risk-free  interest rate |       | 3.59                                       | %          | 4.03 | % | 4.86 | % |
| Expected life            |       | 4.3 years                                  |       | 4.7 years |   | 4.3 years |   |

 

The weighted average grant date fair value of optionsgranted during the years ended December 31, 2004, 2005 and 2006 was $4.71,$4.65 and $3.28, respectively.

The dividend yieldassumption is based on the Company’s history and expectation of future dividendpayouts. The expected volatility is based on a combination of the Company’shistorical stock price and implied volatility. The selection of impliedvolatility data to estimate expected volatility is based upon the availabilityof actively traded options on the Company’s stock. The risk-free interest rateassumption is based upon the U.S. Treasury yield curve in effect at the time ofgrant for periods corresponding with the expected life of the option. Theexpected life of employee stock options represents the weighted-average periodthe stock options are expected to remain outstanding.

93

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Restricted StockUnits*

Thefollowing table summarizes the Company’s restricted stock units as of and forthe year ended December 31, 2006:

| ** **                              | ** ** | ** **           | ** ** | **Weighted**        | ** ** |
|-----------------------------------------|------------|----------------------|------------|---------------------|------------|
| ** **                              | ** ** | ** **           | ** ** | **Average**         | ** ** |
| ** **                              | ** ** | **Restricted**       | ** ** | **Grant Date** | ** ** |
| ** **                              | ** ** | **Stock Units** | ** ** | **Fair Value** | ** ** |
| Nonvested as of  December 31, 2005 |       |                 | 658,000    |                |       |   | $ | 9.81 |   |   |
| Granted                                 |       |                 | 831,000    |                |       |   | 7.89 |   |   |
| Vested                                  |       |                 | (165,000   | )                   |       |   | 9.29 |   |   |
| Forfeited                               |       |                 | (144,000   | )                   |       |   | 9.52 |   |   |
| Nonvested as of  December 31, 2006 |       |                 | 1,180,000  |                |       |   | 8.57 |   |   |

 

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 years ended December 31,2004, 2005 and 2006 was $8.90, $9.49 and $7.89, respectively. As of December 31,2006, there was $7.0 million of total unrecognized compensation cost related tononvested share-based compensation arrangements. That cost is expected to berecognized over a weighted-average period of 3.1 years. The total fair value ofshares vested during the years ended December 31, 2004, 2005 and 2006 was$0.1 million, $0.1 million and $1.2 million, respectively, which represents theclosing price of the Company’s common stock on the vesting date multiplied bythe number of restricted stock units that vested.

**12.**   ProfitSharing Plans

The Company sponsors theEarthLink, Inc. 401(k) Plan (“Plan”), which qualifies as a deferredsalary arrangement under Section 401(k) of the Internal Revenue Code.Under the Plan, participating employees may defer a portion of their pretaxearnings up to the Internal Revenue Service annual contribution limit. TheCompany makes a matching contribution of 50% of the first 6% of basecompensation that a participant contributes to the Plan. The Company’s matchingcontributions vest over four years from the participant’s date of hire. TheCompany contributed $3.0 million, $2.8 million and $2.8 million during theyears ended December 31, 2004, 2005 and 2006, respectively.

94

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**13.   IncomeTaxes**

Thecurrent and deferred income tax provisions were as follows for the years ended December 31,2004, 2005 and 2006:

| ** **            | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|
| ** **            | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **            | ** ** | **(in thousands)**                    | ** ** |
| **Current**           | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal               |       | $                                          | 1,608      |   | $ | 2,338 |   | $ | (328 | ) |
| State                 |       | 883                                        |       | 2,999 |   | 626 |   |
| Total current         |       | 2,491                                      |       | 5,337 |   | 298 |   |
| **Deferred**          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal               |       | 1,969                                      |       | 17,038 |   | 325 |   |
| State                 |       | —                                     |       | 101 |   | 263 |   |
| Total deferred        |       | 1,969                                      |       | 17,139 |   | 588 |   |
| Income tax  provision |       | $                                          | 4,460      |   | $ | 22,476 |   | $ | 886 |   |

 

During the years ended December 31, 2004 and2005, the Company utilized approximately $94.1 million and $123.8 million,respectively, of federal net operating loss carryforwards (“NOLs”) and $88.6million and $67.9 million, respectively, of state NOLs to offset taxableincome; however, EarthLink owed state income and federal and state alternativeminimum tax (“AMT”) aggregating $2.5 million and $5.3 million for theyears ended December 31, 2004 and 2005, respectively, and the AMT waspayable primarily due to limitations associated with the utilization of NOLs incalculating AMT due. A valuation allowance of $1.8 million and $2.6 million hasbeen provided for the years ended December 31, 2004 and 2005 for AMTamounts due, respectively, that may be used to offset tax due in future years. Duringthe year ended December 31, 2006, the Company created federal NOLs of$34.5 million, and $124.2 million of state NOLs were utilized to offset statetaxable income or expired. A valuation allowance of $12.1 million has beenprovided for the year ended December 31, 2006 for the federal NOLscreated, that may be used to offset tax due in future years.

Of the federal NOLs utilized during the years ended December 31,2004 and 2005, $5.6 million and $49.0 million were acquired in connection withthe acquisitions of OneMain.com, Inc., Cidco Incorporated and PeoplePCInc. in 2000, 2001 and 2002, respectively. Upon realization of these NOLs in2004 and 2005, the associated reduction in the valuation allowance of $2.0million and $17.1 million, respectively, was recorded as a reduction togoodwill in accordance with SFAS No. 109, “Accounting for Income Taxes,”resulting in deferred income tax provisions of $2.0 million and $17.1 million,respectively.

95

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Thefollowing table summarizes the significant differences between the U.S. federalstatutory tax rate and the Company’s effective tax rate for financial statementpurposes for the years ended December 31, 2004, 2005 and 2006:

| ** **                                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                              | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                              | ** ** | **(in thousands)**                    | ** ** |
| Federal income  tax provision at statutory rate                                         |       | $                                          | 40,414     |   | $ | 57,840 |   | $ | 2,056 |   |
| State income  taxes, net of federal benefit                                             |       | 5,254                                      |       | 6,688 |   | 923 |   |
| Nondeductible  expenses                                                                 |       | 361                                        |       | 1,087 |   | 5,046 |   |
| Net change to  valuation allowance                                                      |       | —                                     |       | — |   | (7,142 | ) |
| Change in  valuation allowance associated with realized deferred tax assets             |       | (45,360                                    | )          | (62,938 | ) | — |   |
| Valuation  allowance for realized deferred tax assets acquired in business combinations |       | 1,969                                      |       | 17,139 |   | — |   |
| Increase in  valuation allowance for AMT due                                            |       | 1,822                                      |       | 2,582 |   | — |   |
| Other                                                                                   |       | —                                     |       | 78 |   | 3 |   |
|                                                                                    |       | $                                          | 4,460      |   | $ | 22,476 |   | $ | 886 |   |

 

The Company acquired $49.5 million of deferred taxassets, primarily related to NOLs, in conjunction with the acquisition of NewEdge in April 2006. These additional deferred tax assets and liabilitiesimpact the net change to the valuation allowance.

Deferredtax assets and liabilities include the following as of December 31, 2005and 2006:

| ** **                                  | ** ** | **As of December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|
| ** **                                  | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| ** **                                  | ** ** | **(in thousands)**               | ** ** |
| Deferred tax assets:                        |       |                                  |       |   |   |
| Net operating loss carryforwards            |       | $                                     | 158,371    |   | $ | 184,805 |   |
| Accrued liabilities and reserves            |       | 17,773                                |       | 16,696 |   |
| Subscriber base and other intangible assets |       | 97,295                                |       | 92,756 |   |
| Other                                       |       | 38,186                                |       | 62,644 |   |
| Total deferred tax assets                   |       | 311,625                               |       | 356,901 |   |
| Valuation  allowance                        |       | (311,625                              | )          | (356,901 | ) |
| Net deferred tax  asset                     |       | $                                     | —     |   | $ | — |   |
| Deferred tax  liabilities:                  |       |                                  |       |   |   |
| Indefinite lived intangible assets          |       | $                                     | —     |   | $ | (4,586 | ) |
| Net deferred tax  liability                 |       | $                                     | —     |   | $ | (4,586 | ) |

 

As of December 31, 2005 and 2006, the Company hadNOLs for federal income tax purposes totaling approximately $386.9 million and$513.8 million, respectively, which begin to expire in 2017. As of December 31,2005 and 2006, the Company had NOLs for state income tax purposes totalingapproximately $231.1 million and $118.2 million, respectively, which started toexpire in 2005. The Company also had $35.6 million of foreign NOLs as of December 31,2005. During the year ended December 31, 2006, all foreign entities weredissolved and the foreign deferred tax assets were reduced to zero. Under theTax Reform Act of 1986, the Company’s ability to use its federal, state andforeign NOLs 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

and federal and state taxcredit carryforwards to reduce future taxable income and future taxes,respectively, is subject to restrictions attributable to equity transactionsthat have resulted in a change of ownership as defined in Internal Revenue CodeSection 382. During the year ended December 31, 2006, the Companyreduced deferred tax assets and the valuation allowance by $0.7 million basedon an analysis of other deferred tax assets. As a result, the NOL amounts as ofDecember 31, 2006 reflect the restriction on the Company’s ability to useits federal and state NOLs; however, the Company continues to evaluatepotential changes to the Section 382 limitations associated with acquired federaland state NOLs. The utilization of these NOLs could be further restricted infuture periods which could result in significant amounts of these NOLs expiringprior to benefiting the Company.

As of December 31, 2006, the NOLs included $82.5million related to the exercise of employee stock options and warrants. Anybenefit resulting from the utilization of this portion of the NOLs will becredited directly to equity. As of December 31, 2006, the NOLs included$40.0 million of NOLs acquired in connection with business acquisitions thatare currently available and additional NOLs of $118.9 million that could beutilized in future years. Any benefit resulting from the utilization of thisportion of the NOLs will be credited to goodwill.

The Company has provided afull valuation allowance for its deferred tax assets, including NOLs, becauseof uncertainty regarding their realization.

**14.   Commitmentsand Contingencies**

*Leases*

The Company leases certain of its facilities andequipment under non-cancelable operating leases expiring in various yearsthrough 2014. The leases generally contain annual escalation provisions as wellas renewal options. The total amount of base rent payments, net of allowancesand incentives, is being charged to expense using the straight-line method overthe terms of the leases. In addition to the base rent payments, EarthLinkgenerally pays a monthly allocation of the buildings’ operating expenses. Totalrent expense in the years ended December 31, 2004, 2005 and 2006 for alloperating leases, including operating expenses, was $17.8 million, $13.1million and $14.5 million, respectively.

Minimumlease commitments under non-cancelable leases, including estimated operatingexpenses, as of December 31, 2006 are as follows:

| ** **                                                            | ** ** | **Operating** | ** ** |
|-----------------------------------------------------------------------|------------|---------------|------------|
| ** **                                                            | ** ** | **Leases**    | ** ** |
| **Year Ending December 31,**                           | ** ** | ** **    | ** ** | **(in thousands)** | ** ** |
| 2007                                                                  |       |          | $          | 14,854 |   |   |
| 2008                                                                  |       |          | 11,146     |   |   |
| 2009                                                                  |       |          | 12,494     |   |   |
| 2010                                                                  |       |          | 11,632     |   |   |
| 2011                                                                  |       |          | 11,124     |   |   |
| Thereafter                                                            |       |          | 27,705     |   |   |
| Total minimum  lease payments, including estimated operating expenses |       |          | 88,955     |   |   |
| Less aggregate  contracted sublease income                            |       |          | (9,130     | ) |   |
|                                                                  |       |          | $          | 79,825 |   |   |
|                                                                       |            |               |            |  |  |  |  |  |

 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

During the year ended December 31,2006, the Company entered into a financing lease agreement with GeneralElectric Capital Corporation to lease certain equipment necessary to build outits municipal wireless infrastructure in selected markets. Under the agreement,the Company can lease up to $75.0 million of assets. As of December 31,2006, no equipment was leased pursuant to the financing agreement.

*Significant Agreements*

Accessto the Internet for customers outside of the Company’s base of owned POPs is providedthrough capacity leased from a number of third-party providers such as Level 3Communications, Inc. EarthLink is, in effect, buying this capacity in bulkat a discount, and providing access to EarthLink’s customer base. Certainamounts payable as of December 31, 2005 and 2006 under such agreements areincluded in accrued communications costs in Note 8, “Other Accounts Payable andAccrued Liabilities.” Minimum commitments under non-cancelable network serviceagreements and other purchase commitments are as follows as of December 31,2006:

| **Year Ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                        |       | $          | 55,621     |       |
| 2008                                        |       | 37,106     |       |
| 2009                                        |       | 5,102      |       |
| Total                                       |       | $          | 97,829     |       |

 

Cost of revenues fromthese non-cancelable network service agreements totaled $132.6 million, $54.8million and $50.8 million for the years ended December 31, 2004, 2005 and2006, respectively.

*HELIO*

As of December 31,2006, the Company had committed to contribute a total of $19.5 million of cashto HELIO in 2007 pursuant to the Contribution and Formation Agreement, including$13.5 million that was contributed in February 2007 and $6.0 million to becontributed in August 2007.

**15.**    Financial Instruments

*Fair Values of Financial Instruments*

The Company has estimatedthe fair value of its financial instruments as of December 31, 2005 and2006 using available market information or other appropriate valuationmethodologies. Considerable judgment is required in interpreting market data todevelop the estimates of fair value. Accordingly, the estimates presented inthe accompanying consolidated financial statements are not necessarilyindicative of the amounts the Company would realize in a current marketexchange.

The carrying amounts of the Company’s cash, cashequivalents, trade receivables and trade payables approximate their fair valuesbecause of their nature and respective durations. The Company’s short- andlong-term investments in marketable securities consist of available-for-salesecurities and are carried at market value, which is based on quoted marketprices. The Company’s equity investments in publicly-held companies are statedat fair value, which is based on quoted market prices. The Company’sinvestments in privately-held companies are stated at cost, net ofother-than-temporary impairments, because it is impracticable to estimate fairvalue. The estimated fair value of the Company’s long-term debt is based onquoted market prices. The estimated fair value of the Company’s purchased calloptions is based on the Black-Scholes valuation model.

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Thefollowing table presents the carrying value and fair value of the Company’sfinancial instruments as of December 31, 2005 and 2006:

| ** **                                       | ** ** | **As of December 31, 2005** | ** ** | **As of December 31, 2006** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                       | ** ** | ** **                                      | ** ** | **Estimated**                                   | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                       | ** ** | **Carrying**                                    | ** ** | **Fair**                                        | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                       | ** ** | **Amount**                                      | ** ** | **Value**                                       | ** ** | **Amount** | ** ** | **Value** | ** ** |
| ** **                                       | ** ** | **(dollars in thousands)**            | ** ** |
| Cash and cash  equivalents                       |       | $                                               | 173,294    |                                            | $          | 173,294 |   | $ | 158,369 |   | $ | 158,369 |   |
| Investments in  marketable securities-short-term |       | 207,845                                         |       | 207,845                                         |       | 214,947 |   | 214,947 |   |
| Investments in  marketable securities-long-term  |       | 40,980                                          |       | 40,980                                          |       | 21,460 |   | 21,460 |   |
| Investments in other  companies for which it is: |       |                                            |       |                                            |       |   |   |   |   |
| Practicable to estimate fair value               |       | 417                                             |       | 417                                             |       | 48,325 |   | 48,325 |   |
| Not practicable to estimate fair value           |       | 1,000                                           |       | —                                          |       | 11,000 |   | — |   |
| Long-term debt                                   |       | —                                          |       | —                                          |       | 258,750 |   | 277,253 |   |
| Call options                                     |       | —                                          |       | —                                          |       | 47,162 |   | 58,361 |   |
|                                                  |            |                                                 |            |                                                 |            |  |  |  |  |  |  |  |  |

 

*Concentrations ofCredit Risk*

By their nature, allfinancial instruments involve risk, including credit risk for non-performanceby counterparties. Financial instruments that potentially subject the Companyto credit risk consist principally of cash, cash equivalents, investments inmarketable securities, trade receivables and investments in other companies.The Company’s cash investment policy limits investments to investment gradeinstruments. Accounts receivable are typically unsecured and are derived fromrevenues earned from customers primarily located in the U.S. Credit risk withrespect to trade receivables is limited due to the large number of customerscomprising the Company’s customer base. Additionally, the Company performsongoing credit evaluations of its customers and maintains allowances forpotential credit losses. Management regularly evaluates the recoverability ofits investments in other companies based on the performance and the financialposition of those companies as well as other evidence of market value.

*Market Risk*

The Company is exposed tomarket risk as it relates to changes in the market value of its equityinvestments. The Company invests in equity instruments of public and privatecompanies for operational and strategic purposes. These securities are subjectto significant fluctuations in fair market value due to volatility of the stockmarket and the industries in which the companies operate. These securitiesinclude an equity method investment classified as investment in equityaffiliate in the Consolidated Balance Sheets, and investments in privately-heldsecurities, publicly-traded securities and convertible securities classified asinvestments in other companies in the Consolidated Balance Sheets. As of December 31,2005, the Company had $61.1 million of investments accounted for using theequity method of accounting, $0.4 million of fair value investments and$1.0 million of cost-method investments. As of December 31, 2006, theCompany had $61.7 million of investments accounted for using the equitymethod of accounting, $48.3 million of fair value investments and$11.0 million of cost-method investments.

*Interest Rate Risk*

The Company is exposed to interest rate risk withrespect to its investments in marketable securities. A change in prevailinginterest rates may cause the fair value of the Company’s investments tofluctuate. For example, if the Company holds a security that was issued with afixed interest rate at the then-

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

prevailing rate and theprevailing interest rate later rises, the fair value of its investment maydecline. To minimize this risk, the Company has historically held manyinvestments until maturity, and as a result, the Company receives interest andprincipal amounts pursuant to the underlying agreements. To further mitigaterisk, the Company maintains its portfolio of investments in a variety ofsecurities, including government agency notes, asset-backed debt securities(including auction rate debt securities), corporate notes and commercial paper,all of which bear a minimum short-term rating of A1/P1 or a minimum long-termrating of A/A2. As of December 31, 2005 and 2006, net unrealized losses inthese investments were not material. In general, money market funds are not subjectto market risk because the interest paid on such funds fluctuates with theprevailing interest rate. In addition, the Company invests in relativelyshort-term securities and, therefore, changes in short-term interest ratesimpact the amount of interest income included in the statements of operations.

The Company is alsoexposed to interest rate risk with respect with respect to its long-term debt. Achange in prevailing interest rates may cause the fair value of its long-termdebt to fluctuate. The convertible senior notes bear interest at a fixed rateof 3.25% per annum until November 15, 2011, and 3.50% interest per annumthereafter.

**16.   Supplemental Disclosure of Cash FlowInformation**

| ** **                                               | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                               | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                               | ** ** | **(in thousands)**                    | ** ** |
| **Significant non-cash  transactions**                   |       |                                       |       |   |   |   |   |
| Non-cash working capital adjustments to reduce  goodwill |       | $                                          | 5,300      |   | $ | 129 |   | $ | 1,187 |   |
| **Additional  cash flow information**                    |       |                                       |       |   |   |   |   |
| Cash paid during the year for interest                   |       | $                                          | 677        |   | $ | 383 |   | $ | 1,416 |   |
| Cash paid during the year for income taxes               |       | 1,778                                      |       | 5,507 |   | 850 |   |
| **Purchase  of businesses**                              |       |                                       |       |   |   |   |   |
| Cash paid, net of cash acquired                          |       | $                                          | —     |   | $ | 9,352 |   | $ | 108,663 |   |
| Issuance of common stock                                 |       | —                                     |       | — |   | 20,194 |   |
| Net liabilities incurred and assumed                     |       | —                                     |       | 4,203 |   | 15,979 |   |
| Intangible assets  acquired                              |       | $                                          | —     |   | $ | 13,555 |   | $ | 144,836 |   |

 

**17.   RelatedParty Transactions**

*HELIO*

Upon HELIO’s formation,EarthLink and HELIO entered into a services agreement for EarthLink to provideto HELIO 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 itbusiness, the extent to which HELIO relies on EarthLink to provide theseservices has decreased. EarthLink believes that providing these services to HELIOenabled HELIO to more quickly and cost effectively launch its business than ifit had purchased these services from third parties. The management fees weredetermined based on EarthLink’s costs to provide the services, and managementbelieves such fees are reasonable. The total amount of fees that HELIO pays toEarthLink depends on the extent to which HELIO utilizes EarthLink’s services. Feesfor services provided to HELIO are reflected as reductions to the associatedexpenses incurred by EarthLink to provide such services. 

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**EARTHLINK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Duringthe years ended December 31, 2005 and 2006, fees received for servicesprovided to HELIO were $3.0 million and $2.3 million, respectively.

EarthLink markets HELIO’sproducts and services, and during the years ended December 31, 2005 and2006, EarthLink generated revenues of $0.3 million and $0.9 million,respectively, associated with marketing HELIO’s services.

EarthLink purchaseswireless Internet access devices and services from HELIO. During the yearsended December 31, 2005 and 2006, fees paid for products and servicesreceived from HELIO were $0.9 million and $0.9 million, respectively.

As of December 31,2005 and 2006, the Company had accounts receivable from HELIO of approximately$0.3 million and $0.8 million, respectively.

*Sprint*Nextel

Through its ownershipinterest in EarthLink, SprintNextel Corporation (“Sprint”) was considered a related party during theyear ended December 31, 2004. Due to sales of EarthLink common stockduring the year ended December 31, 2005, Sprint is no longer a relatedparty. The Company has amarketing relationship with Embarq Corporation (“Embarq”), a spin-off of Sprint’slocal communications business. During the year ended December 31,2004, the Company’s relationship with Embarq generated approximately 10% ofEarthLink’s total gross organic subscriber additions.

In connection with theCompany’s wholesale and customer referral arrangements with Embarq, the Companyreceived approximately $27.6 million during the year ended December 312004. The prices for services provided by the Company to Embarq were negotiatedat arms-length.

EarthLink paid Embarqapproximately $57.6 million during the year ended December 31, 2004associated with network and voice services agreements. The prices paid forservices purchased from Embarq were negotiated at arms-length.

*Officers and Directors*

As of December 31,2001, the Company had made equity investments totaling $10.0 million in EVG, anaffiliate of eCompanies, LLC (“eCompanies”). The carrying value of theinvestment in EVG as of December 31, 2005 and 2006 was zero. Sky Dayton, amember of EarthLink’s Board of Directors and HELIO’s Board of Directors, is afounding partner in EVG, a limited partnership formed to invest in domesticemerging Internet-related companies, and a founder and director of eCompanies.During the years ended December 31, 2005 and 2006, the Company received$4.4 million and $0.4 million in cash distributions from EVG.

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**19.   Quarterly Financial Data (Unaudited)**

Thefollowing table sets forth certain unaudited quarterly consolidated financialdata for the eight quarters in the period ended December 31, 2006. In theopinion of the Company’s management, this unaudited information has beenprepared on the same basis as the audited consolidated financial statements andincludes all material adjustments (consisting of normal recurring accruals andadjustments) necessary to present fairly the quarterly unaudited financialinformation. The operating results for any quarter are not necessarilyindicative of results for any future period.

| ** **                                         | ** ** | **Three Months Ended**                                   | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **Mar. 31,**                                                  | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** | **Mar. 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                         | ** ** | **2005**                                                           | ** ** | **2005** | ** ** | **2005** | ** ** | **2005** | ** ** | **2006** | ** ** | **2006** | ** ** | **2006** | ** ** | **2006** | ** ** |
| ** **                                         | ** ** | **(unaudited)**                                                    | ** ** |
| ** **                                         | ** ** | **(in thousands, except per share data)** | ** ** |
| Revenues                                           |       | $                                                                  | 334,740    |   | $ | 325,688 |   | $ | 316,996 |   | $ | 312,648 |   | $ | 309,712 |   | $ | 332,096 |   | $ | 331,309 |   | $ | 328,150 |   |
| Operating costs and expenses                       |       | 297,940                                                            |       | 277,835 |   | 273,968 |   | 275,833 |   | 289,983 |   | 304,864 |   | 311,683 |   | 319,095 |   |
| Income from operations                             |       | 36,800                                                             |       | 47,853 |   | 43,028 |   | 36,815 |   | 19,729 |   | 27,232 |   | 19,626 |   | 9,055 |   |
| Gain (loss) on investments in other companies, net |       | (915                                                               | )          | 3,352 |   | — |   | 440 |   | — |   | 352 |   | 25 |   | — |   |
| Net losses of equity affiliate                     |       | (257                                                               | )          | (2,085 | ) | (4,592 | ) | (8,674 | ) | (7,591 | ) | (15,351 | ) | (26,174 | ) | (35,666 | ) |
| Interest income and other, net                     |       | 2,875                                                              |       | 2,936 |   | 3,400 |   | 4,280 |   | 4,216 |   | 4,334 |   | 3,272 |   | 2,814 |   |
| Income (loss) before income taxes                  |       | 38,503                                                             |       | 52,056 |   | 41,836 |   | 32,861 |   | 16,354 |   | 16,567 |   | (3,251 | ) | (23,797 | ) |
| Provision (benefit) for income taxes               |       | 5,156                                                              |       | 8,208 |   | 5,401 |   | 3,711 |   | — |   | — |   | (69 | ) | 955 |   |
| Net income (loss)                                  |       | $                                                                  | 33,347     |   | $ | 43,848 |   | $ | 36,435 |   | $ | 29,150 |   | $ | 16,354 |   | $ | 16,567 |   | $ | (3,182 | ) | $ | (24,752 | ) |
| Basic net income (loss) per share (1)              |       | $                                                                  | 0.23       |   | $ | 0.32 |   | $ | 0.28 |   | $ | 0.22 |   | $ | 0.12 |   | $ | 0.12 |   | $ | (0.02 | ) | $ | (0.20 | ) |
| Diluted net income (loss) per share (1)            |       | $                                                                  | 0.22       |   | $ | 0.31 |   | $ | 0.27 |   | $ | 0.22 |   | $ | 0.12 |   | $ | 0.12 |   | $ | (0.02 | ) | $ | (0.20 | ) |
| Basic weighted average common shares outstanding   |       | 146,594                                                            |       | 138,303 |   | 132,444 |   | 131,008 |   | 131,514 |   | 132,779 |   | 128,321 |   | 122,654 |   |
| Diluted weighted average common shares outstanding |       | 149,425                                                            |       | 140,867 |   | 134,709 |   | 134,687 |   | 133,489 |   | 134,897 |   | 128,321 |   | 122,654 |   |

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(1)    Because of the method used in calculating per share data, thequarterly net income (loss) per share amounts will not necessarily add to thenet income per share computed for the year.

**Item 9.**                        Changesin and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

**Item 9A.**                Controlsand Procedures.

**Evaluation ofDisclosure Controls and Procedures**

Pursuant to Rule 13a-15(b) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), wecarried out an evaluation, with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, of theeffectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) underthe Exchange Act) as of the end of the period covered by this report. Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective to ensurethat information required to be disclosed in the reports that are filed orsubmitted under the Exchange Act, is recorded, processed, summarized andreported, within the time periods specified in the Securities and ExchangeCommission’s rules and forms, and that such information is accumulated andcommunicated to management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.

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**Management’s Reporton Internal Control Over Financial Reporting**

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rule 13a-15(f). Under the supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, we conducted an evaluation of theeffectiveness of our internal control over financial reporting based on theframework in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission. Based on our evaluationunder the framework in Internal Control—Integrated Framework, our managementconcluded that our internal control over financial reporting was effective asof December 31, 2006.

Our management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2006 has been audited by Ernst &Young LLP, an independent registered public accounting firm, as stated in theirreport which is included herein.

**Changes in InternalControl Over Financial Reporting**

There were no changes inour internal control over financial reporting during the three months ended December 31,2006 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

**Item 9B.**               OtherInformation.

There was no informationrequired to be disclosed in a report on Form 8-K during the three monthsended December 31, 2006 covered by this Report on Form 10-K that wasnot reported.

**PART III**

**Item 10.**                 Directors,Executive Officers and Corporate Governance.

Information relating tothe directors and nominees for directors of EarthLink will be set forth underthe captions “Proposal 1—Election of Directors—Nominees Standing for Election”and “Proposal 1—Election of Directors—Directors Not Standing for Election” inour Proxy Statement for our 2007 Annual Meeting of Stockholders (“ProxyStatement”) or in a subsequent amendment to this Annual Report onForm 10-K. Information relating to our executive officers will be setforth under the caption “Executive Officers” in the above-referenced ProxyStatement or in a subsequent amendment to this Report on Form 10-K. Informationregarding compliance by our directors and executive officers and owners of morethan 10% of EarthLink’s common stock with the reporting requirements ofSection 16(a) of the Securities Exchange Act of 1934, as amended,will be set forth under the caption “Executive Officers—Compliance withSection 16(a) of the Securities Exchange Act of 1934” in theabove-referenced Proxy Statement or in a subsequent amendment to this Report.Information relating to EarthLink’s Code of Ethics for directors and officerswill be set forth under the caption “Proposal 1—Election of Directors—CorporateGovernance Matters—Codes of Ethics” in the above-referenced Proxy Statement orin a subsequent amendment to this Report on Form 10-K. Informationrelating to corporate governance will be set forth under the caption “Proposal1—Election of Directors—Corporate Governance Matters” in the above-referencedProxy Statement or in a subsequent amendment to this Report on Form 10-K.Such information is incorporated herein by reference. 

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**Item 11.**                 ExecutiveCompensation.

Information relating tocompensation of our directors and executive officers will be set forth underthe captions “Proposal 1-Election of Directors-Director Compensation” and “ExecutiveCompensation” in our Proxy Statement referred to in Item 10 above or in asubsequent amendment to this Report. Such information is incorporated herein byreference, except for the information set forth under the caption “ExecutiveCompensation—Leadership and Compensation Committee Report,” which specificallyis not so incorporated by reference. 

**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters.

Information regardingsecurity ownership of certain beneficial owners and management of our votingsecurities will be set forth under the caption “Beneficial Ownership of CommonStock” in our Proxy Statement referred to in Item 10 above or in a subsequentamendment to this Report on Form 10-K. Such information is incorporatedherein by reference. 

*SecuritiesAuthorized for Issuance Under Equity Compensation Plans*

Thefollowing table sets forth information as of December 31, 2006 concerningthe shares of our common stock which are authorized for issuance under ourequity compensation plans:

| ** **                                                   | ** ** | ** **                                       | ** ** | ** **                      | ** ** | **Number of Securities**          | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------|------------|---------------------------------------------|------------|
| ** **                                                   | ** ** | ** **                                       | ** ** | ** **                      | ** ** | **Remaining Available for**       | ** ** |
| ** **                                                   | ** ** | **Number of Securities**               | ** ** | **Weighted Average**       | ** ** | **Future Issuance Under**         | ** ** |
| ** **                                                   | ** ** | **to Be Issued on Exercise** | ** ** | **Exercise Price of** | ** ** | **Equity Compensation Plans**     | ** ** |
| ** **                                                   | ** ** | **of Outstanding Options**             | ** ** | **Outstanding Options**    | ** ** | **(Excluding Securities**              | ** ** |
| ** **                                                   | ** ** | **and Warrants**                            | ** ** | **and Warrants**           | ** ** | **Reflected in Column (a))** | ** ** |
| **Plan Category**                                       | ** ** | **(a)**                                          | ** ** | **(b)**                         | ** ** | **(c)**                                     | ** ** |
| Equity Compensation  Plans Approved By Stockholders          |       |                                             | 20,470,236 | (2)                             |       |                                        | $          | 11.27 |   |   |   | 10,781,370 | (1) |   |
| Equity Compensation  Plans Not Approved By Stockholders |       |                                             | 61,212     | (3)                             |       |                                        | 5.29       |   |   |   | — |   |   |
| Total                                                        |       |                                             | 20,531,448 |                            |       |                                        | 11.25      |   |   |   | 10,781,370 |   |   |

----

(1)          Thisnumber includes shares available by plan as follows:

| ** **                                                   | ** ** | **Securities** | ** ** |
|--------------------------------------------------------------|------------|----------------|------------|
| ** **                                                   | ** ** | **Available**  | ** ** |
| ** **                                                   | ** ** | **for**        | ** ** |
| ** **                                                   | ** ** | **Future**     | ** ** |
| **Plan**                                                     | ** ** | ** **     | ** ** | **Issuance** | ** ** |
| EarthLink, Inc.  2006 Equity and Cash Incentive Plan    |       | 9,514,500      |       |
| EarthLink, Inc.  Stock Incentive Plan                   |       | 874,502        |       |
| EarthLink, Inc.  Equity Plan for Non-Employee Directors |       | 392,368        |       |
|                                                         |       | 10,781,370     |       |
|                                                              |            |                |            |  |  |

 

The grants of 1.2million restricted stock units and 28,989 phantom share units have beendeducted from the number of securities available for future issuance.

(2)          Pursuant to our mergeragreement with New Edge Holding Company, we were required to grant options topurchase up to 657,000 shares of our Common Stock to New Edge employees. Theseoptions were “inducement grants” to new employees in connection with ouracquisition of New Edge that qualified under the “inducement grant exception”to the shareholder approval requirement of NASD Marketplace Rule 4350(i)(1)(A).In connection with the closing, the Leadership and 

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Compensation Committeeapproved the EarthLink, Inc. Stock Option Plan for Inducement AwardsRelating to the Acquisition of New Edge Holding Company. The Leadership andCompensation Committee then granted options to purchase 657,000 shares of ourCommon Stock to these New Edge employees in accordance with this plan. Theoptions have an exercise price equal to the last reported price of our CommonStock on the closing date, which was $9.48, and vest 25 percent after 12 monthsand then 6.25 percent each quarter thereafter. The options have a term of 10years. Approximately 250 New Edge employees received options under this plan.

(3)          Wedo not currently have equity compensation plans that have not been approved bystockholders. However, included in the securities outstanding for equitycompensation plans not approved by stockholders are 61,212 warrants granted duringthe year ended December 31, 1997 to certain officers, consultants andinvestors. The warrants have terms of 10 years and have exercise pricesranging from $4.02 to $5.50 per share. All 61,212 warrants wereexercisable as of December 31, 2006.

**Item 13.**                 CertainRelationships and Related Transactions, and Director Independence.

Information regardingcertain relationships and transactions between EarthLink and certain of ouraffiliates is set forth under the caption “Executive Compensation—Leadershipand Compensation Committee Interlocks” and “Executive Compensation—CertainRelationships and Related Transactions” in our Proxy Statement referred to inItem 10 above or in a subsequent amendment to this Report on Form 10-K.Information regarding director independence is set forth under the caption “ProposalI—Election of Directors—Director Independence” in our Proxy Statement referredto in Item 10 above or in a subsequent amendment to this Report on Form 10-K.Such information is incorporated herein by reference.

**Item 14.**                 PrincipalAccounting Fees and Services.

Information regarding ourprincipal accounting fees and services is set forth under the caption “Proposal2—Ratification of Appointment of Independent Registered Public Accounting Firm”in our Proxy Statement referred to in Item 10 above or in a subsequentamendment to this Report on Form 10-K. Such information is incorporatedherein by reference.

**PART IV**

**Item 15.**                 Exhibitsand Financial Statement Schedules.

**(a)**          Documentsfiled as part of this Annual Report on Form 10-K

**(1)   FinancialStatements**

1.                 Reports ofIndependent Registered Public Accounting Firm

2.                 ConsolidatedBalance Sheets as of December 31, 2005 and 2006

3.                 ConsolidatedStatements of Operations for the years ended December 31, 2004, 2005 and2006

4.                 ConsolidatedStatements of Stockholders’ Equity and Comprehensive Income (Loss) for theyears ended December 31, 2004, 2005 and 2006

5.                 ConsolidatedStatements of Cash Flows for the years ended December 31, 2004, 2005 and2006

6.                 Notes toConsolidated Financial Statements

105

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**(2)   FinancialStatement Schedules**

The FinancialStatement Schedule(s) described in Regulation S-X are omitted fromthis Annual Report on Form 10-K because they are either not requiredunder the related instructions or are inapplicable.

**(3)   Listing of Exhibits**

| 1.1—   | Underwriting Agreement, dated November 13,  2006, by and among EarthLink, Inc., UBS Securities LLC and Banc of  America Securities LLC (incorporated by reference to Exhibit 1.1 to  EarthLink’s Report on Form 8-K dated November 13, 2006—File No. 001-15605).                  |
|-------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1—   | Agreement and Plan of  Merger, dated December 12, 2005, by and among EarthLink, Inc., New  Edge Holding Company and New Edge Merger Corporation (incorporated by  reference to Exhibit 2.1 to EarthLink, Inc.’s Report on Form 8-K  dated December 12, 2005—File  No. 001-15605). |
| 3.1—   | Second Restated  Certificate of Incorporation of EarthLink, Inc. (incorporated by  reference to Exhibit 3.1 to the Registration Statement on Form S-3  of EarthLink, Inc.—File No. 333-109691).                                                                                                  |
| 3.2—   | Amended and Restated  Bylaws of EarthLink, Inc. (incorporated by reference to Exhibit 3.2  of EarthLink, Inc.’s Report on Form 10-K for the year ended  December 31, 2004—File  No. 001-15605).                                                                                        |
| 4.1—   | Specimen Common Stock  Certificate (incorporated by reference to Exhibit 4.3 of the  Registration Statement on Form S-8 of EarthLink, Inc.—File  No. 333-30024).                                                                                                                                      |
| 4.2—   | Rights Agreement, dated  as of August 6, 2002, between EarthLink, Inc. and American Stock  Transfer and Trust Co. (incorporated by reference to Exhibit 4.1 to EarthLink, Inc.’s  Report on Form 8-K dated August 6, 2002—File No. 001-15605).                                    |
| 4.3—   | Indenture, dated  November 17, 2006, by and between EarthLink, Inc. and Wells Fargo  Bank, N.A. (incorporated by reference to Exhibit 4.1 to  EarthLink, Inc.’s Report on Form 8-K dated November 17,  2006—File No. 001-15605).                                                  |
| 10.1#— | EarthLink, Inc.  Stock Incentive Plan, as amended (incorporated by reference to  Exhibit 4.4 of EarthLink, Inc.’s Post Effective Amendment to  Registration Statement on Form S-8—File No. 333-39456).                                                                                      |
| 10.2#— | EarthLink, Inc.  Equity Plan for Non-Employee Directors, as amended (incorporated by reference  to Exhibit 4.4 of EarthLink, Inc.’s Post Effective Amendment to  Registration Statement on Form S-8—File No. 333-108065).                                                                   |
| 10.3#— | EarthLink, Inc.  2006 Equity and Cash Incentive Plan (incorporated by reference to  Exhibit 10.1 to EarthLink, Inc.’s Report on Form 8-K  dated May 5, 2006).                                                                                                                                    |
| 10.4#— | EarthLink, Inc.  Stock Option Plan for Inducement Awards Relating to the Acquisition of New  Edge Holding Company (incorporated by reference to Exhibit 10.1 to  EarthLink, Inc.’s Report on Form 8-K dated April 14,  2006).                                                                    |
| 10.5#— | EarthLink, Inc.  Deferred Compensation Plan for Directors and Certain Key Employees, as  amended (incorporated by reference to Exhibit 10.3 of EarthLink, Inc.’s  Report on Form 8-K dated February 17, 2006—File No. 001-15605).                                                      |
| 10.6#— | Summary of amendment to  the EarthLink, Inc. Deferred Compensation Plan for Directors and Certain  Key Employees (incorporated by reference to EarthLink, Inc.’s Report on  Form 8-K dated December 13, 2004—File No. 001-15605).                                                           |

106

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| 10.7#—  | Summary of EarthLink, Inc. Second Deferred  Compensation Plan for Directors and Certain Key Employees (incorporated by  reference to EarthLink, Inc.’s Report on Form 8-K dated  December 13, 2004—File No. 001-15605).                                |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.8#—  | 1995 Stock Option Plan  (incorporated by reference to Exhibit 4.4 of EarthLink, Inc.’s  Registration Statement on Form S-8—File No. 333-30024).                                                                                                             |
| 10.9#—  | MindSpring  Enterprises, Inc. 1995 Stock Option Plan, as amended (incorporated by  reference to Exhibit 4.5 of EarthLink, Inc.’s Registration  Statement on Form S-8—File  No. 333-30024).                                                             |
| 10.10#— | MindSpring  Enterprises, Inc. 1995 Directors Stock Option Plan, as amended  (incorporated by reference to Exhibit 4.6 of EarthLink, Inc.’s  Registration Statement on Form S-8—File No. 333-30024).                                                    |
| 10.11#— | Form of Incentive  Stock Option Agreement (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report on Form 10-Q for the quarterly  period ended September 30, 2005—File  No. 001-15605).                                           |
| 10.12#— | Form of  Nonqualified Stock Option Agreement (incorporated by reference to  Exhibit 10.2 of EarthLink, Inc.’s Report on Form 10-Q  for the quarterly period ended September 30, 2005—File No. 001-15605).                                         |
| 10.13#— | Form of Performance  Accelerated Nonqualified Stock Option Agreement (incorporated by reference to  Exhibit 10.3 of EarthLink, Inc.’s Report on Form 10-Q  for the quarterly period ended September 30, 2005—File No. 001-15605).                 |
| 10.14#— | Form of Restricted  Stock Unit Agreement (incorporated by reference to Exhibit 10.4 of  EarthLink, Inc.’s Report on Form 10-Q for the quarterly  period ended September 30, 2005—File  No. 001-15605).                                            |
| 10.15#— | Form of  Nonqualified Stock Option Agreement for Nonemployee Directors (incorporated  by reference to Exhibit 10.5 of EarthLink, Inc.’s Report on  Form 10-Q for the quarterly period ended September 30, 2005—File No. 001-15605).               |
| 10.16#— | Form of Restricted  Stock Unit Agreement for Nonemployee Directors (incorporated by reference to  Exhibit 10.6 of EarthLink, Inc.’s Report on Form 10-Q  for the quarterly period ended September 30, 2005—File No. 001-15605).                   |
| 10.17#— | Form of Incentive  Stock Option Agreement under the EarthLink, Inc. 2006 Equity and Cash  Incentive Plan (incorporated by reference to Exhibit 10.2 to  EarthLink, Inc.’s Report on Form 8-K dated May 5, 2006).                                       |
| 10.18#— | Form of  Nonqualified Stock Option Agreement under the EarthLink, Inc. 2006  Equity and Cash Incentive Plan (incorporated by reference to  Exhibit 10.3 to EarthLink, Inc.’s Report on Form 8-K  dated May 5, 2006).                                   |
| 10.19#— | Form of  Nonqualified Stock Option Agreement for Directors under the  EarthLink, Inc. 2006 Equity and Cash Incentive Plan (incorporated by  reference to Exhibit 10.4 to EarthLink, Inc.’s Report on  Form 8-K dated May 5, 2006).                     |
| 10.20#— | Form of Restricted  Stock Unit Agreement under the EarthLink, Inc. 2006 Equity and Cash  Incentive Plan (incorporated by reference to Exhibit 10.5 to  EarthLink, Inc.’s Report on Form 8-K dated May 5, 2006).                                        |
| 10.21#— | Form of Award  Agreement under EarthLink, Inc. Stock Option Plan for Inducement Awards  Relating to the Acquisition of New Edge Holding Company (incorporated by  reference to Exhibit 4.4 to the Registration Statement of Form S-8—File  No. 333-133870). |

107

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| 10.22— | Office Lease Agreement dated November 16, 1999,  between Kingston Atlanta Partners, L.P. and MindSpring  Enterprises, Inc., as amended (incorporated by reference to  Exhibit 10.1 of EarthLink, Inc.’s Report on Form 10-Q  for the quarterly period ended March 31, 2001—File No. 001-15605).                                           |
|-------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.23— | Fourth Amendment to Office  Lease between California State Teacher’s Retirement System and  EarthLink, Inc. (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report on Form 8-K dated December 30,  2004—File No. 001-15605).                                                                                             |
| 10.24— | Office Lease by and  between The Mutual Life Insurance Company of New York, and EarthLink  Network, Inc., dated September 20, 1996, as amended (incorporated  by reference to Exhibit 10.2 of EarthLink, Inc.’s Report on  Form 10-Q for the quarterly period ended March 31, 2001—File No. 001-15605).                                   |
| 10.25— | Lease Agreement Between  WHMNY Real Estate Limited Partnership and EarthLink, Inc. Dated  September 19, 2005 (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report on Form 8-K dated October 14,  2005—File No. 001-15605).                                                                                        |
| 10.26— | Contribution  and Formation Agreement Among SK Telecom International, Inc., SK Telecom  Co., Ltd. and EarthLink, Inc. (incorporated by reference to  Exhibit 10.1 of EarthLink, Inc.’s Report on Form 8-K dated  January 26, 2005—File No. 001-15605).                                                                               |
| 10.27— | Form of Certificate  of Incorporation of SK-EarthLink Management Corp. (incorporated by reference  to Exhibit 10.3 of EarthLink, Inc.’s Report on Form 8-K  dated January 26, 2005—File No. 001-15605).                                                                                                                                        |
| 10.28— | Form of Bylaws of  SK-EarthLink Management Corp. (incorporated by reference to Exhibit 10.4  of EarthLink, Inc.’s Report on Form 8-K dated  January 26, 2005—File No. 001-15605).                                                                                                                                                         |
| 10.29— | Form of  Stockholders Agreement of SK-EarthLink Management Corp. (incorporated by  reference to Exhibit 10.5 of EarthLink, Inc.’s Report on  Form 8-K dated January 26, 2005—File No. 001-15605).                                                                                                                                              |
| 10.30— | Amended and Restated Limited Liability Company  Agreement of HELIO LLC by and among EarthLink, Inc., SK Telecom USA  Holdings, Inc., HELIO, Inc. and HELIO LLC, dated as of  October 25, 2005 (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report on Form 8-K dated November 29,  2005—File No. 001-15605). |
| 10.31— | Purchase Agreement, by  and among EarthLink, Inc., Covad Communications Group, Inc. and  Covad Communications Company dated as of March 15, 2006 (incorporated by  reference to Exhibit 10.1 to EarthLink’s Report on Form 8-K  dated March 15, 2006—File No. 001-15605).                                                                 |
| 10.32— | Form of 12% Senior  Secured Convertible Note due 2011 issued by Covad Communications  Group, Inc. and Covad Communications Company (incorporated by reference  to Exhibit 10.2 to EarthLink’s Report on Form 8-K dated  March 15, 2006—File No. 001-15605).                                                                                    |
| 10.33— | Form of  Registration Rights Agreement, by and between EarthLink, Inc. and Covad  Communications Group, Inc. (incorporated by reference to  Exhibit 10.3 to EarthLink’s Report on Form 8-K dated  March 15, 2006—File No. 001-15605).                                                                                                     |
| 10.34— | Form of Security  Agreement, by Covad Communications Group, Inc. and Covad Communications  Company for the benefit of EarthLink, Inc. (incorporated by reference to  Exhibit 10.4 to EarthLink’s Report on Form 8-K dated  March 15, 2006—File No. 001-15605).                                                                            |

108

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| 10.35—  | Confirmation of Convertible Bond Hedge Transaction,  dated November 13, 2006, by and between EarthLink, Inc. and UBS AG,  London Branch (incorporated by reference to Exhibit 10.1 to EarthLink’s  Report on Form 8-K dated November 13, 2006—File No. 001-15605).                                                       |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.36—  | Confirmation of  Convertible Bond Hedge Transaction, dated November 13, 2006, by and  between EarthLink, Inc. and Bank of America, N.A. (incorporated by  reference to Exhibit 10.2 to EarthLink’s Report on Form 8-K  dated November 13, 2006—File No. 001-15605).                                                      |
| 10.37—  | Confirmation of Issuer  Warrant Transaction dated November 13, 2006, by and between  EarthLink, Inc. and UBS AG, London Branch (incorporated by reference to  Exhibit 10.3 to EarthLink’s Report on Form 8-K dated  November 13, 2006—File No. 001-15605).                                                          |
| 10.38—  | Confirmation of Issuer  Warrant Transaction, dated November 13, 2006, by and between  EarthLink, Inc. and Bank of America, N.A. (incorporated by reference to  Exhibit 10.4 to EarthLink’s Report on Form 8-K dated  November 13, 2006—File No. 001-15605).                                                         |
| 10.39—  | Amended and Restated  Employment Agreement, dated March 27, 2006, between EarthLink, Inc.  and Charles G. Betty, President and Chief Executive Officer of  EarthLink, Inc. (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report of Form 8-K dated March 27,  2006—File No. 001-15605). |
| 10.40#— | EarthLink, Inc.  Board of Director Compensation Plan, dated January 2007 (incorporated  by reference to Exhibit 10.1 of EarthLink, Inc.’s Report on  Form 8-K dated October 24, 2006—File No. 001-15605).                                                                                                           |
| 10.41#*      | Change-in-Control  Accelerated Vesting and Severance Plan, amended effective as of  October 19, 2005 and amended and restated effective as of  February 17, 2006.                                                                                                                                                                                      |
| 10.42#— | Executives’ Position  Elimination and Severance Plan, amended and restated February 17, 2006  (incorporated by reference to Exhibit 10.2 of EarthLink, Inc.’s  Report on Form 8-K dated February 17, 2006—File No. 001-15605).                                                                                      |
| 10.43#— | Stock Appreciation  Rights Agreement for Thomas E. Wheeler, dated February 17, 2006  (incorporated by reference to Exhibit 10.4 of EarthLink, Inc.’s  Report on Form 8-K dated February 17, 2006—File No. 001-15605).                                                                                                    |
| 10.44—  | Summary  of 2006 bonus payments and 2007 salaries for executive officers (incorporated  by reference to EarthLink, Inc.’s Report on Form 8-K dated  January 25, 2007—File No. 001-15605).                                                                                                                                     |
| 21.1*—  | Subsidiaries of the  Registrant.                                                                                                                                                                                                                                                                                                                                 |
| 23.1*—  | Consent of  Ernst & Young LLP, an independent registered public accounting firm.                                                                                                                                                                                                                                                                        |
| 24.1*—  | Power of Attorney (see  the Power of Attorney in the signature page hereto).                                                                                                                                                                                                                                                                                |
| 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.                                                                                                                                                                         |

109

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| 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. |

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*                    Filed herewith.

#                 Managementcompensatory plan or arrangement.

**(b)**          Exhibits

The response to thisportion of Item 15 is submitted as a separate section of this Annual Report on Form 10-K.

**(c)**           FinancialStatement Schedule

The Financial Statement Schedule(s) described inRegulation S-X are omitted from this Annual Report on Form 10-Kbecause they are either not required under the related instructions or areinapplicable.

110

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|          | ** ** | **EARTHLINK, INC.**               |
|----------|------------|-----------------------------------|
|     | By:        | /s/ MICHAEL C. LUNSFORD           |
|     |       | Michael C. Lunsford,              |
| * * | * *   | *Interim Chief Executive Officer* |
|     |       | Date: March 1, 2007               |

 

Each person whosesignature appears below hereby constitutes and appoints Michael C. Lunsford andKevin M. Dotts, the true and lawful attorneys-in-fact and agents of theundersigned, with full power of substitution and resubstitution, for and in thename, place and stead of the undersigned, in any and all capacities, to signany and all amendments to this Report, and to file the same, with all exhibitsthereto, and other documents in connection therewith, with the Securities andExchange Commission, and hereby grants to such attorneys-in-fact and agentsfull power and authority to do and perform each and every act and thingrequisite and necessary to be done, as fully to all intents and purposes as theundersigned might or could do in person, hereby ratifying and confirming allthat said attorneys-in-fact and agents, or their substitute or substitutes, maylawfully do or cause to be done by virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of registrant and in thecapacities and on the dates indicated.
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ MICHAEL C. LUNSFORD                         |
|--------|--------|---------------|--------|--------|--------|--------|-------------------------------------------------|
|   |   |          |   |   |   |   | Michael C. Lunsford, Interim Chief              |
|   |   |          |   |   |   |   | Executive Officer (principal executive officer) |
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ KEVIN M. DOTTS                              |
|   |   |          |   |   |   |   | Kevin M. Dotts, Chief Financial Officer         |
|   |   |          |   |   |   |   | (principal financial and accounting officer)    |
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ ROBERT M. KAVNER                            |
|   |   |          |   |   |   |   | Robert M. Kavner, Chairman of the Board         |
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ SKY D. DAYTON                               |
|   |   |          |   |   |   |   | Sky D. Dayton, Director                         |
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ S. MARCE FULLER                             |
|   |   |          |   |   |   |   | S. Marce Fuller, Director                       |
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ WILLIAM H. HARRIS,  JR.                     |
|   |   |          |   |   |   |   | William H. Harris, Jr., Director           |
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ TERRELL B. JONES                            |
|   |   |          |   |   |   |   | Terrell B. Jones, Director                      |
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ LINWOOD A. LACY, JR.                        |
|   |   |          |   |   |   |   | Linwood A. Lacy, Jr., Director             |
| Date:  |   | March 1, 2007 |   |   | By:    |   | /s/ THOMAS E. WHEELER                           |
|   |   |          |   |   |   |   | Thomas E. Wheeler, Director                     |

 

111

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**EXHIBITINDEX**
| Exhibit     | ** ** | ** **                                                                                                                                                                                                                                                                                                                     | ** ** | **Description** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 1.1—   |       | Underwriting Agreement,  dated November 13, 2006, by and among EarthLink, Inc., UBS  Securities LLC and Banc of America Securities LLC (incorporated by reference  to Exhibit 1.1 to EarthLink’s Report on Form 8-K dated  November 13, 2006—File No. 001-15605).                 |
| 2.1—   |       | Agreement and  Plan of Merger, dated December 12, 2005, by and among  EarthLink, Inc., New Edge Holding Company and New Edge Merger  Corporation (incorporated by reference to Exhibit 2.1 to  EarthLink, Inc.’s Report on Form 8-K dated December 12,  2005—File No. 001-15605). |
| 3.1—   |       | Second Restated  Certificate of Incorporation of EarthLink, Inc. (incorporated by  reference to Exhibit 3.1 to the Registration Statement on Form S-3  of EarthLink, Inc.—File No. 333-109691).                                                                                             |
| 3.2—   |       | Amended and  Restated Bylaws of EarthLink, Inc. (incorporated by reference to  Exhibit 3.2 of EarthLink, Inc.’s Report on Form 10-K for  the year ended December 31, 2004—File No. 001-15605).                                                                                    |
| 4.1—   |       | Specimen Common  Stock Certificate (incorporated by reference to Exhibit 4.3 of the  Registration Statement on Form S-8 of EarthLink, Inc.—File  No. 333-30024).                                                                                                                                      |
| 4.2—   |       | Rights Agreement,  dated as of August 6, 2002, between EarthLink, Inc. and American  Stock Transfer and Trust Co. (incorporated by reference to Exhibit 4.1  to EarthLink, Inc.’s Report on Form 8-K dated August 6,  2002—File No. 001-15605).                                   |
| 4.3—   |       | Indenture, dated  November 17, 2006, by and between EarthLink, Inc. and Wells Fargo  Bank, N.A. (incorporated by reference to Exhibit 4.1 to  EarthLink, Inc.’s Report on Form 8-K dated November 17,  2006—File No. 001-15605).                                                  |
| 10.1#— |       | EarthLink, Inc.  Stock Incentive Plan, as amended (incorporated by reference to  Exhibit 4.4 of EarthLink, Inc.’s Post Effective Amendment to  Registration Statement on Form S-8—File No. 333-39456).                                                                                 |
| 10.2#— |       | EarthLink, Inc.  Equity Plan for Non-Employee Directors, as amended (incorporated by reference  to Exhibit 4.4 of EarthLink, Inc.’s Post Effective Amendment to  Registration Statement on Form S-8—File No. 333-108065).                                                                   |
| 10.3#— |       | EarthLink, Inc.  2006 Equity and Cash Incentive Plan (incorporated by reference to  Exhibit 10.1 to EarthLink, Inc.’s Report on Form 8-K  dated May 5, 2006).                                                                                                                                    |
| 10.4#— |       | EarthLink, Inc.  Stock Option Plan for Inducement Awards Relating to the Acquisition of New  Edge Holding Company (incorporated by reference to Exhibit 10.1 to  EarthLink, Inc.’s Report on Form 8-K dated April 14,  2006).                                                                    |
| 10.5#— |       | EarthLink, Inc.  Deferred Compensation Plan for Directors and Certain Key Employees, as  amended (incorporated by reference to Exhibit 10.3 of  EarthLink, Inc.’s Report on Form 8-K dated February 17,  2006—File No. 001-15605).                                                     |
| 10.6#— |       | Summary of amendment to  the EarthLink, Inc. Deferred Compensation Plan for Directors and Certain  Key Employees (incorporated by reference to EarthLink, Inc.’s Report on  Form 8-K dated December 13, 2004—File No. 001-15605).                                                           |

E-1

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| 10.7#—  |   | Summary of  EarthLink, Inc. Second Deferred Compensation Plan for Directors and  Certain Key Employees (incorporated by reference to EarthLink, Inc.’s  Report on Form 8-K dated December 13, 2004—File No. 001-15605).                                |
|--------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.8#—  |   | 1995 Stock Option  Plan (incorporated by reference to Exhibit 4.4 of EarthLink, Inc.’s  Registration Statement on Form S-8—File No. 333-30024).                                                                                                             |
| 10.9#—  |   | MindSpring Enterprises, Inc.  1995 Stock Option Plan, as amended (incorporated by reference to  Exhibit 4.5 of EarthLink, Inc.’s Registration Statement on  Form S-8—File No. 333-30024).                                                         |
| 10.10#— |   | MindSpring  Enterprises, Inc. 1995 Directors Stock Option Plan, as amended (incorporated  by reference to Exhibit 4.6 of EarthLink, Inc.’s Registration  Statement on Form S-8—File No. 333-30024).                                               |
| 10.11#— |   | Form of  Incentive Stock Option Agreement (incorporated by reference to  Exhibit 10.1 of EarthLink, Inc.’s Report on Form 10-Q  for the quarterly period ended September 30, 2005—File No. 001-15605).                                            |
| 10.12#— |   | Form of  Nonqualified Stock Option Agreement (incorporated by reference to  Exhibit 10.2 of EarthLink, Inc.’s Report on Form 10-Q  for the quarterly period ended September 30, 2005—File No. 001-15605).                                         |
| 10.13#— |   | Form of  Performance Accelerated Nonqualified Stock Option Agreement (incorporated by  reference to Exhibit 10.3 of EarthLink, Inc.’s Report on  Form 10-Q for the quarterly period ended September 30, 2005—File No. 001-15605).                 |
| 10.14#— |   | Form of  Restricted Stock Unit Agreement (incorporated by reference to  Exhibit 10.4 of EarthLink, Inc.’s Report on Form 10-Q  for the quarterly period ended September 30, 2005—File No. 001-15605).                                             |
| 10.15#— |   | Form of  Nonqualified Stock Option Agreement for Nonemployee Directors (incorporated  by reference to Exhibit 10.5 of EarthLink, Inc.’s Report on  Form 10-Q for the quarterly period ended September 30, 2005—File No. 001-15605).               |
| 10.16#— |   | Form of  Restricted Stock Unit Agreement for Nonemployee Directors (incorporated by  reference to Exhibit 10.6 of EarthLink, Inc.’s Report on  Form 10-Q for the quarterly period ended September 30, 2005—File No. 001-15605).                   |
| 10.17#— |   | Form of  Incentive Stock Option Agreement under the EarthLink, Inc. 2006 Equity  and Cash Incentive Plan (incorporated by reference to Exhibit 10.2 to  EarthLink, Inc.’s Report on Form 8-K dated May 5, 2006).                                       |
| 10.18#— |   | Form of  Nonqualified Stock Option Agreement under the EarthLink, Inc. 2006  Equity and Cash Incentive Plan (incorporated by reference to  Exhibit 10.3 to EarthLink, Inc.’s Report on Form 8-K  dated May 5, 2006).                                   |
| 10.19#— |   | Form of  Nonqualified Stock Option Agreement for Directors under the  EarthLink, Inc. 2006 Equity and Cash Incentive Plan (incorporated by  reference to Exhibit 10.4 to EarthLink, Inc.’s Report on  Form 8-K dated May 5, 2006).                     |
| 10.20#— |   | Form of  Restricted Stock Unit Agreement under the EarthLink, Inc. 2006 Equity  and Cash Incentive Plan (incorporated by reference to Exhibit 10.5 to  EarthLink, Inc.’s Report on Form 8-K dated May 5, 2006).                                        |
| 10.21#— |   | Form of  Award Agreement under EarthLink, Inc. Stock Option Plan for Inducement  Awards Relating to the Acquisition of New Edge Holding Company (incorporated  by reference to Exhibit 4.4 to the Registration Statement of Form S-8—File  No. 333-133870). |

E-2

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| 10.22— |   | Office Lease Agreement  dated November 16, 1999, between Kingston Atlanta Partners, L.P. and  MindSpring Enterprises, Inc., as amended (incorporated by reference to  Exhibit 10.1 of EarthLink, Inc.’s Report on Form 10-Q  for the quarterly period ended March 31, 2001—File No. 001-15605).                                           |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.23— |   | Fourth Amendment  to Office Lease between California State Teacher’s Retirement System and  EarthLink, Inc. (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report on Form 8-K dated December 30,  2004—File No. 001-15605).                                                                                                  |
| 10.24— |   | Office Lease by  and between The Mutual Life Insurance Company of New York, and EarthLink  Network, Inc., dated September 20, 1996, as amended (incorporated  by reference to Exhibit 10.2 of EarthLink, Inc.’s Report on  Form 10-Q for the quarterly period ended March 31, 2001—File No. 001-15605).                                        |
| 10.25— |   | Lease Agreement  Between WHMNY Real Estate Limited Partnership and EarthLink, Inc. Dated  September 19, 2005 (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report on Form 8-K dated October 14,  2005—File No. 001-15605).                                                                                                  |
| 10.26— |   | Contribution and Formation Agreement Among SK Telecom  International, Inc., SK Telecom Co., Ltd. and EarthLink, Inc.  (incorporated by reference to Exhibit 10.1 of EarthLink, Inc.’s  Report on Form 8-K dated January 26, 2005—File No. 001-15605).                                                                                          |
| 10.27— |   | Form of  Certificate of Incorporation of SK-EarthLink Management Corp. (incorporated  by reference to Exhibit 10.3 of EarthLink, Inc.’s Report on  Form 8-K dated January 26, 2005—File No. 001-15605).                                                                                                                                             |
| 10.28— |   | Form of  Bylaws of SK-EarthLink Management Corp. (incorporated by reference to  Exhibit 10.4 of EarthLink, Inc.’s Report on Form 8-K  dated January 26, 2005—File No. 001-15605).                                                                                                                                                              |
| 10.29— |   | Form of  Stockholders Agreement of SK-EarthLink Management Corp. (incorporated by  reference to Exhibit 10.5 of EarthLink, Inc.’s Report on  Form 8-K dated January 26, 2005—File No. 001-15605).                                                                                                                                              |
| 10.30— |   | Amended and  Restated Limited Liability Company Agreement of HELIO LLC by and among  EarthLink, Inc., SK Telecom USA Holdings, Inc., HELIO, Inc.  and HELIO LLC, dated as of October 25, 2005 (incorporated by reference  to Exhibit 10.1 of EarthLink, Inc.’s Report on Form 8-K  dated November 29, 2005—File No. 001-15605). |
| 10.31— |   | Purchase  Agreement, by and among EarthLink, Inc., Covad Communications  Group, Inc. and Covad Communications Company dated as of March 15,  2006 (incorporated by reference to Exhibit 10.1 to EarthLink’s Report on  Form 8-K dated March 15, 2006—File No. 001-15605).                                                                 |
| 10.32— |   | Form of 12%  Senior Secured Convertible Note due 2011 issued by Covad Communications  Group, Inc. and Covad Communications Company (incorporated by reference  to Exhibit 10.2 to EarthLink’s Report on Form 8-K dated  March 15, 2006—File No. 001-15605).                                                                                    |
| 10.33— |   | Form of Registration  Rights Agreement, by and between EarthLink, Inc. and Covad  Communications Group, Inc. (incorporated by reference to  Exhibit 10.3 to EarthLink’s Report on Form 8-K dated  March 15, 2006—File No. 001-15605).                                                                                                     |

E-3

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| 10.34—  |   | Form of Security  Agreement, by Covad Communications Group, Inc. and Covad Communications  Company for the benefit of EarthLink, Inc. (incorporated by reference to  Exhibit 10.4 to EarthLink’s Report on Form 8-K dated  March 15, 2006—File No. 001-15605).                                                |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.35—  |   | Confirmation of  Convertible Bond Hedge Transaction, dated November 13, 2006, by and  between EarthLink, Inc. and UBS AG, London Branch (incorporated by  reference to Exhibit 10.1 to EarthLink’s Report on Form 8-K  dated November 13, 2006—File No. 001-15605).                                                |
| 10.36—  |   | Confirmation of  Convertible Bond Hedge Transaction, dated November 13, 2006, by and  between EarthLink, Inc. and Bank of America, N.A. (incorporated by  reference to Exhibit 10.2 to EarthLink’s Report on Form 8-K  dated November 13, 2006—File No. 001-15605).                                                |
| 10.37—  |   | Confirmation of  Issuer Warrant Transaction dated November 13, 2006, by and between  EarthLink, Inc. and UBS AG, London Branch (incorporated by reference to  Exhibit 10.3 to EarthLink’s Report on Form 8-K dated  November 13, 2006—File No. 001-15605).                                                              |
| 10.38—  |   | Confirmation of  Issuer Warrant Transaction, dated November 13, 2006, by and between  EarthLink, Inc. and Bank of America, N.A. (incorporated by reference to  Exhibit 10.4 to EarthLink’s Report on Form 8-K dated  November 13, 2006—File No. 001-15605).                                                             |
| 10.39—  |   | Amended and Restated  Employment Agreement, dated March 27, 2006, between EarthLink, Inc.  and Charles G. Betty, President and Chief Executive Officer of  EarthLink, Inc. (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report of Form 8-K dated March 27, 2006—File No. 001-15605). |
| 10.40#— |   | EarthLink, Inc. Board of Director Compensation Plan, dated  January 2007 (incorporated by reference to Exhibit 10.1 of  EarthLink, Inc.’s Report on Form 8-K dated October 24,  2006—File No. 001-15605).                                                                                                          |
| 10.41#*      |   | Change-in-Control  Accelerated Vesting and Severance Plan, amended effective as of  October 19, 2005 and amended and restated effective as of  February 17, 2006.                                                                                                                                                                                     |
| 10.42#— |   | Executives’  Position Elimination and Severance Plan, amended and restated  February 17, 2006 (incorporated by reference to Exhibit 10.2 of  EarthLink, Inc.’s Report on Form 8-K dated February 17,  2006—File No. 001-15605).                                                                                    |
| 10.43#— |   | Stock  Appreciation Rights Agreement for Thomas E. Wheeler, dated February 17,  2006 (incorporated by reference to Exhibit 10.4 of  EarthLink, Inc.’s Report on Form 8-K dated February 17,  2006—File No. 001-15605).                                                                                                  |
| 10.44—  |   | Summary of 2006 bonus payments and 2007 salaries for executive officers  (incorporated by reference to EarthLink, Inc.’s Report on Form 8-K  dated January 25, 2007—File No. 001-15605).                                                                                                                                     |
| 21.1*—  |   | Subsidiaries of  the Registrant.                                                                                                                                                                                                                                                                                                                                |
| 23.1*—  |   | Consent of  Ernst & Young LLP, an independent registered public accounting firm.                                                                                                                                                                                                                                                                       |
| 24.1*—  |   | Power of Attorney  (see the Power of Attorney in the signature page hereto).                                                                                                                                                                                                                                                                               |
| 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.                                                                                                                                                                        |

E-4

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| 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. |

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*                    Filedherewith.

#                 Managementcompensatory plan or arrangement.

E-5

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